SALE OF A POWER PURCHASE AGREEMENT produced capital gains.
The IRS said in a private ruling released in April that an independent power company that sold its above-market power contract to a third party could treat the sales proceeds as capital gain. Capital gains are taxed at lower rates for individuals, but not for corporations. The power company in question was an “S corporation,” meaning that it is not subject to income taxes itself but rather its shareholders are taxed directly on their shares of any income.
The contract was for the sale of power from a “qualifying facility,” or QF, under the Public Utility Regulatory Policies Act. It was signed at a time when electricity rates were higher than they are today. Utilities have looked for ways to get out of such contracts. In this case, the QF sold the contract to a third party, who then renegotiated it with the utility. The contract remained in place, but with reduced rates for electricity.
The QF wanted to pay tax on income from the sale at the 20% rate for long-term capital gains rather than the 39.6% rate for ordinary income. The IRS approved. The key for the IRS was that the contract was sold to a third party rather than back to the utility directly. A sale back to the utility would have been viewed as a cancellation of the contract rather than as a sale. Only a sale of property produces capital gains. The IRS also said it was important that the money to buy the contract came from borrowing from third parties and was not contributed by the utility. The ruling is Private Letter Ruling 200215037.