The US depreciation bonus rules remain in flux

US depreciation bonus rules remain in flux | Norton Rose Fulbright

October 01, 2002 | By Keith Martin in Washington, DC
THE US DEPRECIATION BONUS rules remain in flux.

Congress authorized a 30% “depreciation bonus” last March as an inducement to companies to invest in new equipment during a window period that runs from September 11, 2001 through 2004 or 2005, depending on the equipment. Most power projects have until 2005 to be completed. The bonus can reduce the cost of a project by as much as 5.39%. It can also be claimed on improvements to existing plants.

Congress is still tinkering with the rules. A package of “technical corrections” is expected to be introduced in October. It will probably not be enacted this year, but the tax-writing committees want to put US companies on notice what changes are anticipated. Some of the technical corrections under discussion would tighten eligibility for the bonus. While there had been discussion last August about the possibility that some of these rule changes might be prospective in effect — they would only apply to transactions after the technical corrections bill is introduced in October — that prospect appears now to have receded. The technical corrections are expected to apply retroactively to last March.

One issue in play is whether power plants are considered “self constructed.” The depreciation bonus cannot be claimed on a project to which the taxpayer was committed before September 11 last year. A company is considered committed to a project it is self constructing, or building itself, once physical construction begins. It was committed to a project that it is “acquiring” from someone else once a binding contract is signed to acquire it. Most power projects are considered self constructed under a broad definition Congress adopted last March. However, Congressional staff are concerned that the definition is so broad that aircraft the airlines purchase from Boeing or Airbus are also self constructed. The technical corrections bill is expected to tighten the definition to knock out aircraft.

Another issue in play is whether someone who buys or invests in a project that is under construction can claim a bonus on the project if the current developer would not have qualified for one. The Joint Tax Committee staff favors letting a bonus be claimed on spending to complete the project after the new owner has purchased it, but not on the purchase price he paid to buy into the project. Most tax counsel believe the current statute allows a full bonus, including on the purchase price. This issue is still in play.

Meanwhile, the Internal Revenue Service is expected to issue guidance on depreciation bonus issues — probably in the form of questions and answers — by next June. The IRS has drawn up a list of possible questions to address. The power industry submitted 25 fact patterns for the IRS to discuss in the guidance. Chuck Ramsey, the IRS branch chief, said that some, but not all, of the 25 will be covered. Other guidance may come in a “blue book” that the Joint Tax Committee staff is writing for publication early next year.

The power industry has discussed with Congressional staff and the IRS whether turbines ordered before September 11, 2001 under master turbine contracts qualify for the depreciation bonus if actual work at the project site did not begin before September 11. The Joint Tax Committee staff suggested the turbines should qualify in such cases under a rule that components of a larger project are treated the same as the rest of the project. However, Chuck Ramsey held open the possibility at an industry meeting that, if actual assembly of the turbines started before September 11, that might taint the entire project. (A project that a taxpayer is self constructing qualifies for a bonus only if construction did not begin before September 11.)

In a potentially helpful development, the IRS released a “technical advice memorandum” on September 30 where it denied investment tax credits to a utility that claimed them on a substation the utility built after the investment tax credit was repealed. A “technical advice memorandum” is a ruling by the IRS national office to settle a dispute between a taxpayer and an IRS agent on audit.

The utility argued that it qualified for the tax credit on grounds that the substation was “self constructed.” In order to qualify, the utility had to show that construction began on the substation by December 1985. It pointed to the fact that a factory had started assembling transformers for the substation before the deadline, citing an example in a Joint Tax Committee “blue book” involving aircraft where it was enough that work had started at the factory on subassemblies for the aircraft. The IRS said the aircraft example does not apply. Construction does not begin on facilities built on land until actual work begins at the site. The ruling is TAM 200239002.

Keith Martin