Like-Kind Exchange of Power Plants Ends Up in Court
A like-kind exchange is being litigated.
A predecessor company of Exelon reinvested the proceeds from sales of two power plants in Illinois in three other power plants in Texas and Georgia in what the company treated as a “like-kind exchange.”
The IRS disagreed, and the issues are now in front of the US Tax Court. Exelon filed a petition in January. The IRS says the company owes $517.4 million on the transaction, plus another $6.6 million for the next tax year after the sale.
Ordinarily, anyone selling a project can defer taxes on the gain from sale by using a bank as a “qualified intermediary” to reinvest the sales proceeds in similar property. The proceeds are paid to the bank. The seller then has 45 days to let the bank know where it wants the money reinvested. The reinvestment must be completed within 180 days or, if earlier, the due date for the tax return for the year in which the original projects were sold (including extensions).
The replacement power plant can be a new power plant that the seller is building.
An Exelon subsidiary, Commonwealth Edison, agreed in March 1999 to sell Edison Mission Energy seven base-load power plants and five peaking units as part of utility deregulation in Illinois. Commonwealth Edison was a subsidiary at the time of Unicorn Corporation. Exelon was formed in a merger of Unicorn and PECO Energy Company in October 2000.
Two of the plants were ultimately sold to Edison Mission Energy on December 15, 1999 in a deferred like-kind exchange using State Street Bank as the qualified intermediary. The two plants were Powerton and Collins.
Powerton is a 1,538-megawatt coal-fired power plant in Pekin, Illinois. It sold for $930 million. Collins was 2,698 megawatts and had a dual capacity to run on gas or oil. Mission paid $830 million for it. (The Collins plant shut down in 2004.)
Exelon told State Street on January 28, 2000 where it wanted the sales proceeds reinvested. It directed the bank to reinvest $725 million in unit 1 of the J.K. Spruce power station in San Antonio, Texas. The plant was owned by the local municipal utility, the City Public Service Board known as “CPS,” and it entered commercial service in December 1992. The transaction closed on June 2, within the 180-day period.
Exelon directed the bank to spend another $870 million to purchase a 15.1% undivided interest in units 1 and 2 of the Wansley power station and a 30.2% undivided interest in units 1 and 2 of the four-unit Scherer power station from the Municipal Electric Authority of Georgia or “MEAG.” The Wansley units were completed in 1976 and 1978. All four Scherer units were completed between 1982 and 1986. The Georgia sales closed on June 9.
Both the Texas and Georgia transactions were structured as SILOs. The IRS does not view SILOs as real purchases. Congress effectively shut down their use (as well as cross-border leases called LILOs) in 2004. The IRS issued a notice in 2005 indicating that it considers SILOs a form of tax shelter called a “listed transaction.” It had listed LILOs earlier. The government has won all six litigated LILO and SILO cases to date. A seventh case had a 10-day trial before the US Court of Federal Claims, but the court has not yet released a decision. The facts of the Exelon case may differ materially from those in the other cases.
Rather than buy interests in the power plants outright, an Exelon subsidiary entered into sale-leasebacks with the two municipal utilities. The subsidiary was the lessor. CPS leased back its project for 31.75 years and has an option to repurchase the project at the end of the lease for 101.2% of the amount Exelon paid for the plant. If CPS fails to purchase, then Exelon can require it to find a power contract or a tolling agreement for Exelon with a third party for a term of 9.58 years. CPS paid the Exelon lessor 76.9% of the purchase price for the plant as advance rent six months after the lease started. The advance rent is being treated as a “section 467 loan” and reported by Exelon as income over the lease term.
MEAG leased back the Wansley units for 27.75 years and the Scherer units for 30.25 years. It has purchase options to buy back Wansley for 83.4% and Scherer for 88.8% of the original purchase price. If it fails to repurchase, then Exelon can require it to find third parties willing to enter into power contracts or tolling agreements for another 8.1 (Wansley) or 8.7 (Scherer) years. MEAG made an advance rent payment six months after the lease started of 77.7% of the original purchase price for Wansley and 111.1% of the original purchase price for Scherer.
New cases filed with the US Tax Court usually take 23 to 50 months to reach a decision.
by Keith Martin