NETWORK UPGRADE payments had to be reported as income by utilities, the IRS said.

A municipal utility needed more electricity to supply local residents. Transmission was a problem. It entered into negotiations with a private transmission company to build a transmission line that would bring the additional electricity. The line was a bridge between two regional grids. The transmission company will own the new line. The municipal utility subscribed for a percentage of the transmission capacity on the new line.

The administrator of one of the two regional grids required three neighboring utilities to upgrade their transmission systems so that the additional power flows over the regional grid on account of the new transmission line will not be impeded by congestion or bottlenecks on neighboring systems.

The transmission company building the new line agreed to reimburse the three neighboring utilities for the cost of the network upgrades to their systems. The municipal utility agreed, in turn, to reimburse the full cost even though it was subscribing for only a portion of the new transmission capacity.

The utilities asked the IRS whether they have to report the cost reimbursements as income. The IRS said yes in two “adverse” rulings the agency released in December and January. The rulings are Private Letter Rulings 201451007 and 201503001.

It is rare to see an adverse ruling. Companies requesting rulings usually withdraw the requests if they are told the IRS will not rule favorably.

The IRS said the utilities could avoid reporting the cost reimbursements as income only if they can show the company reimbursing them is acting solely for the public benefit and not for any private benefit it might receive.

The IRS is walking back from its past positions in this area. The agency said in three notices and one revenue procedure from 1988 through 2005 that payments a utility receives from an independent generator who is not a customer of the utility to reimburse for network upgrades do not have to be reported as income. The IRS issued four private letter rulings from 1991 through 1995 that confirmed the same policy applies to cost reimbursements a utility receives from another utility for network upgrades when a new transmission line is installed.

The current position of the IRS branch handling these issues is that it will not extend the logic to other fact patterns besides those addressed in the existing notices.

The IRS and Treasury lawyers who worked on the first two notices in 1988 and 1990 had no difficulty using the logic behind them to analyze other fact patterns that were not known when the original notices were written. The reason there are three notices and one revenue procedure is the IRS has periodically updated its guidance to address new fact patterns as the power industry has evolved over time.

Keith Martin in Washington