Network upgrade payments had to be reported as income, the IRS said.

Independent generators must connect their power plants to the utility grid. The utility requires the generator to pay the cost of the intertie and any improvements to the grid to accommodate the additional electricity.

Such payments do not normally have to be reported by a utility as income under a policy the IRS laid out in a notice in 1988 and updated in additional notices in 1990, 2001 and 2005. The IRS is in the process of revising its policies in this area. A new notice that will replace the earlier notices is expected in June.

The problem if the utility has to report the payment from the independent generator as income is the utility will charge a tax “gross up” on top of the cost of the intertie and grid upgrades. This makes interconnection more expensive.

The key to avoiding income is for the generator not to be a customer of the utility to whom it makes the payment, even for wheeling power. Thus, it is important to transfer the electricity to someone else before the electricity reaches the grid. For a more detailed explanation, see "IRS Clarifies Tax Treatment Of Electric Interties" in the December 2001 NewsWire and "IRS Addresses Interconnection Payments" in the August 2005 NewsWire.

The IRS said in a private letter ruling issued to a utility, made public in May, that the utility had to report payments from a generator as income. The ruling is Private Letter Ruling 201619007.

The generator had what appears to be corporate PPA under which it agreed to sell its electricity to a corporate buyer. The buyer took title to the electricity at the bus bar for the power plant.

The principal issue was the power plant connected to a distribution line rather than a transmission line. The IRS read its existing notices narrowly to say that the policy of not taxing utilities on such payments only applies where the independent power plant is connected to the transmission grid.

The IRS mentioned one other issue. The IRS has applied a two-step analysis in the recent past to determine whether a utility must report a payment as income. Step one is to determine whether the facts fit within the existing notices where the IRS has said the utility does not have to report income. Step two is to determine when the payment to the utility should be viewed as a “nonshareholder contribution to capital” of a corporation under a trio of Supreme Court decisions in the 1940’s. The IRS said the generator in this case “lacked the requisite motivation to make a nonshareholder contribution to capital” under these cases because it made the payment “in order to sell electricity.”

It is unusual to see an adverse ruling. A ruling request is usually withdrawn if the company that submitted it does not like where the IRS is headed.

This is also the first time the agency found an interconnection payment did not have the right motivation under the 1940 Supreme Court cases.

The IRS is holding at least two other private ruling requests in suspense until a new policy, expected to be favorable to generators, is announced in June.