Renewables and public utility property

Renewables and public utility property

August 19, 2020 | By Keith Martin in Washington, DC

Utilities keep asking the IRS whether renewable energy projects they plan to own will be “public utility property.”

The IRS confirmed in another private letter ruling made public in early August that a solar-plus-storage project that an unnamed utility plans to build, and a second such project that the utility plans to buy under a build-transfer agreement from a developer, will not be.

The ruling is Private Letter Ruling 202032002.

Utilities cannot claim investment tax credits and accelerated depreciation on assets that are “public utility property” if they are forced by regulators to pass the value of the tax benefits to ratepayers more rapidly than under a “normalization” method of accounting. Congress wanted the tax benefits to act as an inducement for utilities to invest more, which it felt would only happen if utilities are able to keep part of the value.

Utilities already have a strong incentive to make investments that add to rate base in order to grow revenue.

Utility rates are usually set by determining the amount of revenue the utility needs to earn the regulated rate of return on its rate base, or invested capital, and then by working backwards to the rates it should charge to get to this projected revenue.

Assets used to supply electricity are “public utility property” if the rates at which the electricity is sold are regulated on a rate-of-return or cost-of-service basis.

The utility that asked for the latest ruling is in a state with a renewable portfolio target, meaning a requirement to deliver a certain percentage of its electricity from renewable energy.

The state increased the target and at the same time authorized the utility regulatory commission to let electric utilities charge competitive rates not tied to rate base or cost of service for electricity from any renewable energy facilities that a utility acquires or builds to comply with the state RPS target. The law also lets utilities charge whatever they agree to pay independent generators under power purchase agreements signed after competitive bid solicitations for electricity from facilities that they then acquire. Neither type of project can be put into rate base.

The ruling is the latest in a series of rulings the IRS has issued confirming that renewable energy projects whose electricity is sold at market-based rates are not public utility property.

In cases where utilities raise tax equity through partnership-flip transactions, they put their investments as partners into rate base. (See, for example, “A utility tax equity filing” in this issue, “Utility partnership flips” in the June 2020 NewsWire and “Utility tax equity structures” in the December 2019 NewsWire.)

The IRS has stopped issuing private letter rulings as a labor-saving measure in areas where it thinks it has already made the law clear enough in a notice, revenue ruling or other published guidance. It will be interesting to see how many more times it is willing to repeat essentially the same advice in private letter rulings about public utility property.