NETWORK UPGRADES — or improvements to utility grids — remain under study at the IRS.

NETWORK UPGRADES — or improvements to utility grids — remain under study at the IRS.

October 01, 2003
NETWORK UPGRADES — or improvements to utility grids — remain under study at the IRS.

A general ruling on which all utilities can rely is expected in the spring. In the meantime, the IRS is collecting fact patterns that should be addressed in the general ruling.

The issue is whether utilities must pay income taxes on monies that an independent generator advances to cover the cost of improvements that must be made to the grid to accommodate the generator’s power plant. A generator seeking to connect his plant must pay the cost of the radial line, protective devices and other equipment that are part of the “direct intertie.” However, the Federal Energy Regulatory Commission has taken the position since late 2000 that the cost of improvements to the grid itself should be borne by all users of the grid. It recognizes that there is a timing problem: the utility must make the network upgrades before it can collect the cost through rates. Therefore, it lets utilities require generators to advance the funds. Under new rules for future interconnection agreements that FERC announced on July 23, the utility must repay the generator within five years with interest.

US tax rules are clear that a utility does not have to report income when it is reimbursed by a generator for the cost of the direct intertie — at least in cases where the generator is not a customer of the utility for anything, including transmission service. (For this reason, most generators are careful to make sure title to their electricity transfers to someone else before the electricity reaches the grid.)

However, the IRS is less sure about the tax treatment in cases where the utility has to repay the money. The IRS is leaning toward letting utilities report advances for network upgrades as loans. It issued one private letter ruling to that effect in February, but on unusual facts. In September, it announced that it will not issue any further private rulings while it sorts out its position. The 10 or 12 ruling requests that it had in the queue in September are being returned to the utilities that requested them.

Lon Smith, an IRS associate chief counsel, said it is a manpower issue. The agency does not have the people to wade through dozens of ruling requests. It expects that with formal adoption of the FERC pricing policy on July 23, all utilities in the country will eventually ask for rulings. The plan is to issue a general ruling on which all utilities can rely and to try in that ruling to address all the fact patterns of which the power industry is aware at this time. Smith said that anyone who still has questions after reading the general ruling can apply for a private ruling. However, he hopes that will not be necessary.

Meanwhile, a model interconnection agreement that FERC issued in late July for use by generators and utilities suggests a utility that takes the position it does not have income may require a tax indemnity from a generator in case the IRS assesses taxes. However, security cannot be required where the utility has a private letter ruling from the IRS confirming that the utility has no income. (FERC said the same thing in an order issued this summer in a dispute between AES and New England Power Company surrounding the Londonderry project.)

This new policy raises interesting questions in California where utilities routinely require that generators post security for 20% of the potential taxes in case something happens to the intertie in the future to trigger a tax.

The model agreement also suggests that the utility must give the generator security in cases where the utility makes the generator “gross up” its interconnection payments for taxes and the parties submit the issue whether a tax is owed to the IRS in a ruling request. The security ensures that the utility will return the tax grossup once the ruling is issued.

Congress may throw a monkey wrench into the process. The energy bill that Congress is expected to pass in late October will probably overrule FERC by requiring generators to pay the cost of grid improvements — with no refund. If that were to occur, then the tax issue with which the IRS is wrestling would disappear because the law is already clear that amounts the utility can keep do not have to be reported as income.

Keith Martin