Power Contract Values

Power Contract Values

May 31, 2012

Power contract values remain under discussion by the US tax authorities.

Many smaller developers are unable to raise funds to build their projects. They do as much development work as possible and then sell the development rights. The rights might include a power contract, interconnection agreement, permits and a site lease.

The Internal Revenue Service suggested in a private letter ruling in April that a company buying the development rights to a project does not have to allocate part of the purchase price to the power contract if the contract requires electricity to be delivered from a particular power plant. Instead, all of the value is in the power plant. The IRS analogized this to buying a building in which tenants have leased office space. Part of the purchase price does not have to be allocated to the leases. Instead, the building comes subject to the leases; they are a burden on the ownership. The purchase price is treated as a cost of the building.

The ruling is important because renewable energy projects qualify for large tax subsidies. These subsidies can only be claimed on the cost of equipment and not on the cost of intangible assets like power contracts and interconnection agreements.

The IRS and US Treasury are now having second thoughts about the ruling.

The ruling was issued to a utility that is buying the rights to a number of wind farms that are still under development. The wind farms come with power contracts. Each contract requires the holder to supply electricity from a specific wind farm. Current electricity prices are lower than the prices in the power contracts.

Until the ruling, most companies would have allocated value to each power contract to the extent it is “in the money,” meaning the contact entitles the holder to a higher electricity price than he can fetch currently in the market. The ruling suggests that any such value is value in the wind farm to which the power contact is welded.

“We have a saying [at the IRS] that you know you issued a bad ruling if 70 people ask you for a copy the next day,” one IRS official said. Some IRS and Treasury officials are not happy with the ruling. Kathy Reed, the chief whose branch issued the ruling, and Ellen Neubauer, the Treasury cash grant program manager, confirmed that it is under study.

A private letter ruling is binding on the IRS only for the taxpayer who received it. It is possible the agency could decide that the ruling makes more sense when someone buys a power plant that is already operating and that comes with a power contract than when only contracts are purchased.

Keith Martin