US Power Companies

US Power Companies

March 01, 2006

US Power companies complain that proposed IRS regulations would deny them a special tax break for domestic manufacturing in cases where a power plant is owned by two or more companies through a partnership or limited liability company, and each company takes and sells its share of the electricity in kind.

The corporate income tax rate in the United States is 35%. However, income from domestic manufacturing is taxed at a lower rate. Generating electricity or producing natural gas or potable water is considered “manufacturing.” Moving these items across power lines or through gas or water mains is not. Companies that do both must allocate their earnings.

A company can exclude 3% of its domestic manufacturing income from federal income taxes in 2006, 6% in 2007 through 2009, and 9% thereafter. This translates into a 34% tax rate in 2006, 33% rate in 2007 through 2009, and a 32% rate thereafter. Even a 1% rate reduction can be worth several million dollars in tax savings.

To qualify for a rate reduction, the company selling the output must have done the “manufacturing” itself. The IRS takes the position in proposed regulations that where a power plant is owned by a partnership, the partnership does the manufacturing. The individual partners do not. This is not a problem if the partnership sells the electricity and allocates income from the sale to the partners. The sales revenue is domestic manufacturing income to the partnership, and it retains that character when distributed to the partners. The problem is where electricity is distributed in kind and the partners sell their shares of the electricity individually. The sales revenue does not qualify in that case since the partner was not the manufacturer of the electricity.

The IRS proposed a special rule for partner- ships engaged solely in the extraction, refining or processing of oil or natural gas. Partners in such partnerships can take their shares of the oil or gas in kind, sell it and still qualify for the rate reduction.

Electric utilities, mining companies and petrochemicals companies are urging the IRS to adopt a similar exception for their industries. Final regulations are expected in early May.

Keith Martin