Utility partnership flips
Utilities continue to get private rulings from the IRS about different ways to engage in the renewable energy sector.
The two latest rulings address a tax equity transaction that a utility entered into to finance a wind farm and a program that another utility is using to supply solar electricity to its commercial customers.
The wind tax equity transaction is a slight variation on a strategy other utilities have used to raise tax equity to finance renewable energy projects that the utilities will own. (For earlier coverage, see “Utility tax equity structures” in the December 2019 NewsWire.)
A utility signed a build-transfer agreement with a project developer to buy a wind farm at the end of construction. The utility will form a partnership with a tax equity investor and assign the build-transfer agreement to the partnership.
The partnership will own the wind farm and sell the electricity generated to the utility under a long-term power purchase agreement.
The utility will resell the electricity into an organized market at the grid node and then buy back at a hub the electricity it needs to supply power to its ratepayers.
The IRS said the project will not be “public utility property.” Utilities must clear an extra hurdle to claim investment tax credits and accelerated depreciation on any assets considered public utility property by showing that their regulators do not require them to pass along to their ratepayers the value of the tax benefits more quickly than under a “normalization” method of accounting.
A project is public utility property if the rates at which electricity from the project is sold are established or approved by a utility regulator on a rate-of-return basis.
The IRS focused on the electricity sales by the partnership to the utility and said they will be at market-based rates. However, the electricity reaching the ratepayers will not be sold at regulated rates, either. The amount the utility pays to buy electricity at the hub for resale to ratepayers will be passed through as a purchased-power expense.
The ruling does not say whether the utility will put its investment in the partnership into its rate base.
The ruling is Private Letter Ruling 202020011. The IRS made it public in May.
One problem with utility partnership flip transactions where the utility buys the electricity from the partnership is section 707(b) of the US tax code. That section does not allow the partnership to claim losses from selling “property” to a partner that owns more than a 50% profits or capital interest in the partnership. Electricity is considered property for this purpose. Most wind and solar partnerships report tax losses for the first three years after a project is placed in service due to accelerated depreciation on the project. These losses are part of what a project owner barters in the tax equity market to raise capital to pay for a project.
The IRS declined to rule on whether the partnership may claim losses in this case.
The simple fix is for the partnership to sell the electricity directly to the grid and to enter into a swap or hedge with the utility to put a floor under the electricity price. Any such arrangement could not be a PPA with the utility in substance.
In the separate solar ruling, a utility launched a voluntary solar energy services program and got approval for it from its regulatory commission.
The utility will put solar systems on customer roofs and retain ownership of the systems. Each customer will receive a percentage of the electricity generated by its system for a fixed monthly fee. The fee amount will be negotiated with each customer. It may be subject to a fixed percentage price escalator.
Participation in the program is limited to certain commercial customers, probably large customers who are candidates to enter into corporate power purchase agreements with independent generators. The cost of the solar systems will not be put into rate base.
The IRS said the systems will not be public utility property. The fees charged customers under the program will not be set on a rate-of-return basis.
The ruling is Private Letter Ruling 202017027. The IRS made it public in late April.