IRS updates safe harbor on contributions to capital for transfers to public utilities.

• Author: Ngai, Nicole

On June 10, 2016, the IRS issued Notice 2016-36 to provide guidance on new safe-harbor rules in which certain property transfers by an energy generating or energy storage facility to a regulated public utility will not be treated as income to the utility company. Instead, as provided under Sec. 118(a) and discussed in Regs. Sec. 1.118-1, these transfers are considered a nontaxable contribution of capital by a nonshareholder to the utility. Notice 2016-36 incorporates and modifies the safe harbor from three previous IRS notices on the matter: Notice 88-129, Notice 90-60, and Notice 2001-82.

Background

In broad terms, the new and old notices focused on property that aids transmission of electricity or energy over the utility's transmission system. In 1978, Congress passed the Public Utility Regulatory Policies Act, P.L. 95-617, which mandated that regulated public utilities must interconnect with qualifying small power producers and qualifying co-generators for the producers and co-generators to sell the power they produced to utilities. These producers and co-generators collectively are known as "qualifying facilities" and, under federal law, must incur the costs related to the equipment necessary to interconnect with the utility. Such an interconnection system is referred to as an "intertie." After the construction and installation of the intertie, the utility commonly holds its legal title.

The transfer of the intertie to the utility normally would be considered gross income for the utility under Sec. 61(a). However, Sec. 118(a) provides that gross income does not include any contribution to the capital of the taxpayer in the case of a corporation. Regs. Sec. 1.118-1 further provides that the income exclusion is not limited to contributions from shareholders and applies to contributions to capital made by persons other than shareholders. According to the legislative history, Congress introduced this exclusion under Sec. 118 in consideration of situations where the contributions fail to be classified as gifts due to possible indirect benefits received or characterization as future service payments due to the intangibility of future benefits (H.R. Rep't No. 1337, 83d Cong., 2d Sess. 17 (1954)). Conversely, the utility cannot exclude the contribution from income if it is considered a contribution in aid of construction (CIAC) or any other contribution made as a customer or potential customer under Sec. 118(b).Transfers that encourage the...