On June 10, the Internal Revenue Service (IRS) issued Notice 2016-36, which updates and expands the existing safe harbor pursuant to which the transfer of an intertie (or reimbursement for the cost thereof) to a regulated public utility will be treated as a contribution to the capital of a corporation, and not a contribution in aid of construction (CIAC) and, accordingly, will not result in taxable income to the utility. Utilities often require developers of new projects to transfer interties as a condition to allowing the developers to transmit the power from their projects over the utilities’ lines.
The safe harbor is relevant to the renewable energy industry because, in addition to requiring the developer of a new power plant, whether of renewable or conventional power, to bear the cost for new or upgraded transmission equipment that is then transferred to the utility for free, the utility will often require that the power plant developer pay a “tax gross up” if the utility must treat the transfer as a CIAC or recognize the transfer as taxable income.
The stated intent of the notice is to facilitate the development and interconnection of renewable energy resources, and it is expected that the industry will view the revised safe harbor requirements under the notice favorably.
The requirements of the revised safe harbor include the following:
1. Over the 10-year period beginning when the contributed intertie is placed in service, no more than 5% of the power that will flow over the contributed intertie (i.e., flowing to and from the utility) can be flowing from the utility to the generator. In most instances, this should not be a problem.
2. If the electricity from the project that the utility required the intertie for is wheeled over the utility’s transmission system, ownership of the wheeled electricity must remain with the project prior to the electricity’s transmission into the grid. This requirement is considered satisfied if title to the electricity passes to the purchaser on the project’s side of the intertie.
3. The utility must not include the cost of the intertie in its “rate base.” (This is not likely to be an issue, as the utility did not pay for the intertie.)
4. The intertie must be used for transmitting electricity.
5. The owner of the project must capitalize the cost of the intertie as an intangible that is amortized straight-line over 20 years.
An important change made under the notice is that developers of storage facilities are eligible for the safe harbor and, thus, will be able to contribute interties to a utility tax-free. This was not the case under the previous IRS notices. The notice explains this change as reflecting the fact that energy storage has become important to grid stability.
Removal of the Long-Term PPA or ICA Requirement
The other significant change made by the notice is the removal of the requirement that the transfer be made by the developer of a facility that has either a long-term power purchase agreement (PPA) or a long-term interconnection agreement (ICA) with the utility receiving the intertie.
In the past, it was typical that a developer of a power plant would only need to provide an intertie to the local transmission provider, and in that case, it would not be unusual to expect that the arrangement would also include a long-term PPA or ICA. The notice recognizes the need to remove this requirement given the evolution of the market.
For example, wind and solar power are often generated a long distance from the markets that purchase the power generated by these projects, which results in the developer of these projects being required to pay for transmission upgrades with distant utilities with which the project will not have an ICA or PPA.
Addition of Upgrades to Distribution Systems
Further, wind and solar are intermittent (i.e., solar power is not produced at night, and far more wind power is produced at night than during the day), and that intermittency can strain not only transmission systems, but also distribution systems. Therefore, a utility may require a new or upgraded intertie for its distribution system prior to allowing wind or solar power to traverse such a system. The notice expands the safe harbor to include intertie distribution upgrades provided by developers
David Burton is a partner and Anne Levin-Nussbaum is a counsel in Mayer Brown’s New York office. Both are members of the firm’s tax transactions and consulting practice, and Burton leads Mayer Brown’s renewable energy group in New York. This article previously appeared on the firm’s Tax Equity Times blog.