SERVICE MODIFIES CAIC TREATMENT OF DEEMED TRANSFERS BETWEEN QUALIFYING FACILITIES AND UTILITIES.

SUMMARY: The Service, in Notice 90-60, has modified Notice 88-129, 1988-2 C.B. 541, which relates to payments or transfers of property to regulated public utilities from qualifying small power producers and qualifying cogenerators ("qualifying facilities"). Upon the termination of the power purchase contract between a qualifying facility and a utility, if the utility obtains or retains ownership for tax purposes of property transferred in a QF transfer, the qualified facility will be deemed to have made a transfer to the utility as of the first day of such termination.

Under Notice 88-129, such a deemed transfer constituted a contribution in aid of construction (CIAC) under section 118(b). Notice 90-60 modifies section 4(B) of Notice 88-129 to provide that such a deemed transfer will not be treated as a CIAC, except where circumstances indicate an intention by the parties to characterize as a QF transfer a transaction that in substance constitutes a CIAC.

The utility shall include in income the fair market value of the property deemed transferred less any amount paid by the utility to obtain or retain ownership of the property for tax purposes, including any amount paid as an extension allowance. The fair market value of the property deemed transferred upon termination (except for any deemed transfer treated as a CIAC) shall be determined by taking into account all facts and circumstances, including the age and condition of the property and whether the property is needed to serve the utility's customers.

Section 4(A) of Notice 88-129 stated that upon the occurrence of a "disqualification event," a portion of the fair market value of property transferred in a "QF transfer" shall be included in income by the utility as a CIAC. In Notice 90-60, the Service makes clear that the fair market value of used CIAC property will normally be the depreciated replacement cost, that is, the percentage of the replacement cost which reflects the remaining economic useful life of the property.

For further information, contact Mr. Bogdonoff at (202) 377- 6349.

The purpose of this notice is to amplify and modify section 4, and to amend section 6, of Notice 88-129, 1988-2 C.B. 541. Notice 88- 129 provides guidance with respect to certain payments or transfers of property to regulated public utilities ("utilities") by qualifying small power producers and qualifying cogenerators (collectively "Qualifying Facilities"), as defined in section 3 of the Federal Power Act, as amended by section 201 of the Public Utilities Regulatory Policies Act of 1978 ("PURPA").

1. Section 4(A) of Notice 88-129, 1988-2 C.B. 541, 1988-52 I.R.B. 10, states that upon the occurrence of a "disqualification event", a portion of the fair market value of property transferred in a "QF transfer" shall be included in income by the utility as a contribution in aid of construction ("CIAC"). Notice 88-129 refers to Section III of Notice 87-82, 1987-2 C.B. 389, for guidance as to the fair market value of a CIAC. Notice 87-82 states that, absent unusual circumstances, the fair market value of a CIAC is determined under the replacement cost method. The implicit reference in Notice 88-129 to the replacement cost method is hereby amplified to clarify that the condition of property deemed transferred as a CIAC under section 4(A) of Notice 88-129 shall be taken into account in establishing its fair market value. Absent unusual circumstances, the fair market value of used CIAC property will be the depreciated replacement cost, that is, the percentage of the replacement cost which reflects the remaining economic useful life of the property. For example, a trunk line originally cost $100x to install. Ten years later the replacement cost of the line is $150x, and 60% of the useful life remains. The depreciated replacement cost is $90x (60% of $150x).

2. Section 4(B) of Notice 88-129 states that upon the termination of a power purchase contract between a Qualifying Facility and a utility, if the utility obtains or retains ownership (for tax purposes) of property transferred in a QF transfer, the Qualifying Facility will be deemed to have made a transfer to the utility which constitutes a CIAC under section 118(b) as of the first day of such termination. Section 4(B) of Notice 88-129 is hereby modified to read as follows:

(B) TERMINATION OF POWER PURCHASE CONTRACT. Upon the termination of the power purchase contract between a Qualifying Facility and a utility, if the utility obtains or retains ownership (for tax purposes) of property transferred in a QF transfer, the Qualified Facility will be deemed to have made a transfer to the utility as of the first day of such termination. Such a deemed transfer will not be treated as a CIAC, except where circumstances indicate an intention by the parties to characterize as a QF transfer a transaction that in substance constitutes a CIAC. The utility shall include in income the fair market value of the property deemed transferred less the amount, if any, paid by the utility to obtain or retain ownership of the property for tax purposes. Therefore, if the amount paid by the utility is fair market value, no amount will be includible in income by the utility. The amount paid by the utility shall include any "extension allowance" or similar payment by the utility to the Qualifying Facility during the term of the power purchase contract. For this purpose, an extension allowance is a payment to compensate the Qualifying Facility in consideration of the anticipated use of the property by the utility to deliver power to customers other than the Qualifying Facility.

The fair market value of the property deemed transferred upon termination (except for any deemed transfer treated as a CIAC) shall be determined by taking into account all facts and circumstances, including the age and condition of the property and whether the property is needed to serve the utility's customers. If a utility pays to a Qualifying Facility an amount which is determined upon termination of a power purchase contract to be the fair market value for such property under a procedure or method established or utilized by the relevant utility commission, such fair market value shall be presumed correct in the absence of substantial contrary evidence. For this purpose, a utility commission may take into account any relevant factors, including payments made in connection with the retention of property by a utility upon the termination of a PURPA contract and payments by the utility during the term of the contract (e.g., extension allowances).

These principles are illustrated by the following examples:

Example 1. The QF transfer property is a circuit breaker that was installed as part of the intertie to protect the utility against damage to its system in the event of a generator breakdown at the Qualifying Facility. At termination, the utility does not need the circuit breaker to serve its customers. The fair market value is the salvage value of the circuit breaker (less any cost of removal).

Example 2. Upon termination of a 20 year power purchase contract, a utility retains ownership of a 50 megawatt trunk line which was the subject of a QF transfer at the commencement of the contract. The utility will not use the trunk line other than to supply power to a 10 megawatt customer who has hooked into the trunk line. The fair market value is the economic value to the utility of a 20 year old 10 megawatt line, taking into account any other characteristics or factors which are relevant.

Example 3. Assume the same facts as Example 2, except that upon termination the local public utility commission requires the utility to pay $10x to the Qualifying Facility, which the commission has determined to be the fair market value of the property. In the absence of substantial contrary evidence, the commission's finding will be presumed correct, $l0x will be treated as the fair market value for federal income tax purposes, and the utility will not be required to include any amount in income upon termination.

Example 4. A Qualifying Facility transfers a trunk line to a utility in a QF transfer. The trunk line cost the Qualifying Facility $10x to construct. Three years later, a customer of the utility hooks into the trunk line, and the local public utility commission requires the utility to pay to the Qualifying Facility an extension allowance of $5x. The following year, another customer of the utility hooks into the line, and the commission requires another extension allowance of $4x. The commission employs a procedure under which the utility will be required to compensate the Qualifying Facility for the fair market value of property deemed transferred upon termination. When the contract terminates, the commission determines that the utility has, by means of the extension allowances, paid to the Qualifying Facility the fair market value of the property. In the absence of substantial contrary evidence, the commission's finding will be respected and the utility will not be required to include any amount in income upon termination.

Example 5. A Qualifying Facility transfers a trunk line to a utility in a QF transfer. Twenty years later the contract terminates. The utility commission determines the fair market value of the trunk line to be $l0x, but does not require the utility to pay this amount to the Qualifying Facility. No presumption of correctness attaches to the utility commission's findings.

3. In Section 6 of Notice 88-129, the last sentence of the second paragraph is amended by deleting the words "as a CIAC". As amended, the sentence reads as follows: "However, if property which is the subject of a QF transfer is subsequently transferred or deemed transferred to the utility, the utility may be allowed to take depreciation deductions with respect to the property."

EFFECT ON OTHER DOCUMENTS

Notice 88-129, 1988-2 C.B. 541 is amplified and modified.

DRAFTING INFORMATION

The principal author of this notice is Glenn Bogdonoff of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this announcement, please contact Mr. Bogdonoff at (202) 377-6349 (not a toll-free call).