IRS Issues LB&I Memorandum on Capitalization of Electric Transmission, Distribution Property Expenses

Impacted IRM 4.51.5

The use of the safe harbor included in this Revenue Procedure is only permitted under the terms and conditions contained therein, and should not be considered for purposes of resolving capitalization issues in prior open exam years under any circumstances. This directive provides the guidance for addressing prior open exam years.

Taxpayers that transmit and distribute electricity incur significant expenditures to maintain, replace, and improve transmission and distribution property. For those taxpayers eligible to adopt the unit of property definitions and safe harbor provisions provided in Rev. Proc. 2011-43, this directive sets forth guidance to the field related to closing current examination activity relating to capital versus repair treatment for expenditures on utility electric transmission and distribution property.

Revenue Procedure 2011-43 waives the scope limitations for a request to change a method of accounting, which normally apply to a taxpayer under examination, for the taxpayer's first and second taxable year ending after December 30, 2010. If a taxpayer with applicable asset expenditures has not adopted the safe harbor method pursuant to Rev. Proc. 2011-43 for its first or second taxable year ending after December 30, 2010, the examiner should follow the guidance under Planning and Examination Guidance -- Tax Years Ending On or After December 31, 2010, as provided in the next section.

Discontinuing the examination of the capital versus repair expense issue should include the following steps:

• Withdraw Forms 4564, Information Document Request, or portions thereof, relating to the development of this issue for transmission and distribution property.

• Withdraw all outstanding Forms 5701, Notice of Proposed Adjustment, which propose an adjustment to repair expenses related to whether costs incurred to maintain, replace, or improve electric transmission and distribution property must be capitalized under I.R.C. § 263(a).

• Develop and issue a Form 5701 with a Form 886-A, Explanation of Adjustments, containing the following language:

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  The Service neither accepts nor rejects the position stated in the tax return related to the method to determine the proper repair expense with respect to electric transmission and distribution property. [Insert taxpayer name] will be allowed a two-year period to adopt the safe harbor method provided in Rev. Proc. 2011-43. If the safe harbor method is adopted, a change in method of accounting can be made in accordance with Section 7 of the applicable revenue procedure for all of the transmission and distribution property. If [Insert taxpayer name] has not adopted the safe harbor method in its first or second taxable year ending after December 30, 2010, the repair expense will be subject to risk assessment and possible examination for tax years ending on or after December 31, 2010.

• After the taxpayer has signed the Form 5701 with the 886A, Explanation of Adjustments, upload the documents into the Information Management System (IMS) to substantiate for the subsequent examination team that the taxpayer was notified of the Service's position to discontinue the issue.

• Complete the Form 5346, Examination Information Report, in accordance with the specific instructions provided for this issue located on the Deductible and Capital Expenditures Issue Practice Group (IPG) website.

• Confirm the issue was input into IMS as follows: UIL 263.14-01, and Issue Tracking Attribute Code 1400.

• If the taxpayer adopted the safe harbor method, the examiner should determine if the adoption is consistent with the Rev. Proc. 2011-43. If the adoption is not consistent, then a determination needs to be made whether the taxpayer correctly adopted the method and the examiner should consult with the Deductible and Capital Expenditures Issue Practice Group for further guidance.

• Rev. Proc. 2011-43 section 5.03(3) provides a transition rule for the first three taxable years ending on or after December 31, 2010, permitting taxpayers to determine the percentage of a unit of linear property replaced based on average circuit length within a county or geographic area similar to a county, such as a parish, borough, or other similar geographic division. Examiners should not challenge a taxpayer's ability to use the transition rule for tax years ending before January 1, 2014.

If the taxpayer did not adopt the safe harbor method, then the agent should perform a risk assessment to determine the materiality of the repair deduction claimed with respect to the electric transmission and distribution property. If the result of the risk assessment is deemed to be material, the examiner should examine the deduction utilizing I.R.C. § 263(a) and the Treasury Regulations thereunder.

If you have any questions, please contact the Deductible and Capital Expenditures IPG.

This Directive is not an official pronouncement of law and cannot be used, cited, or relied upon as such.

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