Rev. Rul. 75-557

Advice has been requested whether, under the circumstances described below, amounts received by the taxpayer for connection fees are includible in its gross income under section 61 of the Internal Revenue Code of 1954 or are excludable as contributions to its capital under section 118.

The taxpayer, a domestic corporation, is engaged in furnishing water through its facilities. It is regulated by the state in which it is incorporated as a public utility subject to a continuing duty to provide services to its customers.

The purchaser of a home in a new subdivision is charged a connection fee to obtain water service. The fee includes a construction charge for furnishing and installing a service line and water meter to the water line running to the purchaser's lot.

Section 1.61-1(a) of the Income Tax Regulations provides, in part, that gross income means all income from whatever source derived, unless excluded by law.

Section 118 of the Code provides that in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer. Section 1.118-1 of the regulations recognizes that the exclusion from gross income extends to non-shareholder contributions to capital. However, the regulation further provides that the exclusion does not apply to money or property transferred in exchange for goods or services to be supplied by the taxpayer.

The Internal Revenue Service has acquiesced in a series of cases in which the United States Board of Tax Appeals held that contributions in aid of the construction of facilities by a public utility or railroad do not result in taxable income to the recipient if the facilities are used to provide services to the contributor at rates subject to regulation by a regulatory body. Liberty Light & Power Co., 4 B.T.A. 155 (1926), acq., VI-1 C.B. 4 (1927); Great Northern Ry., 8 B.T.A. 225 (1927), acq., VII-2 C.B. 16 (1928); Rio Electric Co., 9 B.T.A. 1332 (1928), acq., VII-1 C.B. 27 (1928); El Paso Electric Ry., 10 B.T.A. 79 (1928), acq., VII-2 C.B. 12 (1928); Wisconsin Hydro-Electric Co., 10 B.T.A. 933 (1928), acq., VII-1 C.B. 34 (1928); Tampa Electric Co., 12 B.T.A. 1002 (1928), acq., VII-2 C.B. 39 (1928); Kauai Ry., 13 B.T.A. 686 (1928), acq., IX-1 C.B. 28 (1930); Baltimore & O. R.R., 30 B.T.A. 194 (1934), acq., XIII-2 C.B. 2 (1934).

In Teleservice Company of Wyoming Valley, 27 T.C. 722 (1957), aff'd, 254 F.2d 105 (3rd Cir. 1958), cert. denied, 357 U.S. 919 (1958), it was held that customer contributions to a community television antenna system for the construction of facilities represented taxable income to the taxpayer. The amounts were payments for services. The United States Court of Appeals for the Third Circuit in affirming the Tax Court of the United States' decision, said, "As to [the Liberty Light line of cases] . . . we can only say we are not in accord."

In Rev. Rul. 58-555, 1958-2 C.B. 25, it was announced that the Service had litigated Teleservice Company notwithstanding the acquiescences in the cases cited above because the facts of that case were considered distinguishable from those in which acquiescences were published since the taxpayer in Teleservice Company was not a regulated public utility subject to a continuing duty to provide service to its customers. It was also announced that, if and when the Service should decide upon a change in the position represented by the cited acquiescences in the public utility decisions, the change of position will be given non-retroactive effect under section 7805(b) of the Code with respect to transactions entered into prior to the effective date of the change.

The Service has decided that a change in the position represented by the cited acquiescences in the public utility decisions is warranted in light of the decision of the Supreme Court of the United States in United States v. Chicago, Burlington and Quincy Railroad Co., 412 U.S. 401 (1973), where the taxpayer was a railroad whose rates were subject to regulatory supervision. The Court held that government payments received for improvements at grade-crossings and intersections were not contributions to capital under the Internal Revenue Code of 1939. The Court set forth five characteristics of a nonshareholder contribution to capital for purposes of both the 1939 and 1954 Internal Revenue Code, including that the amounts received must not constitute payments for specific, quantifiable services. Moreover, in Irving J. Hayutin, 31 CCH Tax Ct. Mem. 509 1973, aff'd, 75-1 U.S.T.C. 86,035 (10th Cir. 1974), the United States Tax Court held that payments received for stock by a regulated public utility from contractors were received for services under Teleservice Company. The court said the regulated public utility distinction provided by Rev. Rul. 58-555 was not contained in Teleservice Company and it should not be the basis for decision. Therefore, the Service will no longer recognize the public utility distinction with respect to transactions entered into after February 1, 1976, the effective date of this Revenue Ruling. Rev. Rul. 58-555 is revoked. The acquiescences in the cases cited above are withdrawn. Rev. Rul. 66-353, 1966-2 C.B. 111, dealing with determinations of earnings and profits for amounts excluded from gross income under the authority of Rev. Rul. 58-555, is modified.

Accordingly, in the instant case, since the connection fees charged to a new lot owner are necessary to obtain water services, the amounts will constitute gross income to the taxpayer under section 61 of the Code.

Pursuant to the authority contained in section 7805(b) of the Code, the position expressed in this Revenue Ruling will not apply to transactions entered into prior to February 1, 1976.

¹ Also released as TIR 1423, dated December 4, 1975.