Utility Suggests Keeping the Test the Same for Synthetic Fuel Tax Credit

A. BACKGROUND.

[2] Southern Company, through its operating subsidiaries, is a leading electricity producer in the United States. Our utility companies in the United States include Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company, Savannah Electric Power Company and Southern Energy, Inc., which, in the aggregate, own and operate power plants with a total generation capacity of 43,000 megawatts. Our operating subsidiaries use a wide range of fuels to produce electricity, including oil, coal and natural gas. Specifically, our operating subsidiaries purchase over 65 million tons of coal annually primarily from the following eight states: Alabama, Illinois, Kentucky, Montana, Utah, Virginia, West Virginia and Wyoming.

[3] In addition, Southern Company, through an indirect wholly- owned subsidiary, is an investor in a limited partnership (the "Partnership"), which owns and operates four synthetic fuel facilities. The Partnership uses a process that upgrades coal and coal waste material by chemically converting them into a synthetic fuel. Before making its investment, Southern Company carefully reviewed this chemical process and the qualification of the facilities for Section 29 tax credits based on rulings issued by the Internal Revenue Service (the "Service").

B. SPECIFIC COMMENTS REQUESTED BY REVENUE PROCEDURE 2000-47.

[4] As an overall matter, we believe the Service should not change the "significant chemical change" test under Section 29 in light of the longstanding position of the Service, especially for taxpayers that have received rulings from the Service and invested substantial amounts in synthetic fuel facilities in reliance on those rulings. Our specific comments to your requests set forth in Section 6 of Revenue Procedure 2000-47 are as follows:

1. Whether significant chemical change is an appropriate test

[6] The Partnership operates its synthetic fuel facilities in compliance with these rulings by using a combination of coal fines and coal from conventional sources to produce synthetic fuel pursuant to the chemical process described in these rulings. In reliance on these rulings and the Service's longstanding ruling position, Southern Company along with other investors have invested over $100 million in the Partnership.

[7] If the significant chemical change test is changed as set forth in the Partnership's rulings, the Partnership may be forced to curtail or cease its operations. Consequently, Southern Company and other investors may not be able to recover fully their substantial investment in the Partnership. Even if a change is made on a prospective basis, such a change could be tantamount to a retroactive revocation of the rulings issued by the Service for taxpayers who have not recovered their investments in existing synthetic fuel facilities. As a matter of sound tax policy, we believe that it would be unfair and inappropriate for the Service to change the test now for investments made only two years ago in facilities that have already been placed in service. If the Service decides to change the test, we would respectfully submit that any new test should not apply to taxpayers that have already been issued rulings by the Service.

2. Should the Section 29 credit for solid synthetic fuel under

[9] Even without a specific requirement, we believe that Section 29 is currently increasing domestic energy production based on our experience in the industry. The coal industry in Alabama as well as other states has contracted in recent years. In 1999, the Governor of the State of Alabama commissioned an independent study of the Alabama coal industry. The study found that coal production in the state had declined from 25 million tons in 1995 to approximately 19 million tons in 1999, mostly due to increased competition from foreign coal suppliers. We believe that synthetic fuel facilities will help reverse this trend and keep this production in place.

[10] It is our understanding that in many cases thin seams of coal, which sometimes are disposed of in landfills, are instead being recovered due to the Section 29 tax credit. We also understand that certain coal mines that supply synthetic coal facilities have been able to remain open that otherwise might have shut down. When a coal mine is shut down, it is very difficult and sometimes impossible to recover coal at that mine site at a later date due to safety considerations. We believe that synthetic fuel facilities have had a positive impact of maintaining or increasing domestic coal production, which benefits the electric utility industry and its customers.

3. Under what circumstances should the Section 29 credit for

[12] Moreover, this position is consistent with the rulings issued by the Service to the Partnership as well as other taxpayers. In the rulings issued to the Partnership, the Service specifically determined that the chemical process utilized by the Partnership would produce a qualified fuel within the meaning of Code Section 29(c)(1)(C) when the coal feedstock consists of waste coal (such as coal pond fines and coarse coal refuse recovered from gob piles) or coal from conventional sources.

[13] There is an implication in Revenue Procedure 2000-47 that the Section 29 credit should only be allowed with respect to synfuel produced solely from waste coal fines. We believe this position would contravene the statutory language in Section 29 and the private letter rulings issued by the Service to the Partnership. Also, as a purchaser of large amounts of coal, we believe there would be significant marketability problems associated with synfuel produced with significant portions of coal fines. Coal fines can cause significant operational problems for a power plant, which include handling problems, dust problems (including explosion risk), stickiness of small coal particles at transfer points and the propensity of small coal particles to absorb and retain moisture. In addition, there are limited sources of suitable coal fines, and the quality of coal fines can vary greatly depending upon the source.

4. Must a solid synthetic fuel have a market value that is

C. CONCLUSION.

[15] We believe that Section 29 as currently administered by the Service has had a favorable impact on the coal industry by increasing domestic coal production, which benefits the electric utility industry and its customers. We understand that some taxpayers have abused the Section 29 tax credit program, such as situations involving spraying diesel fuel on coal feedstock. We believe the Service could address those situations on a taxpayer-by-taxpayer basis without the need for changing the standard set forth in existing rulings. As a matter of tax policy, taxpayers who have received rulings from the Service should be entitled to rely on those rulings where such taxpayers are operating in good faith in compliance with the parameters set forth in those rulings. In short, we believe it would be inappropriate and unfair to change the significant chemical change test for taxpayers who have invested substantial sums in reliance on rulings issued by the Service.

Sincerely,

² Priv. Ltr. Rul. 9804050 (Oct. 28, 1997) (issued to an affiliate of the Partnership relating to the chemical process); Priv. Ltr. Rul. 199916049 (Jan. 19, 1999) (issued directly to the Partnership relating to the chemical process and other issues); Priv. Ltr. Rul. 200019022 (Feb. 11, 2000) (issued directly to the Partnership relating to a change in the carrier utilized in the chemical process).