Transcript Available of IRS Hearing on Nuclear Decommissioning Regs

UNITED STATES DEPARTMENT OF THE TREASURY

INTERNAL REVENUE SERVICE

PUBLIC HEARING ON PROPOSED REGULATIONS

"NUCLEAR DECOMMISSIONING FUNDS"

[REG-112800-16]

Washington, D.C.

Wednesday, October 25, 2017

PARTICIPANTS:

For IRS:

CHRISTOPHER T. KELLEY
Acting Deputy Associate Chief Counsel (Passthroughs & Special Industries)

PETER C. FRIEDMAN Senior
Technician Reviewer Branch 6 (Passthroughs & Special Industries)

JENNIFER C. BERNARDINI
Attorney Branch 6 (Passthroughs & Special Industries)

Speakers:

MARTHA GROVES PUGH
McDermott Will & Emery

ROBERT A. KLECZYNSKI
Exelon

BRADLEY SELTZER
Eversheds Sutherlands

JOHN E. MATTHEWS
Morgan Lewis

PROCEEDINGS

MR. KELLEY: Good morning. This is a public hearing for proposed regulations under Internal Revenue Code § 468A regarding nuclear decommissioning funds. Notice of Proposed Rulemaking was published in the Federal Register on July 25, 2017. Written and electronic comments were received and three people have requested the opportunity to speak this morning.

Each speaker will have 10 minutes to present their comments. There is a timer and a light indicator at the top of the podium. The light is going to start out green then it will turn yellow and red. When the light turns green the speaker can go ahead and begin to speak, present their comments. The yellow light is a warning that you have 3 minutes left to summarize your comments. When the light turns red your time will be up.

Let me introduce our panel. My came is Chris Kelley, I'm the Acting Deputy Associate Chief Counsel for the Passthroughs and Special Industries Division. To my far left is Peter Freidman who is a senior technician reviewer in Branch 6 in Passthroughs and Special Industries; he's the primary reviewer of these regulations. To my immediate left is Jennifer Bernardini who is an attorney in Branch 6 of Passthroughs and Special Industries and the principle author of these regulations.

The first speaker on our agenda is Martha Groves Pugh of McDermott Will & Emery speaking on behalf of the Utility Decommissioning Tax Group.

MS. PUGH: Can you hear all right back there? I'm ready.

Good morning, everyone. My name is Martha Pugh and I'm a partner at the law firm of McDermott Will & Emery. I'm here today on behalf of the Utility Decommissioning Tax Group which consists of nuclear electric companies and investment management firms that manage the nuclear decommissioning trusts dedicated to decommissioning commercial nuclear plants in the U.S.

Last fall the Group submitted an extensive paper in response to the inclusion of § 468A in the Treasury Guidance Plan. Additionally, in March of this year the Group offered comments to proposed regs under 468A issued by the Treasury Department last December. The Notice of Proposed Rulemaking asked for comments on the clarity of the proposed regs and how they may be made easier to understand. Today I will address four points that we believe should be included in the final regs issued under 468A.

The first, we believe the final regs should remove the otherwise deductible language from their regulations and confirm the language does not apply to independent spent fuel storage installations, and I'll refer to those as ISFSIs after this.

Second, we believe the final regulations should acknowledge that the addition of the language regarding depreciation and amortization in the proposed regs is a clarification to the rules and not a broadening of the rules.

Third, we believe the final regulations should clarify the added language regarding self-dealing.

Fourth, the final regulations should adjust the effective date so that these clarifications apply to all open tax years as of the effective date of the proposed regulations.

The first item concerns the use of the words "otherwise deductible" in the definition of nuclear decommissioning costs under the regs. It's our view that the "otherwise deductible" language that's in the regulations was not intended to restrict payments from the qualified funds and should be removed. We believe that § 468A was intended to allow a deduction for contributions to a qualified fund but leaves the tax treatment for the payment for decommissioning to other sections of the code such as the economic performance rules.

Neither the code nor the legislative history mentions the requirement to be deductible. The structure of the tax code under 468A says that amounts are deductible when a taxpayer makes a contribution to the qualified fund. As amounts are withdrawn from the qualified fund they're included in the taxable income of the taxpayer. The taxpayer should be able to remove the amounts for property commissioning expenses whether or not they would be deductible. We think these have built-in protections of having the taxpayer include those monies in income whether or not they're deductible.

We believe that the proposed regs were intended to remove this "otherwise deductible" requirement in the regulations to acknowledge that a taxpayer can use qualified funds for ISFSI cost even when the taxpayer is unbale to deduct such cost under § 165 due to a possible recovery from DOE. These recoveries may be many years later, as many of you know. However, we explain more fully in our latest submission the structure and the changes and the retention of the requirement in the balance of the Treasury regulations makes it unclear or could lead to confusion or questions regarding whether expenditures from qualified funds for these legitimate decommissioning expenses are permissible. Taxpayers need clarity and assurance that the monies that they have collected from the rate payers and contributed to the qualified funds are readily available for these purposes.

The second point I'd like to address concerns the amounts disbursed for qualified funds for depreciable and amortizable assets used in decommissioning. The preamble to the proposed rules states that under the existing regulations a qualified fund may pay only for a portion of the depreciation allowable in the tax year in which such property is placed. The services issued both a technical advice memorandum and a chief counsel advice along with seven private letter rulings in the past that conclude under the current regulations that the cost of assets that were recoverable through depreciation or amortization constitute nuclear decommissioning costs. Therefore, we believe that these are clarifications —this added language is a clarification of the current law and it's really the wording in the preamble that needs to reflect that.

This is important because taxpayers have relied on these existing authorities previously and should not have a risk of noncompliance with the rules as a result of the language in the preamble that refers to this as a clarification.

The third aspect of the proposed regulations I will address concerns the exception to the definition of self-dealing under the Treasury regulations for payments for decommissioning liabilities. The preamble to the proposed regs mentions direct or indirect overhead and a reasonable profit element but does not make it clear that these components are allowable reimbursements from qualified funds.

A taxpayer may often pay a vendor directly and then request reimbursement from the qualified fund for administrative convenience as the result of timing that the taxpayer needs to pay the vendors. In all instances the qualified fund should be able to reimburse the electing taxpayer for any payments for decommissioning including overhead and a reasonable profit element.

The Nuclear Regulatory Commission approves all payments for decommissioning. Additionally, state public utility commissions generally have oversight with respect to the payments from the qualified fund. For this reason we do not believe it's necessary to have restrictions in the regulations such that overhead and profits should be excluded from the qualified fund.

The final point that I will mention concerns the effective date of the proposed regulations. The preamble to the proposed regulations states that the Internal Revenue Service will not challenge re-term positions consistent with the proposed regs for taxable years on or after December 29, 2016 which is the date that the proposed regs were published in the federal register.

We believe that all of the changes addressing these proposed regs and final regs to be issued are clarifications of current law and should be effective for all open years as of the issuance of the proposed regs.

Thank you for the consideration of our concerns. I'd be pleased to answer any questions at the appropriate time.

MR. KELLEY: Thank you. Are there any questions from the panel? No? Okay. Thank you very much.

MS. PUGH: Thank you.

MR. KELLEY: Our second speaker today is Robert Kleczynski — I hope I got that right — Vice President of Tax at Exelon Corporation speaking on behalf of the Edison Electric Institute and the Nuclear Energy Institute.

MR. KLECZYNSKI: Good morning. I am Rob Kleczynski, I'm Vice President of Tax at Exelon Corporation and I'm here on behalf of the Edison Electric Institute and the Nuclear Energy Institute.

Today we will address two issues relative to the proposed regulations under § 468A. First, the standard that should be applied under the Treasury Reg § 468A-5(b) for evaluating the amount of distribution of a qualified fund, or QF, is permitted to make to a party related to the QF. And second, the propriety of tying the ability to make a distribution from a qualified fund to the tax treatment of the funded expenditure under 468A-1.

With respect to the first issue, for reasons described further in my testimony, EEI and NEI recommend that proposed Treasury REG 468A-5 be modified to read as follows:

Although the language in the proposed regulation is reasonably clear, we believe it's best to remove any ambiguity by changing the word "paid" to "incurred" and specifying that reimbursement of allocated related party direct and indirect overhead costs and a reasonable cost of capital are also permitted uses of QF assets that are not acts of self-dealing.

The preamble explains that the proposed regulation is intended to remove any lingering uncertainty and the need for private letter ruling requests by clarifying that the QF's reimbursement of decommissioning costs to related parties is not an act of self-dealing. We are concerned that the intent expressed in the preamble can be viewed as contradictory by the next statement that was in the preamble, "However, no amount beyond what was actually paid by the related party, including amounts such as direct or indirect overhead or a reasonable profit element, may be included in the reimbursement by the Fund." This proviso implies that payments to reimburse for direct and indirect overhead costs and a cost of capital are not within the exclusion of self-dealing. In the remainder of my testimony I'll refer to overhead costs as both overhead costs for both direct and indirect.

If this was in fact the intent behind the statement we believe it is in conflict with the policy underlying § 468A which is to facilitate the decommissioning of a nuclear facility. A prohibition against reimbursement from QF assets of overhead costs incurred by a related party or a reasonable cost of capital is at odds with this overarching policy.

The economic and labor resources available to the nuclear plant while in operation are severely curtailed in short order over a short period of time once the plant enters the decommissioning phase of its lifecycle. Consequently, the winding up of a nuclear electricity generating business relies heavily on affiliate services to directly and indirectly support decommissioning including overhead costs. We can conceive of not tax or non-tax policy reason that would be served by prohibiting reimbursement for these activities which are critical to the decommissioning project simply because they've been sourced to an affiliate.

If the preamble expresses the true intent, the proposed regulation will substantively influence the taxpayer's decision regarding a manner in which the decommissioning project will be performed. A taxpayer can choose to manage decommissioning of its nuclear facility itself or have an affiliate do it, together the "Insource option", as I'll call it, or opt to retain a third-party decommissioning contractor to perform and complete the decommissioning project, the "Outsource option."

It must be noted that even if the major decommissioning activities are outsourced the decommissioning project will always require resources to be provided by the taxpayer, its subsidiaries, or affiliates which will likely attract an allocation of overhead costs.

The proposed regulation could effectively force plant owners to select the outsource option. Distributions from QF assets will be made to compensate a third-party contractor for performance of decommissioning services. The contractor's invoices will include its overhead costs and those of its affiliates and subsidiaries which are real, legitimate costs of an activity as well as the cost for capital.

Conversely, a taxpayer employing an insource option that incurs the same overhead costs is prohibited under the proposed regulations from using QF assets to reimburse itself or an affiliate for such expenses incurred. As a result, the insource option requires the taxpayer to fund overhead costs from taxpayer's funds or borrowed funds rather than from assets of the QF as in the case of the outsource option.

The income tax regulations should not distort the economics of the decommissioning decision in such a manner. Instead the income tax regulations must permit taxpayers and their regulators the appropriate latitude to determine the safest, most effective, and most economic decommissioning alternative.

Further support for allowing overhead costs can be found in § 263A where indirect costs are a direct cost or costs that are required to be capitalized. Examples of indirect costs under § 263A include indirect labor costs, officers' compensation pension, and other employee benefits. For self-constructed property these costs are required to be capitalized. For property constructed for a taxpayer by an unrelated party the same result occurs because these overhead costs are included in the amount charged for property and the total amount paid is required to be capitalized.

Furthermore, all nuclear decommissioning trusts are subject to detailed and ongoing oversight or monitoring by the Nuclear Regulatory Commission, and in some cases state regulatory commissions such that penalties are not necessary to prevent undesirable actions. For example, the applicable NRC regulations provide that in order to make a disbursement, other than for ordinary administrative and incidental costs of the fund, from the funds prior to unit shutdown notice must be provided to the NRC at least 30 days prior to disbursement. If within that period there is no objection form the NRC the disbursement may then be made.

For shutdown units the NRC requires a detailed, site-specific cost estimate and an annual report that identifies, among other things, the amount spent on decommissioning, the estimated remaining cost to complete decommissioning, and additional financial assurance if the trusts are not adequate to cover expenses.

Further, in order to use any of the funds at all for spent fuel management a utility must apply for and receive explicit permission from the NRC allowing it to do so. Voluminous studies and reports are required, audits are conducted, and fines and penalties can be imposed. In some states, the state commissions also have meaningful and active oversight.

Public utility regulators and the NRC rely upon decommissioning cost estimates developed for a nuclear plant for a variety of reasons. Decommissioning cost estimates will typically include overheads and a cost of capital in the compilation of the expected costs of decommissioning. Publicly utility regulators and the regulations of the Federal Energy Regulatory Commission expect each utility to manage decommissioning funds prudently by utilizing § 468A to enhance the ability of the nuclear decommissioning trust to grow faster.

The recommended change to the proposed regulations under -5 makes the treatment of such costs absolutely clear to taxpayers by allowing distributions by QF for allocable overheads incurred by related parties including the electing taxpayer and a reasonable cost of capital. The business decision of the taxpayer to select the insource or outsource approach to undertaking and completing a long-term decommissioning project will not be unduly influenced by the proposed regulations.

I will now address the second issue, the otherwise deductible limitation. The language proposed in the last sentence of 468A-1(b)(6) states, "An expense is otherwise deductible for purposes of this paragraph (b)(6) if it would be deductible or recoverable through depreciation or amortization under chapter 1 of the Internal Revenue Code."

We appreciate the relaxation of the limitation for depreciable assets that you provided in the proposed regulations, however you only addressed one symptom and did not cure the underlying problem. We ask that you remove the "otherwise deductible" limitation from the regulation and replace it with a standard that focuses on whether or not the expenditure is appropriate to the task of decommissioning.

The "otherwise deductible" limitation requires correlation of the QF funding with the tax deduction. The focus is upon whether or not the expenditure constitutes a cost appropriate to the prosecution of decommissioning by applying the otherwise deductible limitation, creating uncertainty for taxpayers.

We are uncertain by it was thought necessary to synchronize the payment from the QF with a tax deduction. Possibly it was thought necessary to achieve the correct time value of money result when deductions were permitted to the QF before the decommissioning was performed. That is, by taxing the income as it accumulates in the QF and then taxing it again to offset that deduction; the time value money benefit of the earlier deduction for the contribution is taken away.

The taxpayer gains nothing, however, by reporting the income when a distribution from the QF occurs before the expense is incurred. In fact, in that case the taxpayer is penalized by the mismatch of the income and the expense.

We believe that the most appropriate cure is the removal of the otherwise deductible limitation under -1 and replace it with a standard that focuses entirely on whether or not the expenditure is appropriate to the task of decommissioning. This would correct the overarching uncertainty created by that standard and ensure that adequate funds are available for all decommissioning costs incurred. The need for exchange is illustrated by the anomalies that result from the application of the proposed rule to an independent spent fuel storage installation or ISFSI.

As you know, the construction of ISFSI has become very common with the need to store spent fuel at nuclear facility sites pending removal by the federal government. Because the federal government has not resolved the long-term storage of spent nuclear fuel, nuclear plant operators have made claims for the additional costs they are incurring.

Under the proposed rule a nuclear operator is able to fund the cost of constructing an ISFSI from the QF if the plant is operating because the ISFSI is depreciable. The same is not true, however, for a plant that has been shut down. In that case, the ISFSI costs are losses under § 165 as the costs are incurred. This is so because the ISFSI is abandoned as the costs are incurred. This treatment would result in a deduction but for the taxpayer's claim against the government.

MR. KELLEY: This is just a heads up, but your time is up. If you can wrap up in the next couple sends.

MR. KLECZYNSKI: Sure. In conclusion, to correct this specific problem, in our comments we suggested that the regulation refer to "expenditures made to acquire or construct property of a character that is subject to allowance for depreciation or amortization." Our assertion was that this approach to modifying the regulation which is consistent with the principles of § 1231 will permit the use of QF assets to apy capital expenditures incurred in direct or indirect.

We now suggest that revising the proposed language to clearly articulate:

Thank you for this opportunity to comment today. I would be pleased to answer any questions you have.

MR. KELLEY: Thank you very much. Any questions from the panel? Okay. Thanks very much.

Our third speaker today is Bradley Seltzer of the Energy Tax Group of Eversheds Sutherland.

MR. SELTZER: Good morning. My name is Brad Seltzer. I'm a partner and co-chair of the Energy Tax Group of Eversheds Sutherland. Although we represent many clients with an interest in today's proceedings we are not appearing today on behalf of any particular client. We greatly appreciate the opportunity to speak today, notwithstanding the lateness of our submission. Thank you.

I will keep my comments fairly brief. We applaud this service and agree with both Marti and Rob who have indicated general support for the clarification of the unfortunate "otherwise deductible" language of the current regulations, and the self-dealing rules, and the definition of substantial completion.

Although we support the intent to clarify that ISFSI and other storage costs are properly treated as qualified nuclear decommissioning expenses we do not necessarily believe that the solution lies in being either more prescriptive or more descriptive. Rather, for a number of reasons we believe a more minimalist approach might well be preferable.

Simply stated, the issue of deductibility never should have been part of the § 468A regulations. The sole question for qualification under § 468A should have been on the purpose of the expenditure. Is it incurred to satisfy a decommissioning liability, and is it incurred in connection with (inaudible), decontamination, dismantlement, et cetera, of a nuclear power plant or its components?

Deductibility of nuclear decommissioning costs should be determined solely under general principles of chapter 1 of the Code. Logically, the regs would stop after the first sentence of B(6)(i) and a new second sentence could simply be added to state that deductibility is not determined under § 468A but rather under general principles of chapter 1. We provided some proposed language in our written comments.

We recognize it is hard to undo the past and go back. Some might draw comfort in the continued express inclusion of preparatory and post-decommissioning expenses as well as the general language regarding storage costs in the definition of qualified nuclear decommissioning costs.

Accordingly, if that's the direction you chose to go we would not object to their retention provided that all references to otherwise deductible costs are eliminated and the general rule is added. Similarly, although we don't believe it is necessary we do not object to the retention of the exclusion of disposal fees and costs in the regulations.

Why do we believe that the minimalist approach is the better one? First, particularly with the recent license extensions it will be many decades and perhaps as long as a century until all plants are decommissioned. It seems ill-advised to try to define today the type of qualified costs that will be incurred over such an extended period.

We provided an example in our comments, for instance, of taxpayers who are now looking at acquiring property offsite for their disposal of nuclear waste, something that clearly wasn't contemplated because we always thought we were going to get a federal repository.

Secondly, but related, technology is rapidly evolving and the descriptive regs will likely not stand the test of time if they're written today. Just look at some of the outmoded definitions of qualified technological equipment under Rev Proc. 8756 which still includes calculators and keypunch devices in their definitions.

Thirdly, as others have mentioned, independent regulatory bodies such as the NRC and state PUCs provide the expertise, oversight, and safeguards to ensure that nuclear decommissioning trusts loans are spent for a proper purpose and are prudent in amount. Thus, the additional IRS involvement in this issue is unnecessary. The IRS retains the ultimate interim power of disqualifying the fund should it believe any costs are not qualified.

Again, we do not object if an alternative approach is taken. We don't even believe one approach is necessarily right and the other one is wrong, we simply provide an alternative and believe our solution is both simpler, truer to the statute, and will stand the test of time.

Lastly, I just want to briefly address the self-dealing rules. We believe it's important for the self-dealing rules not to skew economic decisions and to create a level playing field with third-party contractors. Thus, it should be made clear that amounts paid from a qualified fund to a related party may reflect direct and allocated indirect costs as well as a reasonable profit element just as the inclusion of such amounts in the contract price charged by unrelated parties would reflect those costs as well.

Thank you, and I'll be happy to answer any questions.

MR. KELLEY: Thank you very much. Any questions from the panel?

MR. SELTZER: I've got the orange light.

MR. KELLEY: You've got 4:25 left. Thank you very much.

Those are the scheduled speakers for today. I think we've got a few more minutes, close to a half-an-hour before they kick us out of the room. If there is anyone else who would like to chime in today, the more feedback we get the better. If anyone else would like to speak you are welcome to come up.

MR. MATTHEWS: John Matthews with Morgan Lewis. I'm not here representing any particular client.

MR. KELLEY: You have the same rules everyone else had.

MR. MATTHEWS: Okay. I just had two quick thoughts. One is on the self-dealing issue. It seems to me that we should be looking at 4951, which is cross-referenced both in the statute and the regulations. And there is an exception there and that is that expenses incurred by disqualified persons that are reasonable and necessary to affect the purposes of the trust are an exception to the self-dealing rule as long as they're not excessive. I think in other contexts and other kinds of trusts that also cite 4951 there are a couple of PLRs and they basically say that as long as the charges are essentially market, not excessive, they're what are customary in the industry, that that is not self-dealing.

The second thought that I want to make is that with respect to this concept of profit not being allowed it presents a serious problem for the industry because we have an emerging business model in the industry to basically transfer plants to contractors for the purpose of decommissioning.

To cite an example, the Zion Nuclear Station has been in active decommissioning since 2010; that project is likely to complete in mid-2019. And that is a project where it was transferred to a contractor, obviously with a profit incentive to make money in decommissioning the plant, but if you look at the numbers the costs per megawatt of decommissioning those two units has got to be best in class in the history of the industry. So, it's been a very effective cost-effective model of accomplishing this public goal which is to decommission these plants.

So, if we say companies can't execute that business model, can't have some profit, we've just destroyed one of the business models that could be the answer to the emerging plants that have been shut down recently that have exactly this issue. What do we do? Do we self-perform? Do we just have a third-party contractor and oversee them? Or do we execute on this potential business model that may be extremely effective in decommissioning these units? The consequence of saying you can't make a profit if you're self-performing destroys that business model. Thank you.

MR. KELLEY: Thank you very much. Anybody else? If not, I'll say that that concludes our hearing and thank you very much for coming out today.

(Whereupon, at 10:33 a.m., the HEARING was adjourned.)