IRS Updates Safe Harbor on Contributions to Capital for Transfers to Public Utilities

By Nicole Ngai, CPA, MAc, San Francisco

Editor: Mark G. Cook, CPA, MBA, CGMA

On June 10, 2016, the IRS issued Notice 2016-36 to provide guidance on new safe-harbor rules in which certain property transfers by an energy generating or energy storage facility to a regulated public utility will not be treated as income to the utility company. Instead, as provided under Sec. 118(a) and discussed in Regs. Sec. 1.118-1, these transfers are considered a nontaxable contribution of capital by a nonshareholder to the utility. Notice 2016-36 incorporates and modifies the safe harbor from three previous IRS notices on the matter: Notice 88-129, Notice 90-60, and Notice 2001-82.


In broad terms, the new and old notices focused on property that aids transmission of electricity or energy over the utility's transmission system. In 1978, Congress passed the Public Utility Regulatory Policies Act, P.L. 95-617, which mandated that regulated public utilities must interconnect with qualifying small power producers and qualifying co-generators for the producers and co-generators to sell the power they produced to utilities. These producers and co-generators collectively are known as "qualifying facilities" and, under federal law, must incur the costs related to the equipment necessary to interconnect with the utility. Such an interconnection system is referred to as an "intertie." After the construction and installation of the intertie, the utility commonly holds its legal title.

The transfer of the intertie to the utility normally would be considered gross income for the utility under Sec. 61(a). However, Sec. 118(a) provides that gross income does not include any contribution to the capital of the taxpayer in the case of a corporation. Regs. Sec. 1.118-1 further provides that the income exclusion is not limited to contributions from shareholders and applies to contributions to capital made by persons other than shareholders. According to the legislative history, Congress introduced this exclusion under Sec. 118 in consideration of situations where the contributions fail to be classified as gifts due to possible indirect benefits received or characterization as future service payments due to the intangibility of future benefits (H.R. Rep't No. 1337, 83d Cong., 2d Sess. 17 (1954)). Conversely, the utility cannot exclude the contribution from income if it is considered a contribution in aid of construction (CIAC) or any other contribution made as a customer or potential customer under Sec. 118(b). Transfers that encourage the utility to provide the transferor services and do not benefit the public as a whole would be considered a CIAC instead of a contribution to capital. Thus, transfers of an intertie to a public utility are nontaxable to the utility if treated as a contribution to capital under Sec. 118(a) but are taxable if considered a CIAC under Sec. 118(b).

To clarify these issues, the IRS released Notice 88-129 to provide safe-harbor rules for transfers of interties from qualifying facilities to regulated public utilities, excluding them from income. This included transfers made exclusively in connection with the sale of electricity by a qualifying facility to a utility, power purchase contracts of more than 10 years, and other conditions. A few years later, the IRS expanded and modified certain sections in Notice 88-129 with the issuance of Notice 90-60. Then in 2001, the IRS released Notice 2001-82, which extended the safe-harbor provisions to transfers from nonqualifying facilities and further modified and expanded Notice 88-129 for additional guidance on "wheeling" electricity (transmitting it over a utility's grid for sale to consumers or intermediaries) and capitalization.

Since the issuance of the notices, the industry has changed, with interconnection between generators and utilities improving reliability and efficiency of transmission. However, some transfers of interties would still fail the safe-harbor provisions under those earlier notices. For example, electricity generators typically do not enter into long-term power purchase contracts with utilities outside their service areas, so the transfer of an intertie to such a utility would not meet the safe harbor. And even though energy storage facilities play an important role in managing the utility's transmission, their transfers of interties to the utility also would not fall under the safe harbor as outlined in the notices.

New Guidance and Safe Harbor

In response to the industry changes, the IRS issued Notice 2016-36, which modified and superseded Notice 88-129, Notice 90-60, and Notice 2001-82. Under the new safe harbor of Notice 2016-36, a contribution of an intertie by a generator to a utility will not be treated as gross income under Sec. 118(a) or as a CIAC under Sec. 118(b) if the following conditions are met:

  • The intertie is used for transmitting electricity.
  • The cost of the intertie is not included in the utility's base rate. This base rate is used in calculations to determine the rate of return for regulatory purposes.
  • The generator capitalizes the cost of the intertie as an intangible asset and recovers the cost over 20 years using the straight-line method. The utility is not allowed depreciation (or amortization) deductions relating to the intertie.
  • In cases of a dual-use intertie where power may be transmitted from the utility back to the generator, the generator does not purchase the electricity from the utility unless it meets the 5% test. Based on the information available at the time, no more than 5% of the total power may be transmitted to the generator over the intertie in the utility's 10 tax years that begin with the year the intertie is placed in service. If their projection has documentation to support this, then the test is considered met.
  • In cases of electricity wheeled from the generator to the purchaser over the utility's transmission system, the ownership of this electricity remains with the generator prior to transmission onto the grid and passes to the purchaser at the busbar on the generator's end of the intertie.

Although the safe harbor in Notice 2016-36 is similar to the provisions in the previous notices, it makes two main changes. First, a long-term power purchase contract or a long-term interconnection agreement is not required under the new safe harbor. Second, energy storage facilities are included in the definition of a generator and, as such, the safe harbor covers them. If a utility wishes to change a transfer of an intertie to fall under the safe harbor in Notice 2016-36, or if a utility later terminates its safe harbor because an event disqualifies the contribution, the IRS views it as a change in method of accounting under the automatic change procedures in Rev. Proc. 2015-13. In such situations, a Form 3115, Application for Change in Accounting Method, may be required.

Notice 2016-36 is effective for all qualifying transfers that satisfy the updated safe-harbor provisions made on or after June 20, 2016. However, the notice does indicate taxpayers may rely on it for qualifying transfers made prior to the effective date. The IRS also advised that taxpayers may rely on the notice as a revenue ruling or revenue procedure and that it will not issue private letter rulings related to the safe harbor.


The IRS's release of Notice 2016-36 acknowledges the changing industry and modifies the safe-harbor rules to facilitate more qualifying transfers of interties from generators to regulated public utilities. With careful tax planning, both the generator and the utility will reap the tax benefits. A utility may be able to exclude the transfer from its gross income under Sec. 118(a), and a generator may recover the costs over 20 years as discussed in the notice. So, if a generator is planning to transfer an intertie to a utility, the parties should structure the transfer as a contribution to capital to ensure the optimal tax outcome for both parties.


Mark Cook is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600 or

Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.

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