Access to energy: A ‘new’ intangible asset?

Editor: Mo Bell-Jacobs, J.D.

Artificial intelligence (AI), high–performance computing (HPC) workloads, bitcoin mining, and data center development are driving a significant portion of investment and economic growth in the United States. Significant amounts of capital are being invested toward projects capable of generating vast and dependable electricity supplies necessary to meet the enormous power needs of such businesses. This reality is underscored by the U.S. Department of Energy’s announcing plans to increase its focus on nuclear, fossil fuel, and clean energy development as part of its initiative to support AI and other related energy–intensive computing activities.

Since the existing energy infrastructure is likely insufficient to meet the projected energy demands of AI, HPC, bitcoin mining, data centers, and similar businesses, companies are seeking sites with access to existing infrastructure capable of producing massive amounts of electricity. To secure access, leases and similar arrangements are increasingly being structured to include priority access to immense quantities of power. Typically, such priority access to energy is secured through substantial upfront payments, while the underlying electricity is purchased at arm’s length on an ongoing basis.

This raises the question of whether contracts securing priority access to specified quantities of electricity constitute a Sec. 197 intangible asset for tax purposes. If not, are the costs subject to capitalization and amortization under Regs. Sec. 1.263(a)-4?

Below are two examples of arrangements commonly seen in industries relating to AI, HPC, bitcoin mining, data centers, and similar industries.

Scenario 1: Company AI (CAI) runs an AI–focused business that requires a stable and substantial power supply. To support its expansion, CAI plans to construct a new facility and has selected a site next to an established power station. As part of their negotiations, the parties agreed to a 100–year land lease, which for federal tax purposes is treated as a land acquisition. Alongside monthly rent, which aligns with market rates for similar properties, a significant upfront payment of $300 million is also due at the start of the lease. The agreement itself between CAI and the landowner does not define what the $300 million payment covers, but, unlike a standard lease agreement, this agreement grants CAI exclusive access to the first 2,000 kilowatts of electricity produced. If CAI does not use the full allocation, other parties may use the remaining capacity.

Scenario 2: Scenario 2 is the same as Scenario 1, except here CAI plans to lease and improve an existing facility located very near a power station. As part of their negotiations, the parties agree to a 40-year lease, which for federal tax purposes represents a true lease.

In each scenario the contract offers more than just access to electricity, and the total payments far exceed market rates for the property (or lease). Most importantly, the arrangement in each scenario ensures CAI’s priority access to a substantial quantity of electricity, which is essential for CAI to operate its AI business. The key question that arises is whether this exclusive right should be considered a separate intangible asset from the land itself.

How relevant is it that the priority access rights are obtained in a transaction that is called a lease? Substance–over–form principles would tell us that the name or title (form) put on a document does not determine the federal tax treatment; rather, the substance of the arrangement will drive the federal income tax result (see Gregory v. Helvering, 293 U.S. 465 (1935); see also Crenshaw, 450 F.2d 472, 477–78 (5th Cir. 1971)). So, if a lease agreement includes other related substantive items, such as the priority access rights, those should be looked at for what they are in substance.

What is an intangible asset, and when can they be amortized?

For tax purposes, an intangible asset is generally defined as any nonphysical property with measurable economic value that derives its worth from legal rights, relationships, or competitive advantages rather than physical attributes. Common examples include patents, copyrights, trademarks, customer lists, supply contracts, software, franchises, going concern value, and goodwill. To the extent the intangible falls within Sec. 197, a 15–year amortization period is required, regardless of the actual useful life.

Sec. 197 intangible assets

Congress enacted Sec. 197 to resolve recurring disputes over whether and how intangible assets could be amortized. Before its enactment, amortization of intangible assets required proving a determinable useful life, which led to significant litigation. Sec. 197 standardized this treatment by providing a uniform 15–year amortization period for a list of specific intangible assets that are commonly acquired, regardless of actual useful life.

Sec. 197 intangible assets include goodwill, going concern value, workforce in place, information bases, patents, copyrights, customer– and supplier–based intangibles, covenants not to compete, franchises, trademarks, trade names, and certain licenses and permits.

Notably, under Sec. 197, items such as going concern value, supplier–based intangibles, and goodwill are subject to 15–year amortization even if they are not acquired in the acquisition of a trade or business. As discussed below, an upfront payment securing priority access to electricity appears to fall within this type of Sec. 197 intangible.

Going concern value: Pursuant to Regs. Sec. 1.197–2(b)(2), going concern value is an intangible asset tied to a business’s operational continuity. This includes the elements that contribute to the business’s continued operation, such as its existing operational structure, systems, reputation, and relationships, rather than the value of individual assets on a stand–alone basis. Going concern valueoften exists separately from goodwill and may be amortized separately under Regs. Sec. 1.197–2(b). A contract securing priority access to electricity appears to represent going concern value, as the right to the power ensures the business’s enduring ability to generate income following the transaction (and completion of the facility), without interruption or renegotiation.

Supplier–based intangibles: Where there is an economic benefit obtained from a contract or favorable relationships with suppliers, a supplier–based intangible may exist under Regs. Sec. 1.197–2(b)(7). Supplier–based intangibles ensure the future availability of goods or services that are used or sold by a business. This category includes favorable supply arrangements and/or advantageous relationships with parties that provide essential goods or services. Such an arrangement may exist whether it is explicitly defined in an enforceable contract or implicitly expected to continue, based on prior dealings. A right securing priority access to electricity may constitute a supplier–based intangible where it reflects a favorable relationship with an energy producer or landlord and/or where it arises from a long–term contract that guarantees a specified amount of electricity.

Contracts for the use of Sec. 197 intangible assets: Regs. Sec. 1.197–2(b)(11) provides that contractual rights such as licenses, agreements, or similar arrangements that permit a taxpayer to use an intangible asset owned by another party may give rise to a separate intangible asset. This category includes rights to use assets described under Sec. 197(d)(1)(C), such as trademarks, trade names, franchises, customer–based intangibles, supplier–based intangibles, and comparable assets, regardless of whether the taxpayer acquires full ownership or only the right to economically exploit the underlying intangible asset. A contract securing priority access to electricity may also reflect payment for the right to use an existing supplier–based intangible or similar asset, rather than the purchase of property or services.

Other similar items: Regs. Sec. 1.197–2(b)(12) provides an “other similar items” catch–all in the case of intangible assets that are materially similar to the types of intangible assets specifically listed under Sec. 197(d)(1)(C). This includes items such as workforce in place, information base intangible assets, customer or supplier relationships, know–how, and comparable items. This category captures intangible assets that provide similar operational or economic benefits to those listed, even if not explicitly enumerated. This classification is determined based on the asset’s substantive characteristics rather than its form or terminology. A contract securing priority access to electricity may be treated as an “other similar item” where the economic benefit parallels the value derived from favorable supply contracts, right–of–use contracts, and/or going concern value identified elsewhere in the regulations. This is particularly true in the context of AI, HPC, bitcoin mining, data centers, and similar businesses that are largely composed of intangible assets and require enormous amounts of electricity.

Capitalization and amortization under Secs. 263 and 167

Where Sec. 197 does not apply, Sec. 263 and Sec. 167 operate to determine (1) when a cost related to an intangible asset must be capitalized and (2) how that cost may subsequently be recovered. A current deduction is permitted only when the right or benefit does not extend beyond the earlier of 12 months after realization or the end of the following tax year (Regs. Sec. 1.263(a)-4(f)(1)).

Only intangible assets with a definite useful life can be amortized (Regs. Sec. 1.167(a)-3(a)). If an asset has an indefinite life, its basis is recovered only when it is disposed of. When the useful life is uncertain but not indefinite, taxpayers may choose to amortize its cost over 15 years using straight–line depreciation (Regs. Sec. 1.167(a)-3(b)).

Evaluating the substance of arrangements

A guaranteed supply for massive quantities of electricity is a critical asset for AI, HPC, bitcoin mining, data center, and similar businesses. Depending on the structure of the arrangement, priority access rights may fall within existing categories of amortizable intangible assets. In the scenarios discussed above, the economic substance of the transactions reflects more than a simple land purchase or lease. The $300 million upfront payment was above the market price for renting or purchasing the underlying land and was made to secure priority access to a large and dependable supply of electricity. This priority access right is separable from the underlying real property interests and is best viewed as an amortizable intangible asset, regardless of whether the arrangement arises in the context of a land acquisition or a land lease.

Such an arrangement is arguably most similar to going concern value, though it could reasonably align with other amortizable intangible categories discussed in this item. In any case, it is expected that it would be amortizable over a 15–year period. As these types of arrangements become more common, it is vital to evaluate their substance within the current statutory and regulatory framework. Absent further guidance, it is up to tax advisers and taxpayers to determine how such contracts should be amortized.

Editor

Mo Bell-Jacobs, J.D., is a senior manager, Washington National Tax, with RSM US LLP and a member of the AICPA Tax Executive Committee.

For additional information about these items, contact Bell-Jacobs at Mo.Bell-Jacobs@rsmus.com.

Contributors are members of or associated with RSM US LLP.