Addressing Solar and Wind Tax Problems

Taxes are fundamental to strategic planning at all utilities. Tax planning is one more aspect affected by the COVID-19 pandemic. But even smart people have a tough time understanding the tax code. Cue the expert. 

PUF is fortunate to have discussed how utilities are being affected by current events with a law firm partner who specializes in tax issues, Brad Seltzer. Even better, he takes difficult subjects and explains them clearly so they make sense. 

He shares insights here on renewables, nuclear decommissioning, carbon capture, and state and federal regulatory topics affecting utilities. Because as we all know, taxes are one of the two parts in life none of us can escape.
 

PUF's Steve Mitnick: What are some of the most important tax matters you're working on that are affecting the industry?

Brad Seltzer: Some of the biggest ones right now are the concerns surrounding the effective dates for the wind and solar industries. We have two problems. 

One is a placed in service problem. These projects have to be placed in service by specified dates. The other is a continuity rule, which requires that once you start construction, you must maintain construction, but the pandemic has put wrinkles into both of those.

Getting relief on both of those is important. Solving those kinds of problems is not a natural fit for pandemic relief bills, and it's not entirely clear whether the IRS could simply do it on its own because it's the right thing to do. These dates are statutory. [Editor's note: Since this interview, the IRS issued Notice 2020-41 providing the necessary relief.]

Another big issue for us right now involves a number of companies I represent who are either getting started with, or are in the process of, nuclear decommissioning. We've had proposed regulations that are supposed to answer some important questions. 

When they came out with proposed regulations, there weren't a lot of comments. We were one of them. We commented and I testified, and those regulations were supposedly signed off on by OIRA back in January. They're important and we don't have them yet.

PUF: With nuclear decommissioning are there tax issues?

Brad Seltzer: Yes, in a couple of ways. Regulated utilities have what's called a qualified fund, and that qualified fund is tax advantaged in the sense that it is taxed at a lower rate, but not lower compared to what it used to be.

The differential is not as great since the Trump tax legislation lowered corporate rates, but it's still lower. What it allows is the buildup of this fund to finance nuclear decommissioning activities. But there are two problems sitting out there.

The IRS came out with these proposed regulations where they said you can only fund things that are deductible when the recipient spends them. But a lot of what utilities do in decommissioning is build these large structures to store all those contaminated assets. The structures to store nuclear fuel are very expensive. 

The IRS said that the costs are capital. Therefore, they say, you can't use the assets from the decommissioning trust to fund it. Now our belief is that's not the function of the qualified fund rules. All the qualified fund rule should care about is, are you decommissioning? If so, you should be able to finance it with the assets of the trust. 

Let the other part of the code tell you whether it's deductible or capitalizable. But that's a big issue because it affects liquidity. We hope they will come up with the right answer in the regulations.

Then the other issue is that while there are third parties out there that perform decommissioning, a lot of companies have set up non-regulated affiliates to do that work because they say, we know this business, we know how to do this.

With third parties it's presumably an arm's length transaction including the third party's profit. And all of those costs, including the profit, can be paid out of the trust. We say that if an affiliate wants to do this work of nuclear decommissioning, as long as they're not charging more than an outside third party, that should be okay. That gives the IRS angst. We have to clarify that rule as well. They are big issues with lots of zeros.

PUF: As you've pointed out here, tax issues can have major policy impacts, like what you were saying about the wind farms and so forth.

Brad Seltzer: Yes. There are state mandates for switching to renewables, principally retiring all the coal plants and eventually retiring the interim plants, gas plants, so what are you going to do? You build wind and you build solar or you buy power from wind or solar farms under a power purchase agreement. But the point is, they're being forced to, and utilities are fine with the switchover assuming we ever get storage up to its capacity. That is another tax issue.

We've been waiting forever on whether storage, which is added to a system after it is first placed in service year, is eligible for these tax credits. These are again expensive systems and the IRS hasn't told us its view even though they've been talking about issuing regulations for several years.

In all fairness, some of it is a little bit of a challenge for the IRS to deal with issues grounded in engineering and sophisticated technology rather than tax. Do they define eligible storage by function, by usage, by useful life, only by existing technologies, etc.? These are not the types of questions that are readily answered by tax administrators.

I'll give you an example.

Years ago, the IRS issued regulations governing qualified technological equipment. If you go to those regulations today, you will see that amongst the equipment that qualifies are calculators and keypunch cards.

I always tell them, you've got to try not to put your line in the sand and say this qualifies and this doesn't, when you have evolving technology. You have to define it in terms of its use or function as opposed to what it technically is today.

On a similar note, I told the IRS, they should stop trying to define what a qualified nuclear decommissioning cost is, because you have an entity called the NRC and you have entities such as State Regulatory Commissions, which only want you to spend the money correctly to decommission. If they are comfortable that an expenditure is incurred in connection with decommissioning and allows the use of the qualified funds to finance those expenditures, there is no need for the IRS to weigh in on the issue.

Why are you trying so hard to define this stuff? We're waiting for those regulations as well as the storage regulations. It's hard to get regulations out of the IRS, especially given the promises made to focus on TCJA regulations and now all of the COVID-19 relief legislation needing implementation and explanation.

Unfortunately, a traditional route for obtaining guidance, the private letter ruling, is often foreclosed because the IRS has a policy which says if we have a pending regulations project, we won't issue a ruling that will be potentially implicated by the regulations.

That's not a bad policy if you're pushing out regulations. If you're not pushing out regulations you just have people sitting on the edge of their seat waiting.

PUF: What should regulators know about the tax field?

Brad Seltzer: The primary issue where regulation intersects with taxation are the so-called normalization rules of the internal revenue code. The internal revenue code in this regard is interesting because just like insurance is considered as a state function subject, so is this with ratemaking and the way rates are set.

Congress realized what happened back in 1969. Congress realized that it couldn't tell the states how to treat federal taxes in regulation because of the Tenth Amendment. 

Congress was passing accelerated depreciation, and many states and Commissions would say, oh this is great, we'll just give that tax benefit to the ratepayers. The utilities kept saying, hey, what about us? You gave this to us as an incentive to build more plants, but our Commission just gave it away. This doesn't work. So, Congress stepped in and conditioned Federal benefits on certain state action.

For instance, with speed limits, it doesn't tell the state you must have a fifty-five or sixty-mile per hour speed limit. They say if you want federal funds, you have to agree to do it. Congress conditions federal funds on certain state action.

Normalization is the same way. What it says is, if the utilities claim accelerated depreciation, they're not going to keep it if their ratemaking body requires them to give it to ratepayers too quickly.

There are specific mechanisms for the allowed ratemaking treatment and most of your readers won't care about the particular mechanisms. But the treatment of taxes for ratemaking purposes is frequently a contentious subject in rate proceedings. 

The issue gets a little more acute as it did with the drop in tax rates because what happens is, the presumption is that when you collect money from ratepayers you will give it back to them over, to make it simple, the book life of the property and that the tax rate will remain unchanged.

What happens when you collect taxes from ratepayers at a thirty-five percent statutory rate, but the tax rate drops to twenty-one percent - the differential in those taxes between what you collected and what you will be required to pay to the Government are called excess deferred taxes. The issue is how do you treat those excess deferred taxes?

Congress has stepped in and explained it, but there are disputes both at the state level, and FERC also has its own issue, which is related. With respect to deferred taxes, essentially the IRS has said the excess deferred taxes can be shared with ratepayers over the book life of the property.

The other issue is related to whether pass through entities (partnerships) are allowed to collect taxes, which won't be paid by those entities, but will in fact be paid by their corporate owners. FERC has always allowed pass through entities with corporate owners to collect taxes on their owners' behalf. That was called the Lakehead doctrine. 

Several years later, some master limited partnerships came along and said, well our partners pay tax, so can't we collect taxes too?

FERC said, that makes sense. They collected tax too. Well, what's happened over the years is that those partnerships and master limited partnerships, some of them started getting individual taxpayers, pension plan partners, foreign investors, and tax exempt partners.

The argument for collecting taxes by the entity on behalf of partners who were not in fact U.S. taxpayers led to challenges to the Lakehead doctrine.

This dispute over many years is known as the United Airlines litigation. Essentially FERC said that unless the companies could show that they were not already adequately compensated for taxes (through a pre-tax rate of return) there would be no allowance for income taxes on behalf of partners.

That has spawned a whole round of ratemaking at FERC, which is not fully resolved.

Can partnerships and MLPs continue to collect taxes that they say ultimately someone will have to pay and how do they best demonstrate it?

PUF: What's on the horizon?

Brad Seltzer: If you look at the CARES Act and other things, there were bits and pieces that utilities benefit from, but it's bits and pieces. They're not the primary beneficiaries and yet they're seeing their revenues fall because of declining demand by as much as twenty percent.

Given their considerable protection in the form of regulation, utilities are not an obvious recipient of relief. At the same time, there are a lot of orders from state Commissions saying you can't cut people off for non-payment during this pandemic. Not surprisingly, bad debt reserves are going up.

There are two issues. One, is there something that they could get for coronavirus relief and what might that look like? One might be an acceleration of their ability to claim bad debt losses, or something like that. Another would be extensions of the credits and PTCs for solar and wind.

Also, will some of the COVID stimulus include plans for infrastructure? Not infrastructure benefits in the form of accelerated depreciation because again, the normalization rules don't give you the big bang for the buck.

Back in the big tax bill, TCJA, utilities gave up the right to a hundred percent bonus depreciation in exchange for relief under 163(j) because they have large interest expenses. For them the issue is, could they get direct payments for infrastructure because they get cash? 

Or could they get immediate credits? Because a lot of them have NOLs so they don't have taxable income from all those years of bonus depreciation. That would be a big deal for them. If utilities could get cash grants in lieu of energy credits or production tax credits, that would be extremely helpful.

The rest is regulatory relief. We talked about the renewables, and we've just got to get that stuff out. It's very hard because of this normalization rule for utilities to compete in having their own renewables versus a party that's not regulated, because the party that's not regulated can get the rates - the amount they charge for the electricity, they can use that tax benefit and just put it into the purchase price and reduce it.

The utility can't do that because of these normalization rules. Leveling the playing field by eliminating normalization for renewable projects owned by utility will be a big deal for these guys. 

Storage would probably be the next one if we can get the storage rules cleared up. For me, it's decommissioning. We don't really need a lot of legislation in Congress unless it is to extend the effective dates of the renewables so that people can still use them.

There is another big tax benefit out there. Carbon capture. The reason for that is it's like the gift that keeps on giving

It's not limited by your investment and the numbers are huge. Although there are a few projects under construction, many are holding back on making the big investments, because of technological uncertainty and also because of a lack of guidance. [Editor's note: Since the interview, the IRS issued added guidance for CCS, which answers many, but not all, open questions.]

Two, the decline in demand and the restrictions on cutoffs of nonpayers create liquidity problems. That's on the agenda for the future. We did poll our utility clients recently and asked folks what were their top issues, and carbon capture was not high on their list.

What was high on their list, number one, was extend renewables placed in service dates, and number two was clarify the continuity rules for pandemic delays. Three was, level the playing field for utilities on renewables by eliminating normalization and tied for fourth were storage regulations and infrastructure cash grants.