Statement of Power Ahead

Power Ahead is a coalition of electricity transmission owners and transmission equipment manufacturers from across the country. The coalition is dedicated to promoting the expansion, enhancement, and reliability of North America’s electrical transmission system. Power Ahead is working to ensure that there is sufficient transmission capacity to deliver the electricity that America generates to the regions in which it is needed.

New investment in transmission capacity has not grown as quickly as use of the transmission system, and projections for the future indicate little planned growth in transmission investment. The lack of new transmission investment threatens to impair the reliability of our electric power networks and to impede progress toward competition in electric power markets.

Recent changes in electric markets in which more electric generators are independent from transmission and distribution companies require more electric transmission infrastructure to allow multiple generators access to each market and thereby to increase competition. While this problem is most apparent in California, transmission capacity lags behind consumption in all regions of the country, and many needed transmission facilities in each region have not been built.

Tax and regulatory disincentives are a major reason for under-investment in transmission. Private companies that build transmission facilities are subject to federal regulation, and these companies will only invest if they have reasonable expectations of adequate profits. An important component of these expectations is the tax treatment of investments in transmission. While there has been much discussion about the growth in profits for independent power producers, the situation is vastly different for transmission owners.

Allowing transmission owners the opportunity to earn higher returns on their investments can actually reduce consumers’ total costs for power by encouraging investments to expand transmission capacity. Increased transmission capacity will allow more power generators to serve power markets, thus increasing competition among generators and leading to lower rates. Electric transmission costs are a small portion of the total delivered cost of electricity and are far outweighed by costs of generation. While creating regional transmission organizations ("RTOs") and making other regulatory changes are important for improving electric markets, only clear, legislatively mandated tax and regulatory incentives for transmission investment and improved use of existing capacity will ensure that we have the transmission infrastructure we need.

Power Ahead advocates measures designed to increase investment in transmission infrastructure and improve use of existing infrastructure by enhancing the expected returns from such investments.

• "[A]n antiquated and inadequate transmission grid prevents us from routing electricity over long distances and thereby avoiding regional blackouts, such as California’s." National Energy Policy: Report of the National Energy Policy Development Group, May 2001.
• "[T]he real solution to California’s problems lies in increased investments in infrastructure . . . the increased reliance of regions within California and the rest of the West on widely dispersed resources to provide peak needs over the past several years has revealed significant needs for transmission expansion and investment." FERC, Notice Of Opportunity For Comment On Staff Recommendation On Prospective Market Monitoring And Mitigation For The California Wholesale Electric Market, Docket No. EL00-95-012, March 9, 2001.
• "We need to not only increase electricity generation by building new plants in under-served states like California, we need to also build the transmission facilities that will create a reliable electrical grid." House Majority Whip Tom Delay (R-TX), Testimony before the House Energy and Commerce Committee, March 6, 2001.
• "As a complement to the vital initiative of increasing generation supply, we focus today on where we believe this Commission can have the greatest impact--fostering the installation of critical transmission investment." FERC, Order Removing Obstacles To Increased Electric Generation And Natural Gas Supply In The Western United States And Requesting Comments On Further Actions To Increase Energy Supply And Decrease Energy Consumption, Docket No. EL01-47-000, March 14, 2001.

• "[The] shortage [in transmission capacity] could lead to serious transmission congestion and reliability problems . . . . There is a need to ensure that transmission rates create incentives for adequate investment in the transmission system . . . ." National Energy Policy: Report of the National Energy Policy Development Group, May 2001.
• "While attention is focused today on California’s blackouts and the harm that soaring natural gas and electric prices have had on the economies of neighboring states, Abraham said New York State, too, needs to ratchet up its electric transmission capacity to handle rising demand." Energy Secretary Spencer Abraham, quoted in Energy Secretary Encourages Investment, AP Online, March 21, 2001.
• "Since the start of electric power restructuring in earnest in the early 1990s the level of new investment in the transmission sector has lagged behind the growth in consumer electricity demand." PA Consulting Group, The Future of Electric Transmission in the United States, January 2001.
• "[E]lectric grid managers [need] to step up efforts to add new transmission capacity in the state (Massachusetts) and region to help curb soaring electric costs." Massachusetts Attorney General Thomas F. Reilly, quoted in Peter J. Howe and Rick Klein, AG Urges Boost in Power Grid Capacity Says Regional Upgrades of Transmission Systems Would Curb Electric Rates, The Boston Globe, January 10, 2001.
• "Concern about transmission capacity has reached a fevered pitch in the electric industry in recent months. And in truth, if the nation’s electric transmission network continues as it has, failing to expand enough to keep pace with growth in demand for electricity, then within a few years today’s problems could become a crisis." Transmission Crisis Looming? Eric Hirst, Separating Hype From Fact; Hard Numbers and Hopeful Projections on the Adequacy of the Electric Grid, Public Utilities Fortnightly, September 15, 2000.

In keeping with the focus of this hearing, our testimony focuses on eliminating tax disincentives to restructuring the electricity transmission industry and to certain new investments and providing limited incentives for new transmission investment.

The Committee has heard testimony on a number of tax issues relevant to transmission. What follows are some details regarding two of the most important issues faced by transmission owners today.

FERC’s policy has been to encourage the formation of regional transmission organizations or separate transmission companies ("transcos") to separate operating control of transmission and generation assets. Under current tax law, however, it is very difficult for vertically integrated providers to separate transmission from generation without triggering large tax liabilities on the assets they sell. Thus, even when utilities would like to spin-off or sell their transmission assets, they are either constrained from doing so or forced to restructure their assets in ways that lead to other business problems.

One Power Ahead member, an independent transmission owner, had to be structured as a limited liability company ("LLC") to avoid current tax on the separation of generation from transmission that led to its formation. As a practical matter, the LLC structure discourages growth through the addition of transmission facilities from other utilities because it is difficult to acquire transmission assets in exchange for LLC membership interests. Moreover, the LLC structure makes access to the equity capital markets cumbersome.

Section 118(b) requires the inclusion in income of "contributions in aid of construction" ("CIAC") that are made to encourage utilities to sell power to a customer. Section 118, however, does not treat payments made to encourage utilities to purchase power from co-generation facilities as taxable CIAC. The IRS recognized this crucial distinction in its Notice 88-129, stating as follows:

"In a CIAC transaction the purpose of the contribution of property to the utility is to facilitate the sale of power by the utility to a customer. In contrast, the purpose of the contribution by a Qualifying Facility to a utility is to permit the sale of power by the Qualifying Facility to the utility. Accordingly, the fact that the 1986 amendments to Code section 118(b) render CIAC transactions taxable to the utility does not require a similar conclusion with respect to transfers from Qualifying Facilities to utilities."

Notice 88-129, 1988-2 C.B. 541 (Dec. 12, 1988).

The Notice sets forth six criteria that must be met to report the transaction as non-taxable under a "safe harbor" rule.¹ Unfortunately, the Notice excludes from its safe harbor provisions many current transactions that meet the intent of Section 118 merely because the generation facilities being connected to the grid are not "qualifying facilities" ("QFs") under the Public Utility Regulatory Policies Act of 1978. (Following the restructuring of the industry, most generators seeking interconnections to sell power across the grid are not QFs.) Moreover, although some of the other Notice 88-129 criteria--notably, the requirement that the contract last for at least ten years--are not practicable in restructured power markets, the IRS has not updated the Notice to account for the restructuring of the industry.

Compounding this problem, last year, the IRS stopped issuing private letter rulings confirming the non-taxable status of transactions that meet most--but not all--of the Notice 88-129 criteria,² and informal approaches to the IRS National Office have yielded no guidance regarding current market transactions. As a result, utilities have felt compelled to pay the CIAC tax on transactions that clearly meet the Congressional policy of facilitating sales by customers to the grid solely because the IRS no longer will rule on such transactions.

Finally, under current law, even if transactions are treated as nontaxable contributions to capital, that status might not extend to recipients, such as LLCs, that are not corporations. That nontaxable status derives from Section 118(a)’s nontaxable treatment of contributions to the capital of a corporation. Thus, if a non-corporate entity receives otherwise nontaxable CIAC, the CIAC might not be considered a contribution to the capital of a corporation and, accordingly, would be taxable to the non-corporate recipient. Correction of this disparity in treatment of CIAC by corporate and non-corporate entities is important for transmission companies as some are forced to adopt a non-corporate structure for other tax reasons.

Power Ahead proposes that Congress should address the tax disincentives to transmission investment and provide limited tax incentives for new transmission investments. Among the items Congress should consider are the following:

Because FERC’s RTO policy makes dispositions of transmission facilities essentially involuntary, it is appropriate to treat such sales as involuntary conversions under Section 1033. This would allow utilities to defer tax on the separation of transmission and generation assets, provided that the proceeds of such sales are reinvested within the industry.

There are precedents for extending such treatment to sales made to further Federal policy with respect to an industry. For example, Section 1033(c) provides that sales of acreage made to comply with limitations in Federal reclamation laws shall be treated as involuntary conversions. Similarly, Congress allowed the telecommunications industry a window in which to treat certain spectrum sales as involuntary conversions when those sales were made to comply with the FCC’s microwave relocation policy. See Section 1033(j). We believe that FERC’s policies regarding restructuring the electric industry raise similar issues and should be accommodated through tax policy.

Similar provisions are included in H.R. 1459.³

At a minimum, Congress should clarify the policy behind Section 118 so that the IRS will not tax CIAC transactions that connect new sources of generation to the grid. This could be accomplished by updating and codifying the criteria set forth in Notice 88-129 or by directing the IRS to issue regulations. In addition, Congress should confirm that this nontaxable treatment extends to both corporate and non-corporate taxpayers.

Similar provisions are included in H.R. 1459 and S. 389.⁴

As part of a balanced energy policy and considering that current law offers credits as incentives for certain forms of generating capacity, we believe it is appropriate to offer credits as incentives for new investments in transmission capacity that will deliver generated energy where it is needed and enhance competition in the wholesale electricity market.

Under current law, transmission assets are depreciated over relatively lengthy periods--20 years in most cases. In an era of rapid technological change, such lengthy depreciation periods may no longer be appropriate. Moreover, allowing faster depreciation would improve the after-tax returns on new investments in transmission capacity and make such investments more attractive.

Similar provisions are included in H.R. 2108,⁵S. 389, and S. 596.⁶

As part of an overall look at the research and development tax credit rules of Section 41, we urge Congress to clarify that the credit is available for research to improve the efficiency of transmission. Such research has great potential for expanding the capacity of the existing transmission grid and should be encouraged as part of a balanced energy policy.

Finally, we believe that any tax provision enacted by Congress should be structured to ensure that the benefits of those provisions are not taken into account by state public utility commissions in the rate-setting process. A similar approach was taken by Congress to ensure that utilities reaped the benefits of accelerated depreciation.

Congress can make a real difference to the Nation’s energy situation by reducing roadblocks to transmission investment. The Power Ahead proposals can make a difference quickly and spur new investment in transmission capacity.

Alstom Corporation
American Transmission Company LLC
PacifiCorp
Pepco
Xcel Corporation

1. The six criteria include that (1) the generator making the transfer of property is a QF, (2) the transfer is made either exclusively for the sale of electricity by the QF to the utility grid or for a dual-use interconnection where 5% or less of the expected total power flows are sales to the QF; (3) the construction cost is not included in the utility’s rate base; (4) the utility and the QF have entered into a power purchase contract of ten years or longer; (5) no disqualifying event (e.g., a violation of the 5% limit in item #2, above) has occurred; and (6) the utility company does not depreciate or amortize any interconnection property unless or until it becomes a taxable CIAC transaction.
2. Notably, the IRS used to issue private letter rulings confirming the non-taxable status of interconnections that were "analogous" to QFs. See, e.g., PLR 9648030 (Aug. 29, 1996); PLR 9540016 (June 30, 1995); PLR 9443019 (July 22, 1994); PLR 9420012 (Feb. 15, 1994); PLR 9211030 (Dec. 16, 1991).
3. H.R. 1459, the Electric Power Industry Modernization Tax Act, was introduced by Representative Hayworth on April 4, 2001.
4. S. 389, the National Energy Security Act of 2001, was introduced by Senator Murkowski on February 26, 2001.
5. H.R. 2108, the Energy Security and Tax Incentive Policy Act of 2001, was introduced by Representative Matsui on June 7, 2001.
6. S. 596, the Energy Security and Tax Incentive Policy Act, was introduced by Senator Bingaman on March 22, 2001.