LEXIS-NEXIS® Congressional Universe-Document
Federal News Service, Inc.
Federal News Service
OCTOBER 19, 1999, TUESDAY
SECTION: IN THE NEWS
LENGTH: 4560 words
HEADLINE: PREPARED STATEMENT OF
TAX LEGISLATIVE COUNSEL
SENATE COMMITTEE ON FINANCE
SUBCOMMITTEE ON LONG-TERM GROWTH AND DEBT REDUCTION
Mr. Chairman, Ranking Member, and Members of the Subcommittee:
It is a pleasure to speak with you today about the current-law
tax provisions that may affect transactions undertaken with respect to the
restructuring of the
electric power industry.
The Administration supports restructuring of the
electric power industry.
Deregulation and increased competition, as envisioned by the Administration's Comprehensive
Electricity Competition Plan, will encourage more efficient production and
delivery of electricity resulting in savings for consumers, a more competitive
American economy, and reduced greenhouse gas emissions. Almost all States have
either adopted restructuring proposals that allow consumers to choose among
competing power suppliers or are considering such proposals. Federal action is
necessary, however, if State programs are to realize their full potential.
In April, the Administration delivered the Comprehensive Electricity
Competition Plan to Congress. As Secretary Richardson noted when the Plan was
legislation it proposes will provide the tools needed to ensure that
electricity markets operate as competitively and reliably as possible. The
Administration estimates that creating a competitive
electric industry will save consumers $20 billion per year.
Deputy Secretary Glauthier of the Department of Energy and I are here this
morning to discuss the
tax initiatives in the Administration's electricity restructuring proposals.
Certain Internal Revenue Code provisions may hinder certain transactions that
may be undertaken pursuant to the restructuring of the
electric power industry. In general, these provisions were drafted at a time when the
electric power industry was subject to rate regulation and
electric service generally was supplied by a local provider--whether the provider was a
taxable investor-owned utility or a
tax-exempt government-owned facility or cooperative. Toaddress these situations,
the Administration has proposed changes in the rules governing taxexempt
electric companies owned by a State or local governmental entity, a provision that
would allow unregulated utilities to make deductible contributions to nuclear
decommissioning funds, and
tax incentives for investments
in distributed power and combined heat and power facilities.
Under current law, interest on debts incurred by State or local governments is
excluded from income if the proceeds of the borrowing are used to carry out
governmental functions and the debt is repaid with governmental funds. If a
bond is nominally issued by a State or local government, but the proceeds are
used (directly or indirectly) by a private person and interest payments are
derived from the funds of such a private person, interest on the bond is
taxable unless the borrowing is for a purpose specifically permitted under the
Code and certain other conditions are met.
Facilities for electricity generation, transmission, and distribution may be
tax-exempt bonds if the financed facilities are used by and debt service is paid
by a State or local
governmental entity. A facility can satisfy the governmental use requirement
even when the electricity it generates or transmits is sold to private persons
so long as those persons are treated as members of the general public. The
general public for this purpose may include customers, such as large industrial
users, that are charged lower rates than others, such as residential customers,
under a reasonable and customary rate schedule. Private use occurs, however,
when electricity is sold under terms, such as low-rate, take-or-pay contracts,
not available to the general public or when facilities are operated by private
persons (other than under certain permitted management contracts) or the
benefits and burdens of ownership are otherwise transferred to private persons.
Such private .use of a facility (including, under the change-in-use rules,
private use that begins after an initial period of governmental use) may
render the interest on bonds that financed the facility taxable.
Both the Code and Treasury regulations provide certain short term and de
minimis exceptions to these general rules. For example, in some cases, up to
ten percent of the bond proceeds of an issue may be used for certain private
business uses without the entire issuance being treated as a private activity
bond. In addition, temporary Treasury regulations issued in 1998 permit bonds
outstanding on July 9, 1996 (the date of Federal Energy Regulatory Commission
(FERC) action to promote the creation of nondiscriminatory, open-access
transmission services) to retain their
tax-exempt status when the transmission facilities financed with those bonds are
used by private persons in connection with the provision of such openaccess
services. Those temporary regulations also provide that bonds outstanding on
July 9, 1996, may retain their
tax-exempt status notwithstanding certain private use of the generation facility
financed by the bonds. The private use must occur in connection with the sale
of excess capacity resulting from opening the issuer's power system to
competition. The regulations further require that the length of the sales
contracts cannot exceed three years, that the issuer issue no further
tax-exempt bonds to finance increased generation capacity during the term of
thecontract, and that any stranded costs recovered by such sales be used to
redeem outstanding taxexempt bonds.
The temporary regulations expire in January of 2001, about 14 months from now.
We have received useful comments from interested parties regarding these
regulations and will soon begin the process of developing permanent
regulations. Regulations, however, are incapable of fully addressing the issues
raised by restructuring.
Deregulation and Restructuring
The rules prescribing favorable
tax treatment for bonds issued to finance public power facilities were adopted at
a time when such facilities generally were operated to serve a limited, local
geographic area. The restructuring of the
electric power industry may result in situations and transactions that were not
contemplated when those rules were adopted, raising issues that require a
re-examination of such rules. Specifically, achieving a restructured
electricity industry is hampered by the following three issues that arise with
respect to the
tax-exempt bond rules:
First, municipal utilities may be reluctant to open up their service
territories to competition due to concerns regarding private use of their
bond-financed transmission facilities,
Second, some municipal utilities may be unable to compete effectively in a
deregulated environment because their bond-financed generation
facilities are subject to private-use limitations. Third, because municipal
utilities may finance output facilities on a
tax-exempt basis, they have a cost of capital advantage over private, for-profit
providers of electricity.
The efficiency and equity of a restructured industry depend on leveling the
playing field with respect to capital costs while at the same time ensuring
that government-owned facilities are not discouraged from fully participating.
To achieve efficient, nondiscriminatory transmission, it may be necessary to
turn the operation of government-owned transmission facilities over to
independent regional systems operators or in other ways use those facilities in
a manner that may violate the private use rules. As traditional service areas
of both investor-owned and government-owned systems are opened to retail
competition, the latter may find it necessary to
enter into long-term contracts with private users of electricity in order to
prevent their generation facilities from becoming stranded costs. Without
relief from the change-in-use rules, government-owned systems may be unwilling
to open their service areas to competition or allow their transmission
facilities to be operated by a private party.
To maintain fair competition between government-owned and investor- owned
electric companies in a restructured industry, and to avoid unwarranted indirect
federal subsidies in this restructured environment, no new facilities for
electric generation or transmission should be financed with
tax-exempt bonds. Because
electric distribution facilities are inherently local andoften commingled with other
public services, continued access to
tax-exempt financing of such facilities by government-owned
electric systems will not distort competitive balance in the industry. Moreover, these
distribution facilities will continue to serve customers as members of the
general public. Distribution facilities owned by for-profit providers will
continue to be subject to rate regulation as natural monopolies. Continued
tax-exempt financing of distribution facilities does, however, require a
bright-line standard for the distinction between transmission and distribution
The Administration's Comprehensive Electricity Competition Plan proposes the
following changes to the
tax-exempt bond rules to resolve issues under current law and assure that
restructuring of the
electric power industry will deliver real savings for all Americans. To address the
change-in-use issue, pre-effective date bonds (i.e., bonds issued before the
date the proposal is enacted) used to finance transmission facilities would be
permitted to retain their
tax-exempt status notwithstanding private use resulting from actions
pursuant to a FERC order requiring nondiscriminatory open access to those
facilities. Under the Administration's broader plan for encouraging industry
restructuring, FERC would be given the power to require governmental
electric utilities to provide such open access,
To encourage municipal power systems to open their service areas to
competition, preeffective date bonds used to finance generation or distribution
facilities would be permitted to retain their
tax-exempt status notwithstanding private use resulting from the issuer's
implementation of retail competition or from the issuer entering into a
contract for the sale of electricity or use of its distribution property that
will become effective after implementation of retail competition.
These changes will not affect the treatment of a sale to a private entity of a
facility financed with
tax-exempt bonds. Such a sale will continue to constitute a change in use.
To establish fair
competition in a restructured industry, interest on bonds (other than
preeffective date bonds) that finance
electric generation or transmission facilities would not be exempt. Distribution
facilities, defined as those operating at 69 kilovolts or less (including -
functionally related and subordinate property), could continue to be financed
tax-exempt bonds under the change-in-use rules of current law. In addition,
tax-exempt bonds could be issued to refund bonds issued before the enactment of
our proposal, but advance refunding would not be permitted.
Under current law, an accrual basis taxpayer generally may not deduct an item
until economic performance has occurred with respect to that item. This
economic performance requirement defers deductions for costs incurred in
decommissioning a nuclear power plant untildecommissioning occurs.
A taxpayer that is liable for the decommissioning of a nuclear power plant may,
however, deduct contributions to a qualified nuclear decommissioning fund that
will be used to pay the decommissioning costs.
A qualified nuclear decommissioning fund is a segregated fund that accepts only
contributions for which a deduction is allowable and that is used exclusively
for the payment of decommissioning costs,
taxes on fund income, payment of management costs of the fund, and making
investments. The taxpayer establishing or maintaining the fired must have a
direct ownership interest or, subject to certain restrictions, a leasehold
interest in a nuclear power plant and must be liable for decommissioning the
plant. A nuclear power plant is defined for this purpose as a nuclear plant
used predominantly in the trade or business of furnishing or selling
electricity at rates that have been established or approved
by a public utility commission. The fund is prohibited from dealing with the
taxpayer that established the fund. The fund is subject to
tax at a flat 20-percent rate. In general,
tax is imposed on the fund's net investment income after the deduction of
The taxpayer maintaining a qualified nuclear decommissioning fund generally
must include in income any amount distributed by the fund, other than for
payment of management costs. Thus, amounts withdrawn by the taxpayer to pay
nuclear decommissioning costs are included in income when the withdrawal
occurs. At that time, however, the taxpayer will be allowed a deduction for
decommissioning costs with respect to which economic performance has occurred.
Except to the extent provided in regulations, a taxpayer is also required to
include in gross income any amounts that are properly includible when (1) the
a qualified fund results in a deemed distribution of its assets, (2) the
taxpayer is required to terminate a qualified fund because decommissioning of
the nuclear power plant to which the fund relates is substantially complete, or
(3) the taxpayer disposes of the nuclear power plant to which a qualified fund
The regulations provide rules that apply when a taxpayer disposes of a nuclear
power plant and, in connection with the disposition, transfers its interest in
a qualified fund relating to that plant. If the transferee is eligible to
maintain a qualified fund and continues to maintain the fund after the transfer
while satisfying certain other conditions, the transfer of the fund is treated
as a nontaxable transaction. The transferor does not recognize any gain or loss
on the transfer and the transfer is not treated as a distribution of fund
assets with respect to which an inclusion in gross income is required. The
transferee also does not recognize any gain or loss on the transfer and takes
the transferor's basis in the fund. Under the regulations, the IRS may, if
necessary and appropriate to carry out the purposes of the statutory and
regulatory provisions relating to qualified funds, apply these rules (and
permit continued qualification of the fund) even in cases in which the
transferee would not otherwise be permitted to maintain a qualified fund.
The amount that may be contributed to a qualified nuclear decommissioning fund
for a taxable year is limited to the lesser of the cost of service amount or
the ruling amount. The cost of service amount is the amount of nuclear
decommissioning costs included in the taxpayer's cost of service for ratemaking
purposes for the taxable year. The ruling amount is the amountthat the IRS
determines to be necessary to provide for level funding of an amount equal to a
specified percentage of the nuclear
decommissioning costs of the taxpayer. The percentage of nuclear
decommissioning costs that can be funded through a qualified fund is determined
by dividing the period during which the fund is in effect by the useful life of
the nuclear power plant. In general, the effect of this limitation is that
qualified funds cannot be used to fund nuclear decommissioning liabilities that
relate to taxable years beginning before the enactment in 1984 of the provision
permitting taxpayers to establish such funds. The IRS specifies a schedule of
ruling amounts in a ruling issued to the taxpayer. If circumstances change, a
taxpayer may request a revised schedule of ruling amounts. In addition, the
schedule is reviewed at intervals of no more than 10 years (5 years if, instead
of a schedule prescribing a dollar amount for each taxable year, the IRS has
formula or method for determining the schedule of ruling amounts).
Taxpayers may set aside funds for nuclear decommissioning in addition to the
amounts they contribute to qualified funds. In some instances, State or Federal
regulators require such additional funding. In addition, some taxpayers
maintained segregated nuclear decommissioning funds prior to the effective date
of the qualified decommissioning fund rules. In the case of amounts irrevocably
set aside for nuclear decommissioning before July 19, 1984 (the effective date
of the economic performance requirement), taxpayers may have taken the position
that a deduction was allowable at the time the funds were set aside.
Alternatively, taxpayers may have taken the position in taxable years ending
before that date that such amounts, if set aside to comply with State or
Federal regulatory requirements, were not includible in gross income.
Since 1984, no deduction or exclusion from gross income has been allowable with
respect to contributions to, or segregation of amounts in, nonqualified funds
and the income of a nonqualified fund is taxed to the taxpayer at the
taxpayer's marginal rate.
Issues Raised by
Deregulation and Restructuring
The rules prescribing favorable
tax treatment for qualified nuclear decommissioning funds were adopted at a time
when almost all nuclear power plants were operated by regulated public
utilities and a nuclear power plant and decommissioning fund would not be
transferred except between regulated public utilities.
Deregulation and restructuring of the
electric power industry have resulted in situations and transactions that were not
contemplated when those rules were adopted. These novel circumstances have
given rise to a number of questions, including the following:
May an unregulated taxpayer maintain a qualified nuclear decommissioning fund?
may arise when, as part of
deregulation, a nuclear power plant and the related decommissioning fund are transferred
from a taxpayer subject to rate regulation to an unregulated taxpayer.
Alternatively, a taxpayer that was previously subject to rate regulation with
respect to electricity produced at a nuclear power plant may, because of
deregulation, no longer be subject to such regulation.
Does the transfer of a qualified nuclear decommissioning fund to an unregulated
taxpayer result in recognition of gain or loss by the transferor or the fund?
Is such a transfertreated as a distribution of fired assets required to be
included in the gross income of the transferor?
Is the transferor of a nuclear power plant entitled to a deduction for
decommissioning liabilities assumed by the transferee?
To what extent may the purchaser of a nuclear power plant derive an immediate
tax benefit from assumption of the seller's decommissioning liabilities?
May an unregulated taxpayer make deductible contributions to a qualified
nuclear decommissioning fund? This issue also arises with respect to both
previously regulated taxpayers and unregulated transferees.
Guidance under Current Law
Under current law, the IRS may permit the transfer, without disqualification,
of a qualified nuclear decommissioning fund, together with the nuclear power
plant to which it relates, to a taxpayer that is not a regulated public
utility. In addition, the IRS may permit the unregulated transferee to maintain
the qualified fund after the transfer. In the cases that have been brought to
our attention, it is our view that such treatment is both necessary and
appropriate to carry out the purposes of the statutory and regulatory
provisions relating to qualified funds. Similarly, a regulated taxpayer that
becomes unregulated should also be permitted, in appropriate cases, to continue
maintaining a qualified fund.
The IRS may
similarly permit the transfer of a qualified nuclear decommissioning fund from
a regulated taxpayer to an unregulated taxpayer to qualify as a nontaxable
transaction that (1) does not result in recognition of gain or loss by either
the transferor or the fund and (2) is not treated as a distribution of fired
assets required to be included in the gross income of the transferor. If the
transaction is nontaxable, the basis of fund assets will not change and the
transferee will take the transferor's basis in the fund. Again, in the cases
that have been brought to our attention, it is our view that such treatment is
necessary and appropriate under current law.
Under current law, the seller of a nuclear power plant will be allowed a
current deduction for any amount treated as realized or otherwise recognized as
income as a result of the purchaser's assumption of the seller's
decommissioning liability. The economic performance
rules would ordinarily defer the seller's deduction until decommissioning
occurs. However, regulations provide that, if a trade or business is sold and
the purchaser assumes one of its liabilities, economic performance occurs with
respect to the liability when the amount of the liability is included in the
amount realized by the seller.
Under current law, a liability is not treated as incurred until economic
performance occurs with respect to the liability. Thus, the purchaser of a
trade or business is not allowed a deduction for liabilities assumed in
connection with the purchase until economic performance occurs with respect to
the liabilities. The regulations clarify, in the case of nondeductible items,
that the economic performance requirement also defers the
tax benefit of an increase in basis. The regulations state,
"an amount a taxpayer expends or will expend for capital improvements toproperty
must be incurred (i.e., economic performance must occur)
before the taxpayer may take the amount into account in computing its basis in
the property." In the case of decommissioning liabilities assumed in connection with the
purchase of a nuclear power plant, the regulations suggest that the liabilities
may not be taken into account in determining the basis of the acquired assets
until decommissioning occurs.
Deregulation will generally eliminate traditional cost of service determinations for
ratemaking purposes. Because the amount of the deductible contribution to a
qualified nuclear decommissioning fund is limited to the amount of nuclear
decommissioning costs included in the taxpayer's cost of service for ratemaking
deregulation may result in complete loss of the deduction for contributions to the fund. In
many cases, a line charge or other fee will be imposed by a State or local
government or a public utility commission to ensure that
adequate funds will be available for decommissioning. This charge or fee could
be viewed as the equivalent of an amount included in cost of service for
nuclear decommissioning, but there is no assurance that all State
deregulation plans will provide for such a funding mechanism.
tax treatment of contributions to nuclear decommissioning funds recognizes the
national importance of the establishment of segregated reserve funds for paying
nuclear decommissioning costs. Although the favorable
tax treatment was adopted at a time when nuclear power plants were operated by
regulated public utilities,
deregulation will not reduce the need for such funds. Accordingly, the Administration's
Comprehensive Electricity Competition Plan proposes to repeal the cost of
service limitation on deductible contributions to nuclear decommissioning
funds. Under the Administration proposal, unregulated taxpayers would be
deduction for amounts contributed to a qualified nuclear decommissioning fund.
As under current law, the maximum contribution and deduction for a taxable year
could not exceed the ruling amount for that year. The new rules would apply in
taxable years beginning after December 31, 1999.
DISTRIBUTED POWER AND COMBINED HEAT AND POWER PROPERTY
The Administration's Plan also includes two
tax proposals intended to reduce current barriers to the development of
distributed power and combined heat and power technologies. Distributed Power
Newly developed distributed-power technologies have made it possible to place
electricity generation assets in or adjacent to commercial and residential
establishments, as well as in industrial settings. The current depreciable
property classification system, however, does not adequately account for these
assets, particularly when they are used to produce both electricity or
mechanical power and
usable heat. Also, under current law, distributed power assets used to produce
electricity in a commercial or residential setting are likely to be depreciated
over much longer lives than are similar, or identical, assets used to produce
process energy in an industrial setting.The Administration's Plan proposes to
clarify that distributed power property has a 15-year depreciation recovery
period. Such property would include assets used to produce electricity that is
primarily used in a building owned or leased by the taxpayer. Such assets may
also be used to produce usable thermal energy. To avoid abuse, at least 40
percent of the total energy produced would have to consist of electrical power,
and no more than 50 percent of the electricity produced could be sold to, or
used by, unrelated persons.
This proposal will simplify current law by clarifying the assignment of
periods to distributed power property. It will remove taxpayer uncertainty,
tax litigation, and level the playing field for distributed power assets. It
should also encourage the use and development of more energy-efficient and less
polluting electrical generation technologies.
Combined heat and power (CHP) systems utilize thermal energy that is otherwise
wasted in producing electricity by more conventional methods. Such systems
achieve a greater level of overall energy efficiency, and thereby lessen the
consumption of primary fossil fuels, lower total energy expenditures, and
reduce carbon emissions. The Administration's Plan proposes a temporary
tax credit for investments in CHP equipment. The eight-percent credit would be
available for investments in large CHP systems that have a total energy
70 percent and in smaller systems that have a total energy efficiency exceeding
60 percent. It would be available for qualifying investments made through 2002.
To prevent abuses, a qualifying CHP system would be required to produce at
least 20 percent of its total useful energy in the form of thermal energy and
at least 20 percent of its total useful energy in the form of electrical or
The CHP investment
tax credit is expected to accelerate planned investments and induce additional
investments in such systems. The increased demand for CHP equipment should, in
turn, reduce production costs and spur additional technological innovation in
improved CHP systems.
We urge Congress to enact the
tax proposals I have outlined in my testimony. These proposed changes are needed
to encourage restructuring plans that are being developed
by individual States and to permit those plans to realize their full potential.
Mr. Chairman, this concludes my prepared testimony. I will be pleased to answer
any questions you or other members of the Subcommittee may have.
LOAD-DATE: October 21, 1999