In the wake of the devastating wildfires that engulfed the State of California in 2019, California enacted legislation, California Assembly Bill 1054, to, amongst other things, authorize the creation of a Wildfire Fund. The Wildfire Fund enables California’s electric facilities to receive reimbursement for the costs and expenses related to a catastrophic wildfire. In addition, if a participating electric utility engaged in specified safety activities delineated by the public utility commission, it would be eligible for a relaxed standard of review in determining the prudency of its conduct (improving the likelihood it would not have to reimburse the Fund for prior recoveries), as well as an overall liability cap.
The Fund was initially capitalized with contributions from the State and the California electric utilities that chose to participate (Initial Contribution). In addition, a participating utility would need to make annual contributions (Annual Contributions) to retain the benefits under the legislation, but did not receive any new rights or protections from such contributions. There was no stated expiration date for the legislation or of the rights created thereunder.
In PLR 202024002 (available here), the Internal Revenue Service (IRS) addressed the appropriate tax treatment of a participating utility’s Initial Contribution and the Annual Contributions made thereafter. Given the substantial current and future benefits conferred upon the utility by making the Initial Contribution, there was no dispute that such costs were properly capitalizable under Section 263(a) and Treas. Reg. Sec. 1.263(a)-4(b)(1). The issue was how the utility could properly recover the capitalized costs.
The first question that needed to be addressed was whether the costs were attributable to the acquisition of an “amortizable section 197 intangible.” Why? Section 197(b) provides that section 197 is preemptive, i.e., if section 197 applies, recovery is not available under any other provision of the Code, including section 167.
To answer this question, the IRS had to determine the nature of the bundle of rights received for the contributions. Were they “an amortizable section 197 intangible” recoverable over 15 years? More specifically, were they a “license, permit, or other right granted by a government unit” as described in Section 197(d)(1)(D)? There is scant authority addressing the scope of this provision, but Treas. Reg. Sec. 1.197-2(b)(8) provides several examples, including a liquor license, a taxi cab medallion, airport slots and airline routes, and radio and television broadcast licenses. The IRS concluded that the rights obtained in exchange for the Initial Contribution were sufficiently akin to the rights delineated in the regulations to warrant recovery under that provision. Accordingly, the IRS ruled that the utility’s Initial Contribution was amortizable over the 15-year period provided in section 197(a).
The second question was whether the Annual Contributions were further payments for the rights created by the Initial Contribution or instead created new rights presumably subject to a new 15-year amortization period. The taxpayer represented that the Annual Contributions merely enabled the participating utility to maintain the rights obtained from the Initial Contribution rather than enhancing those rights or creating new ones. Accordingly, the IRS concluded that the Annual Contributions would be amortizable over the remaining amortizable basis of the Initial Contribution, beginning with the first day of the month in which the Annual Contribution is added to basis under Treas. Reg. Sec. 1.197-2(f)(2).
| Eversheds Sutherland Observation – Although presented with a rather unique fact pattern, the IRS undoubtedly reached the right conclusion; the taxpayer received significant intangible benefits granted by a government and its subsequent payments did not confer additional rights on the taxpayer. Given the indefinite period of the benefits, section 197(d)(1)(D) was likely the only feasible means of recovery. Taxpayers should consider whether to apply the appropriately expansive view of the governmental grant rule if they seek recovery of the costs of acquiring any type of acquired governmental right. |
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1 All section references are to the Internal Revenue Code of 1986, as amended, or to the Treasury Regulations issued thereunder
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