2. Income attributable to utility services (sec. 821 of the Act and sec. 451 of the Code)101 Prior Law Under both present and prior law, taxpayers using an accrual method of accounting recognize income at the time all the events have occurred which establish the taxpayer's right to receive the income and the amount of income can be established with reasonable accuracy. Under prior law, utilities using an accrual method of accounting were allowed to recognize income in the taxable year in which a customer's utility meter was read, providing a similar technique was used for financial accounting purposes (Rev. Rul. 72-114, 1972-1 C.B. 124). Some judicial decisions rendered prior to the enactment of the Act allowed income to be recognized in the taxable year in which a customer's utility meter was read regardless of the technique used for financial accounting purposes. See, e.g., Orange and Rockland Utilities v. Commissioner, 86 T.C. No. 14 (1986). Reasons for Change The Congress believed that a method of accounting that recognized income in accordance with an event other than the provision of utility services did not accurately measure the taxable income of an accrual basis utility. Methods of accounting that recognized income at the time a customer's utility meter was read or at the time the customer was billed fail to recognize income as it was earned and resulted in a mismatching of income and expense. The continued allowance of such methods of accounting would have provided an unwarranted exception to the rules of accounting applicable to other taxpayers. In addition, the Congress also was aware that the proper method of accounting for utility services by an accrual basis utility was then a matter of controversy between taxpayers and the Internal Revenue Service. In order to minimize disputes over prior taxable years, the Congress believed that a method of accounting that took into account income from the provision of utility services on the basis of the accounting period in which the customers' meters were read should be accepted for those prior years. Explanation of Provision The Act requires accrual basis taxpayers to recognize income attributable to the furnishing or sale of utility services to customers not later than the taxable year in which such services are provided to the customer. The year in which utility services are provided may not be determined by reference to the time the customer's meter is read or to the time that the customer is billed (or may be billed) for such services. The effect of the provision is to require an estimate of the income attributable to utility services provided during the taxable 101 For legislative background of the provision, see: H.R. 3838 as reported by the Senate Committee on Finance on May 29, 1986, sec. 322; S. Rep. 99-313, pp. 120-121; and H. Rep. 99-841, Vol. II (September 18, 1986), pp. 322-324 (Conference Report). year but after the final meter reading or billing date which falls within the taxable year. It is anticipated that, where it is not practical for the utility to determine the actual amount of services provided through the end of the current year, this estimate may be made by assigning a pro rata portion of the revenues determined as of the first meter reading date or billing date of the following taxable year. Utility services subject to the provision of the Act are the provision of electrical energy, water or sewage disposal, the furnishing of gas or steam through a local distribution system, telephone and other communications services, and the transportation of gas or steam by pipeline. The Congress anticipated that similar rules also would be applicable to other utility services which might come into existence at some future date. Whether or not a utility service is regulated by a government or governmental agency does not affect its treatment under this provision. It is expected that taxpayers required to accrue income at the time that utility services are furnished to customers also will be able to accrue at such time any deductions for the related costs of providing the utility services, so long as economic performance has occurred with respect to such costs in the year in question. The Act provides that, for any taxable year beginning before August 16, 1986, a method of accounting which took into account income from the providing of utility services on the basis of the period in which the customers' meters were read shall be deemed to be proper for Federal income tax purposes. The Congress also intended such a method to be deemed proper for Federal income tax purposes for a taxable year beginning after August 16, 1986 and before January 1, 1987, if the taxpayer used such method for its preceeding taxable year.102 Such a method is deemed to be proper only if that method was actually used by the taxpayer for the preceeding taxable year. No inference is intended as to whether or not such a method is proper if the method is retroactively adopted by the taxpayer. No inference is intended as to other methods of accounting for utility services (e.g., a method of accounting which takes income into account on the basis of the date the customer is billed for utility services or a hybrid method that combines the recognition of income at the time customers' meters are read with another method). Also, no inference is intended with regard to other questions of law, including but not limited to the treatment of prepaid income amounts for the provision of utility services at a future date, the treatment of deposits made by utility customers, or the treatment of amounts received by a taxpayer under a "budgetbilling" procedure. Effective Date The provision is effective for taxable years beginning after December 31, 1986. The amount of any adjustment required to be made as a result of this provision is to be included in income ratably over the first four taxable years for which the provision is effective. 102 A technical correction may be necesary to reflect this intention. It also is anticipated that (1) net operating loss and tax credit carryforwards will be allowed to offset any positive section 481 adjustment; and (2) for purposes of determining estimated tax payments, the section 481 adjustment will be recognized in taxable income ratably throughout the year in question. In the case of a taxpayer that has delayed the deductions of related costs of providing the utility services in order to match such costs with the period in which income is recognized, the change in accounting method required under this provision will include any change in accounting method for the related items of expense or deduction necesary in order to allow the deduction of these items in the same period as the related income is recognized. This change in method of accounting, however, is limited to items of expense or deduction for which economic performance has occurred within the taxable year in question. The net amount of the two changes is taken into income ratably over a 4-year period. Revenue Effect The provision is estimated to increase fiscal year budget receipts by $191 million in 1987, $356 million in 1988, $384 million in 1989, $387 million in 1990, and $200 million in 1991. 3. Contributions in aid of construction (sec. 824 of the Act and secs. 118(b) and 362(c)(3) of the Code)103 Prior Law Under both present and prior law, the gross income of a corporation does not include contributions to its capital (sec. 118(a)). Under prior law, a corporate regulated public utility that provides electric energy, gas (through a local distribution system or transportation by pipeline), water, or sewage disposal services was allowed to treat contributions received in aid of construction as a contribution to capital not includible in gross income (sec. 118(b)). Such contributions could not have been included in the utility's rate base for rate making purposes. Property received (or purchased with the proceeds of) a contribution to capital had no depreciable basis for Federal income tax purposes and was not eligible for the investment tax credit. Reasons for Change The Congress believed that all payments that are made to a utility either to encourage, or as a prerequisite for, the provision of services should be treated as income of the utility and not as a contribution to the capital of the utility. The Congress believed that prior law allowed amounts that represented prepayments for services to be received by corporate regulated public utilities without the inclusion of such payments in gross income. Accordingly, the Act repeals the prior law treatment and requires the recipient utility to include the value of such contributions in income at the time 103 For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, sec. 908; H. Rep. 99-426, pp. 643-645; and H. Rep. 99-841, Vol. II (September 18, 1986), p. 324 (Conference Report). of their receipt and to depreciate the value of any asset contributed, or purchased with a contribution of cash, over the recovery period of the asset. Explanation of Provision The Act repeals the provision of prior law (sec. 118(b)) that provided that contributions in aid of construction received by a corporate regulated public utility be treated as a contribution to the capital of the utility. Congress intended that the effect of the change be to require a utility to report as an item of gross income the value of any property, including money, that it receives to provide, or to encourage it to provide, services to, or for the benefit of, the person transferring the property to the utility. A utility is considered as having received property to encourage the provision of services if the receipt of the property is a prerequisite to the provision of the services, if the receipt of the property results in the provision of services earlier than would have been the case had the property not been received, or if the receipt of the property otherwise causes the transferor to be favored in any way. Congress intended that a utility include in gross income the value of the property received regardless of whether the utility had a general policy, stated or unstated, that requires or encourages certain types of potential customers to transfer property, including money, to the utility while other types of potential customers are not required or encouraged to make similar transfers. If members of a group making transfers of property are favored over other members of the same general group not making such transfers, the fact that the contributing members of the group may not be favored over the members of other groups in the receipt of services will not prevent the inclusion of the value of the transfer in the gross income of the utility. For instance, where a utility generally requires developers of multiple tracts of residential housing to transfer property to the utility in order to obtain service, but does not require such a transfer from individual homeowners, the fact that both groups will receive service without preference of one group over the other will not prevent the utility from being required to include in gross income the value of the property received from the developers. Where all members of a particular group make transfers of property to the utility, normally it will be assumed that such transfers are to encourage the provision of services, despite the absence of any formal policy requiring such transfers, unless it is clearly shown that the benefit of the public as a whole was the primary motivating factor in the transfers. The person transferring the property will be considered as having been benefitted if he is will receive the services, is an owner of the property that will receive the services, is a former owner of the property that will receive the services, or derives any benefit from the property that will receive the services. Thus, a builder who transfers property to a utility in order to obtain services for a house that he was paid to build will be considered as having benefitted from the provision of the services. This is the case despite the fact that the builder may never have had an ownership interest in the property and may make the transfer to the utility after the house has been completed and accepted. A transfer of property to the utility from a person benefitting from the services will be deemed to occur under this provision if such treatment is in accordance with the substance of the transaction, regardless of the form in which such transaction is conducted. For example, a transfer of property to the utility may occur even though the person benefitting from the services nominally retains legal title to such property, if the the effect of the transaction is to transfer to rights and burdens of ownership to the utility. Similarly, a transfer of property from a real estate developer to obtain services for a tract being developed will be deemed to occur even though such transaction is arranged in the form of a loan from the developer to the utility, unless adequate interest is charged on the moneys lent. Where repayment of a loan to a utility is contingent, it is normally expected that a taxable transfer of property will be considered to have occurred, if the contingent loan is made to allow or to encourage the utility to provide services for the benefit of the person making the contingent loan. To the extent that income is recognized by the utility in such a case, it is anticipated that a deduction will be allowed for repayment in the period in which the repayment is made. The amount of any such deduction should reflect any depreciation deductions that may have previously been taken with regard to the property transferred (or purchased with the proceeds of the transfer). The value of property transferred to a utility, and thus the amount required to be included in income, is its fair market value. Fair market value is to be determined in the same manner as for the purpose of determining gain or loss when property is received in a sale or exchange. That is, the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell. This amount may be different than the cost to the transferor of constructing or acquiring the property transferred. Whether or not the value of the property transferred is allowed to be included in the rate base of the transferree, or the depreciation on the property transferred is allowed as an expense for the purpose of determining if the transferree is earning an adequate return on its rate base, is not intended to be a determinant of the transferred property's value. A sale of property to a utility at less than fair market value or its lease to a utility for less than a fair market rental is treated as a taxable transfer as a result of this provision. The provision does not effect transactions that would not have been treated as nontaxable contributions in aid of construction under section 118(b) of prior law. For example, a transaction that qualifies as a like-kind exchange under section 1031, or that qualifies as an involuntary conversion under section 1033 is taxed under those sections and not as a taxable transfer under this provision. Effective Date The provision is effective for contributions received after December 31, 1986. |