Revenue Procedure 2010-20 provides guidance on a technical issue of profound interest to the electric utility industry, but does so in a manner that should interest any taxpayer receiving a non-shareholder contribution to capital. The guidance, issued March 10, 2010, provides a safe harbor under which the IRS "will not challenge" a corporation's treatment of certain "Smart Grid" grants received from the Department of Energy as non-shareholder contributions to capital excluded from income under section 118(a) of the Internal Revenue Code. The safe harbor is available only if the grant recipient reduces the basis of tangible property in the amount of the grant.
For the electric utility industry, the revenue procedure is a half-measure. On one hand, the guidance shields from immediate taxation grants received under the Smart Grid Investment Matching Grant Program of 42 U.S.C. § 17386 ("SGIG"). Smart Grid grants received under a separate program for technology research, development, and demonstration are not eligible for the safe harbor. On the other hand, the IRS's pledge that it "would not challenge" the application of section 118 to SGIG payments is not the permanent income exclusion for which many in the industry were hoping. Because section 362(c) requires an offsetting reduction in the basis of tangible property, the IRS effectively has permitted only a deferral of income, rather than a permanent exclusion.
This approach also arguably excludes from its scope grant recipients not organized as corporations. The IRS's position is that section 118(a), which by its terms applies only to corporations, is the exclusive mechanism to exclude from gross income non-shareholder contributions to capital. For these reasons, a number of constituencies within the electric utility industry had urged the Treasury Department to conclude that these grants are not includible in gross income without regard to section 118(a).
Of broader concern than the treatment of Smart Grid grants, however, is the procedural route taken by the IRS. Assuming the grants are not otherwise excludible from gross income, the SGIG program appears to fall squarely within the scope of a non-shareholder contribution to capital as described in section 118(a) of the Code and the Supreme Court's standard articulated in United States v. Chicago, Burlington & Quincy Railroad Co., 412 U.S. 401 (1973). The terms of 42 U.S.C. § 17386 state that the grants are to be used for specified infrastructure improvements and not for routine operating expenses. As such, it is troubling that the IRS did not conclude in an authoritative revenue ruling that these grants are non-shareholder contributions to capital as a matter of law, rather than taking the more equivocal approach of stating that the IRS "will not challenge" that position.
The procedural posture taken with respect to Smart Grid grants in Revenue Procedure 2010-20 is yet another indication of the IRS's narrow approach to section 118(a) and the audit risks inherent in relying on this provision to exclude from income a non-shareholder capital contribution. This concern is heightened by the IRS's recently announced "transparency" initiative with respect to "uncertain tax positions."
Revenue Procedure 2010-20 also signals the likely approach to be taken by the IRS with respect to grants made to members of the telecommunications industry under the Department of Commerce's Broadband Technology Opportunities Program. The telecommunications industry has been seeking guidance with respect to broadband grants since that program's 2009 enactment. As does a March 4, 2010, letter from the IRS Chief Counsel to the Commerce Department's General Counsel, Revenue Procedure 2010-20 signals the likely direction to be taken by the IRS in that guidance.
Above all else, the IRS's treatment of Smart Grid grants highlights the importance of ensuring that legislation providing targeted grants specifically provides for their exclusion from gross income. Otherwise, as seen in Revenue Procedure 2010-20, the intended incentive may be blunted administratively.
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Marc Gerson, email@example.com, 202-626-1475
Patricia Sweeney, firstname.lastname@example.org, 202-626-5926