Two Congressional resolutions would allow utilities to deduct the cost of energy conservation services in the year the costs are incurred. Supporters hope they will end a challenge by some Internal Revenue Service agents who are forcing some utilities to capitalize those costs.

A number of IRS agents have interpreted a Supreme Court decision, INDOPCO Inc. versus Commissioner 112 S. Ct. 1039 (1992), to mean that expenditures related to energy-efficiency should be capitalized--that is, deducted over a period of time. But taking tax deductions on energy conservation investments in the year in which they are made is more economically attractive to utilities than deducting the expenses over a longer period.

A capitalization interpretation would add to the cost of conservation programs and expose utilities to punitive losses for tax benefits that have flowed through to utility ratepayers in prior years, contends Gloria Quinn, of the Edison Electric Institute (EEI). This is really part of a broader debate because it isn't just utilities that are affected but a lot of other companies too, she adds.

Utility energy conservation programs frequently defer cost recovery and provide performance incentives to compensate utilities for administering the programs. Utilities have consistently deducted conservation expenditures in the year paid or incurred for federal income tax purposes regardless of the rate recovery methods imposed by regulators. Quinn warns that the new IRS interpretation could be taken so far as to disallow deductions made in previous years by utilities.

In fact, Southern California Edison Co. recently informed the California Public Utilities Commission that because of the potential tax liability, it will suspend its rebate programs in January 1995, if the issue hasn't been resolved. The utility annually spends about $50 million of its $138 million demand-side management budget on rebates.

In a hearing last year before the Subcommittee on Select Revenue Measures of the House Ways and Means Committee, Tony Smith, director of taxes at Southern California Edison Co., argued that the IRS interpretation is contrary to the National Energy Policy Act. These utilities expend considerable funds for conservation services to assist customers to utilize energy more efficiently [but] the products the customers purchase, such as energy-efficient appliances, are owned by the customers, not by the utilities, he said.

In 1991, the national IRS office issued a Technical Advice Memorandum (TAM9128010) to Puget Sound Power and Light Co. covering the company's 1979-'80 tax years, ruling that conservation expenditures are not required to be capitalized, yet leaving the issue unresolved by indicating that such expenditures may be subject to capitalization where a cause and effect link is established to significant future benefits.

Now, EEI claims, the IRS is ignoring the memorandum, and is asking the Treasury Department to publish a ruling clarifying that conservation expenditures are currently deductible regardless of the rate-making methods and performance incentives that may be authorized by regulators to encourage conservation programs.

Utilities want an administrative solution to clarify that conservation expenditures are fully deductible in the year incurred. Two proposed measures (H.R. 784, and Senate Bill 988) would do this, but they are not expected to go before Congress this year. Supporters of these resolutions are still hoping for a favorable outcome and some think a resolution can be reached by the end of this year through a Treasury Department ruling.

In 1993, the IRS lost a bid to tax residential utility customers who got rebates for installing energy-efficient appliances. Under the Federal Energy Policy Act, the rebates aren't taxable (see IRS to Lose Its Slice of Utility Rebates, HE May/June '93, p.8).
 

Jim Hammett is a San Francisco-based freelance writer.
 

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