Business & Money

Utilities will gain from new regs for research tax credits.

The 1990s ushered in the era of deregulation, bringing the disposition of generation assets by utilities, the decline or end of rate cases, and the reluctance of state commissions to approve large capital expenditures for transmission and distribution (T&D). Unfortunately, time has shown that this reduced level of spending was not enough to maintain existing T&D assets, let alone add new capacity.

To make up for this, capital spending has increased dramatically in the last few years: between 2002 and 2004, investor-owned utilities averaged $5.4 billion a year on new distribution, and another $3.5 billion annually on new transmission construction expenditures, according to Edison Electric Institute (EEI) estimates. ¹

Now the federal government is stepping in to help utilities prime the pump: To partially mitigate these cash outlays and or to help utilities make additional funds available for this construction, the government created several opportunities for tax relief. EEI President Tom Kuhn acknowledged the importance of these tax savings presentation to Wall Street analysts in January.

The final regulations, issued in early 2004 by the U.S. Department of the Treasury should make it a little easier for utilities, as well as other taxpayers, to use research and development (R&D) expenditures to help lower their effective tax rates.

Significantly, the regulation both expands the definition of what can be considered R&D activities for tax credit purposes and eases certain record keeping requirements for companies seeking to recoup a portion of their R&D outlays. These rule changes had been under consideration since December 2001.

As the regulations are now written (under U.S. Internal Revenue Code Sections 174 and 41), utility companies can earn tax credits for "processes of experimentation" without having to prove that "new-to-the-world" technological information has been discovered.

In the past, the IRS took a more narrow view of R&D. For utilities, that meant R&D tax credits could be earned only for projects or activities that resulted in the discovery of information that was new to the industry, such as those relating to alternative energy sources like wind- or solar-power generation. Under the newly written regulations, it is the inherently competitive nature of the now-deregulated industry sector that will spark wider eligibility for the credits:

Specifically, the wording of the new regulations allows utilities to seek tax credits for conducting "a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer's research activities." (The IRS cautions, however, that the mere "existence" of uncertainty will not satisfy this requirement.)

When these requirements or tests are met and fully documented, utility companies are likely to find that more commonplace activities-for example, searching for the optimal design for a new substation or the best materials to protect underground cables-are now eligible for a tax credit.

Taxpayers Must Pass A Four-Part Test

Under the final regulations, utilities seeking tax credits must demonstrate that their R&D