EXHIBIT 99.2
PRIVATE RULING 200101023; 2000 PRL LEXIS 1768
DATE: October 4, 2000
REFER REPLY TO: [*1] Refer Reply To: CC:FIP:2/PLR-111110-00
Release Date: 1/5/2001
LEGEND:
Parent = * * *
Company = * * *
Department = * * *
Authority = * * *
State A = * * *
State B = * * *
Statute = * * *
SPE Securities = * * *
Investor Securities = * * *
a = * * *
b = * * *
c = * * *
d = * * *
Date 1 = * * *
Dear * * *
[1] This letter is in reply to your letter dated June 1, 2000, asking the
Internal Revenue Service to rule on the transaction described below.
FACTS
[2] Parent is the common parent of an [*2] affiliated group of corporations
that includes Company. Parent files a consolidated return for the group.
[3] Company, a calendar year taxpayer that uses the accrual method of
accounting, is an investor-owned electric utility in State A. Company generates,
transmits, and distributes electricity to residential, commercial, industrial,
and governmental customers within its service area. Company has a monopoly for
providing electricity within its service area and is regulated by Department,
the Federal Energy Regulatory Commission, and the Nuclear Regulatory Commission.
[4] State A is deregulating the power-generation portion of its electric
industry. After industry restructuring, Company's customers will be allowed to
contract directly with alternative suppliers of electricity, and electric
utilities and other suppliers will compete to sell electricity.
[5] Statute contemplates that certain costs of electric utilities,
including previously incurred costs associated with generation facilities that
have market values below their book value, costs associated with contracts to
purchase electricity at above- market prices, and other external costs, will not
be recoverable from customers [*3] in a reorganized, competitive electric
industry. To facilitate the transition from the current regulated system to a
competitive one, Statute permits the electric utilities to recover a portion of
these costs (Stranded Costs). To permit this recovery of Stranded Costs, Statute
authorizes and directs Department to allow the utility to collect from consumers
of electricity located in its service area and using the distribution system of
the utility a special charge (Competitive Transition Assessment or CTA) that is
based on the amount of electricity purchased by the consumers, regardless of
from whom they purchase electricity.
[6] After enactment of Statute, Department approved Company's collection of
a CTA to recover its Stranded Costs pursuant to Statute.
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[7] Statute also authorizes Department to permit the utility to securitize
a specified portion of its CTA. Statute contemplates that securitization
transactions will be executed pursuant to a financing order (Financing Order)
issued by Department and provides a comprehensive framework for such
securitization.
PROPOSED TRANSACTION
[8] Company has applied for a Financing Order from Department pursuant to
Statute authorizing Company [*4] to finance a portion of its Stranded Costs,
together with transaction costs and credit enhancement, through the issuance of
SPE Securities and Investor Securities each with an aggregate principal amount
of approximately a. Pursuant to Statute, the Financing Order is expected to
identify the portion of Company's CTA that may be securitized (such portion,
once securitized, RRB Charge). The RRB Charge is defined as a non- bypassable
charge payable by customers, that will yield the amounts necessary to provide
for interest on the Investor Securities, the amortization of all Investor
Securities in accordance with the applicable expected amortization schedule, the
payment of fees and expenses related to the issuance and servicing of the
Investor Securities, the collection of an overcollateralization amount and the
replenishment of a capital subaccount. The RRB Charge is a usage- based tariff
on each retail user's monthly bill until the SPE Securities and Investor
Securities are discharged in full.
[9] The principal asset to be used to support the SPE Securities is the
right to collect the RRB Charge, which Statute establishes as a separate
property right (Transition Property) that includes [*5] all right, title, and
interest in and to all revenues, collections, claims, payments, money, or
proceeds of or arising from the RRB Charge. Statute also provides that the
Financing Order must include a procedure for the periodic adjustment of the RRB
Charge. Pursuant to Statute and the Financing Order, the Transition Property and
the RRB Charge will be irrevocable, and cannot be reduced, rescinded, altered,
amended or impaired by either Department or State A. The RRB Charge will be set
to provide for recovery of the costs associated with billing and collecting the
RRB Charge as well as for an excess amount (Overcollateralization Amount) that
will eventually reach at least b percent of the initial principal amount of the
SPE Securities. The Overcollateralization Amount will be collected ratably over
the expected term of the SPE Securities.
[10] Company will form a wholly owned limited liability company (SPE) under
State B law as a bankruptcy remote company for the special purpose of
effectuating the proposed transaction. The SPE will use the accrual method of
accounting, and Company effectively will be the sole member of the SPE.
Authority will establish a State B business trust (Trust). [*6] The Trust will
not be an agency or instrumentality of State A.
[11] For federal income tax purposes, the SPE is expected to be treated as
a division of Company and not as a separate entity. The SPE will not elect to be
treated as a business entity taxable as a corporation under section
301.7701-3(b)(1) of the Procedure and Administration Regulations. Company will
contribute, as equity to the SPE, cash equal to at least b percent of the
initial principal balance of the Investor Securities (Capital Amount). The SPE
will invest the equity in financial instruments that are issued by parties
unaffiliated with Company and that can be readily converted to cash.
[12] Pursuant to the Financing Order, the SPE will issue SPE Securities to
the Trust. The SPE Securities will be nonrecourse to Company but will be secured
by the assets of the SPE including (a) the Transition Property, (b) accounts
maintained for payments on the SPE Securities (collectively, Collection
Account), (c) all amounts or investment property on deposit in or credited to
the Collection Account, (d) all other property of whatever kind owned by the SPE
(less amounts owed to certain service providers), and (e) all rights of [*7] the
SPE in and to the transaction documents such as the purchase agreement for the
Transition Property. The SPE Securities will not be subordinated to the claims
of any creditors or equity owners of the SPE, other than for payments of
trustee, servicing, and administrative fees. The SPE Securities will be issued
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in one or or more series. Each series of the SPE Securities may be offered in
one or more classes, each expected to have a different principal amount, term,
interest rate, and amortization schedule. The SPE Securities will have legal
maturities accordance with Statute, and the Company expects that the longest SPE
Securities will have scheduled maturities that are at least c months earlier, as
necessary to meet the rating agencies' triple-A rating standards. Scheduled
maturity is the date on which the final principal payment is expected to be
paid; legal maturity is the date on which nonpayment is a default.
[13] The SPE Securities are expected to be sold at or near par value and
will not in any event be sold for more than par value. Interest on the SPE
Securities will be payable not more frequently than quarterly. Principal
payments are expected to be applied in sequential [*8] class order within each
series until the outstanding balance of such class or series is reduced to zero.
The SPE Securities will also be subject to an optional "clean-up" call when the
outstanding principal amount of a series declines to less than d percent the
original principal amount of such series.
[14] The Trust will issue Investor Securities to underwriters, who will
sell the Investor Securities to public investors. The Investor Securities will
be in the form of pass-through certificates representing beneficial ownership
interests in the SPE Securities held by the Trust. Each class of each series of
Investor Securities will represent fractional undivided beneficial interests in
a class of a series of SPE Securities held by the Trust and the proceeds
thereof. Therefore, each class of Investor Securities will have a principal
amount, term, interest rate, amortization, and call provisions that are
identical to the corresponding class of SPE Securities. The Investor Securities
will be secured by a statutory lien on the Transition Property as provided by
Statute.
[15] The Trust will transfer the proceeds from the issuance of the Investor
Securities, net of its transaction expenses, [*9] if any, to the SPE, as
consideration for the SPE Securities. The SPE will then transfer to Company, as
consideration for the transfer of the Transition Property to the SPE, the
balance of such proceeds, net of any remaining transaction expenses. The assets
of the Trust will consist of the SPE Securities and any swap or other hedging
agreement executed solely to permit the issuance of variable rate Investor
Securities. The Investor Securities are expected to be sold at or near par
value.
[16] Upon issuance of the initial series of SPE Securities, the SPE will
establish the Collection Account, which will consist of at least four
subaccounts entitled General, Reserve, Overcollateralization, and Capital.
Additional subaccounts may be established in respect of additional credit
enhancements or as necessitated for convenience by the transaction documents.
These accounts will be maintained and administered in trust by the trustee for
the SPE Securities.
[17] On behalf of the SPE, Company will act initially as the servicer for
the Transition Property. As servicer, Company will bill and collect the RRB
Charge and retain all books and records regarding the RRB Charge, subject to the
right of [*10] the SPE and the Trust to inspect those records. Company, or any
successor servicer, will periodically remit (as frequently as required by the
rating agencies and in all events within one calendar month of collection) the
billed and collected RRB Charge to the trustee for the SPE Securities. Monies
deposited with the trustee for the SPE Securities will be held in the Collection
Account. Only in the event that Company fails satisfactorily to perform its
servicing functions will Company be subject to replacement as servicer.
Company's ability to resign as servicer will be restricted.
[18] The billed and collected RRB Charge will be remitted to the Collection
Account. Amounts in the Collection Account will be used to pay trustee fees,
servicing fees, administrative costs, operating expenses of the SPE and the
Trust, accrued but unpaid interest on all classes of the SPE Securities, and
principal (to the extent scheduled) on the outstanding SPE Securities. Any
remaining billed and collected RRB Charge will be allocated to the Capital
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Subaccount (to the extent that the Capital Subaccount is below the required
capital level), the Overcollateralization Subaccount (to the extent scheduled),
[*11] and then to the Reserve Subaccount.
[19] If the billed and collected RRB Charge in any period is insufficient
to satisfy the SPE's payment obligations on the SPE Securities, then amounts in
the Reserve Subaccount, the accumulated Overcollateralization Amount, and
Capital Amount will be used (in that order) to satisfy scheduled principal and
interest payments. To the extent that the Overcollateralization Amount or the
Capital Amount is used to satisfy principal and interest payments on the SPE
Securities, the RRB Charge will be adjusted in the future to restore those
amounts.
[20] Investment earnings on amounts in the Collection Account also may be
used to satisfy scheduled interest and principal payments on SPE Securities and
to restore the Capital Amount and the scheduled Overcollateralization Amount.
Except for earnings on the Capital Subaccount, any excess earnings will be
remitted to the SPE and, after the last scheduled date for the payment of
accrued interest and principal on the bonds, will be distributed to Company for
the benefit of its customers. Investment earnings on amounts in the Capital
Subaccount, to the extent not used to satisfy the Investor Securities, will be
paid [*12] to Company periodically. Amounts in the Capital Subaccount and any
investment earnings thereon, to the extent not used to satisfy the Investor
Securities, will be returned to Company after the Investor Securities are paid
in full.
[21] The SPE Securities will provide for the following events of default:
(1) a default in the payment of accrued interest on any class of SPE Securities
(after a specified grace period); (2) a default in the payment of outstanding
principal as of the legal maturity date; (3) a default in payment of the
redemption price following a call as of the redemption date; (4) certain
breaches of covenants, representations or warranties by the SPE in the indenture
under which the SPE Securities are issued; and (5) certain events of bankruptcy,
insolvency, receivership or liquidation of the SPE. In the event of a payment
default on the SPE Securities, the trustee for the SPE Securities or holders of
a majority in principal amount of all series then outstanding may declare the
principal of all classes of the SPE Securities to be immediately due and
payable.
[22] ISSUES
1. Does the issuance of the Financing Order result in gross income to
Company?
2. Does the issuance [*13] of the SPE Securities or the Investor
Securities result in gross income to Company?
3. Are the SPE Securities obligations of Company?
LAW
[23] Section 61 of the Internal Revenue Code generally defines gross income
as "income from whatever source derived," except as otherwise provided by law.
Gross income includes income realized in any form, whether in money, property,
or services. Section 1.61-1(a) of the Income Tax Regulations. This definition
encompasses all "accessions to wealth, clearly realized, and over which the
taxpayers have complete dominion." Commissioner v. Glenshaw Glass Co., 348 U.S.
426, 431 (1955), 1955-1 C.B. 207.
[24] The right to collect the RRB Charge is of significant value in
producing income for Company, and State A's action in making the RRB Charge
rights transferable has enhanced that value. Generally, the granting of a
transferable right by the government does not cause the realization of income.
Rev. Rul. 92-16, 1992-1 C.B. 15 (allocation of air emission rights by the
Environmental Protection Agency [*14] does not cause a utility to realize gross
income); Rev. Rul. 67-135, 1967-1 C.B. 20 (fair market value of an oil and gas
lease obtained from the government through a lottery is not includible in
income).
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[25] The economic substance of a transaction generally governs its federal
tax consequences. Gregory v. Helvering, 293 U.S. 465 (1935), XIV-1 C.B. 193.
Affixing a label to an undertaking does not determine its character. Rev. Rul.
97-3, 1997-1 C.B. 9. An instrument secured by property may be an obligation of
the taxpayer or, alternatively, may be a disposition of the underlying property
by the taxpayer. Cf. id. (the Small Business Administration is the primary
obligor of certain guaranteed payment rights that are created under its
participating security program).
CONCLUSIONS
[26] Based on the facts as represented, we rule as follows:
1. The issuance of the Financing Order authorizing the collection of the
RRB Charge by Company will not result in gross income to Company.
2. Neither the issuance of the SPE Securities to the Trust nor the issuance
of the Investor Securities [*15] by the Trust will result in gross income to
Company.
3. The SPE Securities will be obligations of Company.
[27] Except as specifically ruled on above, no opinion is expressed or
implied regarding the federal tax aspects of the transaction.
[28] This ruling is directed only to Company. Under section 6110(k)(3) of
the Code, this ruling may not be used or cited as precedent.
[29] A copy of this letter should be attached to the federal income tax
return of Company for the taxable years that include the transaction described
in this letter.
Sincerely yours,
Acting Associate Chief Counsel
(Financial Institutions &
Products)
By: /s/ MARSHALL FEIRING
---------------------------------
Marshall Feiring
Senior Technician Reviewer,
Branch 2
