IRS offers new guidance on utilities tapping securitization

On Thursday the Internal Revenue Service provided updated guidance on how utility companies are allowed to use securitization to recover costs through rate increases to customers.  

The new regulations are denoted by the IRS as Rev. Proc. 2024-15 which updates Rev. Proc. 2005-62. The ruling expands the definition of public utility companies to include publicly owned power companies, co-ops and investor-owned utilities.  The new guidelines also change the definition of a “qualifying securitization.” 

The highly technical bulletin spells out that securitizations must be issued by a state qualifying financing entity identified as “a state, political subdivision thereof, or other organization authorized to issue debt on behalf of a state or political subdivision thereof.” 

Qualifying securitizations are defined as “as an issuance of any bonds, notes, other evidences of indebtedness, or certificates of participation or beneficial interest.”  

The securitization must be secured by the intangible property right to collect charges for the recovery of specified costs and other assets owned by the utility. 

The financing entity must be owned by the utility and have equity interests that are at least 0.5% of the aggregate principal amount of the non-equity interests issued. Payments are required to be made on a quarterly or semi-annul basis. 

The new regulations appear to be aimed at investor-owned utilities looking for ways to finance what’s known in the industry as “stranded assets.” 

“I’m guessing this has to do with a situation like, ‘I’m an investor-owned utility and I’ve got a large coal-fired plant. The state wants me to stop operating it because it’s polluting, but I’m still paying everything off,'” said John Godfrey, senior government relations director, American Public Power Association.  

Most of the electricity in the U.S. is provided by investor-owned utilities and merchant generators. Publicly owned power companies and rural electric co-ops, combined produce about thirty percent of the nation’s power. 

Securitization is becoming a useful debt financing tool for utility companies stuck with fossil fuel power plants on their books that are not paid off and have become too expensive to operate.

Assuming the state and local public services commission allow it, the cash flow from the troubled plant can be converted into a debt instrument, which is then sold to investors as bonds secured by future utility payments as the plant continues to operate.

“The state issues bonds to pay off the debt and makes it an irrevocable election to have the cost of that paid in the utility customers bills on a monthly basis,” said Godfrey. “The purpose of this red flag is to clarify the tax treatment of that transaction for purposes of the investor-owned utility.”  

Last June the IRS sent the publicly owned power industry, which operate as non-profits, good news in the form of clarified rules governing trading clean energy tax credits for cash.

The ruling is expected to boost bond issuance. The tax credits were delivered via the Inflation Reduction Act and until the guidance was changed, could only be accessed by for-profit power companies. 

The American Public Power Association states that that “tax-exempt municipal bonds are the single most effective tool for financing investments in public infrastructure, including the generation, transmission, and distribution used to serve public power utility customers.”