United States: IRS Issues Guidance On Tax Treatment Of Energy Savings Performance Contracts

On January 19, 2017, the Internal Revenue Service (IRS) issued Rev. Proc. 2017-19, 2016-6 I.R.B. (the Rev. Proc.), providing a safe harbor under which it will not challenge the tax treatment of an Energy Savings Performance Contract Energy Savings Agreement (ESPC ESA) as a service contract under Section 7701(e)(3). While the application of the guidance is limited to the ESPC ESA context, the Rev. Proc. nonetheless provides potential insight into the IRS's views of other power purchase agreements for the purchase of renewable energy generally.

In Depth

On January 19, 2017, the Internal Revenue Service (IRS) issued Rev. Proc. 2017-19, 2016-6 I.R.B. (the Rev. Proc.), providing a safe harbor (the Safe Harbor) under which it will not challenge the tax treatment of an Energy Savings Performance Contract Energy Savings Agreement (ESPC ESA) as a service contract under Section 7701(e)(3). While the application of the guidance is limited to the ESPC ESA context, the Rev. Proc. nonetheless provides potential insight into the IRS's views of other power purchase agreements for the purchase of renewable energy generally.


42 U.S.C. § 8287 authorizes a federal agency (FA) to enter into an ESPC ESA with an energy service company (ESCO) for the purpose of achieving energy savings. The statute, and the ESPC ESA structure in particular, was enacted to encourage FAs to invest in onsite renewable energy generation projects. The ESPC ESA structure is governed by requirements in § 8287 and guidance issued by the Office of Management and Budget (OMB). Under the typical ESPC ESA structure, the ESCO installs, owns and operates the renewable energy generating property at the federal site for the term of the contract. The FA purchases energy generated from the project from the ESCO, and pays the value of its energy savings to the ESCO for the term of the contract. 

Under 42 U.S.C. § 8287 and the OMB guidance, the term of the ESPC ESA cannot exceed 25 years, and title to the renewable energy generation asset must transfer to the FA at the end of the ESPC ESA term. To facilitate the purchase, the ESCO must set aside a portion of the ESPC ESA payments into a reserve account for the FA's future purchase of the generating asset. Accordingly, the amount charged by the ESCO includes both the price of energy and the defeasance amount, and cannot exceed the energy savings under the project. This structure facilitates investment into renewable energy assets by the FA without requiring a significant upfront expenditure.

In 2016, the US Department of Energy (DOE) requested comments on the ESPC ESA program because of market reluctance to pursue these projects. The DOE determined that there was concern that the reserve account and purchase obligation, described above, could adversely affect the treatment of the ESPC as a service contract under Section 7701 for tax purposes, jeopardizing the availability of the Section 48 investment tax credit (the ITC). The ITC is generally not available if the relevant project is "used" by governmental entities, as discussed further below.

Section 7701

Section 7701(e) provides rules to determine, for federal income tax purposes, whether a contract that purports to be a service contract should in fact be treated as a lease of property. Section 7701(e)(1) provides factors that should be taken into account for determining whether a service contract should be treated as a lease. Notwithstanding the general rule of Section 7701(e)(1), Section 7701(e)(3) and (4) provide that a purported service contract with respect to an alternative energy facility will be respected as a service contract, unless any of the following applies:

(1)        The service recipient operates the facility;

(2)        The service recipient bears any significant financial burden if there is non-performance under the contract;

(3)        The service recipient receives any significant financial benefit if the operating costs of such facility are less than the standards of performance or operation under the contract; or

(4)        The service recipient has an option or obligation to purchase all or part of the facility at a fixed and determinable price, other than for the fair market value of the facility.

An "alternative energy facility" means a facility producing electrical or thermal energy if the primary energy source for the facility is not oil, natural gas, coal or nuclear power.

Responses to the DOE's requests for comments stated a concern that the mandatory defeasance and purchase obligation could adversely affect the treatment of the ESPC ESA under Section 7701(e). If a service contract under the ESPC ESA program is not respected, the IRS could treat the FA as the lessee of the energy generating equipment, which would make the project ineligible for the ITC under Section 50(b)(4)(A)(i). Section 50(b)(4)(A)(i) prohibits the use of ITC projects by governmental entities.

Safe Harbor under Rev. Proc. 2017-19

In response to these concerns, the IRS issued the Safe Harbor in the Rev. Proc. under which the IRS will not challenge the treatment of a ESPC ESA as a service contract under Section 7701(e)(3). The Safe Harbor requirements are as follows:

(1)        The total term of the ESPC ESA cannot exceed 20 years in length. The term must be consistent with and appropriate for the scope and scale of the renewable project.

(2)        The ESPC ESA must satisfy the requirements of 42 U.S.C § 8287 and the OMB guidance.

(3)        Under no circumstances will the FA attempt to operate the renewable energy generation asset. In the event of a shutdown or mechanical issue, the FA will immediately notify the ESCO or its designated contractor.

(4)        The ESCO bears all financial risk for non-performance, except to the extent such non-performance is attributable to a temporary shutdown of the facility for repairs, maintenance or capital improvements.

(5)        The contract price for electricity will not be reduced if operating costs should diminish.

(6)        The FA may have the option to purchase, or may be required to purchase, the renewable energy generation asset at the end of the contract term, for its fair market value at the time of the purchase.

The Rev. Proc. states that the Safe Harbor applies only to an ESPC ESA between an ESCO and a FA for the provision of electricity through an alternative energy facility, and the Rev. Proc. may not be relied upon, in whole or part, for any other kind of transaction. 

The Rev. Proc. provides an example of the application of the Safe Harbor. In the example, the contract term is 20 years and the FA will purchase the renewable energy generation asset at its fair market value as appraised at the time of the sale by the end of the contract term. To ensure that the reserve account has sufficient funds for the purchase at the end of the contract term, there may be periodic reappraisals of the assets and contract modifications (if and as necessary).

Significance of the Rev. Proc.

The Safe Harbor generally tracks the requirements for treatment as a service contract under Section 7701(e)(4), but with one notable addition: under the Safe Harbor, the contract length cannot exceed 20 years. Based on our review of the Rev. Proc., the DOE's requests for comments and the responses thereto, it is unclear why the IRS introduced the 20-year limitation. It is also unclear why the Safe Harbor notes that there may be a purchase option, when the ESPC ESA program requires the sale to the FA at the end of the contract term. 

Further, the Rev. Proc.'s effectiveness is uncertain in light of the regulatory freeze announced by the Trump administration in a White House memorandum ("Regulatory Freeze Pending Review") on January 20, 2017. Specifically, it is unclear whether the memorandum places a "freeze" on sub-regulatory guidance such as the Rev. Proc. The Rev. Proc. was intended to be effective for transactions entered into on or after the date of its publication in the Internal Revenue Bulletin, but was not published prior to the announcement of the regulatory freeze. 

Adding to the ambiguity surrounding the Rev. Proc., it has uncertain relevance to contracts outside the ESPC context for the purchase of energy from renewable energy generation assets.  Although the Rev. Proc. is limited to ESPC ESA contracts entered into under 42 U.S.C. § 8287 with a mandatory defeasance and purchase obligation, it raises questions as to whether the Safe Harbor—and the 20-year contract term limitation in particular—reflects the IRS's views towards renewable energy contracts outside the ESPC context. We will be following this issue with interest to see if the Rev. Proc. survives the regulatory freeze or if the IRS otherwise speaks on this subject.

IRS Issues Guidance On Tax Treatment Of Energy Savings Performance Contracts

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.