Independent solar generators Sunvestment Energy Group and Saranac Lake Community Solar entered into interconnection contracts with National Grid to connect their solar projects to the utility's electric distribution grid. Under these agreements, National Grid charges the solar generators a 'tax gross-up adder' to offset federal income tax liability that National Grid claims it must pay on the interconnection payments. The solar generators disputed whether these payments were actually taxable income under IRS Notice 2016-36 and whether National Grid could legally pass these costs through. Unable to resolve the disagreement, the generators filed a federal lawsuit seeking a declaratory judgment that the payments were not taxable and state-law claims for breach of contract, restitution, and unjust enrichment. The district court dismissed the case, finding it lacked subject-matter jurisdiction because the federal tax issue was not substantial enough to support federal-question jurisdiction and the Declaratory Judgment Act did not provide an independent basis for jurisdiction.
The Second Circuit affirmed the dismissal based on a lack of subject-matter jurisdiction. First, regarding the Declaratory Judgment Act claim, the court applied the 'well-pleaded complaint rule' by conceptually realigning the parties to imagine a hypothetical coercive suit. The court reasoned that if National Grid sued the generators for breach of contract to recover the fees, the federal tax issue would only arise as a defense. Since a state-law breach of contract claim does not inherently require resolving a federal question, the Declaratory Judgment Act could not create jurisdiction. Second, regarding the state-law claims, the court applied the four-part test from Gunn v. Minton to determine if the claims 'arose under' federal law. The court focused on the 'substantiality' requirement, which asks whether the federal issue is important to the federal system as a whole. The court found the issue was not substantial for two reasons. First, the issue was not a 'pure issue of law' but rather a fact-bound question dependent on the specific nature of the parties' agreements and whether the projects connected to distribution or transmission systems. Second, the issue lacked broader significance for the federal government. Unlike cases where the IRS itself is directly involved in administrative actions, here the dispute was between private parties regarding their contractual interpretation of tax liability. The court concluded that resolving this dispute would not affect IRS practices or the federal system as a whole, leaving the matter for state forums or regulatory channels.
The decision reinforces the boundary between state and federal courts in disputes involving regulated utilities and tax pass-throughs. Solar generators and other independent power producers must resolve similar fee disputes through state regulatory commissions or state courts rather than federal litigation. The ruling leaves the underlying question of whether interconnection payments are taxable income unresolved by the federal judiciary, pending potential guidance from the IRS or resolution in state forums.
Podcast (federal-narrative-summaries): Play in new window | Download