Utility must prorate deferred taxes for projected test periods

Plain-English summary

A regulated electric utility asked how the tax normalization rules applied to projected rate adjustments, formula rates, and later true-ups. The IRS ruled that projected rate periods are future test periods, so the utility must use the deferred-tax proration formula when calculating rate base for those projections. A true-up based on actual historical results does not itself require proration, although the original projected amount remains prorated. The IRS also ruled that removing a cash-working-capital allowance to offset the effect of proration would violate the normalization rules, while minor differences in averaging conventions did not violate the consistency requirement. Because the utility and its regulators had intended to comply and agreed to corrective action, the IRS declined to impose the sanction of denying accelerated depreciation for the prior errors.

Ruling snapshot

• Question: How the normalization rules apply to projected utility rates, true-ups, cash-working-capital adjustments, and averaging conventions
• Outcome: Mixed, with proration required for projected periods but not historical true-ups, and no sanction imposed for corrected prior failures
• Key authorities: I.R.C. §§ 167, 168; Treas. Reg. § 1.167(l)-1(h)(6)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201541010                                              Third Party Communication: None
Release Date: 10/9/2015                                        Date of Communication: Not Applicable
Index Number: 167.22-01
                                                               Person To Contact:
------------------------------------------------------         ------------------------, ID No. ------------------
-----------------------------------                            ----------------------------------------------------
----------------------------                                   Telephone Number:
-----------------------------                                  ----------------------
                                                               Refer Reply To:
                                                               CC:PSI:B06
                                                               PLR-143241-14
                                                               Date:
                                                               July 06, 2015




LEGEND:

Taxpayer                   =         -------------------------------------------------------
------------------------------------------------------------
Parent                     =        -------------------------------------
 -------------------------------------------------------------
State A                    =        -----------
State B                    =        ---------------------
Commission A               =        -----------------------------------------------------
Commission B               =        -------------------------------------------------
Commission C               =        -------------------------------------------------------
Operator                   =        ------------------------------------
Year A                     =        -------
Case A                     =        --------------------------------------
Case B                     =        --------------------------------------
Case C                     =        --------------------------------------
Date X                     =        ------------------
Director                   =         --------------------------------------------------------------------------------
                           ---------------------------------------------------------------------------------------
-----------------------------------------------------

Dear --------------------:

       This letter responds to Parent’s request, made on behalf of Taxpayer, dated
January 9, 2015, for a ruling on the application of the normalization rules to certain
regulatory procedures applied in State as described below.

         The representations set out in your letter follow.
PLR-143241-14                                 2

         Taxpayer, a wholly-owned subsidiary of Parent, is primarily engaged in the
business of generating, transmitting, distributing, and selling electric power to customers
in State A and State B. It is subject to regulation by Commission A, Commission B, and
Commission C with respect to terms and conditions of services, including the rates it
may charge for its services. All three Commissions establish Taxpayer’s rates based on
Taxpayer’s costs, including a provision for a return on the capital employed by Taxpayer
in its regulated business.

       The law of State A provides a process under which a utility may recover its costs
relating to projects such as new electric generation facilities as a stand-alone rate
adjustment added to customers’ base rates. As relevant to this ruling request, the
process for setting the rates involves two components. First, a taxpayer files estimated
projections of all factors, including Accumulated Deferred Federal Income Taxes
(ADFIT), relevant to the costs associated with the facility that is the subject of the rate
adjustment. Rate base for this purpose is calculated using an average of the thirteen
projected end of month balances of the components of rate base. The rate adjustment
computed using these projections goes into effect at the beginning of the test period.
The test period is a twelve month period. The anticipated collections from rate payers,
the actual cost incurred with respect to the generating facility and any differences
between anticipated amounts and actual amounts are reconciled by a “true-up”
mechanism at the end of the test year. Under this mechanism, the reconciliation
amount is either charged to ratepayers (if actual revenues are below estimates) or
credited to ratepayers (if actual revenues exceed estimates) as part of the rates
established for the forthcoming rate year. For both under and over collections, a
carrying charge is imposed.

       Taxpayer owns and operates electric transmission lines in several states,
including State A and State B. These lines are integrated into Operator, a regional
transmission operator. The rates that Taxpayer may charge its customers for these
transmission services are set using a formula approved by Commission C. The formula
rates are calculated using a methodology similar to that used to calculate the rate
adjustments, inasmuch as the formula rates are calculated using projected costs to
establish rates during the period for which rates are being set and a true-up based on
over or under recoveries that are reflected in a subsequent rate year. The rates are
determined by application of the formula approved by Commission C and go into effect
with no additional action by Commission C.

        Taxpayer claims accelerated depreciation on its tax returns to the extent
permitted by the Internal Revenue Code. Taxpayer normalizes the federal income
taxes deferred as a result of its use of accelerated depreciation and thus maintains an
ADFIT balance on its regulatory books. In ratemaking proceedings before
Commission A to authorize rate adjustments as well as in calculation of the formula
rates, rate base is reduced by the calculated ADFIT balance. In calculating its ADFIT
balance for purposes of both the projection and true-up elements of the rate adjustment
PLR-143241-14                               3

calculations, Taxpayer followed the same averaging conventions it used for the other
components of rate base. However, for prior formula rate filings, Taxpayer had
calculated its ADFIT balance by an average of the beginning and ending balances
notwithstanding that it used a 13-month average for computation of the plant portion of
rate base. In those prior cases, the averages are calculated in accordance with the
provisions of the Commission-approved template and the differences in averaging
conventions are required by the regulations adopted by Commission C.

       Section 1.167(l)-1(h)(6) of the Income Tax Regulations requires that a proration
methodology be used by Taxpayer to calculate its applicable ADFIT balance for future
test periods. Prior to Year A, Taxpayer had not used the proration methodology either
in estimating its projected ADFIT balance or for the calculation of ADFIT for purposes of
the true-up. Members of Taxpayer’s tax department became concerned about the
normalization implications of not using the proration formula during Year A. In filing
Case A, Case B, and Case C, Taxpayer incorporated the proration methodology into the
calculation of its projected ADFIT balance. In addition, Taxpayer incorporated the
proration methodology into the calculation of the true-up in Case B. The staff of
Commission A did not agree that the test period used for the rate adjustment
ratemaking was a future test period and therefore asserted that the proration
methodology was not required. In each of these cases, Commission A approved the
use of the proration methodology in the projected ADFIT balance but denied its use in
the true-up. When Commission A approved the use of the proration methodology for
the projected ADFIT balance, it revised a portion of the Taxpayer’s cash working capital
allowance to reflect the adoption of the proration methodology. The adjusted portion
was intended to compensate Taxpayer for the lag in time between when expenditures
are made for services by Taxpayer and when collections for those services are received
by Taxpayer. Commission A concluded that the item in the cash working capital
allowance was duplicative of the effect of the proration methodology and was thus
unnecessary. Due to the uncertainty surrounding the application of the proration
methodology and the adjustment to cash working capital, Commission A directed
Taxpayer to seek this ruling from the Internal Revenue Service.

         Both Commission A and Commission C at all times have required that all public
utilities under their respective jurisdictions use normalized methods of accounting.

      Taxpayer requests that we rule as follows:

   1. The proration methodology requirement does not apply to stand-alone rate
      adjustment ratemaking and to the Commission C formula rates even if they
      involve future test periods.
   2. The estimated projection component of both the stand-alone rate adjustment
      ratemaking and the formula rate does not employ a future test period within the
      meaning of § 1.167(l)-1(h)(6)(ii) and therefore Taxpayer is not required to use the
      proration methodology in order to comply with the normalization rules.
PLR-143241-14                                4

   3. The true-up component of both the stand-alone rate adjustment ratemaking and
      the formula rate does not employ a future test period within the meaning of §
      1.167(l)-1(h)(6)(ii) and therefore Taxpayer is not required to use the proration
      methodology in order to comply with the normalization rules.
   4. In Taxpayer’s stand-alone rate adjustment proceedings, an adjustment to
      eliminate from the Taxpayer’s cash working capital allowance any provision for
      accelerated depreciation-related ADFIT if the proration methodology is employed
      does not conflict with the normalization rules.
   5. In order to comply with the consistency requirement of the normalization rules, it
      is not necessary that the Taxpayer use the same averaging convention it uses in
      computing the other elements of rate base in computing its ADFIT balance for
      purposes of the formula rates.
   6. If the Service rules adversely with respect to Rulings 1, 2, or 3, above, any failure
      by Taxpayer to employ the proration methodology prior to the proceedings in
      Cases A, B, or C or the effective date approved by Commission C for the
      requested modification of the formula rates was not a violation of the
      normalization rules requiring sanctions for such violation.
   7. In the event that the Service rules adversely with respect to Ruling 5, above,
      Taxpayer’s failure to comply with the consistency requirement in connection with
      its formula rates prior to the effective date approved by Commission C for the
      requested modification of the formula rates was not a violation of the
      normalization rules.

Law and Analysis

       Issues 1 and 2

                 Former section 167(l) of the Code generally provided that public utilities
were entitled to use accelerated methods for depreciation if they used a "normalization
method of accounting." A normalization method of accounting was defined in former
section 167(l)(3)(G) in a manner consistent with that found in section 168(i)(9)(A).
Section 1.167(1)-1(a)(1) of the Income Tax Regulations provides that the normalization
requirements for public utility property pertain only to the deferral of federal income tax
liability resulting from the use of an accelerated method of depreciation for computing
the allowance for depreciation under section 167 and the use of straight-line
depreciation for computing tax expense and depreciation expense for purposes of
establishing cost of services and for reflecting operating results in regulated books of
account. These regulations do not pertain to other book-tax timing differences with
respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes and
items.

      Section 168(f)(2) of the Code provides that the depreciation deduction
determined under section 168 shall not apply to any public utility property (within the
PLR-143241-14                                 5

meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of
accounting.

        In order to use a normalization method of accounting, section 168(i)(9)(A)
requires that a taxpayer, in computing its tax expense for establishing its cost of service
for ratemaking purposes of establishing its cost of service for ratemaking purposes and
reflecting operating results in its regulated books of account, to use a method of
depreciation with respect to public utility property that is the same as, and a
depreciation period for such property that is not shorter than, the method and period
used to compute its depreciation expense for such purposes. Under section
168(i)(9)(A)(ii), if the amount allowable as a deduction under section 168 differs from the
amount that-would be allowable as a deduction under section 167 using the method,
period, first and last year convention, and salvage value used to compute regulated tax
expense under section 168(i)(9)(A)(i), the taxpayer must make adjustments to a reserve
to reflect the deferral of taxes resulting from such difference.

       Section 1.167(l)-1(h)(6) sets forth additional normalization requirements with
respect to public utility property. Under § 1.167(l)-1(h)(6)(i), a taxpayer does not use a
normalization method of accounting if, for ratemaking purposes, the amount of the
reserve for deferred taxes excluded from the rate base, or treated as cost-free capital,
exceeds the amount of the reserve for the period used in determining the taxpayer's
ratemaking tax expense. Section 1.167(l)-1(h)(6)(ii) also provides the procedure for
determining the amount of the reserve for deferred taxes to be excluded from rate base
or to be included as no-cost capital. If, in determining depreciation for ratemaking tax
expense, a period (the "test period") is used which is part historical and part future, then
the amount of the reserve account for this period is the amount of the reserve at the end
of the historical portion of the period and a pro rata amount of any projected increase to
be credited to the account during the future portion of the period. The pro rata amount
of any increase during the future portion of the period is determined by multiplying the
increase by a fraction, the numerator of which is the number of days remaining in the
period at the time the increase is to accrue, and the denominator of which is the total
number of days in the future portion of the period.

       Section 1.167(l)-1(h)(6)(i) makes it clear that the reserve excluded from rate base
must be determined by reference to the same period as is used in determining
ratemaking tax expense. A taxpayer may use either historical data or projected data in
calculating these two amounts, but it must be consistent. As explained in section
1.167(l)-1(a)(1), the rules provided in section 1.167(l)-1(h)(6)(i) are to insure that the
same time period is used to determine the deferred tax reserve amount resulting from
the use of an accelerated method of depreciation for cost of service purposes and the
reserve amount that may be excluded from the rate base or included in no-cost capital
in determining such cost of services.

       If a taxpayer chooses to compute its ratemaking tax expense and rate base
PLR-143241-14                                  6

exclusion amount using projected data then it must use the formula provided in section
1.167(l)-1(h)(6)(ii) to calculate the amount of deferred taxes subject to exclusion from
the rate base. This formula prorates the projected accruals to the reserve so as to
account for the actual time these amounts are expected to be in the reserve. As
explained in § 1.167(l)-1(a)(1), the formula in section 1.167(l)-1(h)(6)(ii) provides a
method to determine the period of time during which the taxpayer will be treated as
having received amounts credited or charged to the reserve account so that the
disallowance of earnings with respect to such amounts through rate base exclusion or
treatment as no-cost capital will take into account the factor of time for which such
amounts are held by the taxpayer.

       The purpose of the proration formula is to prevent the immediate flow-through of
the benefits of accelerated depreciation to ratepayers. The proration formula stops flow-
through by limiting the deferred tax reserve accruals that may be excluded from rate
base, and thus the earnings on rate base that may be disallowed, according to the
length of time these accruals are actually in the reserve account.

        The effectiveness of § 1.167(l)-1(h)(6)(ii) in resolving the timing issue has been
questioned by its failure to define some key terms. Nowhere does this provision state
what is meant by the terms "historical" and "future" in relation to the period for
determining depreciation for ratemaking tax expense (the "test period"). One
interpretation focuses on the type or quality of the data used in the ratemaking process.
According to this interpretation, the historical period is that portion of the test period for
which actual data is used, while the portion of the period for which data is estimated is
the future period. The second interpretation focuses on when the utility rates become
effective. Under this interpretation, the historical period is that portion of the test period
before rates go into effect, while the portion of the test period after the effective date of
the rate order is the future period.

        The first interpretation, which focuses on the quality of the ratemaking data, is an
attractive one. It proposes a simple rule, easy to follow and to enforce: any portion of
the reserve for deferred taxes based on estimated data must be prorated in determining
the amount to be deducted from rate base. The actual passage of time between the
date ratemaking data is submitted and the date rates become effective is of no
importance. But this interpretation of the regulations achieves simplicity at the expense
of precision; in other words, it is overbroad. The proration of all estimated deferred tax
data does serve to magnify the benefits of accelerated depreciation to the utility, but this
is not the purpose of normalization. Congress was explicit: normalization "in no way
diminishes whatever power the [utility regulatory] agency may have to require that the
deferred taxes reserve be excluded from the base upon which the utility's permitted rate
of return is calculated." H.R. Rep. No. 413, 91st Cong., 1st Sess. 133 (1969).
       In contrast, the second interpretation of section 1.167(l)-1(h)(6)(ii) of the
regulations is consistent with the purpose of normalization, which is to preserve for
PLR-143241-14                                        7

regulated utilities the benefits of accelerated depreciation as a source of cost-free
capital. The availability of this capital is ensured by prohibiting flow-through. But
whether or not flow-through can even be accomplished by means of rate base
exclusions depends primarily on whether, at the time rates become effective, the
amounts originally projected to accrue to the deferred tax reserve have actually
accrued.

       If rates go into effect before the end of the test period, and the rate base
reduction is not prorated, the utility commission is denying a current return for
accelerated depreciation benefits the utility is only projected to have. This procedure is
a form of flow-through, for current rates are reduced to reflect the capital cost savings of
accelerated depreciation deductions not yet claimed or accrued by the utility. Yet
projected data is often necessary in determining rates, since historical data by itself is
rarely an accurate indication of future utility operating results. Thus, the regulations
provide that as long as the portion of the deferred tax reserve based on projected
(future estimated) data is prorated according to the formula in section 1.167(l)-1(h)(6)(ii),
a regulator may deduct this reserve from rate base in determining a utility's allowable
return. In other words, a utility regulator using projected data in computing ratemaking
tax expense and rate base exclusion must account for the passage of time if it is to
avoid flow-through.

        But if rates go into effect after the end of the test period, the opportunity to flow
through the benefits of future accelerated depreciation to current ratepayers is gone,
and so too is the need to apply the proration formula. In this situation, the only question
that is important for the purpose of rate base exclusion is the amount in the deferred tax
reserve, whether actual or estimated. Once the future period, the period over which
accruals to the reserve were projected, is no longer future, the question of when the
amounts in the reserve accrued is no longer relevant (at the time the new rate order
takes effect, the projected increases have accrued, and the amounts to be excluded
from rate base are no longer projected but historical, even though based on estimates).

       There are two kinds of ratemaking at issue here, with identical components. For
both the stand-alone rate adjustment and the formula rates, Taxpayer estimates the
various components of rate base. Rates go into effect as of the beginning of the service
year.1 As such, the rates are in effect during the test year and the proration formula
must be used. The addition of the true up increases the ultimate accuracy of the rates
but does not convert a future test period into a historical test period as those terms are
used in the normalization regulations. Therefore, Taxpayer is required to apply the
proration formula in calculating accumulated deferred income taxes for purposes of
calculating rate base.

        Issue 3
1
 We note that, because Taxpayer is using estimated data for the test period, the test period at issue here
constitutes a “future test period” under the first interpretation discussed above as well.
PLR-143241-14                                8


       As discussed above, where a taxpayer computes its ratemaking tax expense and
rate base exclusion amount using projected data then must use the proration formula
provided in section 1.167(l)-1(h)(6)(ii) to calculate the amount of deferred taxes subject
to exclusion from the rate base. This formula prorates the projected accruals to the
reserve so as to account for the actual time these amounts are expected to be in the
reserve. As explained in § 1.167(l)-1(a)(1), the formula in section 1.167(l)-1(h)(6)(ii)
provides a method to determine the period of time during which the taxpayer will be
treated as having received amounts credited or charged to the reserve account so that
the disallowance of earnings with respect to such amounts through rate base exclusion
or treatment as no-cost capital will take into account the factor of time for which such
amounts are held by the taxpayer.

       The purpose of the proration formula is to prevent the immediate flow-through of
the benefits of accelerated depreciation to ratepayers. The proration formula stops flow-
through by limiting the deferred tax reserve accruals that may be excluded from rate
base, and thus the earnings on rate base that may be disallowed, according to the
length of time these accruals are actually in the reserve account.

       In contrast to the projections discussed above, the true-up component is
determined by reference to a purely historical period and there is no need to use the
proration formula to calculate the differences between Taxpayer’s projected ADFIT
balance and the actual ADFIT balance during the period. In calculating the true-up,
proration applies to the original projection amount but the actual amount added to the
ADFIT over the test year is not modified by application of the proration formula.

Issue 4

        In Taxpayer’s stand-alone rate adjustment proceedings, Commission A adjusted
the already-approved cash working capital allowance specifically to mitigate the effect of
the use of the proration methodology, finding the effects duplicative. In general,
taxpayers may not adopt any accounting treatment that directly or indirectly circumvents
the normalization rules. See generally, § 1.46-6(b)(2)(ii) (In determining whether, or to
what extent, the investment tax credit has been used to reduce cost of service,
reference shall be made to any accounting treatment that affects cost of service); Rev.
Proc 88-12, 1988-1 C.B. 637, 638 (It is a violation of the normalization rules for
taxpayers to adopt any accounting treatment that, directly or indirectly flows excess tax
reserves to ratepayers prior to the time that the amounts in the vintage accounts
reverse). Here, Commission A adjusted the cash working capital allowance specifically
to mitigate the effect of the application of the proration methodology. This is
inconsistent with the normalization rules. We do not hold that the normalization rules
require a similar type of cash working capital adjustment in all cases; we hold only that,
where, as here, it is adjusted or removed in an attempt to mitigate the effects of the
PLR-143241-14                                 9

application of the proration methodology or similar normalization rule, that adjustment or
removal is not permitted under the normalization rules.

Issue 5

         Former section 167(l) of the Code generally provided that public utilities were
entitled to use accelerated methods for depreciation if they used a "normalization
method of accounting." A normalization method of accounting was defined in former
section 167(l)(3)(G) in a manner consistent with that found in section 168(i)(9)(A).
Section 1.167(1)-1(a)(1) of the Income Tax Regulations provides that the normalization
requirements for public utility property pertain only to the deferral of federal income tax
liability resulting from the use of an accelerated method of depreciation for computing
the allowance for depreciation under section 167 and the use of straight-line
depreciation for computing tax expense and depreciation expense for purposes of
establishing cost of services and for reflecting operating results in regulated books of
account. These regulations do not pertain to other book-tax timing differences with
respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes and
items.

      Section 168(f)(2) of the Code provides that the depreciation deduction
determined under section 168 shall not apply to any public utility property (within the
meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of
accounting.

        In order to use a normalization method of accounting, section 168(i)(9)(A)
requires that a taxpayer, in computing its tax expense for establishing its cost of service
for ratemaking purposes of establishing its cost of service for ratemaking purposes and
reflecting operating results in its regulated books of account, to use a method of
depreciation with respect to public utility property that is the same as, and a
depreciation period for such property that is not shorter than, the method and period
used to compute its depreciation expense for such purposes. Under section
168(i)(9)(A)(ii), if the amount allowable as a deduction under section 168 differs from the
amount that-would be allowable as a deduction under section 167 using the method,
period, first and last year convention, and salvage value used to compute regulated tax
expense under section 168(i)(9)(A)(i), the taxpayer must make adjustments to a reserve
to reflect the deferral of taxes resulting from such difference.

       Section 168(i)(9)(B)(i) of the Code provides that one way the requirements of
section 168(i)(9)(A) will not be satisfied is if the taxpayer, for ratemaking purposes, uses
a procedure or adjustment which is inconsistent with such requirements. Under section
168(i)(9)(B)(ii), such inconsistent procedures and adjustments include the use of an
estimate or projection of the taxpayer's tax expense, depreciation expense, or reserve
for deferred taxes under section 168(i)(9)(A)(ii), unless such estimate or projection is
PLR-143241-14                                10

also used, for ratemaking purposes, with respect to all three of these items and with
respect to the rate base.

       In order to satisfy the requirements of §168(i)(9)(B), there must be consistency in
the treatment of costs for rate base, regulated depreciation expense, tax expense, and
deferred tax revenue purposes. Here, rate base, depreciation expense, and
accumulated deferred income taxes are all calculated in consistent fashion – all are
averaged over the same period. While there are minor differences in the convention
used to average all elements of rate base including depreciation expense on the one
hand, and ADFIT on the other, for purposes of §168(i)(9)(B), it is sufficient that both are
determined by averaging and both are determined over the same period of time. Thus,
the calculation of average rate base and accumulated deferred income taxes as
described above complies with the consistency requirement of §168(i)(9)(B).

        Because of the conclusion reached above, Taxpayer’s seventh issue is moot and
will not be considered further.

Issue 6

        Because the Service has ruled in Issue 1 and 2 that Taxpayer was required to
use the proration formula applicable to future test periods for the projected revenue
requirement, prospectively adhering to the Service’s interpretation of § 1.167(l)-
1(h)(6)(ii) require adjustments to conform to this ruling. Any rates that have been
calculated using procedures inconsistent with this ruling (“nonconforming rates”) which
are or which have been in effect and which, under applicable state or federal regulatory
law, can be adjusted or corrected to conform to the requirements of this ruling, must be
so adjusted or corrected. Where nonconforming rates cannot be adjusted or corrected
to conform to the requirements of this ruling due to the operation of state or federal
regulatory law, then such correction must be made in the next regulatory filing or
proceeding in which Taxpayer’s rates are considered. Specifically, the current timing of
Taxpayer’s stand-alone rate adjustment filings with Commission A will accommodate all
adjustments or corrections to any prior estimated projections or true-ups necessary to
conform to the requirements of this ruling in rates having an effective date no later Date
X, including Case A, Case B, and Case C. In addition, Taxpayer has already sought an
order from Commission C to make the necessary changes to the rate templates, not
simply unilaterally adjusting the calculations (or the manner in which the templates are
completed) in the next annual projections or true-up adjustments. If Taxpayer must
request these changes through a filing with Commission C, Taxpayer has represented
that it will make a filing with Commission C to amend its formula rate template within six
months of receipt of this ruling letter, requesting that Commission C apply a
methodology in accordance with this letter using an effective date of the first month
following the date of the filing made with Commission C. Following Commission C’s
order in that filing, Taxpayer will prospectively apply the methodology consistent with
PLR-143241-14                                11

this letter approved by Commission C. Until Commission C acts on the filing, Taxpayer
will continue to use the methodology described above.

       Section 168(f)(2) of the Code provides that the depreciation deduction
determined under section 168 shall not apply to any public utility property (within the
meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of
accounting. However, in the legislative history to the enactment of the normalization
requirements of the Investment Tax Credit, Congress has stated that it hopes that
sanctions will not have to be imposed and that disallowance of the tax benefit (there, the
ITC) should be imposed only after a regulatory body has required or insisted upon such
treatment by a utility. See Senate Report No. 92-437, 92nd Cong., 1st Sess. 40-41
(1971), 1972-2 C.B. 559, 581.

      Here, Taxpayer has received stand-alone rate adjustments from Commission A
without application of the proration methodology as required. In addition, Taxpayer
used a template approved by Commission C to calculate formula-based rates. Both
Commission A and Commission C have, at all times, required that utilities under their
respective jurisdictions use normalization methods of accounting. Taxpayer also
intended at all times to comply with the normalization rules. As concluded above,
Taxpayer was required to use the proration methodology in these ratemaking
proceedings. However because Commissions A and C as well as Taxpayer at all times
sought to comply, and because Taxpayer will take the corrective actions described
above, it is not currently appropriate to apply the sanction of denial of accelerated
depreciation to Taxpayer.

Conclusions

   1. The proration methodology requirement applies to all future test periods.
   2. The estimated projection component of both the stand-alone rate adjustment
      ratemaking and the formula rate does employ a future test period within the
      meaning of § 1.167(l)-1(h)(6)(ii) and therefore Taxpayer is required to use the
      proration methodology in order to comply with the normalization rules.
   3. The true-up component of both the stand-alone rate adjustment ratemaking and
      the formula rate does not employ a future test period within the meaning of §
      1.167(l)-1(h)(6)(ii) and therefore Taxpayer is not required to use the proration
      methodology in order to comply with the normalization rules.
   4. In Taxpayer’s stand-alone rate adjustment proceedings, an adjustment to
      eliminate from the Taxpayer’s cash working capital allowance any provision for
      accelerated depreciation-related ADFIT if the proration methodology is employed
      does conflict with the normalization rules.
   5. In order to comply with the consistency requirement of the normalization rules, it
      is not necessary that the Taxpayer use the same averaging convention it uses in
      computing the other elements of rate base in computing its ADFIT balance for
      purposes of the formula rates.
PLR-143241-14                               12

   6. The Service rules adversely with respect to Rulings 1 and 2, above. Any failure
      by Taxpayer to employ the proration methodology prior to the proceedings in
      Cases A, B, or C or the effective date approved by Commission C for the
      requested modification of the formula rates was not a violation of the
      normalization rules requiring sanctions for such violation.
   7. Because the Service rules favorably with respect to Ruling 5, above, Taxpayer’s
      requested Ruling 7 is moot.

      Except as specifically determined above, no opinion is expressed or implied
concerning the Federal income tax consequences of the matters described above.

       This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
of the Code provides it may not be used or cited as precedent. In accordance with the
power of attorney on file with this office, a copy of this letter is being sent to your
authorized representative. We are also sending a copy of this letter ruling to the
Director.




                                      Sincerely,



                                      Peter C. Friedman
                                      Senior Technician Reviewer, Branch 6
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)