IRS rules a gas pipeline may return TCJA excess deferred taxes to ratepayers over a revised regulatory life without a normalization violation

Plain-English summary

A regulated interstate natural gas pipeline uses accelerated depreciation for tax purposes, which is allowed for utilities only if they follow the "normalization" rules. Those rules govern the timing of when the tax savings from accelerated depreciation are passed back to customers through rates, and they got extra attention after the 2017 Tax Cuts and Jobs Act (TCJA) cut the corporate tax rate, leaving utilities with a pool of "excess deferred income taxes" (excess EDIT) that must be returned to ratepayers, but not too quickly. Because this pipeline uses a composite (average-life) depreciation rate and lacks the detailed vintage records needed for the standard method, it is allowed to use the alternative "Reverse South Georgia Method," which returns the protected excess EDIT ratably over the property's remaining regulatory life. In a rate settlement, the pipeline's approved depreciation rate changed, which shortened the average remaining life of its property, and it asked the IRS whether amortizing the protected excess EDIT over that new, shorter remaining life would violate the normalization rules. The IRS ruled it would not: the rate change was based on a depreciation-and-salvage analysis of existing property (a permitted basis), not on cost-of-removal or other unprotected items, so using the revised remaining life is allowed. This kind of ruling gives utilities and their regulators certainty before finalizing rates.

Ruling snapshot

• Question: Does amortizing protected excess deferred income taxes over the revised, shorter remaining regulatory life set in a rate settlement violate the TCJA normalization requirements?
• Outcome: approved (no normalization violation; the taxpayer may amortize the protected excess EDIT over the revised remaining regulatory life)
• Key authorities: IRC §§ 168(f)(2), 168(i)(9), 168(i)(10), former 167(l); Treas. Reg. § 1.167(l)-1; TCJA (Pub. L. 115-97) § 13001(d)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202150003 Third Party Communication: None
Release Date: 12/17/2021 Date of Communication: Not Applicable
Index Number: 168.24-01
Person To Contact:
------------------- -----------------------, ID No. ------------
----------------------------------- Telephone Number:
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------------------------------ Refer Reply To:
--------------------------- CC:PSI:B6
PLR-106524-21
Date:
September 17, 2021

LEGEND:
Parent = --------------------------
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Corporation = ----------------------------
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Taxpayer = -------------------------------------------

State = -------------

Commission = ----------------------------------------------------------------

Date 1 = --------------------------

Date 2 = ----------------------

Date 3 = --------------------------

Date 4 = -----------------------

Date 5 = -----------------

Year 1 = -------

a= ------

b= --------

c= ------

d= --------

Docket 1 = --------------------------------------

Docket 2 = ----------------------------------------------

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

    This letter responds to a request for a private letter ruling dated March 12, 2021,

and additional submission dated August 23, 2021, submitted on behalf of Taxpayer.
Taxpayer requests a ruling on the application of section 13001(d) of Public Law 115-97
(commonly known as the "Tax Cuts and Jobs Act" or "TCJA") specifically as well as
generally the application of § 168(i)(9) of the Internal Revenue Code, former § 167(l),
and § 1.167(l)-1 of the Income Tax Regulations (collectively referred to as the
Normalization Rules). The relevant facts as represented in Taxpayer's submission are
set forth below.

                                          FACTS

   Parent is a corporation organized under the laws of State. Parent's fiscal year for

accounting purposes is the calendar year, and it uses the accrual method of accounting
in maintaining its books and for tax purposes. Parent is the common parent of a
consolidated group of corporations that includes Corporation, a corporation organized
under the laws of State. Corporation's fiscal year for accounting purposes is the
calendar year, and it uses the accrual method of accounting in maintaining its books
and for tax purposes. Corporation owns indirectly all of the partnership interests in
Taxpayer, a State limited partnership which is disregarded as an entity separate from
Corporation for federal income tax purposes.

   Parent provides natural gas and liquids transportation services in interstate and

intrastate commerce throughout the United States, connecting major supply basins to
existing and growing energy markets. Corporation owns and operates a portfolio of
natural gas-related energy assets in North America that provide transmission, storage,
gathering, distribution, and processing services. Taxpayer is a regulated natural gas
company under the Natural Gas Act that engages in the interstate transportation of
natural gas through its pipeline system extending through several states. Taxpayer is a
"public utility" for purposes of the TCJA.

    Taxpayer's rates for providing interstate natural gas transmission services

(jurisdictional services) are subject to the Commission. As part of setting rates and
pursuant to Section 9 of the Natural Gas Act, Commission establishes the rates of
depreciation applicable to the property used by a Commission-regulated natural gas
company to provide jurisdictional services (jurisdictional property). For ratemaking
purposes and for purposes of reflecting operating results on its books, Taxpayer uses a
single composite depreciation rate. The depreciation rate and Taxpayer's jurisdictional
property existing on the day rates go into effect are used to calculate the average
remaining life of Taxpayer's assets for ratemaking purposes. On Date 1, Taxpayer's
Commission-approved onshore transmission depreciation rate, which constitutes the
depreciation rate for the vast majority of Taxpayer's pipeline system, was a%. This
depreciation rate was approved by Commission in Year 1 in Docket 1. The application
of this rate to Taxpayer's jurisdictional property resulted in an average remaining life for
its jurisdictional property of b years.

   For federal income tax purposes, Taxpayer depreciates its property using

accelerated methods of depreciation under § 168 of the Internal Revenue Code of 1986.
As required by § 168(i)(9), Taxpayer uses a normalization method of accounting for
regulatory purposes. Accordingly, in computing its tax expense for ratemaking
purposes and for reflecting operating results on its regulated books of account,
Taxpayer uses a depreciation method and period that is consistent with the depreciation
used for ratemaking purposes. Adjustments are made to a deferred tax reserve
(generally referred to as the "Accumulated Deferred Income Taxes" or "ADIT") to
account for the difference between its actual tax expense and its tax expense as
computed for ratemaking purposes. ADIT reflects all differences between book
depreciation and tax depreciation including, but not limited to, accelerated depreciation.
Taxpayer's ADIT became overfunded as of Date 2 due to the reduction in corporate tax
rates affected by the TCJA. The portion of the excess amount in ADIT attributable to
accelerated depreciation is referred to herein as the "Protected EDIT". The amount of
the Protected EDIT is calculated based on Taxpayer's jurisidictional property existing at
the time the Protected EDIT is established.

               Ratemaking Proceeding and Settlement Agreement

   On Date 3, Taxpayer filed revised tariff records with Commission proposing

changed rates in Docket 2. On Date 4, Taxpayer and the parties to the Docket 2
proceeding filed a Stipulation and Agreement memorializing a settlement in principle
(the "Settlement"). The Settlement provides for new tariff rates that became effective
retroactively as of Date 5. Upon approval of the Settlement, Taxpayer's depreciation
rate for ratemaking purposes for its onshore transmission system increased from a% to
c%. The change to the depreciation rate was calculated using an analysis of
depreciation and salvage rates for such jurisdictional property. The application of the
Settlement depreciation rates to Taxpayer's jurisdictional property as of Date 5 results in
an average remaining life for that property of d years as of that date.

    In the Settlement, the parties agreed that Taxpayer would seek a private letter

ruling from the Internal Revenue Service (the "IRS") requesting the IRS to rule that
amortizing the Protected EDIT over d years – the remaining regulatory life of Taxpayer's
jurisdictional property as of the effective date of the new rates (i.e. Date 5) – would not
result in a normalization violation. The parties further agreed that Taxpayer will
amortize the Protected EDIT over d years if the IRS rules that using d years would not
result in a normalization violation. If the IRS determines that using the d year
amortization would result in a normalization violation, Taxpayer will continue to amortize
the Protected EDIT over b years.

  The Stipulation and Agreement remains in effect as of the date of the PLR

submission.

                              RULING REQUESTED

   Taxpayer requests a ruling that Taxpayer would not violate the normalization

requirement set forth in section 13001(d) of the TCJA if it began amortizing the
Protected EDIT ratably over d years beginning on Date 5.

                               LAW AND ANALYSIS

   Section 168(f)(2) provides that the depreciation deduction determined under

§ 168 shall not apply to any public utility property (within the meaning of § 168(i)(10)) if
the taxpayer does not use a normalization method of accounting.

    In order to use a normalization method of accounting, § 168(i)(9)(A) requires that

a taxpayer, in computing its tax expense for establishing its cost of service for
ratemaking purposes and reflecting operating results in its regulated books of account,
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
§ 168(i)(9)(A)(ii), if the amount allowable as a deduction under § 168 differs from the
amount that would be allowable as a deduction under § 167 using the method, period,
first and last year convention, and salvage value used to compute regulated tax
expense under § 168(i)(9)(A)(i), the taxpayer must make adjustments to a reserve to
reflect the deferral of taxes resulting from such difference.

   Former section 167(l) 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 § 167(l)(3)(G)
in a manner consistent with that found in § 168(i)(9)(A). Section 1.167(l)-1(a)(1)
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 § 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.

     In addition to the normalization requirements set forth in section 168(i)(9),

Section 13001(d) of the TCJA includes accompanying but uncodified normalization
requirements related to the reduction of the corporate tax rate. Section 13001(d)(1)
provides that "[a] normalization method of accounting shall not be treated as being used
with respect to any public utility property for purposes of [§§ 167 or 168] if the taxpayer,
in computing its cost of service for ratemaking purposes and reflecting operating results
in its regulated books of account, reduces the excess tax reserve more rapidly or to a
greater extent than such reserve would be reduced under the average rate assumption
method" (ARAM).

    Section 13001(d)(2) of the TCJA provides an alternative method for certain

taxpayers. If, as of the first day of the taxable year that includes the date of enactment
of the TCJA, the taxpayer was required by a regulatory agency to compute depreciation
for public utility property on the basis of an average life or composite rate method, and
the taxpayer's books and underlying records did not contain the vintage account data
necessary to apply ARAM, the taxpayer will be treated as using a normalization method
of accounting if, with respect to such jurisdiction, the taxpayer uses the alternative
method for public utility property that is subject to the regulatory authority of that
jurisdiction.

    Section 13001(d)(3)(A) of the TCJA defines the "excess tax reserve" as the

excess of (i) the reserve for deferred taxes as described in § 168(i)(9)(A)(ii) as of the
day before the corporate rate reductions made by the TCJA take effect, over (ii) the
amount which would be the balance in such reserve if the amount of such reserve were
determined by assuming that the corporate rate reductions provided in the TCJA were
in effect for all prior periods.

   Section 13001(d)(3)(B) of the TCJA provides, in part, that under ARAM, the

excess in the reserve for deferred taxes is reduced over the remaining lives of the
property as used in its regulated books of account which gave rise to the reserve for
deferred taxes.

   Section 13001(d)(3)(C) of the TCJA defines the alternative method as the

method in which the taxpayer computes the excess tax reserve on all public utility
property included in the plant account on the basis of the weighted average life or
composite rate used to compute depreciation for regulatory purposes, and reduces the
excess tax reserve ratably over the remaining regulatory life of the property. The
alternative method is also known as the Reverse South Georgia Method ("RSGM").

    Commission continues to allow entities subject to its jurisdiction to amortize the

Protected EDIT using either ARAM or the RSGM, which is permitted as an exception, if
a rate regulated company does not have vintage records for its plant assets to support
the reversal of book/tax differences. Commission requires Taxpayer to depreciate its
jurisdictional property using a composite depreciation rate, and Taxpayer's books and
records lack the vintage account data necessary to use ARAM. Thus, Taxpayer may
amortize its Protected EDIT using the alternative method described in section
13001(d)(3)(C) of the TCJA. Taxpayer will be using the RSGM, the alternative method
adopted by Commission, to amortize the Protected EDIT.

   Under section 13001(d)(3)(C) of the TCJA, Taxpayer's Protected EDIT must be

amortized "over the remaining regulatory life of the property." Section 13001(d)(3)(C)
of the TCJA does not specifically state whether the regulatory authority (that is,
Commission in this case) must determine the "remaining regulatory life of the property"
as of any specific date. The Settlement is the first time Taxpayer's Commission-
approved depreciation rates changed since passage of the TCJA.

    Taxpayer's use of an average remaining life of Taxpayer's jurisdictional property

calculated using the Commission-approved composite depreciation rate that changed
after passage of the TCJA and was approved in the Settlement does not violate the
Normalization Rules per se. That is, amortizing Protected Edit using a revised
depreciation rate and thus average remaining life is not prohibited by the Normalization
Rules. However, § 1.167(l)-1(a)(1) 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 § 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. Here, the change to the
depreciation rate was based on an analysis of the depreciation and salvage rates of
Taxpayer's existing jurisdictional property. Such factors are within § 1.167(l)-1(a)(1)
and therefore the revised depreciation rate adopted in the Settlement Agreement and
the resulting change in the average remaining life for that property do not violate the
Normalization Rules.

   We note that cost of removal (COR) amounts are not protected by the

Normalization Rules. While COR may be a component of the calculation of the amount
treated as book depreciation, it is a deduction under § 162 and has nothing to do with
actual accelerated tax depreciation. While depreciation method and life differences are
created and reversed solely through depreciation, such is not the case with COR. While
the COR timing differences may often originate as a component of book depreciation, it
reverses through the incurred COR expenditure. If factors such as COR were used to
revise the depreciation rate, such use could result in an impermissible acceleration of
the return of the deferred taxes to ratepayers in violation of the Normalization Rules.

  Based on the foregoing, we conclude that Taxpayer would not violate the

normalization requirement set forth in section 13001(d) of the TCJA if it began
amortizing the Protected EDIT ratably over d years beginning on Date 5.

  Except as specifically set forth above, no opinion is expressed or implied

concerning the federal income tax consequences of the above described facts under
any other provision of the Code or regulations.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.

    This ruling is based upon information and representations submitted by Taxpayer

and accompanied by penalty of perjury statements executed by an appropriate party.
While this office has not verified any of the material submitted in support of the request
for rulings, it is subject to verification on examination.

     In accordance with the power of attorney on file with this office, a copy of this

letter is being sent to your authorized representatives.

                                    Sincerely,

                                       /S/

                                    Patrick S. Kirwan
                                    Chief, Branch 6
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

Enclosure:
Copy for § 6110 purposes

cc: