Reducing a utility's stand-alone loss deferred tax asset because affiliates paid for the loss would break normalization

Plain-English summary

This is another ruling in the same normalization series as PLR 202426002 and 202426003, for a regulated electric utility owned by a larger parent group. The utility once had a net operating loss that, using accelerated depreciation, created a deferred tax asset (a stored-up tax benefit). Profitable affiliates in the group used that loss on the consolidated return and paid the utility cash for it under a tax-allocation agreement, so on the utility's financial books the deferred tax asset was written down to zero. In the rate case, intervenors argued the utility should not be allowed to reinstate the stand-alone asset just for setting rates. The utility asked the IRS to confirm that reducing its stand-alone deferred tax asset because of those intercompany payments, or leaving its excess deferred income taxes unreduced, would violate the depreciation normalization rules of Section 168(i)(9). The IRS agreed on all three requests: the intercompany payments are not a permitted input to the deferred-tax computation, and treating whether group members share tax liabilities among themselves as relevant would introduce a variable the rules do not allow. The IRS also noted that the harsh penalty (loss of accelerated depreciation) would not apply here, because the utility and its commission always intended to comply and are correcting the treatment at the next opportunity.

Ruling snapshot

• Question: Would reducing the utility's stand-alone NOL deferred tax asset because of intercompany tax-allocation payments, or leaving excess deferred income taxes unreduced, violate the depreciation normalization rules?
• Outcome: Approved (all three rulings granted in the taxpayer's favor; the sanction of denied accelerated depreciation held not applicable on these facts)
• Key authorities: IRC § 168(i)(9), (f)(2), (i)(10); former IRC § 167(l); Treas. Reg. § 1.167(l)-1(h); TCJA § 13001; Rev. Proc. 2020-39

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202426004
Third Party Communication: None
Release Date: 6/28/2024
Date of Communication: Not Applicable
Index Number: 168.24-01
Person To Contact:
[Taxpayer name and address redacted]
--------------, ID No. --------
Telephone Number:
--------------
Refer Reply To:
CC:PSI:B06
PLR-107770-22
Date:
March 08, 2024

Legend:

Parent = --------------
Taxpayer = --------------
Additional Subsidiary = --------------
Date 1 = --------------
Date 2 = --------------
Date 3 = --------------
Commission A = --------------
Commission B = --------------
Commission C = --------------
Office = --------------
Group = --------------
a = --------------
b = --------------
c = --------------
d = --------------
e = --------------
f = --------------
Year 1 = --------------
Year 2 = --------------
Year 3 = --------------
Year 4 = --------------
State = --------------
Form A = --------------
Form B = --------------
Enforcement Matter = --------------
Agency = --------------
Opinion = --------------

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

On Date 1, on behalf of Parent and its wholly-owned subsidiary, Taxpayer, Parent's and Taxpayer's authorized representatives requested rulings under § 168(i)(9) regarding the potential implementation of a proposed ratemaking adjustment under the depreciation normalization provisions of the Internal Revenue Code of 1986, as amended ("Code") and the regulations thereunder. In response to a request for additional information, Taxpayer submitted additional responses on Date 2. Taxpayer's request is made pursuant to, and in compliance with, Rev. Proc. 2022-1.

Parent, through its operating subsidiaries, serves nearly a customers in b states.
Taxpayer, a wholly owned subsidiary of Parent, is a regulated public utility serving more than c customers in State. As a member of the Parent affiliated group, Taxpayer joins in the filing of a consolidated return with other Parent operating companies. As is relevant to this private letter ruling request, Taxpayer is subject to the ratemaking jurisdiction of Commission A.

Parent and each of its subsidiaries are accrual basis taxpayers. Parent is the common parent of an affiliated group of corporations filing a consolidated return on a calendar-year basis. Parent, as the common parent of the affiliated group, serves as the agent of Taxpayer for purposes of this private letter ruling request pursuant to § 1.1502-77(a) of the Income Tax Regulations.

On a separate return basis, Taxpayer had a federal income tax net operating loss carry-forward ("NOLC"). On its ratemaking books of account for purposes of its current rate case, Taxpayer recorded a total NOLC deferred tax asset ("DTA") attributable to tax losses for certain years during the period Year 1 through the Year 2.
The projected NOLC DTA balance as of Date 3 (the end of the test period) is $d. The entire DTA balance is deemed to be attributable to accelerated depreciation, as determined using the "with or without" approach, pursuant to which an NOL is treated as being created first by accelerated tax depreciation deductions and only to the extent the NOL is larger than the accelerated tax depreciation deductions is it considered to have been created by other tax deductions.

Under the Parent Tax Allocation Agreement ("TAA") amongst the Parent affiliated group members joining in the filing of a consolidated return, certain profitable members of the affiliated group were able to utilize the Taxpayer NOLC to offset their separate company taxable income. None of these profitable subsidiaries provided electric utility service to customers in State within the service territory of Taxpayer and their operations were either subject to the jurisdiction of Commission B and/or state public utility commissions other than Commission A or were unregulated businesses not subject to the jurisdiction of any public utility commission.

Pursuant to the TAA, the profitable members made cash payments to Parent for their separate return tax liability, and Parent remitted cash payments of $e to Taxpayer for the tax benefit derived by the affiliated group from the use of Taxpayer's losses.

On its financial (GAAP) books, Taxpayer reduced its DTA for the NOLC to reflect the receipt of cash for the use of its loss by other members of the affiliated group, thereby recording an adjusted DTA balance of zero. For ratemaking purposes, Taxpayer includes all used and useful public utility property in rate base, calculates depreciation expense thereon using a straight-line method, depreciates such property for federal income tax purposes using accelerated depreciation (MACRS), and makes an adjustment to the reserve for deferred taxes (at the federal statutory rate) to reflect the difference in tax liability attributable to the use of different depreciation methods for book and tax purposes. All of these calculations were done on a separate return basis without regard to the property, tax attributes, or separate tax liability, of affiliates of Taxpayer.

In accordance with section 13001 of Public Law 115-97, commonly referred to as the Tax Cuts and Jobs Act ("TCJA"), Taxpayer calculated its so-called excess deferred income taxes ("EDIT") as of December 31, 2017, representing the amount of accelerated depreciation-related taxes previously collected from customers that had not yet been paid by Taxpayer and became excess due to the reduction in tax rates in the TCJA. (Rev. Proc. 2020-39, Section 2.05.) The total EDIT so-calculated was based on the deferred tax balances on Taxpayer's financial (GAAP) books and as a result did not include any adjustment for the NOLC DTA. Had the calculation of EDIT taken into account the NOLC DTA, it would have resulted in a reduction to the balance of $f.
Pursuant to TCJA § 13001(d)(1), Taxpayer began amortizing the unadjusted EDIT balance on its ratemaking books in accordance with the Average Rate Assumption Method ("ARAM") beginning as of January 1, 2018. In connection with the preparation of Taxpayer's current General Rate Case ("GRC"), Taxpayer determined that consistent with its proposed changed in treatment of the NOLC DTA for ratemaking purposes prospectively to comply with the normalization provisions of the Code, that amortization of its EDIT must take into account the $f related to the NOLC DTA as a reduction to the total EDIT available to be amortized and seeks to correct such treatment prospectively in the current GRC, the "next available opportunity," pursuant to Section 4.01(6) of Rev.
Proc. 2020-39.

In the rate case at issue, intervenors in the case -- the Office, the Group, and certain Joint Municipalities (Joint Municipals) -- entered testimony recommending elimination of Taxpayer's reinstatement of its standalone NOLC DTA, which does not exist on its GAAP books and records.

Office's witness testified that Taxpayer's proposed adjustment to reinstate its standalone NOLC for ratemaking purposes is improper because it would result in a double counting and allow Taxpayer to earn a return on cost-free capital at ratepayers' expense. The witness testified that reinstating Taxpayer's NOLC is improper for ratemaking purposes because: 1) Taxpayer received payments from the parent company for the use of its NOLC; 2) Taxpayer took those payments (non-investor cost- free capital) and used the funds to acquire additional rate base assets upon which Taxpayer is earning a full rate base return; 3) the parent company fully utilized the NOL, so there is no carryforward to reinstate; 4) a consolidated group is considered a single entity for tax purposes—thus, Taxpayer's NOLC is $0 because it has been fully utilized; and 5) the current ratemaking treatment has been followed for the last 12 years without triggering a normalization violation. The existing treatment is appropriate because it tracks with economic realities. Office's witness explained that to reinstate a hypothetical standalone NOLC at the subsidiary level, solely for ratemaking purposes, would violate consistency principles and be contrary to sound ratemaking policy. The witness also testified regarding a pending proceeding before Commission C in which Additional Subsidiary, a regulated utility within Parent's consolidated group, similarly proposed to reinstate its standalone NOLC for ratemaking purposes, but Commission C rejected the proposal based on its finding that such an adjustment would result in a double recovery for the utility at ratepayers' expense.

Group witness testified that utility income tax expenses should be reflected in cost of service in a manner that ensures that the utility's costs are no higher than what the utility could achieve on a stand-alone basis. However, the witness noted that the purpose of an affiliate agreement allows the utility to incur benefits for itself and its ratepayers that could not be achieved on a stand-alone basis. Taxpayer has been participating in the Parent tax agreement for many decades. Because of this agreement, Taxpayer and its ratepayers have benefitted under the tax agreement when Taxpayer has income tax deductions that exceed its taxable income, and those tax benefits can be used by affiliate companies to reduce consolidated taxable income.
Under the Parent affiliate tax agreement, cash payments are made to Taxpayer if its tax deductions exceed its taxable income, which are then reflected in its cost of service for rate-setting purposes. Participation in the affiliate tax agreement benefits customers.
This practice is consistent across all Parent utility affiliates that participate in the consolidated tax filing agreement, and this agreement maximizes the use of tax deductions available to the consolidated enterprises, and reallocates those affiliates' tax benefits to utility affiliates to reduce cost of service. Because income taxes are no higher for ratemaking purposes than what could be achieved on a stand-alone basis, participation in these affiliate agreements has the effect of benefitting all stakeholders, the utility and its end-use customers. The creation of these consolidated income tax benefits has been permitted under IRS normalization rules, and the reallocation of tax benefits across all participants in a consolidated filing ensures the affiliate that contributes the tax benefits, realizes the benefits, which in turn reduces its cost of service and retail rates. Taxpayer's proposal in this case would no longer pass the consolidated tax benefits on to customers but would retain the benefits for its shareholders.

The Joint Municipals' witness stated that Taxpayer admitted in discovery responses that its GAAP books accurately reflect it has already received cash payments from its parent, Parent, (the taxpayer) for its NOLC pursuant to the companies' tax sharing agreement and has thus been made whole. Taxpayer's GAAP books show the NOLC as having a $0 balance, both historically and as budgeted for Year 3 and Year 4, because those cash payments have eliminated the NOLC. By reinstating the NOLC on a standalone basis, however, Taxpayer fails to account for the cash payments from Parent, which it uses to increase its capital at no cost to the Company. Taxpayer is using this already refunded NOLC deferred tax asset solely for rate-making purposes to artificially increase its rate of return. In other words, in the real world, Taxpayer increases its level of capital with the use of the zero-cost NOLC cash payment from Parent, yet by reinstating a stand-alone NOLC deferred tax asset and deducting it from ADFIT solely for regulatory purposes, Taxpayer artificially increases the apparent overall Weighted Average Cost of Capital to be applied to the increased investment.
The witness stated that Taxpayer is essentially double counting the impact of its tax burden, once by including a restated NOLC deferred tax asset, and then again by failing to account for the tax sharing payment it received from Parent. She explained that it would only be appropriate to include the NOLC deferred tax asset based on a Taxpayer stand-alone tax return if the payment from Parent for use of the NOLC in a consolidated tax return is credited to Taxpayer's ratepayers. Thus, the witness concluded that Taxpayer's claim that the adjustment to reinstate a stand-alone NOLC deferred tax asset is required by the IRS normalization rules is incorrect when no NOLC deferred tax asset is reported in accordance with GAAP. The witness also noted that Taxpayer did not claim a normalization violation existed in either of its last two State rate cases (both of which were finalized after the TCJA went into effect), and the cumulative effect of the company's proposal would be to reduce the customer refunds previously approved when Taxpayer's tax rate was reduced pursuant to the TCJA.

Taxpayer asserted that excluding Taxpayer's standalone NOLC DTA from the calculation of accumulated deferred income tax ("ADFIT") treated as cost-free capital in Taxpayer's capital structure would violate the normalization rules of § 168(i)(9), and particularly the consistency rules of § 168(i)(9)(B). Taxpayer also asserted that excluding the NOLC DTA from ADFIT as advocated by the intervenors in the case would violate the deferred tax reserve computational rules of § 1.167(l)-1(h)(2) by introducing a variable, that is, the profits of affiliates and/or the TAA payments, other than the difference between book and tax depreciation and the statutory tax rate.

Taxpayer explained more in its additional submission dated Date 2 that journal entries are not made to the financial statements of Taxpayer to re-establish the NOLC DTA for ratemaking purposes. Taxpayer says the tax allocation method utilized by the Parent group for financial reporting reflects the NOLC (and other tax attributes) as realized or realizable when it is realized or realizable by the consolidated group.
Taxpayer represents that this methodology conforms to the requirements outlined by Commission B for financial accounting and reporting (Form A and Form B) in Enforcement Matter.

Taxpayer explains that the "separate return method" terminology used by Agency is a method of allocating taxes amongst the members of an affiliate group. This methodology allocates current and deferred taxes to members of the group as if it were a separate taxpayer.

Regarding Commission B Financial Reporting, Taxpayer explains that Commission B issued Enforcement Matter to discuss the acceptable accounting for income taxes, addressing both a "separate return method" and a "stand alone method" of accounting. Commission B describes the "separate return method" as a method that allocates current and deferred taxes to members of the group as if each member were a separate taxpayer, which is similar to the definition of separate return used by the Agency. Under the "separate return method," the sum of the individual member's allocations will not align with the consolidated tax return. In Enforcement Matter, Commission B also defines the "stand alone method" and distinguishes it from the "separate return method". The "stand alone method" allocates the consolidated group tax expense to individual members through the recognition of the benefits/burdens contributed by each member of the consolidated group to the consolidated return.
Under this method, the sum of the amounts allocated to individual members equals the consolidated amount. Commission B concludes in Enforcement Matter that Commission B requires the use of the "stand alone method" and expressly provides that the use of the "separate return method" will not be permitted for Commission B financial accounting and reporting (Commission B Form A and Form B.)

Commission B has issued several decisions rejecting the use of the "separate return method" for determining income tax expense when an entity files as part of a consolidated group. Instead, Commission B relies on the "stand alone method" of allocating income taxes between members of a consolidated group. Under the "stand alone method," the consolidated tax expense is allocated to individual members through recognition of the benefits/burdens contributed by each member of the consolidated group to the consolidated return. Under the "stand alone method," the sum of amounts allocated to individual members equal the consolidated amount.

Regarding Commission B Ratemaking, Opinion from Commission B describes the "stand alone method" as an income tax allowance "that takes into account the revenues and costs entering into the regulated cost of service without increase or decrease for tax gains or losses related to other activities ... " The "stand alone method" results in the tax allowance being equal to the tax the utility would pay on the basis of its projected revenues less deductions for all operating, maintenance, and interest expenses included in the cost of service. Based on this definition, for ratemaking purposes, the Commission B-approved tax allocation method for ratemaking purposes aligns with the Agency definition of "separate return method" despite using the term "stand alone method" in that the tax expense is only attributable to the cost of service and the activities involved in providing service to a utility's customers.

The receipt of cash from the Taxpayer's Parent Company for the consolidated utilization of the NOL results in the DTA being reduced to zero on Commission B Form A and Form B. Journal entries are not made to the financial statements of the subsidiary to re-establish the NOLC DTA for ratemaking purposes. The tax allocation method utilized by the Parent group for financial reporting reflects the NOLC (and other tax attributes) as realized or realizable when it is realized or realizable by the consolidated group. This methodology conforms to the requirements outlined by Commission B for financial accounting and reporting (Form A and Form B) in Enforcement Matter.

Because no journal entries are recorded to the financial statements to re- establish the DTA, Taxpayer represents that it is necessary to make adjustments for ratemaking purposes in order to comply with the normalization rules. Accordingly, these adjustments are incorporated into the filing package presented to the respective state regulatory bodies as part of the Taxpayer's rate requests. The filing packages include schedules that start with the financial information on Commission B's Form A and Form B and the financial information presented in Agency financial statements. Consistent with the separate return methodology, however, adjustments are made to align the rate request with the revenues and costs entering into the regulated cost of service. These adjustments are where the NOLC DTA is re-established as a component of accumulated deferred income taxes.

Taxpayer emphasizes the role that Commission B Form A and Form B play (and do not play) in the ratemaking context. Taxpayer asserts that Commission B Form A and Form B are simply the starting point for the financial data included in ratemaking.
Adjustments are then made to arrive at the end result of a tax allowance for the test year associated with the provision of utility service to the regulatory jurisdiction's customers. The financial statement data in Commission B Form A and Form B are first adjusted to remove items of income and expense that are not associated with the provision of utility service. An example of one of these items is the expense in the financial statements for lobbying which is removed along with the income tax associated with that expense. In addition to the adjustments to remove non-utility activity, there are also adjustments that are made to the Commission B Form A and Form B financial statements for ratemaking purposes. An example of these ratemaking adjustments is changes to payroll expenses for known increases/decreases in the expense relative to the expense reported on the Commission B Form A and Form B. After these adjustments are made, a further adjustment is made to the income and expense to allocate it to the customers within the respective regulatory jurisdiction to which the filing is being made.

Per Commission B's guidance in Opinion, Taxpayer asserts that the income tax allowance in ratemaking should reflect the tax the utility would pay on the basis of its projected revenues less deductions for all operating, maintenance, and interest expenses included in the cost of service. Taxpayer asserts this ratemaking aligns with the consistency requirement set forth in § 168(i)(9) such that any projections of tax expense, depreciation expense, rate base and the deferred tax reserve remain in synch.
Taxpayer believes that setting rates based on the unadjusted Commission B financial statements would violate the consistency requirement of the normalization rules.

Taxpayer and the intervenors in the case entered into a Joint Stipulation and Settlement Agreement (the "Settlement"). Pursuant to the terms of the Settlement, the stipulating parties agreed that the NOLC DTA will be excluded from ADFIT and treated as cost free capital for purposes of the base rate revenue requirement resulting from the rate case. Instead, the stipulating parties would request the Commission A allow that amount to be deferred as a regulatory asset until rates are effective in Taxpayer's next base rate case. If Taxpayer obtains a PLR concluding that excluding Taxpayer's stand- alone NOLC DTA from ADFIT treated as cost free capital would constitute a normalization violation, Taxpayer will initiate a limited proceeding to update Taxpayer's Tax Rider to reflect the NOLC adjustments, along with any Commission A-approved offsets, in rates on an ongoing basis and to recover the regulatory asset. Taxpayer is seeking this private letter ruling in accordance with the terms of the Settlement.

RULINGS REQUESTED

Taxpayer requests the following rulings:

1. Reducing Taxpayer's stand-alone DTA by reason of the TAA payments would violate the deferred tax reserve computational rules of § 1.167(l)-1(h)(2).
2. Reducing Taxpayer's standalone NOLC DTA by reason of the TAA payments as an offset to the total EDIT available to be amortized, would constitute a violation of the normalization requirements of TCJA section 13001.
3. Reducing Taxpayer's standalone NOLC DTA by reason of the TAA payments would result in Taxpayer losing its right to claim accelerated depreciation on all of its State public utility property.

LAW & ANALYSIS

Section 168(f)(2) of the Code 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.

Section 168(i)(10) defines, in part, public utility property as property used predominantly in the trade or business of the furnishing or sale of electrical energy if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof.

Prior to The Revenue Reconciliation Act of 1990, the definition of public utility property was contained in § 167(l)(3)(A) and that definition is essentially unchanged in § 168(i)(10) and the regulations promulgated under former § 167(l) remain valid for application of the normalization rules.

In order to use a normalization method of accounting, § 168(i)(9)(A) of the Code 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, 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 § 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.

Section 168(i)(9)(B)(i) provides that one way the requirements of § 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 § 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 § 168(i)(9)(A)(ii), unless such estimate or projection is also used, for ratemaking purposes, with respect to all three of these items and with respect to the rate base (hereinafter referred to as the "Consistency Rule").

Former § 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.

Section 1.167(l)-1(h)(1)(i) provides that the reserve established for public utility property should reflect the total amount of the deferral of federal income tax liability resulting from the taxpayer's use of different depreciation methods for tax and ratemaking purposes.

Section 1.167(l)-1(h)(1)(iii) provides that the amount of federal income tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess (computed without regard to credits) of the amount the tax liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax liability. This amount shall be taken into account for the taxable year in which the different methods of depreciation are used. If, however, in respect of any taxable year the use of a method of depreciation other than a subsection (1) method for purposes of determining the taxpayer's reasonable allowance under § 167(a) results in a net operating loss carryover to a year succeeding such taxable year which would not have arisen (or an increase in such carryover which would not have arisen) had the taxpayer determined his reasonable allowance under § 167(a) using a subsection (1) method, then the amount and time of the deferral of tax liability shall be taken into account in such appropriate time and manner as is satisfactory to the district director.

Section 1.167(l)-1(h)(2)(i) provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve account. This regulation further provides that, with respect to any account, the aggregate amount allocable to deferred tax under § 167(1) shall not be reduced except to reflect the amount for any taxable year by which Federal income taxes are greater by reason of the prior use of different methods of depreciation. That section also notes that the aggregate amount allocable to deferred taxes may be reduced to reflect the amount for any taxable year by which federal income taxes are greater by reason of the prior use of different methods of depreciation under § 1.167(l)-1(h)(1)(i) or to reflect asset retirements or the expiration of the period for depreciation used for determining the allowance for depreciation under § 167(a).

Section 1.167(l)-1(h)(6)(i) provides that, notwithstanding the provisions of subparagraph (1) of that paragraph, a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes under § 167(l) which is excluded from the base to which the taxpayer's rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer's tax expense in computing cost of service in such ratemaking.

Section 1.167(l)-1(h)(6)(ii) provides that, for the purpose of determining the maximum amount of the reserve to be excluded from the rate base (or to be included as no-cost capital) under subdivision (i), above, if solely an historical period is used to determine depreciation for Federal income tax expense for ratemaking purposes, then the amount of the reserve account for that period is the amount of the reserve (determined under § 1.167(l)-1(h)(2)(i)) at the end of the historical period. If such determination is made by reference both to an historical portion and to a future portion of a period, the amount of the reserve account for the period is the amount of the reserve at the end of the historical portion of the period and a pro rata portion of the amount of any projected increase to be credited or decrease to be charged to the account during the future portion of the period.

Rev. Proc. 2020-39 provides guidance concerning the implementation of the EDIT normalization rules of TCJA § 13001 solely with respect to effects of tax rate reductions on timing differences related to accelerated depreciation. Sec. 4.01(6) of Rev. Proc. 2020-39 allows taxpayers that have amortized their EDIT in a manner not in accordance with the Revenue Procedure to prospectively correct the erroneous method at the next available opportunity. Taxpayers so correcting the erroneous method at such time and in such manner will not be treated as having violated the normalization rules of the TCJA.

Section 1.167(l)-1(h)(1)(iii) provides that the amount of federal income tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess (computed without regard to credits) of the amount the tax liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax liability. Section 1.167(l)-1(h)(2)(i) provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve account. The deferred tax computation rules involve the method and life differences between book and tax depreciation and the statutory tax rate. In regard to request (1), Commission A's proposal to reduce Taxpayer's stand-alone DTA by reason of the TAA payments would introduce a variable, that is, the profits of affiliates and/or the TAA payments, other than the method and life differences between book and tax depreciation and the statutory tax rate.

Section 168(i)(9)(B)(ii) provides that the use of a procedure or adjustment that uses an estimate or projection of any of (1) the taxpayer's tax expense, (2) depreciation expense, or (3) reserve for deferred taxes under § 168(i)(9)(A)(ii) does not comply with the Consistency Rule unless such estimate or projection is also used, for ratemaking purposes, with respect to all three of these items and with respect to the rate base.
Therefore, generally, the Normalization Rules do not permit Taxpayer to adjust its rate base by removing used and useful assets) without making similar adjustments to book and tax depreciation expense, tax expense, and the reserve for deferred taxes.

Taxpayer and Staff generally agreed that the proper treatment of Taxpayer's EDIT should be determined in the same manner as the resolution of the DTA issue. In regard to request (2), based on the response to request (1), Taxpayer's amortization of its EDIT must take into account the $f related to the separate return NOLC DTA as a reduction to the total EDIT available to be amortized.

In the setting of utility rates, a utility's rate base is offset by its EDIT and/or ADIT balance. Taxpayer maintains that the amortization of its EDIT must take into account the $f related to the separate return NOLC DTA as a reduction to the total EDIT available to be amortized. The EDIT should be reduced because these are the amounts that did not actually defer tax due to the presence of the NOLC, as represented in the DTA account. If the EDIT is not reduced, this results in an inappropriate flow-through of tax benefits to ratepayers.

In regard to request (3), Taxpayer sought to correct such treatment prospectively in the current GRC, the "next available opportunity," pursuant to Section 4.01(6) of Rev.
Proc. 2020-39. Our understanding is that Commission A is in agreement to follow the outcome of the letter ruling request.

The Normalization Rules were enacted in response to Congressional concerns over the growing number of public utility commissions that were mandating investor- owned regulated utilities to not retain these tax benefits from accelerated depreciation, but, instead, to immediately flow-through all of these tax incentives to ratepayers in the form of lower income tax expense in regulated cost of service rates. Congress' response was to enact legislation that would preclude regulated investor-owned utilities from utilizing accelerated depreciation methods of tax purposes if the related tax benefits were immediately flowed-through to ratepayers in rates or were flowed-through to ratepayers faster than permitted under the Normalization Rules.

The underlying concept and purpose of the Normalization Rules is to prevent the flow-through of these accelerated depreciation-related tax benefits to ratepayers in regulated rates any faster than permitted by the Normalization Rules. Thus, the flow- through of these tax benefits to ratepayers faster than permitted by the Normalization Rules would result in a normalization violation that would preclude the taxpayer from using any of the accelerated tax depreciation methods on public utility property and, instead, require the taxpayer to use the same depreciation method and period as those used to compute depreciation expense in its cost of service for ratemaking purposes.
Conversely, a taxpayer that flows through these tax benefits to ratepayers slower than permitted by the Normalization Rules, or that never flows through any of the tax benefits from accelerated depreciation to ratepayers, would not be in violation of those rules.

By reducing Taxpayer's stand-alone DTA by reason of the TAA payments (or achieving a similar result through other methods), this improperly involves amounts that did not actually defer tax due to the presence of the NOLC, as represented in the DTA account. If the EDIT is not reduced, this results in an inappropriate flow-through of tax benefits to ratepayers

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. However, in the legislative history to the enactment of the normalization requirements of the Investment Tax Credit (ITC), Congress 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. See also, Rev. Proc. 2017-47, 2017-38 I.R.B. 233, September 18, 2017.

Commission A has, at all times, required that utilities under its jurisdiction use normalization methods of accounting. Taxpayer also intended at all times to comply with the Normalization Rules. Taxpayer has initiated the measures necessary to conform to the Normalization Rules. Taxpayer's failure to comply with the Normalization Rules was inadvertent. Because Commission A, as well as Taxpayer, at all times sought to comply, and because corrective actions will be taken at the earliest available opportunity, it is not appropriate to conclude that the failure to follow the Consistency Rule or the deferred tax reserve computational rules constituted a normalization violation and apply the sanction of denial of accelerated depreciation to Taxpayer.

We are not providing a ruling on the overall merits of Commission A's policies towards separate return or consolidated return ratemaking. This ruling is solely with respect to the four normalization elements relevant to depreciation-related ratemaking.
The treatment of non-ratemaking related payments as part of a TAA does not determine the normalization consequences of those arrangements. Ultimately, since depreciation normalization is based upon the construct of the extension of an interest free loan from the federal government to the utility in the form of deferred taxes, whether and how the group members allocate tax liabilities amongst themselves is irrelevant to the analysis.
While under certain circumstances, the intercompany payments under a TAA might create an imputed loan between members, that is not a loan from the federal government, which is the sine qua non of depreciation normalization.

RULINGS

We rule as follows in response to Taxpayer's requested rulings:

1. Reducing Taxpayer's stand-alone DTA by reason of the TAA payments would violate the deferred tax reserve computational rules of § 1.167(l)-1(h)(2).
2. Reducing Taxpayer's standalone NOLC DTA by reason of the TAA payments as an offset to the total EDIT available to be amortized, would constitute a violation of the normalization requirements of TCJA section 13001.
3. Reducing Taxpayer's standalone NOLC DTA by reason of the TAA payments would result in Taxpayer losing its right to claim accelerated depreciation on all of its State public utility property. However, as described this disallowance of Taxpayer's right to claim accelerated depreciation would only occur under facts not present in this case.

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.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement 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 representative.

This letter is being issued electronically in accordance with Rev. Proc. 2020-29, 2020-21 I.R.B. 859. A paper copy will not be mailed to Taxpayer.

Sincerely,

/S/

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

Enclosure: Copy for § 6110 purposes
cc: [representatives redacted]