Unreceived bonus-depreciation refunds cannot reduce a utility's rate base through ADIT

Plain-English summary

A rate-regulated electric utility made estimated federal tax payments before Congress retroactively extended bonus depreciation for two tax years. Electing bonus depreciation created overpayments, and the utility claimed refunds that it had not yet received. Its accounting entries did not reduce rate base while the refund claims were pending. The IRS ruled that an accumulated deferred income tax (ADIT) reserve used for normalization should include only tax actually deferred and zero-cost capital actually received. Therefore, reducing rate base by adding unreceived depreciation-related tax benefits to ADIT, without an offsetting regulatory asset, would violate the normalization requirements.

Ruling snapshot

• Question: May a utility reduce rate base through its ADIT account for depreciation-related tax benefits that it has claimed but not yet received, without a corresponding regulatory asset?
• Outcome: Approved: the proposed net reduction would not comply with normalization
• Key authorities: IRC §§ 168(f)(2), 168(i)(9), and former 167(l); Treas. Reg. § 1.167(l)-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201842001 Third Party Communication: None
Release Date: 10/19/2018 Date of Communication: Not Applicable
Index Number: 167.22-01
Person To Contact:
--------------------- ----------------------, ID No. -----------
--------- Telephone Number:
--------------------------------------------- --------------------
------------------------------------- Refer Reply To:
----------------------------- CC:PSI:B06
PLR-101912-18
Date:
July 18, 2018

LEGEND

Taxpayer = ---------------------------------

Parent = -------------------------------

State A = ------------

State B = ----------

Commission A = -----------------------------------------------

Commission B = ----------------------------------------------------------------

Director = ------------------------------------------------------------------------
----------------

Year 1 = ------

Year 2 = ------

Year 3 = ------

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

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

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

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

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

a = ------------------

b = -----------------

c = ------------------

d = ------------------

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

   This letter responds to a request for a private letter ruling dated

November 27, 2017, submitted on behalf of Taxpayer by your authorized
representatives. Taxpayer requested a ruling regarding the application of the
normalization rules under § 168(i)(9) of the Internal Revenue Code and § 1.167(l)-1 of
the Income Tax Regulations (the normalization requirements.) The relevant facts as
represented in your submissions are set forth below.

                                            FACTS

   Parent is a publicly traded holding company incorporated in State A. Parent is

the parent of a group of affiliated companies, which includes Taxpayer, that
electronically file a consolidated federal income tax return using an accrual basis of
accounting and a calendar year for both tax and financial reporting purposes. Parent is
under the audit jurisdiction of LB&I. Taxpayer is a vertically-integrated, cost-based,
rate-regulated electric utility, providing retail electric service in State B. Taxpayer is
subject to regulation by Commission A with respect to its retail electric rates and by
Commission B with respect to its wholesale rates. Taxpayer is a wholly owned
subsidiary of Parent.

     Parent consolidated group made first and second quarter Year 2 estimated tax

payments to the Internal Revenue Service (Service), part of which was Taxpayer’s
respective share. Parent’s Year 1 federal income tax return was filed on Date 1
showing an overpayment which was applied to Year 2 estimated taxes. Part of the Year
1 overpayment was Taxpayer’s share causing the Taxpayer’s share of the total Year 2
federal estimated tax payments to be in the amount of a (Year 2 ES Payment). As of
the filing date of the Year 1 consolidated return and the application of the Year 1
overpayment to Parent group’s Year 2 estimated taxes, the additional 50% first year
depreciation deduction (“Bonus Depreciation”) was not applicable to otherwise qualified
property (except long production period property). Accordingly, Taxpayer’s Year 2 ES
Payment was calculated without regard to Bonus Depreciation for Taxpayer’s qualified
property placed in service in the Year 2 tax year (other than long production period
property).

   On December 19, 2014, the Tax Increase Prevention Act of 2014 (P.L. 113-295)

(the “2014 Tax Act”) was enacted into law, which, among other things, retroactively
extended the option to elect Bonus Depreciation for all qualified property placed in
service before January 1, 2014. After the enactment of the 2014 Tax Act, Parent
decided that it would elect Bonus Depreciation for the consolidated group’s Year 2
federal income tax return. As a result of its decision to elect Bonus Depreciation for the
Year 2 tax year, Taxpayer’s Year 2 ES Payment was in excess of the required amount
had Bonus Depreciation not been elected in the amount of b (the Year 2 Tax
Overpayment.) On Date 2, Taxpayer filed a refund claim with the Service for the Year 2
Tax Overpayment. Taxpayer recorded entries on its financial books of account that had
net effect of not decreasing rate base by the amount of the tax refund claimed but not
yet received by Taxpayer.

  Taxpayer received a refund of the Year 2 Tax Overpayment from the Service on

Date 3.

   Similarly, for the Year 3 tax year, Parent consolidated group made first and

second quarter Year 3 estimated tax payments to the Service, part of which was
Taxpayer’s respective share. Taxpayer’s share of the total Year 3 federal estimated tax
payments was in the amount of c (the Year 3 ES Payment). Similar to what occurred in
the previous year, as of the filing date of the Year 2 consolidated return and the
application of the Year 2 overpayment to Parent group’s Year 3 estimated taxes, Bonus
Depreciation was not applicable to otherwise qualified property (except long production
period property). Accordingly, Taxpayer’s Year 3 ES Payment was calculated without
regard to Bonus Depreciation for Taxpayer’s qualified property placed in service in the
Year 3 tax year (other than long production period property.)

    On December 18, 2015, the Protecting Americans from Tax Hikes (PATH) Act of

2015 (P.L. 114-113) (the “2015 Tax Act”) was enacted into law, which, among other
things, retroactively extended the option to elect Bonus Depreciation for all qualified
property placed in service before January 1, 2016. After the enactment of the 2015 Tax
Act, Parent decided that it would elect Bonus Depreciation for the consolidated group’s
Year 3 federal income tax return. As a result of its decision to elect Bonus Depreciation
for the Year 3 tax year, Taxpayer’s Year 3 ES Payment was in excess of the required
amount had Bonus Depreciation not been elected in the amount of d (the Year 3 Tax
Overpayment.) On Date 4, Taxpayer filed a refund claim with the Service for the Year 3
Tax Overpayment. ). Taxpayer recorded entries on its financial books of account had
the net effect of not decreasing rate base by the amount of the tax refund claimed but
not yet received by Taxpayer.

  Taxpayer received a refund of the Year 3 Tax Overpayment from the Service on

Date 5.

                                 RULING REQUESTED

   A net reduction of rate base by means of including in Taxpayer’s ADIT Account

tax benefits resulting from timing differences due to depreciation that have not yet been
received by Taxpayer and are not offset by a corresponding regulatory asset does not
comply with the normalization requirements.

                                  LAW AND 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.

    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,
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 section 167(a) results in a net operating loss carryover (NOLC) 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 section 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 section 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 section 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 section 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 section 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 expense in
computing cost of service in such ratemaking.

    Similar to a taxpayer that must take into account the portion of a NOLC that is

attributable to accelerated depreciation in calculating the amount of the ADIT
under § 1.167(l)-1(h)(1)(iii), a taxpayer’s reserve for deferred taxes for normalization
purposes should include only amounts of tax that are actually deferred and amounts of
zero-cost capital that are actually received. In this case, prior to the Service refunding
the Year 2 Tax Overpayment and Year 3 Tax Overpayment, these were not in the
possession of the Taxpayer. Taxpayer used different regulatory accounts to reflect the
tax refund claimed but not yet received in Year 2 and Year 3; in both years, however,
the net effect of the entries was to not reduce Taxpayer’s rate base by the amount of
the refund claimed but not yet received. A net reduction of rate base by means of
including in Taxpayer’s ADIT Account tax benefits resulting from timing differences due
to depreciation that have not yet been received by Taxpayer and are not offset by a
corresponding regulatory asset does not comply with the normalization requirements.

  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 who requested it. Section 6110(k)(3) of

the Code provides 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 representative. We are also sending a copy of
this letter ruling to Director.

                                   Sincerely,

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