Electric utility received ADFIT normalization guidance

Plain-English summary

A regulated electric transmission utility used formula rates with projected revenue requirements and later true-up adjustments. After an earlier private letter ruling required corrective action for its accumulated deferred federal income tax calculations, its regulator ordered a different computation and the utility sought assurance that changing methods would not jeopardize accelerated depreciation. The IRS ruled that the earlier corrective example was not the only permissible ADFIT computation. For projected rates based on a fully future test period, the utility could prorate projected ADFIT changes without also applying a separate averaging convention. For true-ups, actual changes already reflected in projected and prorated amounts did not need averaging, but differences between actual and projected changes had to be averaged. Any actual ADFIT change that was neither prorated nor averaged would violate the normalization rules.

Ruling snapshot

• Question: How could the utility change its projected and true-up ADFIT calculations while preserving depreciation normalization?
• Outcome: approved as described, with every actual ADFIT change required to be either prorated or averaged
• Key authorities: IRC §§ 167, 168(f)(2), 168(i)(9), 168(i)(10); Treas. Reg. § 1.167(l)-1

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201930015                                              Third Party Communication: None
Release Date: 7/26/2019                                        Date of Communication: Not Applicable
Index Number: 168.00-00
                                                               Person To Contact:
----------------------                                         --------------------, ID No. ------------------
-----------------------------------                            Telephone Number:
-------------------                                            ----------------------
-------------------------------------------------              Refer Reply To:
------------------------------------------------------------   CC:PSI:B06
--------------------------------                               PLR-130886-18

In Re: ---------------------------------------------------- Date:
---------------------                                       April 10, 2019




LEGEND

Taxpayer                   = ---------------------------------------------------------------------------------------
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Parent                     =        ---------------------------------------------

State 1                    =        --------------

State 2                    =        --------------

Holdings                   =        ---------------------------------------------------------------------------------
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Commission                 =        -------------------------------------------------------

Organization               =         -------------------------------------------------------------------
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Formula Rate               =         -------------------------------------------------------------------
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                                    ---------------------------------------------

Location                   =        ---------------------------------

PLR                        =        -----------------------

Year 1                     =        -------

Year 2                  =   -------

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

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

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

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

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

Date 6                  =   ------------------------

Date 7                  =   ----------------------------

Date 8                  =   ----------------------

Date 9                  =   ----------------------

Date 11                 =   -----------------------

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

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

c                       =   ----

d                       =   --

e                       =   --

f                       =   ----

g                       =   --


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

      This letter responds to a request for a ruling dated October 16, 2018, and
subsequent correspondence submitted on behalf of Taxpayer by your authorized
representatives. Taxpayer requests a ruling on the application of the depreciation
normalization rules of § 168(i)(9) of the Internal Revenue Code and § 1.167(I)-1 of the
Income Tax Regulations (together, the “normalization rules”) to certain Commission

regulatory procedures, which are described below. The relevant facts as represented in
your submission are set forth below.

       Taxpayer, an independent electric transmission utility incorporated in State 2,
operates a high-voltage transmission system in State 2. Taxpayer is owned by
Holdings, an indirect subsidiary of Parent, which is a State 1 corporation. Taxpayer files
a consolidated federal income tax return on a calendar year basis with its affiliates,
including Parent. Taxpayer’s rates are regulated by Commission and are established
on a cost-of-service model.

       Taxpayer implemented formula-based rates effective Date 9, as calculated under
Organization’s Formula Rate, as authorized by a Commission order. The formula-
based rates are based on a forward-looking test year and are subject to a true-up
adjustment based on the actual financial results of the test period. Since Year 2, the
Formula Rate employed by Taxpayer has been authorized by a Commission order. The
modifications to the Formula Rate templates of Taxpayer in Year 2 were, in part,
intended to implement the holdings of a private letter ruling (PLR) issued to Taxpayer
related to the normalization rules.

        Organization is a not-for-profit regional transmission organization managing the
operations and investments in approximately a miles of high-voltage transmission and b
megawatts of power-generating resources owned by utilities in the all or parts of c U.S.
states and Location. Its objectives include improving reliability, coordination of
operations, seams management, and price and informational transparency of the
electric transmission utilities operating in its region. Organization bills and collects
revenues from the customers of Taxpayer.

       Taxpayer’s transmission rates are set annually using a Commission-approved
formula rate. The rates remain in effect for a d-year period. On Date 1 of each year,
Taxpayer estimates its revenue requirement for the forthcoming calendar year, the
service year, based in part on the facilities in service or expected to be placed in service
during that forthcoming year. The revenue requirement determined based on the
annual projection becomes effective on Date 2 of the service year. By completing the
formula rate templates approved by Organization on an annual basis, Taxpayer is able
to adjust its transmission rates to reflect changing operational data and financial
performance, including the amount of network load on the transmission systems,
operating expenses and additions of utility plant when placed in service, among other
items.

       The Commission-approved rate formulas use previously-approved rates of return
on equity and do not require further action or Commission filings for the calculated rate
to go into effect, although the rate is subject to legal challenge at Commission.
Taxpayer will continue to use formula rates to calculate its annual revenue requirements

unless Commission determines that such rate formulas are unjust and unreasonable or
another mechanism is determined by Commission to be just and reasonable.

       The cost-based formula templates include a true-up mechanism, whereby
Taxpayer compares its actual revenue requirement (determined after the end of the
service year) to its billed revenues for the service year to determine any over-collection
or under-collection of the revenue requirement. The intent of the true-up mechanism is
to ensure that customers are paying no more than the actual cost of service if the actual
net revenue requirement is less than the billed revenues that were based on the
projected revenue requirements (an over-collection), and to protect Taxpayer if the
actual net revenue requirement is more than the billed revenues (an under-collection).
The actual net revenue requirement for the service year, and accordingly, the true-up
amount computed in the year following the service period are based largely on the
amounts reported to Commission for the service year.

        The amount of over-collection or under-collection is reflected in customer bills
within e years of the service year under the provisions of the Formula Rate.
Specifically, an over-collection for a given service year is subtracted from the revenue
requirement for the service year that is e years after the service year to which the over-
collection relates. A regulatory liability is recorded for over-collections under the true-up
mechanism and carrying charges are paid to customers until these amounts reduce
prices charged in the future. An under-collection for a given service year is added to the
revenue requirement for the service year that is e years after the service year to which
the under-collection relates. A regulatory asset is recorded for under-collections under
the true-up mechanism and carrying charges are charged to customers until these
amounts are recovered.

        Thus, the actual revenue requirement for a service year is charged both during
such service year and as part of a true-up adjustment reflected in rates charged e years
after the service year to which it relates. The revenue requirement charged for a given
service year that is charged during such period is based on the monthly billing rate
calculated in the previous year in the filing due by Date 1 (using the projected revenue
requirement and projected customer loads for such service year) as applied to the
actual monthly peak loads during the service year. The actual revenue requirement for
a service year is determined after the end of the service year. The true-up adjustment
reflects differences primarily between projected and actual operating costs, rate base
and interest expense as well as differences between projected and actual customer
loads (sales volumes). An over-collection or under-collection typically results from
differences between the projected revenue requirement used to establish the billing rate
charged during the service year and actual revenue requirement determined after the
service year or from differences between actual and projected monthly peak loads.

      In accordance with the provisions of the Commission-approved formula rate
templates, Taxpayer computes the rate base for its annual projections and its actual

revenue requirements used to determine the true-up adjustments using average rate
base calculations. Average rate base uses average plant balances, including
accumulated depreciation, in determining the annual revenue requirement based on f-
month averaging. Average rate base uses simple averaging for land held for future use,
materials and supplies, and prepayments. Gross rate base is reduced by Accumulated
Deferred Federal Income Taxes (“ADFIT”). Prior to the issuance of the PLR to
Taxpayer, average ADFIT was computed based on the simple averaging convention.
Since the issuance of the PLR, average ADFIT has been computed on the basis of the
f-month averaging convention for purposes of the projected revenue requirement
computations and on the basis of the simple averaging methodology for purposes of the
actual revenue requirement computations used to determine the true-up adjustments.
The same test year is used for all rate base components for the annual projected
revenue requirement components for the annual projected revenue requirement
computations and actual revenue requirement computations used to determine true-up
adjustments. Balances for all month-ends agree with accounting records, and year-end
balances for the actual revenue requirement calculation agree with the relevant
Commission filings.

        Prior to the issuance of the PLR, Taxpayer did not apply the § 1.167(l)-1(h)(6)
proration requirement to ADFIT increases or decreases for purposes or either projected
revenue requirements or the actual revenue requirements used to determine the true-up
adjustments. Since the issuance of the PLR, Taxpayer has computed monthly ADFIT
balances for purposes of the projected revenue requirements based on the application
of the proration formula to forecasted monthly ADFIT increases or decreases, and used
these prorated month-end ADFIT amounts in the f-month averaging for its projected
revenue requirement computations. Taxpayer does not apply the proration formula to
any portion of actual ADFIT increases or decreases to compute average actual ADFIT
for its actual revenue requirements used to determine its true-up adjustments.

       Taxpayer has modified its formula rate templates, as necessary, to conform to
the guidance in the PLR, including corrective actions that the Service described as a
condition required to avoid the denial of accelerated depreciation. Taxpayer considers
the PLR to be clear and complete, and intended that the modifications to its ADFIT
calculations implemented shortly after receipt of the PLR would be the only template
modifications required to maintain compliance with the normalization rules in the
foreseeable future. However, Taxpayer currently believes that its formula rate template
ratemaking practices since the receipt of the PLR comply with the normalization rules
because they adhere to the holdings of the PLR.

       A Date 3 Commission Order (“the Date 3 Commission Order”) instituted
proceedings to examine the methodology used by f utilities for calculating their ADFIT
balances in their projected test year and annual true-up calculations for their
transmission formula rates. The Date 3 Commission Order requires the f companies,
including Taxpayer, to change their computations of ADFIT (and rate base) in a manner

that applies one of the holdings of -----------------------. Taxpayer responded to the Date 3
Commission Order by jointly filing an initial brief (not on a consolidated basis) with its e
affiliates that are filing substantially identical private letter ruling requests, and g
unrelated companies that are Organization members (“Date 4 Initial Brief”).

         Further, Taxpayer and its e affiliates that are filing substantially identical private
letter ruling requests, jointly filed with Commission proposed revisions to their Formula
Rate templates complying with the Date 3 Commission Order for projected revenue
requirement computations and actual revenue requirement computations used to
determine true-up adjustments of each of the companies, to become effective after the
Service issues the private letter rulings that Taxpayer and its e affiliates are requesting
(“Date 4 Filing”). Taxpayer jointly filed a reply brief (not on a consolidated basis) with its
e affiliates filing a substantially identical private letter ruling request, and g unrelated
Organization companies on Date 7, in response to a brief filed by an intervenor (“Date
10 Reply Brief”).

       The specific ADFIT computational change ordered by Commission involves the
use of averaging (and, thus, the deferred tax consistency requirement) and would be
contrary to a statement in the PLR, describing the corrective actions involving the
ADFIT computations required in Taxpayer’s subsequent rate proceedings. The change
mandated by the Date 3 Commission Order would affect both the projected revenue
requirement computations and the actual revenue requirement computations used to
determine true-up adjustments.

        Although Taxpayer is not contesting that the ADFIT computational change
ordered by Commission would also comply with the normalization rules, Taxpayer is
hesitant to unilaterally cease adhering to one of the corrective actions described in the
PLR as a condition required to avoid the sanction of denial of accelerated depreciation
due to its pre-Year 2 formula rate ADFIT computational methodology. Taxpayer is
seeking a private letter ruling to supplement the PLR to clarify that the corrective actions
described in the PLR were not intended to be the sole ADFIT computation allowable
after issuance of the PLR in order for Taxpayer to be treated as having complied with
the normalization rules in years prior to receipt of the PLR. Thus, Taxpayer may make
further ADFIT computational changes in order to comply with the Date 3 Commission
Order prospectively, while maintaining compliance with the normalization rules.

       Taxpayer also addresses certain holdings of -----------------------that are not the
focus of the Date 3 Commission Order. The holdings clarify that the proration
requirement used in the projected revenue requirement also applies, to an extent
specified in -----------------------, to actual revenue requirement computations used to
determine true-up adjustments. Taxpayer intends to modify its templates used for true-
up adjustments at the next available opportunity in order to apply these holdings if the
Service rules favorably in this supplemental ruling request.

         The Date 3 Commission Order and related proceedings are focused on an
ADFIT computation that the Commission refers to as ----------------------------------------------
------------------- and -------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
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----------------------------------------------------Specifically, the Commission refers to ADFIT
averaging using ADFIT amounts that have been prorated as ------------------------------------
---------------------Taxpayer has employed this approach since the annual projected
revenue requirement filing immediately following the receipt of the PLR. Until formally
instructed otherwise by the Service, Taxpayer considers its ADFIT computational
approach to be a mandatory aspect of the corrective actions in accordance within the
analysis of issue 4 of the PLR.

         This computational issue was not analyzed in the private letter ruling request
submitted by Taxpayer resulting in the PLR, and this topic was not the subject of any of
the specific rulings requested by Taxpayer at that time. Thus, the terms of compliance
with the normalization rules were likely not intended to imply that the approach
Taxpayer indicated it would use after issuance of the PLR was the only means to satisfy
the normalization rules applicable to future test periods and average rate base.
However, Taxpayer believes that unilaterally ceasing to adhere to a specific corrective
action described in the PLR may be inappropriate and inconsistent with the historical
practice of the Service and the utility industry in establishing, maintaining and
remedying compliance with the normalization rules prior to the issuance of the safe
harbor guidance of Revenue Procedure 2017-47, 2017-38 I.R.B. 233, which permits
utilities to “self-correct” inadvertent non-compliance with the normalization rules in
certain circumstances.

         In addition to addressing ---------------------------------------------------- Taxpayer
proposed to Commission in its Date 4 Filing that its template for its actual revenue
requirement used to compute its true-up adjustment be amended to reflect the
principles of -----------------------regarding preservation of the effects of the proration
formula. Although Taxpayer considers itself in compliance with the normalization rules
at this time because this aspect of the proration computation in annual ratemaking with
true-up adjustments is not mandated in the PLR, Taxpayer believes that it is necessary
to revise its templates to adopt all clarifications of the ADFIT normalization rules
resulting from ------------------------if it modifies its templates to reflect any of the holdings
of -----------------------.

         On Date 4, Taxpayer responded to the Commission Date 3 Order by filing an
initial brief. Taxpayer is willing to make the ADFIT computational change as mandated
by the Commission Date 3 Order and believes such computational method would also

comply with the deferred tax normalization rules. However, Taxpayer is hesitant to
unilaterally cease adhering to the corrective action described in Taxpayer’s private letter
ruling without the Service’s guidance.

         On Date 5, Commission issued an order: (1) indicating that it did not believe it
was necessary for Taxpayer to delay the implementation of the template changes
pending approval from the Internal Revenue Service, and (2) ordering Taxpayer to
make a compliance filing to implement the template changes. On Date 6, Taxpayer
submitted its compliance filing addressing -------------------------------------------------,
including tariff revisions to reflect the preservation-of-proration holdings of ------------------
---------------- (the “Date 6 Compliance Filing”). Taxpayer represents that it intended to
continue to employ --------------------------------------------------allowed in the PLR until
receiving additional guidance from the Service. However, to comply with the
Commission Date 5 Order, Taxpayer will cease using ---------------------------------------------
-------------------beginning on Date 8.

                                   RULINGS REQUESTED

   Taxpayer requests the following rulings:

    1. The corrective action described in the PLR includes an example of an ADFIT
      computation that would comply with the normalization requirements, but it was
      not intended to be the sole allowable computation. Therefore, Taxpayer would
      not be subject to the sanction of denial of accelerated depreciation in years prior
      to the receipt of the PLR, and would maintain compliance with the normalization
      rules if another ADFIT computation consistent with the normalization
      requirements were employed in any of the rate cycles after receiving the PLR.

    2. Taxpayer would comply with the consistency requirement under § 168(i)(9)(B) in
      computing its projected revenue requirement employing a future test period with
      an average rate base computation by (a) applying the proration formula rules
      under § 1.167(l)-1(h)(6) to the projected monthly increases or decreases in
      ADFIT without (b) further applying an averaging convention, as applied to other
      elements of rate base, either to the prorated end-of-period ADFIT balance or to
      the prorated increases or decreases in ADFIT used to compute the prorated end-
      of-period ADFIT balance.

    3. Taxpayer would comply with the consistency requirement under § 168(i)(9)(B)
      and the proration formula rules under § 1.167(l)-1(h)(6) in computing its actual
      revenue requirement computations used to determine true-up adjustments by (a)
      continuing to apply the proration formula rules to its actual ADFIT increases or
      decreases to the extent such increases or decreases were projected and
      prorated in computing its projected revenue requirement and (b) applying an
      averaging convention to actual ADFIT increase or decreases (or portions thereof)

       to the extent not previously subjected to the proration formula. Taxpayer would
       violate the normalization rules in computing its actual revenue requirement used
       to determine its true-up adjustments if any portion of its actual ADFIT increases
       or decreases is neither prorated nor averaged.

                                  LAW AND ANALYSIS

      Section 168(f)(2) of the Internal Revenue 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)(9)(C) provides that in the case of any public utility property to
which § 168 does not apply by reason of § 168(f)(2), the allowance for depreciation
under § 167(a) shall be an amount computed using the method and period referred to in
§ 168(i)(9)(A)(i).

       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(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 § 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.

        Prior to the Revenue Reconciliation Act of 1990, the definition of public utility
property was contained in § 167(l)(3)(A) and § 168(i)(10), which defined public utility
property by means of a cross reference to § 167(l)(3)(A). The definition of public utility
property is unchanged. Section 1.167(l)-1(b) provides that under § 167(l)(3)(A),
property is public utility property during any period in which it is used predominantly in a
§ 167(l) public utility activity. The term “section 167(l) public utility activity” means, in
part, 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, are regulated, i.e., have been established
or approved by a regulatory body described in § 167(l)(3)(A). The term “regulatory body
described in section 167(l)(3)(A)” means a State (including the District of Columbia) or
political subdivision thereof, any agency or instrumentality of the United States, or a
public service or public utility commission or other body of any State or political
subdivision thereof similar to such a commission. The term “established or approved”
includes the filing of a schedule of rates with a regulatory body which has the power to

approve such rates, though such body has taken no action on the filed schedule or
generally leaves undisturbed rates filed by the taxpayer.

        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 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 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 (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
§ 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).

        Under § 1.167(l)-1(h)(6)(i), 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 the period is the amount of the reserve
(determined under § 1.167(l)-1(h)(2)(i)) at the end of the historical period. If solely a
future period is used for such determination, the amount of the reserve account for the
period is the amount of the reserve at the beginning 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 such 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. The pro
rata portion of any increase to be credited or decrease to be charged during a future
period (or the future portion of a part-historical and part-future period) shall be
determined by multiplying any such increase or decrease by a fraction, the numerator of
which is the number of days remaining in the period at the time such increase or
decrease is to be accrued, and the denominator of which is the total number of days in
the period (or future portion).

        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”).

Issue 1

       The corrective action in the PLR includes an example of an ADFIT computation
that would comply with the normalization rules. We agree that the example was not
intended to be the sole allowable computation. Therefore, Taxpayer would not be
subject to the sanction of denial of accelerated depreciation in years prior to the receipt
of the PLR, and would maintain compliance with the normalization rules if another
ADFIT computation consistent with the normalization rules were employed in any of the
rate cycles after receiving the PLR.

Issue 2

       Taxpayer states that if the purpose of the regulatory averaging and proration can
be shown to be the same, the consistency requirement should not apply. Taxpayer
represents that the purpose of the proration requirement is to take into account for
ratemaking purposes the economic fact that changes in ADFIT balances in a future test
period (and the attendant cash flows) will occur over a period of time. According to
Taxpayer, the critical question is whether the averaging convention has a different
purpose. According to Taxpayer, the answer appears to lie in the nature of the test
period. If the test period is part historical, part future, the timing of the rate base
expenditures cannot be what regulatory averaging was meant to address.

        However, Taxpayer maintains that the purposes of regulatory averaging and
proration can be the same when the entire test year is a future test period. Taxpayer
maintains, and we agree, that averaging conventions, when applied to entirely future
test periods, should presumptively be treated as having the same purpose as the
Proration Requirement, thereby negating the necessity to apply both conventions
serially to changes in ADFIT balances. Therefore, Taxpayer would comply with the
consistency requirement under § 168(i)(9)(B) in computing its projected revenue
requirement employing a future test period with an average rate base computation by
(a) applying the proration formula rules under § 1.167(l)-1(h)(6) to the projected monthly
increases or decreases in ADFIT, and without (b) further applying an averaging
convention, as applied to other elements of the rate base, either to the prorated end-of-
period ADFIT balance or to the prorated increases or decreases in ADFIT used to
compute the prorated end-of-period ADFIT balance.

Issue 3

       It is satisfactory under the normalization rules to determine ADFIT in the
projected revenue requirement for a future period with an average rate base by applying
the proration formula rules to projected ADFIT increases and decreases without a
separate averaging convention identical or similar to the averaging applied to other rate
base items. For purposes of the actual revenue requirement used for the true-up
mechanism we believe that 1) it is permissible under the normalization rules to not

average the portion of actual ADFIT increases and decreases that were prorated in the
calculation of the projected revenue requirement, and 2) it is impermissible under the
normalization rules for the differential between actual and projected ADFIT increases
and decreases to not be subjected to an averaging convention.

        Therefore, Taxpayer would comply with the consistency requirement under
§ 168(i)(9)(B) and the proration formula rules under § 1.167(l)-1(h)(6) in computing its
actual revenue requirement computations used to determine true-up adjustments by (a)
continuing to apply the proration formula rules to its actual ADFIT increase or decreases
to the extent such increases or decreases were projected and prorated in computing its
projected revenue requirement and (b) applying an averaging convention to actual
ADFIT increase or decreases (or portions thereof) to the extent not previously subjected
to the proration formula. Taxpayer would violate the normalization rules in computing its
actual revenue requirement used to determine its true-up adjustments if any portion of
its actual ADFIT increases or decreases is neither prorated nor averaged.

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

      The rulings contained in this letter are based upon information and
representations submitted by Taxpayer and accompanied by a penalties 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 upon
examination.

      This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

        A copy of this ruling must be attached to any federal income tax return to which it
is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling. In accordance with the power of attorney on file with this
office, a copy of this letter is being sent to your authorized representatives. We are also
sending a copy of this letter to the appropriate Industry Director, LB&I.


                                              Sincerely,



                                             David A. Selig
                                             Senior Counsel, Branch 6
                                             Office of Associate Chief Counsel
                                             (Passthroughs & Special Industries)