Acquired utility excess deferred taxes remained protected under normalization rules

Plain-English summary

A regulated natural-gas utility bought distribution assets and assumed the seller's regulatory liability for protected excess deferred income taxes. Those excess reserves arose when the 2017 tax law reduced the corporate rate, leaving amounts previously collected from customers that must be returned under utility normalization rules. A state commission required the buyer to obtain an IRS ruling on whether the acquired reserve remained protected. The IRS ruled that it would remain protected if the buyer treated the reserve under Revenue Procedure 2020-39 using the same amortization schedule previously used by the seller.

Ruling snapshot

• Question: Did the protected excess deferred tax reserve remain subject to utility normalization rules after the regulated assets and related liability were acquired?
• Outcome: Approved, conditioned on continuing the seller's schedule under Revenue Procedure 2020-39
• Key authorities: IRC §§ 167 and 168; Treas. Reg. §§ 1.167(l)-1 and 1.168(i)-3; TCJA § 13001(d); Rev. Proc. 2020-39

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202303003 Third Party Communication: None
Release Date: 1/20/2023 Date of Communication: Not Applicable
Index Number: 167.22-00
Person To Contact:
--------------------- ---------------, ID No. ------------
------------------------------------------------ Telephone Number:
------------------------------ ---------------------
-------------------------------- Refer Reply To:
CC:PSI:B06
Re: -------------------------- PLR-109627-22
Date:
October 24, 2022

LEGEND:

Taxpayer = --------------------------------------------------
State A = ------------
State B = ------------
State C = --------
State D = -----------
State E = --------------
State F = --------
Company = ---------------------------------
County = ----------------------------
Subsidiary 1 = ---------------------------------
Subsidiary 2 = -----------------------------
Subsidiary 3 = ---------------------------------------
Subsidiary 4 = ------------------------------------------
Subsidiary 5 = -----------------------------------------
Subsidiary 6 = ------------------------------------------
a = --
b = -----------
c = ---------
d = -----
e = -------------
Commission A = ------------------------------------------------
Commission B = --------------------------------------------------
Date 1 = -----------------------

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PLR-109627-22

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

   This letter responds to your letter, dated May 10, 2022, submitted by your

authorized representative, requesting a ruling concerning the applicability of the
normalization provisions under § 1.168(i)-3(a) of the Income Tax Regulations.

FACTS

   Taxpayer owns natural gas distribution and transmission subsidiaries that

operate in State A, State B, State C, State D, State E, and State F. Taxpayer provides
safe, clean and affordable natural gas to businesses and residents in a states through
Subsidiary 1, Subsidiary 2, Subsidiary 3, Subsidiary 4, Subsidiary 5, and Subsidiary 6.
Taxpayer’s subsidiaries serve approximately b customers and operate more than c
miles of pipeline.

   On Date 1, Subsidiary 5 and Subsidiary 6 (the “purchasers”) acquired through an

asset purchase agreement certain gas distribution assets of Company. The purchasers
acquired from Company the assets and other rights necessary for the operations of
Company’s natural gas distribution systems in State A, State E, and certain portions of
County.

    In order to acquire the assets from Company, Taxpayer and Company had to

seek approval from Commission A and Commission B. Although both commissions
ultimately approved the acquisition, as part of a settlement agreement approved in the
final order, Commission B required Taxpayer to obtain a private letter ruling from the
IRS to determine the appropriate treatment of the acquired protected excess deferred
income taxes (EDIT). Pursuant to the parties’ settlement agreement, the request for a
private letter ruling would be submitted within d days following the transaction closing.

   Pursuant to section 13001(d) of Public Law No. 115-97, 131 Stat. 2054 (2017)

more commonly referred to as the Tax Cuts and Jobs Act (TCJA), Company established
protected EDIT reserves based on the remeasurement of protected method and life
depreciation differences between tax and regulatory books. These reserves were
amortized using the prescribed Average Rate Assumption Method (ARAM) detailed in
section 13001(d) of the TCJA. Taxpayer assumed the regulatory liability representing
the protected EDIT liability of Company, which amounted to approximately $e, as part of
the asset acquisition.

RULING REQUESTED

   Taxpayer requests a ruling as to whether the acquired regulatory liability

associated with the “protected” excess deferred income taxes or excess tax reserve
included in the asset purchase agreement of certain gas distribution assets will continue
to be protected by the normalization rules following the acquisition.

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PLR-109627-22

LAW AND ANALYSIS

    Section 168 of the Internal Revenue Code generally allows taxpayers to

compute their depreciation deduction for federal income tax purposes under the
accelerated cost recovery system. Section 168(f)(2) of the Internal Revenue Code
(Code), provides that the depreciation deduction determined under § 168 of the Code
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)(i) requires

the 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. This reserve is referred to as
the Accumulated Deferred Income Taxes (ADIT) reserve. Taxpayers calculate the
amount of the adjustments to the ADIT reserve by reference to the corporate tax rate
applicable in each year that the depreciation deduction allowable as a deduction under
§ 168 exceeds the amount calculated under § 168(i)(9)(A)(i) for the taxpayer's regulated
tax expense.

   Section 1.167(l)-1(h)(2)(i) of the Income Tax Regulations 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 and
included in such reserve under § 167(l) “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” under § 1.167(l)-1(h)(1)(i). That
section notes that, additionally, the aggregate amount allocable to deferred taxes may
be properly adjusted to reflect asset retirements or the expiration of the period for
depreciation used for determining the allowance for depreciation under § 167(a).
Consequently, the ADIT increases in each year the accelerated depreciation
under § 168 exceeds the tax depreciation amount used for calculating the taxpayer's
regulated tax expense and the ADIT decreases in each year the accelerated
depreciation under §168 is less than the tax depreciation amount used for calculating
the taxpayer's regulated tax expense. These increases and decreases are measured
by the differences in the two depreciation methods multiplied by the tax rate in effect for
the year of the adjustment to the ADIT.

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PLR-109627-22

   The TCJA, enacted on December 22, 2017, generally reduced the corporate tax

rate under § 11 from 35 percent to 21 percent for taxable years beginning after
December 31, 2017. Section 13001(a) of the TCJA. Because of the reduction in rates,
for property subject to depreciation in a taxable year beginning on or before December
31, 2017, and not yet fully depreciated in the first taxable year beginning after
December 31, 2017, a portion of the ADIT reserve will reflect this reduction. The portion
of the ADIT reserve that reflects the difference in tax rates due to accelerated
depreciation is referred to as the Excess Tax Reserve (ETR). The ETR represents the
amount by which the ADIT reserve exceeds the amount it would have contained had the
reduction in rates been in effect for every year the property was subject to depreciation.
That is, the ETR is the amount of accelerated depreciation-related taxes that have been
collected from ratepayers but have not yet been paid by the utility and become excess
due to the reduction in rates.

   Section 13001(d) of the TCJA includes accompanying but uncodified

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

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

taxpayers. If, as of the first day of the taxable year that includes the date of enactment
of the TCJA, the taxpayer was required by a regulatory agency to compute depreciation
for public utility property on the basis of an average life or composite rate method, and
the taxpayer's books and underlying records did not contain the vintage account data
necessary to apply ARAM, the taxpayer will be treated as using a normalization method
of accounting if, with respect to such jurisdiction, the taxpayer uses the alternative
method for public utility property that is subject to the regulatory authority of that
jurisdiction. Section 13001(d)(3)(C) of the TCJA defines the “alternative method” as the
method in which the taxpayer computes the ETR on all public utility property included in
the plant account on the basis of the weighted average life or composite rate used to
compute depreciation for regulatory purposes, and reduces the ETR ratably over the
remaining regulatory life of the property.

    Section 4.01 of Rev. Proc. 2020-39, 2020-36 I.R.B. 609, provides that under

section 13001(d)(1) of the TCJA, taxpayers must use ARAM to calculate the reversal of
their ETR if the taxpayer’s regulatory books (the financial and tax information used by
their regulator in setting rates which may include but is not limited to materials submitted
to public service commissions as well as any supporting materials) are based upon the
vintage account data necessary to use ARAM. However, if the taxpayer’s regulatory
books are not based upon the vintage account data that is necessary for the ARAM, use
of the ARAM is not required.

                                            5

PLR-109627-22

  Section 1.168(i)-3(a) provides rules for the application of section 203(e) of the Tax

Reform Act of 1986, Public Law 99-514 (100 Stat. 2146) to a taxpayer with respect to
public utility property (within the meaning of section 168(i)(10)) that ceases, whether by
disposition, deregulation, or otherwise, to be public utility property with respect to the
taxpayer and that is not described in § 1.168(i)-3(a)(2) (deregulated public utility
property).

   Under § 1.168(i)-3(b), if public utility property of a taxpayer becomes deregulated

public utility property to which this section applies, the reduction in the taxpayer's ETR
permitted under section 203(e) of the Tax Reform Act of 1986 is equal to the amount by
which the reserve could be reduced under that provision if all such property had
remained public utility property of the taxpayer and the taxpayer had continued use of
its normalization method of accounting with respect to such property.

   Section 1.168(i)-3(a)(2)(ii) provides an exception to the rule under § 1.168(i)-3(b)

for property transferred by a taxpayer if after the transfer, the property is public utility
property of the transferee and the taxpayer's ETR with respect to the property (within
the meaning of section 203(e) of the Tax Reform Act of 1986) is treated as an ETR of
the transferee with respect to the property.

   Section 4.01 of Rev. Proc. 2020-39, provides that under section 13001(d)(1) of

the TCJA, taxpayers must use ARAM to calculate the reversal of their ETR, if the
taxpayer's regulatory books are based upon the vintage account data necessary to use
ARAM. However, if the taxpayer's regulatory books are not based upon the vintage
account data that is necessary for the ARAM, use of the ARAM is not required. Section
4.02 of Rev. Proc. 2020-39 provides that the determination of whether a taxpayer's
regulatory books contain sufficient vintage account data necessary to use the ARAM is
determined based on all the facts and circumstances. Under section 5 of Rev. Proc.
2020-39, the TCJA ETR normalization requirements are part of the overall pre-existing
deferred tax normalization rules. The revenue procedure is intended to be consistent
with those rules.

    Section 4.03 of Rev. Proc 2020-39 provides that the rules in § 1.168(i)-3, apply

only to section 203(e) of the Tax Reform Act of 1986. Generally, the IRS will apply
§ 1.168(i)-3 as if that limitation date language is not present. Thus, the sharing of ETRs
with customers continues to be permitted in most circumstances after a retirement or
disposition and upon the sale of public utility property to another regulated utility as set forth
in § 1.168(i)-3.

   The exception under § 1.168(i)-3(a)(2)(ii) applies if the transferor’s ETR is treated

as an ETR of the transferee. Accordingly, Taxpayer’s acquired regulatory liability
associated with the “protected” excess deferred income taxes or ETR included in the
asset purchase agreement of certain gas distribution assets will continue to be
protected under the normalization rules if the ETR in the hands of the Taxpayer is

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PLR-109627-22

treated in accordance with Rev. Proc. 2020-39 using the same schedule previously
used by Company.

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

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

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

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

   This ruling is based upon information and representations submitted by Taxpayer

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

  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.

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

letter is being sent to your authorized representatives.

                                       Sincerely,



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

Enclosure:
Copy for § 6110 purposes

cc: