500 LEE STREET EAST SUITE 1600 PO. BOX 553 CHARLESTON, WEST VIRGINIA 25322 TELEPHONE: 304-340- 1000 TELECOPIER: 304-340-1 I30 www.jackionkelly.com
(304) 340-1251 Fax No. (304) 340-1080
e-mail: ccallas@jackson kelly.com State Bar ID No. 5991
November 2 1’20 12
VIA HAND DELIVERY
Ms. Sandra Squire Executive Secretary West Virginia Public Service Commission 201 Brooks Street Charleston, West Virginia 25301
Re: Mountaineer Gas Company (Closed Entry) Case No, 11-1627-G-42T
Dear Ms. Squire:
We enclose an original and twelve copies of the Company’s Limited Petition for Reconsideration, filed in accordance with Procedural Rule 19.3 and the Commission’s November 8’20 12 procedural order.
As we noted in our November 7 letter to you, the Petition asks the Commission to reconsider its ruling on the Company’s proposal to reduce accumulated deferred income taxes by $2.6 million in connection with the Company’s net operating loss and alternative minimum tax credit carry-forwards. See Commission Order dated October 3 1,20 12, at 14- 16.
Please file this letter and attachment and circulate the additional copies to the appropriate parties at the Commission. We also ask that you date stamp the extra copies provided and return them with our messenger. As always, we appreciate your assistance in this matter.
CLC/mrv Enclosure
Ms. Sandra Squire November 2 1,20 12 Page 2
c: Scott Klemm (w/enc.) Tom Taylor (w/enc.) Tom White, Esq. (w/enc.) Britt A. Freund, Esq. (w/enc.) John Auville, Esq. (w/enc.)
(C2482544.1)
CHARLESTON
LIMITED PETITION FOR RECONSIDERATION OF MOUNTAINEER GAS COMPANY
Mountaineer Gas Company (“Company”) presents this Limited Petition for
Reconsideration (“Petition”), in accordance with Procedural Rule 19.3 and the Commission’s
November 8,2012 procedural order, to ask that the Commission reconsider a limited component
of its final order entered on October 3 1 20 12 (“Order”).
In the Order, the Commission erred in declining to recognize the Company’s proposed
$2.6 million offset to accumulated deferred income taxes (“ADITS”) associated with the 13-
month average of net operating loss carryforwards (“NOLs”) and alternative minimum tax
(“AMT”) credit carryforwards (as described in Mr. Klemm’s direct and rebuttal testimonies, the
“Minimum Adjustment”). Order at 16. No competent evidence supported the Commission’s
decision on this issue, and it both contravened the significant weight of authority on NOL ADIT
assets and exposed the Company’s customers to the loss of the benefits of accelerated
depreciation tax deductions. The Commission should reconsider and reverse decision, or at a
minimum direct the Company to obtain a private letter ruling on whether the Order presents a
violation of IRS normalization rules.
(C2478248.3j
A. Reasons Why Reconsideration is Appropriate
Reconsideration of the Commission’s rejection of the Minimum Adjustment is
appropriate for three reasons.
1. No Legal or Evidentiary Basis
The Commission’s rejection of the Minimum Adjustment has no evidentiary or legal
basis. The Commission’s only justification for rejecting the Minimum Adjustment is the Staffs
reference to Bluefield Gas Company, Case No. 1 1-04 10-G-42T (Commission Order entered
January 17, 2012) (“Bluefield Order”). In the Bluefield Order, the Commission found no
potential normalization violation because the utility had not proven that its NOL carryforwards
were entirely traceable to accelerated depreciation. By contrast, the NOLs involved in the
Minimum Adjustment in this case were entirely traceable to accelerated depreciation, and no
party has contended otherwise. Consequently, the Bluefield Order does not even remotely
support rejection of the Minimum Adjustment.
Moreover, the Order fails to address, much less account for, compelling evidence the
Company and the CAD presented. These parties proved (i) the significant risk arising from a
failure to incorporate the Minimum Adjustment in rates, (ii) the “general consensus” that a
deferred tax asset must be recognized for NOL carryforwards arising from a utility’s claim of
accelerated depreciation, and (iii) the numerous decisions from other regulators that uniformly
approve this approach. The Commission is obligated to ensure that its orders are supported by
the facts and sound legal principles. The Commission’s rejection of the Minimum Adjustment
lacks any such support, and must be reconsidered.
{ C2478248.3) 2
Normalization violations are not prevented simply because a regulator contends that no
violation exists. They are prevented because the eflect of the regulator’s decision does not create
a violation. In this case, the Company and its tax consultant have concluded that the Order, by
flowing through to current customers the benefit of accelerated depreciation in respect of the
Minimum Adjustment, creates a significant risk of violating normalization rules. This risk is
more than theoretical, and does not simply disappear because the Commission might choose to
ignore it. Unless the Commission reverses course on the Minimum Adjustment, applicable
Treasury regulations require the Company to “self-report” a “change in regulatory accounting”
within 90 days of the Order - effectively to report that the Commission’s decision, by making
rate base higher than it would be without the Minimum Adjustment, flows through the benefits
of accelerated depreciation associated with the NOL to current customers.
The Commission has repeatedly indicated its concern for preserving utilities’ access to
accelerated depreciation deductions. Protecting the Company’s access to this tax benefit is
critically important to both the Company and its customers. A tax normalization violation would
result in the Company losing its ability to claim accelerated tax depreciation on its federal
income tax returns for assets existing as of the violation date and for future years. Furthermore,
the Internal Revenue Service (,‘IRSyy) could require the Company to amend its tax returns for
open tax years, the effect of which would be to deny the Company significant amounts of bonus
depreciation taken in recent years and expose the Company to IRS penalties and interest. More
importantly, the Company and its customers would lose the interest-free loan associated with the
deferral of federal income tax payments. As a consequence, the Company would essentially
(C2478248.3 } 3
have to repay the federal ADIT liability of $15.7 million on its books - resulting in a significant
increase to rate base that would be reflected in higher customer rates.
These negative impacts are the severe, very real consequences of a normalization
violation, and simply turning a blind eye will not make them disappear. To avoid a significant
negative impact on the Company and its customers, the Commission should reconsider and
reverse its rejection of the Minimum Adjustment.
3. Request for Private Letter Ruling
If the Commission does not change its position on the inclusion of the Minimum
Adjustment in rate base, then the Commission should at least direct the Company to request
private letter ruling (“PLR”) from the IRS. The IRS has a process by which a PLR request can
be used to obtain an IRS determination on whether or not a rate order complies with the
normalization requirements for using accelerated depreciation methods for federal income tax
purposes. Other utilities have used this process to obtain a ruling on a regulator’s treatment of an
NOL position in similar situations. The Company would be willing to abide by an IRS
determination on whether the Commission’s rejection of the Minimum Adjustment constitutes a
normalization violation. If the IRS upholds the Commission’s ruling, then no hrther action need
occur. On the other hand, if the IRS finds that the Commission’s rejection of the Minimum
Adjustment does create a normalization violation, then the Commission would correct its error,
and if required to avoid a normalization violation, authorize the Company to recover the
additional revenue associated with including the Minimum Adjustment in rate base,
retrospectively from the effective date of the Order and prospectively as well.
{ C2478248.3) 4
B. Background and Analysis of Commission Rejection of Minimum Adjustment
The Minimum Adjustment was just that - a minimum offset to the Company’s ADIT
balance required (i) to account for NOLs generated exclusively by the impact of accelerated
depreciation deductions and (ii) to avoid a normalization violation. The much larger component
of the Company’s ADITs recommendation was an $11.4 million offset associated with the
Company’s history of significant losses and its lack of benefit from the interest-free loan impact
of accelerated depreciation when it generated no taxable income (as described in Mr. Klemm’s
direct testimony, the “$1 1.4 Million Adjustment”). The $1 1.4 Million Adjustment was the real
focus in the Company’s case and the CAD’S extensive testimony - in part because they
considered the appropriateness of the Minimum Adjustment as a given. Indeed, the Company’s
primary justification for the $1 1.4 Million Adjustment was its conceptual similarity to the
Minimum Adjustment that the Company and the CAD supported. Order at 14-15.
1. The Company’s Evidence
Mr. Klemm’s amended direct testimony (Co. Ex. SFK-D) devoted considerable analysis
to these issues. See Co. Ex. SFK at 20-48. Mr. Klemm argued that the Commission should
reduce the Company’s federal ADIT liability on plant by $1 1.4 million, because only the portion
of plant-related deferred tax liability that ratepayers have actually been charged through and paid
for in rates should constitute a reduction to rate base. Id. at 44. Nevertheless, even if the
Commission did not accept the $1 1.4 Million Adjustment, the Company advocated the Minimum
Adjustment, one calculated on its “deferred tax assets” for both NOL and AMT carryforwards.’
Note that the Minimum Adjustment is comprised of the 13-month average federal ADIT liabilities for both NOL carryforwards ($1,924,382) and AMT credit carryforwards ($685,290), for a total of $2,609,672. Co. Ex, SFK-D at 46. As discussed below, the CAD recommendation to offset plant ADITs was limited (incorrectly, the Company believes) to the NOL component. Also, in reality, the $2.6 million figure is understated, in that it does not take into account the ADIT deferred tax assets associated with contributions in aid of construction (an amount totaling $882,229) that Mr. Smith properly used to
1
{ C247 824 8.3 } 5
As the 13-month average federal ADIT liability related to property, plant and equipment booMtax differences has reduced rate base, the federal NOL and AMT carryforwards attributable to accelerated depreciation should be added back to rate base to prevent a potential normalization violation. The 13-month average of these carryforward amounts is $2,609,672. This is the minimum amount that needs to be added back to rate base.
Id. at 46 (emphasis in original).
To demonstrate that the NOL component of this amount is entirely associated with the
Company’s claim of accelerated tax depreciation, Mr. Klemm presented a “with and without”
approach - a calculation of the NOL with accelerated tax depreciation and without accelerated
tax depreciation. The calculation took the total deferred tax NOL and AMT credit carryforward
assets (which includes the accelerated depreciation deduction) and computed what the deferred
tax NOL and AMT credit carryforward amounts would have been without such a deduction. The
difference between the two NOL calculations can then be attributed to the effects of accelerated
depreciation. Based on this analysis, there can be no question that the NOLs represent
unrealized tax deductions - a clear justification to adjust the ADIT NOL asset related to
accelerated depreciation. Since the NOLs represent unrecognized tax deductions, there is no
associated cash benefit and no interest free loan from the U.S. Treasury. This adjustment, the
Company argued, is the “minimum amount that needs to be added back to avoid the potential
normalization violation.” Id. at 47.
offset the total ADIT liability, thereby increasing rate base. See Company Reply Brief at 13-14, n.10; see also Co. Ex. SFK-R at 22, lines 11-12; CAD Ex. RCS-D at 15 and Ex. LA-1, Sch. B-2.1, page 1 of 2, lines 5 and 6 . Consequently, the minimum adjustment amount should be approximately $3.5 million - the initial $2.6 million plus the nearly $900,000 in the ADIT deferred tax asset on CIACs that Mr. Smith identified.
I
2. The CAD’S Evidence
Although the CAD’S witness, Ralph C. Smith, argued against the $11.4 Million
Adjustment, he supported the Minimum Adjustment. Citing the Company’s explanation of the
“with and without” methodology referenced in PLR 8818040, Mr. Smith opined that where
computed taxes using accelerated depreciation produce an NOL carryover, the deferral should be
made when the taxpayer realizes an actual tax benefit from the use of accelerated depreciation,
Although the Staff opposed any use of a PLR not directly prepared for the Company (see Section
B.3 below), Mr. Smith conceded the applicability of PLR 8818040, particularly the IRS’s
application of the “with and without” calculation and the Company’s explanation, based on PLR
8818040, of the IRS position that NOL carryfonvards created by the use of accelerated
depreciation do not create an “actual tax benefit” for the taxpayer:
Where such computed taxes using accelerated depreciation produce an NOL carryover, the deferral is appropriately made at the time the taxpayer realizes an actual tax benefit from the use of accelerated depreciation.
CAD Ex. RCS-D at 21, quoting Ex. LA-2 at pp. 3-4.2 Based on this analysis, and apparently also
on the rationale of PLR 8818O4Oy3 Mr. Smith then argued that the Federal NOL Carryforward
Exhibit LA-2 to Mr. Smith’s testimony excerpted the Company’s explanation of the application of PLR 8818040 to the Minimum Adjustment. This Company data response (to CAD 11-E-106), as well as its response to CAD 9-B-57, are found in Exhibit LA-2 at pp. 2-9 (Company response to CAD 1l-E- 106) and pp. 14-39 (Company response to CAD 9-B-57), respectively. PLR 8818040, which Mr. Smith attached at pp. 2 1-23 of Exhibit LA-2, is attached for reference as Exhibit 1 to this Petition.
2
In his rebuttal testimony, Mr. Klemm explained the relevance of PLR 881 8040: 3
Despite their limitations, PLRs are clearly reflective of IRS reasoning and can be instructive to other taxpayers. [PLR 88180401 addressed the situation in which a utility generated significant depreciation deductions in 1985 and 1986. Because the depreciation deductions were so large, they could not all be used and a NOL carryforward was created. Instead, it was not until 1987, the year in which the NOL would be used, that deferred taxes were created. In this PLR, the IRS determined that this approach would be consistent with the normalization requirements. This ruling supports the approach that it is
{ C2478248.3) 7
ADIT of $1,924,382 is an amount that “has not yet produced a tax benefit.” Id. at 21; see also
id, at 23 (federal NOL carryforward included in net ADIT balance because it represents
deductions “that had not yet produced a net reduction to federal income taxes”).
Mr. Smith even included the Company’s “with and without” calculations as an exhibit to
his direct testimony. CAD Ex. RCS-D at Ex. LA-2, p. 20 of 135. The “with and without”
calculation, attached for the Commission’s reference as Exhibit 2 to this Petition, shows that with
accelerated depreciation deductions, the Company experienced a taxable loss of approximately
$18.8 million, while without the impact of accelerated depreciation deductions, the Company
would have had a taxable gain of over $20 rn i l l i~n .~ The “with and without” calculation proved
that the Company’s taxable loss situation (and consequently, its NOL carryforward) is
attributable solely to the impact of accelerated depreciation deductions.
Accordingly, Mr. Smith observed that the Company’s federal NOL carryforward ADIT
of $1,924,3 82 was an amount that “has not yet produced a tax benefit” (CAD Ex. RCS-D at 2 1).
Consequently, reflecting that amount in rate base and correspondingly reflecting the rate base deduction for the full amount of federal ADIT recorded for Plant . , . produces the right result for ratemaking. It reduces rate base for the amount of tax benefit realized by the taxpayer, and by including the recorded amount ... for the federal NOL carry-forward impact, does not reduce rate base by tax benefits not yet realized.
inappropriate to record ADIT until they are realized; if this were not the case, the IRS likely would have concluded that the ADIT should have been recorded at the tax rate when the deductions occurred.
Co. Ex. SFK-R at 30 (emphasis added). Mr. Klemm then argued - and no party has disputed -that PLR 8818040 “strongly suggests that a normalization violation would occur if ADITs are used to reduce rate base before the cash benefits of accelerated depreciation have been realized.” Id. at 3 1.
The “Final Taxable Income (Loss)” entries in Exhibit 2 are shown in the final two columns of the 4
calculation (captioned “Grand Total” and “Grand Total w/o Depreciation,” respectively).
{ C2478248.3 } 8
CAD Ex. RCS-D at 22 (emphasis added).5
Mr. Smith not only applied the NOL component of the Minimum Adjustment; he also
explained the rationale for it in considerable detail. He argued that because the $1,924,3 82 debit
balance ADIT for the federal NOL “will be reversed to reduce deferred income tax expense in
future periods,” and that he included it in rate base for two reasons: (i) to eliminate concerns
about a potential normalization violation, (ii) because coordinating ADIT and deferred federal
income tax expense related to NOLs is consistent with recent guidance provided by a KPMG
representative at a recent NARUC accounting group meeting. Id. at 15-1 6 . At that meeting, the
KPMG representative’s presentation,6 and the discussion that followed, reflected a “general
consensus” that to the extent the NOL “prevented a utility from fully using the benefit of the
bonus/accelerated depreciation deductions during a test yearhate effective period,” customers
should not have to pay the full deferred tax expense. Id. at 17.
To implement the “general consensus” on accounting for NOL carryforwards created by
the use of accelerated depreciation deductions, and to address normalization violation concerns,
Mr. Smith said that the correct accounting approach is to place the federal NOL carryforward
into a “deferred tax asset,” which then would be used - ‘ le . , amortized to expense” - as the
utility is able to use the NOLs to offset future income tax expense. Id. This approach, Mr. Smith
noted, reflects a “basic principle” that ratepayers should pay deferred income taxes “only to the
5 Again, Mr. Smith noted that he included in rate base the federal NOL carryforward component “because it represents deductions that had not yet produced a net reduction to federal income taxes.” Id. at 23.
6 To support his analysis and reflect the KPMG representative’s presentation, Mr. Smith prepared an illustrative example attached to his testimony as Exhibit LA-3, showing the appropriate accounting for deferred taxes related to bonus depreciation in the case of an NOL carryforward. In Exhibit LA-3, Mr. Smith noted as its source as an “original illustration” included in the KPMG representative’s presentation at the NARUC 201 1 Fall Accounting Conference in Denver, Colorado. Id. A copy of Mr. Smith’s illustration is attached as Exhibit 3 to this Petition.
(C2478248.3) 9
extent that the utility is receiving the benefit of the tax depreciation deduction net of NOL” (id.)
- exactly the rationale Mr. Klemm had presented (see, e .g . , Co, Exs. SFK-D at 37-38, SFK-R at
18-20).
The only material difference between the CAD position and the Company’s position is
what the Minimum Adjustment should include. As noted, the Company’s $2.6 million
“minimum” adjustment was comprised of both NOL and AMT carryfonvards. Co. Ex. SFK-D at
46. Mr. Smith, on the other hand, chose to use only the NOL carryforward in his recommended
ADIT offset. CAD Ex. RCS-D at 21-22. In his rebuttal, Mr. Klemm explained that there is no
legitimate reason to treat NOL and AMT carryforwards differently, as they both arise from the
use of accelerated depreciation. Co. Ex. SFK-R at 32.’
3. The Staffs Argument
The Staff position reflected no analysis of any of these issues. Mr. Oxley only described
the Company’s position that “NOL and AMT carryfonvards due to accelerated depreciation
should increase the Company’s Rate Base to comply with normalization requirements.” Staff
Ex. ELO-D at 27. Citing the Bluefield Order, and without even addressing the concept of a
“deferred tax asset” or the need for the utility to recognize a tax benefit before an ADIT
~~
Moreover, during the Company’s recent consultations on the tax and ratemaking impacts of the Order, the Company’s tax consultant has indicated there is also a potential normalization issue related to the NOL component associated with the AMT Credit. The consultant has reasoned that to the extent that AMT credit is caused by accelerated depreciation related to public utility property, a normalization violation could arise for the same reason the concern is present in respect of NOL carryforwards.
7
((22478248.3 } 10
the NARUC Accounting Conference. Nor did the Staff confront these issues in its post-hearing
briefing.
Furthermore, Staffs reliance on the Bluefield Order failed to recognize the S t a f f s own
position in that case - that Bluefield’s tax loss carryforwards were “not entirely traceable to
accelerated depreciation,” and thus Staff had properly applied the losses against the taxable
income to derive a zero effective federal income tax rate. Bluefield Order at 10. In its analysis
of this issue, the Commission in Bluefield Gas focused primarily on the utility’s failure to
demonstrate the effective tax rate calculated on a “properly normalized basis.” In that case, the
Commission found that the utility
had merely argued that the tax loss carryforwards should not be used to develop an effective federal income tax rate. Even if we accept the argument that all of the loss carryforward results from accelerated depreciation and disregard the carryforward, Bluefield has still not met its burden of proof that a thirty-four percent effective federal income tax rate is reasonable.
Id. at 11 (evaluating NOL carryforward arguments in the context of effective tax rate
determination) (emphasis added).
To the contrary, the Commission’s ruling in Bluefield Gas appeared to acknowledge the
ratemaking problem that might arise by incorporating the benefit of accelerated tax depreciation
into a current effective federal income tax rate. The question in Bluefield Gas, however, instead
depended on the composition of the tax loss carryforward itself:
We do not disagree with [the utility] but there is a problem if, for ratemaking purposes, the attempt to accomplish a flow through method by incorporating the benefit of accelerated tax depreciation into a current effective federal income tax rate. Whether Staff did that is arguable and depends on the make up of the tax loss carryforward.
(C2478248.3) 11
Id. at 12 (emphasis added). The Commission stressed that it had not used the tax loss
carryforwards for purposes of evaluating the effective federal income tax rate. Thus, the utility’s
argument that use of tax loss carryfonvards “represents a flow through of the benefits of
accelerated depreciation,” and that an offset ih deferred debit should be recorded as a rate base
addition, “is not applicable to our decision in, this case.” Id.
Staffs post-hearing briefing in this case completely ignored the central concept
supporting the Company and CAD positions on the Minimum Adjustment: that an offset to the
normal ADIT rate base reduction is appropriate where NOLs generated by the use of accelerated
depreciation are present and result in the utility’s inability to recognize the benefits of
accelerated depreciation. Nor did the Staff acknowledge any potential for a normalization
violation arising from this situation, Instead, the Staffs initial brief focused almost entirely on
the Bluefield Order’s discussion of the appropriate characterization of the source of cost-free
capital to a utility in the accelerated depreciation situation. Staff Initial Brief (August 3 1, 20 12)
at 27-28, citing Bluefield Order at 15. Staffs only other focus was Mr. Klemm’s admission, for
what it is worth, that he knew of no other instance where the Commission had made the ADIT
adjustment like the $1 1.4 Million Adjustment the Company had proposed. Id. In other words,
the Staff completely side-stepped the Company’s most significant argument supporting the
Minimum Adjustment, and the CAD’S support for it. Indeed, the Staff did not even differentiate
between the Minimum Adjustment and the $1 1.4 Million Adjustment in its initial brief; its reply
brief (September 17,2012) did not address these issues at all.
(C2478248.3) 12
4, The Commission’s Decision
Although the Commission, in characterizing the parties’ positions (Order at 14- 15)’ did
differentiate between the Minimum Adjustment and the $1 1.4 Million Adjustment, the
Commission’s sole decisional paragraph utterly blurred the distinction between them:
The Commission has thoroughly considered this issue and will deny Mountaineer’s proposed $ I 1.4 million reduction in its plant- related ADIT liability balances.(’) At the outset, we observed that there is no question about the losses Mountaineer experienced in the years 2006 through 2009.(*) The Commission concludes that the $15.658 million ADIT rate base offset proposed by Staff is consistent with the Commission’s historical ratemaking practice of normalization of booMtax depreciation timing differences, and inclusion of plant-related current deferred federal income tax expense for rate recovery.(3) The Commission disagrees with Mountaineer that the ADITS related to booMtax timing differences should be offset by deferred debit when there are NOLs before accelerated depre~iation.(~) The treatment of the $1 1.440 million reduction proposed by Mountaineer effectively creates an offsetting regulatory asset to the ADIT balance which the Commission specifically rejected in the [Bluefield Order].(’) Recording the future federal income tax liability related to temporary depreciation timing differences in the year in which the timing differences occur is not incorrect nor does it in any way violate the tax statutes or IRS regulations.(6)
Order at 16 (superscript sentence numbering added for reference).
From this discussion, it is virtually impossible to know whether the Commission intended
to distinguish between the Minimum Adjustment and the $1 1.4 Million Adjustment.
0 Sentence 1 prefaced this Commission’s discussion by denying the “proposed $1 1.4 million reduction in [the Company’s] plant- related ADIT reliability balances.” Similarly, Sentence 2’s reference to the Company’s historic tax losses between 2006 and 2009, obviously have nothing to do with the Minimum Adjustment,
0 Sentence 3 references the Staffs overall adjustment, but does not distinguish between the two components of it.
(C2478248.3 } 13
e In Sentence 4, the Commission disagreed with the Company’s proposed ADIT offset “when there are NOLs before accelerated depreciation.” Obviously, in the Minimum Adjustment situation, the NOLs at issue solely arose from the Company’s use of accelerated depreciation, as the “with and without test” demonstrated.
e The final two sentences, Sentences 5 and 6, again explicitly relate to the $1 1.4 Million Adjustment, as well as to the Bluefield Order which, as noted above, did not address NOLs arising exclusively from the utility’s claim of accelerated depreciation.
The next two paragraphs of the Order clarified nothing. The first of those (bottom of
page 16) only referenced Mountaineer’s observation that the Commission had normalized
booWtax timing differences in the Company’s last two rate cases, and that the Company might
have sought a way out of its rate moratorium in the late 2000s if it was losing money. The
second (top of page 17) addressed the Company’s concern for the impact of operating and tax
losses in the late 2000s. These observations relate directly to $1 1.4 Million Adjustment, but
have nothing to do with the Minimum Adjustment. Order at 17.
Nothing in the Commission’s decisional language distinguished between the $1 1.4
Million Adjustment and the Minimum Adjustment. Nor did the Commission address the
Company’s rationale for the Minimum Adjustment, the Company and CAD concerns about a
potential normalization violation that might arise if the Commission rejected the Minimum
Adjustment, or the “general consensus” at the October 201 1 NARUC meeting that a deferred tax
asset should be established when a utility is unable to recognize the benefits of accelerated
depreciation in an NOL situation arising from the use of accelerated depreciation. Beyond the
Commission’s few paragraphs in the discussion section, the Order is devoid of justification for
the Commission’s decision to reject the Minimum Adjustment. The Order’s findings of fact and
conclusions of law do not even mention this adjustment.
(C2478248.3) 14
C. Argument
1. The Order Lacked Any Factual or Legal Basis for the Minimum Adjustment.
To withstand appellate review, each element of a Commission Order must be supported
by substantial evidence, and the Commission’s determination must not result from a
misapplication of legal principles. See, e.g., Syl. Pts. 1 and 2, City of New Martinsville v. Public
Service Cornmission of West Virginia, 229 W.Va. 353, 729 S.E.2d 188 (2012). The
Commission’s rejection of the Minimum Adjustment had no competent evidence to support it,
and clearly reflects a misapplication of legal principles.
The only evidence offered on the Minimum Adjustment strongly favored it. The
Company and the CAD proved that failing to incorporate the Minimum Adjustment in the
Company’s revenue requirement creates a significant risk of violating IRS normalization rules.
As Mr. Klemm recounted in his rebuttal:
Mr. Smith contended that “ratepayers should pay deferred income taxes only to the extent that the utility is receiving the benefit of the tax depreciation deduction net of NOL,” and that a “deferred tax asset” should be created to the extent that the utility is reasonably assured of using the NOL. In this connection, Mr. Smith indicated that for NOL carryforward ADIT amounts on the Company’s books that have yet to produce a tax benefit should be reflected in rate base.
Co. Ex. SFK-R at 22, quoting CAD Ex. RCS-D at 17,21-22 (emphasis added; citation references
omitted). See also Company Initial Brief at 5-6.
Not surprisingly, the Staff did not oppose the principle that NOL carryforward ADIT
amounts that have not yet produced a tax benefit should be reflected in rate base. The reason is
obvious. The benefits of accelerated depreciation, to the utility and its customers, can
materialize only if the utility is able to reduce its current income tax liability through the
application of accelerated depreciation deductions. And, the utility can only reduce its current
{C2478248.3 } 15
income tax liability only if it has sufficient taxable income: the existence of NOLs is conclusive
evidence that the utility has not had sufficient taxable income to recognize this benefit. These
concepts support a “general consensus” that to the extent an NOL “prevent[s] a utility from fully
using the benefit of the bonus/accelerated depreciation deductions during a test yeadrate
effective period,” a deferred tax asset should be created to permit future income tax expense to
offset the NOL carryforward. No party challenged this analysis, and the Commission neither
questioned nor analyzed it in the Order.
The Company also showed that this “general consensus” motivated regulators in states
such as Connecticut, Washington, Illinois, New Mexico, and Texas to exclude NOL deferred tax
assets from ADIT liabilities that otherwise would reduce rate base. The Company’s initial brief
cited the Yankee Gas Services case, in which the Connecticut Commission reversed itself on
reconsideration and recognized an NOL tax asset, in part in response to the utility’s contention
that it would be unable to fully recognize the cash benefits of the additional tax depreciation
deductions until the NOL was used in future years. Yankee Gas Services Co., Docket No, 10-
12-02REO1 (Conn. D.P.U.C., September 28, 201 l), 201 1 WL 4609336. The Washington
Commission applied the same rationale in reducing an ADIT liability by the amount of Puget
Sound Energy’s $41.7 million NOL carryforward, effectively increasing the utility’s rate base for
ratemaking purposes. WashinPton Util. and Transn Comm’n v. PuPet Sound Enerav, Inc.,
Dockets UE-111048 and UG-111049, Order 8 (May 7, 2012), at 65. The Company provided
these decisions and others to support the general view on this subject - decisions that, like the
Yankee Gas and Puaet Sound opinions, strongly support this view.’ Again, the Staff did not
See Company Initial Brief at 6-7, citing Pub. Serv. Co. of Co., Docket No. 10AL-963GY 201 1 WL 4825894 (Colo. P.U.C. Order dated September 1, 2011) at 30-31 (approving stipulated settlement in which parties agreed to offset ADIT for NOL carryfonvards); In re Commonwealth Edison Co., Docket 94-0065, 158 P.U.R.4th 458, 1995 WL 45969 (Ill. C.C. Order dated January 9, 1995) at 467-468 (utility’s
8
(C2478248.3) 16
even mention these decisions or their underlying rationale in its evidence or briefing, and the
Order does not acknowledge them or reflect the Commission’s consideration of them.
Finally, the Commission has no evidentiary basis on which to evaluate and compare (i)
the relatively minor increase in rate base, and the associated revenue requirement impact, arising
from the Minimum Adjustment with (ii) the lost cash flow benefits of accelerated depreciation
tax deductions in the event the IRS finds a normalization violation. The rate base impact of
correcting the Commission’s error would be approximately $2.6 million (the effect of including
the Minimum Adjustment in the Company’s ADIT balance, serving as an additional reduction to
rate base). The Company estimates the revenue requirement impact of this change, based on the
Commission’s cost of service in Appendix A of the Order, is approximately $300,000. (See the
calculation attached as Exhibit 4 to this Petition.) By contrast, the negative impact on the
Company’s customers associated with a loss of the use of accelerated depreciation deductions
would be far greater, and much longer lasting (see Section (2.2 below). Without a firm
understanding of these issues, the Commission cannot assess the overall customer impact of its
decision to reject the Minimum Adjustment.
The Commission’s decision to reject the Minimum Adjustment, which has the potential
for such a dramatic negative impact on the Company and its customers, should have addressed
rate base should include deferred tax asset to offset deduction for deferred taxes, so that deferred tax accounting items are treated consistently, and utility does not forfeit federal deferred income tax benefits); APplication of Gulf States Utils. Co.. et al., Texas Pub. Util. Comm’n, Docket Nos. 8702, 8922, 8939, 8940, 8946, 8233, 8944, 8945, 8947, 8948, and 8949, 17 Tex. P.U.C. Bull. 703, 1991 WL 790287 (Examiner’s Report dated May 2, 1991) at 55 (NOLs represent deductions to utility tax liability that utility has not yet realized, and should be used as an offset in the calculation of deferred income tax balance in rate base); Pub. Sew. of New Mexico, Case No. 10-00086-UT, 201 1 N.M. PUC Lexis 35 (NM P.U.C. Final Order dated July 28, 201 1) at 64-65 (rate base increased by amount of NOL-related ADIT asset). See also Kern River Gas Transmission Co., Order No. 486, Docket No. RPO4-274-000, 117 FERC T[ 61,077 (FERC Opinion and Order dated October 19, 2006) at 89-93 (NOL-created ADIT asset used to increase rate base, because utility had not yet achieved tax savings associated with bonus depreciation),
(C2478248.3) 17
the pros and cons of the adjustment in a thorough way. At a minimum, the Commission’s
decision should have included (i) a detailed recitation of the &I1 range of arguments, both in
support of and opposition to, the Minimum Adjustment; (ii) the accounting, ratemaking, and tax
concepts underlying the Company and CAD recommendations on the Minimum Adjustment;
(iii) the relevant legal authority on accelerated depreciation-driven ADITS that generate NOLs;
and (iv) most of all, the potential for, and consequences of, a normalization violation if the
Minimum Adjustment is not included in rate base and in determining rates. The Commission’s
decision on this issue reflects none of these considerations - as noted above, it is difficult even to
determine whether the Commission actually knew that it had rejected the Minimum Adjustment.
In summary, the Order provides no substantive basis for the Commission’s rejection of
the Minimum Adjustment, and fails to account for any of the relevant factual and legal
arguments the Company and the CAD presented - arguments that uniformly supported the
Commission’s acceptance of the Minimum Adjustment, Without such an analysis, meaningful
appellate review would be impossible, and the Commission’s decision on this critical issue could
not withstand scrutiny on appeal. For these reasons alone, the Commission should reconsider its
rejection of the Minimum Adjustment.
2. The Commission’s Rejection of the Minimum Adjustment Will Require the Company to Self-Report the Resulting Normalization Violation and Undermine Its Ability to Claim Accelerated Depreciation.
The consequences of violating depreciation normalization rules are stark. As a condition
for claiming accelerated tax depreciation, a utility must use a normalization method of
accounting; if it does not, it simply is not permitted to use accelerated methods of tax
depreciation, This proscription applies to all the assets the utility owns when the violative order
is issued, and all of the assets it acquires thereafter. These strictures would remain in place until
{ C2478248.3 } 18
an order is entered that cures the normalization violation - a cure that almost certainly would
require a revenue reduction, in order to remove the past “flow through” of the benefits of
accelerated depreciation to customers. These are draconian penalties that would require the
Company to forgo all future interest-free loans, and create a dramatically reduced ADIT liability
balance to reduce the Company’s rate base - increasing customer rates.
The Treasury Regulations promulgated under the tax normalization statute (26 U.S.C. 0
168(i)(9)(B)(ii)) expressly recognize that an NOL tax asset arising from the use of accelerated
depreciation methods must be taken into account in a utility’s tax deferral.’ To exclude from rate
base the deferred tax asset associated with the Minimum Adjustment would not only violate the
tax normalization statute - it would also require the Company to “self-report” the violation to the
IRS. Under Treasury Regulation 1,167( l)(h) (26 C.F.R. 9 1.167(1)-1 (h)(5), attached to this
Petition as Exhibit 6), the Company is required to self-report a change in regulatory accounting
within 90 days of the Order creating the “change in method of regulated accounting” that creates
the potential violation.
(5) Change in method of regulated accounting. The taxpayer shall notifl the district director of a change in its method of regulated accounting, an order by a regulatory body or court that such method be changed, or an interim or final rate determination by a regulatory body which determination is inconsistent with the method of regulated accounting used by the taxpayer immediately prior to the effective date of such rate determination. Such notification shall be made within 90 days of the date that the change in method, the order, or the determination is effective. In the case of a change in the method of regulated accounting, the taxpayer shall recompute its tax liability for any affected taxable year and such recomputation shall be made in the form of an amended return where necessary unless the taxpayer and the district director have consented in writing to extend
The normalization provisions of the Internal Revenue Code, found at 26 U.S.C. 0 168(i)(9) and provided in Exhibit 5 , provide in pertinent part that if the amount allowable as a deduction under accelerated depreciation differs from the amount that would be allowable as a deduction under section 167 using the method (including the period, first and last year convention, and salvage value) used to compute regulated tax expense, the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference. 26 U.S.C.A. 0 168(i)(9)(A)(ii).
9
{C2478248.3} 19
the time for assessment of tax with respect to the issue of normalization method o f regulated accounting.
The Company and its tax consultant strongly believe that the “general consensus” Mr. Smith
recounted from the NARUC presentation (see Exhibit 3), as reflected in the evidence in this case
and reiterated in publications like the attached PriceWaterhouseCoopers client bulletin,” governs
the appropriate accounting for the Minimum Adjustment. The Company will have no choice: it
must report this “change in regulatory accounting” to the IRS under Treasury Regulation
1,167( l)(h)(5).
Beyond the Company’s reporting obligation, the negative impact on customers of an
inability to use accelerated depreciation is quite stark. If the Company is unable to claim
accelerated depreciation for income tax purposes, then the Company’s existing ADIT balances
on plant (approximately $15.6 million) will not be available to reduce rate base, as there will no
longer be a booWtax depreciation difference related to accelerated depreciation. The “interest
free loan“ provided to the Company by being able to claim accelerated depreciation will not be
available, and therefore the Company will be required to replace those funds with traditional
sources of capital. If all of the other issues in the rate case are held constant, the Company’s
revenue requirement would be approximately $1.8 million higher.
And this is the minimum effect of the Commission’s decision. While the $15,658,000 of
existing ADIT liability will reverse (turn around) over time as the booMtax differences reverse
(reducing the benefit of existing ADIT), the capital intensive nature of the Company’s public
service obligations would generate additional book/tax differences (and additional new ADITS)
for the benefit of the ratepayers that the Company would be unable to claim in the future. Thus,
See Exhibit 7 to this Petition (“Rate Case Impact of New ‘Bonus Depreciation’ Provisions of Recent Tax Law Legislation,” PriceWaterhouseCoopers LLP, 20 1 1). This document was not part of the evidentiary record, but does illustrate another viewpoint supporting the Company’s decision that self- reporting of a potential normalization violation will be required.
IO
(C2478248.3) 20
a future increase in the Company’s ADIT balance, which one would otherwise expect to occur,
would not be available to reduce rate base. Obviously, this outcome would be a lose-lose
situation for the Company’s customers.
3. If the Commission Does Not Reverse its Error, It Should At Least Coordinate with the Company to Seek IRS Guidance Through a PLR.
The risks are far too steep, for the Company and its customers, to permit a potential
normalization violation to persist. If it is unwilling to reconsider and reverse its decision, the
Commission should at the very least permit the Company to seek a private letter ruling from the
IRS on the Minimum Adjustment issue.
There is precedent for such an approach. In Aauila Inc.. dba Aauila Networks- WPK, the
Kansas State Corporation Commission considered a utility’s request that the commission
reconsider its decision to approve a Staff-proposed rate base adjustment involving the averaging
of general common plant and depreciation. The utility asserted that adoption of the adjustment
would violate the normalization provisions of IRC Ij 168(i)(9)(B). Aauila Inc., dba Aauila
Networks- WPK, Docket No. 04-AQLE-1065-RTS, 239 P.U.R.4th 400, 2005 WL 784935 (Kan.
S.C.C. Order on Reconsideration dated March 14,2005) at 1 56. In response, the Staff suggested
that the utility seek a PLR from the IRS to indicate whether, under the specific circumstances
presented, a normalization violation would exist. Id. at 7 59. The Kansas Commission granted
limited reconsideration on this issue, maintaining its adoption of the Staff adjustment “on an
interim basis, subject to potential further reconsideration at a later date and true-up.” Although
the commission did not believe that the Staff adjustment created a normalization violation, it
nevertheless did not wish “to inadvertently create a violation,” and recognized that a PLR
“pertaining directly to these specific circumstances would be most persuasive.” Id. at 1 63 .
Accordingly, the Kansas Commission ordered the utility to request a PLR.
{ C2478248.3) 21
The Commission therefore orders WPK to seek a private letter ruling from the IRS regarding Staffs adjustments and the Commission’s adoption of those adjustments. WPK shall work closely with Staff on preparing its request for a private letter ruling to the IRS. During that time, for accounting purposes only, WPK shall also work closely with Staff to develop an appropriate means to track any potential adjustments and true-ups that would have to be made should the IRS in fact conclude in the private letter ruling that an IRC Section violation exists. Should any dispute arise between WPK and Staff in the proper wording of a request for a private letter ruling or in developing an appropriate means to track any potential adjustments, the parties shall bring those matters to the Commission for determination. Upon its request, WPK shall file the private letter ruling in its entirety with this Commission so that the Commission may render a final decision on this issue.
Id. at 764.
Not only has the PLR process been used by regulators to address and resolve ratemaking
determinations that risk violation of normalization provisions - the IRS itself has a process by
which a utility, in coordination with its regulator, may request a PLR to resolve such issues. In a
Revenue Procedure on the subject, the IRS has provided that a PLR request
that involves a question of whether a whether a rate order, proposed or issued by a regulatory agency, will meet the normalization requirements of sections 46(f), 167( l), and 168(e)(3) of the Code, ordinarily will not be considered unless the taxpayer states in the request for ruling whether:
(1) the regulatory authority responsible for establishing or approving the taxpayer’s rates has reviewed the request and believes that the request is adequate and complete, and
(2) the taxpayer will permit the regulatory authority to participate in any National Office conference concerning the request.
Rev, Proc. 85-55, 1985-2 C.B. 737 (1985) (a copy of which is attached as Exhibit 8). This
revenue procedure contemplates the regulator’s review of and participation in the PLR process,
just as the Kansas Commission directed in Aquila.
((22478248.3) 22
The Commission has long expressed its concern about violations of normalization
principles and the consequent harm that a loss of accelerated depreciation deductions would
cause. If the Commission does not reconsider and reverse its decision, the Commission should
direct the Company to seek a private letter ruling from the IRS on the Minimum Adjustment
issue, working with the Commission Staff to develop the request and “to develop an appropriate
means to track any potential adjustments and true-ups that would have to be made should the IRS
in fact conclude in the [PLR]” that a normalization violation exists. Aquila, p. 27, 7 64. This is
the only prudent course if the Commission does not reconsider its decision on the Minimum
Adjustment.
D. Conclusion and Request for Relief
The Commission should reconsider its decision to reject the Minimum Adjustment and,
with full consideration of the factual and legal evidence that preponderate in favor of the
Minimum Adjustment, issue an order reversing its decision, recalculating the Company’s
revenue requirement, and authorizing the imposition of revised rates that provide for
retrospective and prospective recovery of the incremental additional revenue associated with the
Minimum Adjustment.
If the Commission does not reconsider and reverse its decision, it should direct the
Company to seek a private letter ruling from the IRS on the Minimum Adjustment issue, to work
with the Commission Staff to develop the request, and to develop an appropriate means to track
any adjustments and true-ups that may be necessitated by a subsequent IRS determination that a
normalization violation existed in the Order.
{ C2478248.3) 23
Respectfully submitted this 2 1 St day of November, 20 12.
MOUNTAINEER GAS COMPANY
John Philip Melick, WV Bar ID 2522 Christopher L. Calias, WV Bar ID 5991 Stephen N. Chambers, WV Bar ID 694 JACKSON KELLY PLLC 1600 Laidley Tower Post Office Box 553 Charleston, West Virginia 25322 Counsel for Mountaineer Gas Company
(C2478248.3)
Exhibit 1
Exhibit 2
Exhibit 3
Exhibit 4
Exhibit 5
Exhibit 6
Exhibit 7
Exhibit 8
PLR 88 18040 -- CAD Ex. RCS-D at Ex. LA-2, pp. 2 1-23 of 135
“With and Without” Calculation -- CAD Ex. RCS-D at Ex. LA-2, p. 20 of 135
Mr. Smith’s Illustration of Appropriate Accounting for NOL Deferred Tax Assets - CAD Ex. RCS-D at Ex. LA-3
Calculation of Revenue Requirement Impact of Minimum Adjustment
26 U.S.C.A. $ 168(i)(9) - IRC Normalization Provisions
Treasury Regulation 1.167( 1)- 1 (h)(5) (in pertinent part)
PriceWaterhouseCoopers 201 1 client bulletin -- Rate Case Impact of New “Bonus Depreciation” Provisions
Rev. Proc. 85-55, 1985-2 C.B. 737 (1985)
{ C2478248,3} 25
I certify service of LIMITED PETITION FOR MCONSIDERATION OF
MOUNTAINEER GAS COMPANY on November 21, 2012 by United States First Class Mail,
postage prepaid upon:
Tom White, Esq. Consumer Advocate Division 700 Union Building 723 Kanawha Blvd., East Charleston, WV 25301
L. R. Sammons, III., Esq. Christopher Howard, Esq. Public Service Commission of WV Post Office Box 8 12 Charleston, West Virginia 25323
George A. Patterson, 111, Esq. Bowles Rice McDavid Graff & Love LLP P. 0. Box 1386 Charleston, WV 25325-1386
(C2478248.3 } 26
. o 0 0 0 0
3
uti
m;EKi?ir
0
d
I
Exhibit LA-3 IlIustrative example of a utility with an NOL and.the related accounting and ratemaking implications (based 00 a presentation at an October 201 1 NARUC accounting committee meeting by a representative k r n KPMG)
I
3
3
3
3
3
3
3
0
3
L h Na,
1 1 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 I8 19 20 21 22
24 25 26 2? 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 51 53 54 55 56 I7 51 59 60
n
ErhiMtNo. U-3 CMNO. ll-1627542T
D&t Cndt
MOUNTAINEER GAS COMPANY Select Federal ADIT Accounts Revenue Requirement Impact
Rate Base (A)
Federal Income Tax (See below) Revenue Requirement Impact
Federal Income Tax Impact: Equity Return:
Rate Base Weighted Cost of Equity (C)
Federal Income Tax Gross-up (D)
Federal Income Tax Rate Federal Income Tax Impact
Federal ADIT - Plant
Federal ADIT Assets NOL Carryforward AMT Credit
GL 1900.450 GL 1900.460 Total
$ 1,924,382 $ 685,290 $ 2,609,672
$ 140,916 $ 50,182 $ 191,099 35.00% 35.00% 35 I 00%
$ 49,321 $ 17,564 $ 66,885
(A) - Represents 13-month average balance (6) - Appendix A of Order (C) - 48.030% common equity (Page 5 of Order) x 9.90% ROE (Page 13 of Order) = 4.755% (D) - Represents 1+ (0.35/0.65) where 0.35 represents 35% federal tax rate divided by (1 - 0.35 federal tax rate)
NOTE: Analysis does not consider any state income taxes for illustrative purposes.
File Name: C248255O.XLSX
26 U.S.C.A. 0 168(i)(9) - IRC Normalization Provisions
(9) Normalization rules.-- (A) In general.--In order to use a normalization method of accounting with respect to any public utility property for purposes of subsection (f)(2)-- (i) the taxpayer must, in computing its tax expense for purposes of establishing its cost of service for rate-making purposes and reflecting operating results in its regulated books of account, use a method of depreciation with respect to such property that is the same as, and a depreciation period for such property that is no shorter than, the method and period used to compute its depreciation expense for such purposes; and (ii) if the amount allowable as a deduction under this section with respect to such property differs from the amount that would be allowable as a deduction under section 167 using the method (including the period, first and last year convention, and salvage value) used to compute regulated tax expense under clause (i), the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference. (B) Use of inconsistent estimates and projections, etc.-- (i) In general.--One way in which the requirements of subparagraph (A) are not met is if the taxpayer, for ratemaking purposes, uses a procedure or adjustment which is inconsistent with the requirements of subparagraph (A). (ii) Use of inconsistent estimates and projections.--The procedures and adjustments which are to be treated as inconsistent for purposes of clause (i) shall include any procedure or adjustment for ratemaking purposes which uses an estimate or projection of the taxpayer's tax expense, depreciation expense, or reserve for deferred taxes under subparagraph (A)@) unless such estimate or projection is also used, for ratemaking purposes, with respect to the other 2 such items and with respect to the rate base. (iii) Regulatory authority.--The Secretary may by regulations prescribe procedures and adjustments (in addition to those specified in clause (ii)) which are to be treated as inconsistent for purposes of clause (i). (C) Public utility property which does not meet normalization rules.--In the case of any public utility property to which this section does not apply by reason of subsection (f)(2), the allowance for depreciation under section 167(a) shall be an amount computed using the method and period referred to in subparagraph (A)(i).
26 C.F.R. 0 1.167(l)-i(h), Treas. Reg. 9 1.167(l)-i(h
(h) Normalization method of accounting--(l) In general. (i) Under section 167(1), a taxpayer uses a normalization method of regulated accounting with respect to public utility property--
(a) If the same method of depreciation (whether or not a subsection (1) method) is used to compute both its tax expense and its depreciation expense for purposes of establishing cost of service for ratemaking purposes and for reflecting operating results in its regulated books of account, and
(b) If to compute its allowance for depreciation under section 167 it uses a method of depreciation other than the method it used for purposes described in (a) of this subdivision, the taxpayer makes adjustments consistent with subparagraph (2) of this paragraph to a reserve to reflect the total amount of the deferral of Federal income tax liability resulting from the use with respect to all of its public utility property of such different methods of depreciation.
(ii) In the case of a taxpayer described in section 167(1)(1)(B) or (2)(C), the reference in subdivision (i) of this subparagraph shall be a reference only to such taxpayer’s “qualified public utility property”. See B 1.167(1)-2(b) for definition of “qualified public utility property”.
(iii) Except as provided in this subparagraph, the amount of Federal income tax liability deferred as a result of the use of a different method of depreciation under subdivision (i) of this subparagraph is the excess (computed without regard to credits) of the amount the tax liability would have been had a subsection (1) method been used over the amount of the actual tax liability. Such amount shall be taken into account for the taxable year in which such 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 (as determined under section 172) 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.
(2) Adjustments to reserve. (i) The taxpayer must credit the amount of deferred Federal income tax determined under subparagraph (l)(i) of this paragraph for any taxable year to a reserve for deferred taxes, a depreciation reserve, or other reserve account. The taxpayer need not establish a separate reserve account for such amount but the amount of deferred tax determined under subparagraph (l)(i) of this paragraph must be accounted for in such a manner so as to be readily identifiable. With respect to any account, the aggregate amount allocable to deferred tax under section I67(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 under subparagraph (l)(i) of this paragraph. An additional exception is that the aggregate amount allocable to deferred tax under section 167(1) may be properly adjusted to reflect asset retirements or the expiration of the period for depreciation used in determining the allowance for depreciation under section 167(a).
(ii) The provisions of this subparagraph may be illustrated by the following examples:
Example 1.Corporation X is exclusively engaged in the transportation of gas by pipeline subject to the jurisdiction of the Federal Power Commission. With respect to its post-1969 public utility property, X is entitled under section 167(1)(2)(B) to use a method of depreciation other than a subsection (1) method if it uses a normalization method of regulated accounting. With
Exhibit 6 Treasury Regulation l.l67(1)-l(h)
respect to such property, X has not made any election under 0 1.167(a)-ll (relating to depreciation based on class lives and asset depreciation ranges). In 1972, X places in service public utility property with an unadjusted basis of $2 million, and an estimated useful life of 20 years. X uses the declining balance method of depreciation with a rate twice the straight line rate. If X uses a normalization method of regulated accounting, the amount of depreciation allowable under section 167(a) with respect to such property for 1972 computed under the double declining balance method would be $200,000. X computes its tax expense and depreciation expense for purposes of determining its cost of service for rate-making purposes and for reflecting operating results in its regulated books of account using the straight line method of depreciation (a subsection (1) method). A depreciation allowance computed in this manner is $100,000. The excess of the depreciation allowance determined under the double declining balance method ($200,000) over the depreciation expense computed using the straight line method ($100,000) is $100,000. Thus, assuming a tax rate of 48 percent, X used a normalization method of regulated accounting for 1972 with respect to property placed in service that year if for 1972 it added to a reserve $48,000 as taxes deferred as a result of the use by X of a method of depreciation for Federal income tax purposes different from that used for establishing its cost of service for ratemaking purposes and for reflecting operating results in its regulated books of account.
Example 2. Assume the same facts as in example (l), except that X elects to apply 0 l.l67(a)-ll with respect to all eligible property placed in service in 1972. Assume further that all property X placed in service in 1972 is eligible property. One hundred percent of the asset guideline period for such property is 22 years and the asset depreciation range is from 17.5 years to 26.5 years. X uses the double declining balance method of depreciation, selects an asset depreciation period of 17.5 years, and applies the half-year convention (described in 0 1.167(a)-11 (c)(2)(iii)). In 1972, the depreciation allowable under section 167(a) with respect to property placed in service in 1972 is $114,285 (determined without regard to the normalization requirements in 0 l.l67(a)-ll(b)(6) and in section 167(1)). X computes its tax expense for purposes of determining its cost of service for ratemaking purposes and for reflecting operating results in its regulated books of account using the straight line method of depreciation (a subsection (1) method), an estimated useful life of 22 years (that is, 100 percent of the asset guideline period), and the half-year convention. A depreciation allowance computed in this manner is $45,454. Assuming a tax rate of 48 percent, the amount that X must add to a reserve for 1972 with respect to property placed in service that year in order to qualify as using a normalization method of regulated accounting under section 167(1)(3)(G) is $27,429 and the amount in order to satisfy the normalization requirements of 0 1.167(a)-1 l(b)(6) is $5,610. X determined such amounts as follows:
(1) Depreciation allowance on tax return (determined without regard to section 1670) and 0 1. 167(a)-1 l(b)(6)) ......................................................................................................................................... $114,285
(2) Line (l), recomputed using a straight line method ............................................................................. 57,142
(3) Difference in depreciation allowance attributable to different methods (line (1) minus line (2)) .............................................................................................................................................................. $57,143
(4) Amount to add to reserve under this paragraph (48 percent of line (3)) ..................................... 27,429 , ", . ,. . I ~ __I , , ,,, , , , ., , ,,,,. , ,
(5 ) Amount in line (2) ......................................................................................................................................... $57,142
(6) Line (5) , recomputed by using an estimated useful life of 22 years and the half-year convention ........................................................................................................................................................ 45,454
(7) Difference in depreciation allowance attributable to difference in depreciation periods ...... $11,688
(8) Amount to add to reserve under 0 1.167(a)-l l(b)(6)(ii) (48 percent of line (7)) .................... 5,610
If, for its depreciation expense for purposes of determining its cost of service for ratemaking purposes and for reflecting operating results in its regulated books of account, X had used a period in excess of the asset guideline period of 22 years, the total amount in lines (4) and (8) in this example would not be changed.
Example 3. Corporation Y, a calendar-year taxpayer which is engaged in furnishing electrical energy, made the election __.-* *)*---mY -*m- --- --
z -
Exhibit 6 Treasury Regulation 1.167(1) - 1( h)
provided by section 167(1)(4)(a) with respect to its “qualified public utility property” (as defined in 0 l.l67(1)-2(b)). In 1971, Y placed in service qualified public utility property which had an adjusted basis of $2 million, estimated useful life of 20 years, and no salvage value. With respect to property of the same kind most recently placed in service, Y used a flow-through method of regulated accounting for its July 1969 regulated accounting period and the applicable 1968 method is the declining balance method of depreciation using 200 percent of the straight line rate. The amount of depreciation allowable under the double declining balance method with respect to the qualified public utility property would be $200,000. Y computes its tax expense and depreciation expense for purposes of determining its cost of service for ratemaking purposes and for reflecting operating results in its regulated books of account using the straight line method of depreciation. A depreciation allowance with respect to the qualified public utility property determined in this manner is $100,000. The excess of the depreciation allowance determined under the double declining balance method ($200,000) over the depreciation expense computed using the straight line method ($100,000) is $100,000. Thus, assuming a tax rate of 48 percent, Y used a normalization method of regulated accounting for 1971 if for 1971 it added to a reserve $48,000 as tax deferred as a result of the use by Y of a method of depreciation for Federal income tax purposes with respect to its qualified public utility property which method was different from that used for establishing its cost of service for ratemaking purposes and for reflecting operating results in its regulated books of account for such property.
Example 4. Corporation Z, exclusively engaged in a public utility activity did not use a flow-through method of regulated accounting for its July 1969 regulated accounting period. In 1971, a regulatory body having jurisdiction over all of Z’s property issued an order applicable to all years beginning with 1968 which provided, in effect, that Z use an accelerated method of depreciation for purposes of section 167 and for determining its tax expenses for purposes of reflecting operating results in its regulated books of account. The order further provided that Z normalize 50 percent of the tax deferral resulting from the use of the accelerated method of depreciation and that Z flow-through 50 percent of the tax deferral resulting therefrom. Under section 167(1), the method of accounting provided in the order would not be a normalization method of regulated accounting because Z would not be permitted to normalize 100 percent of the tax deferral resulting from the use of an accelerated method of depreciation. Thus, with respect to its public utility property for purposes of section 167, Z may only use a subsection (1) method of depreciation.
Example 5. Assume the same facts as in example (4) except that the order of the regulatory body provided, in effect, that Z normalize 100 percent of the tax deferral with respect to 50 percent of its public utility property and flow-through the tax savings with respect to the other 50 percent of its property. Because the effect of such an order would allow Z to flow-through a portion of the tax savings resulting from the use of an accelerated method of depreciation, Z would not be using a normalization method of regulated accounting with respect to any of its properties. Thus, with respect to its public utility property for purposes of section 167, Z may only use a subsection (1) method of depreciation.
(3) Establishing compliance with normalization requirements in respect of operating books of account. The taxpayer may establish compliance with the requirement in subparagraph (l)(i) of this paragraph in respect of reflecting operating results, and adjustments to a reserve, in its operating books of account by reference to the following:
(i) The most recent periodic report for a period beginning before the end of the taxable year, required by a regulatory body described in section 167(1)(3)(A) having jurisdiction over the taxpayer’s regulated operating books of account which was filed with such body before the due date (determined with regard to extensions) of the taxpayer’s Federal income tax return for such taxable year (whether or not such body has jurisdiction over rates).
(ii) If subdivision (i) of this subparagraph does not apply, the taxpayer’s most recent report to its shareholders for the taxable year but only if (a) such report was distributed to the shareholders before the due date (determined with regard to extensions) of the taxpayer’s Federal income tax return for the taxable year and (b) the taxpayer’s stocks or securities are traded in an established securities market during such taxable year. For purposes of this subdivision, the term “established securities market” has the meaning assigned to such term in 3 1.453-3(d)(4).
(iii) If neither subdivision (i) nor (ii) ofJ&i:* *I_m_j _-**
3
Exhibit 6 Treasury Regulation l.l67(1)-l(h)
before the due date (determined with regard to extensions) of the taxpayer’s Federal income tax return for the taxable year in its regulated books of account for its most recent period beginning before the end of such taxable year.
(4) Establishing compliance with normalization requirements in computing cost of service for ratemaking purposes. (i) In the case of a taxpayer which used a flow-through method of regulated accounting for its July 1969 regulated accounting period or thereafter, with respect to all or a portion of its pre-1970 public utility property, if a regulatory body having jurisdiction to establish the rates of such taxpayer as to such property (or a court which has jurisdiction over such body) issues an order of general application (or an order of specific application to the taxpayer) which states that such regulatory body (or court) will permit a class of taxpayers of which such taxpayer is a member (or such taxpayer) to use the normalization method of regulated accounting to establish cost of service for ratemaking purposes with respect to all or a portion of its public utility property, the taxpayer will be presumed to be using the same method of depreciation to compute both its tax expense and its depreciation expense for purposes of establishing its cost of service for ratemaking purposes with respect to the public utility property to which such order applies. In the event that such order is in any way conditional, the preceding sentence shall not apply until all of the conditions contained in such order which are applicable to the taxpayer have been fulfilled. The taxpayer shall establish to the satisfaction of the Commissioner or his delegate that such conditions have been fulfilled.
(ii) In the case of a taxpayer which did not use the flow-through method of regulated accounting for its July 1969 regulated accounting period or thereafter (including a taxpayer which used a subsection (1) method of depreciation to compute its allowance for depreciation under section 167(a) and to compute its tax expense for purposes of reflecting operating results in its regulated books of account), with respect to any of its public utility property, it will be presumed that such taxpayer is using the same method of depreciation to compute both its tax expense and its depreciation expense for purposes of establishing its cost of service for ratemaking purposes with respect to its post-1969 public utility property. The presumption described in the preceding sentence shall not apply in any case where there is (a) an expression of intent (regardless of the manner in which such expression of intent is indicated) by the regulatory body (or bodies), having jurisdiction to establish the rates of such taxpayer, which indicates that the policy of such regulatory body is in any way inconsistent with the use of the normalization method of regulated accounting by such taxpayer or by a class of taxpayers of which such taxpayer is a member, or (b) a decision by a court having jurisdiction over such regulatory body which decision is in any way inconsistent with the use of the normalization method of regulated accounting by such taxpayer or a class of taxpayers of which such taxpayer is a member. The presumption shall be applicable on January 1, 1970, and shall, unless rebutted, be effective until an inconsistent expression of intent is indicated by such regulatory body or by such court. An example of such an inconsistent expression of intent is the case of a regulatory body which has, after the July 1969 regulated accounting period and before January 1,1970, directed public utilities subject to its ratemaking jurisdiction to use a flow-through method of regulated accounting, or has issued an order of general application which states that such agency will direct a class of public utilities of which the taxpayer is a member to use a flow-through method of regulated accounting. The presumption described in this subdivision may be rebutted by evidence that the flow-through method of regulated accounting is being used by the taxpayer with respect to such property.
(iii) The provisions of this subparagraph may be illustrated by the following examples:
Example 1. Corporation X is a calendar-year taxpayer and its “applicable 1968 method” is a straight line method of depreciation. Effective January 1, 1970, X began collecting rates which were based on a sum of the years-digits method of depreciation and a normalization method of regulated accounting which rates had been approved by a regulatory body having jurisdiction over X. On October 1, 1971, a court of proper jurisdiction annulled the rate order prospectively, which annulment was not appealed, on the basis that the regulatory body had abused its discretion by determining the rates on the basis of a normalization method of regulated accounting. As there was no inconsistent expression of intent during 1970 or prior to the due date of X’s return for 1970, X’s use of the sum of the years-digits method of depreciation for purposes of section 167 on such return was proper. For 1971, the presumption is in effect through September 30. During 1971, X may use the sum of the years-digits method of depreciation for purposes of section 167 from January 1 through September 30, 1971. After September
$
Exhibit 6 Treasury Regulation l.l67(1)-1(h)
is no longer in effect.
Example 2. Assume the same facts as in example (l), except that pursuant to the order of annulment, X was required to refund the portion of the rates attributable to the use of the normalization method of regulated accounting. As there was no inconsistent expression of intent during 1970 or prior to the due date of X’s return for 1970, X has the benefit of the presumption with respect to its use of the sum of the years-digits method of depreciation for purposes of section 167, but because of the retroactive nature of the rate order X must file an amended return for 1970 using a straight line method of depreciation. As the inconsistent decision by the court was handed down prior to the due date of X’s Federal income tax return for 197 1, for 1971 and thereafter the presumption of subdivision (ii) of this subparagraph does not apply. X must file its Federal income tax returns for such years using a straight line method of depreciation.
Example 3. Assume the same facts as in example (2), except that the annulment order was stayed pending appeal of the decision to a court of proper appellate jurisdiction, X has the benefit of the presumption as described in example ( 2 ) for the year 1970, but for 1971 and thereafter the presumption of subdivision (ii) of this subparagraph does not apply. Further, X must file an amended return for 1970 using a straight line method of depreciation and for 1971 and thereafter X must file its returns using a straight line method of depreciation unless X and the district director have consented in writing to extend the time for assessment of tax for 1970 and thereafter with respect to the issue of normalization method of regulated accounting for as long as may be necessary to allow for resolution of the appeal with respect to the annulment of the rate order.
The taxpayer shall notify the district director of a change in its method of regulated accounting, an order by a regulatory body or court that such method be changed, or an interim or final rate determination by a regulatory body which determination is inconsistent with the method of regulated accounting used by the taxpayer immediately prior to the effective date of such rate determination. Such notification shall be made within 90 days of the date that the change in method, the order, or the determination is effective. In the case of a change in the method of regulated accounting, the taxpayer shall recompute its tax liability for any affected taxable year and such recomputation shall be made in the form of an amended return where necessary unless the taxpayer and the district director have consented in writing to extend the time for assessment of tax with respect to the issue of normalization method of regulated accounting.
(6) Exclusion of normalization reserve from rate base. (i) Notwithstanding the provisions of subparagraph (1) of this 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(1) 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.
(ii) 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) of this subparagraph, 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 subparagraph (2) of this paragraph) 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).
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(iii) The provisions of subdivision (i) of this subparagraph shall not apply in the case of a final determination of a rate case entered on or before May 3 1, 1973. For this purpose, a determination is final if all rights to request a review, a rehearing, or a redetermination by the regulatory body which makes such determination have been exhausted or have lapsed. The provisions of subdivision (ii) of this subparagraph shall not apply in the case of a rate case filed prior to June 7, 1974 for which a rate order is entered by a regulatory body having jurisdiction to establish the rates of the taxpayer prior to September 5 , 1974, whether or not such order is final, appealable, or subject to further review or reconsideration.
(iv) The provisions of this subparagraph may be illustrated by the following examples:
Example 1. Corporation X is exclusively engaged in the transportation of gas by pipeline subject to the jurisdiction of the Z Power Commission. With respect to its post-1969 public utility property, X is entitled under section 167(1)(2)(B) to use a method of depreciation other than a subsection (1) method if it uses a normalization method of regulated accounting. With respect to X the Z Power Commission for purposes of establishing cost of service uses a recent consecutive 12-month period ending not more than 4 months prior to the date of filing a rate case adjusted for certain known changes occurring within a 9-month period subsequent to the base period. X's rate case is filed on January 1, 1975. The year 1974 is the recorded test period for X's rate case and is the period used in determining X's tax expense in computing cost of service. The rates are contemplated to be in effect for the years 1975, 1976, and 1977. The adjustments for known changes relate only to wages and salaries. X's rate base at the end of 1974 is $145,000,000. The amount of the reserve for deferred taxes under section 167(1) at the end of 1974 is $1,300,000, and the reserve is projected to be $4,400,000 at the end of 1975, $6,500,000 at the end of 1976, and $9,800,000 at the end of 1977. X does not use a normalization method of regulated accounting if the Z Power Commission excludes more than $1,300,000 from the rate base to which X's rate of return is applied. Similarly, X does not use a normalization method of regulated accounting if, instead of the above, the Z Power Commission, in determining X's rate of return which is applied to the rate base, assigns to no-cost capital an amount that represents the reserve account for deferred tax that is greater than $1,300,000.
Example 2. Assume the same facts as in example (1) except that the adjustments for known changes in cost of service made by the Z Power Commission include an additional depreciation expense that reflects the installation of new equipment put into service on January 1, 1975. Assume further that the reserve for deferred taxes under section 167(1)' at the end of 1974 is $1,300,000 and that the monthly net increases for the first 9 months of 1975 are projected to be:
January 1-31 $3 10,000 ....................................................................................................................................................................
Exhibit 6 Treasury Regulation l.l67(1)-l(h)
For its regulated books of account X accrues such increases as of the last day of the month but as a matter of convenience credits increases or charges decreases to the reserve account on the 15th day of the month following the whole month for which such increase or decrease is accrued. The maximum amount that may be excluded from the rate base is $2,470,879 (the amount in the reserve at the end of the historical portion of the period ($1,300,000) and a pro rata portion of the amount of any projected increase for the future portion of the period to be credited to the reserve ($1,170,879)). Such pro rata portion is computed (without regard to the date such increase will actually be posted to the account) as follows:
$3 10,000 x 2431273 = ................................................................................................................................................... $275,934
..................................................................................................................................................... 236,264 300,000 x 2151273 =
300,000 x 1841273 = ..................................................................................................................................................... 202,198
280,000 x 1541273 = ..................................................................................................................................................... 157,949
270,000 x 1231273 = ..................................................................................................................................................... 121,648
260,000 x 931273 = ........................................................................................................................................................ 88,571
260,000 x 621273 = ........................................................................................................................................................ 59,048
240,000 x 11273 = .......................................................................................................................................................... 879
$1,170,879
Example 3. Assume the sam