IRS written determination 201436038

Private letter rulings and published taxpayer determination letters. Native document type is retained separately; a determination letter is not labeled a private letter ruling. These taxpayer-specific releases cannot be used or cited as precedent under 26 USC 6110(k)(3); applicability and current legal force are not independently certified. Keep repeated UILC subjects attached to one actual numbered document.

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 201436038
Release Date: 9/5/2014
Index Number: 167.22-01
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Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact:
----------------------, ID No. ----------------
Telephone Number:
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Refer Reply To:
CC:PSI:B06
PLR-148311-13
Date:
May 22, 2014
LEGEND:
Taxpayer=-----------------------------------------------
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Parent=----------------------------
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State A=------------
State B=----------------------------------
State C=------------
Commission A=--------------------------------------------------
Commission B=----------------------------------------------------
Commission C=------------------------------------------------------
Year A=------
Year B=------
Date A=--------------------
Date B=--------------------------
Date C=-----------------
Date D=---------------------
Date E=---------------------------
Case =--------------------
Director=---------------------------------------------------------------------------------
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Dear ---. -------:
This letter responds to the request, dated November 25, 2013, of Taxpayer for a
ruling on the application of the normalization rules of the Internal Revenue Code to
certain accounting and regulatory procedures, described below.

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2
The representations set out in your letter follow.
Taxpayer is a regulated public utility incorporated in State A and State B. It is
wholly owned, through a limited liability company, by Parent. Taxpayer is engaged in
the transmission, distribution, and supply of electricity in State A and State C. Taxpayer
also provides natural gas and natural gas transmission services in State A. Taxpayer is
subject to the regulatory jurisdiction of Commission A, Commission B, and Commission
C with respect to terms and conditions of service and particularly the rates it may
charge for the provision of service. Taxpayer’s rates are established on a rate of return
basis. Taxpayer takes accelerated depreciation, including “bonus depreciation” where
available and, for eachyear beginning in Year A and ending in Year B, Taxpayer
individually (as well as the consolidated return filed by Parent) has or expects to,
produce a net operating loss (NOL). On its regulatory books of account, Taxpayer
“normalizes” the differences between regulatory depreciation and tax depreciation. This
means that, where accelerated depreciation reduces taxable income, the taxes that a
taxpayer would have paid if regulatory depreciation (instead of accelerated tax
depreciation) were claimed constitute “cost-free capital” to the taxpayer. A taxpayer that
normalizes these differences, like Taxpayer, maintains a reserve account showing the
amount of tax liability that is deferred as a result of the accelerated depreciation. This
reserve is the accumulated deferred income tax (ADIT) account. Taxpayer maintains
an ADIT account. In addition, Taxpayer maintains an offsetting series of entries – a
“deferred tax asset” and a “deferred tax expense” - that reflect that portion of those ‘tax
losses’ which, while due to accelerated depreciation, did not actually defer tax because
of the existence of an net operating loss carryover (NOLC). Taxpayer, for normalization
purposes, calculates the portion of the NOLC attributable to accelerated depreciation
using a “with or without” methodology, meaning that an NOLC is attributable to
accelerated depreciation to the extent of the lesser of the accelerated depreciation or
the NOLC.
Taxpayer filed a general rate case with Commission B on Date A (Case). The
test year used in the Case was the 12 month period ending on Date B. In computing its
income tax expense element of cost of service, the tax benefits attributable to
accelerated depreciation were normalized in accordance with Commission B policy and
were not flowed thru to ratepayers. The data originally filed in Case was updated in the
course of proceedings. In establishing the rate base on which Taxpayer was to be
allowed to earn a return Commission B offset rate base by Taxpayer’s ADIT balance,
using a 13-month average of the month-end balances of the relevant accounts.
Taxpayer argued that the ADIT balance should be reduced by the amounts that
Taxpayer calculates did not actually defer tax due to the presence of the NOLC, as
represented in the deferred tax asset account. Testimony by various other participants
in Case argued against Taxpayer’s proposed calculation of ADIT.
On Date C, a settlement agreement was filed with Commission B, incorporating
the Taxpayer’s proposed treatment of the tax consequences of its NOLC. In an order

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3
issued on Date D, Commission B issued an order approving the settlement agreement
and also ordered Taxpayer to seek a ruling on the effects of an NOLC on ADIT. Rates
went into effect on Date E.
Taxpayer proposed, and Commission B accepted, that it be permitted to
annualize, rather than average, its reliability plant additions and to extend the period of
anticipated reliability plant additions to be included in rate base for an additional eight
months. Taxpayer also proposed, and Commission B accepted, that no additional ADIT
be reflected as a result of these adjustments inasmuch as any additional book and tax
depreciation produced by considering these assets would simply increase Taxpayer’s
NOLC and thus there would be no net impact on ADIT.
Taxpayer requests that we rule as follows:
1. Under the circumstances described above, the reduction of Taxpayer’s rate base
by the full amount of its ADIT account balances offset by a portion of its NOLC-
related account balance that is less than the amount attributable to accelerated
depreciation computed on a “with or without” basis would be inconsistent with the
requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.
2. The imputation of incremental ADIT on account of the reliability plant addition
adjustments described above would be inconsistent with the requirements of §
168(i)(9) and § 1.167(l)-1.
Law and Analysis
Section 168(f)(2) of the Code provides that the depreciation deduction
determined under section 168 shall not apply to any public utility property (within the
meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of
accounting.
In order to use a normalization method of accounting, section 168(i)(9)(A)(i) of
the Code 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 propertythat is not shorter than, the
method and period used to compute its depreciation expense for such purposes. Under
section 168(i)(9)(A)(ii), if the amount allowable as a deduction under section 168 differs
from the amount that-would be allowable as a deduction under section 167 using the
method, period, first and last year convention, and salvage value used to compute
regulated tax expense under section 168(i)(9)(A)(i), the taxpayer must make
adjustments to a reserve to reflect the deferral of taxes resulting from such difference.
Section 168(i)(9)(B)(i) of the Code provides that one way the requirements of
section 168(i)(9)(A) will not be satisfied is if the taxpayer, for ratemaking purposes, uses

PLR-148311-13
4
a procedure or adjustment which is inconsistent with such requirements. Under section
168(i)(9)(B)(ii), such inconsistent procedures and adjustments include the use of an
estimate or projection of the taxpayer’s tax expense, depreciation expense, or reserve
for deferred taxes under section 168(i)(9)(A)(ii), unless such estimate or projection is
also used, for ratemaking purposes, with respect to all three of these items and with
respect to the rate base.
Former section 167(l) of the Code generally provided that public utilities were
entitled to use accelerated methods for depreciation if they used a “normalization
method of accounting.” A normalization method of accounting was defined in former
section 167(l)(3)(G) in a manner consistent with that found in section 168(i)(9)(A).
Section 1.167(1)-1(a)(1) of the Income Tax Regulations provides that the normalization
requirements for public utility property pertain only to the deferral of federal income tax
liability resulting from the use of an accelerated method of depreciation for computing
the allowance for depreciation under section 167 and the use of straight-line
depreciation for computing tax expense and depreciation expense for purposes of
establishing cost of services and for reflecting operating results in regulated books of
account. These regulations do not pertain to other book-tax timing differences with
respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes and
items.
Section 1.167(l)-1(h)(1)(i) provides that the reserve established for public utility
property should reflect the total amount of the deferral of federal income tax liability
resulting from the taxpayer’s use of different depreciation methods for tax and
ratemaking purposes.
Section 1.167(1)-1(h)(1)(iii) provides that the amount of federal income tax
liability deferred as a result of the use of different depreciation methods for tax and
ratemaking purposes is the excess (computed without regard to credits) of the amount
the tax liability would have been had the depreciation method for ratemaking purposes
been used over the amount of the actual tax liability. This amount shall be taken into
account for the taxable year in which the different methods of depreciation are used. If,
however, in respect of any taxable year the use of a method of depreciation other than a
subsection (1) method for purposes of determining the taxpayer’s reasonable allowance
under section 167(a) results in a net operating loss carryover to a year succeeding such
taxable year which would not have arisen (or an increase in such carryover which would
not have arisen) had the taxpayer determined his reasonable allowance under section
167(a) using a subsection (1) method, then the amount and time of the deferral of tax
liability shall be taken into account in such appropriate time and manner as is
satisfactory to the district director.
Section 1.167(1)-1(h)(2)(i) provides that the taxpayer must credit this amount of
deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve
account. This regulation further provides that, with respect to any account, the

PLR-148311-13
5
aggregate amount allocable to deferred tax under section 167(1) shall not be reduced
except to reflect the amount for any taxable year by which Federal income taxes are
greater by reason of the prior use of different methods of depreciation. That section
also notes that the aggregate amount allocable to deferred taxes may be reduced to
reflect the amount for any taxable year by which federal income taxes are greater by
reason of the prior use of different methods of depreciation under section 1.167(1)-
1(h)(1)(i) or to reflect asset retirements or the expiration of the period for
depreciationused for determining the allowance for depreciation under section 167(a).
Section 1.167(1)-(h)(6)(i) provides that, notwithstanding the provisions of
subparagraph (1) of that paragraph, a taxpayer does not use a normalization method of
regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred
taxes under section 167(l) which is excluded from the base to which the taxpayer’s rate
of return is applied, or which is treated as no-cost capital in those rate cases in which
the rate of return is based upon the cost of capital, exceeds the amount of such reserve
for deferred taxes for the period used in determining the taxpayer’s expense in
computing cost of service in such ratemaking.
Section 1.167(1)-(h)(6)(ii) provides that, for the purpose of determining the
maximum amount of the reserve to be excluded from the rate base (or to be included as
no-cost capital) under subdivision (i), above, if solely an historical period is used to
determine depreciation for Federal income tax expense for ratemaking purposes, then
the amount of the reserve account for that period is the amount of the reserve
(determined under section 1.167(1)-1(h)(2)(i)) at the end of the historical period. If such
determination is made by reference both to an historical portion and to a future portion
of a period, the amount of the reserve account for the period is the amount of the
reserve at the end of the historical portion of the period and a pro rata portion of the
amount of any projected increase to be credited or decrease to be charged to the
account during the future portion of the period.
Section 1.167(l)-1(h) requires that a utility must maintain a reserve reflecting the
total amount of the deferral of federal income tax liability resulting from the taxpayer’s
use of different depreciation methods for tax and ratemaking purposes. Taxpayer has
done so. Section 1.167(1)-(h)(6)(i) provides that a taxpayer does not use a
normalization method of regulated accounting if, for ratemaking purposes, the amount
of the reserve for deferred taxes which is excluded from the base to which the
taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate
cases in which the rate of return is based upon the cost of capital, exceeds the amount
of such reserve for deferred taxes for the period used in determining the taxpayer’s
expense in computing cost of service in such ratemaking. Section 56(a)(1)(D) provides
that, with respect to public utility property the Secretary shall prescribe the requirements
of a normalization method of accounting for that section.

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6
In Case, Commission B has reduced rate base by Taxpayer’s ADIT account, as
modified by the account which Taxpayer has designed to calculate the effects of the
NOLC. Section 1.167(1)-1(h)(1)(iii) makes clear that the effects of an NOLC must be
taken into account fornormalization purposes. Further, while that section provides no
specific mandate on methods, it does provide that the Service has discretion to
determine whether a particular method satisfies the normalization requirements.
Section 1.167(1)-(h)(6)(i) provides that a taxpayer does not use a normalization method
of regulated accounting if, for ratemaking purposes, the amount of the reserve for
deferred taxes which is excluded from the base to which the taxpayer’s rate of return is
applied, or which is treated as no-cost capital in those rate cases in which the rate of
return is based upon the cost of capital, exceeds the amount of such reserve for
deferred taxes for the period used in determining the taxpayer’s expense in computing
cost of service in such ratemaking. Because the ADIT account, the reserve account for
deferred taxes, reduces rate base, it is clear that the portion of an NOLC that is
attributable to accelerated depreciation must be taken into account in calculating the
amount of the reserve for deferred taxes (ADIT). Thus, the order by Commission B is in
accord with the normalization requirements. The “with or without” methodology
employed by Taxpayer is specifically designed to ensure that the portion of the NOLC
attributable to accelerated depreciation is correctly taken into account by maximizing the
amount of the NOLC attributable to accelerated depreciation. This methodology
provides certainty and prevents the possibility of “flow through” of the benefits of
accelerated depreciation to ratepayers. Under these facts, any method other than the
“with and without” method would not provide the same level of certainty and therefore
the use of any other methodology is inconsistent with the normalization rules.
Regarding the second issue, § 1.167(1)-(h)(6)(i) provides, as noted above, that a
taxpayer does not use a normalization method of regulated accounting if, for ratemaking
purposes, the amount of the reserve for deferred taxes which is excluded from the base
to which the taxpayer’s rate of return is applied exceeds the amount of such reserve for
deferred taxes for the period used in determining the taxpayer’s expense in computing
cost of service in such ratemaking. Increasing Taxpayer’s ADIT account by an amount
representing those taxes that would have been deferred absent the NOLC increases the
ADIT reserve account (which will then reduce rate base) beyond the permissible
amount.
We rule as follows:
1. Under the circumstances described above, the reduction of Taxpayer’s rate base
by thefull amount of its ADIT account balances offset by a portion of its NOLC-
related account balance that is less than the amount attributable to accelerated
depreciation computed on a “with or without” basis would be inconsistent with the
requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

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2. The imputation of incremental ADIT on account of the reliability plant addition
adjustments described above would be inconsistent with the requirements of §
168(i)(9) and § 1.167(l)-1.
This ruling is based on the representations submitted by Taxpayer and is only
valid if those representations are accurate. The accuracy of these representations is
subject to verification on audit.
Except as specifically determined above, no opinion is expressed or implied
concerning the Federal income tax consequences of the matters described above.
This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
of the Code provides it may not be used or cited as precedent. In accordance with the
power of attorney on file with this office, a copy of this letter is being sent to your
authorized representative. We are also sending a copy of this letter ruling to the
Director.
Sincerely,
Peter C. Friedman
Senior Technician Reviewer, Branch 6
(Passthroughs & Special Industries)
cc: