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).
5
(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