In a recent private letter ruling (PLR 201949006),¹ the Internal Revenue Service (IRS) addressed the computation of the pro rata portion of accumulated deferred federal income tax reserve (ADFIT, together with the total accumulated deferred state income tax reserve, ADIT) that could be used to reduce rate base in accordance with Treas. Reg. § 1.167(l)-1(h)(6) (the “proration rules”) and the consistency rules under § 168(i)(9) of the Internal Revenue Code (Code).

The utility that requested the ruling was subject to regulation as to rates and conditions of service by Commission A and Commission B. Before Commission A, the utility filed revisions to its Transmission Owner Tariff that utilized a formula ratemaking approach to compute its transmission revenue requirement (Base TRR²). Commission A used ADIT balances to reduce rate base in the computation of Prior Year TRR and the True-Up Adjustment. The proration rules were not applied in computing the Rate Year TRR, but they were applied in calculating the True-Up Adjustment. The pro rata balance used to adjust rate base for purposes of the True-Up Adjustment included a 13-month average of: (1) the Prior Year beginning ADIT balance; and (2) the pro rata ADIT balance at the end of the Prior Year. The Incremental Capital Cost balance used to calculate IFPTRR did not include ADIT amounts.    

Before Commission B, the utility typically filed a general rate case (GRC) every three years. ADIT balances related to Commission B-jurisdictional assets were used to adjust Commission B rate base in computing the GRC revenue requirement. To derive the ADIT adjustment to forecast test-year rate base, the forecasted ADIT balance at the beginning of the test year was added to the product of the change in ADIT for the test year multiplied by the pro rata percentage.³ 

The utility sought rulings:

Commission A

• That reflecting Prior Year ADIT amounts as adjustments to rate base in the computation of the Prior Year TRR and reflecting Incremental Capital Costs in the IFPTRR computation without adjustments for ADIT in calculation of rate year TRR would not violate the normalization rules; 
• That adjusting rate base by the pro rata computation of ADIT subject to normalization in the True-Up Adjustment would not be a normalization violation; and
• That eliminating the application of a regulatory averaging convention to the pro rata portion of ADIT subject to normalization in computing the adjustment to rate base in the True-Up Adjustment would not be a normalization violation.

Commission B

• That utilizing a pro rata percentage portion of ADIT subject to normalization as an adjustment to rate base in the GRC test year is consistent with normalization requirements; and
• That eliminating application of a regulatory averaging convention to the pro rata portion of ADIT subject to normalization as an adjustment to rate base in the GRC test year would not be a normalization violation. 
• The IRS granted each of these requests, noting that the use of “the average of” the pro rata calculation in the utility’s Commission A Formula Rate True-Up Adjustment and in the Commission B GRC is unnecessary to avoid a violation of the Consistency Rule of § 168(i)(9)(B)(ii) of the Code.    

As the calculation of income tax expense for the utility’s Commission A Formula Rate Year TRR looks to both a historical period (Prior Year TRR) and a future period (IFPTRR), the maximum amount of the reserve to be excluded from rate base is: (1) the amount of the reserve at the end of the historical portion of the period; and (2) a pro rata portion of the amount of any projected increase or decrease to be charged to the reserve account during the future portion of the period. That the utility’s Formula Rate Year TRR reflects the Prior Year year-end balance of Commission A related amounts in the Prior Year TRR and excludes ADIT amounts in the IFPTRR as adjustments to Incremental Capital Costs is not a normalization violation because the total of such reserve amount is less than the maximum amount that can be excluded from rate base. In other words, the normalization rules do not require that any amount of the reserve be used to reduce rate base; they merely establish the maximum amount of the permissible reduction.

PLR 201949006 is similar to earlier rulings addressing comparable issues⁴, and confirms that the purposes of the proration formula and the consistency rules are essentially the same, that is, to reflect the time value of changes to ADFIT balances over a future test period or the future portion of a part historical, part future test period. Accordingly, the utility must employ one procedure or the other, but not both. Thus, if proration is applied, averaging is not also required; but if the proration rules were not applied (e.g., for the true-up of actual versus projected revenue requirements), averaging must be applied.

______

¹Dated Aug. 27, 2019; Released December 6, 2019.

²Base TRR is the sum of three components: (1) Prior Year Transmission Revenue Requirement (Prior Year TRR); (2) Incremental Forecast Period Transmission Revenue Requirement (IFPTRR); and (3) the True-Up Adjustment, the difference between the revenue requirement based on actual costs incurred in a Prior Year and actual revenue received during that Prior Year.

³The pro rata percentage is equivalent to the 13-month average of the pro rata computation of the change in ADIT occurring during the test year, as described in Treas. Reg. § 1.167(l)-1(h)(6)(ii).

⁴See PLRs 201930016, 201930015, 201828010, 201745002, and 201717008 and our prior Legal Alert. 

[View source.]