current utility tax issues david j. yankee deloitte tax llp october 13, 2008

Current Utility Tax Issues

David J. YankeeDeloitte Tax LLPOctober 13, 2008

2Copyright © 2008 Deloitte Development LLC. All rights reserved.

Current Utility Tax IssuesOverview

• Normalization update– Recent private letter rulings

• Consistency requirement• ITC amortization and ARAM• Oregon tax adjustment clause• Section 199 and NOL carryover

– Final regulations – deregulation, dispositions

• Other developments– Bonus depreciation

– Emergency Economic Stabilization Act of 2008

– Re-proposed capitalization regulations

Recent Private Letter Rulings –Consistency Requirement

Copyright © 2008 Deloitte Development LLC. All rights reserved.


Normalization RequirementsConsistency Rules*

• Estimates or projections of:– Tax expense

– Depreciation expense

– Deferred tax liability

– Rate base

• Must be used consistently for all elements

*Section 168(i)(9)(B)


Normalization Consistency RequirementsPLR 200651026 – Facts

• The PUC proposed that a utility adjust rate base for general common plant so that a historical five-year average is used to determine most of the components of general common plant rather than the end-of-test-year balances

• PUC did not propose to use the five-year balance for accumulated depreciation or ADIT

• A tariff reflecting this treatment was put into effect, but was not finalized (pending the outcome of the ruling request)


Normalization Consistency RequirementsPLR 200651026 – Holding and Analysis

• The use of a five-year average for certain components of rate base, but not the ADIT component, violates the normalization consistency requirement of Section 168(i)(9)(B)

• Issuing a new rate order correcting the calculations prospectively (i.e., without providing for rate relief from the effective date of the order) would trigger a normalization violation as of the effective date of rates


Calculation of ADFITPLR 200824001 – Facts

• Commission’s procedure for determining rate base has been used since the early 1980s– Involves use of (a) 12-month historical period(s)

• Taxpayer filed a general rate case in which it no longer calculated gross rate base differently than the ADFIT amount to be subtracted


Calculation of ADFITPLR 200824001 – Holding and Analysis

• For periods during which Taxpayer used the former methodology, “. . . such a procedure is not in accord with the consistency requirement . . .”

• The 1971 committee reports indicate that “the harsh sanctions of disallowance of a public utility’s use of accelerated depreciation and recapture of the tax benefits of the past use of accelerated depreciation” should only be imposed if a regulatory accounting body has required or insisted upon such treatment

• No disallowance or recapture because– both Taxpayer and the PUC at all times intended that Taxpayer

comply with the normalization rules

– the specific matter of Taxpayer’s use of the procedure had never been directly considered by the PUC

Recent Private Letter Rulings – ITC Amortization and ARAM



ITC Normalization RequirementsOperating Rules

• Option 1 - reduce rate base; restore rate base not less rapidly than ratably

• Option 2 - reduce regulatory tax expense; amortize no more rapidly than ratably

• What is "ratable" is determined by considering the period of time actually used in computing the taxpayer's regulated depreciation expense for the property for which a credit is allowed.

• "Regulated depreciation expense" is the depreciation expense for the property used by a regulatory body for purposes of establishing the taxpayer's cost of service for ratemaking purposes.

• If such composite annual percentage rate were revised for purposes of computing regulated depreciation expense beginning with a particular accounting period, the computation of ratable restoration or ratable portion (as the case may be) must also be revised beginning with such period.

• A composite annual percentage rate is determined solely by reference to the period of time actually used by the taxpayer in computing its regulated depreciation expense without reduction for salvage or other items such as over and under accruals.


Option 2 ITC AmortizationPLRs 200802025-026 – Facts

• Regulatory depreciation expense computed based on a composite annual percentage rate for each functional group reflecting average useful life and net salvage– Net salvage could be positive or negative for a given

functional group

– Net salvage was negative in the aggregate

• Depreciation rates were also used to amortize ITC – More rapid amortization than if only the actual asset life

been used

• PUCs were not specifically aware that negative salvage affected ITC amortization


Option 2 ITC AmortizationPLRs 200802025-026 – Holding and Analysis

• It was not the intent of the utility or its PUCs to amortize ITC more rapidly than allowed

• 1971 and 1975 committee reports indicate that the sanctions for ITC normalization violations should only be imposed if a regulatory body has required or insisted upon a violative regulatory accounting treatment

• No disallowance or recapture of ITC because the PUCs at all times required the utility to comply with the normalization rules and because the ITC flow-through calculation was not specifically addressed in earlier rate orders

• Orders concerning this matter finalized by either PUC after the date of the PLR are not necessarily subject to the same analysis


Option 2 ITC Amortization and ARAMPLR 200811004 – Facts

• Regulatory depreciation expense of nuclear power plant originally computed based on the 40-year life of its operating license

• PUC ordered an adjustment to depreciation rates to extend the life to 60 years to correspond to the life used by a co-owner of the plant– Operating license not yet extended

• New, longer life was used for depreciation purposes – Utility erroneously failed to consider the impact of the life

extension on ITC amortization and reversal of excess deferred taxes and AFUDC

• Utility corrected the appropriate balance sheet accounts prior to the next rate case


Option 2 ITC Amortization and ARAMPLR 200811004 – Holding and Analysis

• It was not the intent of the utility or its PUC to reduce tax expense by failing to use the extended plant life

• 1971 and 1975 committee reports indicate that the sanctions for ITC normalization violations should only be imposed if a regulatory body has required or insisted upon a violative regulatory accounting treatment

• No disallowance or recapture is required because the PUC did not insist on the errors

• Orders concerning this matter finalized by the utility’s PUCs after the date of the PLR are not necessarily subject to the same analysis

Recent Private Letter Rulings – Oregon Tax Adjustment Clause



Oregon Tax Adjustment Clause

• Senate Bill 408 (enacted September 2, 2005)

• Annual tax reports

• Automatic adjustment clause relating to public utility taxes

• “Taxes authorized to be collected in rates” v. “taxes paid” and “properly attributed to regulated operations of the public utility”

• “Notwithstanding .. . . [t]ax requirements and benefits that are required to be included in order to ensure compliance with the normalization requirements of federal tax law.”


Oregon Tax Adjustment ClauseTimeline

9/2/05 1/1/06 1/9/0810/15/079/18/0712/31/0612/29/06 4/11/08 6/1/08 5/31/10

S.B. 408enacted

First year subjectto adjustment clause

NormalizationPLR requestsfiled

Annual taxreports for 2006 filed

OPUCissuedpermanentrules toimplementS.B. 408

IRSissuedPLRs totaxpayers 2006 refunds paid

(or surchargescollected)

IRSpublishedredactedPLRs; OPUCissued decisionsin its review of2006 reports


Oregon Tax Adjustment ClausePLRs 200815004-007 – Holdings

* * * is also consistent with the normalization requirements of § 168(i)(9) and former §§ 167(l) and 46(f) because it simply adjusts rates based on the calculations described above.

We note that this ruling is based on representations of the anticipated effects of the isolating provisions of the Permanent Rules and theoretical examples of how the provisions discussed herein are expected to apply. Thus, its applicability is limited to situations in which the effects of accelerated depreciation and ITC-related tax benefits are isolated to ensure that the effects of these tax benefits on current and deferred taxes is consistent with the normalization requirements as represented. While it appears that the Act and Permanent Rules are designed to preclude violation of the normalization provisions, this ruling does not hold that, in its application, no normalization violation is possible for any utility operating in State under these provisions.

Recent Private Letter Rulings – Section 199 and NOL Carryover



Section 199 and NOL CarryoverPLR 200833014 – Facts

• Utility did not have test period federal income tax liability due to use of a net operating loss (NOL) carryover

• Commission does not permit use of NOLs in determining revenue requirements

Actual Pro forma

NOL carryover used Yes No

Current tax liability No Yes

Section 199 deduction No Yes


Section 199 and NOL CarryoverPLR 200833014 – Holding and Analysis

• Not a violation to require use of a Section 199 deduction, unavailable due to presence of an NOL, to calculate revenue requirements

• The limited reach of normalization extends only to depreciation and its definite predictable effects– No reserve for tax is created by paying lower taxes as a

result of a Section 199 deduction

– . . . calculation of the [Section 199] deduction results in the opposite of the usual normalization issue.”

• Not concluding that use of pro forma federal income tax liability in calculating revenue requirements in utility ratemaking is never violative of the normalization provisions


Recent Normalization Private Letter RulingsObservations

• Trends

• How to remedy inadvertent violations

• How to avoid violations related to “new” issues

• Reading too much into IRS analysis

• IRS hesitancy to provide conclusions beyond specific fact patterns

Normalization Update – Deregulation and Dispositions



Deregulation and DispositionsOverview

• Final regulations issued March 19, 2008– Corrected on April 7, 2008

• Scope– Types of transactions

– Types of accounting for income tax items

• Changes from PLRs and proposed regulations

• Effective dates


Asset Sales and DeregulationEvolution of Scope of Guidance

• Body of private letter rulings– Buyers, sellers, deregulation

– ADFIT, EDFIT, ADITC

• Proposed regulations (2003)– Sales/deregulation of generation assets

– EDFIT, ADITC

• Reproposed regulations (2005)– Public utility property that ceases, whether by disposition, deregulation or

otherwise, to be public utility property

– EDFIT, ADITC

• More private letter rulings

• Final regulations (2008)– Public utility property that ceases, whether by disposition, deregulation or

otherwise, to be public utility property • Transferee rule

– EDFIT, ADITC


Final RegulationsTypes of Transactions

• Public utility property that ceases, whether by disposition, deregulation or otherwise, to be public utility property

• Actual and deemed asset sales

• Does not apply to normal retirements


Types of TransactionsException for Normal Retirements*

• The term "ordinary retirement" means any retirement of section 1245 property which is not treated as an "extraordinary retirement."

• The retirement of an asset from a vintage account in a taxable year is an "extraordinary retirement" if --

(a) The asset is section 1250 property;

(b) The asset is section 1245 property which is retired as the direct result of fire, storm,shipwreck, or other casualty ; or

(c) (1) The asset is section 1245 property which is retired (other than by transfer to suppliesor scrap) in a taxable year as the direct result of a cessation, termination, curtailment,or disposition of a business, manufacturing, or other income-producing process,operation, facility or unit, and

(2) The unadjusted basis of all such assets so retired in such taxable year from such account as a direct result of the event described in (c)(1) of this subdivision exceeds20 percent of the unadjusted basis of such account immediately prior to such event.

(d) The asset is retired by a charitable contribution.

*Reg. Sec. 1.167(a)-11(d)(3)(ii)


Final RegulationsExcess Deferred Taxes

• Flow back the amount that would have reversed had the deregulation/disposition not occurred

• Taxpayer continues using average rate assumption method (ARAM) or the reverse South Georgia method

• Sales to regulated buyers– Transferee flowthrough in lieu of transferor

flowthrough permitted

– Adds flexibility and administrative convenience

– Rule was not in the proposed regulations


Final RegulationsUnamortized ITC

• Options 1 and 2

• Amortize/restore to the extent of and proportionate to the recovery of stranded costs– Rate base reductions (Option 1) v. reductions to cost of service (Option

2)– Focus on dollar amount of rate recovery, not regulatory life

• Ratepayers contribute to the cost of the disposed or deregulated public utility property through– depreciation expense, or– stranded cost recovery

• Effect: if amount of the annual rate recovery of stranded costs is greater than the amount that would have been recovered had the costs been depreciated over their remaining regulatory lives, the amortization of ADITC attributable to those assets is proportionately accelerated


Final RegulationsEffective Dates

• No retroactive election

• General rule – deregulation or disposition after December 21, 2005

• Flow-through of EDFIT and ADITC consistent with 2003 proposed regulations will be permitted during the period:– March 5, 2003 through the earlier of:

(i) the last date on which utility’s rates are determined under a rate order in effect on December 21, 2005 or

(ii) December 21, 2007

• Transferee rule – transfers of public utility property after March 20, 2008


Final RegulationsTopics Not Addressed

• Transfers to rate-regulated partnerships/LLCs

• Sales at a gain – treatment of Option 2 ITC by transferors

• When does deregulation occur?– “This depends on the particular facts and

circumstances and is more appropriately addressed on a case-by-case basis.”

• Non-recognition transactions – Sections 1031, 1033


Reproposed Normalization RegulationsDeloitte Tax LLP Comment Letter

• Precise and consistent use of the term “deregulated public utility property”

• Whether the change in ADITC rules applies to dispositions at a gain

• What is deregulation and when does it occur?

• Whether the normalization rules apply to normal retirements

• Dispositions to rate-regulated buyers

• Other disposition transactions


Other Developments



Bonus Depreciation

• 50 percent deduction in year placed in service– Subject to the normalization requirements

• Qualifying property placed in service during calendar year 2008– Placed-in-service date extended to December 31,

2009 for certain long-lived property

• Guidance and experience

• Election “out” and election “in lieu of”


Emergency Economic Stabilization Act of 2008Tax Provisions Affecting Utilities

• R&D credit

• Production tax credit

• Investment tax credit

• Carbon capture and sequestration projects

• Accelerated depreciation for smart meters and smart grid systems

• Disaster relief bonus depreciation


Re-proposed Capitalization Regulations

• Background and framework

• Issues– Materials and supplies

– De minimis rule

– Casualty losses

– Regulatory method

– Repair allowance

– Network assets

– Relocation costs

– Removal costs

– Power plant examples

• Effective date and transition


Circular 230 StatementAny tax advice included in this written or electronic communication was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.

Limitation on UseThe information contained in this publication is for general purposes only and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by Deloitte Tax LLP to the reader. This material may not be applicable or suitable for the reader’s specific circumstances of needs. Therefore, the information should not be used as a substitute for consultation with professional accounting, tax, or other competent advisors. Please contact a Deloitte Tax LLP professional before taking any action based upon this information.

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NARUCCurrent Utility Tax Issues

current utility tax issues david j. yankee deloitte tax llp october 13, 2008

Documents

puc slide

deloitte development

gross rate base

section 168i9b slide

rate relief

tax benefits

yankee deloitte tax

general rate case