[Federal Register Volume 68, Number 42 (Tuesday, March 4, 2003)]
[Proposed Rules]
[Pages 10190-10193]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-4885]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-104385-01]
RIN 1545-AY75


Application of Normalization Accounting Rules to Balances of 
Excess Deferred Income Taxes and Accumulated Deferred Investment Tax 
Credits of Public Utilities Whose Generation Assets Cease to be Public 
Utility Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that provide 
guidance on the normalization requirements applicable to electric 
utilities that benefit (or have benefitted) from accelerated 
depreciation methods or from the investment tax credit permitted under 
pre-1991 law. The proposed regulations permit a utility whose 
electricity generation assets cease to be public utility property to 
return to their ratepayers the normalization reserves for excess 
deferred income taxes (EDFIT) and accumulated deferred investment tax 
credits (ADITC)) with respect to those assets. This document also 
provides notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by June 2, 2003. 
Requests to speak and outlines of topics to be discussed at the public 
hearing scheduled for June 25, 2003, at 10 a.m. must be received by 
June 2, 2003.

ADDRESSES: Send submissions to: CC:PA:RU (REG-104385-01), room

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5226, Internal Revenue Service, Post Office Box 7604, Ben Franklin 
Station, Washington, DC 20044. Submissions may be hand-delivered Monday 
through Friday between the hours of 8 a.m. and 5 p.m. to: CC:PA:RU 
(REG-104385-01), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers may 
submit comments electronically by submitting comments directly to the 
IRS Internet site at www.irs.gov/regs. The public hearing will be held 
in the Internal Revenue Building, 1111 Constitution Avenue, NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
David Selig, at (202) 622-3040; concerning submissions of comments, the 
hearing, or to be placed on the building access list to attend the 
hearing, Treena Garrett, at (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) relating to the normalization requirements 
of sections 168(f)(2) and 168(i)(9) of the Internal Revenue Code 
(Code), section 203(e) of the Tax Reform Act of 1986, Public Law 99-514 
(100 Stat. 2146), and former section 46(f) of the Code. The proposed 
regulations respond to changes in the electric power industry resulting 
from deregulation of electricity generation facilities.
    Section 168 of the Code permits the use of accelerated depreciation 
methods. Section 168(f)(2) provides, however, that accelerated 
depreciation is permitted with respect to public utility property only 
if the taxpayer uses a normalization method of accounting for 
ratemaking purposes.
    Under a normalization method of accounting, a utility calculates 
its ratemaking tax expense using depreciation that is no more 
accelerated than its ratemaking depreciation (typically straight-line). 
In the early years of an asset's life, this results in ratemaking tax 
expense that is greater than actual tax expense. The difference between 
the ratemaking tax expense and the actual tax expense is added to a 
reserve (the accumulated deferred federal income tax reserve, or 
ADFIT). The difference between ratemaking tax expense and actual tax 
expense is not permanent and reverses in the later years of the asset's 
life when the ratemaking depreciation method provides larger 
depreciation deductions and lower tax expense than the accelerated 
method used in computing actual tax expense.
    This accounting treatment prevents the immediate flowthrough to 
utility ratepayers of the reduction in current taxes resulting from the 
use of accelerated depreciation. Instead, the reduction is treated as a 
deferred tax expense that is collected from current ratepayers through 
utility rates, and thus is available to utilities as cost-free 
investment capital. When the accelerated method provides lower 
depreciation deductions in later years, only the ratemaking tax expense 
is collected from ratepayers and the difference between actual tax 
expense and ratemaking tax expense is charged to ADFIT, depleting the 
utility's stock of cost-free capital.

Excess Deferred Income Tax

    The Tax Reform Act of 1986 reduced the highest corporate tax rate 
from 46 percent to 34 percent. The excess deferred federal income tax 
(EDFIT) reserve is the balance of the deferred tax reserve immediately 
before the rate reduction over the balance that would have been held in 
the reserve if the 34 percent rate had been in effect for prior 
periods. The EDFIT reserves were amounts that utilities had collected 
from ratepayers to pay future taxes that, as a result of the reduction 
in corporate tax rates, would not have to be paid.
    Section 203(e) of the Tax Reform Act of 1986 specifies the manner 
in which the EDFIT reserve can be flowed through to ratepayers under a 
normalization method of accounting. It provides that the EDFIT reserve 
may be reduced, with a corresponding reduction in the cost of service 
the utility collects from ratepayers, no more rapidly than the EDFIT 
reserve would be reduced under the average rate assumption method 
(ARAM). For taxpayers that did not have adequate data to apply the 
average rate assumption method, subsequent guidance permitted use of 
the reverse South Georgia method as an alternative. In general, both 
the average rate assumption method and the reverse South Georgia method 
spread the flowthrough of the EDFIT reserve over the remaining lives of 
the property that gave rise to the excess.

Accumulated Deferred Investment Tax Credits (ADITC)

    Former section 46 of the Code similarly limited the ability of 
ratepayers to benefit from the investment tax credit determined under 
that section. Under former section 46(f)(2), an electing utility could 
flow through the investment credit ratably (that is, could reduce the 
cost of service collected from ratepayers by a ratable portion of the 
credit) over the investment's regulatory life. The balance of the 
credit remaining to be flowed through to ratepayers would be held in a 
reserve for accumulated deferred investment tax credits (ADITC). If the 
utility elected ratable flowthrough of the credit, the rate base (the 
amount on which the utility is permitted to collect a return from 
ratepayers) could not be reduced by reason of any portion of the 
credit.

Deregulation of Generation Assets

    When the normalization provisions were added to the Internal 
Revenue Code, electric utilities were vertically integrated to include 
generation, transmission, and distribution functions. Accelerated 
depreciation, investment credits, and normalization enhanced the cash 
flow needed to acquire and construct new generation assets. Driven by 
changes in technology and economics, however, the electric industry has 
been undergoing substantial changes. Many utilities have been selling 
generation assets to new entities that are not subject to rate of 
return regulation and are becoming transmission and distribution (or 
distribution-only) companies. In many cases, the deregulation of 
generation assets is occurring before the EDFIT and ADITC reserves 
associated with those assets have been flowed through to ratepayers.
    The Service has issued a number of private letter rulings holding 
that flowthrough of the EDFIT and ADITC reserves associated with an 
asset is not permitted after the asset's deregulation, whether by 
disposition or otherwise. These rulings were based on the principle 
that flowthrough is permitted only over the asset's regulatory life and 
when that life is terminated by deregulation no further flowthrough is 
permitted. After further consideration, the Service and Treasury have 
concluded that neither former section 46(f)(2) nor section 203(e) of 
the Tax Reform Act suggests that the EDFIT and ADITC reserves should 
not ultimately be flowed through to ratepayers. Instead, Congress 
provided a schedule for flowing through the reserves so that utilities 
would have the benefit of cost-free capital for a predictable period.
    The proposed regulations provide that utilities whose generation 
assets cease to be public utility property, whether by disposition, 
deregulation, or otherwise, may continue to flow through EDFIT and 
ADITC reserves associated with those assets without violating the 
normalization rules. The rate of

[[Page 10192]]

flowthrough is limited, however, to the rate that would have been 
permitted if the assets had remained public utility property and the 
taxpayer had continued to use a normalization method of accounting (or 
ratable flowthrough of the credit) with respect to the assets. This 
result does not impose on utilities any burden unanticipated prior to 
deregulation and provides the flow-through originally anticipated by 
ratepayers, utility commissions, and utilities.

Comments Requested

    In addition to comments relating to this notice of proposed 
rulemaking, comments are requested on the proper disposition of tax 
reserves (ADFIT, EDFIT, and ADITC) under the following set of facts. 
Regulated transmission assets from several public utilities (related or 
otherwise) are transferred to a utility partnership. This partnership 
is created solely as a transmission company. The transaction is subject 
to section 721 of the Code. The transmission assets are public utility 
property before the transfer and will be public utility property after 
the transfer. Is there a normalization violation if the deferred tax 
reserves are transferred to the new transmission company's regulated 
books and are considered in setting rates for the new transmission 
company? Alternatively, is there a normalization violation if the 
deferred tax reserves remain on the transferors' regulated books and 
are considered in setting their rates?
    In addition, the proposed regulations do not address the treatment 
of deregulated assets under former section 46(f)(1) (relating to the 
use of the investment credit to reduce the rate base of electing 
taxpayers). Comments are also requested on this issue.

Proposed Effective Date

    The regulations are proposed to apply to property that becomes 
deregulated generation property after March 4, 2003. In addition, a 
utility may elect to apply the proposed rules to property that becomes 
deregulated generation property on or before March 4, 2003. The 
election is made by attaching a written statement to the utility's 
return for the tax year in which the proposed rules are published as 
final regulations.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations and, because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Therefore, a Regulatory Flexibility Analysis is not required. 
Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted (in the 
manner described in the ADDRESSES caption) timely to the IRS. All 
comments will be available for public inspection and copying. Treasury 
and IRS specifically request comments on the clarity of the proposed 
regulations and how they may be made clearer and easier to understand.
    A public hearing has been scheduled for June 25, 2003, at 10 a.m. 
in the Internal Revenue Building, 1111 Constitution Avenue, NW., 
Washington, DC. Because of access restrictions, visitors will not be 
admitted beyond the Internal Revenue Building lobby more than 30 
minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit comments and submit an outline of the topics to be discussed and 
the time to be devoted to each topic by June 2, 2003.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is David Selig, Office of 
the Associate Chief Counsel (Passthroughs and Special Industries), IRS. 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.46-6 is amended by adding paragraph (k) to read 
as follows:


Sec.  1.46-6  Limitation in case of certain regulated companies.

* * * * *
    (k) Treatment of accumulated deferred investment tax credits upon 
the deregulation of regulated generation assets--(1) Scope. This 
paragraph (k) provides rules for the application of former section 
46(f)(2) of the Internal Revenue Code with respect to public utility 
property that is used in electric generation and ceases, whether by 
disposition, deregulation, or otherwise, to be public utility property 
(deregulated generation property).
    (2) Amount of reduction. If public utility property of a taxpayer 
becomes deregulated generation property to which this section applies, 
the reduction in the taxpayer's cost of service permitted under former 
section 46(f)(2) is equal to the amount by which the cost of service 
could be reduced under that provision if all such property had remained 
public utility property of the taxpayer and the taxpayer had continued 
to reduce its cost of service by a ratable portion of the credit with 
respect to such property.
    (3) Cross reference. See Sec.  1.168(i)-(3) for rules relating to 
the treatment of balances of excess deferred income taxes when 
utilities dispose of regulated generation assets.
    (4) Effective date--(i) General rule. This paragraph (k) applies to 
property that becomes deregulated generation property after March 4, 
2003.
    (ii) Election for retroactive application. A utility may elect to 
apply this paragraph (k) to property that becomes deregulated 
generation property on or before March 4, 2003. The election is made by 
attaching the statement ``ELECTION UNDER Sec.  1.46-6(k)'' to the 
taxpayer's return for the tax year in which this paragraph (k) is 
published as a final regulation.
    Par. 3. Section 1.168(i)-3 is added to read as follows:

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Sec.  1.168(i)-(3)  Treatment of excess deferred income tax reserve 
upon disposition of regulated generation assets.

    (a) Scope. This section provides rules for the application of 
section 203(e) of the Tax Reform Act of 1986, Public Law 99-514 (100 
Stat. 2146) with respect to public utility property that is used in 
electric generation and ceases, whether by disposition, deregulation, 
or otherwise, to be public utility property (deregulated generation 
property).
    (b) Amount of reduction. If public utility property of a taxpayer 
becomes deregulated generation property to which this section applies, 
the reduction in the taxpayer's excess tax reserve permitted under 
section 203(e) of the Tax Reform Act of 1986 is equal to the amount by 
which the reserve could be reduced under that provision if all such 
property had remained public utility property of the taxpayer and the 
taxpayer had continued use of its normalization method of accounting 
with respect to such property.
    (c) Cross reference. See Sec.  1.46-6(k) for rules relating to the 
treatment of accumulated deferred investment tax credits when utilities 
dispose of regulated generation assets.
    (d) Effective date--(1) General rule. This section applies to 
property that becomes deregulated generation property after March 4, 
2003.
    (2) Election for retroactive application. A taxpayer may elect to 
apply this section to property that becomes deregulated generation 
property on or before March 4, 2003. The election is made by attaching 
the statement ``ELECTION UNDER Sec.  1.168(i)-3'' to the taxpayer's 
return for the tax year in which this section is published as a final 
regulation.

David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.
[FR Doc. 03-4885 Filed 3-3-03; 8:45 am]
BILLING CODE 4830-01-P