[Federal Register Volume 73, Number 55 (Thursday, March 20, 2008)]
[Rules and Regulations]
[Pages 14934-14937]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-5619]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9387]
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 Assets Cease To Be Public Utility 
Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations that provide guidance 
on the normalization requirements applicable to public utilities that 
benefit (or have benefited) from accelerated depreciation methods or 
from the investment tax credit permitted under pre-1991 law. These 
regulations permit a utility whose assets cease, whether by 
disposition, deregulation, or otherwise, to be public utility property 
with respect to the utility (deregulated public utility property) to 
return to its ratepayers the normalization reserve for excess deferred 
income taxes (EDFIT) with respect to those assets and, in certain 
circumstances, also permit the return of part or all of the reserve for 
accumulated deferred investment tax credits (ADITC) with respect to 
those assets.

DATES: Effective Date: These regulations are effective March 20, 2008.
    Applicability Date: For dates of applicability, see Sec.  1.46-
6(k)(4) and Sec.  1.168(i)-3(d) of these regulations.

FOR FURTHER INFORMATION CONTACT: Patrick Kirwan, at (202) 622-3040 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

    This document amends 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. Proposed regulations relating to the 
normalization requirements applicable to electric utilities that 
benefit (or have benefited) from accelerated depreciation methods or 
from the investment tax credit permitted under pre-1991 law [REG-
104385-01] were published in the Federal Register on March 4, 2003 (the 
2003 proposed regulations) and again on December 21, 2005 (the 2005 
proposed regulations). The preambles of both the 2003 proposed 
regulations and the 2005 proposed regulations describe the 
normalization method of accounting and the reserves under the 
normalization method for excess deferred federal income tax (EDFIT) and 
accumulated deferred investment tax credits (ADITC).
    The 2003 proposed regulations provided that electric utilities 
whose generation assets become deregulated public utility property 
could continue to flow through EDFIT reserves associated with those 
assets without violating the normalization requirements. The rate of 
flowthrough was limited to the rate that would have been permitted 
under a normalization method of accounting if the assets had remained 
public utility property.
    The 2003 proposed regulations provided similar rules under which 
electric utilities could continue to flow through ADITC reserves 
associated with generation assets that become deregulated public 
utility property without violating the normalization requirements. The 
2003 proposed regulations addressed the treatment of these assets under 
former section 46(f)(2) (relating to the use of the investment credit 
to reduce the taxpayer's cost of service) but did not address their 
treatment under former section 46(f)(1) (relating to the use of the

[[Page 14935]]

investment credit to reduce the taxpayer's rate base). The 2003 
proposed regulations would have applied to public utility generation 
property deregulated after March 4, 2003. Utilities would have been 
permitted an election to apply the proposed rules to generation 
property that was deregulated on or before that date.
    In response to the public comments and after further analysis, the 
2003 proposed regulations were withdrawn and were replaced by the 2005 
proposed regulations. The 2005 proposed regulations generally retain 
the rule of the 2003 proposed regulations regarding the return of EDFIT 
reserves and extend the application of the rule to all public utility 
property.
    The 2005 proposed regulations permit flowthrough of the ADITC 
reserve with respect to deregulated public utility property to continue 
after its deregulation only to the extent the reduction in cost of 
service does not exceed, as a percentage of the ADITC with respect to 
the property at the time of deregulation, the percentage of the total 
stranded cost that the taxpayer is permitted to recover with respect to 
the property. In addition, the 2005 proposed regulations provide that 
the credit may not be flowed through more rapidly than the rate at 
which the taxpayer is permitted to recover the stranded cost with 
respect to the property. The 2005 proposed regulations provide similar 
rules for property to which former section 46(f)(1) (relating to rate 
base restoration) applies and extend the application of the ADITC 
flowthrough rules to all public utility property.
    The 2005 proposed regulations generally apply to any public utility 
property that becomes deregulated public utility property after 
December 21, 2005. They do not include an election to apply the 
regulations retroactively. For public utility property that became 
deregulated public utility property on or before December 21, 2005, the 
preamble of the 2005 proposed regulations states that the IRS will 
follow the holdings set forth in the private letter rulings prohibiting 
flowthrough of the EDFIT and ADITC reserves associated with an asset 
after the asset's disposition. The 2005 proposed regulations provide, 
however, that flowthrough will be permitted if it is consistent with 
the 2003 proposed regulations and occurs during the period beginning on 
March 5, 2003, and ending on the earlier of (1) the last date on which 
the utility's rates are determined under the rate order in effect on 
December 21, 2005, or (2) December 21, 2007.
    Written comments were received in response to the 2005 proposed 
regulations, and a public hearing was held on April 5, 2006. Three 
commentators spoke at the public hearing. After consideration of all 
the comments, the 2005 proposed regulations are adopted as amended by 
this Treasury decision. In general, the final regulations follow the 
approach of the 2005 proposed regulations.
    A number of commentators suggested that the proposed rules should 
apply on an elective basis to public utility property that was 
deregulated prior to March 5, 2003, if regulatory proceedings for the 
deregulated public utility property are pending. The preamble to the 
2005 proposed regulations explains that the Secretary's authority under 
section 7805(b)(7) to provide for retroactive elections should not be 
exercised in a manner that impairs existing agreements between 
utilities and their regulators. Many commentators agreed with the 
objective of not disturbing previously settled and finalized agreements 
and believed that a retroactive election would likely result in 
taxpayers being compelled to reopen such agreements. The commentators 
suggested, however, that applying the regulations to regulatory 
proceedings that have yet to be finally decided would not impair any 
existing agreement, and that the final regulations should permit 
continued flowthrough of the EDFIT and ADITC reserves if no final order 
or settlement agreement prescribing the treatment of those reserves 
after deregulation was in effect on December 21, 2005. Other 
commentators suggested that the section 7805 limitations on 
retroactivity do not apply to these regulations because the 
normalization provisions were enacted before the effective date of 
those limitations. The IRS and Treasury Department agree that there is 
no statutory impediment that would prohibit the application of the 
regulations to previously deregulated property. Nevertheless, the IRS 
and Treasury Department have concluded that there is no compelling 
argument in this instance for frustrating the expectations of taxpayers 
who embarked upon deregulation of their public utility property before 
the publication of the new rules. Accordingly, the final regulations do 
not depart from the general practice of applying amendments to the 
regulations without retroactive effect and retain the prospective 
effective date of the 2005 proposed regulations without a retroactive 
election. The final regulations retain the proposed transition rule 
under which flowthrough is permitted if it is consistent with the 2003 
proposed regulations and occurs during the period beginning on March 5, 
2003, and ending on the earlier of (1) the last date on which the 
utility's rates are determined under the rate order in effect on 
December 21, 2005, or (2) December 21, 2007.
    One commentator suggested that the regulations should provide 
guidance concerning when deregulation occurs. Under the regulations, 
property becomes deregulated public utility property when it ceases to 
be public utility property with respect to the taxpayer. This depends 
on the particular facts and circumstances and is more appropriately 
addressed on a case-by-case basis.
    Some commentators suggested that the final regulations should 
permit flowthrough of ADITC reserves even in cases in which ratepayers 
do not bear the cost of the asset giving rise to the credit. The 
comments generally argued that this would be consistent with 
Congressional intent to share the benefit of the credit between 
ratepayers and shareholders. The IRS and Treasury Department agree that 
the Code provides for such sharing in the typical situation in which 
ratepayers ultimately bear the full cost of an asset through ratemaking 
depreciation. On the other hand, neither the statutory provision nor 
the legislative history provides any indication that Congress intended 
for ratepayers to share in benefits attributable to costs that they do 
not bear. Accordingly, for the reasons set forth in the preamble of the 
2005 proposed regulations, the final regulations retain the proposed 
rules relating to flowthrough of the ADITC reserve and rate base 
restoration, including the rule allowing flowthrough consistent with 
the 2003 proposed regulations during the transition period.
    Commentators suggested that the use of terms other than deregulated 
public utility property in the preamble of the 2005 proposed 
regulations implies that a distinction exists between property that 
ceases to be public utility property because of deregulation and 
property that ceases to be public utility property because of a 
disposition or other event. To clarify that this is not the case, the 
term deregulated public utility property is the sole term used in the 
final regulations to describe property that ceases to be public utility 
property.
    One commentator questioned whether the term deregulated public 
utility property includes normal retirements. The final regulations 
clarify that they do not apply to ordinary retirements within

[[Page 14936]]

the meaning of section 1.167(a)-11(d)(3)(ii).
    One commentator suggested that deregulated public utility property 
should include property that is public utility property in the hands of 
a transferee. The commentator further suggested that if the transferee 
of public utility property will continue the flowthrough of the 
transferor's EDFIT and ADITC reserves, further flowthrough by the 
transferor should not be required. The IRS and Treasury Department 
agree with these suggestions. Accordingly, the final regulations 
provide, on a prospective basis, that they apply to a taxpayer with 
respect to public utility property that ceases to be public utility 
property with respect to the taxpayer. Thus, the regulations will apply 
even if the property remains regulated public utility property in the 
hands of a transferee. The regulations further provide an exception 
from the generally applicable rule permitting transferor flowthrough 
when the transferee will continue flowthrough of the EDFIT reserves. A 
similar exception was not provided for the ADITC reserve because 
transferor flowthrough of that reserve does not occur if the 
transferee, rather than the transferor, is recovering the cost of the 
property through ratemaking depreciation.

Special Analyses

    It has been determined that this Treasury decision 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, the notice of proposed 
rulemaking preceding these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small businesses.

Drafting Information

    The principal author of the regulations is Patrick S. Kirwan, 
Office of Associate Chief Counsel (Passthroughs & Special Industries). 
However, other personnel from the IRS and the Treasury Department 
participated in the development of the regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

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


0
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 public utility property--(1) Scope--(i) In general. 
This paragraph (k) provides rules for the application of former 
sections 46(f)(1) and 46(f)(2) of the Internal Revenue Code to a 
taxpayer with respect to public utility property that ceases, whether 
by disposition, deregulation, or otherwise, to be public utility 
property with respect to the taxpayer and that is not described in 
paragraph (k)(1)(ii) of this section (deregulated public utility 
property).
    (ii) Exception. This paragraph (k) does not apply to property that 
ceases to be public utility property with respect to the taxpayer on 
account of an ordinary retirement within the meaning of Sec.  1.167(a)-
11(d)(3)(ii).
    (2) Ratable amount--(i) Restoration of rate base reduction. A 
reduction in the taxpayer's rate base on account of the credit with 
respect to public utility property remaining to be restored does not, 
at any time during the period, exceed the restoration percentage of the 
recoverable stranded cost of the property at such time. For this 
purpose--
    (A) The stranded cost of the property is the cost of the property 
reduced by the amount of such cost that the taxpayer has recovered 
through regulated depreciation expense during the period before the 
property becomes deregulated public utility property;
    (B) The recoverable stranded cost of the property at any time is 
the stranded cost of the property that the taxpayer will be permitted 
to recover through rates after such time; and
    (C) The restoration percentage for the property is determined by 
dividing the reduction in rate base remaining to be restored with 
respect to the property immediately before the property becomes 
deregulated public utility property by the stranded cost of the 
property.
    (ii) Cost of service reduction. Reductions in the taxpayer's cost 
of service on account of the credit with respect to public utility 
property that becomes deregulated public utility property are ratable 
during the period after the property becomes deregulated public utility 
property if the cumulative amount of the reduction during such period 
does not, at any time during the period, exceed the flowthrough 
percentage of the cumulative stranded cost recovery for the property at 
such time. For this purpose--
    (A) The stranded cost of the property is the cost of the property 
reduced by the amount of such cost that the taxpayer has recovered 
through regulated depreciation expense during the period before the 
property becomes deregulated public utility property;
    (B) The cumulative stranded cost recovery for the property at any 
time is the stranded cost of the property that the taxpayer has been 
permitted to recover through rates on or before such time; and
    (C) The flowthrough percentage for the property is determined by 
dividing the amount of credit with respect to the property remaining to 
be used to reduce cost of service immediately before the property 
becomes deregulated public utility property by the stranded cost of the 
property.
    (3) Cross reference. See Sec.  1.168(i)-(3) for rules relating to 
the treatment of balances of excess deferred income taxes when public 
utility property becomes deregulated public utility property.
    (4) Effective/applicability dates--(i) In general. Except as 
provided in paragraph (k)(4)(ii) of this section, this paragraph (k) 
applies to public utility property that becomes deregulated public 
utility property with respect to a taxpayer after December 21, 2005.
    (ii) Property that becomes public utility property of the 
transferee. This paragraph (k) does not apply to property that becomes 
deregulated public utility property with respect to a taxpayer an 
account of a transfer on or before March 20, 2008 if after the transfer 
the property is public utility property of the transferee.
    (iii) Application of regulation project (REG-104385-01). A 
reduction in the taxpayer's cost of service will be treated as ratable 
if it is consistent with the proposed rules in regulation project (REG-
104385-01) (68 FR 10190) March 4, 2003, and occurs during the period 
beginning on March 5, 2003, and ending on the earlier of--

[[Page 14937]]

    (A) The last date on which the utility's rates are determined under 
the rate order in effect on December 21, 2005; or
    (B) December 21, 2007.


0
Par. 3. Section 1.168(i)-3 is added to read as follows:


Sec.  1.168(i)-3   Treatment of excess deferred income tax reserve upon 
disposition of deregulated public utility property.

    (a) Scope--(1) In general. 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) to a taxpayer with respect to public utility 
property (within the meaning of section 168(i)(10)) that ceases, 
whether by disposition, deregulation, or otherwise, to be public 
utility property with respect to the taxpayer and that is not described 
in paragraph (a)(2) of this section (deregulated public utility 
property).
    (2) Exceptions. This section does not apply to the following 
property:
    (i) Property that ceases to be public utility property with respect 
to the taxpayer on account of an ordinary retirement within the meaning 
of Sec.  1.167(a)-11(d)(3)(ii).
    (ii) Property transferred by the taxpayer if after the transfer the 
property is public utility property of the transferee and the 
taxpayer's excess tax reserve with respect to the property (within the 
meaning of section 203(e) of the Tax Reform Act of 1986) is treated as 
an excess tax reserve of the transferee with respect to the property.
    (b) Amount of reduction. If public utility property of a taxpayer 
becomes deregulated public utility 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 public utility property.
    (d) Effective/applicability dates--(1) In general. Except as 
provided in paragraph (d)(2) of this section, this section applies to 
public utility property that becomes deregulated public utility 
property after December 21, 2005.
    (2) Property that becomes public utility property of the 
transferee. This section does not apply to property that becomes 
deregulated public utility property with respect to a taxpayer on 
account of a transfer on or before March 20, 2008 if after the transfer 
the property is public utility property of the transferee.
    (3) Application of regulation project (REG-104385-01). A reduction 
in the taxpayer's excess deferred income tax reserve will be treated as 
ratable if it is consistent with the proposed rules in regulation 
project (REG-104385-01) (68 FR 10190) March 4, 2003, and occurs during 
the period beginning on March 5, 2003, and ending on the earlier of--
    (i) The last date on which the utility's rates are determined under 
the rate order in effect on December 21, 2005; or
    (ii) December 21, 2007.

Linda E. Stiff,
Acting Deputy Commissioner for Services and Enforcement.
    Approved: March 6, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E8-5619 Filed 3-19-08; 8:45 am]
BILLING CODE 4830-01-P