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Comments on proposed regulations relating to application of normalization requirements to consolidated tax adjustments.

Comments on Proposed Regulations Relating to Application of Normalization Requirements to Consolidated Tax Adjustments

On February 25, 1991, Tax Executives Institute filed comments with the Internal Revenue Service on the application of the normalization requirements of sections 167(l) and 168(i)(9) of the Code to utility companies that file consolidated federal income tax returns. The proposed regulations address the extent to which certain ratemaking procedures and adjustments that are based on tax savings attributable to the filing of a consolidated return will be treated as inconsistent with the Code's normalization requirements. The Institute's comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is Lester D. Ezrati of the Hewlett-Packard Co. Larry J. Newsome of Florida Progress Corporation contributed materially to the preparation of the submission.

On behalf of Tax Executive Institute, I am pleased to submit these comments on the Internal Revenue Service's proposed regulations on the application of the normalization requirements of sections 167(l) and 168(i)(9) of the Internal Revenue Code to utility companies that file consolidated federal income tax returns. Specifically, the proposed regulations (PS-107-88) establish the extent to which certain ratemaking procedures and adjustments that are based on tax savings attributable to the filing of a consolidated return will be treated as inconsistent with the Code's normalization requirements.

The proposed regulations, which were issued on November 20, 1990, were published in the Federal Register on November 27, 1990 (55 Fed. Reg. 49294), and in the December 10, 1990, issue of the Internal Revenue Bulletin (1990-50 I.R.B. 10).(1*) A public hearing on the regulations was held on February 8, 1991.

TEI supports the issuance of proposed regulations in order to provide guidance to utility taxpayers, as well as to regulatory commissions, on the extent to which consolidated tax adjustments will be deemed to violate the normalization provisions of section 168(i)(9). Although the regulations primarily involve issues relating to the operation of the Code's normalization requirements (which affect a discrete class of taxpayers and require special expertise), the regulations also implicate several general policy issues. In the comments that follow, TEI addresses those policy issues and also comments on those areas of the regulations where additional guidance should be provided.


Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 4,600 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayer and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works - one that evinces solid tax policy, that taxpayers can comply with, and that the IRS can audit.

Members of TEI are responsible for managing the tax affairs of their companies on a day-to-day basis, contending daily with the provisions of the tax laws relating to the operations of business enterprises. A significant number of the Institute's members work for corporations that are affected by the proposed regulations relating to the application of the Code's normalization requirements to utility companies filing consolidated returns. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations.

Sharing of Tax Benefits

The purpose of the proposed regulations is to provide a method for

determining a utility's share of the consolidated group's cumulative net tax savings, which can then be passed on to the utility's ratepayers. The effect of these regulations, however, is to pass all the benefit of filing a consolidated return through to the ratepayers. Thus, under the proposed regulations, the entities generating tax benefits with entities that did not incur the economic cost related to their existence.(2)

This tax sharing methodology is disturbing, for it undermines the goal of, and violates the principles underlying, the Code's normalization rules - to ensure that the tax benefits attributable to non-utility assets achieve their intended purpose rather than to subsidize ratepayers. The preamble acknowledges that section 167(l) of the Code was enacted in 1969 to prohibit the flow through to utility ratepayers of the reduction in current taxes stemming from the use of accelerated depreciation. (1990-50 I.R.B. at 11.) We submit that the proposed regulations, which sanction the flow-through of tax benefits attributable to a non-regulated entity, would frustrate the underlying purpose of the Code's normalization rules. Indeed, Prop. Reg. [section] 1.168(i)-1(b) itself properly recognizes that cost-of-service adjustments attributable to nonregulated tax benefits would violate normalization. Rate base adjustments attributable to the identical factors - the forced "sharing" of tax benefits - would also violate normalization.(3)

Consolidation of Regulated and

Non-Regulated Subsidiaries

Under Prop. Reg. [section] 1.168(i)-1(c) and Treas. Reg. [sub-section] 1.1502-1(a)(2) and 1.1502-33(d)(2)(i), each subsidiary (including second- and third-tier affiliates) is treated on a stand-alone basis for purposes of computing the aggregate amount of consolidated tax savings, with those savings being allocated among the members of the group in proportion to their separate return liabilities. Thus, if the group has a different corporate structure (for example, if two of the non-regulated subsidiaries were organized and operated as a single company), the computation and allocation of consolidated tax savings would be affected.

What the proposed regulations accord too little weight to, however, is the fact that a single vertically integrated business activity may be conducted through the use of several subsidiaries, and that the structure of a group's non-regulated subsidiaries can affect the amount of the consolidated tax savings allocated to a regulated member of the group. Specifically, although one or more vertically integrated (non-regulated) subsidiaries could incur losses, the integrated group as a whole might have taxable income. In such a situation, the allocation of losses to anyone other than the businesses comprising the integrated group does not make sense.

TEI submits that, for purposes of the normalization rules, the business or organizational structure that an affiliated group adopts in respect of its non-regulated members should be tax neutral. Such a rule would not only vindicate the policies underlying the normalization rules, but also recognize that there are many non-tax business and legal reasons for the manner in which a group chooses to organize itself. To achieve the desired neutrality, regulated companies should be combined and considered as one entity and non-regulated companies should be combined and considered as one entity for purposes of determining and allocating consolidated tax savings. Thus, tax benefits should not be allocated to the regulated entity unless its taxable income has been offset by losses of the non-regulated entity to utilize the tax benefit currently.

Effective Dates

Prop. Reg. [section] 1.168(i)-1(a) states that the general rules set forth in the proposed regulations will be effective for rate orders that become final within the meaning of Treas. Reg. [section] 1.46-6(f)(8)(iii) on or after December 20, 1990. (See 1990-50 I.R.B. at 10.) Rate orders, however, frequently are implemented by utilities before they become final within the meaning of the applicable regulations. Thus, a state regulatory commission may have issued a rate order to a utility before December 20, 1990, that is effective and binding (but not final) as of that date. Such an order providing for the flow through of tax savings arising from the filing of a consolidated tax return (other than as provided in Prop. Reg. [section] 1.168(i)-1(c)) would be deemed under Prop. Reg. [section] 1.168(i)-1(b) to violate the Code's normalization requirements.

TEI submits that, in proposing that the regulations be effective in respect of rate orders made final 30 days or more following the issuance of the regulations, the IRS did not fully take into account that considerable time may lapse between the issuance of an order by a regulatory commission and a final determination within the meaning of the regulations. In deference to the state utility regulatory process and to assure against denying utilities the benefits of accelerated depreciation (and, indeed, normalization), the regulations should apply only in respect of rate orders issued on or after December 20, 1990.

Election Year

To determine its cumulative net tax savings, a utility must first determine its share of the consolidated group's tax savings for each year beginning with the "election year." Prop. Reg. [section] 1.168(i)-1(c)(3) provides that the election year may be "any tax year ending on or after a date that is 30 days after the date that final regulations are published, or, if sooner, January 1, 1992."

Because of the many unanswered questions and the complexity associated with these regulations, TEI opposes the selection of an arbitrary date (such as January 1, 1992) in respect of the election year rules. It may be far beyond that date before all the technical issues associated with the proposed regulations are resolved and final regulations are promulgated. Indeed, we believe the election year rules should become effective the later of January 1, 1992, or 30 days after final regulations are promulgated.

TEI also recommends that the final regulations provide more specific guidance with respect to the election year rules to avoid controversies between utilities and their public utility commissions. For example, the regulations could link the election year to either (i) the test year for the first rate case in which consolidated tax savings are used to reduce rate base or create reduced cost of capital, or (ii) the first tax year after the year the final regulations are issued.

Permanent Differences

TEI recommends that the final regulations address what occurs to the cumulative consolidated tax savings on the sale or disposition of an affiliate that produced losses. The IRS has consistently ruled that, when a utility sells public utility property or an activity becomes deregulated, the deferred tax related to the public utility property sold or deregulated must be removed from the deferred tax account and, thus, can no longer be used to reduce rate base or treated as no-cost capital. The final regulations should adopt similar rules with respect to the cumulative consolidated tax savings attributable to affiliates that are sold or otherwise leave the consolidated group.

Alternative Minimum Tax

The proposed regulations provide no guidance regarding the alternative minimum tax (AMT). Presumably, the requirement in Prop. Reg. [section] 1.168(i)-1(a) that a utility must compute its federal income tax expense for determining cost of service for ratemaking purposes as if it filed a separate federal income tax return means that the utility should use the regular tax or the AMT regardless of the AMT position of the consolidated group. The final regulations should make this clear.

The final regulations should also provide guidance concerning the computation of the consolidated rate base adjustment in circumstances where the utility is not in an AMT position but the consolidated group is an AMT taxpayer.

Audit Adjustments

If the final regulations retain the rule in Prop. Reg. [section] 1.168(i)-1(c)(1) that permits a utility to treat consolidated tax adjustments as no-cost capital or, alternatively, as a reduction in rate base, they should provide guidance concerning the treatment of audit adjustments. Specifically, the regulations should describe the proper treatment under circumstances where a loss claimed by a non-regulated affiliate is reduced or eliminated as a result of an audit adjustment. Some mechanism should be provided to "recapture" the tax benefits originally thought to exist.

Test Periods - Reasonable


Prop. Reg. [section] 1.168(i)-1(c)(4) addresses the use of test periods, providing that changes from the test period in the amount excluded from rate base (or treated as no-cost capital) may be projected but the amount projected must be reasonable. The final regulations should clarify both (i) what will be considered a "reasonable projection" and (ii) how projections are to be used. Absent such guidance, a great deal of controversy will ensue between utilities and public utility commissions, which will prompt frequent requests for private letter rulings that would have to be provided without the benefit of regulations. From a quality management perspective, a concerted effort should be made to "get it right the first time" - to resolve outstanding issues now, before controversies arise.

Treas. Reg. [section] 1.167(l)-1(h)(6) deals with a similar issue regarding the maximum amount of deferred tax to be excluded from rate base or to be included as no-cost capital. The regulations set forth standards for determining the maximum amount of the reserve that may be used to reduce rate base if (i) solely an historical period is used, (ii) solely a future period is used, or (iii) an historical period and a future period are used. TEI recommends that similar standards be used in computing the maximum amount of consolidated tax savings available to reduce rate base.

Limitation on Allocation

Method under Treas. Reg.

[section] 1.1502-33(d)(2)

The proposed regulations appear to limit the taxpayers making the consolidated return federal tax allocation to using or adopting the method set forth in Treas. Reg. [section] 1.1502-33(d)(2)(i). (See Prop. Reg. [section] 1.168(i)-1(c)(2)(ii); 1990-50 I.R.B. at 13.) Some consolidated groups, however, have properly adopted the tax allocation procedures under Treas. Reg. [section] 1.1502-33(d)(2)(ii) for purposes of computing the earnings of profits of each member of the consolidated group. Requiring the group to use different tax allocation procedures solely for purposes of Prop. Reg. [section] 1.168(i)-1(c)(2)(ii) would impose an additional administrative burden that is difficult to justify.

TEI believes that taxpayers should be permitted to use the same tax allocation procedures for purposes of determining whether the Code's normalization requirements are complied with as they use for purposes of section 1552 and the applicable regulations. Thus, the final regulations should provide that taxpayers that have properly adopted the allocation procedures prescribed in Treas. Reg. [section] 1.1502-33(d)(ii) will be permitted to use those procedures in applying Prop. Reg. [section] 1.168(i)-1(c)(2)(ii). Alternatively, the regulations should clarify that, in order to obviate the need to use two different tax allocation procedures, consent will be granted to taxpayers under Rev. Proc. 90-39 to change their method prospectively to that prescribed under Treas. Reg. [section] 1.1502-33(d)(2)(i).


Tax Executives Institute appreciates this opportunity to present our views on the IRS's proposed regulations relating to the application of the Code's normalization requirements to utility companies that file consolidated returns. If you have any questions about the Institute's comments, please do not hesitate to call Lester D. Ezrati, chair of TEI's Federal Tax Committee, at (415) 857-2089 or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at (202) 638-5601.

(1) For simplicity's sake, the proposed regulations are generally referred to as "the proposed regulations" and specific provisions are cited as "Prop. Reg. [section]." References to page numbers are to the proposed regulations (and preamble) as published in the Internal Revenue Bulletin.

(2) Indeed, it is arguable whether tax savings are created by the filing of a consolidated return. Tax deductions (savings) are generated through the operation of a business enterprise, without regard to whether a consolidated return is filed. The filing of a consolidated return merely permits the current utilization of those savings. Therefore, the real issue is who should be allocated the benefit created by the current utilization of those savings or losses. We believe sound tax policy requires that the entity that incur the economic cost giving rise to the tax benefit should be allocated the tax benefit because, implicit in the cost of tax benefits, is an assumption that they can be currently utilized. Regrettably, under the proposed regulations, non-regulated entities (or their shareholders) would incur the economic burden of the tax benefits but would not be allocated the value of those benefits if they were generating tax losses; the only entities that participate in the sharing would be the entities that are not required to bear the cost of the tax benefits.

(3) We note in this regard that section 168(i)(9)(B)(ii) requires "symmetry" for cost of service and rate base purposes

the benefit created by the current utilization
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Author:Newsome, Larry J.
Publication:Tax Executive
Date:Mar 1, 1991
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