- IRS Provides Safe Harbor for Inadvertent Normalization Violations
- September 19, 2017 | Authors: Ellen McElroy; Mary E. Monahan; H. Karl Zeswitz; Bradley M. Seltzer; Wes Sheumaker; Amish M. Shah; Engin K. Nural
- Law Firms: Eversheds Sutherland (US) LLP - Washington Office; Eversheds Sutherland (US) LLP - Washington Office
On September 7, 2017, the IRS issued Revenue Procedure 2017-47, which provides a safe harbor for regulated public utilities for inadvertent or unintentional uses of a practice or procedure that is inconsistent with the Normalization Rules of IRC §§ 50(d)(2) and 168(i)(9). If the safe harbor applies, the IRS will not assert that a regulated utility’s practice or procedure constitutes a violation of the Normalization Rules that triggers a disallowance of accelerated depreciation or a recapture of the investment tax credit (ITC). Rev. Proc. 2017-47 does not limit or change a taxpayer’s ability to request a private letter ruling (PLR) or referral for a technical advice memorandum (TAM).
Normalization is a system of accounting used by many regulated public utilities to reconcile the tax treatment of the investment tax credit or accelerated depreciation with their regulatory treatment. The effect of normalization is that the regulated utility obtains the immediate tax benefits of the ITC and accelerated depreciation when permitted by the Code and shares such benefits with ratepayers over the regulatory life of the utility property. The Normalization Rules provide the calculation guidelines that must be followed for a taxpayer to receive and retain these tax benefits on public utility property.
Section 50(d)(2) provides rules governing the ITC similar to the rules of former § 46(f). Former § 46(f)(1) allows regulated public utilities to claim the ITC if the ITC is not used to reduce the taxpayer’s cost of service to any extent or reduce the taxpayer’s rate base, but only if the reduction to rate base is restored no more rapidly than ratably. Former § 46(f)(2), if elected, allows regulated utilities to claim the ITC if the regulated public utility takes into account no more than a ratable portion of the ITC to determine cost of service, but does not reduce its rate base on which its rate of return is calculated to any extent. Before this safe harbor, a normalization violation was deemed to occur under Treas. Reg. § 1.46-6(f)(4) when a regulatory body made a final determination for ratemaking purposes that is inconsistent with former § 46(f)(1) or former § 46(f)(2).
Accelerated depreciation is permitted if the Normalization Rules of § 168(i)(9) are followed, namely if when setting its rates the taxpayer computes its federal income tax expense using a depreciation method that is the same as, and a depreciation period that is no shorter than, the method used to compute depreciation expense in setting rates. In addition, adjustments to a reserve shall be made to reflect the deferral of tax attributable to the different methods. Finally, to the extent that rates are set using an estimate or projection of depreciation expense, tax expense, rate base or the reserve for deferred taxes, consistent estimates and/or projections must be utilized for the other elements as well.
The safe harbor provides that a regulated public utility that failed to act consistently with the Normalization Rules will not lose the benefit of the ITC or accelerated depreciation if the following conditions are met:
- The taxpayer owns public utility property;
- The failure was inadvertent or accidental;
- Upon recognizing a failure to act consistently with the Normalization Rules, the taxpayer changes its inconsistent practice or procedure to a practice or procedure consistent with the Normalization Rules, provided that the taxpayer’s regulator adopts or approves of the change;
- The change to a practice or procedure consistent with the Normalization Rules is made at the “next available opportunity”;
- The change totally reverses the effect of the inconsistent practice or procedure, although the safe harbor does not indicate whether the entire reversal must occur in a single year; and
- Contemporaneous documentation is maintained that demonstrates the effects of the inconsistent practice or procedure and the change to a proper practice or procedure.
For purposes of the safe harbor, the “next available opportunity” is either: (1) for a taxpayer without a pending rate case, the next rate case; and (2) for a taxpayer with a currently pending rate case, the currently pending rate case (unless such change is not permitted to be made during that rate case, in which event it is the next rate case). If at the conclusion of a rate case the taxpayer has a PLR request pending to address whether a practice or procedure is consistent with the Normalization Rules, and following receipt of a PLR the regulators later establish or approve rates to conform to a practice or procedure consistent with the Normalization Rules as specified in the PLR, the taxpayer will be treated as having corrected its inconsistent practice or procedure at the next available opportunity.
If the taxpayer has identified a practice inconsistent with the Normalization Rules, but has not reached the “next available opportunity” to correct it by the time it is required to file its Federal income tax return, the safe harbor is nevertheless available to the taxpayer if a statement describing the inconsistent practice is provided in the taxpayer’s return and the practice is changed at the next available opportunity. That statement must be captioned “Filed Pursuant to Rev. Proc. 2017-47”; must identify the inconsistent practice or procedure; and must include a representation that the taxpayer intends to change to a consistent practice or procedure at the next available opportunity.
The safe harbor is effective for taxable years ending on or after December 31, 2016, but the IRS has made the safe harbor retroactive and will not challenge a violation of the Normalization Rules provided that the requirements of the safe harbor are met.Eversheds Sutherland Observation: This revenue procedure provides welcome relief for regulated utilities and may in many cases avoid the time and expense of seeking a PLR. It also may simplify the regulatory process by permitting regulated utilities to include a statement on their tax returns indicating an intent to utilize the safe harbor, rather than having to convince the PUC to let the regulated utility seek a ruling to avoid a proposed action it believes violates the Normalization Rules.