In two recent private letter rulings (PLRs 201930015 and 201930016), the Internal Revenue Service (IRS) clarified the corrective measures a regulated transmission utility must undertake to avoid a normalization violation. In several prior private letter rulings the IRS had prescribed a method to correct impermissible flow-through of deferred tax benefits where the proration rules were not used for future test periods or the future portion of a part-historic and part-future test period.1 See Treas. Reg. Sec. 1.167(l)-1(h)(6). The Federal Energy Regulatory Commission (FERC) ordered the transmission utility to use a different ratemaking method of corrective action that was not addressed in the prior private letter rulings. The utility sought rulings:
- That the corrective action previously approved by the IRS was not the exclusive permissible means for corrective action;
- That the consistency requirements of IRC section 168(i)(9)(B) are satisfied if the proration rules are applied with respect to a future test period with an average rate base computation without the need to also use an averaging convention to compute the end-of-period Accumulated Deferred Federal Income Taxes (ADFIT) balance; and
- If the proration rules were applied, the true-up of ADFIT for actual increases and decreases need not be averaged, but for the difference between projected and actual ADFIT, an averaging convention must be used where the projections were not previously subject to the proration rules.
In essence, PLRs 201930015 and 201930016 clarify that the purposes of the proration formula and the consistency rules are essentially the same, that is, to reflect the time value of changes to ADFIT balances over a future period. Accordingly, the taxpayer must employ one procedure or the other, but not both. Thus, if proration is applied, averaging is not also required; but if the proration rules were not applied (e.g., for the true-up of actual versus projected revenue requirements), averaging must be applied.