January 23, 2023
IRS rules that taxpayer that purchased another utility through asset sale can continue "protected" excess deferred income tax liability and amortization
In PLR 202303003, the IRS ruled that a taxpayer that purchased a gas utility through an asset purchase agreement could continue the "protected" excess deferred income tax (EDIT) liability and amortization established by the Tax Cuts and Jobs Act (TCJA) under the predecessor's schedule.
Taxpayer owns several natural gas distribution and transmission subsidiaries. Taxpayer acquired through its subsidiaries the gas distribution assets of Company through an asset purchase agreement.
Company had established protected EDIT reserves (the portion of the excess amount in accumulated deferred income taxes attributable to accelerated depreciation under the TCJA). These reserves were amortized using the prescribed average rate assumption method (ARAM). As part of the asset purchase agreement, Taxpayer assumed the protected EDIT regulatory liability of Company.
In this PLR, Taxpayer requests a ruling as to whether the acquired protected EDIT will continue to be protected by the normalization rules following the acquisition.
Law and analysis
Under IRC Section 168(f)(2), the depreciation deduction determined under IRC Section 168 does not apply to any public utility property if the taxpayer does not use a normalization method of accounting. To use a normalization method of accounting, the taxpayer must, under IRC Section 168(i)(9)(A)(i), use the same depreciation method in determining its tax expense for ratemaking and operations purposes. The method used may not be shorter in period than the method and period used to compute the taxpayer's depreciation expenses.
Under Treas. Reg. Section 1.167(l)-1(h), a utility must maintain a reserve that reflects the deferred tax liability resulting from the use of different depreciation methods used for tax and ratemaking purposes.
The TCJA changed the corporate tax rate from 35% to 21%, which produces both a deferred tax shortfall as well as an excess tax reserve (ETR). Under TCJA Section 13001(d)(1), a taxpayer that computes its cost of service in ratemaking by reducing the ETR more rapidly than under the ARAM is not using the normalization method.
If, after the transfer, the property is public utility property of the transferee, and the seller's ETR with respect to the property is treated as the transferee's ETR, Treas. Reg. Section 1.168(i)-3(a)(2)(ii) allows the transferee to share ETRs with customers consistent with the transferor's amortization schedule.
Accordingly, Taxpayer's acquired regulatory liability associated with the "protected" EDIT or ETR included in the asset purchase agreement will continue to be protected under the normalization rules if Taxpayer treats the ETR using the same schedule previously used by Company.
Implications The transaction market continues to be active in the P&U space. The treatment of certain tax-related regulatory liabilities has not been specifically addressed in the context of the TCJA rate change, so it is helpful to confirm that pre-TCJA guidance applies to such liabilities.
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor