Rev. Rul. 81-16
1981-1 C.B. 17, 1981-3 I.R.B. 5.
Internal Revenue Service
Revenue Ruling
INVESTMENT CREDIT; PUBLIC UTILITIES; RATABLE FLOW-THROUGH
Published: January 19, 1981
26 CFR 1.46-6: Limitation in case of certain regulated companies
Investment credit; public utilities; ratable flow-through. A regulated public utility that files a consolidated return with nonpublic utility subsidiaries that historically incur losses elected to flow-through its investment credit as a cost of service reduction under section 46(f)(2) of the Code. In establishing the utility's cost of service, its regulatory agency ignores nonpublic utility income or loss and computes all components of rate making as though the utility was operated as a separate corporation. The amount of the investment credit that the utility flows-through to income does not exceed the ratable portion allowed to be flowed-through by reason of the utility's election of section 46(f)(2).
ISSUE
Under the circumstances described below does the amount of investment tax credit (ITC) that a public utility taxpayer flows-through to income exceed the ratable portion allowed to be flowed-through by reason of the taxpayer's election of section 46(f)(2) of the Internal Revenue Code?
FACTS
The taxpayer is a regulated public utility that holds "public utility property" as that term is defined in section 46(c)(3)(B) of the Code and that timely elected to flow-through ratably its ITC as a cost of service reduction under section 46(f)(2). The taxpayer filed a consolidated federal income tax return with three wholly owned nonpublic utility subsidiaries. Historically, these nonpublic utility subsidiaries have incurred taxable losses that reduced the income taxes required to be paid by the taxpayer on its combined operations. As a result of such reduced income taxes, the ITC otherwise allowable to the taxpayer is reduced by reason of the limitation based on tax under section 46(a).
In establishing the utility's cost of service, the regulatory commission having jurisdiction uses the most recent 12 consecutive month period, called a test year, for which all of the cost factors used to determine rates are known. In so doing, the commission ignores nonpublic utility income or loss for tax purposes and computes test year federal income tax expense and all other components of rate making, including the ITC, as though the regulated utility were operated as a separate corporation filing a separate return. Statutory tax rates are applied to the test year taxable income of the utility. The amount of federal income tax expense so obtained for rate making purposes is used to compute the limitation of ITC based on the amount of tax provided by section 46(a) of the Code. Because such test year federal income tax expense computed for the utility alone would be higher than the actual income tax on the consolidated return, the retable portion of the amount of ITC, applicable to public utility property, that the taxpayer used to reduce cost of service is greater than the ratable portion of the actual amount allowed on the consolidated return.
LAW AND ANALYSIS
Section 46(a) of the Code limits the amount of allowable ITC to an amount based on a percentage of tax liability.
Section 46(c)(3)(B) of the Code provides that the term "public utility property" means property used pre-dominantly in the trade or business of the furnishing or sale of (i) electrical energy, water, or sewage disposal services, (ii) was through a local distribution system, or (iii) telephone service, domestic telegraph service, or other communication services, if the rates for such furnishing or sale have been established or approved by a governmental agency or instrumentality.
Section 46(f)(2) of the Code provides a special rule that, if the taxpayer makes an election under section 46(f)(2), the general rule of section 46(f)(1) (which considers reduction and restoration of rate base) does not apply, but no credit shall be allowed by section 38 with respect to any public utility property if the taxpayer's cost of service for rate making purposes or in its regulated books of account is reduced by more than a ratable portion of the credit allowable by section 38, or if the base to which the taxpayer's rate of return for rate making purposes is applied is reduced by reason of any portion of the credit allowable by section 38.
Section 1.46-6(b)(1) of the Income Tax Regulations provides that "section 46(f) property" is public utility property within the meaning of section 46(c)(3)(B) of the Code.
The term "credit allowable by section 48" is used in section 46(f) of the Code with respect to property over which the regulatory commission has rate making authority, namely, public, public utility property within the meaning of section 46(c)(3)(B). Therefore, the exclusion by the regulatory commission of nonpublic utility operations from the computation of ratemaking costs (which include the ITC for public utility property, and federal income tax expense by reason of which the ITC is limited) is consistent with the commission's ratemaking authority over public utility property to which section 46(f) applies in accordance with section 1.46-6(b)(1) of the regulations.
Whether the exclusion of nonpublic utility operations from the computation of ratemaking costs is consistent with the requirements of section 46(f)(2) of the Code (even though the amount of ITC so computed may exceed the amount of ITC from investments in public utility property allowed based on the combined taxable income from public utility and nonpublic utility operations) may be analyzed as follows: Section 46(f) of the Code recognizes that in a ratemaking context there is a fundamental relationship between the use of the ITC, the rate base, and the cost of service. In its exclusion of nonpublic utility operations in this case, the regulatory commission has not isolated the ITC from other ratemaking factors but has kept constant the ITC's fundamental relationship with other cost of service factors. In particular, although the ITC used to reduce cost of service is greater than ITC actually allowed, the federal income tax expense (used to compute cost of service) by which ITC is limited under section 46(a), is commensurately greater than federal income taxes incurred.
HOLDING
The amount of ITC that this public utility taxpayer flows-through to income does not exceed the ratable portion allowed to be flowed-through by reason of the taxpayer's election of section 46(f)(2) of the Code.
Rev. Rul. 81-16, 1981-1 C.B. 17, 1981-3 I.R.B. 5.