A Rate Increase

A Rate Increase

September 01, 2006

A rate increase that was later rejected led to more taxable income than a utility wanted.

A utility was organized as a parent holding company with five subsidiaries. One of the subsidiaries produced electricity, gas or water that it sold at regulated rates to the other four subsidiaries. The other four were distribution companies whose rates charged to customers were also regulated.

The subsidiary that produced the product received provisional authority to increase the rates it charged its affiliates, subject to a possible refund after the public service commission had time for a full hearing. The production subsidiary set up a reserve on its books for the potential refunds, but never actually set aside any of the additional revenue in a formal reserve or bank account. The four distribution companies passed through the higher charges to their customers.

The public service commission ultimately allowed only a fraction of the rate increase.

The utility group tried to amend the tax returns for the period the rate increase was provisional to reduce the taxable income it reported in those years.

The IRS said it could not in a private letter ruling that the agency made public in mid- August. The ruling is Private Letter Ruling 200632015.

The IRS said the proper treatment is a deduction in future years when refunds are paid.

It rejected arguments by the utility group that its case is similar to other cases involving Houston Industries and Florida Progress Corporation — now called CenterPoint and Progress Energy. In those cases, the utilities passed through estimated fuel costs to customers, but were required by law to refund any over-recoveries.

The IRS said the case in the ruling is different. Houston Industries and Florida Progress had a fixed obligation by year end, when each could calculate its actual fuel costs, to refund any overcharges. In this case, it was not clear whether any refunds would be required. The utility group in the ruling continued to press for the full rate increase through both the full hearing and a rehearing.

Taxpayers usually withdraw private ruling requests rather than have the IRS rule against them. The utility group in this case may have wanted to put its regulators and possibly other utilities on notice. A private ruling is binding only on the taxpayer who requested it.

Keith Martin