UNITED STATES OF AMERICA BEFORE THE FEDERAL ENERGY REGULATORY COMMISSION Southern California Edison Company, et al. ) ) ) Docket No. EL18-164-000 ANSWER OF SOUTHERN CALIFORNIA EDISON COMPANY TO ORDER INSTITUTING 206 PROCEEDINGS Pursuant to the Order Instituting 206 Proceedings, Commencing Paper Hearing Procedures, and Establishing Refund Effective Date 1 issued by the Federal Energy Regulatory Commission ( FERC or the Commission ) on June 21, 2018, and Rules 209 and 213(a) of the Commission s Rules of Practice and Procedure, 2 Southern California Edison Company ( SCE ) submits this answer. I. INTRODUCTION In the 206 Proceedings, the Commission directed each utility respondent ( Respondent ) to consider whether transmission formula rates should be revised to eliminate the use of two-step averaging methodology in calculating the Accumulated Deferred Income Tax ( ADIT ) component of rate base in the Respondent s projected test year calculations and/or annual true-up calculations. 3 SCE s primary concern with this change is ensuring it is not violating the tax normalization rules ( Tax Normalization Rules ) of the Internal Revenue Code and Treasury 1 Ameren Illinois Company, et al., 163 FERC 61,200 (2018) ( 206 Proceedings ). 2 18 C.F.R. 385.209, 385.213(a) (2018). 3 See supra note 1, 206 Proceedings at P. 13-17. 1
Regulations issued by the Internal Revenue Service ( IRS ) by changing FERC s well-established practice of approving the use of the two-step averaging methodology. Although the Commission appears to have changed its position in response to a recent private letter ruling ( PLR ), 4 SCE remains concerned that, because the taxpayer to which this PLR was issued is not SCE, the PLR provides no tax audit protection for SCE if IRS auditors challenged SCE s elimination of its use of the two-step averaging methodology as violating the Tax Normalization Rules. SCE s solution to this uncertainty is to seek its own PLR. SCE is currently preparing a request to the IRS for a PLR on this issue. Prior to the submission of this request for a PLR, SCE will submit a draft of the PLR request to this Commission for review and acknowledgement that the request is adequate and complete. In the meantime, SCE requests that the Commission issue a ruling in this 206 Proceeding stipulating that SCE continue to use the two-step averaging methodology pending the issuance of the requested PLR to SCE. Once SCE is in receipt of this PLR, SCE will either: (1) cease using the two-step averaging methodology if the IRS rules that doing so would not violate the Tax Normalization Rules, or (2) continue using the two-step averaging methodology if the IRS rules that eliminating it would violate the Tax Normalization Rules. SCE s FERC formula transmission rate 5 ( Formula Rate ) includes a true-up ratemaking mechanism that, if the IRS states the elimination of the two-step averaging methodology would not violate the Tax Normalization Rules, would properly reduce the revenue requirement, with interest, for the true-up year to reflect a one-step approach. II. COMMUNICATIONS SCE requests that the following individuals be added to the official service list for this 4 See I.R.S. Priv. Ltr. Rul. 201717008 (Jan. 25, 2017) (released Apr. 28, 2017) ( April 2017 PLR ). 5 Southern California Edison Co., 161 FERC 61,309 (2017). 2
proceeding: 6 Rebecca A. Furman Director & Managing Attorney Southern California Edison Company 2244 Walnut Grove Avenue Rosemead, California 91770 (626) 302-3475 rebecca.furman@sce.com Alexa J. Mullarky Attorney Southern California Edison Company 2244 Walnut Grove Avenue Rosemead, California 91770 (626) 302-1577 alexa.j.mullarky@sce.com Alfred L. Lopez Senior Tax Advisor Southern California Edison Company 2244 Walnut Grove Avenue Rosemead, California 91770 (626) 302-8797 alfred.lopez@sce.com III. ANSWER TO 206 PROCEEDINGS This answer responds to the Commission s concerns regarding its continued efforts to ensure just, reasonable, nondiscriminatory and non-preferential formula rates given a recently issued PLR to a taxpayer which is, presumably, not a Respondent to the 206 Proceedings, and in which the IRS ruled, inter alia, that: averaging conventions, when applied to entirely future test periods, should presumptively be treated as having the same purpose as the Proration Requirement, thereby negating the necessity to apply both conventions serially to changes in ADFIT balances. 7 SCE s primary concern regarding eliminating the two-step averaging methodology is to ensure that, in doing so, it would not be violating the Tax Normalization Rules, a violation of which would prohibit SCE from using accelerated depreciation for tax purposes and, as a result, reduce or eliminate ADIT otherwise used to reduce rate base (and revenue requirement) for ratemaking purposes. However, if SCE receives assurance from the IRS that eliminating the two-step 6 SCE respectfully requests waiver of 18 C.F.R. 203(b)(3) to permit more than two persons to be listed on the official service list. 7 See supra note 4, April 2017 PLR at 12. 3
averaging methodology would not violate the Tax Normalization Rules, SCE will make such a change to its Formula Rate. SCE s concerns regarding the elimination of the two-step averaging methodology and, as a result, the reasons for its current use of the two-step approach, include the following: A. A Commission Order Eliminating the Two-Step Averaging Methodology Would Not Protect SCE from a Normalization Violation Assessment in an IRS Tax Audit If the Commission orders SCE to stop using the two-step averaging methodology and the IRS subsequently challenges the elimination of the two-step approach as a violation of the Tax Normalization Rules in a tax return audit, SCE would not be protected from losing its ability to use accelerated depreciation for tax return purposes. Although a normalization ruling issued to a taxpayer by the IRS in a PLR provides (a) audit protection to that particular taxpayer, and (b) insight to others into the IRS s current position on that particular tax issue, no other taxpayer can use that PLR to protect itself against a subsequent tax audit challenge, even if the tax audit challenge concerns the very same issue(s) and facts. Only a PLR issued to SCE, an IRS Revenue Procedure, or an IRS Revenue Ruling would provide adequate protection against the risk of violating the Tax Normalization Rules for the specific tax issue raised in the 206 Proceedings. 8 B. The Commission Is Relying on the April 2017 PLR, Which Appears to be Inconsistent with PLRs 9202029, 9224040 and 9313008 Over the years, the IRS has issued numerous PLRs on the topic of two-step averaging methodology, all of which concluded that the use of such methodology was consistent with the 8 Unless the Secretary of the Treasury otherwise establishes by regulations, a written determination may not be used or cited as precedent. See 26 U.S.C 6110(k)(3). 4
requirements of the Tax Normalization Rules. The April 2017 PLR thus contradicts these prior PLRs, leaving SCE uncertain as to the correct position. For example, in PLR 9313008, 9 following a dispute about the application of the proration formula set forth in Treasury Regulations 1.167(l)-1(h)(6)(ii), 10 a public utilities commission requested the utility to seek a PLR from the IRS to determine whether: when rates are based on a test period that is part historical and part future and an average rate base is used to compute rates, the average rate must [sic] be reduced by the average of (1) the projected deferred income tax reserve balance at the beginning of the test period and (2) the prorated projected deferred income tax reserve balance at the end of the test period. 11 In response, the IRS ruled that: [w]here an average rate base is used to compute rates and where a test period is part historical and part future, the average rate base may be reduced by an amount no greater than the average of the projected deferred income tax balance at the beginning of the test period and the prorated projected deferred income tax reserve balance at the end of the test period. 12 Similarly, in PLR 9224040, 13 the public utilities commission and the utility again disagreed about the proper application of Treasury Regulations 1.167(l)-1(h)(6)(ii), prompting the utility to seek a PLR to determine: (1) the period to which the proration formula under regulation 1.167(l)-1(h)(6)(ii) is applied[,] and (2) the methodology to use to determine the maximum 9 I.R.S. Priv. Ltr. Rul. 9313008 (Dec. 17, 1992) ( December 1992 PLR ). 10 26 C.F.R. 1.167(l)-1(h)(6)(ii) (2018). 11 See supra note 9, December 1992 PLR at 3. 12 Id. at 8 (emphasis added). 13 I.R.S. Priv. Ltr. Rul. 9224040 (Mar. 16, 1992) ( March 1992 PLR ). 5
amount of the deferred tax reserve to be deducted from the rate base, when an average rate base is used for the test year and when some or all of the test year is a future period[.] 14 In response, the IRS ruled that: [w]here an average rate base is used and where the test period is part historical and part future for purposes of section 1.167(l)-1(h)(6)(ii) of the regulations, failure to reduce the average rate base by the average of (i) the estimated deferred taxes at the beginning of the test period and (ii) the estimated deferred taxes at the end of the test period as prorated under section 1.167(l)-1(h)(6)(ii), will violate the consistency rules of section 168(i)(9)(B) of the Code. 15 Finally, in PLR 9202029, 16 the taxpayer utility challenged the public utilities commission s rate proposal, arguing in part that a test year based entirely on estimated financial data and extending beyond the effective date of the rate order is a purely future test period under the regulations. 17 The IRS ruled that: [f]ailure to average the deferred tax reserve, as prorated, before excluding the reserve from the average rate base WILL violate the consistency requirement of section 168(i)(9)(B). 18 Thus, this series of PLRs clearly ruled that the ending pro rata amount must be averaged before adjusting rate base to avoid violating the Tax Normalization Rules. Now, more than 20 years after those PLRs were issued, the IRS issued the April 2017 PLR, which appears to be inconsistent with all previous rulings on the issue of averaging of the pro rata amount. In contrast to the aforementioned PLRs, in the April 2017 PLR, the IRS ruled, in part, 14 Id. at 1. 15 Id. at 7 (emphasis added). 16 I.R.S. Priv. Ltr. Rul. 9202029 (Oct. 15, 1991) ( October 1991 PLR ). 17 Id. at 1, 3 (emphasis added). 18 Id. at 8 (emphasis added, capitalized text in original). 6
that averaging conventions, when applied to entirely future test periods, should presumptively be treated as having the same purposes as the Proration Requirement, thereby negating the necessity to apply both conventions serially to changes in ADFIT balances. 19 SCE is unsure what the correct position might be to this issue in light of the opposing conclusion reached in the April 2017 PLR, as compared to the conclusions of all previous PLRs. As such, SCE believes that it is more prudent to maintain its current approach (that clearly would not violate the Tax Normalization Rules) until the IRS provides specific guidance SCE can rely on. C. The April 2017 PLR Applied to Entirely Future Test Periods Which May Not Be Applicable to SCE s FERC Formula Rates The April 2017 PLR ruled that it was not necessary to apply both conventions serially to changes in ADFIT balances when applied to entirely future test periods[.] 20 It is unclear whether the facts in this April 2017 PLR would apply to SCE s Formula Rate proceeding because, unlike the entirely future test period considered in the April 2017 PLR, 21 SCE s future test year includes part historical and part future periods as described in Treasury Regulations 1.167(l)-1(h)(6)(ii) and consistent with previous PLRs. 22 SCE calculates future rates based on the sum of the Prior Year Transmission Revenue Requirement ( TRR ), plus the Incremental Forecast Period TRR, plus the True-Up Adjustment. Thus, the future rate is part historical because recorded costs from SCE s previous year FERC Form 1 are used as components to its future test year revenue requirement; in other words, historical costs form the basis of the Prior Year Transmission 19 See supra note 4, April 2017 PLR at 13. 20 Id. at 13. 21 Id. at 12-13. 22 26 C.F.R. 1.167(l)-1(h)(6)(ii) (2018). 7
Revenue Requirement utilized as an input to calculating future rates. The rate is also part future period because the Incremental Forecasted Period TRR is used as an additional component of its future test year revenue requirement. This lack of clarity on the application of the facts from the April 2017 PLR to the facts in SCE s Formula Rate makes it very problematic to necessarily conclude that the ruling from the April 2017 PLR would apply to SCE. D. Although It May Be Appropriate for the Commission to Question the Use of the Two-Step Approach, Respondents Should be Permitted to Seek Protected Guidance on this Issue for Ratemaking Purposes Violating the Tax Normalization Rules and the resulting loss of a regulated utility s ability to use accelerated tax depreciation would result in significant detrimental ratemaking consequences to ratepayers. SCE would be prohibited from using accelerated depreciation for tax purposes, which would reduce or eliminate ADIT otherwise used to reduce rate base (and revenue requirement) for ratemaking purposes. Although the Commission has final authority on whether or not it is appropriate to use the two-step averaging approach for ratemaking purposes, the IRS has authority to say whether or not the elimination of the two-step approach violates the Tax Normalization Rules. It is therefore particularly important for SCE s transmission customers that in addressing this normalization issue the Commission provide SCE with the opportunity to seek protected guidance from the appropriate tax authority on this issue for ratemaking purposes. IV. CONCLUSION For the reasons set forth above, SCE requests that the Commission issue a decision stipulating that SCE continue its use of the two-step averaging methodology pending the issuance of the requested PLR, at which time SCE will either: (1) modify its rate to cease using the twostep averaging methodology if the IRS rules that doing so would not violate the Tax Normalization 8
Rules, or (2) continue using the two-step averaging methodology if the IRS rules that eliminating it would violate the Tax Normalization Rules. SCE s true-up ratemaking mechanism in its Formula Rate will, if the first option occurs, properly reduce the revenue requirement, with interest, to reflect the cost impacts of implementing a one-step approach. Respectfully submitted, REBECCA FURMAN ALEXA MULLARKY /s/ Rebecca Furman By: Rebecca Furman Attorneys for SOUTHERN CALIFORNIA EDISON COMPANY 2244 Walnut Grove Avenue Post Office Box 800 Rosemead, California 91770 Telephone: (626) 302-3475 E-mail: Rebecca.Furman@sce.com Dated: August 27, 2018 9
CERTIFICATE OF SERVICE I hereby certify that I have this day served the foregoing ANSWER OF SOUTHERN CALIFORNIA EDISON COMPANY TO ORDER INSTITUTING 206 PROCEEDINGS upon each person designated on the official service list compiled by the Secretary in this proceeding. Dated at Rosemead, California, this 27 th day of August, 2018. /s/ Jorge Martinez Jorge Martinez Legal Administrative Assistant SOUTHERN CALIFORNIA EDISON COMPANY 2244 Walnut Grove Avenue Post Office Box 800 Rosemead, California 91770 10