Rev. Rul. 75-407

Advice has been requested whether a public utility should continue to deduct the cost of fuel oil actually consumed and used to generate electricity distributed during the taxable year even though part of such fuel expense will be deferred for financial accounting purposes in accordance with the instructions of a state public service commission.

The taxpayer is a regulated public utility that generates, transmits, and distributes electricity in state M. For Federal income tax purposes the taxpayer computes its income under an accrual method of accounting and has properly deducted its fuel expense as a business expense under section 162(a) of the Internal Revenue Code of 1954. Pursuant to section 1.162-3 of the Income Tax Regulations, the taxpayer has in the past deducted the cost of fuel oil actually consumed and used to generate electricity distributed during the respective taxable years. The taxpayer's state public service commission has instructed electrical utilities in state M to defer for book purposes certain increases in the fuel expense that will be passed on to their customers in subsequent periods as charges for electric energy are increased to reflect increases in the fuel costs.

Section 446 of the Code generally requires that taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books unless that method does not clearly reflect income. Section 1.162-3 of the regulations requires taxpayers carrying materials and supplies on hand to deduct the cost of materials and supplies only to the extent they are actually consumed and used in the operation in the taxable year. The deferral of fuel expense ordered by the state public service commission in the instant case does not clearly reflect income by this standard.

Accordingly, the taxpayer should continue to deduct fuel expense in accordance with section 1.162-3 of the regulations. The difference between the taxpayer's book income and taxable income must be reconciled on Schedule M of Form 1120, U.S. Corporation Income Tax Return.