IRS PROVIDES PROCEDURE FOR PUBLIC UTILITIES TO CHANGE ACCOUNTING METHOD FOR CUSTOMER DEPOSITS.

Rev. Proc. 91-31

SECTION 1. PURPOSE

This revenue procedure provides a procedure for certain utility companies to change their treatment of customer deposits as a result of the decision of the Supreme Court of the United States in Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203 (1990). If a utility company consistently includes customer deposits in gross income upon receipt and those deposits are not taxable upon receipt under the decision in Indianapolis Power, a change in the treatment of those deposits is a change in method of accounting. This revenue procedure allows certain utility companies to obtain automatic consent to change their method of accounting for customer deposits to the method consistent with the holding in Indianapolis Power. Any other taxpayers that desire to change their treatment of customer deposits are required to file a current Form 3115, Application for Change in Accounting Method, with the Commissioner in accordance with section 1.446-1(e)(3)(i) of the Income Tax Regulations and Rev. Proc. 84-74, 1984-2 C.B. 736.

SEC. 2. BACKGROUND

01 SUMMARY OF INDIANAPOLIS POWER. In Indianapolis Power, the Supreme Court held that the customer deposits of a regulated utility company engaged in the sale of electricity are not includible in gross income upon receipt if the utility does not acquire "complete dominion" over the deposits at the time of receipt. In Indianapolis Power, customers having suspect credit were required to make deposits to insure prompt payment of future utility bills. The amount of the required deposit ordinarily was twice the customer's estimated monthly bill. For certain years in issue, a customer could obtain a refund of the deposit prior to termination of service by requesting a review and demonstrating acceptable credit. For other years, a deposit was refunded when the customer made timely payments for a certain period, or satisfied the credit test. A refund could be made in cash or by check, or the customer could choose to have the amount applied against future bills. The Court held that, because the utility's right to keep a deposit was, at the time of receipt, contingent on the customer's decision to purchase electricity and the customer's decision to use the deposit as payment, the taxpayer lacked sufficient dominion over its customer deposits to permit the Service to require them to be included in gross income upon receipt.

02 CONFLICT WITH REV. RUL. 72-519. Prior to the decision in Indianapolis Power, the Internal Revenue Service held in Rev. Rul. 72-519, 1972-2 C.B. 32, that the customer deposits received by a water company are items of gross income within the meaning of section 451(a) of the Internal Revenue Code if the purpose of the deposit is to guarantee payment for water supplied by the water company to the customer making the deposit, rather than to secure any property interest of the water company. Under the rationale of Rev. Rul. 72- 519, the deposits at issue in Indianapolis Power would have been includible in gross income upon receipt because they served only to guarantee a utility customer's payment for electricity.

The Court in Indianapolis Power, however, rejected the criteria in Rev. Rul. 72-519 for distinguishing advance payments that may be required by the Service to be included in gross income upon receipt from deposits that are in the nature of loans. The Court concluded, instead, that a deposit is not income when received if the recipient does not have "complete dominion" over and has an "obligation to repay" the deposit at that time, whether or not the purpose of the deposit is to guarantee the customer's payment for electricity received.

03 EARLIER COURT DECISIONS. Consistent with Rev. Rul. 72-519, the Service took the position upon examination that utility customer deposits generally are items of gross income because these deposits are taken to secure payment for utility services, and required them to be reported upon receipt. From 1980 until the Court's decision in Indianapolis Power, some utility companies challenged the application of Rev. Rul. 72-519, both unsuccessfully and successfully. Compare City Gas Co. of Florida v. Commissioner, T.C.M. 1984-44 (advance payments taxable); Gas Light Co. of Columbus v. Commissioner, T.C.M. 1986-118 (advance payments taxable); Oak Industries, Inc. v. Commissioner, T.C.M. 1987-65 (advance payments taxable), withdrawn, 96 T.C. No. 20 (Apr. 1, 1991); with American Telephone & Telegraph Co. v. Commissioner, T.C.M. 1988-35 (deposits nontaxable); Indianapolis Power, 88 T.C. 964 (1987), aff'd, 857 F.2d 1162 (7th Cir. 1988) (deposits nontaxable).

SEC. 3. CHANGE IN METHOD OF ACCOUNTING

01 IN GENERAL. A utility company that has been reporting gross income upon the receipt of customer deposits is not permitted to continue this practice if, under the holding in Indianapolis Power, those deposits are not includible in gross income upon receipt. For the reasons explained below, a change in this reporting of gross income is a change in method of accounting within the meaning of sections 446(e) and 481 of the Code.

02 APPLICABLE LAW. Section 1.446-1(e)(2)(ii)(a) of the regulations provides that a change in the method of accounting includes a change in the overall plan of accounting for gross income or deductions or a change in the treatment of any material item. Although a method of accounting may exist under this definition without a pattern of consistent treatment of an item, in most instances a method of accounting is not established without consistent treatment. A material item is any item which involves the proper time for the inclusion of the item in income or the taking of a deduction. In determining whether a practice involves the proper time for the inclusion of items in income or the taking of a deduction, the relevant question is generally whether the practice permanently changes the amount of taxable income over the taxpayer's lifetime. If the accounting practice does not permanently affect the taxpayer's lifetime taxable income, but does or could change the tax year in which taxable income is reported, it involves timing and is therefore considered a method of accounting. Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d 781, 799 (11th Cir. 1984); Peoples Bank & Trust Co. v. Commissioner, 415 F.2d 1341, 1344 (7th Cir. 1969).

Section 1.446-1(e)(2)(ii)(b) of the regulations provides that a change in method of accounting does not include correction of mathematical or posting errors, or errors in the computation of tax liability (such as errors in computation of the foreign tax credit, net operating loss, percentage depletion, or investment credit). Also, a change in method of accounting does not include the adjustment of any item of income or deduction which does not involve the proper time for the inclusion of the item of income or the taking of a deduction. For example, corrections of items that are deducted as interest or salary, but which are in fact payments of dividends, and of items that are deducted as business expenses, but which are in fact personal expenses, are not changes in method of accounting.

Section 446(e) of the Code and section 1.446-1(e) of the regulations provide that a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 1.446-1(e)(3)(i) provides that this consent may ordinarily be obtained by filing Form 3115 with the Commissioner within 180 days after the beginning of the year of change. However, section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit taxpayers to obtain consent to change to a permissible method of accounting in accordance with section 446(e). Section 481(a) provides that, if a taxpayer changes its method of accounting, there shall be taken into account those adjustments that are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or omitted.

Rev. Proc. 84-74 contains procedures authorized under section 1.446-1(e) of the regulations for obtaining the consent of the Commissioner to change a method of accounting for federal income tax purposes.

03 CHANGE IN TREATMENT OF DEPOSITS. If a utility company consistently includes customer deposits in gross income in the year of receipt and those deposits are not taxable upon receipt under the decision in Indianapolis Power, a change in the treatment of those deposits is a change in method of accounting. A change in the treatment of customer deposits does not affect the lifetime taxable income of a utility company. If deposits are treated as gross income upon receipt, taxable income is reduced when a deposit is either applied to a bill or refunded. Any change from such a consistent practice of reporting a material item of income is a change in method of accounting. See, e.g., Diebold, Inc. v. United States, 891 F.2d 1579, 1583 (Fed. Cir. 1989) (change in treatment of spare service parts from nondepreciable inventory to depreciable property), cert. denied, 111 S. Ct. 73 (1990); Witte v. Commissioner, 513 F.2d 391, 393 (D.C. Cir. 1975) (change from cost recovery to completed transaction method for reporting gain from sale of real estate).

SEC. 4. APPLICATION

01 CHANGE IN METHOD OF ACCOUNTING PERMITTED. In accordance with section 1.446-1(e)(3)(ii) of the regulations, any utility company described in section 4.03 of this revenue procedure whose current method of accounting is to report gross income upon the receipt of customer deposits is hereby granted the consent of the Commissioner to change its method of accounting for that income if, under the holding of Indianapolis Power, those deposits are not includible in gross income upon receipt.

02 PROCEDURES FOR MAKING CHANGE. Consent for any utility company described in section 4.03 to change its method of accounting under this revenue procedure is conditioned upon making the change in accordance with the terms and conditions set forth in section 5.

03 SCOPE OF AUTOMATIC CONSENT PROCEDURE. A utility company is granted consent to change its method of accounting under the terms and conditions of section 5 of this revenue procedure only with respect to customer deposits for utility services and only if, under the utility company's customer deposit arrangements, a customer is under no obligation to purchase utility services (including a minimum monthly charge or guarantee) at the time of making a deposit and has the option to get a full refund of the deposit at or prior to the termination of the arrangement subject only to the condition of meeting the customer's contractual obligations. For purposes of this revenue procedure, the term "utility services" includes only the providing of electrical energy, water, sewage disposal, or telephone or other communications, the furnishing of gas or steam through a local distribution system, or the transporting of gas or steam by pipeline. For purposes of this revenue procedure, the term "utility company" includes any taxpayer providing "utility services" that is regulated by a Federal or state agency (other than the Securities and Exchange Commission or a state counterpart) having the power to regulate the provision of utility services as described above. However, any utility company described in the preceding sentence that is subject to a closing agreement concerning the treatment of utility service deposits for any prior year is not eligible to make the change in method of accounting under this revenue procedure. But see section 4.04 below.

04 OTHER TAXPAYERS. Any taxpayer that is not described in section 4.03 of this revenue procedure that must request permission to change its method of accounting for customer deposits or any taxpayer described in section 4.03 that does not make a change under this revenue procedure may only request to change its method of accounting in accordance with the procedures of Rev. Proc. 84-74. However, any utility company applying under Rev. Proc. 84-74 that would be eligible to use this revenue procedure except for being subject to a closing agreement ordinarily will be granted a change in method of accounting under the same terms and conditions that apply to this revenue procedure, including the year of change, the amount of the section 481(a) adjustment, and the section 481(a) adjustment period.

SEC. 5. AUTOMATIC CONSENT PROCEDURE

01 Any utility company described in section 4.03 may change its method of accounting for customer deposits to the method consistent with the holding in Indianapolis Power by following the procedures in this section 5 and without regard to the 180-day period for filing Form 3115.

02 YEAR OF CHANGE. In view of the unique and extraordinary circumstances underlying the treatment of customer deposits by utility companies, a utility company is permitted to make the change for any one of the following three tax years:

(1) The first tax year ending after June 30, 1990;

(2) The second tax year ending after June 30, 1990; or

(3) The first open affected tax year of a series of consecutive open tax years ending prior to the first tax year ending after May 28, 1991. For purposes of the terms and conditions set forth below, a change described in this section 5.02(1) or (2) is referred to as a "current-year" change, and a change described in this section 5.02(3) is referred to as a "prior-year" change. In the case of a taxpayer making a prior-year change that reported customer deposits as gross income upon receipt pursuant to a closing agreement under section 7121 of the Code or Form 870-AD (Offer of Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment), the "first open tax year of a series of consecutive open tax years" begins after the final year for which the closing agreement or Form 870-AD was entered into by the taxpayer.

03 DEADLINE FOR MAKING AUTOMATIC CHANGE. Consent is granted for a utility company making a change in method of accounting on an original return for the first tax year ending after June 30, 1990, under section 5.02(1) only if the change is made by the due date (determined with regard to extensions) of the timely filed original return for the first tax year ending after June 30, 1990. Consent is granted for a utility company making a change in method of accounting on an amended return for the first tax year ending after June 30, 1990, under section 5.02(1) only if all amended returns are filed on or before September 25, 1991. Consent is granted for a utility company making a change in method of accounting on an original return for the second tax year ending after June 30, 1990, under section 5.02(2) only if the change is made by the due date (determined with regard to extensions) of the timely filed original return for the second tax year ending after June 30, 1990. Consent is granted for a utility company making a change in method of accounting on an amended return for the first open affected tax year under section 5.02(3) only if all amended returns are filed on or before September 25, 1991.

04 FORM 3115. A taxpayer makes the change in method of accounting under this revenue procedure by attaching a completed and signed Form 3115 to the tax return for the year of change (including an amended return, if applicable). This change is not subject to a user fee. The following statement should be made on the top of the Form 3115: "AUTOMATIC CHANGE FILED UNDER REV. PROC. 91-31." The following representations must be made a part of the Form 3115 and are a condition of the change:

(1) The taxpayer is a utility company (as defined in section 4.03),

(2) The change in method of accounting is being made with respect to customer deposits for utility services, and

(3) Under the taxpayer' s customer deposit arrangements for all deposits that are reflected as part of the change in method of accounting, a customer is under no obligation to purchase utility services (including a minimum monthly charge or guarantee) at the time of making a deposit and has the option to receive a full refund of the deposit at or prior to the termination of the arrangement subject only to the condition of meeting the customer's contractual obligations.

05 COMPUTATION OF SECTION 481(a) ADJUSTMENT:

(1) GENERAL RULE. A utility company making a change in method of accounting under this section is required to take into account a section 481(a) adjustment to prevent the duplication of items of income (unless the year of change is the year the method was adopted). The change in method of accounting gives rise to a negative section 481(a) adjustment determined as of the beginning of the year of change. The amount of the section 481(a) adjustment is equal to the amount of deposits on hand as of the beginning of the year of change that have been included in gross income prior to the year of change and that have not been applied to the payment of a utility bill or refunded prior to the year of change. If applicable, the amount described in the preceding sentence must exclude the amount of any cost of goods sold taken into account in the computation of the amount previously included in gross income.

(2) EFFECT ON PREVIOUS CHANGE IN METHOD. If the earliest open affected tax year is the year in which the taxpayer adopted or made a previous change to the method of including deposits in gross income upon receipt, the prior-year change authorized by this revenue procedure does not involve a section 481(a) adjustment. If the year of change under this revenue procedure is a year that otherwise falls within the section 481(a) adjustment period relating to a previous change in method of accounting to include deposits in gross income upon receipt, the previous change in method of accounting is terminated as of the beginning of the year of change. In that case, the section 481(a) adjustment under this revenue procedure includes only the net increase in deposits occurring from the year of the previous change through the year immediately preceding the change in method under this revenue procedure, plus the amount of the section 481(a) adjustment from that previous change that was included in gross income prior to the year of change under this revenue procedure. Thus, the unamortized balance of the section 481(a) adjustment from that previous change is not taken into account in the year of change or thereafter.

06 SECTION 481(a) ADJUSTMENT PERIOD. With respect to a current- year change, the entire amount of the section 481(a) adjustment is taken into account in the year of change. In the case of a prior-year change, the section 481(a) adjustment is taken into account in accordance with the rules set forth in sections 5.06(1)(a) (attributable to the immediately preceding tax year rule), 5.06(1)(b) (67-percent rule), and 5.06(1)(e) (for all other situations, ratably over the lesser of 6 tax years or the number of years the taxpayer has used the method being changed) of Rev. Proc. 84-74. However, if a taxpayer ceases to engage in the trade or business that gave rise to the section 481(a) adjustment at any time during the adjustment period, the entire remaining balance of the section 481(a) adjustment as of the beginning of that year is taken into account in that year. See section 5.09 of Rev. Proc. 84-74 for rules relating to the acceleration of a section 481(a) adjustment when a corporation, partnership, or sole proprietorship is deemed to cease operation of its trade or business. There are no limiting terms imposed with respect to a net operating loss carryback all or part of which results from a negative section 481(a) adjustment.

SEC. 6. EFFECT ON OTHER DOCUMENTS AND ON PENDING APPLICATIONS

The Service will issue guidance modifying Rev. Rul. 72-519 in a separate document. Any request for change in method of accounting filed under the provisions of Rev. Proc. 84-74 that qualifies for automatic consent pursuant to this revenue procedure and that is pending as of May 28, 1991, may be withdrawn with a refund of the user fee, and the change in method of accounting may be made under this revenue procedure.

DRAFTING INFORMATION

The principal author of this revenue procedure is Carol Conjura of the Office of Associate Chief Counsel (Technical). For further information regarding this revenue procedure, contact Barbara Young on (202) 566-3823 or Cheryl Oseekey on (202) 566-3388 (not a toll- free call).