Rev. Rul. 59-122

Advice has been requested whether, in determining the extent to which a company's gross income (computed without regard to dividends and capital gains and losses) for the taxable year is derived from sources described in section 1503(c) of the Internal Revenue Code of 1954, any refunds or repayments made pursuant to an order promulgated by the Federal Power Commission, or other governmental body, instrumentality or agency as defined in such section, must be taken into account in determining gross income.

During the year 1957, the M, N and O companies were an affiliated group of corporations within the meaning of section 1504 of the Code and filed a consolidated return for such year. The M company was engaged in the business of transporting natural gas, which it either produced or purchased, by long distance pipeline. It sold its gas at various points along the pipeline system to local distributing utilities for resale and to industrial consumers. It also produced oil and extracted natural gasoline and other heavier hydrocarbons from the gas stream. The rates for gas sold for resale in interestate commerce were subject to the jurisdiction of the Federal Power Commission. Direct sales to industrial purchasers and intrastate sales were subject to jurisdiction by state regulatory bodies.

In 1952 and 1955, the M company had placed in effect increased tariffs for its jurisdictional customers and had begun collecting, under bond, the resulting increased revenues pending determination by the Federal Power Commission as to the justice of such rates. During the period of collection under bond, the increased revenues were included in taxable income under the `claim of right doctrine.' See North American Oil consolidated v. Burnet , 286 U.S. 417, Ct. D. 499, C.B. XI-1, 293 (1932), and G.C.M. 16730, C.B. XV-1, 179 (1936).

Pursuant to an opinion handed down by the Federal Power Commission, the M company effected a series of partial refunds in the succeeding years and took deductions for such refunds in the respective years of repayment in computing taxable income. During 1957, the M company's gross income from gas sales entirely regulated by the Federal Power Commission constituted an amount in excess of 80 percent of the gross income for such year, without taking into account any refunds made during that year pursuant to the opinion of the Federal Power Commission.

Section 1503(a) of the Internal Revenue Code of 1954 provides, as far as here pertinent, that the tax imposed under section 11(c) of the Code shall be increased for any taxable year by two percent of the consolidated taxable income of the affiliated group of includible corporations filing a consolidated return.

Section 1503(b) of the Code provides, in part, as follows:

(b) LIMITATION.-If the affiliated group includes * * * one or more regulated public utilities (as defined in subsection (c), the increase of 2 percent provided in subsection (a) shall be applied only on the amount by which the consolidated taxable income of the affiliated group exceeds the portion (if any) of the consolidated taxable income attributable to * * * regulated public utilities in such group.

Section 1503(c)(2) of the Code, which defines `regulated public utility,' provides, as far as here pertinent, as follows:

For purposes of subsection (b), the term `regulated public utility' does not (except as provided in paragraph (3)) include a corporation described in paragraph (1) unless 80 percent or more of its gross income (computed without regard to dividends and capital gains and losses) for the taxable year is derived from sources described in paragraph (1).

Thus, section 1503(c) of the Code provides that the additional tax of two percent of the consolidated taxable income of an affiliated group filing consolidated returns is not applicable to that portion of the consolidated taxable income of the group which is attributable to a `regulated public utility,' as defined in such section. In the instant case, if the M corporation meets the 80 percent requirement of section 1503(c) of the Code, it constitutes a `regulated public utility,' and the additional tax of two percent provided for in section 1503(c) of the Code would in effect not apply to that portion of the consolidated taxable income attributable to it.

Section 1341(b)(2) of the Code, relating to the computation of tax where a taxpayer restores a substantial amount held under a claim of right, provides in part as follows:

This paragraph shall not apply if the deduction arises out of refunds or repayments made by a regulated public utility (as defined in section 1503(c) without regard to paragraph (2) thereof if such refunds or repayments are required to be made by the government, political subdivision, agency, or instrumentality referred to in such section.

The above quotation, as far as here pertinent, stands for the proposition that such refunds or repayments are considered as deductions. As such, they are not amounts to be taken into account in the determination of gross income.

Accordingly, it is held that, in determining whether 80 percent or more of the M company's gross income (computed without regard to dividends and capital gains and losses) for the taxable year is derived from sources described in section 1503(c) of the Code, any refunds or repayments made pursuant to an order promulgated by the Federal Power Commission, or other governmental body, instrumentality or agency as defined in such section shall not be taken into account in determining gross income, such refunds having been taken as a deduction from gross income in computing taxable income.