Rev. Rul. 63-182

Advice has been requested regarding the proper treatment, for Federal income tax purposes, of a refund received by the taxpayer, a natural gas distributor, by reason of a retroactive decrease in the price charged for gas provided by the taxpayer's supplier pursuant to an order of the Federal Power Commission approving such decrease. Advice has also been requested regarding the proper date for the accrual of refunds required to be made by the taxpayer to its customer-consumers where the liability to make such refunds is established at the same time that there is a retroactive decrease in the price of purchased gas.

The taxpayer is a natural gas distributor using the accrual method of accounting and reporting its income on the calendar-year basis. It purchases gas from a transmission company, hereinafter called the `supplier,' and distributes it to its customer-consumers. The rates charged by the supplier for natural gas are subject to regulation by the Federal Power Commission.

As a public utility, the taxpayer's charges for gas service are regulated by the public utilities commission of the state in which it is located and in which it does business. Under provisions contained in the gas service tariff filed with the state public utilities commission, the taxpayer's gas service charges are subject to increase or decrease to reflect changes in the price paid for gas purchased by the taxpayer.

On June 20, 1960, the taxpayer's supplier increased the price charged for gas after having filed appropriate notice with the Federal Power Commission. On the same date the taxpayer increased its charges for gas service to reflect the increased cost of purchased gas.

On June 21, 1960, a proceeding was instituted before the Federal Power Commission to determine the lawfulness of the increased rate being charged for gas by the taxpayer's supplier.

Prior to the outcome of the proceedings before the Federal Power Commission, the taxpayer, and others served by the supplier, entered into a proposed settlement agreement with the supplier on December 15, 1960, under which the rate charged for natural gas would be retroactively reduced as of June 20, 1960. The rate agreed upon by the parties was higher than that in effect prior to June 20, 1960, but lower than that fixed by the supplier. The agreement contained various provisions relating to the supplier's costs of service and to the disposition of certain refunds which the supplier expected to receive from natural gas producers. The agreement also provided that the taxpayer, among others, would receive a refund with interest in an amount equal to the difference between the amount charged for gas from June 20, u960, and the amount required to be paid at the rate fixed in the agreement. It was expressly provided that the effectiveness of the agreement was conditioned upon acceptance and approval of all its terms by the Federal Power Commission.

On May 21, 1961, the Federal Power Commission issued an order approving the proposed settlement agreement. The order approved the refunds to be made under the agreement and terminated the proceedings before it with respect to all matters covered by the agreement.

The taxpayer received the agreed refund and interest from its supplier on May 25, 1961, and made arrangements to pass it on to its customers by an adjustment in their gas service bills over the next succeeding 12 months by offsetting or crediting the refund against such future charges.

The specific questions upon which advice has been requested are (1) whether the proper date for the accrual of the income represented by the refund and interest received by the taxpayer is the date the proposed settlement agreement was entered into or the date the agreement was approved by the Federal Power Commission, and (2) as to the proper date for the accrual of refunds required to be made by the taxpayer to its customer-consumers.

Section 451(a) of the Internal Revenue Code of 1954 provides that, as a general rule, the amount of any item of income shall be included in gross income for the taxable year in which it is received by the taxpayer unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.

Under section 461 of the Code, it is provided that, as a general rule, the amount of any deduction or credit shall be taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income.

Section 1.451-1 of the Income Tax Regulations provides, in part, that gains, profits, and income are to be included in gross income for the taxable year in which they are actually or constructively received by the taxpayer unless includible for a different year in accordance with the taxpayer's method of accounting. It is further provided that, under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

Section 1.461-1(a)(2) of the regulations provides that an expense is deductible by a taxpayer using the accrual method of accounting for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy.

In the instant case the taxpayer and others agreed with the supplier to a diminution in the rates charged for gas supplied after June 20, 1960. That agreement was entered into prior to the close of the taxpayer's taxable year 1960. However, the effectiveness of that agreement was expressly conditioned upon approval of all its terms and conditions by the Federal Power Commission. Although the Federal Power Commission did, in fact, later approve the agreement and terminate proceedings with respect to the increased rates put into effect by the supplier on June 20, 1960, that approval was not forthcoming until the taxable year 1961.

On December 15, 1960, it could not be concluded that the Federal Power Commission's approval of the proposed settlement agreement was a mere formality. The possibility that the agreement would not be approved in the form and under the conditions submitted was a real and substantial possibility which left the taxpayer's right to the refund, if any, and its amount open to considerable uncertainty. Thus, as of the close of the taxable year 1960, it could not be said that all the events had taken place which fixed the taxpayer's right to the refund in question.

Similarly, the taxpayer's duty to make refunds to its customers under the terms of the gas service tariff filed with the state public utilities commission did not come into being until its own right to a refund was established. Since the events which fixed that right did not occur until the Federal Power Commission's approval was given in 1961, neither the fact nor the amount of the taxpayer's liability for refunds to its customers was established as of the close of the taxable year 1960.

On the basis of the facts set forth above it is concluded that the taxpayer's right to a refund from its supplier and its commensurate liability to make refunds to its customers were established on May 21, 1961, the date when the Federal Power Commission issued its order approving the rate settlement agreement entered into by the taxpayer and its supplier.

Accordingly, it is held that May 21, 1961, is the proper date for the taxpayer to accrue as income the refund to which it became entitled and to accrue the liability to make refunds to its own customers. It is further held that the means chosen by the taxpayer to make refunds to its customers, whether by cash disbursements in individual customers or by a credit or offset against subsequent gas service charges, does not affect the time when the liability is properly accruable. The taxpayer may under no circumstances, however, reduce it gross receipts for 1961 or subsequent taxable years to reflect customer refunds made by means of a credit or offset against gas service charges or claim another deduction for cash refunds when they are made to customers even though the refunds are actually made in a taxable year after the taxable year 1961.