Note 10 — Taxes on Income

Registrant provides deferred income taxes for temporary differences under the accounting guidance for income taxes for certain transactions which are recognized for income tax purposes in a period different from that in which they are reported in the financial statements. The most significant items are the tax effects of accelerated depreciation, certain regulatory balancing accounts, and advances for, and contributions in aid of construction. The accounting guidance for income taxes also requires that rate-regulated enterprises record deferred income taxes for temporary differences given flow-through treatment at the direction of a regulatory commission. The resulting deferred tax assets and liabilities are recorded at the expected cash flow to be reflected in future rates. Given that the CPUC has consistently permitted the recovery of flowed-through tax effects, GSWC has established regulatory liabilities and assets offsetting such deferred tax assets and liabilities (Note 2). Deferred investment tax credits (“ITC”) are amortized ratably to deferred tax expense over the lives of the property giving rise to the credits.

GSWC is included in AWR’s consolidated federal income tax and combined California state franchise tax returns. Consistent with the method adopted for regulatory purposes, GSWC’s tax expense is computed as if GSWC was autonomous and filed separate returns.

As a regulated utility, GSWC treats certain temporary differences as flow-through adjustments in computing its income tax provision consistent with the income tax approach approved by the CPUC for ratemaking purposes. Flow-through adjustments increase or decrease tax expense in one period, with an offsetting decrease or increase occurring in another period. Giving effect to these temporary differences as flow-through adjustments typically results in a greater variance between the effective tax rate (“ETR”) and the statutory federal income tax rate in any given period than would otherwise exist if GSWC were not required to account for its income taxes as a regulated enterprise. The GSWC ETRs deviated from the statutory rate primarily due to state taxes and differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements (principally plant-, rate-case- and compensation-related items).

The significant components of the deferred tax assets and liabilities from continuing operations as reflected in the balance sheets at December 31, 2012 and 2011 are:

	AWR						GSWC
	December 31,						December 31,
(dollars in thousands)	2012			2011			2012			2011
Deferred tax assets:
Regulatory-liability-related: ITC and excess deferred taxes	$	1,649		$	1,699		$	1,649		$	1,699
Regulatory-liability-related: California Corp Franchise Tax	3,690			3,272			3,690			3,272
Other property-related	—			6,612			—			6,605
Other nonproperty-related	2,609			1,157			2,151			336
Balancing and memorandum accounts	—			2,632			—			2,632
Contributions and advances	9,443			12,068			9,443			12,068
	$	17,391		$	27,440		$	16,933		$	26,612
Deferred tax liabilities:
Fixed assets	$	(121,802	)	$	(117,681	)	$	(121,881	)	$	(117,763	)
Regulatory-asset-related: depreciation and other	(21,754		)	(22,003		)	(21,754		)	(22,003		)
Other property-related	(152		)	—			(151		)	—
Balancing and memorandum accounts	(1,020		)	—			(1,020		)	—
Deferred charges	(6,632		)	(7,164		)	(6,632		)	(7,164		)
	(151,360		)	(146,848		)	(151,438		)	(146,930		)
Accumulated deferred income taxes - net	$	(133,969	)	$	(119,408	)	$	(134,505	)	$	(120,318	)

The current and deferred components of income tax expense from continuing operations are as follows:

	AWR
	Year Ended December 31,
(dollars in thousands)	2012		2011			2010
Current
Federal	$	15,585	$	9,107		$	10,785
State	5,273		7,108			6,110
Total current tax expense	$	20,858	$	16,215		$	16,895
Deferred
Federal	$	13,088	$	15,189		$	7,465
State	1,999		(1,328		)	(1,325		)
Total deferred tax expense	15,087		13,861			6,140
Total income tax expense from continuing operations	$	35,945	$	30,076		$	23,035

	GSWC
	Year Ended December 31,
(dollars in thousands)	2012		2011			2010
Current
Federal	$	7,957	$	5,246		$	6,543
State	3,830		6,920			5,852
Total current tax expense	$	11,787	$	12,166		$	12,395
Deferred
Federal	$	12,670	$	15,118		$	8,366
State	2,043		(1,313		)	(1,678		)
Total deferred tax expense	14,713		13,805			6,688
Total income tax expense	$	26,500	$	25,971		$	19,083

The reconciliations of the effective tax rates to the federal statutory rate are as follows:

	AWR
	Year Ended December 31,
(dollars in thousands, except percent)	2012			2011			2010
Federal taxes on pretax income at statutory rate	$	31,533		$	25,230		$	18,944
Increase (decrease) in taxes resulting from:
State income tax, net of federal benefit	4,957			3,781			3,657
Flow-through on fixed assets	636			1,026			525
Flow-through on pension costs	10			254			(567		)
Investment tax credit	(91		)	(91		)	(91		)
Other – net	(1,100		)	(124		)	567
Total income tax expense from continuing operations	$	35,945		$	30,076		$	23,035
Pretax income from continuing operations	$	90,093		$	72,086		$	54,126
Effective income tax rate	39.9		%	41.7		%	42.6		%

	GSWC Year Ended December 31,
(dollars in thousands, except percent)	2012			2011			2010
Federal taxes on pretax income at statutory rate	$	23,002		$	21,278		$	15,468
Increase (decrease) in taxes resulting from:
State income tax, net of federal benefit	4,048			3,707			3,282
Flow-through on fixed assets	636			1,026			525
Flow-through on pension costs	10			254			(567		)
Investment tax credit	(91		)	(91		)	(91		)
Other – net	(1,105		)	(203		)	466
Total income tax expense	$	26,500		$	25,971		$	19,083
Pretax income	$	65,720		$	60,793		$	44,193
Effective income tax rate	40.3		%	42.7		%	43.2		%

The following table provides a reconciliation of AWR’s and GSWC’s unrecognized tax benefits at December 31, 2012, 2011 and 2010:

	2012				2011				2010
(dollars in thousands)	AWR		GSWC		AWR		GSWC		AWR			GSWC
Unrecognized tax benefits at beginning of period	$	—	$	—	$	—	$	—	$	4,110		$	4,110
Increases as a result of tax positions taken prior to the period	—		—		—		—		—			—
Decreases as a result of tax positions taken prior to the period	—		—		—		—		(4,110		)	(4,110		)
Increases as a result of tax positions taken during the period	—		—		—		—		—			—
Decreases as a result of tax positions taken during the period	—		—		—		—		—			—
Decreases relating to settlements with taxing authorities	—		—		—		—		—			—
Reductions as a result of lapses of statute-of-limitation periods	—		—		—		—		—			—

Unrecognized tax benefits at end of period	$	—	$	—	$	—	$	—	$	—		$	—

For both AWR and GSWC, there was no portion of the unrecognized-tax-benefit balance at December 31, 2012 that would affect the effective tax rate if recognized.

Registrant’s policy is to classify interest on income tax over/underpayments in interest income/expense and penalties in “other operating expenses.”

At December 31, 2012, AWR and GSWC included $2,838,000 and $2,775,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. AWR and GSWC recognized $473,000 and $461,000, respectively, of interest income from taxing authorities during the year ended December 31, 2012. At December 31, 2011, AWR and GSWC included $2,364,000 and $2,314,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. AWR and GSWC recognized $121,000 and $102,000 respectively, of interest income from taxing authorities during the year ended December 31, 2011. At December 31, 2010, AWR and GSWC included $2,285,000 and $2,319,000, respectively, of net interest receivables from taxing authorities in other current and noncurrent assets. AWR and GSWC recognized $1,367,000 and $1,345,000, respectively, of interest income from taxing authorities during the year ended December 31, 2010.

At December 31, 2012, 2011 and 2010, Registrant had no significant accruals for income-tax-related penalties. Registrant did not recognize any significant income-tax-related penalties during the years ended December 31, 2012, 2011 and 2010.

Registrant files federal and various state income tax returns. The U.S. federal filings for the years 1997 through 1999 and 2002 came under Internal Revenue Service (“IRS”) examination during 2007 as a result of AWR having filed an amended 2002 return in 2006. The 2002 return was amended primarily due to AWR’s request for approval to change a tax accounting method (“Consent”). During 2008, the IRS issued a Revenue Agent’s Report (“RAR”) in connection with its examination of the 2002 tax year which resulted in Registrant recognizing certain tax benefits in accordance with the accounting guidance for tax uncertainties. In connection with the Consent, AWR filed amended 2003 through 2006 returns prior to the expiration of each year’s refund-claim period. The 2003, 2004 and 2007 returns also came under IRS examination.

During 2010, Registrant and the IRS reached a settlement on all years under examination, which revised the RARs for all of the years under examination. The agreement resulted in Registrant decreasing its unrecognized-tax-benefit balance to zero as of December 31, 2010, with corresponding adjustments to its deferred taxes. The refund amounts resulting from the agreement were subject to review by the Congressional Joint Committee of Taxation (“JCT”). During 2012, AWR and the IRS revised the settlement to reflect the IRS’s acceptance of Registrant’s refund claims as originally filed, and the IRS submitted a special report on its examination to the JCT for its review. In the fourth quarter of 2012, the JCT completed, without exception, its review of the IRS’s report supporting the refund claims. The IRS is processing the resulting refunds and Registrant has received most of the refunds during the first quarter of 2013.

AWR’s 2006 through 2011 tax years remain subject to examination by the IRS and state taxing authorities. AWR has filed protective refund claims with the applicable state taxing authority for the 2002 through 2006 tax years, also in connection with the Consent. During 2012, the California Franchise Tax Board commenced examining these claims.

Changes in Federal Tax Law

The Small Business Jobs Act of 2010 and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“Tax Relief Acts”) extended 50% bonus depreciation for qualifying property through 2012 and created a new 100% bonus depreciation for qualifying property placed in service between September 9, 2010 and December 31, 2011. As a result of these law changes, Registrant’s current tax expense for 2010 - 2012 reflects benefits from the Tax Relief Acts. In January 2013, The American Taxpayer Relief Act of 2012 further extended 50% bonus depreciation for qualifying property through 2013. Although these law changes reduce Registrant’s current taxes payable, they do not reduce its total income tax expense or ETR.

In December 2011, the U.S. Treasury Department (“Treasury”) issued temporary regulations related to the tax treatment of tangible property, including guidance on expensing certain repairs and maintenance expenditures for which separate guidance has not been issued. The regulations were to be effective for tax years beginning on or after January 1, 2012. In December 2012, Treasury amended the regulations and changed the effective date to be for tax years beginning on or after January 1, 2014. Registrant is evaluating its water-pipeline tax repair-cost method, as well as other tax-method changes provided under the regulations. The effects on its tax expense and tax balances are not anticipated to be significant. Although the regulations are expected to reduce Registrant’s current taxes payable, they do not reduce its total effective income tax rate.

Change in State Tax Law

As a result of a 2009 change to California tax law effective for tax years beginning on January 1, 2011, AWR elected an alternative state apportionment method with its 2011 tax return filing. This alternative approach will become mandatory for tax years beginning on January 1, 2013 due to a California ballot measure passed in November 2012.

AWR receives a tax benefit for expenses incurred at the parent-company level. While unitary apportionment will continue to affect AWR’s state taxes, the future effects may be beneficial or detrimental depending on a combination of the profitability of AWR’s non-California activities as well as the proportion of its California sales to total sales.

GSWC continues to compute its state tax expense as if GSWC was autonomous and not a member of AWR’s unitary group. This approach is consistent with the methodology used for ratemaking purposes. Given that all of GSWC’s activities are conducted within California, GSWC’s state tax expense does not reflect apportionment of its income. Consequently, the California law changes have had no impact on GSWC’s state taxes.