548 A.2d 1310 | Pa. Commw. Ct. | 1988
Opinion by
The Office of Consumer Advocate (OCA) petitions for review of an order of the Pennsylvania Public Utility Commission (PUC or commission) that approved a rate increase for the Peoples Natural Gas Company (Peoples or utility).
Peoples does not pay federal income taxes directly to the federal government, but rather participates in a consolidated tax return filed by its parent corporation, Consolidated Natural Gas Company (CNG or parent). The PUC acknowledges that, where a utility realizes federal income tax savings because of its participation in a consolidated return, Pennsylvania law requires that those savings be passed on to the ratepayers by means of an adjustment to the utility’s allowance for tax expense. However, the method that the PUC used to calculate consolidated tax savings in this case yielded no adjustment, although the method proposed by OCA would have reduced Peoples’ tax expense allowance by approximately $1.7 million.
Therefore, this case presents the issue of whether the method used by the commission to calculate federal income tax savings resulting from consolidation should be determined as a matter of law or should be regarded as a matter within the discretion of the commission.
When consolidated tax returns are used, each subsidiary of a parent corporation calculates its separate income, deductions, tax liability and tax credits on a stand-alone basis. However, the subsidiary does not then file a separate federal income tax return or pay the calculated tax to the Internal Revenue Service (IRS). Rather, the subsidiary submits its calculations (and, typically, the amount of its stand-alone tax liability, if any) to the parent corporation. As is permitted by sections 1501-1505 of the Internal Revenue Code (Code), 26 U.S.C. §§1501-1505, the parent corporation then offsets taxable income generated by some subsidiaries with tax losses and credits generated by other subsidiaries to arrive at a figure representing the taxable income of the consolidated group. See Continental Telephone Co. of Pennsylvania v. Pennsylvania Public Utility Commission, 120 Pa. Commonwealth Ct. 25, 548 A.2d 344 (1988).
Peoples is one of a group of thirteen wholly-owned subsidiaries of CNG. The subsidiaries include both regulated and nonregulated companies engaged primarily in various aspects of the business of discovering, developing, transporting and selling natural gas resources. Peoples calculates its stand-alone tax liability, but then pays that amount to a depository account set up by CNG. CNG subsidiaries with tax losses make withdrawals from that account to the extent of their negative income tax liabilities.
Peoples filed a rate increase request on January 28, 1986, seeking an increase in its base rates of approximately $19.9 million. The rate request included a claim for tax expense equal to Peoples’ full stand-alone tax liability. The PUC instituted an investigation into the rate request, and various parties, including OCA, filed com
After the filing of exceptions and reply exceptions to the recommended decision, the PUC issued an opinion and order on October 31, 1986, authorizing Peoples to increase its rates by $7.1 million. On the issue of consolidated tax savings, the PUC, applying the method of calculating such savings advocated by the commissions Office of Trial Staff, known as the “pour-over” or United Gas Pipe Line method, concluded as follows:
We concur in the conclusion of the AJL that [Peoples] has not experienced and will not experience a consolidated tax savings which should be reflécted in our tax calculations for Peoples.
Therefore, the commission allowed the full tax expense claimed.
We note that, by contrast, in our recent Continental Telephone case, the commission did not use the pour-over method in a consolidated tax return issue, and consequently reduced allowable tax expense.
“Actual-Taxes-Paid” Doctrine
Before Continental Telephone, this court had also considered the problem of consolidated tax returns in Cohen v. Pennsylvania Public Utility Commission, 78 Pa. Commonwealth Ct. 545, 468 A.2d 1143 (1983), aff'd sub nom. Barasch v. Pennsylvania Public Utility Commission, 507 Pa. 561, 494 A.2d 653 (1985). Cohen involved a utility participating in a consolidated tax return, in a situation very similar to this case.
The PUC had allowed the full stand-alone tax expense claimed by the utility on the basis of its “chronic
Only the question of the legality of the method used by the PUC to determine consolidated tax savings was before us on OCAs cross-appeal from the commissions order, not the merits of OCAs proposed method for adjusting tax expense. We noted that a utility may pass along to its ratepayers only those expenses or costs that it actually incurs, because any other approach would permit the utility, by charging higher rates than necessary, to gain a profit from its customers under the guise of recovering operating expenses. Id. at 558, 468 A.2d at 1150.
We therefore held that the PUCs insistence on the presence of a chronic loss company was error of law, and ordered that the case be remanded to the commission for a determination of how the utility should account for the consolidated tax savings. Id. at 559-60, 468 A.2d at 1151.
On further appeal by the PUC and the utility, the Pennsylvania Supreme Court affirmed. Barasch v. Pennsylvania Public Utility Commission, 507 Pa. 561, 493 A.2d 653 (1985). The Supreme Court noted that the arguments advanced by the utility and the PUC in support of the chronic loss method of calculating consolidated tax savings failed to recognize the basic ratemaking maxim that only expenses that are actually paid or payable by the utility may be included for the purpose of
‘The fact that Riverton actually pays to [its parent company] an amount for taxes greater than its proper proportionate share of the consolidated tax liability merely accomplishes in fact that which it is forbidden to do. The making of an improper payment does not eliminate its impropriety. The only proper tax expense which Riverton may pass on to its customers is its proportionate share after the consolidated return is filed and the actual tax paid’.
Barasch, 507 Pa. at 568, 493 A.2d at 656 (quoting Riverton Consolidated Water Co. v. Pennsylvania Public Utility Commission, 186 Pa. Superior Ct. 1, 20, 140 A.2d 114, 123 (1958), emphasis supplied in Barasch). In a strong affirmance of the “actual taxes paid” doctrine, the Court then held:
All tax savings arising out of participation in a consolidated return must be recognized in rate-making, otherwise we would be condoning the inclusion of fictitious expenses in the rates charged to the ratepayers.
Barasch, 507 Pa. at 568, 493 A.2d at 656.
Positions of the Parties
This courts scope of review of a final order of 1:he Public Utility Commission is “limited to a determination of whether constitutional rights have been violated, an error of law has been committed, or the Commissions findings and conclusions are, or are not, supported by substantial evidence.” Barasch v. Pennsylvania Public Utility Commission, 507 Pa. 561, 566, 493 A.2d 653, 655 (1985). See 2 Pa. C. S. §704.
On the basis of the Barasch and Cohen cases, discussed above, OCA contends that, as a matter of law,
The method advocated by OCA in these proceedings for calculating consolidated tax savings may be characterized as a “modified effective tax rate” method. An effective tax rate method calculates the consolidated tax savings by determining the difference between the total of the stand-alone tax liabilities of all of the members of the consolidated group and the tax actually paid after offsetting of income because of consolidation and then allocates those savings among all of the members. The rationale of this method is that, because the parent pays tax at the marginal rate but on an amount of income reduced by consolidated offsetting, the parent, and in turn the subsidiaries, should be viewed as paying at an “effective” tax rate that is below what they would have paid if the tax had been calculated by applying the marginal tax rate to the full income of each member on a stand-alone basis.
In this case OCAs expert witness, Nancy B. Bright, calculated the amount of savings by an effective tax rate method and then allocated those savings among members of the group based on the ratio between the individual members stand-alone tax liability and the total of the stand-alone liabilities of all subsidiaries with positive taxable income. OCA Statement No. 2 at 30; R.R. 29a. Ms. Brights method was a modified instead of a pure effective tax rate method because (1) it examined tax losses before consideration of investment tax credits (ITCs) in order to avoid any flow-through of those credits to companies other than those to whom they were due, and (2) it excluded losses of regulated compa
The PUC responds by arguing that the Barasch decision, although it rejected the chronic loss method as a matter of law and required that all consolidated tax savings must be recognized in ratemaking, did not require that the commission adopt any particular method for calculating consolidated tax savings. The PUC characterizes its choice of one method for calculating such savings over another in this case as being simply the resolution of a factual question after consideration of conflicting expert testimony. Therefore, the commission argues, the issue here is not one of law but rather one of fact, and hence not within our scope of review, apart from our assuring that the finding of fact was based on substantial evidence.
The method of calculating consolidated tax savings advocated by the witness for the Office of Trial Staff, Robert F. Wilson, and adopted by the commission in its order, is that known as the “pour-over” or United Gas Pipe Line method.
Analysis
The PUC’s characterization of its adoption of the pour-over method as a factual determination is not convincing. Although the commission’s opinion did not elaborate on the commission’s reasons for adopting the pour-over method, the PUC’s result followed the rationale advanced by that method’s advocate, Mr. Wilson. However, an examination of that rationale shows that it is not based on purely factual considerations. In his prepared testimony, Mr. Wilson stated:
The pour-over method limits the non-utility losses to be allocated to utilities to the amount which is not absorbed by non-utility profits. This is done to avoid excessive inter-industry cross-subsidization, by the non-regulated sector of the regulated utilities.
Trial Staff Statement No. RFW-1 at 9; R.R. 59a. In rer sponse to a question from Judge Mindlin during cross-examination, Mr. Wilson said:
*301 I agree; the whole thing comes down to a matter of philosophy of fairness: is it fair to take all of the losses of the non-regulated sector and lower the rates of the regulated sector such that it reflects the actual taxes paid?
Although the Supreme Court did not expressly require the PUC to apply an effective tax rate method in Barasch, the Courts endorsement of “proportionate share after . . . the actual tax [is] paid” as the “only proper tax expense” strongly implies that the Court requires that an effective tax rate method be used. (Emphasis added.)
Moreover, the commissions choice of pour-over method in this case is essentially very similar to its choice of the chronic loss method disapproved in Barasch. In both cases the PUC imposed a barrier threshold to be surmounted — proof of the presence of a chronic loss company or proof of nonregulated losses in excess of nonregulated gains — before the commission would agree to allocate to utility members of a group
The idea that such offsetting should be minimized to the extent that it works to the benefit of utility ratepayers is a self-serving overlay upon the theory of consolidated tax returns. As we observed in Cohen:
The decision to file a consolidated return is one which the parent and its member companies must make; we may reasonably conclude that, when they do choose to file on a consolidated basis, they perceive some financial benefit from doing so.
Cohen, 78 Pa. Commonwealth Ct. at 560, 468 A.2d at 1151.
If the parent corporation is concerned about the benefits of consolidated tax savings reaching the ratepayers of its utility subsidiary, the parent always has the option of removing the utility from the consolidated group. As the Trial Staffs witness acknowledged, however, public utilities, because of the guaranteed rate of return assured to them pursuant to regulation, reliably generate positive income. N.T. 1271; R.R. 113a. Because of consolidation, this positive income is available to the group for offsetting of losses of other utilities. If the parent chooses to keep the utility in the consolidated group, we may conclude that the reliability of this source of positive income represents a benefit to the parent, even in a year in which nonregulated subsidiaries’ losses do not exceed nonregulated subsidiaries’ gains.
Within the existing structure, however, the language and the overall thrust of the Supreme Courts decision in Barasch require that the benefits accruing to the parent company as a result of the filing of a consolidated tax return be apportioned among all the members of the consolidated group, and not be withheld discriminatorily from some members simply because those members happen to be regulated utilities.
Peoples, as intervenor in this appeal by OCA, has sought to raise issues beyond those raised by OCA and the commission, namely, whether the actual-taxes-paid doctrine of Barasch should be reexamined (1) in the light of a recent federal appeals court decision criticizing the concept of actual taxes paid and holding that the Federal Energy Regulatory Commissions use of a markedly different approach to consolidated tax savings was sufficiently reasonable so as to be within the limits of that agency’s discretion, City of Charlottesville v. Federal Energy Regulatory Commission, 774 F.2d 1205 (D.C. Cir. 1985), cert. denied, 475 U.S. 1108 (1986), and (2)
This court must remand this case and direct that the modified effective tax rate method shall be applied to determination of the utility’s tax expense for recomputation of the proper revenues and rates.
Order
Now, October 11, 1988, the order of the Pennsylvania Public Utility Commission at Docket No. R-850270, entered October 31, 1986, is reversed. This matter is remanded to the commission with instructions to the commission to issue a new order after incorporating in its‘rate calculations the consolidated tax savings adjustment proposed by the Office of Consumer Advocate.
Jurisdiction relinquished.
This decision was reached prior to the resignation of Judge MacPhail.
Pennsylvania Public Utility Commission v. The Peoples Natural Gas Co., Docket No. R-850270 (order entered October 31, 1986).
The United States Supreme Court approved the Federal Power Commissions use of this method for calculating consolidated tax savings in Federal Power Commission v. United Gas Pipe Line Co., 386 U.S. 237 (1967).
We have, in any event, disposed of the accelerated depreciation deductions question in the Continental Telephone case, referenced above, by holding that consolidated tax savings adjustments do not violate the accelerated depreciation provisions if the adjustments do not diminish the amount required to be entered into a reserve for deferred taxes under those provisions.