Memphis Light, Gas and Water Div. v. F.E.R.C.

• Decision Date: 06 May 1983
• Docket Number: 82-1302,Nos. 81-2356,s. 81-2356
• Citation: 707 F.2d 565
• Parties: MEMPHIS LIGHT, GAS AND WATER DIVISION, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent, Texas Gas Transmission Corporation, Terre Haute Gas Corporation, Intervenors. MEMPHIS LIGHT, GAS AND WATER DIVISION, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent, United Gas Pipe Line Company, Texas Gas Transmission Corporation, Texas Eastern Transmission Corporation, Intervenors.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 565

707 F.2d 565

227 U.S.App.D.C. 368

MEMPHIS LIGHT, GAS AND WATER DIVISION, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent,

Texas Gas Transmission Corporation, Terre Haute Gas

Corporation, Intervenors.

MEMPHIS LIGHT, GAS AND WATER DIVISION, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent,

United Gas Pipe Line Company, Texas Gas Transmission

Corporation, Texas Eastern Transmission

Corporation, Intervenors.

Nos. 81-2356, 82-1302.

United States Court of Appeals District of Columbia Circuit.

Argued Nov. 23, 1982.

Decided May 6, 1983.

Petitions for Review of Orders of the Federal Energy Regulatory commission.

Reuben Goldberg, Washington, D.C., with whom Glenn W. Letham, Washington, D.C., was on the brief, for petitioner. Channing D. Strother, Jr., Washington, D.C., also entered an appearance for petitioner in 81-2356.

Andrea Wolfman, Atty., F.E.R.C., Washington, D.C., with whom Barbara J. Weller, Deputy Sol., F.E.R.C., Washington, D.C., was on the brief, for respondent.

Cecil W. Talley, Houston, Tex., with whom Thomas W. Pounds and Irving Jacob Golub, Houston, Tex., were on the brief for United Gas Pipe Line Co., intervenor in 82-1302.

Christopher T. Boland, Washington, D.C., with whom J. Derrill Cody and William A. Williams, were on the brief for Texas Gas Transmission Corp., intervenor in 81-2356 and 82-1302 J. Evans Attwell, Houston, Tex., also entered an appearance for Texas Eastern Transmission Corp., intervenor in 82-1302.

Albert J. Feigen, Washington, D.C., also entered an appearance for Terre Haute Gas Corp., intervenor in 81-2356.

Before MIKVA and EDWARDS, Circuit Judges, and SWYGERT, ^* Senior Circuit Judge, United States Court of Appeals for the Seventh Circuit.

Opinion for the Court filed by Circuit Judge MIKVA.

MIKVA, Circuit Judge:

These two petitions for review of orders of the Federal Energy Regulatory Commission (FERC or Commission) represent the latest episode in the continuing saga of the Commission's treatment of accelerated depreciation when taxes are computed as an includable expense in cost of service. Specifically at issue is the Commission's reaction, in the context of the "normalization" method of depreciation currently used by natural gas companies, to recent reductions in the corporate income tax rate. The petitioner in both of these cases, Memphis Light, Gas and Water Division (Memphis), claims that rates included in various settlement agreements and approved by the Commission improperly use higher tax rates that are no longer in effect. As a consequence, Memphis contends, the settlements provide for excess collections that either should be returned to the ratepayers or credited against future collections. Given that the courts have allowed the Commission broad discretion in establishing proper depreciation methods for ratemaking purposes, and that the Commission's treatment of declining tax rates as evidenced in these cases is a reasonable exercise of that discretion, we affirm each of the orders being challenged.

I. BACKGROUND

Under Section 4 of the Natural Gas Act, 15 U.S.C. Sec. 717c (1976), the Commission is required to determine "just and reasonable" rates that will be sufficient for a natural gas company to recover its costs of service and to obtain a fair return on its investment. Traditionally included as a cost of service is a proper allowance for federal income taxes. Although the federal tax laws specify depreciation methods for income tax purposes, courts normally have granted the Commission broad discretion in establishing proper depreciation methods for ratemaking purposes. See FPC v. Memphis Light, Gas & Water Division, 411 U.S. 458, 466-67, 93 S.Ct. 1723, 1728-29, 36 L.Ed.2d 426 (1973). The petitions for review filed in these cases challenge the Commission's exercise of that discretion, not because of the particular method of depreciation used by the companies, but for the way that method has been adjusted in order to take account of declining tax rates.

A. The Commission's Treatment of Accelerated Depreciation

Under section 167 of the Internal Revenue Code, I.R.C. Sec. 167 (1976 & Supp. V 1981), natural gas companies and other utilities are permitted to depreciate their properties for income tax purposes using an accelerated or liberalized method of depreciation rather than the straight-line method that usually is used for bookkeeping purposes. Cf. id. Sec. 168 (Supp. V 1981) (including latest depreciation rules, but not applying to property placed in service before January 1, 1981). The use of such an accelerated depreciation schedule results in higher deductions and lower taxes for a utility in early years, and theoretically lower deductions and higher taxes in later years. The deferral aspects of accelerated depreciation are theoretical because, given constantly expanding investments made by utilities and continuous inflation in the economy, a utility is able to avoid the "turnaround" point when taxes are supposed to become higher than under the usual straight-line method. Thus, the accelerated depreciation methods sanctioned by section 167 often result in large and permanent tax The use of section 167 by utilities presents the Commission with a ratemaking problem when taxes are included in cost of service. Two basic methods of accounting for accelerated depreciation have been utilized at various times. The "flow-through" method allows a utility to include in cost of service only those taxes actually paid in a given year, thus ensuring that the benefits of accelerated depreciation flow directly to customers of the utility. The "normalization" method, currently applied by the Commission, is somewhat more complicated. Under normalization, the ratepayers are charged not the actual income taxes paid, but a hypothetical higher figure for taxes (i.e., the "tax allowance") computed as if the utility was using a straight-line method of depreciation. The difference between the actual taxes paid and the larger tax allowance charged to the ratepayers is accumulated in a "deferred tax account." Assuming that the utility's actual taxes will someday become higher than the amount charged to the ratepayers (i.e., after the turnaround point), the deferred tax account then will be drawn upon to finance the extra tax payments that must be made by the utility.

                savings for a utility.   See Alabama-Tennessee Natural Gas Co. v. FPC, 359 F.2d 318, 328 (5th Cir.), cert. denied, 385 U.S. 847, 87 S.Ct. 55, 17 L.Ed.2d 78 (1966);  see also Public Systems v. FERC, 606 F.2d 973, 976 (D.C.Cir.1979)
                

Several important procedures result from the use of the normalization method and its deferred tax account. First, because the deferred account is composed of monies contributed by the ratepayers and is available to the utility for investment without finance charges, the amount of funds included in the account is deducted from the rate base. In this way, the ratepayers need not pay the utility a rate of return on their own money. Second, because the money collected from ratepayers is a hypothetical amount larger than actual taxes paid, the excess amount is income to the utility in the year it is collected and is taxed as such. These extra taxes are referred to as the "tax-on-tax" effect of accelerated depreciation with normalization, and are charged to the ratepayers along with other tax expenses.

When section 167 was first applied in the ratemaking process, the Commission decided that Congress had mandated use of the normalization method. See Amere Gas Utilities Co., 15 F.P.C. 760 (1956). Between 1960 and 1963, however, several courts of appeals concluded that normalization in ratemaking was not required by the tax code, see, e.g., Panhandle Eastern Pipe Line Co. v. FPC, 316 F.2d 659 (D.C.Cir.) (en banc), cert. denied, 375 U.S. 881, 84 S.Ct. 147, 11 L.Ed.2d 111 (1963), and in 1964 the Commission adopted the flow-through method as controlling, see Alabama-Tennessee Natural Gas Co., 31 F.P.C. 208 (1964), aff'd, 359 F.2d 318 (5th Cir.), cert. denied, 385 U.S. 847, 87 S.Ct. 55, 17 L.Ed.2d 78 (1966); cf. Midwestern Gas Transmission Co., 36 F.P.C. 61 (1966), aff'd, 388 F.2d 444 (7th Cir.) (Commission may impute the use of accelerated depreciation with flow-through regardless of the method actually used in computing taxes), cert. denied, 392 U.S. 928, 88 S.Ct. 2286, 20 L.Ed.2d 1386 (1968).

Amendments made to section 167 by the Tax Reform Act of 1969, see I.R.C. Sec. 167(l) (1976), led the Commission to change policy once again. The Commission first announced that, as a general policy under section 167(l)(4)(A), it would permit utilities to elect accelerated depreciation with normalization for all their post-1969 expansion property. See FERC Order No. 404, reprinted in 43 F.P.C. 740 (1970), aff'd, Memphis Light, Gas & Water Division v. FPC, 462 F.2d 853, 856-60, 865 (D.C.Cir.1972). Then the Commission announced that utilities also would be allowed to abandon flow-through in favor of normalization for certain replacement properties and for properties acquired prior to 1969. See Texas Gas Transmission Corp., 43 F.P.C. 824 (1970). This latter preference for normalization was initially rejected by this court, 462 F.2d at 860-65; however, given the broad authority of the Commission in this area, and no statutory directives to the The temporary use of the flow-through method between 1964 and the early 1970's, however, resulted in deficiencies in the deferred tax accounts because contributions to the account were not being made during those years. Such deficiencies in the deferred accounts, in turn, mean that normalization cannot be fully utilized as it was designed. Specifically, because these deferred accounts cannot be relied upon completely in later years when a utility's tax liability theoretically will exceed its then-current receipts, ratepayers in some future year might have to bear a very large tax burden. To guard against this possibility,...