Public Systems v. F.E.R.C.
| Citation | 709 F.2d 73 |
| Decision Date | 31 May 1983 |
| Docket Number | 82-1214,Nos. 82-1183,s. 82-1183 |
| Parties | PUBLIC SYSTEMS, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent, Cities Service Gas Company, Arkansas Power & Light Company, et al., Electric Utilities, Central Illinois Light Company, Potomac Electric Power Company, Central and South West Corporation, et al., El Paso Natural Gas Company, Edison Electric Institute, East Tennessee Group, Intervenors. CITIES OF ALTAMONT, et al., Petitioners, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent, Potomac Electric Power Company, et al., Intervenors. |
| Court | United States Courts of Appeals. United States Court of Appeals (District of Columbia) |
Petitions for Review of Orders of the Federal Energy Regulatory commission.
James N. Horwood, Washington, D.C., with whom Bonnie S. Blair, Gary J. Newell, and P. Daniel Bruner, Washington, D.C., were on the brief, for petitioner Public Systems. David R. Straus, Washington, D.C., also entered an appearance for Public Systems.
Philip B. Malter, Washington, D.C., with whom Charles F. Wheatley, Jr., Washington, D.C., was on the brief, for petitioners Cities of Altamont, et al. Michael J. Thompson and William S. Paleos, Washington, D.C., also entered appearances for Cities of Altamont, et al.
Alfred O. Holl, Oklahoma City, Okl., Dale A. Wright, Gregory Grady and Barbara J. Klein, Washington, D.C., were on the brief for intervenor Cities Service Gas Co. Kim M. Clark, Washington, D.C., also entered an appearance for Cities Service Gas Co.
Robert F. Shapiro, Atty., F.E.R.C., Washington, D.C., with whom Jerome M. Feit, Atty., F.E.R.C., Washington, D.C., was on the brief, for respondent.
Arnold D. Berkeley and Richard I. Chaifetz, Washington, D.C., were on the brief for intervenors The East Tennessee Group.
Edward A. Caine, Washington, D.C., was on the brief for intervenor Potomac Elec. Power Co.
Edward Berlin, Thomas M. Lemberg, Richard M. Merriman, James K. Mitchell, C. Frank Reifsnyder, Frederick T. Searls, Leonard W. Belter, Clark Evans Downs, and Carolyn Y. Thompson, Washington, D.C., were on the joint brief for intervenors in support of respondent F.E.R.C.
Joseph C. Swidler and Steven J. Agresta, Washington, D.C., entered appearances for intervenor Electric Utilities.
Donald J. MacIver, Jr., and Scott D. Fobes, El Paso, Tex., entered appearances for intervenor El Paso Natural Gas Co.
Before TAMM and GINSBURG, Circuit Judges, and JOHN W. PECK, * U.S. Senior Circuit Judge for the Sixth Circuit.
Opinion for the court filed by Circuit Judge TAMM.
Income taxes are one of the costs of service that the Federal Energy Regulatory Commission must consider in setting wholesale rates for public utilities and natural gas pipeline companies. Determining the proper tax allowance is complicated by disparities between the policies of the Commission and the Internal Revenue Service. For example, ratemaking rules may require that a current utility expense not be borne entirely by current ratepayers but rather be charged to customers over time, while tax rules may permit the utility to deduct the entire expense in the current year. The issue then is whether the utility's tax deduction for the expense should reduce rates only in the current year, the flow-through method, or whether the benefit of the tax deduction should be spread over the period that ratepayers are charged for the expense, the normalization method. Over the past twenty years the Commission has several times changed its position on the normalization versus flow-through issue. In 1976 the Commission adopted a general policy of permitting normalization. This court in Public Systems v. FERC, 606 F.2d 973 (D.C.Cir.1979) [hereinafter Public Systems I ], held that the Commission had failed to provide a reasoned basis for its action. On remand the Commission addressed the concerns of the court and the issues raised by commenters and ruled that generally normalization must be employed in computing the income tax component of cost of service. We find that the Commission has adequately answered the concerns expressed by the court in Public Systems I and that the tax normalization policy is the product of reasoned decisionmaking. Accordingly, we affirm.
Under the Federal Power Act, 16 U.S.C. Sec. 824 et seq., and the Natural Gas Act, 15 U.S.C. Sec. 717 et seq., the Federal Energy Regulatory Commission 1 is charged with setting just and reasonable wholesale rates for interstate, investor-owned public utilities and natural gas pipeline companies. The rates are based on cost of service, which comprises "all expenses incurred, including income taxes, plus a reasonable return on capital." Public Service Co. v. FERC, 653 F.2d 681, 683 (D.C.Cir.1981).
Determining the cost of service tax allowance is difficult because of timing difference transactions. Timing differences arise from differences between tax regulations and regulatory pricing policies. Because their policy objectives are not always the same, taxing authorities and regulatory commissions do not always allocate costs and revenues to the same time period. A timing difference occurs when an expense or revenue is recognized for tax filings in periods before or after it is recognized in rates. For example, the interest expense incurred in constructing a plant yields the utility a tax deduction in the year the expense is incurred, but the expense is capitalized and deferred for ratemaking purposes until the plant is constructed and placed in service. See Notice of Proposed Rulemaking, Docket No. RM80-42, Appendix A, Staff Study on Comprehensive Tax Normalization (Staff Study), at 6-10 (March 31, 1980), Joint Appendix (J.A.) at 85-89. 2
Flow-through and normalization are methods of dealing with the tax effects of timing difference transactions. Under flow-through, ratepayers realize the tax benefits of expenses when those expenses are used as tax deductions by the utility. 3 The entire benefit arising from a tax deduction passes through to the company's current customers. The primary rationale for flow-through is the actual taxes paid principle, i.e., in each year customers are charged no more than the current tax liability of the utility. Under normalization, the ratepayers who are charged with an expense receive the benefit of the tax deduction. 4 Normalization matches the tax effect of an expense with the ratemaking treatment for recovery of that expense. The primary rationale for normalization is the matching principle, i.e., equity demands that the customers who pay the expense receive the tax benefit associated with that expense.
By definition, timing differences do not result in permanent differences in the ratemaking and tax books. Every difference that arises in one period will exactly reverse itself in one or more subsequent periods. Regardless of whether flow-through or normalization is employed, over time the ratemaking and tax accounting procedures will recognize the same amount of revenue or expense with respect to each transaction. In contrast, permanent differences are not offset by reversals in other periods. Permanent differences arise when the tax law places a different dollar value on a revenue or expense than does the ratemaking law. An example of a permanent difference is municipal bond interest, which is excluded from taxable income but receives no special treatment in ratemaking. See generally Staff Study at 7-8, J.A. at 86-87. Permanent differences are not within the scope of the rules under review in this case.
The flow-through versus normalization dispute focuses primarily on the possibility that normalization will lead to utilities' enjoying continual tax deferrals. Under normalization, a deferred tax account records the difference between taxes actually paid by the utility and taxes charged to ratepayers. Because the predominant timing differences are those that arise from expenses that are recognized as tax deductions prior to their collection in rates, during the first year of normalization customers are usually charged for more taxes than the utility actually pays. 5 If the utility produces the same revenues and expenses for a number of years, the utility will eventually be paying the same amount of taxes that it charges ratepayers. Utilities, however, generally grow and produce more revenues and expenses each year. Therefore, the deferred tax account tends to grow each year. 6 Although each timing difference will reverse itself, the deferred tax account may increase for the foreseeable future. Petitioners argue that this continual tax deferral results in ratepayers' being charged for taxes that are never paid by the utility.
The normalization versus flow-through issue first arose after the 1954 enactment of section 167 of the Internal Revenue Code, which authorized the use of accelerated depreciation for tax purposes. The Commission initially permitted utilities to normalize the benefits of rapid depreciation, and the courts upheld this policy. E.g., El Paso Natural Gas Co., 22 F.P.C. 260, 267 (1959), aff'd 281 F.2d 567, 573-74 (5th Cir.1960), cert. denied, 366 U.S. 912, 81 S.Ct. 1083, 6 L.Ed.2d 236 (1961). The Commission changed its position in the mid-1960's and required the use of flow-through with accelerated depreciation. Alabama-Tennessee Natural Gas Co., 31 F.P.C. 208 (1964). 7 The courts again affirmed the Commission's choice. E.g., Alabama-Tennessee Natural Gas Co. v. FPC, 359 F.2d 318, 339 (5th Cir.), cert. denied, 385 U.S. 847, 87 S.Ct. 69, 17 L.Ed.2d 78 (1966). The Tax Reform Act of 1969 partially reversed Commission policy by allowing a utility to use normalization with respect to expansion property. Tax Reform Act of 1969, Sec. 441(a), Pub.L. No. 91-172, 83 Stat. 487, 625-28 (codified at I.R.C. Sec. 167(l )). 8 Again changing its position, the Commission in 1970 extended normalization to utility property acquired before 1970 and replacement...
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