City of Charlottesville, Va. v. F.E.R.C.

• Decision Date: 18 October 1985
• Docket Number: No. 83-2059,83-2059
• Citation: 774 F.2d 1205
• Parties: CITY OF CHARLOTTESVILLE, VIRGINIA, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 1205

774 F.2d 1205

249 U.S.App.D.C. 236

CITY OF CHARLOTTESVILLE, VIRGINIA, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent.

No. 83-2059.

United States Court of Appeals District of Columbia Circuit.

Argued Sept. 28, 1984.

Decided Oct. 18, 1985.

Petition for Review of an Order of the Federal Energy Regulatory commission.

William T. Miller, Washington, D.C., with whom Susan N. Kelly, Washington, D.C., was on brief, for petitioner.

Andrea Wolfman, Atty., F.E.R.C., Washington, D.C., with whom Stephen R. Melton, Acting Gen. Counsel, and Barbara J. Weller, Deputy Sol., F.E.R.C., Washington, D.C., were on brief, for respondent. Robert F. Shapiro, Atty., F.E.R.C., Washington, D.C., also entered an appearance.

John H. Pickering, Washington, D.C., with whom Giles D.H. Snyder, Charleston, W.Va., Timothy N. Black, and James E. Coleman, Jr., Washington, D.C., were on brief, for intervenors Columbia Gas Transmission Corp. and Columbia Gulf Transmission Co.

Dale A. Wright, James T. McManus, and John H. Cheatham, III, Washington, D.C., were on brief, for intervenor Interstate Natural Gas Ass'n of America.

Before BORK and SCALIA, Circuit Judges, and GASCH, ^* District Judge for the United States District Court for the District of Columbia.

Opinion for the Court filed by Circuit Judge SCALIA.

SCALIA, Circuit Judge:

Each year since 1947, Columbia Gas System, Inc. ("Columbia System"), a public utility holding company, has filed a consolidated federal income tax return on behalf of itself and its subsidiaries, pursuant to the Internal Revenue Code of 1954, 26 U.S.C. Sec. 1501 (1982). The subsidiaries include two interstate natural gas pipelines subject to the jurisdiction of the Federal Energy Regulatory Commission ("FERC"): Columbia Gas Transmission Corp. ("Columbia Gas") and Columbia Gulf Transmission Co. ("Columbia Gulf"). For the second time, see City of Charlottesville, Va. v. FERC, 661 F.2d 945 (D.C.Cir.1981) ("Charlottesville I "), the City of Charlottesville, Virginia, a customer of Columbia Gas, much of whose gas is transported by Columbia Gulf, petitions this court for review of the Commission's decision to use a "stand-alone" methodology to determine the tax allowances included in the costs of services, and hence the rates, of the two pipelines. Charlottesville contends that FERC must require the pipelines to share with their ratepayers the tax savings resulting from the use of tax losses of the system's gas supply subsidiaries in the consolidated return; and that the Commission's methodology fails to accord to ratepayers, as the Commission agrees it should, a proportionate share of the tax savings resulting from the parent company's interest expense deduction from consolidated income.

I

The Natural Gas Act requires the Commission to insure that the rates of pipelines subject to its jurisdiction are "just and reasonable." 15 U.S.C. Sec. 717c(a) (1982). Under cost-of-service ratemaking principles, this means rates yielding sufficient revenue to cover all proper costs, including federal income taxes, plus a specified return on invested capital. See Public Service Co. of New Mexico v. FERC, 653 F.2d 681, 683 (D.C.Cir.1981). When a utility is an unaffiliated company and files its own tax return, calculation of the appropriate tax allowance is in principle no different from determination of any other operating or maintenance expense, although differences in the timing of recognition of expenses for tax and ratemaking purposes often complicate the calculation. See Public Systems v. FERC, 709 F.2d 73, 75 (D.C.Cir.1983). When the utility is part of a consolidated group, however, only the group files a return and pays taxes, computed on the cumulated revenues and deductions of all affiliates and the parent. The Commission must nonetheless determine separate tax allowances for the affiliated utilities it regulates, which it has done over the years by using one or the other of two basic methodologies.

The more venerable, the so-called "flow-through" methodology, immediately reflects in rates all the tax savings resulting from use of a consolidated return. These savings are twofold. First, unless all affiliates with tax losses would be able to take advantage of carry-forward or carry-back provisions of the tax code allowing them to use their losses to reduce their own future taxes or collect refunds on past payments, see 26 U.S.C. Sec. 172, aggregating them in a consolidated return with income-producing affiliates results in less taxable income for the group than there would be if each affiliate filed separately. Second, even if each affiliate could make use of its losses in future periods, the group gains the time value of money by using the losses immediately. Although the group in fact pays taxes on its net aggregate income at the statutorily prescribed rate, it can be thought of as, in a sense, paying at a "lower" tax rate than it would if all of its affiliates filed separate returns, because of the lower total taxable income that results from consolidation. A flow-through methodology applies this hypothetical lower (or "effective") tax rate to the earnings of the (presumably) profitable utilities to yield the tax allowances. For instance, the form of flow-through recommended in this case by Charlottesville would derive an effective tax rate by determining the ratio of each pipeline's taxable income to the total taxable income of all affiliates, multiply this fraction by the group's consolidated tax liability, and divide this figure by the pipeline's taxable income.

The second basic methodology, used by the Commission only in recent years, seeks, for tax purposes, to segregate the affiliated utility from the rest of the consolidated group. With minor adjustments not pertinent here, the calculation proceeds as follows: The utility's tax base is determined by identifying the taxable income and deductions of the consolidated group specifically attributable to the utility's jurisdictional activities. The statutory tax rate (which, in the case of regulated utilities, will almost always be the maximum rate) is then applied to the tax base to yield the stand-alone tax allowance. Usually, as in the present case, a stand-alone calculation will produce a higher tax allowance than a flow-through methodology, because the tax base, and hence the effective tax rate, is not reduced by the tax losses of other affiliates.

Until 1972, the Commission (then the Federal Power Commission) generally required regulated companies to flow through consolidated tax savings to their ratepayers. In United Gas Pipe Line Co. v. FPC, 357 F.2d 230 (5th Cir.1966), and Cities Service Gas Co. v. FPC, 337 F.2d 97 (10th Cir.1964), two circuit courts held that it was beyond the Commission's statutory authority to consider nonjurisdictional losses of members of a consolidated group when determining the proper tax allowance for jurisdictional companies. The Supreme Court reversed these decisions, holding that "in the proper circumstances the Commission has the power to reduce cost of service, and hence rates, based on the application of nonjurisdictional losses to jurisdictional income." FPC v. United Gas Pipe Line Co., 386 U.S. 237, 245, 87 S.Ct. 1003, 1008, 18 L.Ed.2d 18 (1967). The Court thus authorized, though it did not require, the general use of flow-through methodology to calculate tax allowances.

Five years later, perceiving a need to encourage gas exploration, the Commission decided to switch to stand-alone methodology, announcing that

if a case were before us where an affiliated, regulated or non-regulated, producer of oil or gas showed a tax loss, and this loss company were joined in a consolidated return with a pipeline, the United or Cities Service cases, in our opinion, would no longer be persuasive authority, for to reduce the rates of a regulated pipeline because of such affiliated exploration and development activities would be discouraging to the very enterprise we now want to encourage.

Florida Gas Transmission Co., 47 F.P.C. 341, 362 (1972). More generally, the Commission felt that "as the pipeline business develops with numerous subsidiaries we should avoid regulating one company on the basis of the activities of others in the affiliated group." Id. at 363. It concluded that "a utility should be regulated on the basis of its being an independent entity; that is a utility should be considered as nearly as possible on its own merits and not on those of its affiliates." Id.

The Commission further explained the stand-alone methodology in Southern California Edison Co., 59 F.P.C. 2167 (1977). Edison, an electric rather than a gas utility, and a member of a consolidated group, had calculated its tax allowance on a stand-alone basis, which practice a Commission administrative law judge had upheld on the strength of the "incentive" rationale of Florida Gas. The Commission acknowledged that the Florida Gas policy of encouraging exploration was based on the special circumstances of the gas industry, but nonetheless found the stand-alone policy applicable to Edison (and all other utilities) because "as an alternative ground for decision in [Florida Gas ] ..., the Commission determined that utilities should henceforth be considered as separate entities for the ratemaking purpose of determining their costs of providing jurisdictional service." 59 F.P.C. at 2173. This is to be done by considering the source of the consolidated tax savings, which normally

will be attributable to business activities which are totally unrelated to the providing of electric utility service.... Certainly, if this were the case, it would be difficult to justify the appropriation of any tax savings attributable to [such activities] ... by the jurisdictional consumers when these same consumers did not pay the expenses which created the deductions for tax purposes.

Id. at 2174 (emphasis added). The standard set out in the emphasized passage...