Opinion
No. CV 03 052 3949S
June 20, 2006
MEMORANDUM OF DECISION
I INTRODUCTION
The captioned matter is an appeal from a decision (decision) by the Department of Public Utility Control (DPUC). The proceeding before the DPUC in which the decision was issued was initiated by the plaintiff (CLP) in an effort to reverse the accounting treatment previously established by the DPUC relative to accumulated deferred income tax benefits (ADITS) which inured to CLP under federal tax law (IRC). Although CLP had originally concurred in the DPUC's establishment of that treatment, it has been represented to the court that advice from new accountants for CLP prompted its request to change that treatment.
The parties have agreed that CLP's previous concurrence in the challenged accounting treatment is not a bar to the DPUC's revisiting that issue at CLP's request, or to the court's reviewing the decision.
The field of public utility accounting is technical and complex. As in other such disciplines, a shorthand jargon has developed among those in the field (i.e., regulators, regulated entities and their respective accountants, staffs and counsel) which is as foreign to the layperson as the symbols in the periodic table of elements. Because the decision and the briefs of the parties contain much of that jargon, a translation for the benefit of the court became essential.
Pursuant to Canon 3(a)(4)(B) of the Code of Judicial Conduct, and with the greatly appreciated cooperation and consent of the parties, the court retained two disinterested experts in the field of public utility regulation to assist by translating the jargon of the decision and the briefs into terms understandable by the court. Each of those experts was unanimously recommended by the parties, and each was of great assistance to the court. Those experts, who have the gratitude of the court, are Attorney Robert Golden and Attorney Linda Randell.
As required by Canon 3(a)(4)(B), Attorneys Randell and Golden have advised the parties of the substance of their advice, and the parties have had an opportunity to respond to that advice in a hearing before the court.
In order to make this decision as intelligible as possible to people without expertise in utility accounting, an effort has been made to avoid jargon. In that regard, this decision creates its own glossary and uses some terms differently from the way they are normally used in the industry. It is hoped this results in a more readable and understandable decision.
Counsel have argued several subsidiary issues in this case. However, it is felt that the ultimate issue in this case can be resolved without a discussion of each of them. Therefore, in the interests of clarity and brevity, those subsidiary issues are not addressed.
The mechanics and mysteries of double entry utility accounting are as strange to a layperson as the jargon of the trade. Accordingly, many of the intermediate accounting steps which have been gone through by the parties are subsumed in this decision's characterization of the ultimate economic effects of those steps.
II. BACKGROUND History
This appeal has its roots in P.A. 98-28, entitled "An Act Concerning Electric Restructuring" (restructuring act). Prior to the restructuring act, the rates charged by utilities for electricity generated by them were regulated by the DPUC. Pursuant to the restructuring act, utilities were required to sell their generating plants at auctions supervised by the DPUC. The restructuring act also provides that, post-sale, the rates charged for electricity by the buyers of those plants are not regulated by the DPUC. The principal purpose of the act is to allow the marketplace, rather than regulators, to set the price of electricity.
When CLP was generating electricity, it was also transmitting and distributing that electricity. In setting the price of electricity, the DPUC calculated the operating expenses of generation, transmission and distribution (operating expense). Operating expense included, inter alia, taxes and depreciation of plant and equipment. (As discussed hereinafter, the DPUC's calculation of depreciation for rate-making purposes often differed substantially from the depreciation allowed for federal tax purposes.)
Conceptually, the collective value of CLP's depreciated plant and equipment (as determined by the DPUC) constituted CLP's rate base (rate base). Also conceptually, CLP's operating expense, plus a reasonable rate of return on its rate base, composed CLP's electric charge.
ADITS
In order to encourage new investment in plant and equipment, the IRC allows the depreciation of new plants on an accelerated schedule of only 10 years. That means, for example, if CLP constructed a plant which was anticipated to have a useful life of 40 years, which was to be depreciated, for DPUC purposes, over that period, CLP could nonetheless depreciate that plant, for federal tax purposes, over only 10 years.
Pursuant to the IRC, depreciation is deductible from taxable income as an ordinary and necessary business expense. Therefore, depreciating a plant which has a useful life of 40 years on an accelerated basis of only 10 years artificially reduces taxable income, and taxes, during those 10 years. However, after those 10 years, depreciation for the plant has been exhausted and, if the taxpayer then enjoys profits, its taxable income artificially increases, resulting in increased taxes during the 30 years which follow the accelerated depreciation period. Theoretically, the sum of the increased taxes paid after the 10-year period of accelerated depreciation has expired will equal the amount of taxes avoided through the use of accelerated depreciation during the first 10 years.
Although the same amount of taxes will be paid over the useful life of an asset whether or not it is depreciated on an accelerated basis (assuming the taxpayer enjoys profits each year), it has been represented to the court that the use of accelerated depreciation is attractive to investors, thereby generating increased stock prices for CLP.
As required by the IRC, CLP reported to the DPUC, as an operating expense, a figure for federal taxes which it would have paid if it had not used accelerated depreciation, even though the federal taxes actually paid by it were lower than the federal taxes reported to the DPUC as an operating expense. The DPUC accepted that inflated federal tax figure as an operating expense. In this way, CLP's operating expense was overstated (during the period when accelerated depreciation was used) for rate-making purposes, and during that period CLP enjoyed a cash stream in excess of the rate of return which had been established for it by the DPUC. That excess cash stream, equal to the difference between the taxes reported to the DPUC as an operating expense and the taxes actually paid, has been characterized as ADITS. CLP's ADITS are, essentially, a reserve account for the increased taxes which must be paid by it when accelerated depreciation benefits for an asset have been exhausted.
Under the IRC, when CLP sells an asset to a nonaffiliate for a price in excess of its tax basis, a capital gains tax is due on the profit for the year of the sale. However, the IRC treats a profitable sale to an affiliate differently by not taxing that sale (treating it, effectively, as an intracompany transfer) and instead requiring the selling entity to pay to its affiliate buyer, in each of the 20 years following the sale, one-twentieth of the accumulated ADITS for the transferred asset. Therefore, for the 20 years following the sale of an asset to an affiliate, CLP retains a declining balance of the ADITS for that asset.
The parties have stipulated that the DPUC's treatment of ADITS should provide cash neutrality for both CLP and ratepayers. The parties have also stipulated that, prior to the restructuring act, the DPUC's accounting treatment of ADITS was proper. That treatment avoided a windfall profit to CLP at the expense of rate payers by periodically deducting from CLP's rate base an amount equal to its newly accrued ADITS. As a result, while CLP was depreciating an asset on an accelerated basis, it was always foregoing a return on that asset's ADITS (which had been subtracted from its rate base). In this way, CLP was left in a neutral cash posture.
Cash neutrality for CLP is understood by hypothesizing that in each year for which accelerated depreciation is taken, CLP invests its newly accrued ADITS in its rate base. That investment generates the rate of return established by the DPUC on CLP's rate base. That return is equal to the return which was foregone by CLP as a result of the subtraction from its rate base of an amount equal to those newly accrued ADITS.
Stranded Costs Recovery
As indicated above, CLP was able, before the restructuring act, to recover its investment in each of its assets through the depreciation component of its electric charge. Thus, when a plant was sold at auction for a price less than the portion of CLP's investment in that plant which had not yet been recovered from ratepayers through depreciation expense (unamortized cost), CLP suffered a capital loss equal to the difference, between its unamortized cost and the sale price. That difference, in utility jargon, is a stranded cost (stranded cost). "Stranded" is the appropriate term because, after the restructuring act, CLP no longer had an electric charge containing a depreciation component for a generating plant through which it could recoup the unamortized portion of its investment in that plant.
Even though CLP no longer generates electricity, it remains in the business of transmitting and distributing electricity which is generated by others. To compensate CLP for those services, the DPUC establishes a service rate (service rate) which is paid by ratepayers. The DPUC includes in CLP's service rate a component, based on its cumulative stranded costs (stranded cost rate base), which is intended to allow CLP to recover its stranded costs over time and to earn its allowed rate of return on those stranded costs.
Pursuant to the restructuring act, CLP has to offer electricity to those who choose not to purchase electricity directly from generators. CLP thus purchases electricity from generators, which it then resells to CLP ratepayers. The charge for that resold electricity is established by the DPUC (standard offer). The standard offer also has a component, based on CLP's stranded cost rate base, which is calculated to allow it to recover those stranded costs over time and to earn its allowed rate of return on those stranded costs.
Capital Losses Under Federal Tax Accounting and Utility Accounting
When a plant was depreciated over 10 years for federal tax purposes and over 40 years for rate-making purposes, its DPUC rate base value was always, throughout those 40 years, higher than its federal tax basis. As a result, some plants were sold at auction for prices greater than their federal tax basis but less than their DPUC rate base value, resulting in simultaneous taxable capital gains for federal tax purposes and capital losses, or stranded costs, for rate-making purposes.
DPUC'S Accounting Treatment of ADITS For a Post Restructuring Act Sale to an Affiliate
The restructuring act allows nonregulated affiliates of utilities to bid for plants being sold at auction. This vehicle is intended to increase the number of bidders, in the hope that more bidders will mean higher auction prices which, in turn, will minimize stranded costs and depress service rates and standard offers. The DPUC's accounting treatment of ADITS after a plant is sold to an affiliate, which was affirmed in the decision, is to add, annually, to CLP's stranded cost rate base the annual intercompany payments most recently made by CLP to the affiliate. In that way, there is restored to CLP's stranded cost rate base, over 20 years, an amount equal to all subtractions which had been made from its pre-restructuring act rate basis while ADITS had accrued during the accelerated depreciation period.
Circumstances Giving Rise To This Appeal
This case arises out of the sale at auction of hydro-electric generation plants (hydro plants), which carried ADITS, at prices in excess of both their federal tax bases and their DPUC depreciated values by CLP to an affiliate buyer.
CLP's Position
CLP argues that, instead of adding, annually, to its stranded cost rate base one-twentieth of the annual intercompany payments which the IRC requires CLP to pay to its affiliate buyer over 20 years, the DPUC should have added the entire ADITS for those plants to its stranded cost rate base, immediately upon the conclusion of that sale; that is, before any of the annual intercompany payments had been made by CLP.
Defendants' Position
The DPUC and the office of consumer counsel (OCC) argue that it would have been improper to add to CLP's stranded cost rate base all of the ADITS which existed for the hydro plants at the time of the sale. They point out that to do so would have increased CLP's stranded cost rate base (on which it realizes its allowed rate of return) by the amount of ADITS for the sold plants, even though CLP would continue to have the use of the portion of those ADITS which had not yet been paid over to its affiliate. In that way, they argue, CLP would realize a double return on the balance of its ADITS.
III. DISCUSSION
The narrow issue between the parties is whether the entire ADITS for the hydro plants should have been added to CLP's stranded cost rate base at the time of sale of those plants. Because CLP is entitled to a return on its stranded cost rate base, enlarging that base by the amount of the ADITS would increase the service rate and the standard offer. Because the outcome of this case will have a direct effect on those rates, this decision is based on the law governing the making of utility rates.
Utility rates are governed by constitution and statute. The underlying constitutional principle concerning rate base was articulated in Duquesne Light Co. v. Barasch, 488 U.S. 299, 109 S.Ct. 609 (1989), where the United States Supreme Court noted with approval:
General Statutes §§ 16a-19(a) and 16-19e(a)(4). (Further section references are to the General Statutes.)
[T]he just compensation safeguarded to a utility by the fourteenth amendment of the federal constitution is a reasonable return on the fair value of its property at the time it is being used for public service.
Id. at 305 (internal citations omitted; internal quotation marks omitted).
The Connecticut Supreme Court also spoke on the constitutional mandate concerning return on rate base in New Haven v. New Haven Water Co., 118 Conn. 389, 172 A. 767 (1934), where it said:
A basic consideration in deciding what are reasonable and proper rates to be charged by a public utility is the fair value of its property useful and being used by it in the service of the public, as just compensation consists in a fair return upon such reasonable value.
Id. at 401.
Section 16-19e(a)(4) mandates "that the level and structure of rates be sufficient, but no more than sufficient, to allow public service companies to cover their operating and capital costs, to attract needed capital and to maintain their financial integrity . . ."
In Vernon v. Public Utilities Commission, 164 Conn. 117, 318 A.2d 128 (1972), the Connecticut Supreme Court adopted the trial court's memorandum of decision, reported at 30 Conn.Sup. 36. Vernon concerned, inter alia, the public utility commission's decision to add new investment by a water company to its rate base. The Vernon trial court observed:
The water company was . . . forced to construct a water treatment plant which would furnish water of satisfactory quality to its customers. It did so at a considerable expense and has dedicated the plant to public service. To require it to continue to do so without reasonable compensation would be unfair and confiscatory.
Id. at 46.
In the New Haven case, the court also made the following observation on the manner of determining the rate base of a public utility:
. . . Ascertainment of this value `is not a matter of formulas, but there must be a reasonable judgment having its basis in a proper consideration of all relevant facts.'
New Haven v. New Haven Water Co., supra, at 401 (internal citation omitted).
Synthesizing Duquesne, New Haven and Vernon with the directive of § 16-19e(a)(4), CLP's return should be no greater than what is necessary to allow it to perform its statutory function, and determining the rate base for that return is not a formulaic calculation, but rather a reasoned judgment to be made by the DPUC within a band of authorized discretion.
The issue in this case can now be phrased, in the language of the New Haven court, whether the ADITS, before they are paid over to CLP's affiliate buyer, are "useful and being used . . . in the service of the public . . ." for rate-making purposes.
The ADITS for the hydro plants are, in reality, bookkeeping entries. They reflect revenues previously received by CLP in excess of its allowed rate of return, which were subtracted from its rate base as those excess revenues were received. Under the decision, when the ADITS are paid over to CLP's affiliate buyer, these entries will be reversed and the amounts previously subtracted will be restored to CLP's rate base (in this case, stranded cost rate base).
Upon the sale of the hydro plants, the ADITS were not transformed into new plant or equipment "useful and being used . . . in the service of the public . . ." Rather, they remained bookkeeping entries. Because any benefit from the ADITS inures to CLP, and since the ratepayers do not share in those benefits, the court cannot conclude that the DPUC went beyond its permitted band of authority in deferring the addition of the ADITS to CLP's stranded cost rate base until the ADITS are actually paid over to its affiliate buyer. As the DPUC has ruled, when the ADITS have been paid over, there will be no reason to continue to subtract them from the stranded cost rate base, and they will then be restored to CLP's stranded cost rate base so that CLP will then be entitled to amortize and earn a return on them.
The parties have stipulated that a sale by CLP of the hydro plants to a nonaffiliate, which would have triggered the payment of the entire ADITS in federal taxes and the immediate addition of the entire ADITS to CLP's stranded cost rate base, would have been more advantageous to CLP than the treatment of the ADITS provided in the decision. From that stipulation, CLP argues that the DPUC was obligated to treat the ADITS in this case as if the hydro plants had been sold to a nonaffiliate, by adding the entire ADITS to its stranded cost rate base immediately upon the sale.
The accounting anomaly created by the IRC's different treatment of ADITS when an asset is sold to an affiliate rather than to a nonaffiliate does not establish that the ADITS are, in the words of the New Haven court, "useful and being used . . . in the service of the public." While the DPUC is required to consider the tax obligations of CLP in determining its operating expense for ratesetting purposes, the DPUC is not obligated to track, in lockstep, the IRC's accounting system. This is particularly true when the effect of the IRC is to defer a CLP tax liability (hardly onerous to CLP) rather than to accelerate it.
In sum, the DPUC was obligated to establish rates for CLP that are "no more than sufficient" to allow it to perform its duties as a public utility. Within that mandate, the DPUC was free to conclude that adding an amount equal to the entire ADITS to rate base, while CLP still held and could receive a return on some of those ADITS, would allow a return that was "more than sufficient."
Section 16-19e(a)(4).
Private Letter Rulings
After the decision was issued, the Internal Revenue Service (IRS) released Internal Revenue Service Private Letter Ruling No. 200418001, release date April 30, 2004, (PLR1). CLP argued that PLR1 indicated that the IRS would rule that the DPUC's treatment of CLP's ADITS would bar CLP from employing accelerated depreciation in the future. The court inquired whether CLP wanted this matter remanded to the DPUC for consideration of the effects of PLR1. CLP responded that it did not want the matter remanded for that purpose.
Since the last hearing on the appeal, the IRS has issued Internal Revenue Service Private Letter Ruling No. ____ (PLR-128393-00, release date ____ (letter to David R. McHale, Connecticut Light and Power Company, dated April 18, 2006) (PLR2). If any of the parties wants this matter remanded to the DPUC for consideration of PLR2, a request for reconsideration should be filed promptly with the court.
IV. CONCLUSION
The appeal is dismissed.