backOn July 18, 2018, FERC issued two orders that address the manner in which pipelines may include allowances for income taxes in their ratemaking calculations. These orders include the following findings by the Commission that may significantly affect certain pipelines and their customers: (1) pass-through entity pipelines owned by corporations may collect tax allowances through rates, (2) pass-through entity pipelines that eliminate income tax allowances from ratemaking calculations may also eliminate accumulated deferred income tax (ADIT) balances, and (3) customers of a pass-through entity pipeline that eliminates tax allowances and ADIT balances are not entitled to credits or refunds for any ADIT balances so eliminated.
Revised Policy Statement – Order on Rehearing
FERC’s Order on Rehearing[1] of its March 15, 2018 Revised Policy Statement on Treatment of Income Taxes[2] elaborates on the Commission’s response to United Airlines,[3] a D.C. Circuit Court of Appeals decision on judicial review of a crude oil pipeline rate order in which the court held that FERC had failed to explain why there was no double recovery of income taxes when the Commission authorized a pipeline owned in a master limited partnership (MLP) structure to recover a rate of return, calculated using the discounted cash flow (DCF) methodology, as well as an allowance for income taxes. The court directed FERC to explain on remand why such a double recovery would not occur. Rather than provide an explanation, FERC chose to accept the proposition that granting MLP-owned pipelines an allowance for income taxes while also employing the DCF methodology would result in a double recovery of income tax expense, and issued the Revised Policy Statement and related issuances. Taken together, the Revised Policy Statement and the companion issuances effectively precluded an MLP-owned pipeline, and potentially other pass-through entities, from including income tax allowances in their ratemaking calculations.
FERC’s practice is to dismiss requests for rehearing of a policy statement and reserve any further discussions of the issues for specific proceedings in which the policy is applied, because a party is not aggrieved by an order of the Commission until the policy is applied to that party. Accordingly, FERC dismissed the requests for rehearing. FERC did, however, provide significant guidance on two topics:
- Because the Revised Policy Statement is not a rule of law, pass-through entities may in future proceedings include allowances for income taxes in ratemaking calculations (calculated on the basis of the currently effective 21% corporate income tax rate) along with argument and evidentiary support justifying the inclusion of such allowances.
- A pass-through entity that eliminates income tax allowances from its ratemaking calculations may also eliminate the effects of previously-accumulated ADIT balances from its calculations without being required to credit such previously-accumulated ADIT balances for the benefit of ratepayers.
FERC noted that elimination of ADIT, which serves as a no-cost source of financing in ratemaking calculations, would tend to increase rates. Thus, eliminating ADIT from ratemaking calculations would offset the effect of eliminating income tax allowances. In determining that customers are not entitled to refunds for elimination of a pass-through entity’s previously-accumulated ADIT balances, FERC stated that this guidance is consistent with: (1) Commission and Internal Revenue Service regulations; (2) Commission precedent that shippers do not have an ownership interest in previously accumulated sums in ADIT; and (3) D.C. Circuit precedent suggesting that returning the ADIT amounts would violate the prohibition against retroactive ratemaking.
Commissioners LaFleur and Glick filed a concurrence stating their belief that, for a pass-through entity that eliminates its income tax allowances, the arguments for applying previously-accrued ADIT balances to reduce future rate base are compelling. However, they recognize the majority’s position that action by the Commission to mandate those reductions would be prohibited as retroactive ratemaking. They further call for a “legislative fix” for the Commission’s lack of authority to establish a refund date under NGA Section 5, claiming that the lack of such authority will delay the benefits to customers of income tax-related rate reductions. Commissioners LaFleur and Glick filed an essentially identical concurrence to the rulemaking order discussed below.
Order No. 849 – Final Rule
In Order No. 849, FERC adopted procedures for determining which jurisdictional natural gas pipelines may be collecting unjust and unreasonable rates in light of changes in tax law and Commission policy.[4] The rulemaking was motivated by FERC’s desire to investigate whether rate reductions would be appropriate as a result of the reduction in the corporate income tax rate under the Tax Cuts and Jobs Act[5] from 35% to 21% and the United Airlines decision (as addressed in the Revised Policy Statement).
The primary innovation introduced in Order No. 849 is a one-time reporting requirement, to be satisfied by filing new Form No. 501-G, which is designed to present the effect of the change in the tax rate and tax allowances on each pipeline’s cost recovery and rates. FERC proposes to use this information to determine whether rate adjustments are appropriate and, if so, the magnitude of such adjustments. FERC observed that some pipelines may be able to demonstrate that their current rates continue to be just and reasonable even after factoring in the lower income tax rate and/or elimination of tax allowances.[6]
FERC’s Form No. 501-G uses a structured spreadsheet into which pipelines are to enter their Form No. 2 or 2-A information. The spreadsheet includes formulas that mandate key calculations, such as the tax allowance and the indicated rate reduction. The structure of the spreadsheet does not afford pipelines flexibility in making their Form No. 501-G filings. FERC received numerous comments regarding this lack of flexibility, but generally made only minor changes to the Form No. 501-G format. FERC did, however, provide for an Addendum to Form No. 501-G. FERC notes throughout Order No. 849 that a pipeline may use the Addendum to provide information regarding its unique circumstances.
In addition to filing Form No. 501-G, each interstate natural gas pipeline must elect one of the following options:
- Option 1 - Voluntarily implement the rate reduction indicated by Form No. 501-G by making a limited NGA Section 4 filing proposing to adjust rates;
- Option 2 - Indicate that the company will voluntarily initiate a Section 4 general rate case by December 31, 2018;
- Option 3 - Explain why the rate reduction indicated by Form No. 501-G would be inappropriate (e.g., because the current rates result in an under-recovery of the pipeline’s costs or because a settlement moratorium is in effect); or
- Option 4 - Do nothing other than filing Form No. 501-G.[7]
FERC stated that it will consider undertaking Section 5 proceedings against pipelines that do not voluntary take action to reduce their rates.
For a pass-through entity, the Form No. 501-G spreadsheet formulas calculate a tax allowance of zero. In accordance with the concurrent guidance issued for the Revised Policy Statement, FERC has revised the formulas so that they also eliminate a pass-through entity’s ADIT balances. FERC notes, however, that since the Revised Policy Statement is not a rule of law, pass-through entities are not prohibited from including allowances for income taxes in their ratemaking calculations. Accordingly, a pass-through entity is only required to revise its tax allowance calculations to use the 21% federal income tax rate in making an Option 1 voluntary rate reduction. FERC notes that a pipeline may reflect and justify such calculations in the Addendum.
FERC included provisions in Order No. 849 that are likely to affect the rights of a number of pipelines and their customers:
- FERC held that a pass-through entity pipeline whose income is consolidated on the tax return of a parent company organized as a corporation may include an allowance for income taxes in its rates.
- As an incentive to pipelines to voluntarily reduce their rates (FERC recognized that it cannot order a pipeline to make a Section 4 filing), the Commission will grant a three-year moratorium from Section 5 review to a pipeline that properly implements an Option 1 rate reduction, if its Form No. 501-G filing indicates that the pipeline’s return on equity is 12% or less.
- FERC will not presume that settlements filed prior to March 26, 2018 properly incorporate the tax-related issues addressed by the rulemaking. A pipeline may explain in its Form No. 501-G Addendum how its settlement addresses such tax related-issues.
- FERC retained its position, as expressed in the Notice of Proposed Rulemaking, that rates charged to customers under negotiated rate agreements would not be subject to adjustments to reflect changes under the Tax Cuts and Jobs Act or the United Airlines decision.
The Commission determined that it would address tax-related rate reductions for intrastate and Hinshaw pipelines under its current five-rate review procedure; provided that, if an intrastate pipeline’s rates on file with the appropriate state regulatory agency are reduced to reflect the lower income tax rate, the intrastate pipeline must file a new rate election with FERC. Filing of such a rate election restarts the clock for the pipeline’s five-year rate review.
The Final Rule becomes effective on September 13, 2018, 45 days following the July 30, 2018 publication of Order No. 849 in the Federal Register. The rulemaking’s Implementation Guide provides a schedule for pipeline companies to make their Form No. 501-G filings. Pipeline companies are arranged into three groups: the first group’s filings are due 28 days following the rule’s effective date; the second group’s filings are due 28 days after that first group’s filings; and the third group’s filings are due 28 days after the second group’s filings.
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