On June 11, 2016, Pennsylvania enacted House Bill 1436, which prohibits the use of consolidated tax savings adjustments ("CTSA") in public utility ratemaking. A CTSA is an adjustment to the revenue requirement in a rate case that attempts to capture, for ratepayers, the tax benefits associated with the losses of unregulated operations that a utility holding company may realize by filing a consolidated tax return. Typically, a state public utility commission attempts to implement a CTSA by either: (1) reducing a utility's rate base by the tax savings the utility may experience when its parent company files a consolidated tax return; or (2) computing the federal income tax expense included in a utility's cost of service with reference to the utility's pro rata share of its parent company's net operating losses and the related tax benefits.

CTSAs are controversial and not widely used by state public utility commissions when setting rates because the use of a CTSA may violate the stand-alone principle of ratemaking and may also result in the loss of funds available to the utility for infrastructure investment. For that reason, until relatively recently, only five state public utility commissions routinely imposed CTSAs; New Jersey, Oregon, Pennsylvania, Texas, and West Virginia. Over the past decade, Oregon and Texas have legislatively prohibited the use of CTSAs and New Jersey has revised its CTSA methodology to mitigate the revenue requirement impact of the adjustment. Thus, today, only Pennsylvania and West Virginia routinely impose CTSAs upon rate-regulated utilities.

Historically, Pennsylvania courts require the Pennsylvania Public Utility Commission (the PUC) to impose a CTSA upon a rate-regulated utility unless the utility can demonstrate that will not be able to take advantage of the consolidated tax savings that the utility's parent company may realize, i.e., the utility is expected to incur a net operating loss for federal income tax purposes during the test period.¹ Currently, the PUC calculates the CTSA based upon the average of the three most recent consolidated tax returns available when the rate case is filed, excluding non-recurring items. The PUC sets the CTSA to zero when the utility expects to have a net operating loss for the test period.

House Bill 1436 prohibits the use of a CTSA by stating: "If an expense or investment is allowed to be included in a public utility's rates for ratemaking purposes, the related income tax deductions and credits shall also be included in the computation of current or deferred income tax expense to reduce rates. If an expense or investment is not allowed to be included in a public utility's rates, the related income tax deductions and credits, including tax losses of the public utility's parent or affiliated companies, shall not be included in the computation of income tax expense to reduce rates. The deferred income taxes used to determine the rate base of a public utility for ratemaking purposes shall be based solely on the tax deductions and credits received by the public utility and shall not include any deductions or credits generated by the expenses or investments of a public utility's parent or any affiliated entity. The income tax expense shall be computed using the applicable statutory income tax rates."

Implications

According to Pennsylvania's Office of Consumer Advocate, the use of CTSAs by the PUC in recent Pennsylvania rate cases has, cumulatively, reduced utility revenue requirements by approximately $30 million. As a result of the prohibition on the use of CTSAs, Pennsylvania utilities will need to evaluate the effect of this legislative development on current rate structures. This legislation should result in more flexibility to make nonregulated investments without the risk of regulatory backlash. By legislatively prohibiting the use of CTSAs in public utility ratemaking, Pennsylvania joins the recent trend established by New Jersey, Oregon and Texas to reduce the effect of, or to repeal the use of, CTSAs. Even though there is a trend away from the use of CTSAs in public utility ratemaking, many state public utility commissions are under increasing pressure to reduce utility rates. Because most state regulators have the discretion to impose a CTSA, the use of CTSAs in public utility ratemaking has the potential to arise in other states that do not routinely impose CTSAs.

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ENDNOTES

¹ See Barasch v. Pa. Public Utility Comm'n, 507 Pa. 561, 493 A.2d 653 (1985); Met-Ed Indus. Users Group v. Pa. Public Utility Comm'n, 2008 Pa. Commw. LEXIS 534 (2008); Barasch v. Pa. Public Utility Comm'n, 120 Pa. Commw. 292, 548 A.2d 1310 (1988); Continental Tel. Co. v. Pa. Public Utility Comm'n, 120 Pa. Commw. 25 (1988); Western Pa. Water Co. v. Pa. Public Utility Comm'n, 54 Pa. Commw. 187 (1980); Bell Tel. Co. v. Pa. Public Utility Comm'n, 47 Pa. Commw. 614 (1979); Bell Tel. Co. v. Pa. Public Utility Comm'n, 17 Pa. Commw. 333 (1975); Riverton Consol. Water Co. v. Pa. Public Utility Comm'n, 186 Pa. Super. 1 (1958); Pittsburgh v. Pa. Public Utility Comm'n, 182 Pa. Super. 551 (1956).