26 July 2018 FERC tax allowance orders issued The Federal Energy Regulatory Commission (FERC) recently released an Order on Rehearing (Docket No. PL17-1-001) providing guidance on the elimination of income tax allowances from cost-of-service rates under the post-United Airlines policy. Concurrently, FERC released a Final Rule (Docket 18-11-000) setting forth procedures to determine the impact of the Tax Cuts and Jobs Act (TCJA) and the case of United Airlines v. FERC, 827 F.3d 122, (D.C. Cir. 2016), on interstate natural gas pipelines' revenue requirements, including voluntary actions to reduce rates to reflect the income tax rate reductions and the United Airlines decision. On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), which lowered the corporate income tax rate from 35% to 21% and permitted up to a 20% deduction of pass-through income, effective January 1, 2018. Consequently, the TCJA has rate-recovery implications for income tax allowances for partnerships interests permitted under FERC's Policy Statement on Income Tax Allowances (Docket No. PL05-5-000), issued back in May 2005. On March 15, 2018, FERC issued a Notice of Proposed Rulemaking (NOPR), in response to the DC Circuit's remand of United Airlines, stating it no longer will allow master limited partnership (MLP) interstate natural gas and oil pipelines to recover an income tax allowance in cost-of-service rates. In United Airlines, the Court held that FERC failed to demonstrate there was no double recovery of income tax costs when permitting SFPP, L.P., an MLP, to recover both an income tax allowance and a return on equity determined by the discounted cash flow methodology. (See Tax Alert 2018-0660) Generally, interstate natural gas pipelines set stated rates for their services under a Natural Gas Act (NGA) Section 4 or 5 rate-making proceeding designed to provide the pipeline the opportunity to recover all components of the pipeline's cost of service, including income tax allowances. Most of the agreements are "black box" settlements that do not provide detailed cost-of-service information. In a Section 4 general rate case proceeding, the pipeline files to reset its rates and, in these proceedings, the Commission reviews all of a pipeline's rates and services. The Commission has authority to initiate a Section 5 proceeding to require prospective changes in the rates charged by a pipeline when it can be demonstrated that the rates are no longer just and reasonable. In a Section 5 proceeding, the Commission has the burden of demonstrating that the currently effective rates of the pipeline are no longer just and reasonable, and of establishing just and reasonable rates. FERC has granted most interstate natural gas pipelines negotiated rate authority, allowing the pipelines to set rates directly with individual customers. Cost-based recourse rates must be on file with FERC in order to be eligible for negotiated rate authority. Changes to recourse rates occurring under NGA Sections 4 and 5 do not affect a customer's negotiated rate since the negotiated rate is a rate-making alternative. FERC also provides market-based rates negotiated between the pipeline and its customers, subject to an approved tariff on file with FERC. Lastly, for local distribution pipelines served by interstate pipelines, rates may be set by an approved state regulatory agency or the local distribution pipeline may petition for approval of its own proposed rates as fair and equitable under the Natural Gas Policy Act of 1978 (NGPA). The Order on Rehearing (Docket No. PL17-1-001) focuses on corrective actions pertaining to the previously issued NOPR on March 15, 2018, in which FERC, in the United Airlines case, concluded the impermissible double recovery of investors' tax costs resulted from granting an MLP pipeline both an income tax allowance and a discounted cash flow (DCF) return on equity (ROE). The FERC order on rehearing puts forth a series of "carrots" to pipelines that exercise their Section 4 filing rights to quickly flow those tax benefits back to their customers rather than a Section 5 general rate case proceeding (the stick). FERC clarified that, under the revised policy, if an MLP or other pass-through pipeline eliminates its income tax allowance from its cost of service, the Commission anticipates that accumulated deferred income tax (ADIT) will similarly be removed from the cost of service. The Commission noted that this guidance does not create a binding rule, but rather is an expression of general policy intent and that FERC will have to fully support and justify the application of this guidance in individual cases. FERC recognized uncertainty regarding the treatment of previously accumulated sums in ADIT before an MLP pipeline's elimination of its income tax allowance and requested comment. In light of these comments, FERC clarified that an MLP pipeline (or other pass-through entity) no longer recovering an income tax allowance under the revised policy may also eliminate previously-accumulated sums in ADIT from cost of service instead of flowing these previously-accumulated ADIT balances to ratepayers. It was felt this adjustment was necessary to comply with the normalization rules and to avoid retroactive rate-making considerations. It is noteworthy that the Commission indicated there is nothing preventing a shipper from claiming an income tax allowance in the future if it can prove there is no double collection of taxes. FERC issued Final Ruling (Docket 18-11-000), adopting procedures for determining which jurisdictional natural gas pipelines may be collecting unjust and unreasonable rates in light of the TCJA and the United Airlines case. The Commission sets forth four options for each interstate natural gas pipeline from which to choose in filing the one-time report (Form 501-G), including to voluntarily make a filing to address the changes to the pipeline's recovery of tax costs, or explain why no action is needed. FERC modifies, however, the NOPR's proposed treatment of MLP pipelines and other pass-through entities in several respects. First, FERC Form No. 501-G will automatically enter a federal and state income tax of zero and eliminate ADIT from the pipeline's cost of service. Second, the final rule specifies that an interstate gas pipeline could file a limited NGA Section 4 filing to reduce rates for the lower federal tax rates and eliminate the MLP income tax allowance on a single-issue basis, without consideration of any other cost or revenue changes. Additionally, FERC Form No. 501-G, is modified to include the hypothetical capital structure to be used by pipelines that cannot use their own or their parent's capital structure. Finally, FERC stated that it will not initiate an NGA Section 5 rate investigation for a three-year moratorium period of an interstate pipeline that makes a limited NGA Section 4 rate-reduction filing that reduces its ROE to 12% or less. The final rule requires all interstate natural gas pipelines that file a 2017 FERC Form No. 2 or 2-A and have cost-based, stated rates for service under any rate schedule to file with the Commission a FERC Form No. 501-G, referred to as the One-time Report. A natural gas company currently undergoing an NGA Section 4 or 5 rate case proceeding need not file the One-time Report. The One-time Report is an Excel spreadsheet with formulas that estimate: (1) the percentage reduction in the pipeline's cost of service as a result of the TCJA and the United Airlines case, and (2) the pipeline's current ROEs before and after the reduction in corporate income taxes and the elimination of income tax allowances for MLP pipelines. Despite comments to the contrary, FERC maintained that the One-time Report is not the equivalent of an NGA Section 4 rate filing nor does it improperly shift to the pipeline the burden of justifying its existing rates in violation of NGA Section 5. In addition to filing FERC Form No. 501-G, an interstate natural gas pipeline may opt to file a limited NGA Section 4 filing to reduce its rates to reflect the reduced income tax rates and elimination of the MLP pipeline income tax allowance on a single-issue basis, without consideration of any other cost or revenue changes. FERC noted that it generally does not permit pipelines to change any single component of their cost of service outside of a general NGA Section 4 rate case but believes an exception to that policy is justified in order to allow interstate pipelines to voluntarily reduce their rates as soon as possible. Alternatively, an interstate natural gas pipeline may include with its FERC Form No. 501-G a commitment to file either a prepackaged uncontested settlement or, if that is not possible, a general NGA Section 4 rate case to revise its rates based upon current cost data. A pipeline choosing this option should indicate an approximate time frame regarding when it will file the settlement or the NGA Section 4 filing. FERC created a safe harbor that, if a pipeline commits to make that filing by December 31, 2018, FERC will not initiate an NGA Section 5 investigation of its rates before that date. While FERC denied requests from commenters to universally extend the safe harbor period, it clarified that, if a pipeline is engaged in productive settlement negotiations as the December 31, 2018, end-of-the-safe-harbor period approaches, it may file a request for an extension of the safe harbor period. A pipeline also has the option to include with its FERC Form No. 501-G a statement explaining why no adjustment in its rates is needed. The statement should include a full explanation of why, after accounting for its reduction in tax costs, its rates do not recover its overall cost of service and therefore no rate reduction is justified. The pipeline would provide this statement along with any additional supporting information it deems necessary. Finally, a pipeline may choose to take no action other than submitting FERC Form No. 501-G. FERC stated that this is consistent with the fact that it lacks authority to order an interstate pipeline to file a rate change under NGA Section 4. FERC adopted the proposed 28-day staggered implementation schedule with the 133 identified pipelines divided into three groups. Under this schedule, all filings will be completed by early December. TCJA provided a regulated trade or business carve-out provision for gas pipelines (including gas and electric utilities) if rates for furnishing or selling have been established or approved by a state public commission or agency of the United States. Gas pipelines satisfying the definition of the TCJA regulated trade or business are not subject to the revised Section 163(j) interest limitation and not eligible for immediate expensing for qualified property. Analysis and determination of whether gas pipelines are viewed as a TCJA regulated trade or business is key given the impact of 100% expensing and interest deductibility to ADIT in rate base as a component of rates. Many gas companies include bundled pipeline and storage services; the TCJA did not mention storage or any other ancillary services common in the midstream industry, which raises issues on interpretation of TCJA and implications to tax allowances recovered in rates. In addition, as previously stated, FERC permits negotiated and market-based rate authority when pipelines negotiate rates directly with customers, which raises the issue of whether this type of rate-making satisfies the TCJA requirement of rates established or approved by FERC. Another consideration is to review regulatory alternatives for flowing back tax savings to customers pertaining to the excess ADIT that generally was established as a regulatory liability in the period of TCJA enactment and to be amortized back to customers based on agreed-upon settlements with the state or federal commissions. TCJA prescribed federal normalization methods to flow back ADIT for Section 167 and 168 accelerated depreciation (referred to as protected balances), but all other ADIT components, such as benefits, repairs, reserves (referred to as unprotected balances) flow back over a negotiated period with the Commission. The Section 4 filing under Option 1 proceeds on a single-issue basis, without consideration of any other cost or revenue changes, whereas a Section 5 filing reviews all of a pipeline's components for rates and services, which may allow for flexibility in flowing back tax savings. Certain public utilities have prevailed in reinvesting a portion of the tax savings into infrastructure investments, balancing passing benefits to current and future generations. Gas pipelines will be evaluating options to flow back tax savings to their customers and it may be advantageous to proceed with a Section 5 case for a more comprehensive rate case proceeding to achieve a reinvestment strategy. Lastly, consideration of the implications to the overall financial company position, including earnings, credit ratings, capital investment plans, distributions and valuation will be key to identity risks and raise strategic alternatives. Risk factors disclosed in SEC filings may need to be updated for such financial implications. Upfront regulatory tax planning associated with the recovery of tax allowances in cost of service and rate base will be critical for a successful outcome in the next full rate case proceeding. The Commission has put forth orders for gas pipelines to properly adjust tax allowances recovered in rates for both: 1) the double-inclusion of taxes in cost-of-service models applying a discounted cash flow as presented in the United Airlines case and 2) the lower federal tax rates enacted with TCJA. FERC also recognized the need for rate-making guidance intended to flow back tax savings to customers in a more expeditious manner prospectively. Careful analysis and planning of the one-time filing options presented in the Final Ruling will be critical to achieve more favorable outcomes and minimize unintended consequences. Document ID: 2018-1505 |
