Case ID: ohio-st_174/html/0575-01.html
Source: Caselaw Access Project
Author: {"author": "O’Neill, J. Zimmerman, J., Herbert, J. Taft, C. J.,", "license": "Public Domain", "url": "https://static.case.law/"}
Date Created: 2024-08-24T03:29:51.129683

General Telephone Co., Appellant, v. Public Utilities Commission of Ohio, Appellee.
    (No. 37280
    Decided May 31, 1963.)
    
      Messrs. Power, Griffith, Jones & Bell, for appellant.
    
      Mr. William B. Saxbe, attorney general, Mr. Andrew B. Sarisky and Mr. Jay C. Floivers, for appellee.
   O’Neill, J.

The commission found the statutory rate base of the appellant company for this rate determination to he $59,827,440, and the appellant agrees that this is correct.

This is the dollar-amount value as of a date certain of the reconstruction cost new less existing depreciation of the property of the public utility, used and useful, in rendering the public utility service for which rates are to be fixed. See paragraph numbered 1, page 443, of the per curiam opinion in City of Cleveland v. Public Utilities Commission, 164 Ohio St., 442, 132 N. E. (2d), 216.

The commission found that the appellant was entitled to a rate of return upon the statutory rate base of 5.8%. See paragraph numbered 2, page 443, of the per curiam opinion in City of Cleveland v. Public Utilities Commission, supra.

The commission found, and it is agreed, that multiplying this 5.8% rate of return by the statutory rate base results in an annual dollar return of $3,469,992 to which the appellant is entitled. See paragraph numbered 3, page 443, of the per curiam opinion in City of Cleveland v. Public Utilities Commission, supra.

It is a simple matter then to determine the actual annual expenses of the company for wages, maintenance, taxes, etc., and calculate the rates required to produce the annual dollar return, plus the annual expenses. See paragraph numbered 4, page 443, of the per curiam opinion in City of Cleveland v. Public Utilities Commission, supra. This is in accord with the steps laid down for determinatoin of rates by the Public Utilities Commission in City of Cleveland v. Public Utilities Commission, supra, in the per curiam opinion at pages 443 and 444 in paragraphs numbered 1 through 6, inclusive.

The error complained of here is that the commission allowed, as an item of expense for federal income taxes, $112,017 less than the amount the federal income tax law requires the appellant to pay upon the annual dollar return which the commission has found the appellant is entitled to receive.

The income tax which the company is required to pay to the federal government under the income tax law on its annual dollar return can be calculated mathematically according to the federal income tax law to an exact accurate amount.

However, instead of allowing this known exact and accurrate expense for taxes to the appellant, the commission chose a different procedure.

At this point in the computation of allowable rates, the commission created a hypothetical public utility company. This was done by capitalizing the statutory rate base and thus converting the statutory rate base {i. e., the dollar-amount value of the public utility’s property) into a capitalization rate base composed of fictitious amounts of debt and fictitious amounts of equity.

This is contrary to law (Sections 4909.04, 4909.05 and 4909.15, Eevised Code).

This is contrary to the decisions of this court in a long line of cases in which the court has held, and repeatedly reaffirmed the proposition, that, for purposes of rate making, the statutory rate base of a public utility company is the dollar value of its property, used and useful, in rendering the public utility service, and that the value is to be found by a determination of the reconstruction cost new less existing depreciation of the prop-of the public utility. Lima Telephone S Telegraph Co. v. Public Utilities Commission, 98 Ohio St., 110, 120 N. E., 330; Lindsey v. Public Utilities Commission, 111 Ohio St., 6, 144 N. E., 729; East Ohio Gas Co. v. Public Utilities Commission, 133 Ohio St., 212, 12 N. E. (2d), 765; City of Marietta v. Public Utilities Commission, 148 Ohio St., 173, 74 N. E. (2d), 74; City of Cleveland v. Public Utilities Commission, supra (164 Ohio St., 442), per curiam opinion, page 443, paragraph numbered 1; and Ohio Edison Co. v. Public Utilities Commission, 173 Ohio St., 478, 184 N. E. (2d), 70, paragraph four of the syllabus.

It can be noted here that all counsel appearing before this court in the oral reargument of this and related public utility cases asserted the position that the “hypothetical company concept” was either unsound regulatory practice or unconstitutional, unlawful and arbitrary, though for different reasons.

The result in this case of this creation of a “hypothetical company” is to create a fictitious debt for the appellant and to create an increased obligation upon the appellant for the payment of $1,243,633 hypothetical interest upon this fictitious debt, when the interest actually paid by the appellant is $1,028,215.

It is apparent that the increased hypothetical interest obligation is $215,418 in excess of the amount which the appellant is actually required to pay. It is admitted that this procedure results in an expense allowance, for federal income tax payment, of an amount -which is $112,017 less than the appellant is actually required to pay the federal government under the income tax law on the annual dollar return which the commission has determined the appellant is entitled to receive.

The commission computed the expense item for income tax by taking the allowed annual dollar return of $3,469,992 and deducting from it hypothetical interest of $1,243,633, which left taxable income of $2,226,359.

This taxable income of $2,226,359 multiplied by the federal income tax rate of 52% gives a tax due of $1,157,706.68.

However, when the company goes to compute its tax the federal income tax law will not permit the deduction of hypothetical interest. The law requires that only the actual interest paid can be deducted.

Under the federal income tax law the tax must be computed by taking the allowed annual dollar return of $3,469,992 and deducting from it the actual interest paid of $1,028,215, which leaves a taxable income of $2,441,777. This multiplied by the 52% tax rate gives a tax which the company must pay of $1,269,724.04.

The commission allowed as expense for income tax $1,157,706.68. The company is required by law to pay $1,269,724.04. The commission allowed $112,017.36 less than the company is required to pay by the federal tax law. This is admitted by the commission.

The result of this is to compel the appellant to divert $112,017 of the annual dollar return which it is entitled to receive for the use of its property to pay the expense of federal income taxes. This means that the appellant actually has $112,017 less dollars for its annual dollar return than the commission has found it is entitled to receive, i. e., $3,357,975 instead of $3,469,992.

The commission found that the appellant was entitled to a rate of return of 5.8%. The amount of $3,357,975 is a 5.8% return on a rate base of $57,896,121. This is $1,931,319 less than the rate base ($59,827,440) which the commission found to be the statutory rate base in this case.

It is apparent that the creation of this “hypothetical company” has as its ultimate purpose the reduction of the statutory rate base, which is a circumvention of the law of Ohio. It should be noted that the rate base arrived at by the hypothetical-company procedure was not determined by finding the reconstruction cost new less existing depreciation of the property of the public utility company, used and useful, in rendering a public utility service, as required by the statutes of Ohio and the decisions of this court. It is $1,931,319 less than the statutory rate base and it is a figure which is unrelated to the capitalization of the actual company, to the book value of the actual company and to the statutory rate base of the actual company. This is arbitrary and contrary to law. Lima Telephone & Telegraph Co. v. Public Utilities Commission, supra; Lindsey v. Public Utilities Commission, supra; East Ohio Gas Co. v. Public Utilities Commission, supra; City of Marietta v. Public Utilities Commission, supra; City of Cleveland v. Public Utilities Commission, supra, per curiam opinion, page 443, paragraph numbered 1; and Ohio Edison Co. v. Public Utilities Commission, supra, paragraph four of the syllabus.

If it is argued that the statutory rate base dollar amount is not reduced, then it must be conceded that an annual dollar return of $3,357,975 is a return of only 5.61% on a rate base of $59,827,440, whereas the commission has held that the appellant is entitled to an annual fair rate of return of 5.8%. This reduction in the annual fair rate of return is arbitrary and contrary to law.

At first it was argued, in defense of this unusual procedure, that income tax was not an item of expense, but part of the cost of capital. This contention was disposed of in City of Cincinnati v. Public Utilities Commission, 153 Ohio St., 56, 90 N. E. 126), 681, paragraph two of the syllabus of which reads:

“The general rule is that validly imposed taxes of all kinds paid by a utility may properly be considered as an operating expense of such utility for rate-making purposes.”

Such holding was reaffirmed in Ohio Edison Co. v. Public Utilities Commission, supra, where the court said, in discussing this exact problem, at page 490:

“The commission should not have so reduced the amount allowed as expense for federal income tax.”

It is now contended that this procedure is justified because there is a tax advantage to the company.

This position is equally untenable. There is no tax advantage because the federal income tax law does not permit the deduction of hypothetical interest in computing income tax. The federal law allows for the deduction of only the amount of interest actually paid. To argue that this is a tax advantage is to assert, in simple words, that it is a tax advantage for a company to be allowed, as expense for income taxes, an amount less than the amount of taxes which it is actually required to pay under the law. It is evident that there is no tax advantage here, but rather a disadvantage which results in the appellant’s annual dollar return to which it is entitled being reduced arbitrarily and either its statutory rate base, which has been determined and agreed upon, being reduced arbitrarily and unlawfully, or the annual fair rate of return which the commission has held it is entitled to receive being reduced arbitrarily and unlawfully.

In East Ohio Gas Co. v. Public Utilities Commission, 133 Ohio St., 212, the commission allowed less for income tax than the company was actually required to pay. Judge Gorman, in his opinion at page 226, said:

“* * * An allowance for the payment of federal income taxes must be made in rate cases. * * *
i i # # #
í í * * * The finding is therefore reversed and remanded with instructions to determine the amount of taxes actually paid or which will be paid during the ordinance period and charged against The East Ohio Gas Company.”

Likewise, the commission allowed less for the payment of excise taxes than the company was required to pay, on the ground that an improvement in economic conditions might result in increased sales for the company, with resulting gains that would more than offset the increased expenses of operation. The court said, at page 227:

“Such a ruling is predicated upon a speculative assumption that neither court nor commission can make. To withhold a complete allowance for taxes because business may improve is mere guess work. ‘To prefer forecast to experience in such cases is arbitrary.’ (Syllabus) West Ohio Gas Co. v. Public Utilities Commission, 294 U. S., 79, 79 L. Ed., 773, 55 S. Ct., 324.
“It being conceded that during the ordinance period the company would be called upon to pay 2.96% for excise taxes, such an amount should be allowed. The finding of the commission that only 2.26% be allowed is hereby reversed, and the commission is instructed to allow the percentage of 2.96% as that actually paid. To do otherwise would be to permit admitted confiscation.”

This court is not passing upon the other alleged errors concerning rate of return and depreciation accrual rates. The commission may re-examine these matters and make a determination concerning each, based upon the competent evidence in the record.

The order is reversed and the cause remanded for further proceedings.

Order reversed.

Zimmerman, Matthias, Griffith and Herbert, JJ., concur.

Zimmerman, J.,

concurring in this case and in cases Nos. 37110, 37111 and 37112, at page 604, and in cases Nos. 37276, 37277 and 37473, at page 585. Although I was one of the concurring judges in the cases of City of Cleveland v. Public Utilities Commission, 164 Ohio St., 442, 132 N. E. (2d), 216, Ohio Fuel Gas Co. v. Public Utilities Commission, 171 Ohio St., 10, 167 N. E. (2d), 496, and Ohio Edison Co. v. Public Utilities Commission, 173 Ohio St., 478, 184 N. E. (2d), 70, I am now of the view that the formulae and procedures outlined and adopted in the two latter cases, which set up a hypothetical company, represent an overly complicated and technical method for determining accurately the rate of return to be allowed a public utility on the rate base as prescribed by statute. It is apparent that neither interested municipalities, the public utilities, nor the Public Utilities Commission is satisfied with the law f>s most recently pronounced by this court. It seems to me that Judge O’Neill in his majority opinions in these cases has materially simplified the methods of procedure to be followed by the Public Utilities Commission in fixing a fair rate of return in line with statutory provisons, and, for these reasons, I am concurring therein.

Matthias, J., concurs in the foregoing concurring opinion.

Herbert, J.

I concur in the opinions of O’Neill, J., in cases Nos. 37110, 37111, 37112, 37276, 37277, 37473 and 37280. I appreciate the thorough study that each member of this court has given to the important and difficult questions raised in these cases.

The complicated, speculative and even disturbing extent to which the hypothetical utility company concept may lead is illustrated in Southern Bell Telephone & Telegraph Co. v. Louisiana Public Service Commission (decided February 25, 1957), 232 La., 446, where in the opinion, at page 462, the following appears:

“Plaintiff contends that in computing its earnings requirement, the commission increased actual earnings by $596,000 — a theoretical amount by which income taxes would be reduced — -with a 45% hypothetical debt ratio; that this fictitious increase in income and downward adjustment in income taxes is based upon the claim that the telephone company should be considered as having a long term debt in its capital structure (which it does not have), and as having paid interest upon that long term debt (which it has not paid).
“Plaintiff further argues that the commission invaded the reasonable range of discretion of its board of directors. Its officials testified, in substance, that the present debt ratio of approximately 22% is the result of prudent and sound policies.”

The court affirmed the order of the commission.

In addition to the speculative forecasting requisite to this method of rate making there is the further possibility that this ‘ ‘ concept ’ ’ may lead to state control and management of public j utilities as is hinted in the Southern Bell case, supra.

Cincinnati Gas & Electric Co. v. Public Utilities Commission, 173 Ohio St., 473 (decided July 5, 1962), indicates a turning point in the thinking of this court relative to theorizing in the areas of rate making. At the foot of page 473 and top of page 474, the court in a per curiam opinion said:

“The company contends that for its future federal income tax liability it should be permitted to ‘normalize’ these taxes for rate-maldng purposes. This would involve having the commission allow for federal income tax expense not only the tax actually paid, but an additional amount of $141,827, equal to the difference between the actual tax and the tax that would have been paid if the company had claimed no more than so-called straight-line depreciation as a deduction from income for federal tax purposes. In other words, the company is contending that the allowance for federal income tax expense should be computed as if straight-line depreciation rather than so-called declining balance depreciation were used.” (Emphasis added.)

Further, on page 474, the court quoted with approval the following conclusion of the Public Utilities Commission:

“* * * we must reject the theory that a deferral of tax liability arises from the use of accelerated depreciation, and consequently must reject normalisation of taxes for rate-mahing purposes; no such deferral exists and no such liability will arise. We will allow only the expense incurred, that is, the federal income tax actually paid by the company. It is our opinion that this treatment will' benefit both the rate-payers and the utility. ’ ’ (Emphasis added.)

It should be noted that that conclusion of the commission was affirmed by a unanimous court, O’Neill, J., dissenting upon another ground, and Thomas Herbert, J., not participating. This is a wholesome doctrine. Neither the ratepayer nor the utility has cause to complain. This doctrine of “actuality” should be encouraged so far as realities permit. We recognize that under any method or formula for rate making there must be indulged some forecast and speculation as to the future.

O’Neill, J., speaking for the majority, and Taft, C. J., for the minority, have ably presented and discussed various phases of the problems incident to rate making.

Griffith, J., concurs in the foregoing concurring opinion.

Taft, C. J.,

dissents for the reasons stated in his dissenting-opinion in the case of Ohio Fuel Gas Co. v. Public Utilities Commission, 174 Ohio St., 585, and especially for the reasons that the syllabus and judgment in the instant case are inconsistent with and cannot be reconciled on any reasonable basis with (1) the opinion by the court in City of Cleveland v. Public Utilities Commission (1956), 164 Ohio St., 442, 444 et seq., 132 N. E. (2d), 216 (concurred in by Judges Matthias, Zimmerman, Stewart, Bell and Taft), (2) the syllabus and judgment in Ohio Fuel Gas Co. v. Public Utilities Commission (1960), 171 Ohio St., 10, 167 N. E. (2d), 496 (concurred in by Judges Zimmerman, Taft, Matthias, Bell and Peck), and (3) the judgments in both Cincinnati Gas & Electric Co. v. Public Utilities Commission (1962), 173 Ohio St., 473, 184 N. E. (2d), 84 (concurred in by Chief Justice Weygandt and Judges Zimmerman, Taft, Matthias and Bell), and Ohio Edison Co. v. Public Utilities Commission (1962), 173 Ohio St., 478, 184 N. E. (2d), 70 (concurred in by Chief Justice Weygandt and Judges Zimmerman, Taft, Matthias, Bell and Griffith).

The apparent effect of the syllabus and decision in the instant case will be to require the ratepayers to provide the utility with an amount which is over $112,000 more than the reasonable annual cost of an amount of capital equal to the agreed RCNLD rate base, and thus with the reasonable annual cost of an amount of capital almost two million dollars ($112,000 is 5.8 fo of $1,930,000 -¡-) in excess of the agreed upon RCNLD rate base.

Gibson, J., concurs in the above dissenting opinion and also in the dissenting opinion referred to therein. (For dissenting opinion by Gibson, J., see page 601.)