Opinion ID: 1720472
Heading Depth: 1
Heading Rank: 7

Heading: Deduction of Interest Expense on Construction Work in Progress

Text: Construction work in progress is a term used to describe that portion of utility plant in the process of construction but not yet placed in service. A utility is generally not allowed to earn a return on such construction until it is actually placed in service. Cf. Application of Northwestern Bell Telephone Co., 78 S.D. 15, 98 N.W.2d 170. There remains the question of how to treat the interest expense incurred on the funds borrowed for such construction. The company elected to capitalize the interest expense in question, amounting to $411,946, by adding the cost of the funds used during construction to the cost of the completed facilities and then recovering this cost through annual depreciation charges. By following this approach, the company argues, future customers receive the tax benefit when the constructed facilities are placed in service. The company claims to have made an allocation of tax benefits between present and future customers by utilizing a net-of-tax or after tax rate in capitalizing the allowance for funds used during construction. To arrive at this net-of-tax figure, the company computed the net cost of that portion of the cost of funds attributable to bond borrowing by deducting from the weighted cost of the bond borrowing the effect of the forty-eight percent federal income tax payable on corporate income. This process is illustrated by one of the company's exhibits: NORTHWESTERN PUBLIC SERVICE COMPANY ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION COMPONENTS OF 7.5% RATE JUNE 30, 1973 TEST YEAR Per Cent of Total Weighted Line Capitalization Gross After Tax Line No. (1) Cost Rate Rate No. ----- -------------- ------- ------- ---------- ------ 1 Bonds 54.36 8.168% (2) 4.440 2.309% (3) 1 2 Preferred Stock 10.83 7.625% .826 .826% 2 3 Common Equity 34.81 4.365% 3 ------ -------- 4 Total 100.00 7.500% ======= ======== (1) Ten Year AverageExhibit B, Statement 17, Page 4-19 (2) Exhibit B, Statement 17, Page 4-19 (3) Gross Cost of Bonds as Reduced by Tax Effect of 48% The cities took the position that the cost of interest on construction work in progress should be deducted in full in the year in which it is accrued. The cities rejected as being unsupported by the record the company's claim that the 7.5% interest rate used as an allowance for funds used during construction was an after tax rate. In many respects, the argument here resembles the dispute over the treatment of the investment tax credit. The company argues that the normalization or capitalization of the interest expense is the only method by which both present and future ratepayers will be treated equitably. The cities contend that by not reducing current federal income taxes payable by the full amount of current interest payable the cost of taxes which the current ratepayers are required to pay is overstated. There is support for the method adopted by the cities. See New England Telephone & Tel. Co. v. Dept. of Public Utilities Com'n, supra; Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 322 A.2d 17. Accordingly, as with the cities' treatment of the investment tax credit, we cannot conclude that the cities' inclusion of the $411,946 as a tax deduction in computing the allowable cost of service was arbitrary, capricious or unreasonable. Moreover, the cities did not err in concluding that the company had not established by competent proof the validity of the 7.5% net-of-tax figure.