Opinion ID: 2603822
Heading Depth: 1
Heading Rank: 3

Heading: PUC Disallowance of $788,000 of Mountain Bell's Federal Income Tax Expense

Text: Mountain Bell contends that the disallowance of $788,000 as a Federal income tax expense is unsupported by any evidence in the record and is an unlawful abuse of the PUC's discretion. We do not agree with either of these assertions. Our review of the record reveals an adequate basis for this disallowance. The PUC did not abuse its discretion in this matter, but on the contrary, it properly acted within its power and authority when it recognized and identified a Federal income tax expense which should not have been charged against revenue in the rate regulation process. To understand why this disallowance is proper, a brief explanation of the method by which Mountain Bell pays its Federal income tax is necessary. The Federal tax regulations and statutes permit affiliated companies to file income tax returns on a consolidated basis. The main condition, before such consolidation is allowed, is that all subsidiary corporations must be at least 80% owned by the parent corporation. Certain tax advantages and savings flow from this election. American Telephone and Telegraph Company (AT&T) owns over 80% of the stock of Mountain Bell and other affiliates in the Bell telephone system including Western Electric. The amount of Federal income tax which Mountain Bell showed as an expense during the test year which was used as a basis for setting the rates here, was approximately $17,636,000. This figure represents the Federal income tax which Mountain Bell would pay if it were a single corporate taxpayer. AT&T in its consolidated return took credit for Federal income taxes on the taxable income of each of its affiliates. AT&T thereby realizes the tax advantages and savings. The PUC made the following finding with reference to this disallowance: Another significant Staff adjustment to Mountain Bell's Colorado intrastate federal income taxes is an adjustment in the amount of $788,000. We agree with Mr. Richards of the Commission Staff who testified that Mountain Bell's federal income tax expense was based upon the fiction that Mountain Bell in fact paid federal income taxes of $17,636,000. This figure assumes that Mountain Bell paid federal income taxes as a single corporate taxpayer. In fact, Mountain Bell's federal income taxes are paid to the federal government through the medium of a consolidated tax return filed by AT&T. The result of a consolidated filing means that Mountain Bell's dollar contribution is some $788,000 less than what it reportedly would pay as a single taxpayer. We note particularly the testimony presented by Mr. Norman W. Leake, a Mountain Bell witness, who testified, among other things, that although the total final Federal income taxes paid by the entire Bell System is based upon a consolidated income tax return, the amount of money paid by Mountain Bell to the Federal government is based upon Mountain Bell's taxable income. Undoubtedly, from this testimony, the commission inferred, and properly so, that the internal accounting practices of the Bell System credits any tax benefits and savings attributable to the filing of the consolidated return to AT&T and not to its operating companies. In a leading case on this subject, Federal Power Commission v. United Gas Pipe Line Company, 386 U.S. 237, 87 S.Ct. 1003, 18 L.Ed.2d 18 (1967), the issue was whether the Federal Power Commission could reduce for rate making purposes the Federal income tax expense claimed by United Gas Pipe Line Company, which participated in a consolidated income tax return with affiliated companies. The United States Supreme Court therein stated: United had not filed its own separate tax return. Instead it had joined with others in the filing of a consolidated return which resulted in the affiliated group's paying a lower total tax than would have been due had the affiliates filed on a separate-return basis. The question for the Commission was what portion of the single consolidated tax liability belonged to United. Other members of the group should not be required to pay any part of United's tax, but neither should United pay the tax of others. A proper allocation had to be made by the Commission. Respondents insist that in making the allocation the Commission would violate the statute unless in every conceivable circumstance, including this one, United is allowed an amount for taxes equal to what it would have paid had it filed a separate return. In their view, United should never share in the tax savings inherent in a consolidated return, even if on a consolidated basis system losses exceed system gains and neither the affiliate group nor any member in it has any tax liability. This is an untenable position and we reject it. Rates fixed on this basis would give the pipeline company and its stockholders not only the fair return to which they are entitled, but also the full amount of an expense never in fact incurred. In such circumstances, the Commission could properly disallow the hypothetical tax expense and hold that rates based on such an unreal cost of service would not be just and reasonable. (Emphasis added.) The Supreme Court of the United States then approved the method chosen by the Federal Power Commission to allocate the tax liability of a system among the regulated members of a group which pays its taxes on a consolidated basis and stated further: If there is more than one regulated company in a group, they will share the tax liability or tax saving in proportion to their taxable income. The method utilized by the PUC in this rate making proceeding was that approved in the United Gas Pipe Line Company case. What the PUC did here, in effect, was to allow as an expense for rate making purposes that portion of the tax liability of the Bell System, determined on a consolidated basis, which was in proportion to Mountain Bell's taxable income. In Chesapeake and Potomac Telephone Company of Maryland v. Public Service Commission of Maryland, 230 Md. 395, 187 A.2d 475 (1963), the court on the same issue stated: We think the commission was justified in its action [in disallowing for rate making purposes an income tax expense of $144,110]. The owner and managers of the company have the right to determine what its debt-equity ratio should be, but they may not always make the ratepayers foot the bill resulting from the choice. There was no legal need for the company to pay more than its proportionate share of the joint tax liability. It has not shown any reason or necessity for its assumption of a tax liability greater than it owed or any particular consideration passing to it from AT&T . . . for contributing a gift to that owner. . . . Since liability for taxes was figured on the theory of one system-wide entity, liability might fairly be set, as the Commission set it, among the component entities on a proportionate basis. There would seem to be no reason why Maryland telephone subscribers should pay more than the company's proportionate share of the total Bell System tax liability.  (Emphasis added.) See also Southwestern Bell Telephone Company v. Kansas State Corporation Commission, 192 Kan. 39, 386 P.2d 515 (1963). In summary, it must be pointed out that the PUC did not find that Mountain Bell had paid $788,000 less than it would have paid if it had filed a separate Federal income tax return. In effect, the PUC properly found that Mountain Bell paid monies to the Federal government at a single rate. AT&T, in the consolidated return, credited Mountain Bell with this payment, and thus, AT&T received the income tax advantage. The PUC found that Mountain Bell's share of this tax advantage was $788,000, which it properly determined should not be borne by Colorado ratepayers. By this disallowance, Mountain Bell also argues that the PUC is unlawfully discriminating against its minority stockholders by allocating certain tax advantages to Colorado ratepayers. If this be so, the disadvantage cannot be blamed on the PUC. It properly exercised its power and authority to adjust Federal income tax expenses of a public utility which joins in a consolidated return filed by a parent company, which in turn, gains the resultant tax savings and benefits. Federal Power Commission v. United Gas Pipe Line Company, supra ; Southwestern Bell Telephone Company v. Kansas State Corporation Commission, supra ; and Chesapeake and Potomac Telephone Company of Maryland v. Public Service Commission of Maryland, supra .