Opinion ID: 2173140
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Heading: Averaging of Annual Effective Federal Income Tax Rates

Text: The Water Companies filed federal income tax returns on a consolidated basis with I. U. International in the same manner and to the same effect as their sister water companies in Mechanic Falls Water Co. v. Public Utilities Commission, Me., 381 A.2d 1080 (1977). In that case we held that the Commission could disregard the standard 48 per cent federal corporate income tax rate in determining their federal income tax expense for rate-making purposes, and, instead, employ a lower effective tax rate which reflects their proportionate share of the consolidated group's actual tax liability. Our opinion contained a thorough discussion of the issues involved and warrants no repetition or expansion here. See also Maine Water Co. v. Public Utilities Commission, Me., 388 A.2d 493, 494-95 (1978). The Water Companies are bound by this determination of the propriety of the effective tax rate approach by the Law Court's consolidation order of September 22, 1977. In Mechanic Falls Water Co. v. Public Utilities Commission, supra , we approved the Commission's calculation of an effective tax rate of 28 per cent for 1974, which was used to determine the companies' federal income tax expense for rate-making purposes. In the present case the Commission determined that the effective tax rate for 1975 was 36.84 per cent. [3] Then, the Commission averaged the 1974 and 1975 effective tax rates to produce a 33 per cent tax rate for purposes of determining the Water Companies' federal income tax expense for rate-making purposes. [4] The Water Companies challenge the Commission's calculation of a 33 per cent effective tax rate on two grounds: First, they argue that the Commission's averaging of the individual effective tax rates for 1974 and 1975 was, in and of itself, unjustified. Second, they claim that the Commission's averaging approach constituted a change in past rate-making policy, requiring sufficient notice thereof, which, they argue, was not provided in this case. We reject each of these contentions. As this Court recently emphasized in New England Telephone & Telegraph Co. v. Public Utilities Commission, Me., 390 A.2d 8 (1978), we must give considerable deference to the rate-making methods employed by the Commission. As we repeatedly emphasize throughout this opinion, the Legislature has vested the Commission with the authority and duty to exercise its expertise and skill in the setting of just and reasonable rates. The Commission must necessarily be allowed to exercise wide discretion in setting rates, which is essentially a legislative function. Our role upon review is limited to the consideration of errors of law. We may not interfere with the Commission's findings if the methodology and result are reasonable and are supported by substantial evidence in the record. The Commission may exercise reasonable discretion in selecting methods by which to establish just and reasonable rates. It is not bound to any particular methodology, whether suggested by its own Staff or by the utility. Id. at 48-49. Accordingly, choice of methods to compute such factors as the effective tax rate belongs to the Commission, at least in the realm where rational persons could disagree. Central Maine Power Co. v. Public Utilities Commission, Me., 382 A.2d 302, 317 (1978). Therefore, our review is limited to whether the Commission's methodology and result were reasonable and whether they were supported by substantial evidence. As the evidence indicates, the effective tax rate of a consolidated system, calculated on the chronic loss theory approved in Mechanic Falls Water Co. v. Public Utilities Commission, supra , may be subject to considerable fluctuation from year to year. In fact, the Water Companies' own witness, David Surwit, stated that utility rates, based upon an annual single effective tax rate, would have a tendency to bounce up and down like a yo-yo. In Central Maine Power Co. v. Public Utilities Commission, 382 A.2d at 317, we stated: This Court has made clear, in the context of regulating this very public utility, that the experience of one test year is not the sole factor to be considered by the Commission. See also New England Telephone & Telegraph Co. v. Public Utilities Commission, 390 A.2d at 49-50. Because rate making is prospective in nature, the Commission should not limit itself to the utility's experience during any single year when such a limitation would produce an inaccurate assessment of its true financial situation. Central Maine Power Co. v. Public Utilities Commission, 153 Me. 228, 236, 136 A.2d 726, 732 (1957). It is reasonable and proper for the Commission to assess a utility's effective annual federal income tax rate over a period of years in order to determine an average effective tax rate for the setting of rates to be effective in the future. This is not a case in which the Commission is splitting the difference between conflicting figures endorsed by its staff and the utility. See Casco Bay Lines v. Public Utilities Commission, Me., 390 A.2d 483, 488-89 (1978). [5] Rather, the Commission has reasonably determined that a more proper effective tax rate may be calculated by averaging the individual effective tax rates for the past two years. Ratemaking is not an exact science and often calls for estimations and predictions. 390 A.2d at 494. The methodology used by the Commission in its rate-making determinations need not be suggested by any witness in the record. [6] The methodology itself lies within the Commission's expertise and discretion, and is subject only to a test of reasonableness. If the methodology is reasonable, then the result will not be disturbed if the factual findings employed in that methodology are supported by the record. In the circumstances, we cannot find that the Commission's method is unreasonable. We also find that the record adequately supports the Commission's determination. The Commission was warranted in finding a 28 per cent effective tax rate for the I. U. International consolidated system in 1974. The Commission simply took official notice of its finding in Re Mechanic Falls Water Co., 13 P.U.R. 4th 347 (Me. Pub. Util. Comm'n 1976), which finding we subsequently approved in Mechanic Falls Water Co. v. Public Utilities Commission, Me., 381 A.2d 1080 (1977). The 1975 effective tax rate of 36.84 per cent was derived from calculations based on the same formula used by the Commission in the Mechanic Falls case. Re Mars Hill & Blaine Water Co., 19 P.U.R. 4th 380, 384 (Me. Pub. Util. Comm'n 1977). [7] We find that the record provides sufficient support for the Commission's use of those figures. We hold that the Commission's method of averaging effective tax rates was reasonable and that substantial evidence supports the findings of the facts to which the method was applied. We find no substantive error in its averaging of effective tax rates in this case. The Water Companies' second objection to the Commission's averaging of effective tax rates is that this allegedly novel approach was used by the Commission without adequate notice or opportunity to be heard on the issue. The Water Companies cite New England Telephone & Telegraph Co. v. Department of Public Utilities, 371 Mass. 67, 354 N.E.2d 860, 871 (1976), for the principle that a utility commission should not make a major change in rate-making policy without sufficient warning to the utility involved in order that it may prepare its presentation. Although this Court has held that the Commission is not bound by rate-making policies used in prior cases, New England Telephone & Telegraph Co. v. Public Utilities Commission, 390 A.2d at 55; Central Maine Power Co. v. Public Utilities Commission, 382 A.2d at 319, we have also recognized that the affected utility is entitled to notice sufficient to enable it to present evidence on any issue relevant to that proceeding. Mechanic Falls Water Co. v. Public Utilities Commission, supra at 1103. Moreover, Where . . . the Commission is contemplating a change in a long-standing policy which would adversely affect a utility, a general notice of a rate proceeding may not be sufficient. . . . In such circumstances, due process may require a more particularized notice so that the utility could introduce evidence on that issue if it so desires. Id. The Water Companies must make three showings in order to substantiate their claim of denial of such due process: (1) that the Commission is contemplating a change in a long-standing policy which would adversely affect a utility; (2) that the utility did not receive a sufficiently particularized notice of the contemplated change; and, (3) that the lack of such notice subjected the utility to substantial prejudice. The Water Companies have not made even the first of those showings. They have failed to show that the Commission's averaging of annual effective tax rates constituted a change in policy. The Commission introduced the effective-tax-rate approach in Re Mechanic Falls Water Co., 13 P.U.R. 4th 347 (Me. Pub. Util. Comm'n, Jan. 26, 1976), only a few months before the Water Companies submitted their rate increase requests. The effective tax rate theory was still in its formative stages at the time of the proceedings below. No real change in policy occurred. Rather, the Commission was already using an average effective tax rate in those circumstances where the annual effective tax rates for more than one year were properly before it. The Water Companies do not disprove the Commission's assertion that in Re Mechanic Falls Water Co., supra, and in Re Continental Telephone Co., 18 P.U.R. 4th 636 (Me. Pub. Util. Comm'n, Jan. 21, 1977), there was only one annual effective tax rate available from the record. [8] On the other hand, in Re Maine Water Co., (Me. Pub. Util. Comm'n, F.C. No. 2156, July 2, 1976), aff'd Maine Water Co. v. Public Utilities Commission, Me., 388 A.2d 493 (1978), and in Re Camden and Rockland Water Co., (Me. Pub. Util. Comm'n, F.C. No. 2132, March 26, 1976), where the Commission had available from the record effective tax rates for more than one year, it averaged such effective tax rates. Therefore, by averaging the 1974 and 1975 effective tax rates in this case, the Commission was following a policy which it had recently formulated and was currently applying. The Water Companies cannot now successfully claim that there was a change in policy of which they had no notice. [9] We hold that the Commission committed no error in its calculation of a 33 per cent effective tax rate for purposes of determining the Water Companies' federal income tax expense for rate-making purposes.