Opinion ID: 2454404
Heading Depth: 1
Heading Rank: 3

Heading: federal income tax liability

Text: The PUC and GTE argue that the PUC properly calculated GTE's federal income tax liability in determining GTE's reasonable and necessary operating expenses. However, this general issue presents us with two more specific questions. First, whether the PUC was compelled by section 41(c)(2) and/or Public Util. Comm'n v. Houston Lighting & Power Co., 748 S.W.2d 439 (Tex.1987), to include losses of unregulated affiliated companies when determining GTE's fair share of a reduction in its federal income tax liability resulting from the filing of a consolidated income tax return? Second, whether the PUC was required to include the income tax deductions actually taken by GTE for expenses disallowed by section 41(c)(3) when determining GTE's federal income tax liability? It is the PUC's duty to insure that every rate made, demanded, or received by any public utility ... shall be just and reasonable. Tex.Rev.Civ.Stat. art. 1446c, § 38. In fixing the rates of a public utility the ... [PUC] shall fix its overall revenues at a level which will permit such utility a reasonable opportunity to earn a reasonable return on its invested capital used and useful in rendering service to the public over and above its reasonable and necessary operating expenses. TEX.REV.CIV.STAT. art. 1446c, § 39(a). One of the reasonable and necessary operating expenses which a utility incurs is federal income tax. The calculation of GTE's federal income tax liability is significant because a reduction in its income tax liability reduces its operating expenses which are passed on to consumers in the form of a lower rate. Section 41(c) of the PURA states that the PUC shall determine expenses and revenues in a manner consistent with the following:       (2) Income Taxes. If the public utility is a member of an affiliated group that is eligible to file a consolidated income tax return, and if it is advantageous to the public utility to do so, income taxes shall be computed as though a consolidated return had been so filed and the utility had realized its fair share of the savings resulting from the consolidated return, unless it is shown to the satisfaction of the regulatory authority that it was reasonable to choose not to consolidate returns.... (3) Expenses Disallowed. The regulatory authority shall not consider for ratemaking purposes the following expenses: (A) legislative advocacy expenses, whether made directly or indirectly, including but not limited to legislative advocacy expenses included in trade association dues; (B) payments ... made to cover costs of an accident, equipment failure, or negligence at a utility facility owned by a person or governmental body not selling power inside the State of Texas; (C) Costs of processing a refund or credit ...; or (D) any expenditure found by the regulatory authority to be unreasonable, unnecessary, or not in the public interest, including but not limited to executive salaries, advertising expenses, legal expenses, and civil penalties or fines....
The PUC and GTE argue that the PUC was not compelled by section 41(c)(2) to include losses of unregulated affiliated companies when determining GTE's fair share of a reduction in its federal income tax liability resulting from the filing of a consolidated income tax return. We agree. Through the enactment of PURA, the legislature has granted the PUC broad powers and discretion in regulating public utilities. See City of Corpus Christi v. Public Util. Comm'n, 572 S.W.2d 290, 297 (Tex. 1978) (An administrative agency is created to centralize expertise in a certain regulatory area and, thus, is to be given a large degree of latitude by the courts in the methods by which it accomplishes its regulatory function.); TEX.REV.CIV.STAT. art. 1446c, §§ 2, 16, 18, 37, 38, 89. The PUC's discretion in regulating public utilities extends throughout the ratemaking process. See Southwestern Bell Tel. v. Public Util. Comm'n, 571 S.W.2d 503, 515 (Tex.1978) (PUC has discretion in setting rate of return); Texas Alarm & Signal Ass'n v. Public Util. Comm'n, 603 S.W.2d 766, 772 (Tex.1980) (PUC has discretion to determine the method of rate design); Suburban Util. Corp. v. Public Util. Comm'n, 652 S.W.2d 358, 362 (Tex.1983) (The PUC's ratemaking power includes the discretion to disallow improper expenses.); Public Util. Comm'n v. AT & T Communications, 777 S.W.2d 363, 366 (Tex.1989) (As long as the commission addresses the rate considerations set by the Public Utility Regulatory Act, the particular factors and the weight to be given those factors are within the discretion of the commission.). In this case, GTE's parent company, GTE Corporation, filed a consolidated income tax return on behalf of itself and its subsidiary companies. Under the conditions set out in section 41(c)(2), [14] the PUC is required to calculate GTE's federal income tax liability as though a consolidated [income tax] return had been ... filed and ... [GTE] had realized its fair share of the savings resulting from the consolidated return.... As a result, the PUC was required to determine GTE's fair share of a reduction in its federal income tax liability which resulted from the filing of a consolidated income tax return. However, the language of section 41(c)(2) neither includes nor excludes losses of unregulated affiliated companies. Consequently, the PUC had discretion in determining GTE's fair share of the savings and was not compelled by section 41(c)(2) to include losses of unregulated affiliated companies when determining GTE's federal income tax liability. The PUC and GTE argue that the PUC was not compelled by Public Util. Comm'n v. Houston Lighting & Power Co., 748 S.W.2d 439 (Tex.1987) to include losses of unregulated affiliated companies when determining GTE's fair share of a reduction in its federal income tax liability resulting from the filing of a consolidated income tax return. We agree. In Public Util. Comm'n v. Houston Lighting & Power Co ., the PUC disallowed $166 million of expenditures related to a nuclear power project as imprudent. In other words, these expenditures could not be included as operating expenses for ratemaking purposes. The PUC recognized that HL & P [Houston Lighting & Power] intended to write-off for tax purposes, the $166 million of imprudent ACNP [Allen's Creek Nuclear Project] expenditures. The effect of such a write-off would provide tax savings to HL & P and cause it to bear less than its $166 million share of ACNP. In order to give effect to its ruling that HL & P bear the full burden of these imprudent expenses, the PUC determined that any tax savings derived from a write-off should inure to the benefit of the ratepayers. 748 S.W.2d at 440-41. This court stated: [T]he PUC asserts that the court of appeals erred as a matter of law by allocating the tax savings attributable to HL & P's write-off of the ACNP disallowed expenses to the utility and its shareholders rather than to the ratepayers. The issue before this court then is whether HL & P can recover from ratepayers a federal income tax expense which it did not incur. The resolution of this issue does not rest upon a determination of whether the disallowed expenses which generated the tax savings have been included in the calculation of the new rate. The question is whether HL & P actually incurred this tax expense.       [R]atepayers can be held accountable only for those tax expenses that are actually incurred by a utility. Accordingly, when a utility claims federal income tax deductions for all of the expenses it has incurred, the resulting tax savings will necessarily reduce the utility's actual federal income tax expense. This will be the effect regardless of whether the expenses are allowed or disallowed in the calculation of a new rate. Id. at 441-42 (emphasis in original). [15] This court held that the tax savings generated from HL & P's imprudent expenses should inure to the benefit of the ratepayers. The utility's rates must reflect the tax liability actually incurred. Id. at 442. See Southern Union Gas v. Railroad Comm'n of Texas, 701 S.W.2d 277, 279 (Tex.App.Austin 1985, writ ref'd n.r.e.). However, the actual taxes incurred language of Public Util. Comm'n v. Houston Lighting & Power Co . cannot be applied literally when determining the income tax liability in a ratemaking case. First, the determination of just and reasonable utility rates is far from a precise process; instead, ratemaking relies substantially upon informed judgment and expertise and utilizes projections and estimates in virtually all areas. The ratemaking process is not capable of being neatly characterized as actual or hypothetical. Ratemaking begins with an historic test year. Although the use of historic data adds some certainty, this does not mean that the process begins with actual cash paid by the utility. Because utilities use accrual accounting, the books and records include certain expensessuch as pension, depreciation and nuclear decommissioning expensesthat are estimated allocations to the period in question. Since the rates are to be charged in the future, the historic test year amounts must be adjusted to more accurately reflect costs which will be incurred in the future. These adjustments include normalizing and prospective adjustments such as removing non-recurring expenses, modifying test year data to reflect the number of customers served at the end of the period and modifying expenses and rate base for known and measurable changes. In addition, the test year results must be separated between interstate and intrastate service. After the appropriate adjustments have been made, the adjusted test year results are further adjusted to produce the return level that the PUC determines to be appropriate. The income tax calculation is no different than other elements of utility ratemaking. Since rate determinations are made using an adjusted test year, the tax expenses will always be a hypothetical amount because the components which produce the calculation of income tax have been adjusted from the test year amounts. Second, under certain conditions, section 41(c)(2) requires the determination of GTE's fair share based upon the filing of a hypothetical consolidated income tax return. If the public utility is a member of an affiliated group that is eligible to file a consolidated income tax return, and if it is advantageous to the public utility to do so ... section 41(c)(2) specifically requires the PUC to calculate GTE's federal income tax liability as though a consolidated [income tax] return had been ... filed and ... [GTE] had realized its fair share of the savings resulting from the consolidated return.... In other words, even if a consolidated income tax return is not filed, under certain conditions, the PUC is required to calculate GTE's federal income tax liability as if a consolidated income tax return had been filedGTE's rates would not reflect the tax liability actually incurred. Consequently, we conclude that Public Util. Comm'n v. Houston Lighting & Power Co . does not compel the PUC to include losses of unregulated affiliated companies when determining GTE's fair share of a reduction in its federal income tax liability under section 41(c)(2).
The PUC and GTE argue that the PUC was not required to include the income tax deductions actually taken by GTE for expenses disallowed by section 41(c)(3) when determining GTE's federal income tax liability. We agree. First, the PUC has neither the power nor the discretion to consider expenses disallowed under section 41(c)(3) for ratemaking purposes. Although the legislature granted the PUC broad powers and discretion in regulating public utilities including the ratemaking process, the legislature specifically limited the PUC's powers and discretion concerning disallowed expenses. Section 41(c)(3) states that the PUC shall not consider for ratemaking purposes the following expenses ... which include lobbying expenses and any expenditure found by the regulatory authority to be unreasonable, unnecessary, or not in the public interest.... The language of section 41(c)(3) is clear and unequivocal. Second, the actual taxes incurred language of Public Util. Comm'n v. Houston Lighting & Power Co . cannot be applied literally when determining the income tax liability in a ratemaking case. For example, a literal application of the actual taxes incurred language would require that expenses incurred in providing interstate and unregulated services be included in the determination of income tax liability. In addition, as discussed above, tax expenses will always be a hypothetical amount because the components which produce the calculation of income tax have been adjusted from the test year amounts. Third, Public Util. Comm'n v. Houston Lighting & Power Co . considered only the costs related to a nuclear power project which costs were found to be imprudent. No disallowed operating expenses were addressed and no indication was given that this court considered whether the general statements concerning the actual taxes incurred would under all circumstances require the PUC to include all expenses when determining the income tax liability in a ratemaking case. In fact, Public Util. Comm'n v. Houston Lighting & Power Co . did not address or even consider the current version of section 41(c)(3) [16] or statutorily disallowed expenses. Consequently, we conclude that the PUC was not required to include the income tax deductions actually taken by GTE for expenses disallowed by section 41(c)(3) when determining GTE's federal income tax liability. To the extent that they conflict with this opinion, we disapprove Southern Union Gas v. Railroad Comm'n of Texas, 701 S.W.2d 277 (Tex.App.Austin 1985, writ ref'd n.r.e.) and City of Somerville v. Public Util. Comm'n, 865 S.W.2d 557 (Tex.App. Austin 1993, no writ).