Opinion ID: 1140706
Heading Depth: 1
Heading Rank: 1

Heading: iaccelerated depreciation

Text: We hold that the Commission abused its discretion in not imputing tax benefits which would have accrued to Mountain Bell had it availed itself of an accelerated method of depreciation under § 167 of the Internal Revenue Code. We predicate this ruling upon the Commission's finding that the use of accelerated depreciation methods under § 167 would be of benefit both to Mountain Bell and to its ratepayers. We deem it appropriate preliminarily to discuss the factual and legal setting in which this matter was presented to the Commission. Prior to 1954, straight-line depreciation was the only method permitted under the federal laws relating to income tax. In 1954, § 167 was enacted permitting a taxpayer to use any of three methods of depreciation: (1) straight-line; (2) double declining balance; and (3) sum-of-the-digits. The second and third methods involve accelerated tax depreciation, i. e., during the early years of the depreciable life of an asset greater depreciation is permitted than that allowable under the straight-line method and, as no more than 100% of cost can be depreciated, the rate of depreciation during the remaining depreciable life of the item is less than straight-line. The Bell System consists of a number of regional telephone companies having American Telephone & Telegraph Company as their parent company. The parent company owns in excess of 86% of the entire stock of Mountain Bell. The policy of the parent company has been and is that none of the operating companies in the Bell System should use accelerated depreciation. This is in contrast to the policies of many other utilities which now use accelerated depreciation methods. When a public utility uses accelerated depreciationor when the regulatory agency imputes accelerated depreciation to the utilityone of two accounting procedures can be used, viz., the normalization method or the flow-through method. Under the normalization method a reserve account is created, and the difference between the amount of income taxes payable if the straight-line method were used and the amount of taxes actually paid by use of accelerated depreciation is put into the account. This reserve is for use in the payment of income taxes during the sunset years of the depreciable life of the property involved. The effect of the normalization method is to give the utility use of additional money with a resulting reduction of the amount of money which must be borrowed by the utility. The method therefore reduces a certain amount of interest payments. Under this normalization method telephone rates are relatively unchanged and the benefits accrue to the utility's stockholders rather than to its customers. Under the flow-through method the benefit of reduced expenses is passed along to the customers in the form of reduced rates. In its findings relating to investment tax credit under the Internal Revenue Code, the Commission stated that the benefits of this tax credit are more appropriately flowed through to the benefit of ratepayers over the service life of the property   . While the Commission did not expressly find that the flow-through method would be used if accelerated depreciation were imputed, such an implication is to be found in a number of its other findings. It is significant that the Commission adopted the flow-through method for rate making purposes with respect to the Public Service Company of Colorado (Commission Order dated May 27, 1969 in application No. 17,406). Therefore, we treat this matter as if the Commission had made an express finding that on imputation of accelerated depreciation the flow-through method is to be used. Counsel for Mountain Bell argue that accelerated depreciation results in tax deferral but not in tax savings. However, a tax saving does result from the use of accelerated depreciation as long as plant addition equals or exceeds plant retirement, and the Commission so found. This has been held as a matter of law. Midwestern Gas Transmission Co. v. Federal Power Commission, 7 Cir., 388 F.2d 444, cert. denied, 392 U.S. 928, 88 S.Ct. 2286, 20 L.Ed. 2d 1386; and Alabama-Tennessee Natural Gas Co. v. Federal Power Commission, 5 Cir., 359 F.2d 318, cert. denied, 385 U.S. 847, 87 S.Ct. 69, 17 L.Ed.2d 78. The Commission further found that there is every expectation that new plant will be constructed [by Mountain Bell] at a high rate in the future. The Commission found that, if Mountain Bell had commenced use of accelerated depreciation in 1954, the income taxes attributable to its intrastate Colorado operations for the test year of 1967 would have been reduced by more than $3,000,000. It further found that if accelerated depreciation had been taken in 1967 on only the assets which were acquired and qualified during that year, the tax benefits would have amounted to $446,572. The evidence showed that, if Mountain Bell had adopted an accelerated depreciation method in 1954, its tax savings on its Colorado intrastate operations through 1967 would have been in excess of $24,000,000. The Bell System's operating company in California is The Pacific Telephone & Telegraph Company. In keeping with the policy of the parent company, it used straight-line depreciation. The same issue was presented to the California Public Utilities Commission as was presented to our Commission and it ordered the imputation of an accelerated method of depreciation. Re The Pacific Telephone & Telegraph Company, 77 P.U.R.3d 1. To illustrate the magnitude of this policy in the Bell System, the California Public Utilities Commission found that, if the utility had used accelerated depreciation during the period 1954 1967, its rate payers would have saved $450,000,000 in rates. Also, in the test year of 1967, the company would have saved $27,400,000 in taxes with a resulting increase in gross revenues of approximately $57,000,000. With this preface, we now address ourselves to the pertinent findings of the Commission here relating to accelerated depreciation. These findings were as follows: Second, there is no doubt in the minds of this Commission, from the record herein, that using accelerated depreciation methods under Section 167 of the Internal Revenue Code would be of benefit to the Applicant and its ratepayers alike. The rebuttal testimony presented by Applicant in no way indicated that this was not so. Mr. Kesselman, independent expert witness, testified mainly on the relative merits of flow-through or normalization accounting. It is undisputed, however, that the aggregate tax benefits continue to increase under the conditions where new plant is added by a utility every year at a relatively high rate. Certainly in the case of the Applicant and its Colorado operations there is every expectation that new plant will be constructed at a high rate in the future. Applicant's Exhibit No. 61 indicates that invested capital is expected to grow at a minimum compound rate of 6.9% per year. By the use of accelerated depreciation methods for tax purposes, which are optional under the Internal Revenue Code, Applicant could, therefore, not only offset the effects of inflation, but probably reduce its costs far beyond any allowance for attrition that might be suggested. As a comparison, Protestant's Exhibit A shows that if accelerated depreciation had been used since 1954, income taxes attributable to Applicant's intrastate Colorado operations would have been reduced in 1967 by more than 3 million dollars; whereas the Applicant suggested an allowance for attrition of less than one-half million dollars a year. Even if Applicant's estimates of the impact of 1968 and 1969 wage increases should be included, which we would not consider proper in any event, the total possible attrition is less than the total possible tax benefits mentioned. Protestant's Exhibit A, which was prepared by Applicant, further shows that if accelerated depreciation would have been taken in 1967 only on those assets which were acquired and qualified during 1967, the tax benefits would amount to $446,572. This benefit could be derived without the necessity of obtaining permission from the Internal Revenue Service to change accounting procedures. Furthermore, it should be noted that this figure arises from taking only one-half year depreciation on the assets acquired during the current year, and this figure would necessarily be approximately three times larger in the following year, as tax benefits are derived from assets added in two separate years, and would continue to grow in subsequent years as the process is continued. It would logically follow from these findings that an accelerated method of depreciation would be imputed to Mountain Bell. However, the Commission did just the opposite, using the following language: The Applicant has not taken advantage of the provisions of Section 167 of the Internal Revenue Code regarding accelerated methods of depreciation for tax purposes, and this Commission will not in this proceeding impute any tax benefits that might have accrued had Applicant used the provisions of accelerated depreciation.       We strongly believe that further study of these matters should be made by the Applicant before another proceeding involving these same issues should be instituted by the Applicant before this Commission. The single reason given by the Commission for not ordering the imputation of accelerated depreciation is contained in its following language: As a separate adjustment, Staff Exhibits Nos. 4 and 7 show the pro forma effect on net operating earnings if Applicant had taken accelerated depreciation deductions for tax purposes under Section 167 of the Internal Revenue Code. Applicant has, however, not used accelerated depreciation for tax purposes, and consequently, we do not deem it proper to impute the estimated benefits to operating earnings without considering the far reaching effects that this might have. The record, of course, fully discloses that the use of accelerated depreciation for tax purposes would have decreased the income taxes payable by Applicant for the test year 1967. On the other hand, it appears that there might be the added risk to the common equity holder that an increase may occur in the federal income tax sometime in the future, even though a possibility of an increase may be based on several contingencies that cannot even be foreseen at this time. Since our rate of return determination will be based on the actual cost of capital to the Applicant under existing conditions, it would be improper to impute any tax benefits that might impose additional risk to Applicant's business without making adjustments in the capital costs. There is no evidence in the record that would permit us to make such an adjustment in the cost of capital. Paradoxically after having found that there might be some added risk to Mountain Bell, the Commission proceeded to find that there was no evidence showing that there would be any risk: The reasons for not using this advantageous provision in the income tax law by the Applicant have not been sufficiently explained in this record. Neither has it been shown in this record to what extent, if any, the risks to investors would be increased under more aggressive policies with respect to increased debt ratio and the use of accelerated depreciation. Before reaching the last quoted antonymous finding, the only reservation the commission appeared to have in mind was that, if federal income tax should increase sometime in the future, there would be an added risk to Mountain Bell. The discussion of impropriety of imputing tax benefits without making adjustments in capital cost is simply the construction and destruction of a straw man. There was no evidence that taxes are going to increase, no evidence of the extent of the speculative added risk, and no evidence as to the extent of adjustment in cost of capital to compensate for the speculative tax increase. A highly qualified expert, Mr. Melwood W. Van Scoyoc, testified that it is a fundamental concept of utility regulation that the utility should receive its fair return free and clear of all taxes. We find it difficult to disagree with Mr. Scoyoc's following remarks: The allowed fair return is after taking into account the cost of all taxes. The customers of a utility are specifically required to carry the burden of taxes. In substance and equity, the customers of the utility are the tax payers even though the utility files a tax return and issues the check to the taxing authority. The utility is basically a conduit for the collection of taxes along with its other costs from its customers.       In my opinion, the very fact that tax laws have changed in the past and the possibility of future changes exist, it is, in reality, a sound basis for the use of actual taxes in setting rates. Throughout our history of rate regulation, actual taxes have been used in rate determinations, although changes have occurred from time to time in our tax laws. As I see it, there is no valid reason why this practice should not be continued. Today's ratepayers should pay the taxes assessed today by our government, while future ratepayers should pay the taxes assessed by the government at that time. I see no justification whatsoever for ratepayers having to pay now for future income taxes on the theory that Section 167 of the Internal Revenue Code might be repealed or modified in the future. The Public Utilities Law of Colorado was designed to permit an adjustment of rates in order to prevent the hazard or risk of an increase in taxes and to make savings for the ratepayers in case of a decrease in taxes. C.R.S. 1963, 115-3-1 et seq. The second sentence of the cited statute provides, Every unjust or unreasonable charge made, demanded or received for such rate, fare, product or commodity or service is hereby prohibited and declared unlawful. In the light of the findings made by the Commission in this matter, it would appear that its order with respect to accelerated depreciation results in unreasonable charges to the customers. Mountain Bell argues that, since the federal law gives the taxpayer a right to choose the method of depreciation to be used, the imputation of a method not chosen by the taxpayer is beyond the power of the Commission. It is true that some courts and some commissions have subscribed to the view that it is improper to require a utility to use a particular method of depreciation when the law permits the use of any of several methods. See, e. g., City of Pittsburgh v. Pennsylvania Public Utility Commission, 187 Pa.Super. 341, 144 A.2d 648. In the light of the Commission's finding that the use of accelerated depreciation would benefit the customers and in the light of the statutory requirement already quoted that a utility must not make unreasonable charges, we prefer to follow authorities to the contrary and rule that the Commission not only has the power but also the obligation to impute a method of depreciation which will reasonably permit a substantial saving to ratepayers. See Southern New England Telephone Company, 78 P.U.R.3d 504 and cases therein cited. Mountain Bell presents the related argument that the method of depreciation to be used is a decision to be made by management and, therefore, is beyond the purview of the Commission. In the following language to be found in Re The Pacific Telephone and Telegraph Company, supra, one might substitute Mountain Bell for Pacific: Pacific, as does the rest of the Bell System, uses the straight-line method for tax purposes as well as for book purposes. Its policy is exactly that of its parent. It refuses to use an accelerated method and is adamant in its position that the election not to use accelerated depreciation is one of management prerogative alone and, further, that there is no basis in law for this commission to upset management's judgment. We are thoroughly convinced that the Bell System in general and the Mountain Bell in particular is possessed of skilled, well-trained, extremely intelligent personnel in its varied fields of management. Courts and commissions should respect the decisions of management and, in general, not succumb to the temptation of assuming the role of management. However, no matter how much deference we have and should have for highly-trained management, when that management abuses its managerial discretion to the detriment of its customers, our regulatory commissions have a duty to declare the abuse and make such orders as will give to ratepayers the advantage of those economies of which management has failed to avail itself. Midwestern Gas Transmission Company v. Federal Power Commission, supra ; Alabama-Tennessee Natural Gas Co., supra ; and Re Pacific Telephone & Telegraph Company, supra. On reading this opinion one might conclude that we believe, from studying the record, that Mountain Bell should use an accelerated method of depreciation. Our decision must not be predicated upon any such conclusion; actually, it is for the Commissionand not for usto make such a finding. However, we have jurisdiction to determine whether an order of the Commission is reasonably commensurate with its findings. Parrish v. Public Utilities Commission, 134 Colo. 192, 301 P.2d 343; United Transit Company v. Nunes, 99 R.I. 501, 209 A.2d 215; Carolina Aluminum Co. v. Federal Power Commission, 4 Cir., 97 F.2d 435. In the instant matter the Commission found the necessity for and the desirability of the use of accelerated depreciation. After that finding it abused its discretion and was derelict in its duty by not ordering such a method of depreciation to be imputed. Our opinion of necessity is predicated upon the provisions of the Internal Revenue Code as they existed at the time the Commission held its hearings. The effect of any subsequent amendments to the Code should first be considered and determined by the Commission.