Opinion ID: 2363714
Heading Depth: 2
Heading Rank: 2

Heading: Revenues and Expenses

Text: The company charges that the commission erroneously accepted Hartikka's recommendation that test-year earnings should be adjusted upward to recognize the effect of post-test-year changes in directory advertising revenues and expenses. Specifically, Hartikka proposed to recognize additional revenues of $502,000, which produced an overall increase in test-year earnings of $177,000. The company's response was essentially that the expenses associated with those revenues were so speculative that the commission should have disregarded this new revenue. The task of the commission is to base future rates upon known past and present conditions through the use of data generated during a specific test period. Narragansett Electric Co. v. Harsch, 117 R.I. 395, 416, 368 A.2d 1194, 1206 (1977); Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 278, 302 A.2d 757, 763 (1973). However, in order to ensure that the test year is representative of the conditions that will prevail when the new rates take effect, Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 397, 322 A.2d 17, 24 (1974), the commission has both the authority and responsibility to undertake a reasoned exercise of its discretion in altering test-year data to reflect changes of known magnitude occurring subsequent to the test year. Northwestern Bell Telephone Co. v. State, Minn., 253 N.W.2d 815, 822 (1977). Yet, despite the broad discretion it possesses in this area, the commission generally considers only post-test-year revenue and expense changes that affect test-year results with certainty. Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 393, 322 A.2d 17, 22 (1974). See also Narragansett Electric Co. v. Harsch, 117 R.I. at 416-17, 368 A.2d at 1206-07. To factor in changes of unknown magnitude would in most cases increase what speculation already exists in the ratemaking process and thereby tend to undermine the effectiveness of the test-year concept. Central Maine Power Co. v. Public Utilities Commission, 153 Me. 228, 242-43, 136 A.2d 726, 735-36 (1957); Public Service Co. v. State, 102 N.H. 150, 162-63, 153 A.2d 801, 810 (1959). On the other hand, we have never determined that the commission is entirely without discretion to adjust test-year data unless all relevant figures are ascertainable with complete exactitude. To do so would be, in our opinion, to bind the commission's hands in cases where flexibility is necessary to `do justice,' to decide what is just and reasonable based on the evidence before it. Rhode Island Consumers' Council v. Smith, 111 R.I. at 289, 302 A.2d at 769, quoting Narragansett Electric Co. v. Kennelly, 88 R.I. 56, 73, 143 A.2d 709, 719 (1958). When the commission for articulated reasons determines that its figures are reliable and finds that an adjustment of the type made here is necessary to ensure that test-year data remain representative, we see no reason to deny the commission the discretion to act solely because it cannot do so with complete precision. Cf. General Telephone Co. v. Public Service Commission, 78 Mich.App. 528, 539-40, 260 N.W.2d 874, 879 (1977) (once anticipated increases in directory advertising revenues were recognized, commission should have considered as well somewhat speculative wage increases). With respect to the present controversy, there apparently exists little dispute that the $502,000 in increased revenues associated with the directory advertising rate increases constitute just the sort of known and measurable future economic condition of which the authorities overwhelmingly approve. Narragansett Electric Co. v. Harsch, 117 R.I. at 418, 368 A.2d at 1207. Both the commission and the division agree, however, that the adjustment urged by Hartikka and accepted by the commission incorporates an expense figure that is not so thoroughly based on fact. The company contends that the expense figure is speculative and may therefore not be considered, with the result that it is equally inappropriate to consider the effect of the increased revenues; in so arguing it appears to rely upon the simple proposition that an adjustment for changes in revenues occurring after the test year should require a commensurate change in expenses in the same period. City of Pittsburgh v. Public Utility Commission, 187 Pa.Super. 341, 363, 144 A.2d 648, 660 (1958). See also City of Los Angeles v. Public Utilities Commission, 7 Cal.3d 331, 346-47, 102 Cal.Rptr. 313, 325, 497 P.2d 785, 797 (1972). Although we have already stated that the general rule can accommodate less than mathematical precision, and have thereby affirmed that the treatment of post-test-year occurrences is, to a large extent, within the discretion of the commission, Narragansett Electric Co. v. Harsch, 117 R.I. at 417, 368 A.2d at 1207, the commission has in this case failed to demonstrate that its findings are based upon legally probative evidence; consequently, we must remand with directions that the commission provide us with that information or, if necessary, alter its decision. Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 283, 302 A.2d 757, 765 (1973). In its report and order the commission stated that rejection of Hartikka's recommended adjustment would unfairly penalize the ratepayers. It may well be that to ignore altogether known revenues of such magnitude would detract from the representative nature of the test year, at the consumer's expense. This is especially so because, despite the protests of the company's accounting witness, John F. O'Neill (O'Neill), that an analysis of the relevant expenses would be quite long and complex because it involves a great number of departments and a great number of different items   , the company itself had already adjusted test-year data to reflect increased wage expense, which company figures in turn suggest accounted for about half of the total directory advertising expense. On the other hand, the report and order reveals that Hartikka based part of his calculations on the assumption that directory advertising expense would increase by the same percentage that directory advertising revenues would be increased   a theory that standing alone is too speculative to be relied upon. Cf. General Telephone Co. v. Public Service Commission, 78 Mich.App. 528, 540, 260 N.W.2d 874, 879 (1977) (conclusion that directory advertising revenues will increase at same rate as in past was probably too speculative for adoption). If and to the extent that the commission adopted that formula as a measure of directory advertising expense, we direct that on remand it exclude the arrived-at sum as an adjustment to test-year data. In conclusion, we must remand so that the commission can detail its reasons for having adopted Hartikka's methodology, [7] both in general and specifically with regard to the expense that was not wage related, and so that it can as well reconsider and perhaps modify its decision in light of what we have said here.
During the course of the hearings and in his prepared testimony, Hartikka recommended that certain out-of-period accounting entries adopted by the company be excluded from computation of the company's overall expense figure. The company's adjustments were intended to reflect what it considered typical expense changes of various kinds, namely, changes in the level of unemployment taxes, social security tax accruals, and medical insurance expenses. The commission accepted Hartikka's proposal to eliminate those out-of-period entries, thereby increasing pro forma intrastate earnings for the test period by $72,000. The problem facing the commission in treating these out-of-period accounting entries is not unlike that which we have just discussed concerning directory advertising revenues. The commission must, when necessary, adjust test-year data so that it will reflect typical operating conditions and thereby hopefully prove representative of future conditions. Narragansett Electric Co. v. Harsch, 117 R.I. 395, 416-17, 368 A.2d 1194, 1206-07 (1977); Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 397, 322 A.2d 17, 24 (1974). The commission had before it Hartikka's testimony that the disputed entries would have distort[ed] the company's actual test-year operating results; Hartikka had as a general matter suggested on cross-examination that, although future periods will probably require their own out-of-period adjustments, the unpredictability of the type, amount, and impact of such adjustments upon earnings makes untenable any theory that future periods will be affected in much the same way as was a given test year. Notwithstanding an apparent abundance of oral testimony before the commission both in support of and in opposition to use of the company's out-of-period entries as acceptable indicators of similar future adjustments, the commission found in its report and order that the company had waived whatever objection it might have had to Hartikka's proposal. The commission's conclusion might have resulted in part from the company's failure to brief its position with the vigor characteristic of its other efforts; indeed, the company had confined its remarks on the issue to a footnote in its brief to the commission, declaring there, in part, that [t]he position of the parties is sufficiently clear on the record   . Our review of the commission's decision to accept Hartikka's recommendation cannot, however, turn upon the question of the existence and effect of an alleged waiver, because, in our opinion, the commission itself did not so limit its determination. Rather, despite its reference to waiver, the commission found quite specifically and as a matter of fact that [t]he out-of-period accounting entries    would, if included in test period operating results, have a distorting effect. Although that finding is presented without elaboration of any kind, it nonetheless makes clear both that the commission felt that there existed sufficient evidence of the type properly relied upon in making necessary factual determinations, and that the commission in fact acted on the basis of that evidence. Having so acted, it was incumbent upon the commission to support factually and legally its decision that exclusion of the entries was necessary to avoid distortion of the company's test-year operating results. E. g., Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 285-86, 302 A.2d 757, 766-67 (1973). We must mow remand this matter to the commission so that it may discharge that responsibility in a supplementary decision. [8]
The final expense item challenged by the company raises a question not previously before the commission in the context of a New England tariff filing. The company contends that the commission acted arbitrarily when it adopted an adjustment designed to reflect supposed tax savings related to the company's participation in a consolidated federal income tax return filed by the American Telephone and Telegraph Company (AT&T). The company has, for the past several years, joined the many other Bell System operating companies that, along with Western Electric, participate in AT&T's consolidated return. Certain tax advantages flow to AT&T as a result of that consolidated return, the most obvious being that the tax liability of the system as a whole is less than what it would be if the affiliated companies each filed a separate return. This situation exists in large part because AT&T itself issues a significant portion of the debt capital raised to finance system operations, with the result that the accompanying interest expense deductions are available to AT&T in the computation of its tax liability. There seems to be no dispute that, because of the system's internal accounting practices, AT&T itself retains the tax benefits resulting from the interest expense and does not utilize the savings so as to credit its operating companies, such as New England, directly. See also Mountain States Telephone & Telegraph Co. v. Public Utilities Commission, Colo., 576 P.2d 544, 550 (1978); Chesapeake & Potomac Telephone Co. v. Public Service Commission, 230 Md. 395, 411-12, 187 A.2d 475, 484 (1963). The company's position is essentially that the commission must for ratemaking purposes proceed as if there were no overall tax savings whatsoever; it argues that to use as a cost of service anything but what the company would pay in taxes if it filed a separate return is no less than to claim as a tax deduction the interest expense of another corporation. Hartikka, on the other hand, argued that, absent an adjustment to reflect an operating company's proportionate share of the total savings and thereby to lower that company's stated tax liability, the Bell System as a whole would earn revenues including provisions for federal income taxes greater than the taxes actually payable   . See also FPC v. United Gas Pipe Line Co., 386 U.S. 237, 244, 87 S.Ct. 1003, 1007, 18 L.Ed.2d 18, 24 (1967). The commission agreed with Hartikka's assessment of the problem and accepted as the solution a tax adjustment recommended by an accounting committee of the National Association of Railroad and Utility Commissioners (NARUC). Hartikka explained that the NARUC adjustment, which takes into consideration the fact that the company is not wholly owned by AT&T, allocates total system debt among the operating companies in proportion to their relative average capital obligations associated with AT&T ownership. The difference between the allocated debt and the debt of each company constitutes the AT&T debt allocated to that company, which in turn determines the amount of interest expense allocated. Using this formula, Hartikka concluded that the company's share of the AT&T tax savings applicable to its intrastate operations totalled $139,332 for 1975 and $238,073 for 1976, or $196,931 for the test year. The effect of the decreased tax liability recognized by the commission was to increase the company's pro forma intrastate earnings by $144,000. We have stated in the past that, when reviewing a decision of the commission, our concern is not with the method used to attain a particular result but with the fairness and reasonableness of the end result itself. Narragansett Electric Co. v. Harsch, 117 R.I. 395, 418, 368 A.2d 1194, 1208 (1977), citing FPC v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S.Ct. 281, 287-88, 88 L.Ed. 333, 344-45 (1944). In this case we find nothing to indicate that the commission's action was unjustified. Indeed, keeping in mind that the determination of what is fair and reasonable requires a balancing of investor and consumer interests, FPC v. Hope Natural Gas Co., 320 U.S. at 603, 64 S.Ct. at 288, 88 L.Ed. at 345, we agree with one commentator's statement that in general [i]t seems difficult to resist the    argument that a Bell subsidiary's ratepayers should not be called upon to meet tax outlays greater than the subsidiary's allocated proportion of the system's tax liability   . 1 Priest, Principles of Public Utility Regulation 58 (1969). The commission utilized the NARUC tax adjustment in order to ensure that recovery not be allowed for an overall tax expense never in fact incurred. Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 396, 322 A.2d 17, 23 (1974), citing FPC v. United Gas Pipe Line Co., 386 U.S. 237, 244, 87 S.Ct. 1003, 1007, 18 L.Ed.2d 18, 24 (1967). Contrary both to the suggestion of the company and to the view of the minority of jurisdictions to consider this problem, e. g., Re Diamond State Telephone Co., 1 Storey 532-33, 51 Del. 525, 532-33, 149 A.2d 324, 328-29 (1959); General Telephone Co. v. Public Utilities Commission, 174 Ohio St. 575, 577-80, 191 N.E.2d 341, 343-44 (1963), we do not feel that adoption of the NARUC formula either improperly ignores the separate corporate identities of New England and AT&T or in any impermissible way invades the conceded prerogatives of New England's management to achieve what it considers its maximum prudent debt ratio. Indeed, if there has been any limited disregard of separate corporate identities, it is unquestionably because AT&T and New England themselves have chosen to disregard their separateness for income tax purposes. The NARUC adjustment recognizes only that it is the commission's responsibility to determine the company's allowable tax expense and that its duty cannot be discharged properly if the commission is bound by figures that would appear on a separate return that the company in fact did not file. See Chesapeake & Potomac Telephone Co. v. Public Service Commission, 230 Md. 395, 413, 187 A.2d 475, 485 (1963); United Inter-Mountain Telephone Co. v. Public Service Commission, Tenn., 555 S.W.2d 389, 393 (1977). We hold that the commission did not abuse its discretion by disallowing a claimed federal income tax expense that was greater than the company's proportionate share of the consolidated tax liability.