Opinion ID: 2268472
Heading Depth: 2
Heading Rank: 4

Heading: Interest Expense Deduction from the Company's Federal Income Tax Requirement

Text: The next question raised by the company is whether the commission erroneously included in its calculation of the company's federal tax requirement a deduction for the interest expense which arose as a consequence of a post-test year bond issue. In calculating its federal tax liability, the company is entitled to an income deduction for its interest expense. In the present case, the company sought to include in its interest expense deduction only the actual interest expense incurred by it during the test year. The council rejected this approach and suggested the inclusion in the account of the forward looking interest expense based on the actual cost of outstanding debt pro-formed to accommodate the annualized expense of the April, 1975 bond issue of $15,000,000, and the retirement of $7,500,000 of debt during 1975. In adopting the latter position, the commission described the issue as being whether the change in interest expense based on already-determined capital structure (that is, including the 1975 bond issue) over actual expense in the test year is sufficiently known and measureable to warrant its inclusion in the calculation of the company's taxes. The commission held that the change in interest expense was known and measurable and that there was no element of speculation involved. Thus, it arrived at a total interest expense figure of $7,642,000. The company attacks the inclusion of post-test-year interest expense as being hypothetical and suggests that the commission's decision in this regard runs counter to our own decision in Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 395-96, 322 A.2d 17, 23-24 (1974). That is, the company reads that decision to state that only those expenses actually incurred may be included in the company's tax deduction. We believe that the company misstates the thrust of the relevant portion of our decision in Rhode Island Consumers' Council v. Smith, id . That case involved a dispute over what types of interest expense are properly included as deductions from taxable income. Specifically, the parties therein debated whether interest expense on short-term debt qualified as a deduction or whether the company would prevail in its method of excluding such debt from its capital structure. Id. at 395-96, 322 A.2d at 23-24. This is to be contrasted to the instant case wherein there is no dispute as to deductibility of the interest expense arising from the 1975 bond issue. The only issue herein is whether that interest expense, having been incurred subsequent to the test year, should be reflected as a pro forma adjustment to test year calculations. Ratemaking, by its very nature, is prospective and in order to neutralize the negative effects of speculation and guesswork about future economic conditions, it is accepted practice to base future rates upon known past and present conditions through the use of data gathered during a specified test period. Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 278, 302 A.2d 757, 763 (1973). This process of prognostication creates a conflict between the need to lend some finality to ratemaking by utilizing a well-defined, finite test period and the need to base calculations upon the latest available relevant data which often pertains to time periods other than the test period. Duquesne Light Co. v. Pennsylvania Pub. Util. Comm'n, 174 Pa.Super. 62, 69, 99 A.2d 61, 64 (1953). A satisfactory resolution of this conflict is that when known and measurable posttest-year changes affect with certainty the test-year data, the commission may, within, its sound discretion, give effect to those changes. Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 393, 322 A.2d 17, 22 (1974). Regarding the inclusion of relevant data other than that which pertains directly to a utility's test-period experience, it has been observed that : If the test period used does not reflect the present operating experience of the company and the reasonably expected future economic conditions which the company will be confronted with, or if adjustments in the test period are not made so as to take these two factors into consideration and give effect to them, then the rate-making process does not and cannot become an honest and intelligent forecast of probable conditions of the company in and during a reasonable period in the immediate future. (Emphasis added.) Southern Bell Tel. & Tel. Co. v. Tennessee Pub. Serv. Comm'n, 17 P.U.R.3d 311, 319 (Tenn.Ch.Ct.1957). We believe, therefore, that the commission has broad discretion in making pro forma adjustments to test-year data provided that there is substantial evidence in the record warranting its action. Pittsburgh v. Pennsylvania Pub. Util. Comm'n, 182 Pa.Super. 551, 560, 128 A.2d 372, 376 (1956). The company has not demonstrated an abuse of discretion in this case. The issuance of $15 million in bonds and the retirement of $7.5 million of debt constitutes a significant change in the company's capital structure which will obviously create an escalation of the company's interest expense presently and in the near future. The commission, employing the method proffered by the council's witness, computed an amount of interest expense based upon the capital structure of the company at that time as used by the company's own witness in his testimony before the commission. The commission felt that this approach did not yield speculative results, and in the absence of something more than the naked assertion by the company that the interest figure is hypothetical, we are constrained to agree. The commission's determinations in these matters are presumptively reasonable and will not be interfered with unless the company satisfies us by clear and convincing evidence that it is clearly, palpably and grossly unreasonable. Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 295, 302 A. 2d 757, 772 (1973). The company has come forth with no such showing in this case. In fact, it appears to the court that this adjustment to test-year data is just the sort of known and measurable future economic condition of which the authorities overwhelmingly approve. We find no error in the interest expense deduction as determined by the commission.