Opinion ID: 2173140
Heading Depth: 1
Heading Rank: 2

Heading: Flow-Through of Income Taxes Deferred Because of Accelerated Depreciation

Text: This Court is again confronted with the Commission's treatment of the depreciation deduction for purposes of determining the proper income tax expense for rate-making purposes. In three recent cases, we have considered carefully the arguments with respect to normalization versus flow-through methods of accounting, especially in the light of I.R.C. § 167( l ) (1978) (Tax Reform Act of 1969 § 441(a)): New England Telephone & Telegraph Co. v. Public Utilities Commission, Me., 390 A.2d 8, 15-25 (1978); Central Maine Power Co. v. Public Utilities Commission, Me., 382 A.2d 302, 318-21 (1978); Mechanic Falls Water Co. v. Public Utilities Commission, Me., 381 A.2d 1080, 1100-03 (1977). See also Central Maine Power Co. v. Public Utilities Commission, 153 Me. 228, 246-49, 136 A.2d 726, 737-39 (1957). In its decision below, the Commission continued the policy it established in Re Central Maine Power Co., 15 P.U.R. 4th 455 (Me. Pub. Util. Comm'n 1976), aff'd, Central Maine Power Co. v. Public Utilities Commission, Me., 382 A.2d 302 (1978), that the benefits of accelerated depreciation with respect to state income taxes would be flowed through to the Water Companies' rate-payers. The Commission also ordered the flow-through of the benefits of accelerated depreciation with respect to federal income taxes on both pre-1970 and post-1969 public utility property. With only a general policy discussion of the merits of normalization versus flow-through, the Water Companies' brief challenges the Commission's decision to flow through all the benefits of accelerated depreciation for federal and state income tax purposes. Over twenty years ago, in Central Maine Power Co. v. Public Utilities Commission, 153 Me. 228, 136 A.2d 726 (1957), we held that for rate-making purposes the Commission could properly require flow-through of the benefits of accelerated depreciation. We reaffirmed that holding in Mechanic Falls Water Co. v. Public Utilities Commission, Me., 381 A.2d 1080 (1977). Recent cases have focused on the effect of § 167( l ) of the Internal Revenue Code on a utility's continued ability to take advantage of accelerated depreciation. Where we have found no conflict between the Commission's actions and section 167( l ), we have continued to leave the treatment of accelerated depreciation to the Commission's discretion and expertise. Central Maine Power Co. v. Public Utilities Commission, supra (1978); Mechanic Falls Water Co. v. Public Utilities Commission, supra (1977). On the other hand, where we have found that the Commission's actions arbitrarily jeopardized a utility's ability to take accelerated depreciation under section 167( l ), we have held the Commission's actions to be an unreasonable exercise of power and abuse of discretion. New England Telephone & Telegraph Co. v. Public Utilities Commission, supra (1978). In this case we find no incompatibility between the Commission's actions and the provisions of section 167( l ) of the Internal Revenue Code and therefore uphold the Commission's exercise of its rate-making power.
In Central Maine Power Co. v. Public Utilities Commission, supra (1978), this Court held that federal income tax law, as expressed in section 167( l ), had no controlling effect upon the Commission's treatment of the benefits of accelerated depreciation for state income tax expense purposes. That issue remains a matter of state law. Thus, the Commission's decision in this respect must be sustained under the authority of Central Maine Power Co. v. Public Utilities Commission, supra (1978), and Central Maine Power Co. v. Public Utilities Commission, supra (1957).
In Mechanic Falls Water Co. v. Public Utilities Commission, Me., 381 A.2d 1080, 1101 (1977), we discussed the operation of section 167( l )(1), which concerns pre-1970 public utility property: [10] For pre-1970 property, the Code provides that a utility may use 1) straight-line depreciation, 2) the method used prior to August of 1969 if it also employs normalization, or 3) accelerated depreciation with flow-through, but only if that method was used prior to August of 1969. In interpreting the pre-1970 utility property provision, the United States Supreme Court has declared that a utility may not unilaterally switch from flow-through to normalization. Rather, if a utility is flowing through the benefits of accelerated depreciation, it must continue to do so unless the appropriate regulatory body permits a change. Federal Power Commission v. Memphis Light, Gas and Water Division, 411 U.S. 458, 93 S.Ct. 1723, 36 L.Ed.2d 426 (1973). If, before August, 1969, the Water Companies were using accelerated depreciation with flow-through, they must continue to flow through the benefits of accelerated depreciation with respect to pre-1970 property, unless permitted to change to normalization by the Commission. Moreover, The burden was on the Companies to convince the Commission that a change from flow-through to normalization would be in the public interest. Mechanic Falls Water Co. v. Public Utilities Commission, supra, at 1101. In its decree, the Commission notes that the Water Companies provided no evidence or documentation as to the method of accounting used during the July, 1969, accounting period. See Re Mars Hill & Blaine Water Co., 19 P.U.R. 4th 380, 389 (Me. Pub. Util. Comm'n 1977). [11] The Water Companies may thus be treated as if they used a flow-through method of accounting prior to August, 1969, in accordance with the Commission's long-standing policy of flowing through the benefits of accelerated depreciation. See 35 M.R.S.A. § 307. Moreover, at the time of the proceedings before the Commission, there was no showing that the Commission had ever permitted the Water Companies to change to a normalization method of accounting. The burden was therefore on the Water Companies to seek the Commission's permission to change from a flow-through to a normalization method of accounting. The choice between flow-through and normalization rests in the sound judgment of the Commission. Central Maine Power Co. v. Public Utilities Commission, supra (1957). On the basis of the record we cannot find that the Water Companies have sustained their burden of showing that the Commission abused its discretion in deciding to require the flow-through of the benefits of accelerated depreciation for pre-1970 property. See Mechanic Falls Water Co. v. Public Utilities Commission, supra at 1102.
With respect to post-1969 public utility property, the Internal Revenue Code provides that a utility may use as a method of depreciation: (A) a subsection ( l ) method [straight-line depreciation], (B) a method otherwise allowable under this section [accelerated depreciation] if the taxpayer uses a normalization method of accounting, or (C) the applicable 1968 method [the method used prior to August of 1969], if, with respect to its pre-1970 public utility property of the same (or similar) kind most recently placed in service, the taxpayer used a flow-through method of accounting for its July 1969 accounting period. I.R.C. § 167( l )(2). If the conditions provided by subparagraph (C) are met, the Commission may, in its discretion, require a public utility to use accelerated depreciation with flow-through for post-1969 property for rate-making purposes without jeopardizing the utility's right to take accelerated depreciation. In paragraph (4)(A) of section 167( l ) of the Code Congress provided a method by which utilities could avoid the effect of paragraph (2)(C), set forth above: If the taxpayer makes an election under this subparagraph before June 29, 1970, in the manner prescribed by the Secretary, in the case of taxable years beginning after December 31, 1970, paragraph (2)(C) shall not apply with respect to any post-1969 public utility property, to the extent that such property constitutes property which increases the productive or operational capacity of the taxpayer with respect to the goods or services described in paragraph (3)(A) and does not represent the replacement of existing capacity. I.R.C. § 167( l )(4)(A). If the Water Companies had made a valid election under this subparagraph, the available depreciation methods would be limited to those provided in § 167( l )(2)(A) and (B), namely, straight-line depreciation or accelerated depreciation with normalization. Treas.Reg. § 1.167( l )-2(a)(1) (1978). See Federal Power Commission v. Memphis Light, Gas & Water Division, 411 U.S. 458, 93 S.Ct. 1723, 36 L.Ed.2d 426 (1973). In the present case, the Water Companies did not produce evidence that they had made any election under paragraph (4)(A). The flow-through of the benefits of accelerated depreciation on post-1969 property was at issue in New England Telephone & Telegraph Co. v. Public Utilities Commission, Me., 390 A.2d 8 (1978). In that case, New England Telephone, which had been using a straight-line depreciation method, switched from straight-line to accelerated depreciation with normalization on its post-1969 property. Thus, paragraph (2)(C) of section 167( l ) was not applicable because New England Telephone had not used a flow-through method of accounting for its July, 1969, accounting period. We held that the Commission abused its discretion in requiring flow-through of the benefits of accelerated depreciation for rate-making purposes while ordering the Company to continue using a normalized method of accounting in its regulated books of account. The present case differs from New England Telephone in a crucial respect: Unlike New England Telephone, the Water Companies were subject to the operation of paragraph (2)(C) of I.R.C. § 167( l ). As we noted in the discussion of pre-1970 property, above, the Commission could properly act on the basis that before August, 1969, the Water Companies' rates had been determined by using accelerated depreciation with flow-through and thus the conditions for application of I.R.C. § 167( l )(2)(C) have been satisfied. Nothing in I.R.C. § 167( l ) prevents the Commission from determining the Water Companies' rates on the basis of accelerated depreciation with flow-through for post-1969 property. In conclusion, we find no error or abuse of discretion in the Commission's requiring that, for rate-making purposes, the Water Companies flow through the benefits of both state and federal accelerated depreciation.