Opinion ID: 2312375
Heading Depth: 1
Heading Rank: 2

Heading: Adjustment in the Company's Income Tax.

Text: This is the second attempt by the Commission to adjust, i. e., arbitrarily reduce for rate-making purposes, the amount of federal income taxes paid by the Company and deducted as an operating expense. The argument back of the adjustment runs as follows: The Company, one of the units of the Bell System, participates in a consolidated income tax return filed by the parent corporation; it pays as its share of the total tax the amount it would pay if it filed a separate return; the Company has a funded debt ratio of only seven per cent, in contrast to the average debt ratio of the Bell System of 34.5 per cent; the result is that it pays more income tax than it would if it had a larger funded debt, or the average funded debt; if it paid less tax, its net earnings would be increased and the rates to customers could be correspondingly reduced; since the Company is a unit of the Bell System, its funded debt should be taken to be the average debt of all the companies in the System, and its income tax, as a deduction from operating expenses, reduced accordingly. The effect of this ruling is obvious. An actual expense incurred by the Company is disallowed by assuming a tax saving that does not exist. How can such an arbitrary ruling be defended? The Commission insists that this action is only a pragmatic adjustment of a capital structure that is totally unrealistic. By this is apparently meant that a utility company ought to have a substantial amount of long-term debt, instead of relying on financing by its parent corporation in the form of temporary loans later converted into stock. The simple answer to this contention is that the Commission cannot arbitrarily disallow actual expenses on the theory of reforming the Company's capital structure. We say arbitrarily because there is nothing in this record on the basis of which the Commission could have found that the parent corporation has abused its control or has been guilty of any wrongdoing adversely affecting the Company's subscribers. If it be said that the Company is forced by its management to pay more for its capital than is fair, because the cost of equity capital is greater than the cost of debt capital, the answer is that the Commission has already taken this fact into account in fixing the rate of return. For that purpose it assumed debt capital of 35%. The Commission appears to argue that because it is proper in fixing a fair rate of return to use a hypothetical debt ratio, it is also proper to use it to disallow tax expense actually incurred. This does not follow. The fixation of a fair return, like the determination of fair value, requires the consideration of a large number of factors, the making of many assumptions, and an overall exercise of judgment. The allowance of legitimate expenses presents no such problem. In effect the Commission is here attempting to do indirectly that which it could not do directly under its statutory powers  control the fiscal policies of the Company by penalizing it for adherence to those policies. This question was presented to the Superior Court in 1954 and disapproved. 9 Terry 317, 103 A.2d 304, 323, 324. Judge Layton commented: I know of nothing more exclusively within the sound discretion of corporate directors than the exercise of judgment concerning its financial affairs.    If this Commission's decision were upheld in this respect, the Corporation might feel compelled against its judgment to increase its debt limit in order to gain actual, rather than fictitious advantage, of the tax deductions so thrust upon it. Obviously, this places the Commission in a position indirectly to influence important decisions of the directors. We agree with these comments. See also Public Service Commission v. Indiana Bell Telephone Co., 235 Ind. 1, 130 N.E.2d 467, 480. We approve the holdings of the Superior Court on this question.