Opinion ID: 2225567
Heading Depth: 1
Heading Rank: 3

Heading: net revenue

Text: The circuit court determined that the rates fixed by the Commission will generate more funds and consequently yield a greater return than estimated by the Commission because the Commission erroneously allowed certain expenses and ignored certain elements of income. We discuss the income and expense items separately below. Income Tax Expenses Deferred Due to Accelerated Depreciation. The Company has elected to depreciate its property, for income tax purposes, at an accelerated rate, as authorized by section 167 of the Internal Revenue Code of 1954. That section permits the cost of plant installed after December 31, 1953, to be depreciated for Federal tax purposes by methods which produce more depreciation in the early years of the property's useful life, and less in the later years, than would be produced by straight-line depreciation. Since the depreciation deduction is larger, taxable income is reduced in the early years. The tax will increase in later years as the depreciation deduction falls below what it would have been under the straight-line method. Actual tax liability may remain depressed, however, if the Company should continue to add new facilities which may similarly be depreciated at the accelerated rate. The Commission allowed the Company to subtract from gross income as a current expense not only the amount of Federal taxes actually paid, but also an amount equal to the difference between the taxes paid and the taxes that would have been due if the Company had used straight line depreciation for tax purposes. The order directed that the amount so accrued each year was to be credited to a special account which could not be used for dividend distribution to shareholders or transferred to surplus, but might be used for plant expansion. The circuit court held that the Commission's approach was erroneous and that only taxes actually paid should have been allowed as current expenses. This conflict between the views of the Commission and those of the court reflects a deep division in accounting and regulatory thinking which exists throughout the country. Persuasive reasoning and numerous decisions of courts and regulatory agencies may be cited in support of each position. The Commission also maintains that by enacting section 167, Congress intended to afford corporations the opportunity to retain internally generated funds for expansion, and that this purpose would be thwarted and an unwarranted discrimination created if utilities were denied the same tax treatment as other corporations. The purpose of section 167, as revealed in the House and Senate reports bearing on the section, is to encourage plant expansion, particularly in high risk, growing and small businesses. (See H.R. Rep. No. 1337, 83d Cong. 2d Sess. 22-25 (1954), 1954 U.S. Code Cong. & Ad. News, Vol. 3, p. 4046-4050; S. Rep. No. 1622, 83d Cong., 2d Sess. 25-26 (1954), 1954 U.S. Code Cong. & Ad. News, Vol. 3, p. 4655-4656.) Under the policy of this State, utilities are allowed a rate of return calculated to attract the capital required for necessary expansion. (See, e.g., City of Chicago v. Illinois Commerce Com. 4 Ill.2d 554.) Since in this respect utilities differ from other corporations, the purpose of section 167 would not be thwarted nor would discrimination be introduced into the Federal tax law by requiring utilities to pass the savings of accelerated depreciation on to their customers. We must remember, furthermore, that we are not here dealing with the tax treatment of utilities but with the pricing of their product, that is, with the rate charged for their services. Congress has provided that all corporations may reduce their taxes by accelerated depreciation. It has not required the money thus retained to be used for expansion. ( City of Pittsburgh v. Pennsylvania Public Utility Com. 182 Pa. Super. 551, 573-74, 128 A.2d 372 (1957).) Nor has it forbidden corporations to pass these savings on to their customers, and it may be supposed that many corporations have done so under the pressure of competition. If they have not, the purchaser has the option of changing to a different product. But utilities are at least partial monopolies, and no competition exists to induce them to pass savings on to the public. The customer cannot change products. We think, therefore, that this argument is not convincing as to State regulated utilities. The other arguments advanced in support of the Commission's approach are more persuasive. They are founded on the assertion that accelerated depreciation does not reduce taxes but merely defers them from the early years of the useful life of an asset to the later years. So it is said that there is no tax saving, but merely a tax deferral. It is argued that if no provision is made currently for the increased tax liability which must arise, future ratepayers will be forced to carry a tax burden that is properly attributable to present operations. Furthermore, it is contended that the existence of an unfunded tax liability must have an adverse impact upon the financial standing and credit of regulated utilities. Those who favor the court's approach respond that if a utility maintains a constant or increasing level of capital expenditure, a reasonable assumption in many cases in the utility field, deferrals in future years due to accelerated depreciation of additional new assets will equal or exceed the increased tax liability arising during the later years of the useful life of the older assets. Thus it is said that a continuous tax deferral might result from accelerated depreciation, producing in effect a permanent tax saving. (See In the Matters of Amere Gas Utilities Co. (F.P.C. 1956) Docket No. G-6358 (Majority and Dissenting Opinions); Note, 69 Harv. L. Rev. 1096 (1956).) This saving, it is argued, should benefit the consumers; the utility should not be allowed to establish a permanent reserve for a liability which will never have to be paid. The assumption of a continuous deferral of taxes due to accelerated depreciation may be justified in many cases and the Commission would be justified in acting on this assumption if it saw fit. (See, e.g., Maine Power Co. v. Public Utilities Com. 153 Me. 228, 136 A.2d 726; City of Pittsburgh v. Pennsylvania Public Utilities Com. 182 Pa. Super. 551, 128 A.2d 372.) Experience may show that proper results can only be achieved by this approach. However, several not unlikely events might occur which would prove the assumption erroneous. A war, a general depression or a decline in the local market might curtail a utility's capital expenditures, and prevent further tax deferrals. As a result, taxes might increase just at the time when economic circumstances would make the added expense most burdensome. It is also possible that section 167 will be repealed, thus ending further tax deferrals. If we could see clearly into the future and say with certainty that continuing expansion was certain, and countervailing considerations were nonexistent, we would hold that the Commission may not permit current charges for a liability that will never arise. Predictions of future developments, however, are unsure estimates at best. The problem is a new one; the factual and policy considerations that bear upon its solution have not as yet been fully developed. Even the future of accelerated depreciation in the Federal tax structure is not entirely settled. If for any reason continued investment in utility plant at current levels should cease, or accelerated depreciation be denied, the financial stability of utilities might be jeopardized if some provision had not been made for the increased taxes that would result. Rate regulation is a continuing process; greater experience may bring greater wisdom in dealing with these problems. At this time, we think it permissible for the Commission to safeguard the financial integrity of utilities by recognizing as present expenses those tax liabilities which are deferred by use of accelerated depreciation for Federal tax purposes. The Commission may not, however, shift the benefit of accelerated depreciation from the ratepayers to utility shareholders. The Commission's order states that prepayment of deferred taxes by present ratepayers will not benefit the Company's shareholders because the funds so collected by the company may not be distributed as dividends or transferred to surplus. The order does not provide, however, that the prepaid funds must be deducted from the Company's rate base. If this deduction is not made, the entire benefit of accelerated depreciation goes to the shareholders, since earnings produced by the prepaid funds  either interest if the funds are invested in securities or income if the funds are put into new plant facilities  will belong to the shareholders, who would thus receive a return on money they did not invest in the Company. The Commission's order therefore can not stand. Funds generated by accruing deferred tax expenses, and any facilities financed out of those funds, must be excluded from the rate base. The earning power of this money then will either decrease consumer rates or increase service. The economic benefit to consumers over the life of any given asset should be about the same as if no accrual of deferred tax expenses were allowed, but it will be spread evenly over the useful life of the asset rather than being concentrated in the early years when depreciation rates for tax purposes are above normal. Increased income from improved meter maintenance and changes from flat rates to metered rates. A Commission order requires the Company to inspect ten per cent of its meters (about 1400) every year. In recent years preceding the test year the Company examined approximately 750 meters, or approximately one-half the number required by the Commission's order. During the test year the Company inspected 1287 meters. In the same year pumped but unbilled water decreased from 22.49 per cent to 19.84 per cent of total water pumped. In the circuit court and in this court the intervenors have referred to trade publications indicating that inspection and repair of meters always increases the amount of water measured. Thus if in the future the Company complies with the Commission's order, and compliance can rightfully be expected since the Commission allowed $9100 annually for the expense of meter inspection, further reduction in the pumped but unbilled water, and correspondingly increased billings not included in the Commission's estimate, might result. The Commission ordered the Company to introduce metered rates for some customers now receiving service at a flat rate. Assuming that the same amount of water will be delivered to these customers, the evidence indicates that an increase in income may result which likewise was not included in the Commission's estimate. Although, as we have indicated, it seems reasonable to expect some increase in income from these two items, the evidence bearing upon them is so incomplete that it is difficult to determine whether increases will actually result and, if so, how great they will be. Since the case must be remanded to the Commission on other issues, it will have an opportunity to apply its experience in solving the difficult problems of prediction that are involved. For the reasons stated above, the circuit court properly reversed and set aside the order of the Illinois Commerce Commission. Its judgment must be modified, however, to order the cause remanded to the Commission for further proceedings in accordance with the views expressed in this opinion. (See State Public Utilities Com. ex rel. City of Springfield v. Springfield Gas and Electric Co. 291 Ill. 209, 236-37.) The judgment as so modified is affirmed. Judgment modified and affirmed.