Opinion ID: 1362962
Heading Depth: 1
Heading Rank: 5

Heading: Rate Increases.

Text: Based on the testimony and a recognition that each tax year must stand upon its own feet, the tax court concluded that only rate increases already granted prior to the assessment date can properly be considered by the appraiser as affecting the cash flow to be capitalized. 7 OTR at 227. The court also found that defendant had exaggerated the return expected due to rate increases already granted, with its estimation of a return of 52 percent of operating revenues while plaintiff had actually been able to achieve only 34 percent. Defendant asserts that both rate increases granted prior to the assessment date and pending rate proceedings should be considered. Its argument is that a knowledgeable buyer would consider the pending rate proceedings and expect some of the increase to be granted. As described above, defendant removed what it determined to be the partial year effect of rate orders granted in 1974 when defendant computed its performance ratio. After finding a value for total year end plant and multiplying it by the performance ratio to achieve an income value to capitalize, defendant then added values representing the effect of 1974-1975 rate increases. These values were determined, taking the 1975 increase as an example, by adding the additional annual revenue sought, $22,000,000, reducing it by a 48 percent tax rate to $11,440,000, and reducing it again by assuming only 75 percent of the request would be granted to $8,580,000. After the addition of these rate changes, the probable future operating income was capitalized. Plaintiff's witnesses, Mr. Goodman and Dr. Ring, also testified in favor of considering pending rate cases. However, Dr. Ring testified that the least squares method of projection of income includes consideration of rate changes. Dr. Ring testified on cross-examination: Q Now set aside the department's projection and I'm asking you about pending rate proceedings and rate orders in effect at or near the assessment date. A Right. Q You would give consideration to those? A I have given consideration to it.    Q As to projecting earnings, are you interested in the immediate ensuing assessment year's earnings? A Absolutely. Q Is that the total basis of the projection? A The projection is on a basis of the last least square line which shows a continued growth and, therefore, in this particular instance, I took the maximum for the end of the years. What I normally should have done is take the median within the year because the company will not earn if the starting increment of a rate increase, let's say in March, before it would take effect, the increment would not be there for the full year. So therefore, actually, statistically, we should take the region between the beginning of the year and the end of the year. I took the end of the year in my projection, which is generous.    Q Well, in this projection on Exhibit 17, are you testifying that the matters affecting earnings, namely, rate orders in effect at or near the assessment date, not yet in operating income for past years or pending rate increase, is reflected on this exhibit? A Only increases known about. There was no increase in 1976. There was an increase in 1975 and that's reflected in here. Any increase  any rate increase that we knew was pending or in effect is reflected in this estimate. Q Well, looking at the year 1976 on Exhibit 17  A Um-mum. Q  that 100,000 [sic] figure, is that Mr. Hoffmann's estimate? A No, Mr. Hoffmann probably took my estimate. Q That's your estimate? A My estimate. Q But your black line is your projection? A Right. Q Below that estimate? A What do you mean below that estimate? Q Well, as I see your  the 100,000 [sic] at the point '76 inter  intersects with  A I'm taking  Q  100,000 [sic]  A My estimate  Q  your projection is below that intersection. A My estimate is the end of 1977. I told you I took the end of the year. I took the high estimate. Actually, if you take  the mid-year would be $98,500,000. I took $100,000 [sic]. As to the tax court's finding that defendant's estimate of a 52 percent return of operating revenues from the rate increases is exaggerated, defendant contends that the rate increase need not correspond to plaintiff's actual experience of earning approximately 34 percent of operating revenues. Rather, defendant argues, the rate orders deal with net operating income, and the expenses of the year at issue are already allowed in the rate proceeding. Only state and federal taxes and any expense increases between the test year used to determine the rate increase and the year when such increase is granted would reduce the net operating income. Defendant allowed for federal taxes, but not state taxes and expenses incurred beyond the test year level. However, there were no federal taxes and defendant argued that that deduction should make up for the state taxes and expenses not figured in. Plaintiff questioned, however, whether 52 percent of the rate increase was in fact realized by the company. Out of the operating revenues only 34.2 percent in 1974 and 32.9 percent in 1975 resulted in net utility operating income. Plaintiff argues that if in fact 52 percent of the 1974 and 1975 rate cases were realized, then the percentage of net utility operating income would not have dropped in 1975. The explanation for the drop was regulatory lag and the fact that costs are rising faster than the company is able to secure rate increases. Since the parties agreed that pending rate cases should be considered in determining income, the tax court's conclusion that only rate increases already granted prior to the assessment date should be considered is incorrect. Because defendant's estimation of income from pending rate increases appears to be excessive, and there was no effective rebuttal of plaintiff's position that the least squares method naturally includes the effective rate changes, we accept plaintiff's position here.