Court Opinion

ID: 5173491
Source: CourtListenerOpinion
Date Created: 2022-01-02 05:13:40.924821+00
Date Added: 2024-06-11T08:26:11.315185
License: Public Domain

SHEPARD, Chief Justice,
dissenting.
I cannot agree with the conclusion reached by the majority opinion, and hence dissent. Although the amount of money involved and in dispute here is not large, the principle is significant. The core of the issue is the Commission’s treatment of interest expense of the company, and tax savings which would result therefrom.
In my view, the majority correctly points out the facts, but fails to engage in any substantial analysis, but rather relies upon a Pennsylvania case which I believe is distinguishable from the instant action. Although the majority cosmetically utilizes the substantial evidence rule, it overlooks any analysis of the principle involved.
As noted by the majority, the Commission concluded that for ratemaking purposes in determination of a fair rate of return, the company’s capital structure was *1067overweighted on the equity side, and that the Commission would utilize an equity 50 percent and debt 50 percent ratio. That process has been approved by this Court in past cases. See General Telephone Company of the Northwest, Inc. v. Idaho Public Utilities Commission, 109 Idaho 942, 712 P.2d 643 (1986), and Citizens Utilities Company v. Idaho Public Utilities Company, 99 Idaho 164, 579 P.2d 110 (1978). The Commission then took for the first time a further step, which has not been previously considered by this Court, of calculating a hypothetical interest expense based upon the hypothetical capital structure. Since that hypothetical capital structure was more heavily weighted toward debt, the hypothetical interest expense was larger, which theoretically would have resulted in a different income tax impact than that actually sustained by the company. Thus, in my view the Commission erroneously substituted its hypothetical view of costs for the actual costs incurred by the company.
The only cases cited by the majority in support of the Commission’s action here are those where a commission specifically found that a utility had consciously abused its management discretion in adopting a disproportionate capital structure. My view of the record demonstrates no such finding or conclusion of the Commission in the case at bar, but rather a continual recitation that the Commission and its staff are not purporting to intrude upon management’s authority and discretion relating to the capital structure of the company. Hence, the cases cited by the majority for its position are not applicable in the case at bar.
The decisions of the United States Supreme Court establish the minimum due process requirements for state regulation of utility rates. See Smyth v. Ames, 169 U.S. 466, 18 S.Ct. 418, 42 L.Ed. 819 (1898). In Bluefield Water Works & Improvement Co. v. Public Service Commission of West Virginia, 262 U.S. 679, 43 S.Ct. 675, 67 L.Ed. 1176 (1923), the court set guidelines for determining a rate of return, which were further refined in Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944). In Hope, the Court stated:
From the investor or company point of view it is important that there be enough revenue not only for operating expenses but also for the capital costs of the business. These include service on the debt and dividends on the stock. (Citation omitted). By that standard the return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital. (Citation omitted). The conditions under which more or less might be allowed are not important here. Nor is it important to this case to determine the various permissible ways in which any rate base on which the return is computed might be arrived at. For we are of the view that the end result in this case cannot be condemned under the Act as unjust and unreasonable from the investor or company viewpoint.
Smith, Bluefield, and Hope make clear that the primary objective in ratemaking is to allow the utility to meet its legitimate operating expenses, as well as to pay creditors, provide dividends to shareholders, and maintain its financial integrity so that it might attract new capital.
In a case essentially similar to the case at bar, the Ohio court in General Telephone Company v. Public Utilities Commission, 174 Ohio St. 575, 191 N.E.2d 341 (1963) held, contrary to the conclusion of the majority here, that only the actual, rather than the hypothetical, interest should be considered, stating:
This position is equally untenable. There is no tax advantage because the federal income tax law does not permit the deduction of hypothetical interest in computing income tax. The federal law allows only for the deduction of only the amount of interest actually paid. To argue that this is a tax advantage is to assert in simple words that it is a tax advantage for a company to be allowed *1068as expense for income taxes an amount less than the amount of taxes which it is actually required to pay under the law. It is evident that there is no tax advantage here but rather a disadvantage which results in the appellant’s annual dollar return to which it is entitled, being reduced arbitrarily and either its statutory rate base which has been determined and agreed upon being reduced arbitrarily and unlawfully, or the annual fair rate of return which the commission has held it is entitled to receive being reduced arbitrarily and unlawfully.
Likewise, the Indiana court in Indiana Public Service Commission v. Indiana Bell Telephone Company, 235 Ind. 1, 130 N.E.2d 467 (1955), held that although the commission had assumed a hypothetical capital structure, it was improper to determine the utility’s income tax liability on that basis, stating:
This had the effect of depriving appellee of that amount of income to which it was entitled. Appellants cannot arbitrarily disallow federal taxes which appellee had paid or was obligated to pay by assuming a tax savings under a capital structure which did not exist. This action was both arbitrary and unlawful.
In the case of In re Kauai Electric Division of Citizens Utilities Company, 30 PUR4th 299 (1979), it is stated:
The county’s proposal to increase the interest expense associated with hypothetical debt component to reduce that amount of income taxes to be allowed, cannot be allowed. The reason the county’s proposal is not accepted is because its proposal not only creates a fictitious income tax liability which reduces the income tax expense and revenue requirements, but after the rates are placed into effect it also reduces the income available for earning a fair return because the income tax liability is substantially higher than that allowed in the rates. In effect then the rates are designed so that the company does not have an opportunity to earn a fair return. We conclude that the county’s proposal is unreasonable and cannot be allowed. We further noted that the courts have always declared such a procedure as that proposed by the county and adopted by the consumer advocate to be inappropriate whenever a commission has attempted to follow it. (Citations omitted.)
The company had prior cases before the Commission, in 1980 and 1983.1 In the 1980 case the Commission staff had recommended that a hypothetical interest derived from a hypothetical capital structure be utilized by the Commission, but the Commission recognized the impact that such a hypothetical interest expense would have upon income taxes and rejected the staff’s recommendation.
As noted above, certain Pennsylvania cases have permitted the use of a hypothetical interest expense. See T.W. Phillips Gas and Oil Co. v. Pennsylvania Public Utility Commission, 81 Pa.Cmwlth. 205, 474 A.2d 355 (1984); Big Run Telephone Company v. Pennsylvania Public Utility Commission, 68 Pa.Cmwlth. 296, 449 A.2d 86 (1982); Carnegie Natural Gas Company v. Pennsylvania Public Utility Commission, 61 Pa.Cmwlth. 436, 433 A.2d 938 (1981). However, as made clear in T.W. Phillips Gas and Oil Co. v. Pennsylvania Public Utility Commission, 50 Pa. Cmwlth. 217, 412 A.2d 1118 (1980), even in Pennsylvania the commission’s use of a hypothetical interest expense is not permitted absent a showing of an abuse of management discretion in adopting a capital structure.
In sum, while the Commission may adopt a hypothetical capital structure for a utility for certain ratemaking purposes, neither it nor the utility may wave a magic wand and in an instant convert a utility's capital structure into a hypothetical nonexistent capital structure. Likewise, a commission may not make an actual expense of a utility disappear by theorizing that a hypothetical capital structure would have yielded a dif*1069ferent hypothetical interest expense, and therefore income tax treatment would have been different than actuality. In my view there is no support for the Commission’s conclusion and decision in this case, and hence it is arbitrary and must be reversed.

. Case U-1007-34, Order #15330 (Feb. 20, 1980), 34 PUR 4606 (1980); Case U-1007-45, Order # 17915 (Feb. 28, 1983).