On March 15, 2018, the Federal Energy Regulatory Commission (FERC, or the Commission) announced two major actions addressing taxes. First, FERC announced actions it is taking in response to the 2017 tax reform legislation (commonly referred to as the Tax Cuts and Jobs Act), signed into law by President Trump on December 22, 2017. The goal of these actions will be to ensure that regulated entities pass the benefits of the reduced corporate income tax rate on to consumers. Second, FERC responded to the July 2016 decision of the US Court of Appeals for the District of Columbia in United Airlines v. FERC and announced a new Revised Policy Statement on Treatment of Income Taxes (Revised Policy Statement). The Revised Policy Statement does not allow master limited partnerships (MLPs) to recover an income tax allowance in their costs of service. Regulated entities should ensure that they comply with the Commission’s orders regarding the treatment of income taxes and consider whether to file comments on the proposed rulemaking and notice of inquiry.
Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act lowered the federal corporate income tax rate from a maximum of 35 percent to a flat 21 percent rate. The Commission regulates rates for some public utilities, interstate natural gas pipelines and oil pipelines using cost-of-service rates, which currently include an income tax allowance. As a result of the change in the income tax rate, those entities will have a lower tax expense and thus a lower cost of service. The Commission announced several different actions to address this change.
First, the Commission issued an order to show cause to 48 public utilities using transmission formula rates that include a fixed line item for federal corporate tax income or use stated rates. The order to show cause directed those utilities to either propose revisions to their transmission rates or show cause why they should not be required to do so. No filing is necessary for public utilities using a transmission formula that does not contain a fixed line item for income taxes or a stated rate.
Second, the Commission issued a Notice of Proposed Rulemaking (Docket No. RM-11-000) to address the effect of the corporate income tax rate cut on the rates of interstate natural gas pipelines. The notice proposes requiring interstate natural gas pipelines to make an informational filing to evaluate the impact of the tax cut and the Revised Policy Statement. The notice proposes to collect financial information from the pipelines and permit the pipelines to voluntarily file rate reductions reflecting the reduction in corporate income taxes, explain why no action is needed, or take no action other than the informational filing. The Commission also proposed separate procedures for intrastate pipelines providing interstate service under Section 311 of the Natural Gas Act and Hinshaw pipelines performing interstate transportation pursuant to a limited jurisdiction certificate from the Commission.
Third, the Commission announced that it would not take any industry-wide action with respect to oil pipeline rates, because most oil pipelines set rates using indexing, and the Commission is currently scheduled to reassess that index in 2020 based on cost changes between 2014 and 2019. That reassessment will consider any effect of the tax cuts.
Finally, the Commission issued a Notice of Inquiry that seeks comment on other effects of the tax cut. In particular, the Commission has requested comments on the treatment of accumulated deferred income taxes (ADIT), which are collected from customers in anticipation of paying federal taxes. ADIT balances for regulated entities do not accurately reflect current tax liability due to the tax rate cut. The Commission has also requested comments on the impact of changes to the bonus depreciation rules.
Revised Policy Statement on Treatment of Income Taxes
The Commission’s Revised Policy Statement on Treatment of Income Taxes no longer allows master limited partnerships (MLPs) to recover an income tax allowance in their cost of service. The Revised Policy Statement is in response to a decision by the DC Circuit in 2016 holding that the Commission had failed to demonstrate that there was no double recovery of income tax costs when an MLP was permitted to receive both an income tax allowance and a return on equity determined by a discounted cash flow methodology. After soliciting comments on how to address any double recovery resulting from the rate of return policies and the income tax allowance policy, the Commission reversed its previous policy and found that granting an MLP an income tax allowance would result in an impermissible double recovery. According to the Commission, the discounted cash flow methodology determines the pre-tax investor return required to attract investment, so permitting an MLP to recover both an income tax allowance for the partner’s tax costs and a discounted cash flow return on equity leads to a double recovery of the MLP’s income tax costs.
For oil pipelines, the Revised Policy Statement directs oil pipelines organized as MLPs to indicate the elimination of the income tax allowance in their reporting requirements to be incorporated into the Commission’s industry-wide five-year review in 2020.
For natural gas pipelines, the Commission’s Notice of Proposed Rulemaking issued in response to the corporate income tax rate cut will also consider issues arising from the elimination of the income tax allowance for natural gas pipelines organized as MLPs. The Commission’s stated goal in its Notice of Proposed Rulemaking is to ensure that interstate natural gas pipelines and intrastate pipelines providing interstate service “flow through the benefits of the corporate income tax reduction and elimination of MLP income tax allowances to consumers to the extent that their rates would otherwise over-recover their costs of service.” The Commission proposes requiring natural gas pipelines to file a one-time informational report, and additionally either (a) file a limited Natural Gas Act (NGA) Section 4 Filing to voluntarily reduce their rates to reflect changes due to the Tax Cuts and Jobs Act and the Revised Policy Statement; (b) commit to filing a uncontested settlement or general NGA Section 4 rate case by December 31, 2018; (c) file a statement explaining why an adjustment is not needed; or (d) make only the informational filing. The Commission will consider whether to initiate an investigation of those pipelines electing not to file a reduction or commit to filing a rate case.