TAXATION COMMITTEE MEETING

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TAXATION COMMITTEE MEETING
AGA/INGAA

• REGULATORY TAX DEVELOPMENTS

Jim Warren Thelen Reid Priest LLP June 25, 2006
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What Are The Issues?

• The regulatory communitys response to the
  proposed normalization rules
• Consolidated tax adjustments
• The necessity to fix outstanding normalization
  foot-faults

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Environmental Impact Statement

• 70 per barrel oil
• 6-7 per mcf gas
• Billions in stranded costs collected and to be
  collected
• 10-70 rate increases

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The Regulatory Communitys Response To The
Proposed Normalization Rules
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The Issue

• Electric Industry Restructuring
• The Implications of Stranded Costs
• Who gets ADITC?
• Who gets EDFIT?

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Flash Points

• Texas
• New Jersey
• Connecticut
• New York
• Maryland
• D.C.

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2003 Proposed Regulations

• Treat ADITC and EDFIT as if nothing had happened
• Effective date post - March 4, 2003
• Retroactive election
• Hearings held on June 25, 2003

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2005 Proposed Regulations

• Treat ADITC as if nothing had happened to extent
  funded by ratepayers
• Treat EDFIT as if nothing had happened
• Effective date post-December 21, 2005
• Soft landing in certain cases
• Hearings held on April 5, 2006

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Recent PLRs

• All unfavorable
• Regulators tried to stop the process
• Were amazed at the IRS process
• Texas
• Intervenor makes emergency motion to compel
  withdrawal
• New Jersey
• BPU direct companies to withdraw
• Connecticut

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Status

• A lot of money at stake
• 600 million in Texas
• 300 million in New Jersey
• 60 million in Connecticut
• Regulators are angry
• Regulators are frustrated
• Challenge to rulings?
• Challenge to regulations?

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Regulatory Options

• Change the regulations
• Change the law
• Go toe to toe with the normalization rules
• AA and AAA methods
• Mythical interest
• Consolidated tax adjustments
• Implications for normalization rules

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Consolidated Tax Adjustments
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NEW YORK TIMESMarch 15, 2006

• Many Utilities Collect for Taxes They Never Pay

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WHAT IS A CTA?

• Consideration of the tax benefit of affiliate
  losses in the computation of regulated rates.

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Variations

• Cost of service adjustment
• Pour Over
• Parent Company Loss
• Chronic Loss
• Comprehensive
• Interest credit
• Rate Base Offset
• Pour over
• Comprehensive
• Interest credit

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UNDERLYING THEORY

• Cant charge customers for a tax that is not paid
• Actual taxes paid
• Tax benefit could not be recognized without
  presence of utility
• Sharing?

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WHATS IT ALL ABOUT?
Tax Allocation Timing and Amount
But, dont we have a tax sharing agreement?
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EARLY RUMBLINGS

• Diversification
• PUHCA
• Rule 45(c)
• Couldnt pay parent for losses
• Must pay others
• New Jersey Power Light case
• Water companies
• Diversified
• Small amounts
• Irritating!!!
• Gas transmission companies
• Telephone companies
• Mainly parent company debt

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FERC

• United Gas Pipeline - 1967
• 2 EP companies
• Pour over
• Not impermissible
• Divided court
• City of Charlottesville - 1985
• Gas supply subs
• Stand alone
• Not impermissible

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THE 80S

• Electric
• Finished large plant additions
• Positive cash flow
• Non-regulated investments
• Telephone deregulation
• Gas diversification
• Enron was a gas company
• Earlier holdings and dicta cited
• Supreme Court of PA said CTA was mandatory

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NORMALIZATION

• 5 PLRs
• 8525156
• 8643052
• 8711050
• 8801041
• 8904008
• Indirect flow through
• Consistency rules

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CONTEL CASE

• In 1988 PA court held PUC could impose a CTA even
  if a PLR had been received
• Court disagreed with Service

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REGULATIONS

• Reg project opened 12/1988
• Proposed regs issued 11/1990
• Split the baby
• 100 comments
• Hearing held 2/1991
• Proposed regs withdrawn 4/1991
• Hearing held 11/1991
• Subcommittee on Select Revenue Measures
• Graetz comments

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OFF TO THE RACES

• Pennsylvania
• New Jersey
• Texas
• West Virginia
• Connecticut
• Oregon
• Vermont

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A CAUTIONARY NOTE
Many commissions have considered CTAs and
rejected them as inappropriate ratemaking.
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PENNSYLVANIA

• Mandated by Supreme Court in 1985
• UGI (Barasch) case
• 22 non-regulated subs
• Comprehensive COS
• 5 year average effective rate

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NEW JERSEY

• 1950s cases
• Normalization hiatus
• Atlantic City Electric
• 1992
• Holding company
• Leasing
• Real estate
• Rate base offset
• Starts 7/1/1990
• NJ Utility TI/All TI X total losses X tax rate
• Now SOP

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TEXAS

• PURA
• Fair share
• GTE SW case
• Fair share can be 0
• Comprehensive CTA
• 15 years of data
• Interest credit method
• Adjustment to tax expense
• Computed at cost of debt

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WEST VIRGINIA

• Parent company loss
• Proposals to broaden it to comprehensive COS
• 3 year average
• 5 year average

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CONNECTICUT

• Has used CTAs
• Case-by-case determination
• Looks at predictive value

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OREGON

• Enron taint
• Vitriolic newspaper campaign
• Senate Bill 408 9/2/2005
• Imposes tax tracker
• Paid to government v. collected in rates
• Amounts tracked are those that are properly
  attributable to the regulated operation
• Capped at total group tax
• Normalization fail safe
• Workshops during 2006 to establish rules
• Final rules to be adopted 9/06

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VERMONT

• Just raised by consumer advocate
• No adjustment proposed

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THE TREES

• The sound-bite
• actual taxes paid
• The mechanics for computing and apportioning
  consolidated savings
• What do you do with
• Sold members
• Merged members
• Regulated members
• Etc.

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THE FOREST

• Correct inquiry
• Paid or incurred
• Estimated or actual
• Properly attributable to the regulated operation

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MORE FOREST

• To what operations are the tax benefits of
  affiliate losses attributable?
• Who is most responsible?
• Is it proper to compensate loss affiliates for
  the absorption of their losses?
• The gift card analogy
• How does consolidated filing produce cost-free
  capital?

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STATUS

• The PR war is well under way
• Opposing actual taxes is the regulatory
  equivalent of clubbing baby harp seals
• Better off opposing taxes paid
• Political advantage and/or pressure will often
  triumph over thoughtfulness

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The Necessity To Fix Normalization Foot Faults
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Who Has Violated Normalization?
Probably Everyone In Some Way Or Another
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What Has Changed?

• Under FAS 5, taxes were a loss contingency
• Unasserted claims were often harmless
• New FASB asset model
• Must presume that all problems surface

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Consequences?

• Interest accruals
• Disclosure
• Classification

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Solution?
Come Clean