Appeal from Order and Opinion of Commonwealth Court at No. 362 C.D. 1982, Entered August 15, 1983 affirming Order of Pennsylvania Public Utility Commission at Docket No. R-811510, entered January 22, 1982; 76 Pa. Commonwealth Ct. 353,
Nix, C.j., and Larsen, Flaherty, McDermott, Hutchinson, Zappala and Papadakos, JJ.
The Consumer Advocate appeals by allowance Commonwealth Court's order affirming the Public Utility Commission in a rate case. In dealing with the rates proposed in Pennsylvania Power Company's Tariff Supplement No. 15
the Commission allowed the Company to "normalize"*fn1 both its federal and state taxes for three separate classes of property: (1) property placed in service between 1971 and 1980, (2) property placed in service in 1980 and (3) property placed in service after January 1, 1981. The Commission's order approved the setting of rates on the basis of the higher income taxes the utility would hypothetically have paid if it used straight-line depreciation, an historical method of depreciation related to the asset's actual useful life.
Specifically, the Commission allowed "normalization" of federal and state taxes for: (1) the difference between depreciation by asset class life (ADR) and straight-line depreciation for property placed in service between 1971 and 1980; (2) the difference between depreciation by the Double Declining Balance method (DDB) and straight-line depreciation for property placed in service in 1980; and (3) the difference between depreciation by the Accelerated Cost Recovery System (ACRS)*fn2 provided in the Economic Recovery
Tax Act of 1981 (ERTA), United States Internal Revenue Code (IRC) Section 168, 26 U.S.C. § 168, and straightline depreciation for property placed in service after 1980.
Commonwealth Court, in affirming the PUC order, held (a) that the decision to approve normalization of both state and federal tax expense in all three respects was supported by the Commission's short general analysis of that concept and (b) that the application of normalization to all of these assets did not violate Pennsylvania's longstanding doctrine of allowing only "actual taxes paid" to be considered in the rate base.
The Consumer Advocate challenges those parts of the Commission's order permitting normalization of the state income tax expense for assets placed in service in all three of these periods. He also challenges normalization of the federal income tax expense for assets placed in service for the period 1971 through 1980. He concedes the propriety of normalizing federal taxes for assets placed in service after 1980. The Commission gave no indication that it either recognized any distinction among the situations presented, or that it considered the "actual taxes paid" doctrine.
On the record before us normalization of this utility's state taxes violates the "actual taxes paid" doctrine*fn3 in all instances and offers no offsetting advantage to ratepayers. The decision to permit normalization of state taxes is therefore reversed.
With respect to normalization of the reduced federal taxes attributable to rapid depreciation allowable on pre-1981 assets we remand to the Commission for further
consideration of the "actual taxes paid" doctrine. In so doing we direct the Commission to determine whether the distinctions traced in IRC § 167(l) between assets placed in service at different times require separate calculation of the annual tax reductions attributable to those assets earlier placed in service. On examination the Commission may find that the decline in those tax deductions, concomitant with the ever-shrinking deductible base of such older assets, can be offset by the continuing tax reductions a going concern will obtain from rapid depreciation on the newer assets which it must from time to time provide. On the other hand, the Commission may find, after considering trends in both inflation and energy demand, that this continuing provision of new assets is not likely to produce such an offset. In such case the Commission is further directed to determine when the turn around to higher tax expense is likely to occur. Based on that last determination the Commission must finally determine whether it is reasonable to charge current ratepayers for those future tax expenses. Such findings and conclusions are necessary to enable the judiciary to exercise its reviewing function and to deal separately with the rate-making effect of normalization of federal tax expense for each of the three asset categories covered in the Commission's order.
Commonwealth Court described the procedural and factual history of this case as follows:
Proceedings in this case began on April 15, 1981, when Pennsylvania Power Company filed . . . . Supplement No. 15 requesting an increase in total annual operating revenues of $32,735,000.00 based on a future test year ending December 31, 1981. By order adopted June 11, 1981, the PUC instituted a formal investigation of the lawfulness and reasonableness of the proposed rates . . . . The matter was assigned for hearing and six complaints against the proposed rate increase were filed . . . . The complaints were consolidated with the PUC's investigation for hearing
and disposition . . . . [T]he Administrative Law Judge, on December 3, 1981, issued his recommended decision. Exceptions and Replies to Exceptions were timely filed by the Power Company, the PUC trial staff, and the Consumer Advocate.
On January 22, 1981, the PUC entered the Order appealed here and approved rate levels which would produce total annual operating revenues of $164,238,000.00, an increase in total operating revenues of $24,915,000.00. The order also expressly approved the Power Company's claim for normalization of deferred federal and state income taxes.
Cohen v. Pa. PUC and Pennsylvania Power Company, 76 Pa. Commonwealth Ct. 353, 355, n. 1, 463 A.2d 1274, 1276, n. 1 (1983).
That part of the order generally allowing normalization of tax expenses increased the Company's claimed expenses for cost of service by $2,777,949.00. That total increase breaks down as follows:
book lives with DDB $1,074,293 $265,204 $1,339,497
Depreciation $941,286 $232,369 $1,173,655
Depreciation $212,371 $52,426 $264,797
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Total: $2,227,950 $549,999 $2,777,949
The difference between the tax expense allowable for rate purposes under straight line depreciation and the tax deduction allowable under ...