The Commonwealth Court of Pennsylvania issued a decision on November 3, 2015, available here, that has significant implications for public utilities in Pennsylvania seeking to recover costs associated with distribution system improvement projects through a “Distribution System Improvement Charge” (DSIC) authorized by Act 11 of 2012.1 In McCloskey v. Pa. Pub. Util. Comm’n, No. 1012 C.D. 2014 (Pa. Cmwlth., Nov. 3, 2015) (Columbia Gas), the Commonwealth Court upheld a DSIC calculation methodology approved by the Pennsylvania Public Utility Commission (Commission) that excludes an adjustment to the surcharge for accumulated deferred income taxes (ADIT) and allows the utility to account for the full amount of state income taxes, without anticipated deductions, associated with DSIC revenues. The court reasoned that, notwithstanding the objections of the appellant (the Pennsylvania Office of Consumer Advocate (OCA)), the Commission properly focused on the “overall effect of the rate, as a whole, and not on the omission of individual components from the rate calculation.”2 The court deferred to the Commission’s determination that the resulting DSIC surcharge was “just and reasonable” as required by the Pennsylvania Public Utility Code.

On June 19, 2014, the OCA appealed the Commission’s approval of Columbia Gas’ DSIC calculation methodology to the Commonwealth Court. OCA first argued that the Commission erred as a matter of law by not requiring the utility’s DSIC calculation to include an adjustment for ADIT tax benefits generated by the utility’s investment in the replaced infrastructure. The OCA asserted that the investment recovered through the DSIC must be reduced to account for the ADIT; otherwise, the utility would be allowed to earn a return on the utility’s entire investment even though some of it was essentially financed at zero cost using deferred taxes.

The Commission argued in response that OCA’s position missed the purpose of the DSIC. The Commission contended that a DSIC surcharge calculation does not require the same level of analysis as a general base rate case and that to require such scrutiny would be unreasonable and undercut the goal of the General Assembly in establishing a straightforward and simple process to calculate and audit the DSIC surcharge. The Commission also argued that other provisions within Act 11, specifically including the rate cap that allows the Commission to reset a utility’s DSIC to 0 percent of billed revenues if the Commission finds that the utility is over-earning, ensure that DSIC surcharge is just and reasonable.3

The OCA next argued that a state income tax gross-up in the DSIC calculation would allow the utility to base its DSIC surcharge on the full statutory tax rate even though the utility may not pay taxes at that rate after the application of tax deductions (including repair allowance, accelerated depreciation and bonus depreciation). OCA argued that an elevated tax allowance violated the Public Utility Code that limits DSIC recovery to expenses actually incurred.

In response, the Commission reiterated its previous arguments and also noted that, under the existing water DSIC calculation methodology, water utilities had performed a gross-up for state income tax as part of their DSIC calculations for 18 years. Further, the Commission contended that it was the intent of the General Assembly to model the Act 11 DSIC surcharge mechanism on the prior water DSIC mechanism.

The Commonwealth Court rejected the OCA’s arguments and upheld the Commission’s approval of the DSIC calculation methodology. In doing so, the court relied heavily on the U.S. Supreme Court’s decision in Duquesne Light Co. v. Barasch, 488 U.S. 299 (1989), which “acknowledged that there were many ways to achieve rates that were just and reasonable” and reaffirmed appellate deference to the expertise of the Commission on ratemaking issues.

OCA has until November 17, 2015 to request re-argument before the Commonwealth Court and until December 3, 2015 to petition the Supreme Court of Pennsylvania for allowance of appeal. Should there be further appellate review of the Columbia Gas decision, it is important to remember that “[a]nyone interested in the question involved in any manner pending in an appellate court, excluding Petitions for Allowance of Appeal, although not a party, may … file a brief amicus curiae in regard to those questions.”4