On July 1, the U.S. Court of Appeals for the District of Columbia Circuit issued its opinion in United Airlines, Inc., et al. v. FERC. This oil pipeline rate case appeal involves SFPP, L.P., a pipeline organized as a limited partnership. In its ruling, the court rejects application of the Federal Energy Regulatory Commission’s (the Commission) Policy Statement on Income Tax Allowances (Policy Statement)1 as creating an unjustified “windfall” for the pipeline’s partners. United Airlines thus calls into question the Policy Statement’s continuing validity and opens the door to both a reexamination of the Commission’s income tax allowance policies and additional challenges to such tax allowances for regulated “pass through” entities like SFPP.
Shipper Petitioners in United Airlines challenged the Commission’s decision to grant SFPP an income tax allowance. Petitioners argued that (i) the Commission’s ratemaking methodology already ensured a sufficient after-tax rate of return to attract investment capital, and (ii) because partnership pipelines do not otherwise incur entity-level taxes, the Commission’s tax allowance policy would permit the pipeline’s partners to “double recover” their taxes. In response, the Commission contended that Petitioners’ argument constituted a collateral attack on the court’s prior ruling in ExxonMobil Oil Corp. v. FERC, 487 F.3d 945 (D.C. Cir. 2007) (ExxonMobil), in which the court found that the Commission’s policy of permitting partnership pipelines to receive a tax allowance as set forth in the Policy Statement was “not unreasonable.”2
The court in United Airlines first clarified its earlier holding in ExxonMobil, explaining that its earlier decision had found that the Commission could grant a tax allowance to partnership pipelines to the extent that it had a reasoned basis for doing so. In the present case, however, Petitioners were challenging whether such a reasoned basis existed, rendering the Commission’s collateral attack argument unavailing.
Turning to the merits, the court agreed with Petitioners that the Commission had not adequately justified its income tax allowance policy for partnership pipelines. More specifically, the court found that the Commission had failed to justify its conclusion that an income tax allowance, together with the pipeline’s authorized pre-tax return on equity, would not result in a double recovery of taxes. The court concluded that an income tax allowance that included taxes paid by the pipeline’s partners would afford the partners a “windfall” in after-tax returns compared to shareholders in a corporate pipeline.
Regarding the appropriate remedy, Petitioners had not sought to overturnExxonMobil, an action the court found both unavailable and unnecessary. The Commission acknowledged during oral argument that it might be able to remove any duplicative income tax recovery directly from the pipeline’s authorized return on equity. In addition, the court indicated that it would not foreclose the Commission from eliminating all income tax allowances and setting rates based on pre-tax returns, assuming a reasoned basis existed for doing so. The court then vacated the Commission’s orders with respect to the income tax allowance issue and remanded the matter for the Commission “to consider these or other mechanisms for which the Commission can demonstrate that there is no double recovery.”
The court’s opinion in United Airlines calls into question the continuing validity and applicability of the Commission’s Policy Statement on Income Tax Allowances. The court’s acceptance of Petitioners’ double recovery argument and ensuing remand open the door to both a reexamination of the Commission’s income tax allowance policies and additional challenges to such tax allowances for regulated “pass through” entities like SFPP. As it did prior to issuing the Policy Statement in 2005,3 the Commission ultimately may conduct a notice and comment procedure to reconsider its income tax allowance policies. In the meantime, the United Airlines decision likely will encourage future challenges to income tax allowances for regulated “pass through” entities that do not themselves pay entity-level income taxes.