In concurrent orders issued on July 18, 2018, the Federal Energy Commission (FERC or Commission) established new tax policies for interstate natural gas pipelines that address double recovery and tax allowance questions raised by the United States Court of Appeals for the District of Columbia Circuit in United Airlines, Inc. v. FERC1 and the rate implications of the 2017 Tax Cuts and Jobs Act.
Interstate natural gas pipelines are authorized to charge their customers “just and reasonable” rates to recover specified costof service items, including federal tax expenses. However, the Commission is quickly adapting its tax policies in light of recent judicial developments concerning Master Limited Partnership (MLP) pipelines and sweeping legislative measures that slashed the marginal federal corporate income tax rate from 35 percent to 21 percent.
First, in its Order on Rehearing in Docket No. PL17-1-000, the Commission dismissed requests for hearing and clarification of the Commission’s March 15, 2018, Revised Policy Statement on Treatment of Income Taxes.3 Prompted by the D.C. Circuit’s remand in United Airlines and Commission Opinion No. 511-C,4 the Revised Policy Statement concluded that an impermissible double recovery of investors’ tax costs results when an MLP pipeline collects both an income tax allowance and a return on equity (ROE) based on the discounted cash flow (DCF). Therefore, the Commission precluded MLP pipelines from recovering both an income tax allowance and a DCF-calculated ROE.
While the Revised Policy Statement addressed the question of double recovery, it did not explain how MLP pipelines should treat Accumulated Deferred Income Tax (ADIT) balances that accrued before the Revised Policy Statement’s effective date. ADIT records the amount of income taxes that the pipeline collects in advance and which it will eventually owe the federal government. In the Order on Rehearing, the Commission clarified that “when an MLP pipeline’s income tax allowance is eliminated from cost of service, previously accumulated ADIT balances may also be eliminated.”5 Under these circumstances, an MLP pipeline is not required to refund such ADIT to shippers, nor does the ADIT have to be removed from the pipeline’s rate base.
Although the Order on Rehearing ostensibly advanced the MLP-related policies stemming from United Airlines and Opinion No. 511-C, the Commission also stressed that “[w]hile the Commission declines to reconsider the policy announced in the Revised Policy Statement, it will consider the issues and arguments raised in the rehearing requests in the context of specific cases in which they apply.”6 The Commission went on to caveat that “[a]n entity such as an MLP pipeline will not be precluded in a future proceeding from arguing and providing evidentiary support that it is entitled to an income tax allowance and demonstrating that its recovery of an income tax allowance does not result in a double-recovery of investors’ income tax costs.”7 The Commission clearly signaled that there may be latitude in the application of the MLP pipeline policies set out in the Revised Policy Statement. As noted below, Order No. 849 – a companion to the Order on Rehearing – indicates that a number of MLP pipelines will be able to seek to include income tax allowances in their rates in future rate cases.
The main thrust of Order No. 849 is to evaluate and address the revenue impact of the Tax Cuts and Jobs Act and the United Airlines holding on interstate gas pipeline’s revenue requirements.8 In Order No. 849, the Commission adopted a Final Rule requiring all interstate natural gas companies, with cost-based stated rates, to file a new informational filing, FERC Form No. 501-G, with the Commission. Among other financial components, FERC Form No. 501-G directs pipelines to disclose their capital structure. However, if a pipeline opts to report a hypothetical capital structure, the Final Rule requires that the pipeline’s hypothetical capital structure must be 57 percent equity, instead of 50 percent equity.
Along with FERC Form No. 501-G, interstate natural gas pipelines also have the option of:
filing a limited Natural Gas Act (NGA) section 4 case to reduce the pipeline’s rates in accordance with the Commission’s tax policies; making a commitment to file a general NGA section 4 rate case or prepackaged settlement in the near future; filing a statement explaining why an adjustment to its rates is not needed; or taking no action other than filing the FERC Form No. 501-G.
MLP pipelines that make limited NGA section 4 filings may (1) eliminate their tax allowance and their ADIT or (2) reflect only the tax reductions in the Tax Cuts and Jobs Act. The Final Rule also provides that if a jurisdictional pipeline makes a limited NGA section 4 filing and that pipeline’s FERC Form No. 501-G shows an ROE of 12 percent or less, the Commission will commit to a three-year moratorium period on all Commission-initiated section 5 rate investigations of that pipeline.
Natural Gas Policy Act section 311 and Hinshaw pipelines are not required to file FERC Form No. 501-G or any of the four optional filings. The Commission will instead rely on its five-year rate review process as the primary mechanism to weigh changes to reflect the Tax Cuts and Jobs Act.
Finally, Order No. 849 revisited the issue of MLP pipeline tax cost recovery. The Commission noted that if an MLP pipeline chooses the first optional filing (filing a limited NGA section 4 case), the MLP pipeline may propose in its limited section 4 filing to (1) eliminate their tax allowance, along with their ADIT, or (2) reflect only the tax reductions in the Tax Cuts and Jobs Act.9 The Commission explained that although the Revised Policy Statement prohibits MLP pipelines from including a tax allowance in their cost of service, the Commission will not require MLP pipelines to eliminate their tax allowances in this rulemaking proceeding. Moreover, Order No. 849 provides that “a natural gas company organized as a pass-through entity is considered subject to the federal corporate income tax, if all of its income or losses are consolidated on the federal income tax return of its corporate parent.”10 Under this policy, the pass-through entity would be eligible for a tax allowance.