On March 15, 2018, the Federal Energy Regulatory Commission (“Commission”) unanimously decided to change its policy regarding income tax allowances for Master Limited Partnerships (“MLPs”), citing a 2016 decision by the United States Court of Appeals for the District of Columbia Circuit in United Airlines v. FERC.1 In that opinion, the Court found the Commission had not demonstrated that providing oil pipelines with both an income tax allowance and an after tax return avoided a double recovery of the tax allowance in rates for such pipelines. Thus, the Commission announced that it will revise its 2005 Income Policy Statement on Income Tax Allowances,2 which had allowed income tax allowances for certain pass-through pipelines. According to the Commission’s issuance today, “the Commission will no longer allow MLPs to recover an income tax allowance in their cost-of- service rates.” (Inquiry on Income Taxes, PL17-1-000). This sweeping statement arguably precludes recognition of an income tax allowance in an MLP pipeline’s rates regardless of the proportion of the MLP’s units owned by corporations. FERC rejected a series of arguments that double recovery was not occurring for MLPs. The Commission stated that the application of this revised policy applied only to MLPs, and that non-MLP entities will be addressed in subsequent proceedings.3
However, the Commission sought input regarding how to reflect the elimination of the income tax allowance with respect to the treatment of accumulated deferred income tax (“ADIT”) balances (as discussed below).
These orders present several concerns for Commission-jurisdictional gas and oil pipelines. First, the Commission erroneously asserts that pipelines can reduce their rates to reflect the reduced income tax rates and elimination of MLP income tax allowances on a single-issue basis, without consideration of any other cost or revenue changes.4 The Commission ignores that the elimination of the income tax allowance for MLPs and the impacts associated with excess ADIT to be returned to customers will raise a number of issues beyond the single issue identified by the Commission, including the impact on cash flow, coverage ratios, and credit quality (and thus capital costs). Thus, the impact of any change will necessarily be broader than just any single issue, which will raise questions about whether a “limited” Section 4 proceeding is an appropriate procedural vehicle to address these issues.
Second, the Commission did not explicitly address the impact of the elimination of the income tax allowance on MLPs that are partly owned by a corporation. The Commission’s statements are facially quite broad. However, arguably, MLPs that are owned both by individuals (who arguably represent only one layer of taxation) and corporations (which owe corporate income taxes in addition to the income taxes owed by shareholders), should be treated differently than MLPs with units held disproportionately by traditional subchapter “C” corporations. Market participants may argue that FERC should take the differing tax consequences of owners of MLP units into account when applying the holdings set forth in United Airlines.
Natural Gas Pipelines
Additionally, the Commission issued the NOPR which would require natural gas pipelines to file a one-time Form 501-G detailing the impacts arising from (i) the change in the treatment of income tax allowances for MLPs, and (ii) the reduction in the federal corporate income tax rate from a maximum 35% to a flat 21%, in accordance with the Tax Cuts and Jobs Act of 2017 (“TCJA”). Specifically, Form 501-G must include an abbreviated cost and revenue study estimating the percentage reduction in the cost-of-service and the pipeline’s current ROEs before and after the reduction in corporate income taxes and the elimination of income tax allowances for MLPs.5 Given the foregoing, jurisdictional natural gas pipelines will be obligated to elect one of four alternatives:
- submit a limited Natural Gas Act Section 4 rate filing, proposing to reduce their rates based on federal corporate income tax changes;
- make a commitment to file a general Section 4 case “in the near future;”
- explain why no rate adjustment is necessary; or
- take no action other than submitting Form 501-G (although they may be subject to Commission investigation of their rates).
The Commission also proposes requiring that intrastate pipelines (performing interstate service pursuant to Section 311 of the Natural Gas Policy Act of 1978), and Hinshaw pipelines, take steps to either reduce interstate rates if interstate rates are reduced, or to make filings that would potentially disclose over-collections.
The Commission’s revised policy will instruct MLP oil pipelines to reflect the Commission’s elimination of the income tax allowance in their Form No. 6, page 700 reporting. Based upon page 700 data, the Commission will incorporate the effects of the elimination of the income tax allowance on industry-wide oil pipeline costs in the 2020 five-year review of the oil pipeline index level.
ADIT for Both Gas and Oil Pipelines
As to ADIT, FERC seeks comments regarding how to treat:
- ADIT balances for MLPs in light of the elimination of income tax allowances for MLPs (eg., “whether previously accumulated sums in ADIT should be eliminated altogether from cost-of-service or whether those previously accumulated sums should be placed in a regulatory liability account and returned to ratepayers” (id., P 25, emphasis added);
- rate base in a consistent manner pre-and post-TCJA, until excess/deficient ADIT treatment is finally resolved (RM18-12, P 14);
- regulatory assets/liabilities in a manner comparable to ADIT liability (id., at P 15);
- carrying cost/interest on excess/deficient ADIT (id., at P 16);
- implementation of the Average Rate Assumption Method or the South Georgia method of flowback in deriving the cost of service (id., at P 17);
- flowback schedules (eg., a shorter 5 year period) for non-plant ADIT (id., at P 19);
- excess ADIT for assets sold or retired after 12/31/17 (id., at P 20);
- amortization of and regulatory accounting for the excess or deficient ADIT (id., at PP 21, 22); and
- bonus depreciation.