Discussion
of Issues
Issue 1:
What should the effective date be for adjustments
associated with the Tax Cuts and Jobs Act of 2017?
Recommendation:
Unless the utilities agree to a January 1, 2018
effective date, the effective date for adjustments associated with the Tax Cuts
and Jobs Act of 2017 should be February 6, 2018, for utilities that do not have
settlement agreements addressing this issue.
For utilities that have settlement agreements addressing this issue, the
terms of each settlement agreement should control. (Cicchetti, Fletcher, Brownless)
Staff Analysis:
Tax
Cuts and Jobs Act of 2017
The Tax
Cuts and Jobs Act of 2017 (Act)
was signed into law by President Trump on December 22, 2017, and applies to the
taxable year beginning after December 31, 2017.
The Act affects many sections of the Internal Revenue Code that will
impact the federal tax liability of regulated utilities. Four areas are of particular importance: 1)
the tax rate reduction for corporations from 35 to 21 percent; 2) limitations
on the amount of interest expense corporations can deduct to lower their tax
bill; 3) flow back of excess deferred taxes caused by the reduction in the
corporate tax rate, and 4) treating Contributions in Aid of Construction (CIAC)
as taxable income for water and wastewater utilities.
Corporate
Rate Change
The Act
lowered the tax rate for corporations from 35 percent to 21 percent. Regulated utilities, like other corporate
entities, will realize a reduction of 14 percentage points from the previous
rate. For unregulated corporations, a
lower tax rate means more cash flow and higher earnings. For most regulated utilities, the tax cut
benefit will accrete to customers. For
electric, natural gas, and certain water and wastewater utilities, taxes
are part of the utilities’ cost-of-service calculation. Therefore, a lower tax rate may translate into
lower utility rates for customers.
Deductibility
of Interest Expense
The new law puts limits on the
amount of interest expense corporations can deduct to lower their tax bill. The limit is set at 30 percent of EBITDA (Earnings
Before Interest, Taxes, Depreciation, and Amortization) and then drops to a
more restrictive measure of 30 percent of EBIT (leaving out the depreciation and
amortization). Regulated utilities,
however, have a 100 percent exemption. Although
regulated utilities maintained their 100 percent exemption, they lost bonus
depreciation (which allows quicker recovery of capital investments for tax
purposes) and utilities cannot write-off capital investments to expense in the
year the investment is made as unregulated companies can do under the new law. That puts utilities back on the modified
accelerated cost recovery system (MACRS) which is beneficial, but not as beneficial
as bonus depreciation or immediate write-off.
Deferred
Taxes
Generally, deferred taxes arise for
regulated utilities due to the book-tax timing difference associated with
utilities being allowed to book higher depreciation expense (accelerated depreciation)
for tax purposes as compared to the straight-line depreciation required by
regulation. Regulators require
straight-line depreciation to allocate the recovery of investments in equal
annual amounts over the life of the investments. Deferred taxes can also arise from various
other book-tax timing differences.
Because taxes have been paid by the
customer before the company pays them to the government, deferred taxes are
recorded on the company’s balance sheet as a regulatory liability. Deferred taxes are a cost-free source of
capital to the utility, and for regulatory purposes, can be included in the
capital structure as zero cost capital or used to reduce rate base. Both treatments have exactly the same effect
on the revenue requirement. In Florida,
deferred taxes are included as a cost-free source of capital in the capital
structure. Deferred taxes reverse over
time as the annual straight-line depreciation expense exceeds the annual
accelerated depreciation expense in the later years of an asset’s useful life. This treatment is required by the Internal Revenue
Service (IRS) and is known as normalization accounting (i.e. spreading the
benefit over time as opposed to flowing it immediately through to customers).
The deferred taxes currently on utilities’
balance sheets were calculated at a 35 percent rate. However, the new lower 21
percent rate means the deferred taxes eventually will be paid to the government
at a lower rate. This is a benefit
(lower cost) for customers. The new law
and normalization accounting require that the deferred tax difference between
the 35 percent and 21 percent be booked as a regulatory liability and flowed
back (returned) to customers over the regulatory remaining life of the asset. For Florida utilities, the annual flow back of
the excess deferred taxes will be a benefit to customers that will be somewhat
offset by the gradual reduction of zero cost capital in the capital structure which
will somewhat increase the overall cost of capital.
Contributions
in Aid of Construction
The previous law included a carve-out
for water and wastewater utilities that excluded CIAC from gross income, (i.e.
non-taxable). The new law removed that
carve-out, thereby making CIAC taxable for water and wastewater utilities.
Consequently, water and wastewater utilities will need to petition the
Commission to gross-up CIAC for taxes thereby increasing the cost to customers of
utilities that receive and record CIAC.
OPC’s
Petition
In its Petition, OPC has made several
requests. First, that the Commission
take jurisdiction over any revenue requirement reduction caused by the Act for
all regulated utilities: electric, natural gas, water, and wastewater. Second, that the Commission place revenues
subject to refund covering at least the amount of the Net Operating Income
(NOI) impact of lowering the corporate rate from 35 to 21 percent. OPC estimates that this amount is
presumptively at least 13 percent of overall NOI for each utility. OPC would accept a corporate undertaking for
the NOI impact or written acknowledgement of Commission jurisdiction. Third, with regard to the creation of excess
accumulated deferred income taxes, OPC requests that the Commission identify
the balances for each utility and order the benefits to be captured and
returned to customers pursuant to applicable law. Fourth, for excess deferred income taxes not
related to depreciation, OPC requests that the Commission identify excess
amounts for each utility and require that those be flowed back to customers to
the greatest degree possible. Fifth, OPC
acknowledges that four electric utilities
have settlement agreements which address the issue of a change in federal tax
rates. For those utilities, OPC states
that the terms of the individual settlement agreements should be followed for
implementation of revenue requirement impacts through filing limited
proceedings within the time limits set forth in each of the agreements.
FPL’s
Response
In its response, FPL takes the position
that while the Commission should attach jurisdiction over the resulting federal
tax savings on February 6, 2018, no generic proceeding is required at this
time. FPL argues that its Settlement
Agreement
allows it to amortize its $1.25 billion of depreciation and dismantlement
reserve surplus as it sees fit to maintain its earnings within its authorized
rate of return range of 9.6 percent to 11.6 percent. At this time FPL has been able to offset most
of its Hurricane Irma expenses by amortizing the full amount of the
depreciation and dismantlement reserve surplus.
FPL intends to use tax savings that are the result of the Act to
partially replenish the reserve surplus through amortization of debits as
allowed by the Settlement Agreement.
Finally, FPL states that this process can be fully tracked through the depreciation and dismantlement reserve report
attached to the December surveillance report required by the Settlement
Agreement to be filed each year.
Discussion
Jurisdiction
The Commission has the authority to
regulate and supervise each electric and gas public utility with respect to its
rates and service as well as to set fair, just, and reasonable rates for those
utilities. Sections 366.04(1) and
366.06(1), F.S. The Commission also has
exclusive jurisdiction over each non-exempt water and wastewater utility with
respect to its authority, service and rates.
Section 367.011(1), F.S. The
Legislature has recognized that regulation of public utilities is in the public
interest and is an exercise of the police power of the state to protect the
public health, safety and welfare. As
such the Commission’s authority shall be liberally construed to accomplish this
purpose. Sections 366.01 and 367.011,
F.S. While the Commission has broad
ratemaking authority, it does not have the ability to impose retroactive rate
modifications. City of Miami v.
Florida Public Service Commission, 208 So. 2d 249, 259 (Fla. 1968); Southern
Bell Telephone and Telegraph Company v. Florida Public Service Commission,
453 So. 2d 780, 784 (Fla. 1984).
Due to the potential significant revenue
requirement impacts that the Act may have on all electric and natural gas
utilities, as well as certain water and wastewater utilities, staff recommends
that the Commission assert jurisdiction over this subject matter effective
either on the date of the vote, February 6, 2018, or the date contained in the
regulated utilities’ settlement agreements.
The practical effect of asserting jurisdiction is to put utilities on
notice that all revenue requirement adjustments ultimately imposed by the
Commission due to the Act’s provisions will be calculated as of February 6,
2018, the date of the Commission vote, or the date contained in each electric
utilities’ settlement agreements.
Attachment A lists the regulated utilities by industry and gives the
effective date for each.
Revenues
Subject to Refund
At the outset, it is important to note that the impact of the
Act on each regulated industry, as well as each individual utility, will be
vastly different as each industry, as well as each utility, has a unique set of financial characteristics
affected by the Act. The most obvious of
these is whether the utility is currently earning within its authorized rate of
return. If a utility is currently
earning below its authorized rate of return range, as is the case for many
water and wastewater utilities, a reduction in corporate tax rate may produce
no reduction in revenue requirements.
The second important consideration is the fact that the Act is complex
with many moving parts some of which will increase revenue requirements and
some of which will reduce revenue requirements.
Further, the IRS has not yet published directives interpreting and
implementing the Act and will not be able to do so for some time. The Act is less than 30 days old. While good corporate management requires that
each regulated utility immediately begin to analyze the impact of the Act on its
finances, that task takes time, particularly when one considers that Florida’s
electric utilities are part of larger conglomerates as are many natural gas,
and water and wastewater companies.
For these reasons, staff does not
recommend that the Commission require each utility without a settlement
agreement to set an amount subject to refund based on a 13 percent reduction in
overall NOI. There simply is no basis
for using that amount, or any other amount, at this time. The date for each regulated utility to
provide the Commission with its calculation of the impacts of the Act should be
made with input from all utilities affected as part of developing an overall
schedule for processing the issues in this docket. Likewise, staff agrees with OPC that each
regulated utility must calculate the excess accumulated deferred income taxes
and excess deferred income taxes not related to depreciation which result from
the Act. The date that these
calculations must be provided to the Commission should also be the subject of
discussions with all affected utilities as part of developing an overall
schedule for processing the issues in this docket. Discussions with stakeholders on the most
efficient procedure(s) to process the impacts of the Act should be instituted as
soon as practical.
Conclusion
Staff
recommends that unless the utilities agree to a January 1, 2018 effective date,
the effective date for adjustments associated with the Tax Cuts and Jobs Act of
2017 should be February 6, 2018, for utilities that do not have settlement
agreements addressing this issue. For
utilities that have settlement agreements addressing this issue, the terms of
each settlement agreement should control.
