FERC's Proposed Treatment of Excess Accumulated Deferred income taxes

Below is a summary of a recent FERC Notice of Proposed Rulemaking and Policy Statement.  In these documents, FERC puts forth how it proposes entities under its jurisdiction to account for and reflect in rates the impacts on accumulated deferred income taxes from the reduction in federal income taxes from the Tax Reform Act.  Dumais Consulting (www.DumaisConsulting.com) welcomes the opportunity to help your company navigate through for ratemaking and accounting these income tax items.  Comments to FERC are due on the Rulemaking in mid-January 2019. 
 
On November 15, 2018. FERC issued 1) a Notice of Proposed Rulemaking (NOPR) regarding Transmission Rate Changes to Address Accumulated Deferred Income Taxes and 2) and a Policy Statement on Accounting and Ratemaking Treatment of Accumulated Deferred Income Taxes and Treatment Following the Sale or Retirement of an Asset.  FERC is proposing to require that public utilities deduct excess accumulated deferred income taxes (ADIT) from or add deficient ADIT to their rate base and adjust their income tax allowances by amortized excess or deficient ADIT.  FERC is also proposing to require all public utilities with transmission formula rates to incorporate a new permanent worksheet that will annually track ADIT information.  Lastly, FERC is proposing to require all public utilities with transmission stated rates to determine the amount of excess and deferred income tax caused by the Tax Cuts and Jobs Act’s (Act) reduction to the federal corporate income tax rate and return or recover this amount to or from customers.
 
In the NOPR, FERC identifies two components that are necessary to maintain accurate cost of service following a change in income tax rates, such as that caused by the Act:  (1) preservation of rate base neutrality through the removal of excess ADIT from or addition of deficient ADIT to rate base; and (2) the return of excess ADIT to or recovery of deficient ADIT from customers.  FERC is not proposing to prescribe a specific adjustment mechanism which applies to all transmission owners (TOs) with transmission formula rates as prescribing a one-size-fits-all approach is not appropriate.  FERC instead proposes to allow TOs to propose any necessary changes to their formula rates on an individual basis.  Regarding the period over which the amortization of excess or deficient ADIT must occur, FERC proposes that TOs follow the guidance provided in the Act, which requires returning excess protected ADIT no more rapidly than over the life of the underlying asset using the Average Rate Assumption Method, or, where a TO’s books and underlying records do not contain the vintage account data necessary, it must use an alternative method.  The Act does not specify what method TOs must use for excess or deficient unprotected ADIT, which will be determined on the specific facts and circumstances. 
 
Regarding transmission stated rates, FERC proposes maintaining Order No. 144’s requirement that TOs reflect any adjustments made to their ADIT balances as a result of the Act (and any future tax changes) in their next rate case.  However, to increase the likelihood that those customers who contributed to the related ADIT accounts receive the benefit of the Act, FERC proposes to require TOs with stated rates to (1) determine any excess or deficient ADIT caused by the Act and (2) return or recover this amount to or from customers.  FERC proposes that TOs calculate this excess or deficient ADIT using the ADIT approved in their last rate cases, which allows preservation of the costs of service as accepted in their last rate case.  FERC plans to evaluate each proposal on an individual basis.  Since FERC’s existing regulations already require all the information necessary to support the changes from the Act, FERC is not requiring any additional worksheets.
 
In the Policy Statement (PS), FERC clarifies that for both accounting and ratemaking purposes, public utilities and natural gas companies should record the amortization of the excess or deficient ADIT in Account 254 (Other Regulatory Liabilities) or Account 182.3 (Other Regulatory Assets) and record the offsetting entries to Account 410.1 (Provision for Deferred Income Taxes, Utility Operating Income) or Account 411.1 (Provision for Deferred Income Taxes – Credit, Utility Operating Income), as required by the Uniform System of Accounts (USofA).  FERC further clarifies that for accounting purposes, oil pipelines should adjust their ADIT balances to reflect the change in federal income tax rates with offsetting entries to the appropriate income statement account, as required by the USofA.  Accordingly, oil pipeline companies will not record excess or deficient ADIT for accounting purposes but should provide additional disclosures in the Notes that accompany their FERC Form No. 6, Annual Report of Oil Pipeline Companies (Form No. 6).  FERC reiterates that public utilities and natural gas pipelines must continue to follow the accounting guidance issued by the Chief Accountant in Docket No. AI93-5-000 with respect to changes in tax law or rates.  To ensure transparency in the accounting adjustments to the deferred tax accounts, entities should provide additional disclosures in their 2018 FERC annual financial filing within the Notes to the Financial Statements. 
 
With respect to ratemaking, for a public utility or natural gas pipeline that continues to have an income tax allowance, any excess or deficient ADIT associated with an asset must continue to be amortized in rates even after the sale or retirement of that asset.  This excess or deficient ADIT will continue to be refunded to or recovered from customers based on the schedule that was initially established as the balances of excess and deficient ADIT recorded in Account 254 and Account 182.3, respectively, continue to exist as regulatory liabilities and assets after an asset sale, in cases for which the excess and
deficient ADIT do not transfer to the purchaser of the plant asset.  Thus, in order to provide transparency regarding the accounting and rate treatment of amounts removed from the ADIT accounts, public utilities and natural gas pipelines should disclose in their FERC annual financial filings within the Notes to the Financial Statements:  (1)  the FERC accounts affected; (2) how any ADIT accounts were remeasured in the determination of the excess or deficient ADIT amounts in Accounts 182.3 and  254; (3) the related amounts associated with the reversal and elimination of ADIT balances in those accounts; (4) the amount of excess and deficient ADIT that is protected and unprotected; (5) the accounts to which the excess or deficient ADIT will be amortized; and (6) the amortization period of the excess and deficient ADIT to be returned or recovered through rates for both protected and unprotected ADIT.  Disclosures should also summarize how excess and deficient will be included in rates by rate jurisdiction.  As for oil pipelines, as discussed above, ADIT balances will be reduced immediately by the full amount of the excess or deficient tax reserve in line with the USofA for oil pipelines outlined in General Instruction 1-12.76 b, Ratemaking Guidance. 
 
The Commission has previously found that the sale or retirement of an asset with an ADIT balance is usually deemed a taxable event under IRS rules, and, as such, the ADIT balance is extinguished as the deferred taxes then become payable to the appropriate government authorities, and there is no longer an ADIT balance to “return” to customers.  However, we believe that excess or deficient ADIT associated with post-December 31, 2017, asset dispositions and retirements should be treated differently for ratemaking purposes.  For these assets, there are two associated balances: (1) the ADIT balance based on the 21 percent tax rate that will be owed to the IRS and (2) deficient ADIT or excess ADIT balances resulting from the reduced tax liability that will not be payable to the IRS upon the sale or retirement of the asset.  While the ADIT balance that needs to be settled with the IRS would be extinguished following a sale, the deficient ADIT or excess ADIT balances is more reflective of a regulatory liability or asset, and no longer reflects deferred taxes that are still to be settled with the IRS and need not be extinguished.  Additionally, FERC noted that the rationale for continuing to amortize deficient ADIT or excess ADIT balances in rates upon sales or retirements of assets is substantively like the rationale for amortizing excess ADIT in rates for assets that have not been sold or retired.  The difference is that for a sale or retirement, ADIT based on a 21 percent tax rate will be settled with the IRS immediately, while for an asset that is not sold or retired, the ADIT will be settled with the IRS over the remaining life of the asset as it depreciates.  In other words, the difference between the ADIT for assets that are sold or retired and ADIT for assets that are not sold or retired is the timing of when companies will settle the 21 percent of ADIT with the IRS.  In both scenarios, there is excess ADIT based on the 14 percent previously collected from the customers that will no longer be payable to the IRS.   Current IRS regulations speak specifically to the normalization requirements for sales and retirements as a result of the Tax Reform Act of 1986.  These regulations permit the amortization of protected excess and/or deficient ADIT even if the underlying asset associated with the ADIT has been sold or retired.  That is, the selling jurisdictional entity can continue to amortize excess ADIT in rates after the sale without violating the IRS’ normalization requirements.  The only limitation imposed by the IRS is that the timing of the amortization must be like protected excess or deficient ADIT for which the underlying asset has not been sold or retired.  Consistent with the above discussion, oil pipelines should continue maintaining excess or deficient ADIT within the appropriate ADIT accounts for ratemaking purposes.  When jurisdictional assets are retired or sold the oil pipeline should continue to amortize any excess or deficient amounts associated with those assets as part of the process of determining an income tax allowance within the rate making process or seek prior Commission approval to do otherwise.