July 26, 2018

On July 18, in two companion orders, the Federal Energy Regulatory Commission (FERC): (1) affirmed the Revised Policy Statement on Treatment of Income Taxes, and (2) provided guidance regarding the treatment of accumulated deferred income taxes (ADIT) where the income tax allowance is eliminated from cost-of-service rates.

Simultaneously, FERC issued a final rule that establishes procedures for the Commission to determine which jurisdictional natural gas pipelines may be collecting unjust and unreasonable rates in light of the income tax reductions provided by the Tax Cuts and Jobs Act signed into law Dec. 22, 2017. The final rule also clarifies FERC’s policy and precedent concerning tax allowances to address the double recovery issue identified by United Airlines, Inc. v. FERC.

In United Airlines v. FERC, the U.S. Court of Appeals for the D.C. Circuit held that FERC failed to demonstrate that there was no double recovery of income tax costs when FERC permitted a master limited partnership (MLP) pipeline to recover both an income tax allowance and a return on equity (ROE) based on the discounted cash flow (DCF) methodology. In response to the court’s decision, FERC issued a notice of inquiry and received comments regarding how to address any double recovery resulting from FERC’s current income tax allowance and rate of return policies. On March 15, FERC issued its revised policy statement, which stated that FERC generally will not permit MLPs to recover income tax allowance in their cost of service.

The final rule affirms FERC’s revised policy statement but also provides guidance for other partnership and pass-through business forms that are not MLPs. The final rule reiterates that tax pass-through entities (including MLPs) that recover an income tax allowance in addition to an ROE based on the DCF methodology double-recover investors’ tax costs, and clarifies that while pass-through entities may eliminate previously accumulated sums of ADIT from cost of service, they do not need to refund those ADIT balances to ratepayers. FERC reasoned that if MLPs are required to provide ADIT refunds to their ratepayers, this “would raise retroactive ratemaking concerns,” which is a violation of the Natural Gas Act (NGA). Although FERC’s guidance on ADIT does not establish a binding rule, the guidance puts entities on notice of the course of action FERC intends to follow in future adjudications.

The final rule does not impact negotiated rate contracts. FERC declined to establish a process under which it would review every currently effective negotiated rate contract in order to determine whether that contract can and should be modified to reflect the pipeline’s reduced tax costs or the elimination of MLP tax allowances. The commission stated that negotiated rate contracts should be allowed to remain in effect without change but clarified that a shipper may file a complaint pursuant to NGA Section 5 if it believes that its negotiated contract should be modified. Alternatively, a shipper may file a complaint or seek to enforce the contract in court if it believes that the terms of its negotiated contract provide for a reduction in the negotiated rate to reflect the pipeline’s reduced tax costs, and the pipeline has failed to comply with the contract.

The final rule requires pipelines to file FERC Form No. 501-G and clarifies that Form No. 501-G will automatically enter a federal and state income tax of zero for all tax pass-through entities, consistent with the revised policy statement. The final rule also encourages each pipeline to file an addendum to the FERC 501-G to reflect its individual financial situation. In addition to filing the one-time report, the final rule provides interstate natural gas pipelines four options to address changes to the pipeline’s revenue requirements as a result of the tax reductions:

  • Make a limited Section 4 filing to reduce its rates to reflect the reduced tax rates. Pipelines that choose this option are guaranteed a three-year moratorium on NGA Section 5 rate investigations if the pipeline’s FERC Form 501-G shows the pipeline’s estimated ROE as 12 percent or less.
  • Commit to file either a prepackaged uncontested rate settlement or a general NGA Section 4 rate case. If the pipeline commits to do this by Dec. 31, 2018, FERC will not initiate a Section 5 investigation of its rates before that date.
  • Explain why no rate change is needed.
  • Take no further action.

Based on the option a pipeline selects, and the contents of the pipeline’s FERC 501-G, FERC will consider whether to initiate a Section 5 investigation of a pipeline’s rates if it appears those rates may be unjust and unreasonable.

The final rule takes effect 45 days after publication in the Federal Register. The deadline for the first group of pipelines to file their FERC Form No. 501-Gs will be 28 days after the effective date of the final rule, and the deadlines for the second and third groups will each be 28 days after the previous group’s deadline.