In an apparent effort to reduce the market moving impacts of its tax announcements, FERC issued two decisions on July 18th after the markets closed. While holding firm on its previously announced decision to deny an income tax allowance (ITA) for MLPs that are “like SFPP,” FERC did adopt the industry’s requested relief of pairing the income tax disallowance with the complete elimination of an MLP’s accumulated deferred income taxes (ADIT), (which we anticipated in FERC Tax Rule Comments Are In – What to Expect.)
A companion final rule addressing the rate impacts of the Tax Cuts and Jobs Act remained mainly unchanged, particularly for pipeline companies that are separate tax paying entities. The main substantive changes made in the final rule will primarily impact pass-through entities such as MLPs that were given certain options that may allow them, for at least three years, to retain a substantial portion of their rate revenue. Both of these developments may be welcome news for MLP investors — but probably not as welcome by the shippers on interstate gas pipelines.
While the rules of the road are now clear, the impact on any particular pipeline or the public company that owns it is still far from certain. That is why we will soon be preparing the final Form 501-G for every company required to file the form, to provide access and insight to our customers ahead of the first filing date.
What FERC Issued
Back in March, FERC issued three documents. The first document was a Revised Policy Statement on Treatment of Income Taxes (Revised Tax Allowance Policy). The second was a Notice of Proposed Rulemaking (NOPR) for determining which jurisdictional natural gas pipelines may be collecting unjust and unreasonable rates in light of (1) the income tax reductions provided by the Tax Cuts and Jobs Act; and (2) the Commission’s Revised Tax Allowance Policy. The third document was the Notice of Inquiry (NOI) seeking comments on the regulatory treatment of ADIT. Wednesday evening’s decisions were FERC’s final actions with regard to the first two documents. FERC indicated that the third document was an “open-ended process and may or may not result in any final rulemaking.”
Changes to ADIT Treatment
Various parties had sought rehearing or reconsideration of the Revised Tax Allowance Policy, even though it was only a policy. FERC dismissed all of those requests but did provide guidance regarding ADIT. In particular, FERC stated that, going forward, if an MLP or other pass-through pipeline eliminates its ITA from its cost of service, the Commission “anticipates” that ADIT will similarly be removed from the cost of service. This result, (which we anticipated in Tax Issues Are Now in FERC’s Court), had been argued for by the industry as appropriate and provides relief in two ways. First, ADIT balances are generally a reduction in the rate base of a pipeline. Second, any excess ADIT generated by a change in tax laws has to be passed back to the pipeline’s shippers over the remaining useful life of the assets, and acts as a reduction in the tax allowance. By eliminating the entire ADIT balance, a pipeline that can no longer claim an ITA will get an immediate increase in its rate base and will not have to share any reduction in the ADIT balance with its customers.
Distribution of Major Pipelines Based on ADIT Balances
MLP Rate Reduction Via Two Options
In the final rule, FERC held that pass-through entities that choose to voluntarily file for a limited rate reduction (Option 1) would have the option to calculate that rate reduction on the 501-G form in one of two ways. First, the pipeline could choose to be treated like an MLP (i.e., calculate a reduction based on an elimination of its ITA completely), but have its ADIT balance simply eliminated, as well. As a second option, the pipeline could choose to be treated as if it were a tax paying entity (i.e., calculate a reduction based on the corporate rate change from 35% to 21%) but would retain both an ITA and its ADIT balance, including returning any excess ADIT to its shippers. This allows the rate reductions to move forward without the need for a final resolution of the Revised Tax Allowance Policy.
For those electing Option 1, FERC decided that, for three years from the effective date of the rate reduction resulting from the pipeline’s limited rate proceeding, it would not launch a Section 5 rate investigation provided that (1) the Commission accepts the limited rate filing; and (2) following the rate reduction, the pipeline’s estimated ROE, as calculated on Form 501-G, is 12 percent or less.
In addition to these major adjustments, FERC also adopted some tweaks to the Form 501-G and its instructions. One of these, a change in the default capital structure from a 50/50 debt to equity ratio to a 43/57 ratio which will actually cause an increase in the rate reductions calculated under Form 501-G, as we previously discussed in Impact of Form 501G on Pipeline Rates – Transco as an Example, and thus may adversely affect the industry in some cases.
Open Question for Many Ownership Structures
In our view, FERC left open a big question regarding both the rehearing requests for the Revised Tax Allowance Policy and the NOPR concerning the ITA for entities that are neither “MLPs like SFPP” nor independent tax paying entities. In the decision dismissing all of the rehearing requests on the Revised Tax Allowance Policy, FERC noted that “when applied in specific cases, opportunity will be afforded to affected parties to challenge or support the revised policies through factual or legal presentation.” In other words — a case-by-case basis. In response to similar comments made on the proposed rule, FERC did clarify that “a natural gas company organized as a pass-through entity all of whose income or losses are consolidated on the federal income tax return of its corporate parent” will be eligible for an ITA if it opts to file a limited rate proceeding.
While this appears to be the end to these proceedings, there is always the chance that one or both of the decisions issued Wednesday night will be appealed. Where Do We Go From Here?
We will be diving deeper into some of the changes to the 501-G form to assist our customers in understanding the strategies that pipelines may use to minimize any potential rate reductions. In the meantime, if you would like to discuss any of the issues discussed above in greater detail, please give us a call.