PAYMENTS IN LIEU OF CORPORATE INCOME TAXES

Transcription

1 Filed: September 0, 00 EB-00-0 Tab Page of PAYMENTS IN LIEU OF CORPORATE INCOME TAXES.0 INTRODUCTION Under the Electricity Act,, Hydro One Networks Inc. ( Networks ) is required to make payments in lieu of corporate income taxes ("PILs") relating to taxable income earned by its transmission business. The Ontario Energy Board ( the Board ) has directed that the taxes payable method should also be used for regulatory purposes, according to its 00 EDR Handbook, Section. OEB 00 Regulatory Taxes Expense Methodology. Under the taxes payable method, no provision is made for future income taxes that result from timing differences between the tax basis of assets and liabilities and their carrying amounts for accounting purposes. Accordingly, the taxes payable method will result in the PILs income tax payable being different from the amount that would have been recorded, had the combined Canadian Federal and Ontario statutory income tax rate been applied to the regulatory net income before tax. When unrecorded future income taxes become payable, it is expected that they will be included in the rates approved by the Board and recovered from customers at that time. 0 PILS installments are remitted by Networks to the OEFC at the end of each month. Any balance owing at the end of the year is required to be paid by February th of the following year. In the absence of an Electricity Transmission Handbook, the 00 and 0 Hydro One transmission regulatory tax calculations have been prepared consistent with the approach found in the 00 EDR Handbook and the 00 EDR Tax Model, as this approach reflects the tax payable relating to taxable income earned by the transmission business. This

2 Filed: September 0, 00 EB-00-0 Tab Page of approach is also consistent with the Board's instructions to distributors in the filing of their 00 rates..0 INCOME TAX RATE (FEDERAL AND ONTARIO) 0 For the test years, a combined income tax rate of % has been used for 00 and % for 0 (The 00 rate comprises a Federal rate of % and an Ontario rate of %. The 0 rate comprises a Federal rate of % and an Ontario rate of %). This reflects the reduction in the federal income tax for corporations enacted on December, 00. The Board's Decision EB respecting Hydro One Transmission's 00 and 00 Revenue Requirement approved a combined income tax rate of. % for 00 (comprising a Federal rate of.% and an Ontario rate of %) and a combined rate of.% for 00 (comprising a Federal rate of 0.% and an Ontario rate of %). There was no difference between the actual tax rate of.% in effect for 00 and that approved by the Board; however, for 00, the actual income tax rate of.% in effect is lower than the.% rate approved by the Board. Any variance between actual taxes payable and forecast taxes, as a result of rate changes for any taxes (such as income tax, capital tax and capital cost allowance) is being captured in a deferral account for tax rate changes, discussed further in Exhibit F, Tab,..0 RECONCILIATION BETWEEN REGULATORY NET INCOME BEFORE TAX AND TAXABLE INCOME A reconciliation between the regulatory net income before tax ("NIBT") and taxable income for the test years 00 and 0 is provided in Exhibit C, Tab,. This schedule contains the income tax component of the PILs computation. It also shows how the taxable income is computed by making adjustments to the regulatory NIBT for items such as depreciation and capital cost allowance (CCA).

3 Filed: September 0, 00 EB-00-0 Tab Page of A reconciliation between the accounting NIBT and taxable income for the historical years is also provided in Exhibit C, Tab,. This reconciliation entails adjustments to regulatory NIBT to arrive at taxable income. In order to make it easier for parties to follow these reconciliations, Hydro One Transmission has placed these adjustments into the following five categories: ) Recurring items that must be added (deducted) because they have been included in the OM&A expenses in arriving at the revenue requirement, or for which appropriate tax adjustments are made (for example, depreciation versus CCA); ) Deferral accounts not included in the revenue requirement; ) Reversal of accounting adjustments not included in the revenue requirement; ) Recurring items not in the revenue requirement; and ) Items whose impact is immaterial in total, and as such, have not been included in the Company s business plan (applicable to forecast years only)..0 OVERVIEW OF PROCESS TO ARRIVE AT TAXABLE INCOME 0 The starting point for the computation of Hydro One Transmission's taxable income is the NIBT as shown on the utility's income statement for the year. The NIBT is prepared using Canadian generally accepted accounting principles, but taxable income is computed using the relevant tax legislation, interpretations and assessing practices. Therefore, many adjustments are typically made to the NIBT to arrive at taxable income. Essentially, the NIBT is increased by amounts that are not deductible for tax purposes. This includes items such as depreciation, contingent liabilities, accounting losses, accounting provisions such as other post employment benefits ("OPEB") and revenue that has been received but not recognized for accounting purposes (for example, transmission export revenue). On the other hand, the NIBT is reduced by amounts that are deductible for tax purposes but have not been deducted in computing NIBT. This includes items such as CCA, the

4 Filed: September 0, 00 EB-00-0 Tab Page of deductible portion of capitalized overhead, accounting gains and OPEB payments. Such reductions also include expenses incurred for which a deferral account has been set up on the balance sheet, rather than shown as a deduction through the income statement. Consequently, it is imperative that the NIBT be adjusted for amounts that have been included (or deducted) for accounting purposes that are not income (or deductible) for tax return purposes. This is a key point in comparing the historical years tax return data to that computed for the forecast years, since the tax return NIBT has been increased (or reduced) by amounts that have not been added (or deducted) in computing the regulatory NIBT (e.g. contingent liabilities, accounting gains, capitalized interest). That is, for test years 00 and 0, adjustments for differences between the tax and accounting rules only (related to costs included in either the regulatory revenue requirement or rate base, such as CCA or capitalized overhead), are made to arrive at taxable income..0 TAX TREATMENT OF DEFERRAL ACCOUNTS (REGULATORY ASSETS AND LIABILITIES) 0 Deferral accounts are typically recognized by utilities' balance sheets for foregone revenue or for expenses that have been incurred, for which recovery will be sought from ratepayers through future rates. Disposition of the deferral accounts is determined by the Board. For example, as shown in Table, assuming that a $0 expense is incurred, the utility will be allowed to deduct the $0 in computing taxable income for the year in which the expense has been incurred. If the Board subsequently approves recovery of these expenses over a four-year period through a rate rider, the income will be included in computing taxable income for the year in which it is billed to ratepayers. The net result is that the utility has recovered the $0 cost although the income or expense has been taxed or deducted in different years.

5 Filed: September 0, 00 EB-00-0 Tab Page of Table Income (deduction) Tax Refund (payable) Cash Inflow (outflow) Year Year Year Year Year CUM (0) Nil (.) (.) (.) (.) Nil ().... Nil Therefore, deferral accounts have not been included in computing tax payable for purposes of the revenue requirement since the tax benefit has or will be obtained through the tax system. It should be noted that this conclusion is consistent with the "00 EDR Handbook Report of the Board" issued May, 00 (page ) that stated as follows: "A PILS or tax provision is not needed for the recovery of deferred regulatory asset costs, because the distributors have deducted, or will deduct, these costs in calculating taxable income in their returns. The Handbook will reflect this treatment.".0 CONTINGENT LIABILITIES/ACCOUNTING RESERVES Where an accounting provision is recognized for certain contingent costs that the utility may have to incur in the future (such as obsolescence provisions, lawsuits, staff reductions), the provision will reduce the NIBT of the utility. In each subsequent year, the balance for the contingent liability/accounting reserve is reviewed by the utility for reasonableness based upon the information available at that time. The balance may be adjusted upward or downward, with NIBT either decreasing or increasing, respectively. 0

6 Filed: September 0, 00 EB-00-0 Tab Page of However, for tax purposes, a contingent liability or accounting reserve is not deductible. Rather, the amount will only be deductible (or capitalized) in computing taxable income for the taxation year in which the obligation has actually been settled. Therefore, to the extent that the current year NIBT has been increased (or decreased) by the contingent liability or accounting reserve provision, the NIBT must be adjusted to reverse the increase (or decrease) in computing taxable income. It is not necessary to adjust the 00 and 0 NIBT for contingent liabilities in computing taxable income since no changes were forecast in the contingent liability balances for 00 and 0. Therefore, such amounts are not included in the tax computation for purposes of the revenue requirement. In summary, the projected level of PILs payable for the test years is significantly lower than that paid in the historic period, as shown in Exhibit C, Tab, Schedule. The main reasons for this change are a lower projected NIBT combined with lower tax rates and a higher level of net adjustments resulting in lower levels of regulatory taxable income (the 00 and 0 regulatory taxable income is one-third and one-half of that in 00). The combined (Federal and Ontario) tax rate reduces from.% during the period to.% in 00, % in 00, and % in ONTARIO CAPITAL TAX Hydro One Transmission pays an Ontario capital tax on its taxable capital as defined by the Corporations Tax Act (Ontario). However, for regulatory purposes, it recovers capital tax that is computed by reference to its rate base net of the applicable Ontario exemption, as directed by the Board. (The Ontario exemption is allocated amongst the related regulated entities, based on rate base). Please refer to Exhibit C, Tab,, Capital Taxes for the calculation of the Ontario capital tax. For the test years, the Ontario capital tax rate used is the enacted rate of 0.% and 0.0% for 00 and 0

7 Filed: September 0, 00 EB-00-0 Tab Page of respectively. This compares to a capital tax rate of 0.% applicable to 00, 0.% for 00 and 0.% for prior years. The Board's Decision EB respecting Hydro One Transmission's 00 and 00 Transmission Revenue Requirement approved a capital tax rate of 0.% for 00 and 00. The actual tax rate in effect for 00 is 0.% and 0.% for 00. The variance between actual capital taxes payable on a rate basis and the rates approved by the Board is being captured in a deferral account for tax rate changes, the disposition of which is subject to the Board s decision. This is discussed further in Exhibit F, Tab,, Exhibit F, Tab, and Exhibit F, Tab,. The net effect of these changes is a decrease in the capital taxes payable from 00 to 00, followed by increases for 00 and 00 as a result of the Company s additional capital investments in those years, followed by a decline in 0 reflecting the reduction in the tax rate for that year, as shown in Exhibit C, Tab,.