THE PUBLIC UTILITIES BOARD, ALBERTA

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1 THE PUBLIC UTILITIES BOARD, ALBERTA DECISION C91023 re: CITY OF CALGARY AND CANADIAN WESTERN NATURAL GAS COMPANY LIMITED In the matter of an Application by the City of Calgary for an Order of the Board regarding the accounting for income taxes of Canadian Western Natural Gas Company Limited for 1990 and future years. BEFORE : T. D. Hetherington Presiding Member R. D. S. Ward Member J. R. Dunstan Member FILE

2 PUBLIC UTILITIES B fll RD. Alberta DECISION ( TABLE OF CONTENTS TITLE PAGE... 1 TABLE OF CONTENTS... 2 APPEARANCES AND WITNESSES INTRODUCTION BACKGROUND APPLICATION FOR REVIEW POSITIONS OF THE PARTIES BOARD FINDINGS ORDER Page July

3 PUBLIC UTILITIES BO d RD, Alberta DECISION C91023 APPEARANCES AND WITNESSES For the City of Calgary Mr. R. F. Goss McCaffery Goss Mr. H. W. Johnson Stephen Johnson Dr. W. R. Waters William R. Waters, Ltd. For Canadian Western Natural Gas Company Limited Mr. M. D. Romanow Bennett Jones Verchere Mr. B. M. Andrews Vice President and Controller Mr. 0. G. Edmondson Treasurer Canadian Utilities Limited For the Canadian Petroleum Association : Mr. C. K. Yates Milner Fenerty

4 PUBLIC UTILITIES BO -J) RD, DECISION C INTRODUCTION The Public Utilities Board (the Board) in Decision C90026 dated July 27, 1990, as amended by Order C90032 dated August 24, 1990, determined the rate base, fair return on rate base and total gas utility revenue requirement for Canadian Western Natural Gas Company Limited (CWNG) for the test years 1989, 1990 and The City of Calgary (Calgary) applied on December 13, 1990 for an Order pursuant to section 28 of the Gas Utilities Act, R. S.A. 1980, c. G-4, as amended, directing CWNG to account for Provincial income taxes pursuant to the Flow-Through method for the purpose of determining revenue requirement in 1990 and onwards (the Application). By letter dated January 15, 1991, the Board directed Calgary to publish Notice of the Hearing, as prescribed by the Board, in daily newspapers in CWNG's service area and to serve notice to interested parties registered in CWNG's general rate application proceedings. A public hearing of the Application was held in Calgary, at the Board's offices, on May 7, The Board accepted Calgary's proof of publication and service of the Board's prescribed notice and deemed notice to be adequate. Evidence in this matter was filed by Calgary and CWNG. of Calgary and CWNG were available for cross-examination. Witnesses on behalf The Board heard oral argument from all interested parties.

5 9 PUBLIC UTILITIES BO RD, DECISION C BACKGROUND The Board issued Report E79079 on August 1, 1979 following an inquiry to examine the question of the income tax component of the utility revenue requirement for regulated utilities (the Inquiry). The Inquiry was held under the authority of section 38(1) of the Public Utilities Board Act, R.S.A. 1980, c. P-37, as amended (the PUB Act), which states, in part: "The Board of its own motion may,... inquire into, hear and determine any matter or thing within its jurisdiction. I' The following definitions were provided and used in Report E These definitions shall also be applied for the purposes of this Decision. (1) Flow-Through Method "The Flow-Through method gives no recognition to the concept of timing differences. The actual minimum income taxes, as calculated according to the appropriate income tax legislation as due and payable, are considered to be the proper tax charge for the period. The income tax charge to be included in the utility revenue requirement is the actual income taxes payable based on taxable income, minimized by claiming, in the calculation of taxable income, full benefit of all available deductions including the maximum capital cost allowances (CCA) that the utility is entitled to claim on utility plant. " (p. 16) (2) Normalization - Deferred Taxes Method "The Normalization - Deferred Taxes method was developed in recognition of the timing difference concept. The total income tax charge to be included in the utility revenue requirement is the tax based on accounting income. This charge may be considered to have two components. The first component is the actual tax currently payable on taxable income. The second component results from timing differences and may be positive or negative, depending on whether accounting income is greater than or less than taxable income.

6 0 PUBLIC UTILITIES BOARD, Alberta a DECISION C BACKGROUND Where the accounting income is greater than taxable income (this generally occurs under growth conditions), the amount of this positive (timing) difference multiplied by the effective tax rate, is the 'deferred tax charge' and is recorded as a deferred credit on the balance sheet. In this case the 'deferred tax charge' is added to the actual tax currently payable in order to arrive at the total tax to be included in the utility revenue requirement. " (p -17) (3) Normalization - All Taxes Paid Method I' The income taxes included in the utility revenue requirement under the Normalization - All Taxes Paid method are, like the Normalization - Deferred Taxes method, the income taxes payable on the basis of accounting income except that no tax is deferred, it is all paid....taxable income is adjusted to equate to accounting income thus relating the provision for income taxes to the accounting income for the period. The net timing difference which gives rise to deferred taxes under the Normalization - Deferred Taxes method is eliminated under the Normalization - All Taxes Paid method because the total claim for the various tax deductions is restricted to that amount required to equate the taxable income with the accounting income. This is normally achieved by reducing the amount of CCA claimed." (p.19) (4) Cross-over Cross-over occurs when "... the total utility revenue requirement under flow-through exceeds that under normalization. " (p.76) The Board concluded in Report E79079 that: "... the Flow-Through method should have general applicability to all utilities, except where it may be shown in a public hearing that special circumstances require consideration. However, the Board acknowledges that in any transition from one method to another, difficulties may arise and the Board should therefore make provision to ensure that any transition is made without serious detriment to the financial integrity of any affected utility or unreasonable fluctuations in customer rates.

7 PUBLIC UTILITIES BO~RD, 0 Alberta DECISION C BACKGROUND The Board has concluded that the Flow-Through method best balances the interests of the utilities, their investors and their customers.... (pp.20-21) Two special circumstances were specifically acknowledged by the Board which may warrant approval of a Normalization method. They were: "(A) Rebating of Income Tax As long as there is legislation in place which provides for the rebating of substantially all income taxes to the utility customers, the Board may allow the utility to include a higher income tax component in its utility revenue requirement, (the Normalization - All Taxes Paid method) if the facts presented in a particular case persuade the Board that such treatment is warranted. (B) Aggregate Income Tax Cross-Over Where the utility can show that the aggregate income tax cross-over is imminent, and is able to calculate with reasonable accuracy the amount of tax that should be collected and deferred for payment, the Board may allow the utility to include a higher income tax component in its utility revenue requirement. " (Report E79O79, p.23) Board Decision E83065 dated May 9, 1983 allowed CWNG to change its method of calculating income tax from Flow-Through to Normalized-All Taxes Paid (NATP) as substantially all taxes were being rebated to utility customers. The Utility Companies Income Tax Rebates Amendment Act, R. S.A 1990 (Bill 26) received Royal Assent on July 5, This Act eliminated the rebating of provincial income taxes paid to all Alberta utilities from the Alberta Provincial Government, effective with the 1990 taxation year. In addition, the federal government's budget of February 20, 1990 announced that transfers of federal income tax rebates, to the provinces, under the Public Utilities Income

8 e PUBLIC UTILITIES BOARD, Alberta 0 DECISION C BACKGROUND Tax Transfer Act were frozen for two years at the level existing for the year ended March 31, The effect of these two changes was to eliminate all rebates of provincial income taxes and to freeze the level of federal taxes. The Board understands that the effect of freezing federal income tax rebates should not have a substantial impact upon CWNG over the next two or three years.

9 a PUBLIC UTILITIES BOARD, AlWEWSION C91023 * 3. APPLICATION FOR REVIEW Calgary applied to revise the method by which CWNG accounts for provincial income taxes for the purposes of determining revenue requirement for 1990 and onwards as approved by the Board. Calgary proposed that CWNG should account for provincial income taxes using the Flow-Through method rather than the currently used NATP method. In its application, Calgary noted the following : The Utility Companies lncome Tax Rebates Amendment Act, R.S.A (Bill 26), eliminated provincial income tax rebates paid to customers of all Alberta Utilities, including CWNG, effective with the 1990 taxation year. Previously, 100% of provincial income taxes paid by CWNG attributable to its electric utility operations, were rebated to its customers through the provincial government. This change decreases total income taxes rebated from approximately 96.7% to 65.8%. The federal government's budget of February 20, 1990 announced that transfers to the provinces of Federal income taxes under the Public Utilities Income Tax Transfer Act were frozen for two years at the level existing for the year ended March 31, In the Board's Income Tax Inquiry Report E79079, the Board stated that the Flow-Through method is the preferable method of accounting for income taxes. The Board, however, noted that the NATP method could be used if substantially all income taxes are rebated to the utility customer -9-

10 PUBLIC UTILITIES BO~RD, Alberta 0 DECISION C APPLICATION FOR REVIEW or the utility can show that the aggregate income tax cross-over is imminent. CWNG, in its filed evidence, submitted that it was indifferent to the income tax methodology approved provided that CWNG would be permitted to recover the full cost of service for the method selected. However, CWNG stated that, after considering the advantages and disadvantages of the alternative tax methods, CWNG would recommend that the NATP method continue to be used for federal income taxes and the normalization-deferred taxes method be adopted for provincial income taxes. CWNG indicated that for the 1990 and taxation years it would be calculating the amount of provincial taxes payable using the maximum CCA available to it. The Board finds that it is appropriate to deal with Calgary's application for a review since the Board, inacwng's Phase I Decision C90026 (p.113) included a provision for CWNG to file an application regarding appropriate changes to the method of accounting for income tax pursuant to changes to customer income tax rebates.

11 PUBLIC UTILITIES BOARD, Alberta - DECISION C91023 POSITIONS OF THE PARTIES (a) Calgary's Position Calgary submitted that provincial income taxes calculated using the Flow-Through method should be included in CWNG's cost of service and rates approved by the Board for 1990 and Calgary noted that the Flow-Through method claims full deductions and minimizes taxes payable in the best interest of the customers of CWNG. Calgary argued that past Board decisions, including the 1979 Income Tax Inquiry Report E79079, indicated that the Flow-Through methodology should used unless substantially all income taxes are rebated. Calgary noted that, in reaching this conclusion in Income Tax Inquiry Report E79079, ' the Board did have evidence of legislative intent before it. Further Calgary noted that: "If it was the intention of the legislatures that the benefits of capital cost allowance should provide some financing as an incentive to investment, they certainly did not prevent the benefits of investment associated with utility plant from being passed on or flowed through to the customers or the utility. " (Tr. p. 116) Calgary further argued that it is inappropriate to require customer's of CWNG to contribute capital to finance CWNG1s assets and plant-in-service through the payment of income taxes that are being deferred. Calgary noted that: I1... customers of Canadian Western do not want to be investors in Canadian Western, certainly not in the inefficient and costly manner that deferred taxes involve. " (Tr. p. 117) Regarding the imminence of crossover, Calgary maintained that forecasts of crossover are "notably unreliable". Calgary also maintained that the effects of

12 PUBLIC UTILITIES BOARD, Alberta 4. POSITIONS OF THE PARTIES * DECISION C91023 lower interest-coverage ratios resulting from the use of Flow-Through are uncertain. Calgary proposed that the refund resulting from the use of Flow-Through for 1990 and 1991 would most appropriately be dealt with by restating base rates. Calgary submitted that if a refund rider is used it should continue into (b) CWNG's Position CWNG submitted that the salient issue in the proceeding was the appropriateness of distributing government-provided financing to customers, and delineated that issue as follows: nif this Board believes that government-provided financing should be distributed to customers, then approve flow- through. If this Board believes that the government-provided financing should not be distributed to customers, then Canadian Western believe the normalized deferred tax method is the appropriate method to go. [sic]" (Tr. p. 132) CWNG argued that, although the Flow-Through method will reduce current customers' rates, the benefits are short- term. CWNG indicated that, as compared with the NATP and NDT methodologies, in 1990 and 1991 the use of the Flow-Through method would reduce revenue requirement by approximately $2 million per year. This advantage however narrows and will disappear after four or five years when the crossover point is reached. CWNG maintained that the normalization deferred methodology is the long-term conservative approach because customers are protected in the long run. The evidence filed by CWNG indicated that from 1994 and onwards the NDT method of accounting for

13 PUBLIC UTILITIES BO~RD, Alberta DECISION C POSITIONS OF THE PARTIES provincial taxes provides the lowest revenue requirements for customers. (Evidence of CWNG, Section 3.1, p2) CWNG submitted that it would not be inappropriate for the Board to review the matter of income tax methodology and reach a different conclusion from that in the 1979 Income Tax Inquiry. CWNG requested in its evidence that: "...if the Board adopts the Flow-Through method for provincial income tax, that deferred tax adjustments be made to eliminate the effect of changes in 'normal' unbilled revenues. " (Evidence of CWNG, Section 3.3, p3) CWNG noted that the Flow-Through method can result in significant earnings variability due to variability in unbilled revenues. (c) Canadian Petroleum Association's Position The Canadian Petroleum Association (CPA) supported Calgary's application. However, the CPA stated that the Flow-Through method of accounting for income taxes should be used to determine both provincial and federal income taxes. The CPA argued that CWNG's evidence, that the Board did not consider legislative intent when it endorsed the Flow-Through methodology in the 1979 Income Tax Inquiry, was incorrect. The CPA submitted that the federal legislative intent of using capital cost allowance as an incentive for investment was discussed during the 1979 Income Tax Inquiry. Further the CPA submitted that:

14 PUBLIC UTILITIES BOARD, Alberta 4. POSITIONS OF THE PARTIES - DECISION C91023 n... the decision in 1983 to allow Canadian Western to go to normalized all-taxes paid was made only because of provided for in the legislation. " (Tr. p.127) the rebates The CPA submitted that, since the only reason why the Board departed from the Flow-Through methodology has been removed, it is appropriate that the Flow-Through methodology be restored.

15 PUBLIC UTILITIES BOARD, Alberta a DECISION C BOARD FINDINGS The Board, in Income Tax Inquiry Report E79079, concluded that the Board will : "... permit an owner of a utility to include as a component of the utility revenue requirement, only the income tax paid or payable in that year, in respect of utility income, calculated according to the 'Flow-Through' method under which full benefit is taken of all deductions, including maximum capital cost allowance, available to the taxpayer to reduce the income tax charge to a minimum. (p. 22) In Report E79079 the Board also found that the NATP method was acceptable under the special circumstances of (i) substantially all income taxes being rebated to utility customers, or (ii) the aggregate income tax cross-over being imminent. With respect to this proceeding, the Board finds that there is neither compelling evidence nor unique circumstances to persuade the Board to revise its findings in Report E Therefore, as provincial income taxes are no longer being rebated to CWNG's customers, CWNG is directed to account for provincial income taxes using the Flow-Through method for the test years 1990 and However, since substantially all federal income taxes are still being rebated, CWNG should continue to use the NATP method for calculating federal income taxes. In response to the Board's information request BR-CWNG.8, CWNG noted that a change to the Flow-Through method for calculating both federal and provincial income taxes would result in a decrease in interest coverage of 50 basis points.

16 PUBLIC UTILITIES BOARD, Alberta DECISION C BOARD FINDINGS However, a change to Flow-Through for provincial taxes only would "have a much lesser impact on interest coverage". The Board also notes that CWNG stated that using different methodologies to calculate provincial and federal taxes will not cause any major administrative difficulties. CWNG argued that the intention of the federal government in enacting the revised CCA rates was to provide financing for the tax payer. The Board notes that CWNG stated that while it was indifferent to the income tax methodology approved for calculating provincial income tax, it preferred the normalization-deferred methodology as it was in the best interests of customers. However, those customers represented by Calgary and the CPA clearly stated their preference for the Plow-Through method. The Board permits CWNG to recover the amount of costs and expenses, including income taxes, incurred by CWNG if the Board finds them to be prudent. The Board finds no justification for determining the revenue requirement using a notional deferred tax account in excess of income taxes actually paid. The Board directs CWNG to recalculate the Board approved 1990 and 1991 utility revenue requirements, as determined in Decision C90026 and Order C90032, using the Flow-Through method to calculate its provincial income taxes. The Board allows CWNG to make the necessary deferred tax adjustments to recognize the effect of changes in unbilled revenues resulting from the use of the Flow-Through methodology. The Board further directs CWNG to provide full details of the revised utility revenue requirement calculations and the

17 PUBLIC UTILITIES BOARD, Alberta a DECISION C BOARD FINDINGS total amounts to be refunded to customers for 1990 and 1991 to the Board by July 31, CWNG shall also provide a proposed rate refund rider schedule which allocates to customer classes the refund for the period January 1, 1990 to December 31, 1991 to each rate class on the same basis as income tax is allocated to customer classes. The refund rider shall commence September 1, 1991 and continue until the appropriate amount is refunded. The rider shall be forecast to run for four months.

18 0 PUBLIC UTILITIES BOARD, Alberta 0 DECISION C ORDER THEREFORE IT IS ORDERED THAT: (1) CWNG shall recalculate its 1990 and 1991 utility revenue requirements as determined by the Board in Decision C90026 and Order C90032, using the Flow-Through method to calculate its provincial income taxes. (2) CWNG shall file with the Board by July 31, 1991, the revised utility revenue requirement calculations for 1990 and 1991 and the total amounts to be refunded to customers with respect to these test years. (3) CWNG shall provide a proposed rate refund rider schedule. (4) It is hereby declared that nothing in this Order shall bind, affect or prejudice the Board in any way in its consideration of any other matter or question relating to CWNG.

19 PUBLIC UTILITIES BOARD, Alberta 0 DECISION ( ORDER Dated in Calgary, Alberta this 12th day of July, 1991.

20 a PUBLIC UTILITIES BOARD, Alberta DECISION C ORDER Dated in Calgary, Alberta this 12th day of July, PUBLIC UTILITIES BOARD (SIGNED) T. D. HETHERINGTON PRESIDING MEMBER (SIGNED) R. D. S. WARD MEMBER (SIGNED) J. R. DUNSTAN MEMBER CERTIFIED A TRUE COPY 0 ACTING SECRETARY

21 PUBLIC UTILITIES BOARD, Alberta e DECISION C ORDER THEREFORE IT IS ORDERED THAT: (1) CWNG shall recalculate its 1990 and 1991 utility revenue requirements as determined by the Board in Decision C90026 and Order C90032, using the Flow-Through method to calculate its provincial income taxes. (2) CWNG shall file with the Board by July 31, 1991, the revised utility revenue requirement calculations for 1990 and 1991 and the total amounts to be refunded to customers with respect to these test years. (3) CWNG shall provide a proposed rate refund rider schedule. (4) It is hereby declared that nothing in this Order shall bind, affect or prejudice the Board in any way in its consideration of any other matter or question relating to CWNG.

22 e PUBLIC UTILITIES BOARD, Alberta e DECISION C ORDER Dated in Calgary, Alberta this 12th day of July, ITIES BOARD ' t --, - MEMBER

23 PUBLIC UTILITIES BOARD, Alberta 0 DECISION C ORDER Dated in Calgary, Alberta this 12th day of July, PUBLIC UTILITIES BOARD (SIGNED) T. D. HETHERINGTON PRESIDING MEMBER (SIGNED) R. D. S. WARD MEMBER (SIGNED) J. R. DUNSTAN MEMBER CERTIFIED A TRUE COPY ACTING SECRETARY

ALBERTA ENERGY AND UTILITIES BOARD

ALBERTA ENERGY AND UTILITIES BOARD re: CANADIAN WESTERN NATURAL GAS COMPANY LIMITED In the matter of an application by Canadian Western Natural Gas Company Limited for approval of a 199511996 winter period Gas Cost Recovery Rate and a 1996