PAYMENTS IN LIEU OF CORPORATE INCOME TAXES

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1 Filed: May, 0 EB-0-00 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 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 the end of February of the following year. In the absence of an Electricity Transmission Handbook, the 0 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.

2 Updated: August, 0 EB-0-00 Tab Page of.0 INCOME TAX RATE (FEDERAL AND ONTARIO) A combined income tax rate of.% has been used for the test years 0 and 0, comprised of a Federal rate of % and an Ontario rate of.% as a result of the Ontario budget bill enacted on June 0, 0. The Board's December, 0 Decision (EB ) respecting Hydro One Transmission's 0 and 0 Revenue Requirements approved a combined income tax rate of.% for 0 and a combined rate of.% for 0. As of June 0, 0, the corporate income tax rate remains at.0% for 0, resulting in a combined income tax rate of.%. Any variance between actual taxes payable and forecast taxes, as a result of rate changes for income tax or capital cost allowance will be captured in a deferral account for tax rate changes, described further in Exhibit F, Tab, Schedules and..0 RECONCILIATION BETWEEN REGULATORY NET INCOME BEFORE TAX AND TAXABLE INCOME 0 Reconciliation between the regulatory net income before tax ("NIBT") and taxable income for the test years 0 and 0 is provided in Exhibit C, Tab,, Attachments &. 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). Reconciliation between the accounting NIBT and taxable income for the historical years 00 and 0 is also provided in Exhibit C, Tab,, Attachments &. This reconciliation entails adjustments to regulatory NIBT to arrive at taxable income. In

3 Filed: May, 0 EB-0-00 Tab Page of order to make it easier 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 test 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 U.S. 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 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.

4 Filed: May, 0 EB-0-00 Tab Page of 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 test 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 0 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) 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. 0 For example, as shown in Table, assuming that a % tax rate and 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 this expense over a -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: May, 0 EB-0-00 Tab Page of Table Year Year Year CUM Income (deduction) (0) 0 0 Nil Tax Refund (payable) (.) (.) Nil Cash Inflow (outflow) ().. 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 0 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. 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

6 Updated: August, 0 EB-0-00 Tab Page of 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 0 and 0 NIBT for contingent liabilities in computing taxable income since no changes were forecasted in the contingent liability balances for 0 and 0. Therefore, such amounts are not included in the tax computation for purposes of the revenue requirement. The combined (Federal and Ontario) enacted income tax rates are as follows: Historic Bridge Test Federal Tax Rate (%) Provincial Rate (%) Total Statutory Tax Rate (%) Capital Tax Rate (%) () nil nil nil nil () As of July, 0, the Ontario capital tax is eliminated. Therefore, there is no Ontario capital tax calculated for the 0 and 0 test years..