SIDLEY AUSTIN LLP 701 FIFTH AVENUE, SUITE 4200 SEATTLE, WA AMERICA ASIA PACIFIC EUROPE

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1 SIDLEY AUSTIN LLP 701 FIFTH AVENUE, SUITE 4200 SEATTLE, WA AMERICA ASIA PACIFIC EUROPE October 1, 2018 Via etariff Filing Kimberly D. Bose Secretary Federal Energy Regulatory Commission 888 First Street, NE Washington, DC Re: Delmarva Power & Light Company Revisions to PJM Tariff Attachment H-3D To Provide for Rate Treatment of FAS 109 Deferred Tax Adjustments, Flow Through to Customers the Deferred Tax Benefits of the TCJA Docket No. ER Dear Secretary Bose: Pursuant to Section 205 of the Federal Power Act ( FPA ), 1 Part 35 of the Federal Energy Regulatory Commission s ( FERC or Commission ) regulations, 2 and the Commission s order in Docket No. ER18-903, 3 Delmarva Power & Light Company ( Delmarva ), submits 4 the attached proposed modifications to Delmarva s formula transmission rate, contained in PJM Interconnection LLC ( PJM ) Open Access Transmission Tariff, 1 16 U.S.C. 824d (2012) C.F.R. Part 35 (2016). 3 Commonwealth Edison, Co., 164 FERC 61,172 at P 130 (2018) ( Exelon 2018 Order ) (( the Exelon Companies may file to recover the tax effect on an ongoing basis if properly supported ). 4 Pursuant to Order No. 714, this filing is submitted by PJM on behalf of Delmarva as part of an XML filing package that conforms with the Commission s regulations. PJM has agreed to make all filings on behalf of the PJM Transmission Owners in order to retain administrative control over the PJM Tariff. Thus, Delmarva has requested PJM submit this filing in the etariff system as part of PJM s electronic Intra PJM Tariff. Sidley Austin (DC) LLP is a Delaware limited liability partnership doing business as Sidley Austin LLP and practicing in affiliation with other Sidley Austin partnerships.

2 Kimberly D. Bose October 1, 2018 Page 2 Attachment H-3D ( Formula Rate ) to incorporate measures (the Application ) to more accurately track expenses arising from tax liabilities, to ensure flow through of the tax benefits arising from the Tax Cuts and Jobs Act of 2017 ( TCJA ) and to clarify the timing for recovery of various accrued tax liabilities. Because the proposed revisions will lead to a rate reduction that benefits customers, Delmarva requests that the Commission waive the 60 day notice period and allow the revised tariff sheets to go into effect on the date of this filing, with an Effective Date of October 1, Alternatively, Delmarva requests the earliest possible Effective Date. As further discussed below, this Application is submitted as a response to the Commission s order in Docket No. ER18-903, in which the Commission rejected recovery through Delmarva s transmission rates of catch-up FAS 109 amounts 5 from 2005 (when the Delmarva Formula Rate went into effect) through the Effective Date of this Application which were not recovered because the Formula Rates did not provide for such recovery through the formula ( Catch-Up FAS 109 Amounts ). 6 While that order rejected catch-up recovery, it made clear that Delmarva could seek recovery of ongoing amounts that would not yet have been collected, even if Delmarva s rates had provided for FAS 109 recovery since This Application seeks recovery only of such ongoing amounts and does not seek recovery of Catch-Up FAS 109 Amounts. 8 5 Amounts recorded pursuant to Financial Accounting Standards Board Statement No. 109 ( FAS 109 ) now included in U.S. GAAP as part of Accounting Standards Codification 740 Income Taxes. 6 See Exelon 2018 Order. See also PJM Interconnection, L.L.C., 161 FERC 61,163 (2017) ( BGE 2017Order ), affirmed and clarified, PJM Interconnection, LLC, 164 FERC 61,173 (2018) ( BGE Rehearing Order ). 7 Exelon 2018 Order at PP See also, BGE Rehearing Order at P 38 (authorizing BGE to amend tariff to obtain recovery of ongoing amounts if properly supported). 8 Delmarva is not seeking recovery of any Catch-Up FAS 109 Amounts in this Application, but nothing in this Application should be construed as Delmarva forgoing its right to such catch-up recoveries. Delmarva reserves its right to seek further review of the order in Docket No. ER

3 Kimberly D. Bose October 1, 2018 Page 3 I. EXECUTIVE SUMMARY This Application will provide transmission customers a mechanism for rate relief from the recent TCJA, which reduced the effective federal corporate income tax rate, and will formulaically flow through other similar changes in deferred tax amounts. Once the filing is accepted, the next annual Formula Rate update of Delmarva, as well as future updates, will provide millions of dollars in rate relief to customers and will provide an automatic approach to ensure that deferred tax adjustments recorded under FAS 109 will be included in rates in a timely fashion. We estimate that the annual net impact of the proposed modifications will be a reduction of approximately $3.791 million per year or a 2.39 % reduction in transmission rates. Delmarva currently tracks adjustments to deferred taxes (tracked pursuant to FAS 109) in accordance with Commission precedent and policy. But the Delmarva Formula Rate has no mechanism to flow those FAS 109 amounts (whether positive or negative) through its transmission rates. As described below, the FAS 109 amounts reflect mismatches between Delmarva s liability for taxes, its accounting for that liability, and recovery of that liability in transmission rates. Allowing Delmarva s Formula Rate to now include a mechanism to pass FAS 109 amounts through to customers as proposed in this Application will ensure, among other things, that customers receive the benefits of the TCJA tax relief, and will ensure over time that customers pay in rates what was paid by Delmarva. While the changes proposed in this Application provide important clarity about timing, they do not alter the overall amount of taxes flowing through rates. The TCJA creates a deferred tax difference that leads to a rate decrease because Delmarva will pay future taxes at a new, lower federal corporate tax rate and must adjust its books to reflect that change. Under the current Delmarva Formula Rate, FAS 109 adjustments including those arising from statutory tax rate changes do not get reflected in rates but are instead tracked for later rate treatment. 9 When approved, the amendments proposed here will ensure that those important benefits, and other adjustments to deferred taxes, are automatically flowed through to ratepayers Unlike the deferred tax impact, the effect on current tax expense of the federal corporate tax cut in the TCJA is automatically reflected in the Delmarva Formula Rate, which computes tax expense using the currently effective income tax rates. Delmarva Formula Rate, PJM Attachment H-3D, Note I. The TCJA was thus reflected in Delmarva s 2018 formula rate update in the current tax calculations, and will be reflected in future rate updates in calculation of tax expense. 10 Consumers across the country have been asking for such flow through of the TCJA benefits. See e.g. February 9, 2018 Letter of Citizens Utility Board to the Commission (Accession No ). In response, the Commission initiated a Notice of Inquiry to consider how best

4 Kimberly D. Bose October 1, 2018 Page 4 Unlike the Application in Docket No. ER18-903, the proposal here is not seeking recovery of Catch-Up FAS 109 Amounts. Because this Application does not seek such catch-up recovery, it is entirely consistent with the Commission s orders in Docket ER and in other recent proceedings, and thus should be accepted promptly and summarily. 11 II. SINGLE ISSUE RATE TREATMENT The Commission has held that it is appropriate to address formula rate filings that concern the timing of deferred tax recovery but do not otherwise modify the formula rate on a single-issue basis. For example, the Commission held in a recent proceeding concerning formula rate modifications to the MISO Tariff to address ADIT recovery and timing that arguments concerning other aspects of the formula rate were beyond the scope of the issues raised in this proceeding and dismissed protests raising such unrelated issues. 12 Because the application here seeks adjustments relating to the timing of deferred tax recovery but does not impact any other aspects of Delmarva s rates, it is appropriate that the Application here similarly be addressed on a single-issue basis. III. SUMMARY AND TIMING OF PROPOSED MODIFICATIONS to accomplish such flow through. Inquiry Regarding the Effect of the TCJA on Commission Jurisdictional Rates, 162 FERC 61,223 (2018) ( ADIT NOI ). Exelon s utility affiliates are committed to flowing all FAS 109 amounts, including this large tax benefit, back to customers in a just and reasonable fashion. In addition to this filing, Delmarva s affiliates Commonwealth Edison Co., Atlantic City Electric Co., Potomac Electric Power Co., and Baltimore Gas and Electric Co. are simultaneously making FPA Section 205 rate filings at the Commission to amend their formula rates to include FAS 109 amounts that will allow the TCJA tax cuts to flow through rates as well as providing the other benefits of this filing. Delmarva s affiliate PECO Energy Co. included FAS 109 passthrough that will flow through these impacts in its formula rate in Docket No. ER (accepted and now effective, and now in hearing proceedings at the Commission). 11 As required by the Commission s determination in Docket No. ER that Delmarva may seek recovery of only excess or deficient ADIT to be calculated as of the effective date in the new filings, the Delmarva rates pursuant to this Application will not flow through the impacts of the TCJA on deferred taxes that could have been collected from January 1, 2018 through the Effective Date of this Application. See Exelon 2018 Order, at P Midcontinent Indep. Sys. Operator, Inc.,153 FERC 61,371 at P 41 (2015).

5 Kimberly D. Bose October 1, 2018 Page 5 The following adjustments are reflected in this Application: 1. Excess/Deficient Deferrals Arising from Tax Rate Changes Adjustment. Due to changes in state or federal tax rates, occurring from time to time, such as the TCJA, Delmarva s accumulated deferred income tax balances do not match the actual tax liabilities of Delmarva. Rather than continuing to allow such tax mismatches to accumulate over time in Delmarva s deferred tax balances, Delmarva proposes to correct the mismatch through automatic adjustments to be incorporated into the formula rate, using the average rate assumption method ( ARAM ) when ARAM is required under the normalization provisions of the Internal Revenue Code, and using an amortization over a 10 year period for non-property items. The automatic adjustments would reflect past tax rate changes that are not yet fully accounted for, and would also provide an automatic mechanism to capture the impact of any future tax rate changes that may be enacted at the state or federal level. 13 Consistent with the order in Docket No. ER18-903, Delmarva is not seeking in this Application any Catch-Up FAS 109 Amounts associated with Tax Rate Changes. 2. AFUDC Equity Adjustment. Federal income tax rules do not permit deduction on the income tax return of the AFUDC equity that is capitalized to plant and included in depreciation expense for financial reporting purposes. Thus, over time, the financial statement reporting of depreciation expense, which includes a component for book basis of AFUDC equity, will be different from the related amount deducted on the income tax return that does not include AFUDC equity. Consistent with the Commission s precedent approving similar formula rate adjustments, Delmarva proposes to modify its formula rates, to recover the tax component associated with the non-deductibility of AFUDC Equity amounts that are reflected in depreciation in each rate year. 14 Consistent with the orders in Docket No. ER18-903, Delmarva 13 See, e.g., Wisconsin Power and Light, Docket No. ER18-216, (February 13, 2018 Letter Order) (approving formula rate change of WPL to provide for recovery of excess and deficient ADIT) ( WPL ); Virginia Electric and Power Co., Docket No. ER ( VEPCO ) (August 2, 2016 Letter Order) (approving formula rate change of VEPCO to provide for recovery of excess and deficient ADIT); Midcontinent Indep. System Operator, 153 FERC 61,374 (2015) ( ITC ) (approving formula rate changes of various ITC affiliates to include a mechanism for the return or collection of excess and deficient ADIT). 14 See, e.g., Indianapolis Power and Light, 162 FERC 61,134 (2018) ( IPL ) (approving formula rate adjustment for AFUDC equity); Wisconsin Power and Light, Docket No. ER18-216, (February 13, 2018 Letter Order) ( WPL ) (approving formula rate adjustment for AFUDC equity); VEPCO (approving formula rate adjustment for AFUDC equity); ITC (approving formula rate adjustment for AFUDC equity).

6 Kimberly D. Bose October 1, 2018 Page 6 does not seek recovery here of tax amounts associated with AFUDC Equity that is not reflected in depreciation that rate year. 3. Flow Through Accounting Adjustment. Consistent with Commission requirements, Delmarva s Formula Rate employs the tax normalization methodology which does not immediately flow through tax savings, and instead normalizes tax liability assessed in rates over time. However, in prior decades, Delmarva employed flow through ratemaking for certain assets, immediately flowing through certain tax savings. The Commission has recognized that while both the flow through and normalization methodology recover the proper amount of taxes from ratepayers over time, the switch from one methodology to another creates timing differences that lead to a difference between a utility s deferred tax account balance and its future tax liability. While the normalization switch for Delmarva occurred years ago, shortfalls remain to be passed through in Delmarva s accounting resulting from the pre-2005 use of the flow through method. Delmarva proposes modifications to its Formula Rate to amortize the tax balances associated with flow through ratemaking over the average remaining life of its assets. 15 In Docket No. ER18-903, the Commission rejected recovery of amounts that could have been sought in rates from 2005 until the present, and rejected recoveries associated with assets that are retired or fully depreciated. This Application is consistent with those rulings, and is limited to only those small remaining amounts that could not have been amortized prior to the Effective Date of this filing and relate to assets that are in service and still being depreciated, and thus meets the ER standards. 4. Timing of Rate Impacts. While we propose that the changes to the formula will go into effect on October 1, 2018, or such other date as approved by the Commission, the actual rate levels charged to customers will not change until June 1, The Delmarva Formula Rate protocols provides for changes to rates to be addressed in the annual update reconciliation mechanism,in lieu of mid-year rate adjustments, in order to avoid administrative inconvenience for PJM, to provide a measure of rate certainty to customers and suppliers, and to avoid the complexities of accounting and true-ups for mid-year formula changes. 16 Interest accrual at the FERC rate on the true-up calculation will ensure that customers are held harmless from the fact 15 See, e.g., Duquesne Light Co., Docket No. ER (April 26, 2013 Letter Order) ( Duquesne ) (accepting deferred tax adjustment charge arising from deferred tax previously accounted for using flow-through methodology using South Georgia method that amortizes over average remaining life of asset)s; PPL Electric Utilities Corp., Docket No. ER (Letter Order issued May 23, 2012) (accepting deferred tax adjustment charge arising from deferred tax previously accounted for using flow-through methodology using South Georgia method that amortizes over average remaining life of assets). 16 Delmarva Protocols, PJM Tariff Attachment H-3E, Section 5(a) (providing that adjustments will be dealt with at time of next annual rate update).

7 Kimberly D. Bose October 1, 2018 Page 7 that the rate levels will not be adjusted until June 1, Assuming the Application is accepted, Delmarva will include in its 2018 FERC Form 1 the amortizations that will permit it to reflect the adjustment in the true-up to 2018 rates, and in the initial rate calculation of 2019 rates, each of which will be submitted by May 15, 2019 and go into effect on June 1, Later year FERC Form 1 s will include amortizations that permit the rate calculation to be performed in following years. IV. DESCRIPTION OF APPLICANT Delmarva, a Delaware and Virginia corporation, is a wholly owned subsidiary of Pepco Holdings, LLC, a public utility holding company. Pepco Holdings, LLC is a wholly owned subsidiary of Exelon, a Pennsylvania corporation. Delmarva owns approximately 13,500 miles of transmission and distribution facilities and provides delivered electric power and retail natural gas service to approximately 600,000 customers in Delaware and Maryland. Delmarva does not own any generation facilities. Delmarva s retail electric service is regulated by the Maryland Public Service Commission and the Delaware Public Service Commission, while the provision of transmission service over its transmission facilities and its sales for resale of electric energy in interstate commerce are regulated by this Commission. 17 Delmarva Formula Rate, PJM Tariff, Attachment H-3D, Attachment 6, line 9 of Reconciliation Details, provides for interest pursuant to 18 C.F.R a for true-up amounts. 18 Because the FAS 109 amounts will only flow through the rate for the portion of 2018 after the Effective Date, Delmarva commits that its 2019 rate update will include workpapers that detail adjustments so that the 2018 true-up reflects only the post-effective Date amortizations.

8 Kimberly D. Bose October 1, 2018 Page 8 V. PERSONS TO BE INCLUDED ON OFFICIAL SERVICE LIST Stan Berman Sidley Austin LLP 701 Fifth Avenue, Suite 4200 Seattle, WA (206) sberman@sidley.com Eric Todderud Sidley Austin LLP 701 Fifth Avenue, Suite 4200 Seattle, WA (206) etodderud@sidley.com Amy L. Blauman Assistant General Counsel Exelon Corporation 701 Ninth St. N.W. Washington, DC (202) alblauman@pepcoholdings.com Christopher A. Wilson Director, Federal Regulatory Affairs Exelon Corporation 101 Constitution Ave. Suite 400 E Washington, DC (202) FERCeFilings@exeloncorp.com VI. BACKGROUND AND HISTORY OF INCOME TAX RATEMAKING The Commission has established accounting procedures for public utilities to record and recover deferred taxes over multi-year periods, including the establishment of regulatory assets and liabilities to record excess or deficient collections, with the excesses and deficiencies experienced in prior years to be dealt with in later years in later rate cases. Delmarva has conformed to and relied on those procedures. A. Commission Orders on Normalization Public Systems I, a 1979 case from the United States Court of Appeals for the District of Columbia Circuit ( D.C. Circuit ), describes the issue of interperiod tax accounting, and recounts the history of the issue. 19 The court explained rulings tracing back to the 1950s, leading to FPC Order No. 530, which generally required that public utilities employ the normalization method of accounting to address interperiod deferred tax issues. 20 In Public Systems I, the court 19 Public Systems v. FERC, 606 F.2d 973 (D.C. Cir. 1979) ( Public Systems I ). 20 Id. at ; Accounting For Premium, Discount and Expense of Issue, Gains and Losses on Refunding and Reacquisition of Longterm Debt, and Interperiod Allocation of Income Taxes, 53 FPC 2123 (1975) ( FPC Order No. 530 ).

9 Kimberly D. Bose October 1, 2018 Page 9 found that the agency (by then, the FPC had become FERC) had not adequately explained its policies, and remanded to FERC for further proceedings. On remand, the Commission initiated the rulemaking that led to Order No In Order No. 144, the Commission re-affirmed and explained its choice to require public utilities to adopt normalization ratemaking. The rule text adopted by the Commission provided that the eventual rate case would address, using methods such as the South Georgia method, the circumstance where: as a result of changes in tax rates, the accumulated provision for deferred taxes becomes deficient in or in excess of amounts necessary to meet future tax liabilities as determined by application of the current tax rate to all timing difference transactions originating in the test period and prior to the test period. 22 After the issuance of Order No. 144 and rehearings, the issue went back to the D.C. Circuit, where challengers again contested the Commission s tax normalization policies, as well as the portions of the rule permitting make-up recovery of prior year excesses and deficiencies. 23 The D.C. Circuit upheld FERC s policies and rejected the contention that this was improperly retroactive, explaining: the provision does not adjust for shortfalls in prior rates. It only adjusts future rates so that tax costs will not fall disproportionately on one ratepayer generation. Ratepayers are not charged for a greater tax allowance under the provision than they otherwise would be; they merely incur the cost over a different time period Public Systems I, 606 F.2d at ; Tax Normalization for Certain Items Reflecting Timing Differences in the Recognition of Expenses or Revenues for Ratemaking and Income Tax Purposes, Order No. 144, FERC Stats. & Regs. 30,254, at 31,519 (1981), order on reh g, Order No. 144-A, FERC Stats. & Regs. 30,340 (1982). 22 Order No. 144 slip op. at ; regulatory text for 18 CFR 2.201(c)(ii) (as then codified). 23 Public Systems v. FERC, 709 F.2d 73, 85 (D.C. Cir. 1983) ( Public Systems II ). 24 Id.; see also Town of Norwood v. FERC, 53 F.3d 377, 381 (D.C. Cir. 1995) (noting that the court has upheld the Order No. 144 make-up provision against charges of retroactive ratemaking on the grounds that past costs collected during the transition were costs that the utility had always planned to charge to future ratepayers ) (emphasis in original).

10 Kimberly D. Bose October 1, 2018 Page 10 The ultimate goal of the Commission policy is an accurate rate that ensures that customers pay, and utilities receive, the accurate measure of tax expense, as measured over both current and prior test periods. B. FAS 109 FAS 109, issued February 1992 by the Financial Accounting Standards Board, updated the accounting and reporting standards for the interperiod tax issues such as those addressed in Order No FAS 109 specifically addresses the amounts at issue in this proceeding. It requires that companies recognize a deferred tax liability for: It further requires: tax benefits that are flowed through to customers when temporary differences originate ( Flowthrough Items ); and the equity component of the allowance for funds used during construction ( AFUDC Equity ). adjustment of a deferred tax liability or asset for an enacted change in tax laws or rates ( Excess/Deficient Deferred Taxes ). 25 On April 23, 1993, the Commission provided guidance on FAS That guidance letter, generally consistent with the prior Commission policy under Order No. 144, authorizes and directs compliance with FAS 109 by public utilities, requiring that excess or deficient deferred tax liability associated with all three categories Flowthrough Items, AFUDC Equity, and Excess/Deficient Deferred Taxes will be accounted for as provided in FAS 109, by recording the associated amounts as an asset or liability in separate accounts where later recovery from or payment to customers could ultimately be sought FAS 109. This standard also states that regulated enterprises, such as Delmarva, that meet the criteria for application of FAS 71, Accounting for the Effects of Certain Types of Regulation, are not exempt from FAS 109. Id. at FAS 71 is the accounting standard that provides for regulatory asset treatment of the future increases (or decreases) in taxes payable if it is probable that the taxes will be recovered from (or refunded to) customers in future rates. Id. 26 Accounting for Income Taxes, Docket No. AI93-5, April 23, 1993 Letter ( 1993 FAS 109 Guidance Letter ). 27 Id.; BGE 2017 Order at P 4.

11 Kimberly D. Bose October 1, 2018 Page 11 Consistent with this guidance, Delmarva and other public utilities have been tracking and recording amounts under FAS 109 since the early 1990s. Rather than automatically flowing through rates, the FAS 109 excesses and deficiencies are retained in the accounting records of the utility, for later recovery, once a specific application is made to the Commission for such recovery. C. Formula Rates Treatment of FAS 109 Amounts Filings by ITC and Virginia Electric Power Company ( VEPCO ) make clear that FAS 109 amounts may be recovered formulaically. For example, in 2015, ITC filed an application in Docket No. ER to amend its transmission formula rate, including new formula provisions for recovery of continued FAS 109 accruals. 28 The Commission approved the proposed recovery. 29 In July 2016, VEPCO, in Docket No. ER , proposed formulaic recovery of FAS 109 amounts, using essentially the same mechanism and theory as ITC. 30 The Commission approved the proposed recovery. 31 The Commission continues to approve formulaic recovery mechanisms for FAS 109 amounts, as can be seen in its February 2018 approval of a proposal by Wisconsin Power and Light that mirrored the earlier ITC filing. 32 In response to a similar filing by Ameren, protestors raised concerns that the AFUDC Equity amount is different from other FAS 109 amounts because it arises from a permanent tax timing difference rather than the temporary timing differences addressed in other FAS 109 amounts. As explained in the Ameren order, the deferred tax effect arising from AFUDC equity is indeed a permanent tax difference but 28 Midcontinent Indep. System Operator, Docket No. ER (ITC October 30, 2015 Application). 29 ITC, 153 FERC 61, Virginia Electric and Power Co., Docket No. ER (VEPCO July 1, 2016 Application). 31 VEPCO, August 2, 2016 Letter Order. 32 WPL, February 13, 2018 Letter Order.

12 Kimberly D. Bose October 1, 2018 Page 12 the Commission has held that it should be treated as a temporary timing difference and thus treated like other amounts addressed in the Commission s normalization policies. 33 D. Delmarva Income Tax Accounting and Rate History Delmarva has adopted FAS 109 accounting. The Commission s guidance and precedent on FAS 109 is directly applicable to Delmarva. Since adopting FAS 109, Delmarva has been properly recording and tracking deferred tax difference amounts, for later rate recovery from customers, or later payment to customers, once appropriate Commission authorization for such recovery was obtained. 34 Delmarva submitted to FERC its first generally applicable transmission tariff in 1994, in Docket No. ER Delmarva submitted a later tariff filing in 1995 in Docket No. ER Delmarva then submitted yet another tariff filing in Docket No. OA in compliance with Order No These rate cases were ultimately resolved in a black box settlements with a single stated rate that that did not expressly address FAS Midcontinent Independent System Operator, 163 FERC 61,163, at P 59 (2018) (Ameren). 34 Consistent with the 1993 FAS 109 Guidance Letter, the deferred tax liability for Delmarva has been recorded to FERC Account 282, and the regulatory asset amounts are recorded to FERC Account These amounts are reflected in each annual Form 1 of Delmarva (the amounts reported in Form 1 are for all of Delmarva, rather than just the transmission-related component at issue in this filing). 35 Delmarva Power & Light Co., Docket Nos. EC95-3 and ER (Application of November 4, 1994). 36 Delmarva Power & Light Co., Docket No. EC (Application of August 28, 1995). 37 Delmarva Power & Light Co., Docket No. OA (Application of July 9, 1996). 38 Delmarva Power & Light Co., Docket Nos. ER (Settlement Offer of June 20, 1997, resolving rates for sole customer under tariff); and (Letter Order of July 31, 1997) (accepting settlement) and 83 FERC 63,003 (1998) (dismissing pending cases in light of settlement with sole customer under tariffs).

13 Kimberly D. Bose October 1, 2018 Page 13 Delmarva submitted new rates in Docket No. ER , to permit the integration of Delmarva into PJM. 39 These rates were again the subject of a black box settlement with a stated rate that did not expressly address FAS In 2005, Delmarva (then a part of Pepco Holdings Inc. ( PHI )) submitted its formula rate, in Docket No. ER This was made effective June 1, The formula rate filing resulted in a settlement 43 accepted on April 19, The Formula Rate, as settled, segregated FAS 109 amounts from current rate recovery, leaving those amounts to continue to accrue in Delmarva s accounts. 45 Delmarva s rates prior to the Formula Rate do not specify FAS 109 recovery, but Delmarva s accounting assumes recovery of an appropriate amortized portion of transmissionrelated FAS 109 amounts in rates (either its bundled retail rates or its FERC established stated rates) until the Formula Rate went into effect in Atlantic City Electric Co., et al. (PJM Supporting Companies), Docket No. ER (Application of June 2, 1997). 40 Delmarva Power & Light Co., 85 FERC 61,349 (1998) (Accepting settlement). 41 Baltimore Gas and Electric Co. and Pepco Holdings, Inc., Docket No. ER (Application of January 31, 2005) (Docket No. ER was jointly submitted by BGE and the PHI companies because the Commission had encouraged joint filings by the PJM utilities. BGE and the PHI companies were unaffiliated at the time, and did not become affiliates until the 2016 closing of the Exelon/PHI merger). 42 Allegheny Power System Operating Companies, 111 FERC 61,308 (2005). 43 Baltimore Gas and Electric Co., et al., Offer of Settlement and Settlement Agreement, Docket No. ER05-15 (Mar. 20, 2006) ( 2006 BGE/PHI Offer of Settlement ). 44 Baltimore Gas and Electric Co., 115 FERC 61,066 (2006) (BGE/PHI Settlement Order) BGE/PHI Offer of Settlement, Docket No. ER The rate formula Attachment H- 3a expressly excludes FASB 109 amounts and 109 amounts in numerous locations. Consistent with the formula rate requirements, in each Annual Update Delmarva identifies on its Attachment 1- ADIT Worksheet, the excluded FAS 109 amounts that are recorded in FERC Account 282.

14 Kimberly D. Bose October 1, 2018 Page 14 Consistent with the rulings in Docket No. ER18-903, Delmarva will likewise assume for this Application that the FAS 109 amounts continued to be amortized away after the Formula Rate went into effect in 2005, even though the Formula Rate did not provide for passthrough of FAS 109 amounts. The attached exhibits document by year, the derivation of the transmission related portion of excess deferred taxes, AFUDC equity, and Other Flow Through items, each type of flow through amount that Delmarva proposes to pass back to customers. Whether or not such passback actually occurred, the calculations reflect the recovery (or assumed recovery) in wholesale and retail rates until To assist the reader, the exhibits are in an excel file that is a working model with all links and calculations intact, structured as follows: - Summary of the total transmission-related FAS 109 regulatory asset as of December 31, 2017, reflecting amortizations each year consistent with the rulings in Docket No. ER (Exhibit C-1). - Spreadsheet summarizing 12/31/2004 balances and subsequent amortizations and reversals. (Exhibit C-2). - Spreadsheet showing the tax calculations on annual AFUDC-Equity originations. (Exhibit C-3). - Spreadsheet report showing AFUDC Equity depreciation by year. (Exhibit C-4). - Spreadsheet showing deferred tax summary by component as of 12/31/2004. (Exhibit C-5). - Spreadsheet showing deferred tax summary by component for general and intangible plant as of 12/31/2004. (Exhibit C-6). 46 Amortizations for 2018 have not yet been computed, but will be done in the same fashion as shown for prior years. Assuming this Application is granted, Delmarva s Form 1 for 2018 will reflect balances based on a continued amortization throughout the Formula Rate period since Because the modifications proposed here will not go into effect prior to the Effective Date, the 2018 Rate Update will include workpapers detailing inclusion in the 2018 rate true-up only of FAS 109 amounts from after the Effective Date.

15 Kimberly D. Bose October 1, 2018 Page 15 - Pro forma calculation of the revenue impact to the 2018 Annual Update, using the proposed modifications to the Formula Rate. (Exhibit D-1). - TCJA excess deferred tax summary including 12/31/17 balances, amortization periods and annual amortizations, by category. (Exhibit D-2). - Example Tariff Calculations showing the pro forma amounts that would be reflected in Formula Rate Attachment 5, if the proposed modifications were part of the 2018 Annual Update. (Exhibit D-3). - Computation of Amortization of AFUDC Equity/Excess Deferred/Other Flow Through Items used to support example tariff calculations. (Exhibit D-3a). - Spreadsheet listing pre-1978 transmission assets that are still in service and not fully depreciated. (Exhibit E). - Various supporting tax documents, including additional amortization calculations for every year from 2004 to (Tax Support). VII. EXPLANATION OF PROPOSED TARIFF REVISIONS Delmarva has appropriately followed Staff accounting guidance and Commission precedent in accounting for FAS 109 amounts. These deferred tax amounts, relating to Excess/Deficient Deferred Taxes, AFUDC Equity, and Flowthrough Items were properly reflected in Delmarva accounts, subject to later recovery in rates when expressly authorized by the Commission. As discussed above, and as required by the Commission s orders in Docket No. ER18-903, Delmarva assumes for this Application that FAS 109 amounts amortized away prior to the Effective Date of this Application.. This Application, unlike the Application in Docket No. ER18-903, does not seek to recover Catch-Up FAS 109 amounts relating to the period from 2005 to the present. A. Proposed Revisions to Attachment H-3D of the PJM Tariff to Permit Return or Recovery of Accumulated Deferred Income Taxes Resulting From Tax Rate Changes. Delmarva proposes to modify its formula transmission rate to ensure that transmission rates automatically adjust to reflect fluctuating tax liabilities arising from federal or state income tax rate changes. This change to the Formula Rate serves to implement a mechanism through which Delmarva can recover deficient deferred taxes tracked and recorded by Delmarva. The Formula Rate change also provides a mechanism through which Delmarva will automatically return excess deferred income taxes should they occur in the future. While there have been several tax rate changes over the years, the TCJA will lead to a large excess in deferred taxes

16 Kimberly D. Bose October 1, 2018 Page 16 that will substantially exceed the other amounts recorded at Delmarva, meaning the overall impact of this Application will be a large rate reduction for customers. The tax rate change in the TCJA and prior tax rate changes have led to a re-measurement of Delmarva s ADIT balances, leading to reduction in the deferred taxes, which will be flowed through to customers over time. However, there is no mechanism available in the current Formula Rate to return to customers any excess deferred taxes that result from a re-measurement of the ADIT balances. Likewise, there is no mechanism available in the current formula rate to recover deficient deferred income taxes that result from the re-measurement of the ADIT balances. In order to flow through excess ADIT, or collect deficient ADIT, a formula rate must include a mechanism to accomplish that task. These two parallel mechanisms are very similar and are included in formula rates for other transmission owners, 47 and are consistent with longestablished precedent for the flow through of ADIT excesses and collection of ADIT deficiencies. 48 To accomplish this result, Delmarva proposes to add an Other Income Tax Adjustment section to its Formula Rate, with a new line 136a titled FAS 109 Amortized Tax Expense that will be added to the Income Tax Component computed on line 138 of the Formula Rate. The FAS 109 Amortized Tax Expense will include the three adjustments reflected in this Section 205 filing, with the detail of the calculation provided for in a new section of Attachment 5 (Cost Support) with accompanying instructions that describe and control the calculation. Delmarva will allocate the cumulative adjustment recognized in its financial records for the remeasurement of its state and federal deferred taxes due to tax rate changes to the transmission function and amortize the amount over the remaining life of the transmission-related assets consistent with the ARAM methodology, which will be used when ARAM is required under the normalization provisions of the Internal Revenue Code. For non-property items, which are not governed by the ARAM methodology, Delmarva proposes to use a ten year amortization, based on analysis of average period of time to eliminate the book to tax basis difference for that group of non-property items. 47 VEPCO, (August 2, 2016 Letter Order) (approving formula rate change of VEPCO to provide for recovery of excess and deficient ADIT); ITC, 153 FERC 61,374 (2016) (approving formula rate changes of various ITC affiliates to include a mechanism for the return or collection of excess and deficient ADIT). 48 See, e.g., Michigan Gas Storage Co., 83 FERC 63,001 (1998), aff d in relevant part, 87 FERC 61,038 (1999).

17 Kimberly D. Bose October 1, 2018 Page 17 Consistent with the holding in the Exelon 2018 Order 49, the calculation will reflect the assumption that these amounts have been amortized in rates until the Effective Date of this Application, and thus will reflect only the portion of these amounts that remain calculated as of the effective date in the new filings. In applying the ARAM methodology, Delmarva will amortize the excess/deficient deferral balances over the remaining useful life of the assets impacted by the tax rate change(s). 50 As stated in the instructions to the newly proposed section of Attachment 5 (Cost Support), the resulting amortized tax expense will be taken directly from Delmarva s tax accounting records (which are currently maintained using the widely used PowerTax tax depreciation and deferred tax software), which relies on amounts recorded by Delmarva pursuant to the Commission s Uniform System of Accounts. Like other such elements of the Formula Rate, the amounts are derived from the Form 1 and the calculations will be subject to review as part of the Annual Update procedures spelled out in Delmarva s Formula Rate Protocols in PJM Tariff Attachment H-3E. B. Proposed Modifications to Attachment H-3D of the PJM Tariff Permitting Flow-Through of Deferred Tax Liabilities for AFUDC Equity. Federal income tax rules do not permit the deduction on the income tax return of the AFUDC equity that is capitalized to plant and included in depreciation expense for financial reporting purposes. Thus, over time, the financial statement reporting of depreciation expense, which includes a component for book basis of AFUDC equity, will be different from the related amount deducted on the income tax return that does not include AFUDC equity. Consistent with the tax recovery mechanisms that the Commission has allowed in recent transmission rate filings, 51 Delmarva proposes to modify its Formula Rate to adjust for the non-deductibility of AFUDC Equity. This treatment will provide ongoing recovery in current rates of the permanent tax differences that would otherwise accrue as a deferred tax liability. Consistent with the holding in the Exelon 2018 Order 52, the calculation will reflect only the taxes associated with AFUDC Equity that is depreciated in a given year. Unlike the 49 Exelon 2018 Order at P Or for a ten year period for non-plant items. 51 See e.g., VEPCO (approving formula rate adjustment for AFUDC equity); ITC (approving formula rate adjustment for AFUDC equity); Ameren. 52 Exelon 2018 Order at P 123.

18 Kimberly D. Bose October 1, 2018 Page 18 Application in Docket No. ER18-903, this Application does not seek recovery of tax amounts associated with depreciation from prior years. In order to recover the tax amount on an ongoing basis, as discussed above, Delmarva proposes to add an Other Income Tax Adjustment section to its Formula Rate, with a new line 136a titled FAS 109 Amortized Tax Expense that will be added to the Income Tax Component computed on line 138 of the Formula Rate. The FAS 109 Amortized Tax Expense will include the amortization of AFUDC Equity amounts recorded under FAS 109, with the detail of the calculation provided for in a new section of Attachment 5 (Cost Support) with accompanying instructions that describe and control the calculation. As described in the instructions to the newly proposed section of Attachment 5 (Cost Support), Delmarva will multiply the amount of AFUDC embedded in the actual gross transmission plant depreciation expense by the depreciation rates included in Attachment 9 (Depreciation Rates) for the underlying plant assets. Furthermore, as stated in the instructions to the newly proposed section of Attachment 5 (Cost Support), the resulting amortized tax expense will tie directly to Delmarva s tax accounting records maintained using the PowerTax tax depreciation and deferred tax software, which relies on amounts recorded by Delmarva pursuant to the Commission s Uniform System of Accounts. Like other such elements of the Formula Rate, the amounts are derived from the Form 1 and the calculations will be subject to review as part of the Annual Update procedures spelled out in Delmarva s Formula Rate Protocols in PJM Tariff Attachment H-3E. C. Proposed Modifications to Attachment H-3D of the PJM Tariff Permitting Recovery of Deferred Tax Liabilities Related to Flow-Through Accounting. Delmarva s Formula Rate follows the rules and policies of the Commission, including rules and policies that require full tax normalization. 53 While Delmarva now collects its transmission rate through the Formula Rate, in past years Delmarva recovered substantially all of its transmission revenue requirement through bundled retail rates, regulated by the DPSC and MPSC. In past years, the DPSC and MPSC required that certain federal income tax savings resulting from temporary differences between the amount of taxes computed for ratemaking purposes and taxes on the amount of actual current federal income tax liability would flowthrough rates on a current basis, but that ratepayers would be responsible for paying higher taxes when the temporary timing differences reversed. These regulators have now changed this 53 See Tax Normalization for Certain Items Reflecting Timing Differences in the Recognition of Expenses or Revenues for Ratemaking and Income Tax Purposes, Order No. 144, 46 Fed. Reg. 26,613 (May 14, 1981), FERC Stats. & Regs. 30,254, at 31,560-61, order denying reh g, Order No. 144-A, 47 Fed. Reg (Feb. 26, 1982), FERC Stats. & Regs. 30,340 (1982); see also 18 C.F.R (c).

19 Kimberly D. Bose October 1, 2018 Page 19 policy and switched to normalization accounting, but certain excess deferral amounts reflecting cumulative timing differences related to the book versus federal tax life of affected property is reflected in Delmarva s accounts maintained consistent with FAS Since Order No. 144, 55 where the Commission required use of tax normalization, the Commission has recognized both that the switch from the flow through method to full normalization creates timing differences that may result in deferred tax reserves which are deficient from that required to provide for the associated future tax liabilities as they arise and that it is appropriate for companies to make some provision in their deferred taxes for the tax effects of timing difference transactions that had previously been flowed through. 56 That is, in the transition from the flow-through method to normalization, utilities were entitled to recover an additional income tax allowance to make up for the prior use of flow-through. 57 While Order No. 144 did not specify a methodology to make such a provision in a utility s deferred taxes, the Commission has since relied heavily on the South Georgia Method, and has accepted filings that employ the South Georgia Method to recover an adjustment to recover these amounts. 58 This filing seeks to recover the difference between Delmarva s deferred tax account and its future tax liability associated with Flow-Through Accounting, and thus clarify when these tax amounts will be recovered, and thus ultimately resolve these accruals of tax liability. Delmarva proposes to recover its future unfunded tax liability over the remaining average depreciable life of its transmission assets. In the Exelon 2018 Order, the Commission disallowed any recovery of Catch-Up FAS 109 Amounts that could have been amortized prior to this filing, and made clear that it would 54 See, e.g., Delmarva Power and Light Co., Order No. 2443, Docket No. PSC 82-22, at P 15 (DPSC 1983) (discussing prior flowthrough treatment of pre-1975 plant additions and pre-1978 capital overheads and change in DPSC policies to normalization). 55 Order No. 144, 15 FERC 61,133 (1981), FERC Stats. and Regs. 30,254 (1981). 56 Order No. 144 at 31, New England Power Company, 61 FERC 61,331 at 62,215 & n. 54 (1992) (citing Order No. 144 at 31,559-60). 58 See, e.g., Duquesne, Docket No. ER (April 26, 2013 Letter Order); PPL, Docket No. ER (Letter Order issued May 23, 2012).

20 Kimberly D. Bose October 1, 2018 Page 20 violate the matching principle to include amounts associated with assets that are either fully depreciated or retired. 59 The Commission questioned whether any costs would remain if limited in that fashion. 60 Exclusion of Catch-Up FAS 109 Amounts reduces the Flowthrough balance substantially, but still leaves a small Flowthrough balance relating to assets that are neither retired nor fully depreciated. A schedule listing transmission assets that pre-date 1978 and that are still in service and not fully depreciated is attached as Exhibit E, demonstrating that the remaining unamortized deferred tax amounts are associated with real assets that remain in service. 61 This Application provides a mechanism to address that relatively small remaining balance in rates. To implement this recovery, as discussed above, Delmarva proposes to add an Other Income Tax Adjustment section to its Formula Rate, with a new line 136a titled FAS 109 Amortized Tax Expense that will be added to the Income Tax Component computed on line 138 of the Formula Rate. The FAS 109 Amortized Tax Expense will include the amortization of Flow-Through amounts recorded under FAS 109, with the detail of the calculation provided for in a new section of Attachment 5 (Cost Support) with accompanying instructions that describe and control the calculation. 62 Delmarva will allocate the flow-through tax amounts to the transmission function and amortize the amount over the average remaining life of its transmission-related assets as discussed above. 59 See Exelon 2018 Order at P See Exelon 2018 Order at n The schedule in Exhibit E includes information on the book cost and remaining book value of each asset. As can be seen, Exhibit E only includes assets that are not yet fully depreciated. 62 As shown in the attached Exhibit D-3A, the remaining average depreciable life of Delmarva s transmission assets is 32 years. The Exelon 2018 Order could be read to require use of the remaining life of the specific assets at issue which is 14 years as can be seen in Exhibit E. Use of the 32 year period is consistent with remaining average depreciable life of all of Delmarva s transmission assets as determined under Generally Accepted Accounting Principles (ASC ), and will lead to a reduced rate that benefits customers. If the Commission determines that 14 years rather than 32 years must be used, Delmarva commits to revise its formula to use 14 years in compliance.

21 Kimberly D. Bose October 1, 2018 Page 21 VIII. DETAILED DESCRIPTION OF PROPOSED TARIFF REVISIONS The proposed revisions to the Formula Rate are provided in the attached clean and redline tariff pages. The specific changes to Appendix A are summarized as follows. Items (a) through (e) and (g) are changes also included in Attachment 4. (a) The heading of section encompassing Line 136a through Line 136c is inserted as Other Income Tax Adjustment to reflect the revised scope of this portion of the Formula Rate. (b) Line 136a FAS 109 Amortized Tax Expense is inserted, which provides for inclusion of the additional tax adjustments computed in the proposed addition to Attachment 5 (addressed below) and a reference to Note T. (c) Line 136b T/(1-T) is inserted, which provides for the income tax percentage taken from existing Line 132, as referenced in the accompanying instruction. (d) Line 136c Other Income Tax Adjustment is inserted along with an accompanying instruction, which provides for the multiplication of Line 136a by 1 plus Line 136b. (e) The instruction for Line 138 is revised to include Line 136c in the summation of Total Income Taxes. (f) Note T is inserted, which provides for references to Attachment 5. The Other Income Tax Adjustment included on line 136a is computed in the proposed addition to Attachment 5 of the Formula Rate consisting of a new calculation block titled Other Income Tax Adjustment. The top portion of the added block shows which lines in the FERC Form 1 that the FAS 109 amortized tax expense is recorded. It further shows the amounts per the Form 1 in each of the income tax expense lines and the embedded amounts for FAS 109 amortized tax expense. The middle portion of the added block provides for the details for each of the Tax Adjustment for AFUDC Equity Component of Transmission Depreciation Expense, Amortized Excess Deferred Taxes, Amortized Deficient Deferred Taxes, and Amortization of Other Flow-Through Items - Transmission Component. The lower portion includes related instructions. The following summarizes the proposed addition to Attachment 5. (a) The first four data entry lines provide the Form 1 amounts for income tax expense, the Transmission-Related FAS 109 Amortization Expense amounts included in each Form 1 income tax expense line, and the Remainder amounts (or differences) between the two aforementioned amounts. A note is included in the Details column that provides for the total amount included in the Transmission-Related FAS 109 Amortization Expense column to be taken to Line 136a, along with a reference to further details, calculations and instructions immediately below.