Miller, Canfield, Paddock and Stone, P.L.C. One Michigan Avenue, Suite 900 Lansing, Michigan TEL (517) FAX (517)

Transcription

1 Founded in 1852 by Sidney Davy Miller MICHAEL C. RAMPE TEL (517) FAX (517) Miller, Canfield, Paddock and Stone, P.L.C. One Michigan Avenue, Suite 900 Lansing, Michigan TEL (517) FAX (517) MICHIGAN: Ann Arbor Detroit Grand Rapids Kalamazoo Lansing Troy FLORIDA: Tampa ILLINOIS: Chicago NEW YORK: New York CANADA: Windsor CHINA: Shanghai MEXICO: Monterrey POLAND: Gdynia Warsaw Wrocław January 19, 2018 Ms. Kavita Kale Executive Secretary Michigan Public Service Commission 7109 West Saginaw Hwy., 3 rd Floor Lansing, MI Re: Upper Michigan Energy Resources Corporation In the matter, on the Commission's own motion, to consider changes in the rates of all Michigan rate regulated electric, steam, and natural gas utilities to reflect the effects of the pending federal Tax Cuts and Jobs Act MPSC Case No. U Dear Ms. Kale: Pursuant to the Michigan Public Service Commission s December 27, 2017 Order in MPSC Case No. U-18494, Upper Michigan Energy Resources Corporation ( UMERC ) hereby submits its Comments in this docket. Please note that UMERC s deferred tax liability information in these Comments is based on information as of September 30, 2017 and reflected in UMERC s parent company s 10Q quarterly report on file with the Securities and Exchange Commission ( SEC ). UMERC has not provided more recent deferred tax liability information in this filing, as this is currently nonpublic information that will be contained in a 10K Annual Report to be filed with the SEC in February Once this information has been filed with the SEC, UMERC will update its deferred tax liability information as of December 31, Very truly yours, Miller, Canfield, Paddock and Stone, P.L.C. By: Michael C. Rampe \

2 STATE OF MICHIGAN BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION * * * * * In the matter, on the Commission's own motion, ) to consider changes in the rates of all of the ) following Michigan rate-regulated electric, ) steam, and natural gas utilities to reflect the effects ) of the federal Tax Cuts and Jobs Act of 2017: ) ALPENA POWER COMPANY, CONSUMERS ) ENERGY COMPANY, DETROIT THERMAL, LLC, ) DTE ELECTRIC COMPANY, DTE GAS COMPANY, ) INDIANA MICHIGAN POWER COMPANY, ) Case No. U NORTHERN STATES POWER COMPANY, ) UPPER PENINSULA POWER ) COMPANY, UPPER MICHIGAN ENERGY ) RESOURCES CORPORATION, ) WISCONSIN ELECTRIC POWER COMPANY, ) PRESQUE ISLE ELECTRIC & GAS CO-OP, ) MICHIGAN GAS UTILITIES CORPORATION, and ) SEMCO ENERGY GAS COMPANY. ) ) COMMENTS OF UPPER PENINSULA ENERGY RESOURCES CORPORATION ( UMERC ) A. Introduction On December 27, 2017, the Michigan Public Service Commission ( the Commission ) issued an order in the above-entitled case ( the Order ). The Order states that Michigan rate-regulated electric, steam, and natural gas utilities shall: 1. Apply regulatory accounting treatment for all impacts resulting from the Tax Cuts and Jobs Act ( TCJA ) beginning January 1, 2018; 2. Submit by January 19, 2018 the impacts of the TCJA on revenue requirements effective January 1, 2018; and, 1

3 3. Outline by January 19, 2018 the preferred method to flow any benefits of the TCJA to customers. Upper Michigan Energy Resources Corp ( UMERC or the Company ) appreciates the opportunity to submit these written comments on the impacts of the TCJA. B. Overview of the TCJA On December 22, 2017 the enactment of the TCJA made sweeping changes to the federal tax landscape for businesses. Determining the estimated effects of these significant changes on UMERC and its customers by the date required by this Order is a challenge due to the complexity of these changes. However, in general, customer rates currently in place will be materially affected in three ways: 1. By the reduction in the federal corporate income tax rate from 35 percent to 21 percent starting January 1, 2018; 2. By the return of the one-time effects of the re-measurement of deferred tax liabilities from 35 percent to 21 percent ( Excess Deferred Taxes ); and, 3. By the re-measurement of pre-existing regulatory tax assets and liabilities due to the change in tax gross-up from the federal tax rate change. The major changes to the corporate tax system that impact utility businesses like UMERC are discussed below and the applicable sections of the enacted tax bill ( P.L ) have been referenced. 2

4 Tax Rate Under prior law corporations were taxed at a rate of 35 percent. Under the new law corporations will be taxed at a rate of 21 percent effective January 1, Interest Expense Under prior law there was no limitation on the deduction of interest expense. Under the new law corporate taxpayers are generally limited in deducting interest expense that does not exceed 30 percent of taxable income before interest, taxes and tax depreciation ( Adjusted Taxable Income or ATI ). 2 Utility companies however are specifically exempted from this provision and will continue to be able to fully deduct all interest expense. Bonus Depreciation / Asset Expensing Under prior law corporate taxpayers including utility companies were generally allowed 40% bonus depreciation in 2018, 30% bonus depreciation in 2019, and thereafter bonus depreciation was not available. Under the new law the prior bonus depreciation rules are eliminated effective September 28, 2017 and replaced with new asset expensing rules. 3 Those asset expensing rules allow corporations to deduct 100 percent of the cost of capital assets in the first year they are placed in service for tax purposes. However, utility companies are prohibited from taking bonus depreciation or asset expensing effective September 28, Section 13001, P.L , Tax Cuts and Jobs Act 2 Section 13301, P.L , Tax Cuts and Jobs Act 3 Section 13201, P.L , Tax Cuts and Jobs Act 4 Section 13201(d), P.L , Tax Cuts and Jobs Act 5 Further clarification may be provided regarding the expiration date of the current bonus depreciation rules for utilities. There is potential that the expiration date may be changed to December 31, 2017 for utilities. 3

5 Normalization Under prior law, normalization provisions required that any federal tax benefits related to the re-measurement of deferred taxes from certain plant assets (i.e. depreciation method and life differences versus book accounting) be returned to customers no faster (i.e. normalized) than the remaining average life of the assets. Two methods were available to utilities to normalize the return of these Excess Deferred Taxes to customers: the average rate assumption method ( ARAM ) and the reverse South Georgia method ( RSGM ). The normalization provisions described above are maintained under the new law and continue to be required. 6 Therefore any return of federal Excess Deferred Taxes on plant assets more quickly than under ARAM or RSGM would result in a normalization violation. This violation would result in the loss of the utility s ability to continue to take accelerated tax depreciation, as well as an increase in tax equal to the amount of the Excess Deferred Taxes returned to customers faster than allowed under ARAM or RSGM. 7 C. Accounting Principles Governing Changes in Tax Law or Rates Financial Accounting Standards Board Accounting Standards Codification 740 ( ASC 740 ) states, Deferred tax liabilities and assets shall be adjusted for the effect of a change in tax laws or rates (ASC ). The deferred income tax effects of the change in tax laws or rates are required to be recorded in the period of enactment as either income tax expense or benefit (ASC ) or as a regulatory asset or 6 Section 13001(d), P.L , Tax Cuts and Jobs Act 7 Section 13001(d)(4), P.L , Tax Cuts and Jobs Act 4

6 liability for regulated entities applying the principles of ASC 980 (ASC ), with recovery from or refund to customers in the future authorized by the regulator. D. Regulatory Policy for Accounting for Changes in Tax Law or Rates As stated previously, ASC 980 directs regulated entities with assurance of future recovery or a refund requirement to defer the net income effects of a change in tax laws or rates in the period of enactment by offsetting the re-measurement of the deferred income tax accounts with regulatory assets or regulatory liabilities. In its order in Case No. U from 1993, the Commission set forth its general policy in accounting for income taxes for ratemaking and accounting purposes. The tenets of this policy can be summarized as follows: 1. Deferred income tax accounting is the preferred method of accounting (as opposed to a cash basis method); 2. The assurance of recovery of any regulatory assets resulting from the remeasurement of deferred taxes; and, 3. The requirement to return to customers any regulatory liabilities resulting from the re-measurement of deferred taxes. This Commission policy of deferring the net income effects of a change in tax law or rates by requiring the recording of regulatory assets or liabilities has been expressly affirmed in numerous cases. For example, with the enactment of the Tax Reform Act of 1986 ( TRA 1986 ) 8 the federal corporate income tax rates went from 46 percent to 34 percent. As a result, the deferred federal income tax liabilities of most utilities were reduced. The bulk of these deferred tax liabilities related to book and tax basis differences 8 The Commission addressed the effect of TRA 1986 in its June 30, 1987 Order in Case No. U-8638 and related utility specific cases (e.g., U-8680 and U-8681 (Consumers Energy), U-8683 (Detroit Edison), and U-8684 (Michigan Consolidated Gas Company)). 5

7 of property, plant and equipment. In order to assure an orderly recognition in utility ratemaking of the effect of the tax rate reduction, this one-time deferred tax adjustment (Excess Deferred Taxes) was recorded as a regulatory liability and has been returned to customers through general rates over the life of the property, plant and equipment. In 2009, the Commission once again affirmed the application of this policy with respect to the enactment of the Michigan Business Tax ( MBT ), which replaced the Michigan Single Business Tax. 89 And finally in its 2012 order in Case No. U-16794, the Commission once again confirmed its preferred approach for handling the effects of a change in tax law. In that case which addressed the enactment of the Michigan Corporate Income Tax ( MCIT ), the Commission authorized the establishment of a regulatory asset to assure recovery of the establishment of deferred tax liabilities for the enactment of the MCIT. This long-standing consistently applied regulatory policy conforms to generally accepted accounting principles ( GAAP ), results in fair and reasonable ratemaking, is widely used in other utility ratemaking jurisdictions, avoids unintended windfalls or detriments caused solely by the enactment of tax law changes, and should continue to be affirmed by the Commission. E. Estimated Impact of 21 Percent Tax Rate from the TCJA on Revenue Requirements For UMERC s electric utility business, recalculating the Company s total tax expense using the reduced federal tax rate of 21 percent results in an estimated reduction in UMERC s revenue requirement of approximately $1.9 million. This amount is comprised of $ 1.3 million for the WEPCO Rate Zone and approximately $ 0.6 million for WPSC Rate Zone. See Exhibit 1A and Exhibit 1B, respectively, for 9 See for example Case Nos. U and U (Consumers Energy Company), U (Detroit Edison Company), U (Michigan Consolidated Gas Company) and U (SEMCO Energy Gas Company). 6

8 the supporting calculations of the reductions in revenue requirement for the WEPCO Rate Zone and the WPSC Rate Zone. For UMERC s natural gas utility business, recalculating the Company s total tax expense using the reduced federal tax rate of 21 percent results in an estimated reduction in the jurisdictional revenue requirement of approximately $ 30,000. See Exhibit 2 for the supporting calculation of this reduction in revenue requirement. It should be noted that these estimated tax savings for electric and gas customers above do not include any impacts of the amounts separately discussed in Section F. Additionally, UMERC has unique circumstances stemming from its recent creation on January 1, UMERC was created through the contribution of all Michigan electric distribution assets by Wisconsin Electric Power Company ( WEPCO ) and all Michigan electric and natural gas distribution assets by Wisconsin Public Service Corporation ( WPSC ). Of particular note, the generation assets of WEPCO were not transferred to UMERC; however, those assets were included in the determination of base rates for WEPCO (now the UMERC WEPCO rate zone). Upon UMERC s creation, the electric load for all UMERC customers is served by Purchased Power Agreements ( PPAs ) with WEPCO and WPSC for each respective rate zone. Those PPAs are governed by FERC formula rates which are expected, through their normal operation, to return the generation-specific benefit of the TCJA to customers. As such, the benefit of the TCJA specifically attributed to generation assets is expected to flow through the formula rate and, for Michigan rate making purposes, through the PSCR process. As such, UMERC believes that this estimate is an accurate projection of the total benefits to customers 7

9 related to the TCJA; however, the portion of those benefits that should be returned through a base rate mechanism are expected to be less than this estimate, with the balance being returned through UMERC s PSCR mechanism. F. Estimated Impact of the TCJA on Deferred Taxes As previously stated, book accounting under ASC 740 requires that the impacts of a tax law change be recorded in the period of enactment. As a result, the Company s deferred taxes were revalued as of September 30, 2017, which is the most recent publicly available data. These deferred tax balances represent taxes that will be paid in the future. After the law change, UMERCs deferred tax liabilities were revalued at a 21 percent rate creating an estimated one-time deferred tax adjustment of approximately $10 million and will be recorded as a net regulatory liability in accordance with the Commission s Order in this docket. The one-time deferred tax adjustment of approximately $10 million is based on the balances as of September 30, It should be specifically noted that 2017 activity included as of September 30, 2017 is the Company s best estimate using publicly available information. Additionally, because the Company will not file its 2017 federal and state tax returns until approximately the fourth quarter of 2018, to the extent that the final federal and state tax returns are different in any manner than the year end 2017 estimates, the onetime deferred tax adjustment estimate of approximately $10 million will need to be adjusted. Additional analysis is needed to determine the annual impact of these benefits. Specifically, UMERC will need to evaluate each of these deferred balances and identify over what period they can be returned to customers. For the purposes of these comments, we have performed our analysis using the revenue requirement impact related to the remeasurement of these deferred income tax balances (estimated to be approximately $ 13 8

10 million) and assumed a 30 year and 50 year average remaining book life, which yield an estimated annual revenue requirement benefit of between approximately $ 250,000 - $ 450,000. G. Total Estimated Impact of the TCJA on UMERC s Revenue Requirement In summary, the total estimated impacts (in millions) to current combined electric and gas revenue requirements from the change in tax law under the TCJA are as follows: Item Rate Impact (in $ 000 s) Annual Change in Rate from 35% to 21% $ 1,930 Estimated Annual Impact of the TCJA on $ Deferred Taxes Total Annual Impact $ 2,180 2,380 H. Recommended Methods for Flowing Benefits of the Revenue Requirement Adjustments Associated with TCJA to Customers As demonstrated by these comments, calculating the customer revenue requirement impacts of the TCJA particularly for UMERC, given its unique circumstances - is highly complex. However the Company recognizes the significant customer impacts of the change in tax law and the impact to the State of Michigan. UMERC s recommendations on how to flow the benefits of the Company s reduced revenue requirement resulting from TCJA to its customers are based on the following guiding principles: 1. Sufficient time should be afforded to UMERC to accurately calculate the customer impacts given the complexity and timing of the law change; 9

11 2. Once accurately determined, the significant benefits of the tax law change should flow to the UMERC s customers as soon as practicable and in accordance with federal tax law; and, 3. The benefits of the tax changes should flow to UMERC s customers in a levelized manner that does not create large annual rate fluctuations for customers or cash flow volatility for investors. Recommended Methodology The Company recommends a phased-in-approach to reflect the customer impacts of the TCJA. First, UMERC should be allowed time to accurately calculate the rate impacts of the tax law change. As stated previously, the Company is required to account for all of the effects of a tax law change in its financial statements in the year of enactment (2017) and the current rate making for UMERC no longer reflects the way that it currently serves its electric customers. Therefore, UMERC will know with more accuracy the full effects of the tax law change once its parent company (WEC Energy Group, Inc.) has finalized its 2017 financial statements and federal and state tax return filings and has also been able to identify the portion of benefits that will be returned to customers by way of the PPAs, the costs of which are recovered through UMERC s PSCR mechanism. The Company currently expects to complete its accounting for year end 2017 and provide the necessary information to facilitate the issuance of its parent company s Form 10-K with the Securities and Exchange Commission ( SEC ) by the end of February Recognizing this complexity the SEC has allowed publicly-traded companies a period of one year to finalize the financial impact of the TCJA on their 10

12 financial statements. 10 Additionally, UMERC expects to complete and file its 2017 federal and state tax returns, including calculating any deferred tax true-ups, by the end of the fourth quarter of Second, the Company believes that the most appropriate approach to determine and implement the appropriate mechanism to return those identified benefits to customers would be best accomplished in a UMERC s next rate case. This approach would provide an opportunity to develop a plan that would not create large rate fluctuations from year to year while also returning to customers all of the benefits associated with the TCJA due to them while minimizing the opportunity for over or under-returning those benefit. Additionally, as stated in Section B, the new tax law governs how federal Excess Deferred Taxes related to plant differences are returned to customers. But there are numerous other types of deferred tax changes in which utilities and the Commission may have discretion in how they are returned to customers. Addressing this matter in UMERC s next rate case would provide the Commission the opportunity to understand the scope of that discretion and apply the benefits in a way that is consistent with its policy objectives. J. Conclusion In accordance with this Order, the Company: 1. Will Establish regulatory tax assets and liabilities as of December 31, 2017 to record the one-time and ongoing impacts of the TCJA; 2. Provided a preliminary estimate of the customer impacts of the TCJA as summarized in Section H; and 10 See SEC Staff Accounting Bulletin (SAB) No

13 3. Recommended a thoughtful and balanced approach in Section I of how to flow the benefits of the tax law changes to customers. UMERC respectfully requests that the Commission consider these comments. Respectfully submitted, UPPER MICHIGAN ENERGY RESOURCES CORPORATION Dated: January 19, 2018 By: 12

14 Exhibit 1A UMERC (WEPCO 2012 MI TY less Mines) dollars in thousands Line 2012 Test Year (As Authorized) 2012 Test Year (With 21% Federal Tax Rate) 1 Pre-Tax Income $ 7,345 $ 7,345 2 Tax Rate % % 3 Statutory Taxes $ 2,941 1,993 4 Perms $ 17 $ 12 5 Excess Deferred Taxes $ 43 $ 43 6 Tax Amortizations $ - $ - 7 ITC Amortization $ (850) $ (850) 8 Wind Credits $ (1,345) $ (1,345) 9 State Tax Credits $ 0 $ 0 10 Total Tax Expense $ 807 $ (147) 11 Tax Savings (To Be Deferred) $ - $ Revenue Requirement of Tax Savings $ - $ 1,309 NOTE: Revenue Requirement of Tax Savings (Line 12) is calculated by grossing up Tax Savings (Line 9) using the associated tax rate on Line 2 of each scenario.

15 Exhibit 1B UMERC (WPS 2015 MI TY Electric) dollars in thousands Line 1 Reconciliation to Schedule J 2015 Test Year (As Authorized) 2015 Test Year (With 21% Federal Tax Rate) 2 Pre-Tax Income $ 3,410 $ 3,410 3 Tax Rate % % 4 Statutory Taxes $ 1,369 $ Perms $ (27) $ (18) 6 Excess Deferred Taxes $ 3 $ 3 7 Crane Creek Amort $ 17,213 $ 17, and R&E Amort $ - $ - 9 Tax And Interest Amortization $ - $ - 10 Tax Amortizations $ 17 $ ITC Amortization $ (7) $ (7) 12 Total Tax Expense $ 1,356 $ Tax Savings (To Be Deferred) $ - $ Statement J Tax Expense $ (256) $ (256) 15 Tax Expense on Revenue Deficiency $ 1,612 $ 1, Difference $ (0) $ (0) 17 Revenue Requirement of Tax Savings $ 592 NOTE: The Revenue Requirement of Tax Savings (Line 17) is calculated by grossing up the calculated Tax Savings (Line 13) using the associated tax rate on Line 3 of each scenario.

16 Exhibit 2 UMERC (WPS MI Gas - based on 1983 TY and 1987 rate adjustment for tax rate change) dollars in thousands MPSC Docket Year Federal Tax Rate a U % b U % Rate Change -12% Previous Revenue Reduction $ % % Rate Change -14% Revenue Requirement of Tax Savings $ Composite Tax Rate 27.26% Tax Savings (To Be Deferred) $ 21.2 a Last WPS MI Gas full rate case, order dated June 7, 1983 b Addressed the effects of the Tax Reform Act of 1986 (TRA) only, settlement dated June 9, 1987