Dykema Gossett PLLC Capitol View 201 Townsend Street, Suite 900 Lansing, MI 48933 WWW.DYKEMA.COM Tel: (517) 374-9100 Fax: (517) 374-9191 Richard J. Aaron Direct Dial: (517) 374-9198 Direct Fax: (855) 230-2517 Email: RAaron@dykema.com January 19, 2018 Kavita Kale Executive Secretary Michigan Public Service Commission 7109 West Saginaw Highway 3rd Floor Lansing, MI 48917 Re: Case No. U-18494 Dear Ms. Kale: Attached for electronic filing, please find Indiana Michigan Power Company s Comments regarding Case No. U-18494. Sincerely, DYKEMA GOSSETT PLLC Richard J. Aaron RJA/rlg Attachment 4814-4224-4186.2 025217\000999 California Illinois Michigan Minnesota Texas Washington, D.C.
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-18494 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. ) ) INDIANA MICHIGAN POWER COMPANY S COMMENTS In its December 27, 2017 Order in this case, the Michigan Public Service Commission (Commission) directed utilities to: (1) apply regulatory accounting treatment, which includes the use of regulatory assets and regulatory liabilities, for all impacts resulting from the Tax Cuts and Jobs Act of 2017 (2017 Tax Act); and (2) submit comments which include the impacts of the 2017 Tax Act including the impacts on current tax and deferred tax, and the impact on revenue requirements with and without the 2017 Tax Act, effective January 1, 2018 and also outline the preferred method to flow the benefits of those impacts to ratepayers. Indiana Michigan Power Company (I&M or the Company) respectfully submits the following comments.
I. It is inappropriate to reflect the impact of the 2017 Tax Act in I&M s rates before new base rates go into effect. I&M has a pending base rate case with a 2018 test year, Case No. U-18370, in which an order from the Commission is expected by April 12, 2018. As discussed further below, it is entirely appropriate for the Commission to incorporate the effect of the 2017 Tax Act in setting I&M s new base rates. But it would inappropriate to incorporate the effect of the 2017 Tax Act during the period before I&M s new base rates go into effect (i.e., from January to April 2018). First, a utility s base rates may be established only through a full cost of service study in a base rate proceeding. See, MCL 460.6a and MCL 460.11. Once base rates are set, typically they are not adjusted until a new cost of service study is performed in a subsequent base case. Id. Thus, it is axiomatic that a utility is only entitled to a reasonable opportunity to earn its authorized return. Ass n of Businesses Advocatign Tariff Equity v Public Service Comm, 208 Mich App 248, lv denied 450 Mich 892 (1994). If expenses unexpectedly rise, a utility cannot raise rates until it establishes the need for higher rates through a cost of service study in a base case. Yet the converse is also true. If expenses unexpectedly decline, the utility is not required to lower its rates until a new cost of service study is performed in a base rate proceeding. Here, therefore, given the circumstances for I&M discussed below, it is inappropriate to attempt to incorporate the impact of a single expense tax expense in I&M s base rates without the benefit of a full cost of service study incorporating all of I&M s expenses and revenues. Second, it would be particularly inappropriate to incorporate the impact of tax reform before new base rates go into effect because it is undisputed that I&M has a significant revenue deficiency in 2018. Although the parties in I&M s pending base case dispute the precise amount of the deficiency, there is no dispute that it exists, and that it is significant. See Case No. U- 18370, 3 Tr 1241 (describing Staff s recommended $48.7 million revenue deficiency). Even 2
taking into account a decrease in tax expenses from the 2017 Tax Act, I&M will still fall short of earning its authorized return until new base rates go into effect. Thus, the 2017 Tax Act is by no means a windfall for I&M. Rather, until new base rates go into effect, it merely partially offsets I&M s undisputed earnings deficiency. Under these circumstances, it would be inappropriate, and unfair, to exacerbate I&M s revenue deficiency by attempting to incorporate the effect of tax reform prior to the establishment of new base rates. Third, it is important to note that I&M is unlike other utilities who have recently had base rates established through a recent test year. If a utility has recently performed a full cost of service study where tax expense was considered alongside all other revenues and expenses, it may be reasonable to simply plug in the new tax values resulting from the 2017 Tax Act and establish new rates that approximate the outcome of a new cost of service study. But this approach is not appropriate for I&M because I&M s current rates were set using a 2012 test year in Case No. U-16801. As demonstrated by I&M s significant revenue deficiency in Case No. U- 18370, this 2012 cost of service study is no longer representative of I&M s cost of providing service to customers in 2018. Therefore, it is not reasonable to simply plug in the effect of tax reform into the 2012 cost of service study that forms the basis of I&M s current rates. Rather, the impact of the 2017 Tax Act should only be reflected through the full cost of service study provided in I&M s pending base case. In sum, if I&M were earning its authorized return, or if it had recently established new base rates, it might be reasonable to account for the effect of tax reform on I&M s current rates. But I&M has a substantial revenue deficiency, and its rates are clearly insufficient even after reflecting the 2017 Tax Act. Therefore, the effect of the 2017 Tax Act should only be reflected in I&M s rates when its new base rates go into effect in April. During the short period before 3
base rates go into effect (i.e., January to April 2018), the impact of the 2017 Tax Act only reduces, but does not eliminate, the revenue deficiency that would otherwise allow I&M to earn its authorized return. Therefore, there should be no change to I&M s current base rates for tax reform. II. When the Commission sets rates in I&M s pending base rate case, it should incorporate the effect of the 2017 Tax Act. The appropriate method to flow the benefits of tax reform to I&M s customers is to incorporate those benefits in I&M s pending base rate proceeding, Case No. U-18370. That is, when the Commission establishes I&M s new base rates, it should adjust those rates to fully account for the tax savings caused by the 2017 Tax Act. This proposal is much like the action the Commission took in Re Consumers Power Co, Opinion & Order, Case Nos. U-3110 and U- 3179 (September 29, 1969), aff d Consumers Power Co v Public Service Comm, 65 Mich App 73 (1975). In those cases, the Commission dealt with the expiration of a Federal Income Tax Surcharge. It its opinion granting rate relief, the Commission ordered: Id. at 56. [I]n the event the Federal Income Tax Surcharge expires or is reduced, Consumers Power Company shall promptly file rate schedules reducing its rates by the amount of the tax reduction. Such reduced rates shall be effective within 30 days of the effective date of the tax reduction. Specifically, analyzing the impact of the 2017 Tax Act on I&M s rate schedules in Case U-18370, I&M s proposed rate relief is affected in the following ways: 1 Current Tax Expense Before Rate Increase The reduction in the federal income tax rate from 35% to 21% reduces I&M s test year tax expense by $0.8 million. Supporting 1 Revenue deficiency impacts provided in these Comments assume no other adjustments to I&M s cost of service. If the Commission were to make other, non-tax-related adjustments, the revenue deficiency impacts provided in these Comments would need to be recalculated. As noted below, the Commission should direct the Company to incorporate all adjustments (including tax reform impacts) in a compliance cost of service study. 4
details for this reduction can be found on Attachment A. After application of the updated gross revenue conversion factor, this reduction in test year tax expense results in a $1.0 million reduction to I&M s test year revenue deficiency. Gross Revenue Conversion Factor The reduction in the federal income tax rate reduces the gross revenue conversion factor from 1.6315 to 1.3424. This is shown on Attachment B, which is an updated Exhibit IM-13, Schedule A-3, C2 in Case No. U-18370. The reduction in gross revenue conversion factor reduces I&M s test year revenue deficiency by $8.3 million. This is shown on Attachment C. Loss of Bonus Depreciation As a result of the 2017 Tax Act, the Company is no longer eligible for bonus depreciation. The loss of bonus depreciation results in increased cash tax payments by the Company and reduces the level of ADIT that can be expected during 2018 as compared to the level included in the Company s filed rate case, thereby increasing the cost of service to I&M s customers. The Company no longer expects its ADIT balance to increase in 2018. The effect of the loss of bonus depreciation can be reflected in the Company s cost of service by excluding the 2018 forecasted ADIT balances from the average ADIT balance used in the cost of capital calculation from the original filing. This would result in a decrease in the ADIT balance of $25.2 million 2 and an increase in the filed rate of return from 6.02% to 6.03%. This is shown on Attachment D, which is an updated Exhibit IM-29, Schedule D-1. The increase in the rate of return increases I&M s test year revenue deficiency by $0.136 million. This is shown on Attachment C. Excess Accumulated Deferred Income Taxes (ADIT) The reduction in federal income tax rate creates excess ADIT. There are two components of excess ADIT that are treated differently under the 2017 Tax Act normalized (also referred to as protected ) excess ADIT and non-normalized (also referred to as non-protected ) excess ADIT: o Normalized Excess ADIT The 2017 Tax Act requires that normalized excess ADIT be amortized over the remaining lives of the property as used in its regulated books of account which gave rise to the reserve for deferred taxes. See 2017 Tax Act Subtitle C, Part I, Sec. 13001(d)(3)(B). While the amortization period for the normalized excess ADIT will not be known with certainty for a number of months, a reasonable estimate using the method dictated by the 2017 Tax Act is 25 years. As shown on Attachment E the Company has estimated a Michigan jurisdictional normalized excess ADIT balance of $48.6 million. Amortized over 25 years, this results in an annual reduction of $1.9 million in test year tax expense on a jurisdictional basis. After application of the updated gross revenue conversion factor, the impact of normalized excess ADIT results in a $2.6 million reduction in I&M s test year revenue deficiency. 2 $25,263,351 = $1,255,608,713 - $1,280,872,064 5
o Non-Normalized Excess ADIT The non-normalized excess ADIT is to be amortized over a period to be approved by this Commission. The Company is proposing that the non-normalized excess ADIT be amortized over a ten year period in order to align these customer savings with the increased costs reflected in the revenue requirement to recover the undepreciated balance of Rockport Unit 1 over its remaining useful life (2028). If the Company s request to depreciate Rockport Unit 1 over a ten year period is denied, the amortization period of the non-normalized excess ADIT may need to be reassessed. As shown on Attachment E, the Company has estimated a Michigan jurisdictional nonnormalized excess ADIT balance of $28.7 million. Amortized over 10 years, this results in an annual reduction of $2.9 million in tax expense on a jurisdictional basis. After application of the updated gross revenue conversion factor, the impact of non-normalized excess ADIT results in a $3.9 million reduction in I&M s test year revenue deficiency. Taking the above elements together, the overall impact of the 2017 Tax Act is a reduction to I&M s test year revenue deficiency in Case No. U-18370 of approximately $15.7 million. If the Commission were to support this approach, it could order the Company to incorporate these specific adjustments to a compliance cost of service study reflecting all of the rulings of the Commission in that case. In addition, there are several points that the Commission should bear in mind when incorporating the effect of the 2017 Tax Act in I&M s pending base case: Estimates Are Preliminary but Reasonable for Ratemaking The Company s excess ADIT balances are based upon December 31, 2017 unaudited data and preliminary allocation factors. Additionally, the amortization period of the normalized excess ADIT balance has been estimated at 25 years. The use of these estimates to set rates in Case No. U-18370 is reasonable if the accounting treatment described below is also authorized. Accounting Treatment To address the use of unaudited excess ADIT balances, preliminary allocation factors, and estimated amortization period for normalized excess ADIT, the following accounting treatment is necessary. To the extent that the actual annual amortization differs from the estimated amount, the amortization of the nonnormalized excess ADIT will be increased or decreased to ensure that the total amortization of normalized and non-normalized excess ADIT is equal to $4.8 million. This accounting treatment is necessary to ensure I&M remains in compliance with tax normalization requirements, therefore avoiding a tax normalization violation. Gross-Up As noted above, the revenue effect of excess ADIT amortizations is grossed up for taxes in the cost of service study. 6
Effect of Tax Reform on Transmission Costs The impact of the 2017 Tax Act on I&M s transmission costs will flow through I&M s share of PJM Open Access Transmission Tariff (OATT) costs and thus is not included in the excess ADIT estimates provided here. As tax reform impacts are realized in I&M s OATT costs, they will be flowed through to customers through I&M s Power Supply Cost Recovery (PSCR) Rider. In sum, I&M proposes that the Commission s order in Case No. U-18370 recognize, as it did in Case Nos. U-3110 and U-3179, that the benefits of lower tax expense be flowed through to customers as reflected in rate schedules finally determined in that case. In response to the Commission s final determination of a revenue requirement based on a 2018 test year in Case No. U-18370, I&M can make a compliance filing of proposed rates reflecting the lower tax expenses. This approach is based on precedent and is administratively expedient given current circumstances. Further, this approach allows for I&M to accurately calculate the rate impacts of the tax law change and ensure that the impacts are appropriately reflected in the allocation of costs and design of tariff rates. Once the final revenue requirement is determined in U-18370, the impact can be calculated. III. I&M is complying with the Commission s order to establish a regulatory liability. Although I&M contends that it would be inappropriate to reflect the impact of the 2017 Tax Act in I&M s rates before new base rates go into effect in Case No. U-18370, I&M wishes to be clear that it is complying with the Commission s December 27, 2017 Order directing all utilities to establish a regulatory liability for all impacts resulting from the [2017 Tax Act]. Specifically, as of December 31, 2017, I&M recorded a $575 million total Company estimated regulatory liability for excess ADIT, consisting of $379 million of estimated normalized excess ADIT and $197 million of estimated non-normalized excess ADIT. These values are reasonable estimates, but final values will not be known until later in 2018 when I&M completes its 2017 federal tax return. Starting in January 2018, I&M will begin amortizing the 7
normalized excess ADIT created by the 2017 Tax Act over the remaining lives of the property as used in its regulated books of account which gave rise to the reserve for deferred taxes as required by statute. This amortization of the normalized excess ADIT will be deferred as a regulatory liability until further order of this Commission. The non-normalized excess ADIT created by the 2017 Tax Act will remain deferred as a regulatory liability until an amortization period is approved the Commission. Also beginning in 2018, I&M will record a regulatory liability for the difference between federal income tax expense calculated at 35 percent and federal income tax expense calculated at 21 percent. I&M will record this regulatory liability for each month once earnings for that month are known. For example, I&M will record the first such regulatory liability i.e., the regulatory liability for reduced January tax expense sometime in February or March once January earnings are known. I&M will continue to record a regulatory liability until base rates are changed that reflect a 21% federal income tax rate. The regulatory liability will be deferred until further order of this Commission. As described above, the appropriate method to flow the benefits of the 2017 Tax Act to I&M s customers is to incorporate those benefits in I&M s pending base rate proceeding, Case No. U-18370. It would be inappropriate to reflect the impact of the 2017 Tax Act in I&M s rates before new base rates go into effect. Therefore, once the Commission establishes new base rates in Case No. U-18370 incorporating the impact of the 2017 Tax Act, the Commission should order that I&M is no longer subject to the regulatory accounting treatment required by the Commission s December 27, 2017 Order in this case. 8
IV. Conclusion In accordance with the Commission s December 27, 2017 Order in this case, I&M has (1) applied regulatory accounting treatment, (2) provided an estimate of the customer impacts of the 2017 Tax Act, and (3) recommended a timely, balanced and reasonable approach for flowing through rates to reflect the tax law changes. Specifically, when setting I&M s new base rates in Case No. U-18370, the Commission should incorporate the impact of the 2017 Tax Act as described above, and the Commission should order that I&M is no longer subject to the regulatory accounting treatment required by the Commission s December 27, 2017 Order in this case. Respectfully submitted, INDIANA MICHIGAN POWER COMPANY Dated: January 19, 2018 By: Richard J. Aaron (P35605) Jason Hanselman (P61813) DYKEMA GOSSETT PLLC 201 Townsend, Suite 900 Lansing, MI 48933 (517) 374-9100 4849-1368-7386.1 111253\000001 9
INDIANA MICHIGAN POWER COMPANY Calculation of Changes in Income Taxes Related to Change in Federal Income Tax Rate from 35% to 21% Test Year Ended December 31, 2018 MICHIGAN JURISDICTION Indiana Michigan Power Company Case No. U-18494 Attachment A Line Amount in Tax Effect as Tax Effect if Difference If Total No. Column A Rebuttal Exhibit Filed @ 35% Rate was @ 21% Rate was @ 21% Tax Expense 1 Total Michigan Jurisdictional Federal Income Tax Expense $ 845,605 as updated for rebuttal exhibit in October 2017 2 Michigan Jurisdictional Pre-Tax Book Income Before FIT $ 5,571,973 $ 1,950,191 $ 1,170,114 $ (780,076) (Including the calculation for interest synchronization) 3 Michigan Jurisdictional Flow-Through & Permanent Items $ 330,677 $ 115,737 $ 69,442 $ (46,295) 4 Other Specific Federal Income Tax Items (Tax Feedback of $ (156,045) $ (156,045) $ (93,627) $ 62,418 Property-Related Basis Differences Embedded in Flow-through depreciation) - Michigan Jurisdictional 5 Total Reductions to Michigan Jurisdictional Federal Income $ 1,909,883 $ 1,145,930 $ (763,953) $ (763,953) Tax Expense as a result in applying a federal income tax rate of 21% instead of 35% to the income tax expense components as initially filed 6 Total Michigan Jurisdictional Federal Income Tax Expense $ 81,652 after applying a federal income tax rate of 21% instead of 35% to the federal income tax expense components as initially filed 7 Estimated revenue requirement impact based upon a gross revenue conversion factor of 1.3424 $ (1,025,531)
Indiana Michigan Power Company Case No. U-18494 Attachment B Schedule C2 Revises: Case No.: U-18370 INDIANA MICHIGAN POWER COMPANY Exhibit No.: IM-13 (MNK-1) Computation of Gross Revenue Conversion Factor Schedule No.: A-3, C2 For the Forecasted Test Year Ended December 31, 2018 Witness: M. N. Kelly Tax change Percentage of Percentage of Incremental Updated Incremental Tax Rates Gross Revenues Tax Rates Gross Revenues 1 Operating Revenues 100.00% 100.00% 2 Less: Uncollectible Accounts Expense 0.0000% 0.0000% 3 Income Before Income Taxes 100.00% 100.00% 4 Less: 5 Public Utility Assessment Fee (MPSC) 0.2240% 0.2240% 0.2240% 0.2240% 6 Base Subject to State Income Taxes 99.7760% 99.7760% 7 Less: State Income Taxes (Line 6 x Effective State Tax Rate) 5.4920% 5.4797% 5.4920% 5.4797% 8 Income Before Federal Income Taxes 94.2963% 94.2963% 9 Less: Federal Income Taxes (Line 8 x Federal Tax Rate) 35.00% 33.0037% 21.00% 19.8022% 10 Operating Income Percentage 61.2926% 74.4941% 11 Gross Revenue Conversion Factor (100% / Line 10) 1.6315 1.3424
Indiana Michigan Power Company Case No. U-18494 Attachment C Estimated Impact of Change in Gross Revenue Conversion Factor and ADIT ($000) (a) (b) (c) (d) (e) Filed Updated GRCF Updated ADIT Line Michigan Michigan Michigan No. Description Source Jurisdictional Jurisdictional Jurisdictional 1 2 Rate Base Exh. IM-3 $ 1,014,566 $ 1,014,566 $ 1,014,566 3 4 Adjusted Net Operating Income Exh. IM-11 32,202 32,202 32,202 5 6 Overall Rate of Return Line 4 / Line 2 3.17% 3.17% 3.17% 7 8 Rate of Return Exh. IM-28 6.02% 6.02% 6.03% 9 10 Income Requirement Line 2 x Line 8 61,077 61,077 61,178 11 12 Income Deficiency Line 10 - Line 4 28,875 28,875 28,976 13 14 Revenue Conversion Factor Exh. IM-13 1.6315 1.3424 1.3424 15 16 Subtotal Line 12 x Line 14 47,109 38,761 38,897 17 18 OATT Costs Exh. IM-43 4,616 4,616 4,616 19 20 Revenue Deficiency Line 16+Line 18 $ 51,725 $ 43,377 $ 43,513 21 22 Impact of Change in GRCF * $ (8,348) 23 24 Impact of Change in ADIT $ 136 * This is the estimated impact based upon the Company's filed case. Any changes included in the Commission's Order in this case will alter the impact of the change in GRCF and ADIT as a result of Tax Reform.
Indiana Michigan Power Company Case No. U-18494 Attachment D Revises: Michigan Public Service Commission Case No.: U-18370 INDIANA MICHIGAN POWER COMPANY Exhibit No.: IM-29 (FDM-1) Rate of Return Summary Schedule No: D-1 Projected 13-Month Period Ended 12/31/2018 Witness: Franz D. Messner (a) (b) (c) (d) (e) (f) (g) $ % % % % % 13-MONTH WITH WEIGHTED WEIGHTED Line AVERAGE PERMANENT RATE BASE COST COST COST No. CAPITAL ELEMENT BALANCE CAPITAL ADJUSTMENTS RATE PERMANENT RATE BASE 1 2 LONG TERM DEBT 2,453,538,462 51.42 40.47 5.15 2.65 2.08 3 SHORT TERM DEBT 103,471,731 2.17 1.71 2.29 0.05 0.04 4 PREFERRED STOCK 0 0.00 0.00 0.00 0 0.00 5 COMMON EQUITY 2,214,804,802 46.41 36.53 10.60 4.92 3.87 6 7 TOTAL WITHOUT TAXES 4,771,814,995 100.00 78.71 7.620 5.99 8 9 ACC. DEF. ITC (3%) 0 0.00 0.00 0.00 10 ACC. DEF. FIT 1,255,608,713 20.71 0.00 0.00 11 ACC. DEF. JDITC 34,861,134 0.58 7.62 0.04 12 13 TOTAL WITH TAXES 6,062,284,842 100.00 6.03 14 ACC. DEF. FIT adjusted to reflect average balance through December 31, 2017.
Indiana Michigan Power Company Case No. U-18494 Attachment E INDIANA MICHIGAN POWER COMPANY ESTIMATED EXCESS ADFIT AS OF DECEMBER 31, 2017 TOTAL FUNCTIONAL Total Functional Total Functional Total Functional Estimated Estimated Estimated Normalized Non-Normalized Total 120 Indiana & Michigan Power - Transmission * (80,787,859) (10,680,990) (91,468,849) 132 Indiana & Michigan Power - Generation (26,428,652) (67,065,678) (93,494,330) 170 Indiana & Michigan Power - Distribution (106,259,626) (35,847,731) (142,107,357) 190 Indiana & Michigan Power - Nuclear (165,104,348) (82,927,951) (248,032,299) (378,580,485) (196,522,350) (575,102,835) ALLOCATED MICHIGAN RETAIL Estimated Estimated Estimated Michigan MI Retail MI Retail MI Retail Allocation Factor Normalized Non-Normalized Total 132 Indiana & Michigan Power - Generation 0.1442059 (3,811,168) (9,671,266) (13,482,434) 170 Indiana & Michigan Power - Distribution 0.1976382 (21,000,961) (7,084,881) (28,085,842) 190 Indiana & Michigan Power - Nuclear 0.1442059 (23,809,021) (11,958,700) (35,767,721) (48,621,150) (28,714,847) (77,335,997) MICHIGAN RETAIL AMORTIZATION OF NORMALIZED OVER 25 YRS AND NON-NORMALIZED OVER 10 YEARS Amortized Amortized Amortized Estimated MI Retail Estimated MI Retail Estimated MI Retail Normalized Non-Normalized Total 132 Indiana & Michigan Power - Generation (152,447) (967,127) (1,119,574) 170 Indiana & Michigan Power - Distribution (840,038) (708,488) (1,548,526) 190 Indiana & Michigan Power - Nuclear (952,361) (1,195,870) (2,148,231) (1,944,846) (2,871,485) (4,816,331) Estimated revenue requirement impact based upon a gross revenue conversion factor of 1.3424 (6,465,443) * Excess ADIT associated with the transmission function will be reflected in the Company's OATT reveneus and expenses.