BEFORE THE UTAH STATE TAX COMMISSION
Petitioner, ) ORDER
PROPERTY TAX DIVISION OF THE ) Appeal No. 93‑0983
STATE TAX COMMISSION, )
STATE OF UTAH, )
Respondent. ) Tax Type: Centrally Assessed
STATEMENT OF CASE
This is an appeal by XXXXX to the Utah State Tax Commission from the assessment by the Property Tax Division of 's Utah property as of XXXXX. The Utah counties in which 's property is located intervened in support of the Division. The intervening counties were XXXXX.
The Commission held a Formal Hearing on XXXXX. Chairman W. Val Oveson, Commissioner Roger O. Tew, Commissioner Joe B. Pacheco, Commissioner Alice Shearer, and Administrative Law Judge Gail S. Reich heard the matter for and on behalf of the Commission. Present and representing XXXXX were XXXXX, XXXXX and XXXXX, from the law firm XXXXX. Present and representing the Property Tax Division were XXXXX and XXXXX, Assistant Attorneys General. Present and representing the Counties was XXXXX from the law firm of XXXXX.
timely appealed the Division's valuation of its property for tax year XXXXX. On XXXXX, XXXXX and the Division entered into a Stipulation resolving all but one issue ‑‑ whether the net book value of XXXXX operating property should be mechanically reduced by the amount of XXXXX's Deferred Federal Income Taxes ("DFIT").
After "correcting certain reporting and calculation errors," the Division and XXXXX stipulated that all remaining valuation issues, other than the DFIT issue, could be resolved by reducing the Division's original assessment of $$$$$ to $$$$$. The Commission has not yet approved this Stipulation of Partial Settlement and Motion to Approve, nor issued an Order to Show cause why it should not be approved. The Commission's Prehearing Order dated XXXXX, limited the Formal Hearing to the DFIT issue.
The Stipulation further provided that if the DFIT adjustment were allowed, XXXXX's assessed value would be reduced to $$$$$. If no DFIT adjustment were allowed, XXXXX's assessed value would remain at $$$$$. During the hearing, the Division and XXXXX revised their Stipulation and agreed that XXXXX's assessed value should be corrected to $$$$$ if the DFIT adjustment were allowed.
The Stipulation was originally based upon a deduction for XXXXX's DFIT in the amount of $$$$$. During the hearing it became apparent that this amount improperly included accounts attributable to XXXXX's non‑operating property. XXXXX and the Division stipulated that the correct amount of DFIT to be used for purposes of the Stipulation was $$$$$. After correlation of the Division's corrected cost indicator with its stipulated income and stock and debt indicators, allocation of 14.55% of the resulting system value to the State of Utah, and deduction of XXXXX's separately assessed and exempt property, this correction resulted in an increase in the stipulated assessed value of $$$$$.
On two prior occasions the Commission has ordered the Division to reduce the net book value of XXXXX's property by the amount of XXXXX DFIT in accordance with Federal Energy Regulatory Commission ("FERC") practice. After an evidentiary hearing on 's consolidated appeals of its XXXXX and XXXXX assessed valuations, the Commission ordered the Division "to adjust its cost indicator of value to reflect a reduction for deferred federal income taxes . . . ." Northwest Pipeline Corp. v. Property Tax Div., Nos. 85‑0074 & 86‑0255 (Dec. 21, 1987) ("Northwest 1987"). In paragraph 4 of its Findings of Fact, the Commission concluded:
4. In the rate making process, FERC adjusts the net book value of ['s] property for deferred federal income taxes (DFIT) to arrive at an allowable rate base upon which  is allowed to earn a rate of return. An informed investor would not be willing to pay full cost as measured by net book value for ['s] operating system because that amount exceeds the value of the rate base upon which the investor would be allowed to earn. Therefore, the net book value should be reduced by the amount of the DFIT in accordance with FERC practice. (Emphasis added.)
For the XXXXX tax year, the Division followed the Commission's decision in Northwest 1987, and mechanically deducted the full amount of DFIT from XXXXX's net book value in its historical cost less depreciation ("HCLD") cost approach. The Division also allowed similar DFIT deductions to every other rate base/rate of return regulated utility for the XXXXX tax year.
Beginning in XXXXX, the Division decided it was no longer required to apply the Commission's Northwest 1987 decision, either to XXXXX property or to any other rate base regulated utility's property. The Division claimed Northwest 1987 required an adjustment for DFIT only in a "rate base" cost indicator, not in an HCLD cost indicator. The Division reached this interpretation following an "informal request for guidance" made to the Commission by its Director and Assistant Director in early XXXXX. Although the substance and nature of these communications were disputed, the Commission's subsequent written Order of Clarification dated XXXXX, states the Commission's understanding of its XXXXX decision. Northwest Pipeline Corp. v. Property Tax Division, Appeal Nos. 88‑1335, 89‑0897, 90‑1081, 91‑1160 and 92‑1377 (XXXXX) ("Northwest 1992"). This practice by the Division continued for the XXXXX, XXXXX, and XXXXX tax years and was challenged by XXXXX in timely appeals each year.
On XXXXX, the Commission conducted an Informal Settlement Conference on XXXXX's XXXXX through XXXXX property tax appeals. The Commission confirmed "that the DFIT issue had been addressed with respect to XXXXX in its XXXXX Decision. "The Commission stated that it did not see any reason to change its previous determination . . . that in determining the cost indicator of value, the net book value should be reduced by the amount of DFIT." Finally, "[t]he Commission indicated that in each of the tax years subsequent to the XXXXX Decision, the DFIT adjustment should have been mechanically applied to reduce the cost indicator in the same manner in which it was applied by the Commission in the XXXXX Decision and by the Division in its assessment of XXXXX for tax year XXXXX."
XXXXX, the Division and the Counties subsequently moved for a written order from the Commission clarifying its statements at the informal settlement conference. On XXXXX, the Commission, reaffirmed its previous oral statements as follows:
The DFIT adjustment should have been mechanically applied to reduce the Division's cost indicator in each of the captioned tax years [XXXXX] in the same manner in which it was applied by the Commission in the XXXXX Decision and by the Division in its assessment of XXXXX for tax year XXXXX."
Because Northwest 1992 was limited to the years XXXXX through XXXXX, the Division again decided to make no DFIT adjustment in its XXXXX assessment. XXXXX's timely appeal of the Division's XXXXX assessment is the matter currently before the Commission.
The parties stipulated that the record would also include portions of the records in two other recent proceedings relating to the DFIT issue: Mountain States Tel. & Tel. Co. V. Property Tax Div., Appeal No. 88‑1334; and XXXXX's XXXXX Petition for Rule making.
FINDINGS OF FACT
1. The subject property is the taxable, tangible, real and personal property owned or operated by XXXXX in Utah as of XXXXX.
2. The standard of value to be applied is "fair market value" ‑‑ the price "at which [the] property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the facts." (Utah Code Ann. '59‑2‑102(8).
3. Because XXXXX's Utah property is owned and operated as part of an integrated, seven‑state gas pipeline system, the fair market value of XXXXX's Utah property is best determined under the unit approach to value. Under the unit approach, the value of XXXXX's entire system is first determined as an integrated operating system. A portion of this system value is then allocated to the state of Utah.
4. The Division and XXXXX have stipulated that the allocated Utah value of XXXXX's property without an adjustment for DFIT is $$$$$. With an adjustment for DFIT, the stipulated value is $$$$$.
Rate Base Regulation.
5. As of XXXXX, XXXXX was a gas pipeline utility subject to traditional rate base/rate of return regulation at the federal level by FERC. Because of the interstate nature of XXXXX's pipeline operations, XXXXX was not subject to parallel regulation by state authorities.
6. As of XXXXX, the regulatory constraints imposed upon XXXXX by FERC were essentially unchanged from those considered by the Commission in Northwest 1987 and Northwest 1992 and were not expected to change in the foreseeable future.
7. Deferred Federal Income Taxes (DFIT) are created by differences in an accounting period when a tax liability is recognized by the utility using the straight‑line depreciation rates allowed for rate making purposes by the Federal Energy Regulatory Commission (FERC) and when the tax liability is recognized by the utility using accelerated depreciation rates allowed for income tax purposes by the Internal Revenue Service (the "IRS"). These book/tax timing differences produce the deferred income tax liabilities that are recorded and tracked in the DFIT account.
8. During the initial years of an asset's useful life, use of the accelerated IRS depreciation rates results in less income tax being due than would be payable if the straight‑line, regulatory depreciation rates were used. During the later years of the asset's life after all accelerated depreciation has been taken, this process reverses with more income tax becoming due than would have been payable under the regulatory, straight‑line depreciation rates. This DFIT account appears on the same (right hand) side of the balance sheet as the liabilities. It is similar to an accrued liability that may be canceled because the tax benefit will reverse after a few years.
9. FERC does not allow Petitioner to include DFIT in its rate base and DFIT must be deducted from its assets. Therefore, Petitioner is not allowed to earn a rate of return on funds represented by DFIT.
10. Because the ratepayers who would receive the benefit of the reduced taxes in the early years of the asset's life in the form of lower utility rates may not be the same ratepayers who will be required to pay the increased taxes in the later years of the asset's life in the form of higher utility rates, FERC requires Petitioner to "normalize" the amount of incomes taxes paid by the ratepayers of Petitioner. Normalization means that during the early part of an asset's life when accelerated depreciation is available, the ratepayers pay the rates that include taxes that will not be due until some future period. When the process reverses in the later years, ratepayers are not then required to pay rates which include the increased amount of taxes actually paid by Petitioner. The deferred taxes paid by the ratepayers to Petitioner because of these timing differences create the source of funds known as DFIT. Because Petitioner is constantly replacing its operating property, DFIT seems to always exist.
11. Similarly, under the applicable regulations of the Internal Revenue Service, Petitioner is not allowed to claim accelerated depreciation for federal income tax purposes unless FERC either deducts the full amount of this DFIT from rate base or treats it as interest‑free or "zero cost" capital in arriving at the total cost of capital used to determine the authorized rate of return on rate base for Petitioner.
12. The treatment of DFIT required by FERC is designed to ensure that all cash flow benefits attributable to DFIT timing differences benefit the ratepayers in the form of lower rates and that there is no net cash flow benefit to the investors of Petitioner.
13. The additional revenues for taxes paid to Petitioner by the ratepayers in the early years through "normalized" tax rates provide a source of additional capital for Petitioner. These funds become part of the common "pool of funds" available to the company for its general purposes.
14. Because the investors did not provide the additional source of capital represented by the DFIT reserves created through normalized rates for the company's future tax liability, FERC does not allow the utility to earn a return on these amounts for its investors. Instead, any value associated with the temporary use of this additional source of capital is required to be passed back to the customers in the form of lower rates. To the extent that rate regulation is effective, this treatment is designed to ensure that there is no net cash flow benefit to the investors from DFIT. However, FERC would find it imprudent for the company not to take advantage of accelerated depreciation by lowering the rates charged to its ratepayers.
15. In prior cases of this Petitioner, as discussed above, the Commission approved the position advocated by Petitioner in this proceeding, i.e., that DFIT should be deducted from the HCLD cost approach indicator of value.
16. Since the time of the earlier decision, two of the Commissioners who signed that decision are no longer members of the Commission, and the Commission is now equally divided as to whether DFIT should be deducted from the HCLD cost indicator of value.
17. The position of the Commissioners Tew and Pacheco is that the reduction in utility rates which results when regulatory agencies require the deduction of DFIT from rate base has effectively dedicated the DFIT portion of the property of to the public sector. Therefore, in the opinion of Commissioners Tew and Pacheco, if XXXXX cannot earn a return on that (DFIT) portion of its property, then XXXXX should not be required to pay property taxes on that (DFIT) portion of its property.
18. Because of the regulatory restrictions on earnings associated with DFIT, Commissioners Tew and Pacheco would require a deduction for DFIT to the extent that it reflects impaired earnings associated with regulation beyond its value as zero‑cost capital, although they acknowledge that the exact amount of DFIT attributable to impaired earnings is not ascertainable from the information presented in this case.
19. Commissioners Tew and Pacheco believe that DFIT is similar to government imposed rent controls where a governmental agency has limited the earning potential of a property. These limited earnings by way of governmental mandate have effectively taken a portion of the bundle of rights of the property and assigned that portion of the rights to the public. Therefore, Commissioners Tew and Pacheco believe that Petitioner should not be required to pay taxes on property that is owned by the Public and is not owned by the company.
20. Commissioners Tew and Pacheco are further of the opinion that the regulatory earnings limitations imposed by regulatory agencies because of DFIT are a legitimate form of economic obsolescence. They therefore believe that it may be preferable for the impact of DFIT and other regulatory limitations to be reflected in an economic obsolescence adjustment to the HCLD cost approach indicator of value.
21. Commissioners Tew and Pacheco base their opinion on the fact that virtually all appraisal texts and theory recognize the concept of adjusting for economic obsolescence, and they therefore believe that such an economic obsolescence adjustment is required.
22. Because of the absence of any studies by the Property Tax Division to account for any economic obsolescence, including regulatory impacts, Commissioners Tew and Pacheco feel that they are left with the only position available to them to account for the economic obsolescence caused by DFIT being to support the deduction for DFIT in the HCLD cost approach indicator of value.
23. The position of Commissioners Oveson and Shearer is that the "value" which is associated with the funds which are booked by the utility as DFIT has been effectively transferred to the utility's ratepayers in the form of lower utility rates. If the value of income producing property is determined by the future income to be produced by the property, then a portion of the value of the property of resides with the utility and will be returned to the utility in the form of future income but another portion of the value of the property resides with the ratepayers and will be returned to the ratepayers in the form of lower utility rates to those ratepayers. Commissioners Oveson and Shearer further believe that to determine the total value of the fee simple interest of the property, the portion of the total value belonging to XXXXX must be added to the portion of the total value belonging to the ratepayers. The Utah Constitution and the statutes of the state require that "All tangible taxable property shall be assessed and taxed at a uniform and equal rate on the basis of its fair market value...."(Utah Code Ann. '59‑2‑103(1).) If DFIT is deducted from the HCLD cost approach value, then in the opinion of Commissioners Oveson and Shearer, the property is being taxed at less than its fair market value. Commissioners Oveson and Shearer would determine that DFIT should not be deducted from the HCLD cost approach indicator of value.
24. Commissioners Oveson and Shearer draw support for their position from the Appraisal Handbook on Valuation of Utility & Railroad Property published in XXXXX by the XXXXX (XXXXX), Committee on Centrally Assessed Property. At page 26 of that handbook it states:
When DFIT are being generated, the amount of federal income tax not being paid results in increased cash flow because the PUC‑allowed expenses include allowance for federal income taxes using straight‑line depreciation instead of the taxes actually paid. This cash flow can be used for any purpose, including acquisition of revenue‑producing property. Although utilities do not track the exact source of equity funds for property acquisition, there is no argument that substantial construction and other property acquisitions are made possible with DFIT.
PUC's deduct accumulated DFIT from rate base so that the utility customers will not have to pay the utility a profit on investments that were acquired with DFIT. The logic here is that a utility should not be able to recover a cost from its ratepayers that it never incurred. The HCLD indicator, however, should not be reduced by DFIT reserve because the property acquired with DFIT exists, is required for the operation and is producing revenue. 2/ A utility's inability to earn an accounting "return on" investment acquired with DFIT is offset by its ability to collect revenue for a tax it does not owe. The regulatory practice of deducting DFIT from HCLD does not impair economic earnings. Management would not willingly exercise an income tax alternative that knowingly reduces the value of its firm. Furthermore, the DFIT relates to the present owner's income tax situation, which may not affect the potential for earnings in the hands of a purchaser of the assets.
25. Commissioners Oveson and Shearer would adopt the position of WSATA as set forth above in the Appraisal Handbook.
26. Commissioners Tew and Pacheco would not adopt the position of WSATA as set forth above in the Appraisal Handbook, because they believe it does not give proper recognition to economic obsolescence which has occurred by not being able to earn a return on the investment represented by DFIT.
27. Rule R861‑1A‑5.E, Utah Administrative Code provides in part:
If the Commission vote results in a tie vote on any matter, the position of the petitioning taxpayer, will be deemed to have prevailed, and the Commission will publish the decision."
28. In view of the equal division of the Commission on the issue of the deductibility of DFIT, the position of the taxpayer prevails. The lack of a majority position on the deductibility of DFIT will leave intact the prior decision of the Commission as set forth in Northwest Pipeline Corp. V. Property Tax Division that DFIT should be deducted from the HCLD cost approach indicator of value. That will also result in the Commission determining the value of the property of Petitioner, as of XXXXX, for Utah, to be $$$$$ as stipulated to by the parties.
DECISION AND ORDER
Based upon the foregoing, the Tax Commission finds that the fair market value of the property of Petitioner allocable to Utah as of January 1, XXXXX is $$$$$. The Property Tax Division is authorized to allocate that value among the various counties. The counties are allowed 30 days from the date of this Decision to show good cause why this stipulated amended value should not be accepted based upon reasons other than the reduction of the HCLD cost indicator of value by the amount of DFIT. If no such cause is shown by the Counties, the County Auditors of each of such counties is hereby ordered to adjust its records in accordance with this decision. It is so ordered.
DATED this 11 day of April, 1996.
BY ORDER OF THE UTAH STATE TAX COMMISSION.
W. Val Oveson Roger O. Tew
Joe B. Pacheco Alice Shearer
NOTICE: You have twenty (20) days after the date of a Final Order to file a Request for Reconsideration with the Commission. If you do not file a Request for Reconsideration with the Commission, you have thirty (30) days after the date of a Final Order to file a.) a Petition for Judicial Review in the Supreme Court, or b.) a Petition for Judicial Review by trial de novo in District Court. (Utah Administrative Rule R861‑1A‑5(P) and Utah Code Ann. ''59‑1-601(1), 63‑46b‑13 et. seq.)
2/ See Pacific Power and Light Company v. Department of Revenue, State of Oregon (OTC 2192; SC 34075) May, 1989 where the Supreme Court found that the Tax Court erred in deducting the DFIT reserve from the HCLD as a measure of obsolescence.