{ "id": 8519342, "name": "STATE OF NORTH CAROLINA ex rel. UTILITIES COMMISSION and the PUBLIC STAFF v. CAROLINA TELEPHONE AND TELEGRAPH COMPANY; STATE OF NORTH CAROLINA ex rel. UTILITIES COMMISSION and CAROLINA TELEPHONE AND TELEGRAPH COMPANY v. THE PUBLIC STAFF", "name_abbreviation": "State ex rel. Utilities Commission v. Carolina Telephone & Telegraph Co.", "decision_date": "1983-03-01", "docket_number": "No. 8210UC706", "first_page": "42", "last_page": "52", "citations": [ { "type": "official", "cite": "61 N.C. App. 42" } ], "court": { "name_abbreviation": "N.C. Ct. App.", "id": 14983, "name": "North Carolina Court of Appeals" }, "jurisdiction": { "id": 5, "name_long": "North Carolina", "name": "N.C." }, "cites_to": [ { "cite": "668 F. 2d 389", "category": "reporters:federal", "reporter": "F.2d", "case_ids": [ 458789 ], "year": 1981, "opinion_index": 0, "case_paths": [ "/f2d/668/0389-01" ] }, { "cite": "102 S.Ct. 2928", "category": "reporters:federal", "reporter": "S. Ct.", "year": 1982, "opinion_index": 0 }, { "cite": "668 F. 2d 1327", "category": "reporters:federal", "reporter": "F.2d", "case_ids": [ 459833, 3687957 ], "year": 1981, "opinion_index": 0, "case_paths": [ "/f2d/668/1327-01", "/us-app-dc/215/0295-01" ] }, { "cite": "653 F. 2d 681", "category": "reporters:federal", "reporter": "F.2d", "case_ids": [ 1466024, 3533952 ], "weight": 2, "year": 1981, "opinion_index": 0, "case_paths": [ "/f2d/653/0681-01", "/us-app-dc/209/0426-01" ] }, { "cite": "Treas. Reg. \u00a7 1.46-6", "category": "laws:admin_compilation", "reporter": "Treas. Reg.", "pin_cites": [ { "page": "(b)", "parenthetical": "i" } ], "opinion_index": 0 } ], "analysis": { "cardinality": 685, "char_count": 20683, "ocr_confidence": 0.81, "pagerank": { "raw": 7.067140959654889e-08, "percentile": 0.4257983766621143 }, "sha256": "8d98f23cc8c67a8ee027b1e558690140a3c57e32190dd7ac9bcafe2867a461d6", "simhash": "1:bd457616e1c7ba40", "word_count": 3360 }, "last_updated": "2023-07-14T21:13:54.976609+00:00", "provenance": { "date_added": "2019-08-29", "source": "Harvard", "batch": "2018" }, "casebody": { "judges": [ "Judges Arnold and Hill concur." ], "parties": [ "STATE OF NORTH CAROLINA ex rel. UTILITIES COMMISSION and the PUBLIC STAFF v. CAROLINA TELEPHONE AND TELEGRAPH COMPANY STATE OF NORTH CAROLINA ex rel. UTILITIES COMMISSION and CAROLINA TELEPHONE AND TELEGRAPH COMPANY v. THE PUBLIC STAFF" ], "opinions": [ { "text": "JOHNSON, Judge.\nDEFENDANT\u2019S APPEAL\nIn our recent decision in Utilities Commission and The New Telephone Co. v. Central Telephone Co., --- N.C. App. ---, --- S.E. 2d --- (No. 8210UC372, filed 18 January 1983), we held that the Commission had properly included the revenues and expenses from yellow page advertising in computing Central Telephone Company\u2019s gross revenues and expenses on three grounds: (1) that the furnishing of classified advertising by a telephone company is an essential part of the service it provides; (2) that there was an insufficient demonstration of competition for advertising revenue in the evidence presented; and (3) that this Court\u2019s judgment should not be substituted for the Commission\u2019s where the Commission\u2019s order is supported by a reasonable construction of the evidence. For the same reasons set forth in that opinion, we affirm in the present case the Commission\u2019s inclusion of revenues and expenses from yellow page advertising in the gross revenues and expenses of CT&T.\nINTERVENOR\u2019S APPEAL\nJDITC is an investment tax credit which was enacted by Congress in 1971 to stimulate employment by encouraging investment in new plants and equipment. I.R.C. \u00a7\u00a7 38 and 46. It allows a taxpayer to reduce its tax liability to the Internal Revenue Service by a percentage of the cost of eligible property purchased during the tax year. To preserve the benefit of the credit for public utilities, Section 46(f)(2) of the Internal Revenue Code restricts the amount of the benefit generated by JDITC which a regulatory agency may require a utility to pass to its ratepayers in the form of reduced rates. Consequently, although JDITC reduces a utility\u2019s actual tax liability to the Internal Revenue Service, it does not so reduce its tax liability for ratemaking purposes. As a result, JDITC generates capital for utilities. CT&T and the Public Staff disagreed as to the treatment of this capital for ratemaking purposes.\nIn determining the issue, the Commission found and concluded as follows:\nFindings of Fact\n10. That the reasonable level of test year intrastate operating revenue deductions after accounting, pro forma, end-of-period, after-period, and supplemental adjustments is $189,878,168 . . .\nEvidence and Conclusions For Finding of Fact No. 10\nAlthough the issues raised herein by the Public Staff concerning the proper rate-making treatment of JDITC may appear somewhat complex upon initial consideration, the Commission believes that, in reality, the issues are rather simple and straightforward. Simply stated, the Public Staff has treated JDITC as if this investment tax credit has been contributed by each component of the Company\u2019s capital structure in the same ratio as those components bear to the whole. Therefore, the methodology advocated herein by the Public Staff treats a portion of JDITC as if it were capital supplied by creditors, a portion as if it were capital supplied by preferred stockholders, and the remainder as if it were advanced by the common stockholders. On this basis, the amount of JDITC attributed to the creditors or debt holders multiplied by the embedded cost of debt results in an amount of hypothetical interest expense related to JDITC. This hypothetical interest expense is then used as a deduction in determining the Company\u2019s test year level of income tax expense for ratemaking purposes.\nIn contrast to the methodology advocated by the Public Staff, the Company\u2019s position is that all effects of JDITC should be excluded from the determination of interest expense to be used in developing the level of the Company income tax expense included in the cost of service. Hence, the methodology used by the Company attributes JDITC entirely to the common shareholders. This treatment is specifically mandated and prescribed by Section 1.46-6 of the Internal Revenue Code of Federal Regulations.\nThe Commission concludes that under Section 1.46-6 of the Internal Revenue Code, the Commission clearly may only treat JDITC as though it were capital contributed by the common shareholders. Therefore, in computing the Company\u2019s tax liability, no imputed interest expense may lawfully be calculated on any portion of JDITC. Rather, JDITC must be treated as capital supplied by common shareholders and must be given a return no less than the overall cost of capital determined to be appropriate by this Commission. In this regard, the Commission strongly believes that the treatment of JDITC proposed by the Company is fair and reasonable and the only treatment which is permissible under Section 1.46-6 of the Internal Revenue Code.\nThe issue on appeal, as stated by the Public Staff in its brief, \u201cis whether the Commission erred as a matter of law in concluding that Section 46(f)(2) of the Internal Revenue Code requires that all effects of JDITC should be excluded from the determination of interest expense.\u201d\nG.S. 62-94 sets forth the standard of judicial review of orders of the Utilities Commission and includes the following:\n(b) So far as necessary to the decision and where presented, the court shall decide all relevant questions of law, interpret constitutional and statutory provisions, and determine the meaning and applicability of the terms of any Commission action. The court . . . may reverse or modify the decision if the substantial rights of the appellants have been prejudiced because the Commission\u2019s findings, inferences, conclusions or decisions are:\n(4) Affected by other errors of law. . .\n(e) Upon any appeal, the rates fixed or any rule, regulation, finding, determination, or order made by the Commission under the provisions of this Chapter shall be prima facie just and reasonable.\nIn this appeal, we are called upon to interpret the applicable sections of the Internal Revenue Code to determine whether the Commission\u2019s order is affected by errors of law. We conclude that the order is not so affected.\nSection 46(f)(2) of Title 26 of the Internal Revenue Code provides that JDITC will be disallowed with regard to public utility property in the following two circumstances:\n(A) Cost of service reduction. \u2014 If the taxpayer\u2019s cost of service for ratemaking purposes or in its regulated books of account is reduced by more than a ratable portion of the credit allowable by section 38 (determined without regard to this subsection), or\n(B) Rate base reduction. \u2014 If the base to which the taxpayer\u2019s rate of return for ratemaking purposes is applied is reduced by reason of any portion of the credit allowable by section 38 (determined without regard to this subsection).\nThe term \u201cratable portion\u201d is explained in Section 46(f)(6):\nFor purposes of determining . . . ratable portions under paragraph (2)(A), the period of time used in computing depreciation expense for purposes of reflecting operating results in the taxpayer\u2019s regulated books of account shall be used.\nThe following example of \u201cratable portion\u201d appears in Section 1.46-6(g)(2) of the Treasury Regulations:\n[I]f cost of service is reduced annually by an amount computed by applying a composite annual percentage rate to the amount of the credit, cost of service is reduced by a ratable portion.\nThe Internal Revenue Service has published the following regulations implementing Section 46(f)(2):\n(2) Cost of service, (i) For purposes of this section, \u201ccost of service\u201d is the amount required by a taxpayer to provide regulated goods or services. Cost of service includes operating expenses . . . maintenance expenses, depreciation expenses, tax expenses, and interest expenses. . .\n(ii) In determining whether, or to what extent, a credit has been used to reduce cost of service, reference shall be made to any accounting treatment that affects cost of service. Examples of such treatment include reducing by all or a portion of the credit the amount of Federal income tax expense taken into account for ratemaking purposes and reducing the depreciable bases of property by all or a portion of the credit for ratemaking purposes.\n(3) Rate base, (i) For purposes of this section, \u201crate base\u201d is the monetary amount that is multiplied by a rate of return to determine the permitted return on investment.\n(ii) In determining whether, or to what extent, a credit has been used to reduce rate base, reference shall be made to any accounting treatment that affects rate base. In addition, in those cases in which the rate of return is based on the taxpayer\u2019s cost of capital, reference shall be made to any accounting treatment that affects the permitted return on investment by treating the credit in any way other than as though it were capital supplied by common shareholders to which a \u201ccost of capital\u201d rate is assigned that is not less than the taxpayer\u2019s overall cost of capital rate (determined without regard to the credit). What is the overall cost of capital rate depends upon the practice of the regulatory body. Thus, for example, an overall cost of capital rate may be a rate determined on the basis of an average, or weighted average, of the costs of capital provided by common shareholders, preferred shareholders, and creditors.\nTreas. Reg. \u00a7 1.46-6(b) (2) (i), (ii) and (3) (i), (ii) (1979).\nEssentially, Section 46(f)(2) and the regulation provide that a utility remains eligible for the credit as long as cost of service is reduced by no more than \u201ca ratable portion of the credit,\u201d and as long as no reduction is made in the rate base. The purpose of this scheme, as revealed by legislative history, is to permit the benefits of the credit to be shared by the consumers and the investors of the utility. H.R. Rep. No. 533, 92d Cong., 1st Sess., reprinted in U.S. Code Cong. & Ad. News 1825, 1839 (1971).\nPursuant to paragraph (A) of Section 46(f)(2), CT&T \u201cflows through\u201d directly to its customers an annual percentage of JDITC based upon the useful life of the property producing the credit and thereby reduces its tax expense, and thus its cost of service, by a ratable portion of the credit. This treatment of JDITC by CT&T is not at issue in the present case.\nPursuant to paragraph (B) of Section 46(f)(2), CT&T makes no reduction in its rate base on account of the credit and assigns the overall cost of capital rate to the capital generated by the credit.\nThe Public Staff advocates an additional adjustment due to the presence of JDITC. Assuming that, in the absence of JDITC, the capital otherwise supplied by JDITC would be contributed by all capital suppliers, including debt, in the same ratio as those suppliers exist in CT&T\u2019s capital structure, the Public Staff maintains that a hypothetical interest expense attributable to that portion of JDITC which would have been provided by debt, in the absence of JDITC, should be deducted from CT&T\u2019s income tax expense for ratemaking purposes, in addition to the ratable reduction in taxes already produced by amortization of the credit. The Public Staff asserts that this adjustment to income tax expense for ratemaking purposes is in accord with Section 46(f)(2) based upon the language in Treas. Reg. Section 1.46-6(b)(3)(ii) that JDITC be \u201cassigned a \u2018cost of capital\u2019 rate that is not less than the taxpayer\u2019s overall cost of capital rate (determined without regard to the credit).\u201d The Public Staff also maintains that its position has been upheld in three federal court decisions and is, therefore, the correct one. Finally, the Public Staff contends that the ratepayers are entitled to an additional benefit from the proposed imputed interest on JDITC because they are the source of the cost free capital provided by JDITC. We reject each of these arguments.\nThe Public Staff\u2019s interpretation of the pertinent regulation completely ignores the words which precede the phrase relied upon by the Public Staff. The regulation clearly states that, to determine whether an improper reduction in rate base has occurred, reference should be made to any accounting treatment which treats JDITC \u201cin any way other than as though it were capital supplied by common shareholders. . .\u201d The phrase relied upon by the Public Staff refers to the determination of the \u201coverall cost of capital rate\u201d which must be applied to JDITC under the regulation. As such, the phrase deals with the rate of return which the utility is entitled to receive on JDITC, but does not require that a utility\u2019s interest expense be calculated without regard to the credit (i.e., as though capital generated by JDITC were supplied by other sources of capital reflected in the utility\u2019s capital structure). Rather, the preceding phrase strongly indicates that in other instances, JDITC is to be treated as \u201ccapital supplied by common shareholders.\u201d The imputation of interest to a portion of JDITC as though supplied by creditors does not treat that portion of JDITC as though supplied by common shareholders and, in addition, reduces the cost of service by more than a \u201cratable portion\u201d of JDITC. For these reasons, the adjustment proposed by the Public Staff contravenes Section 46(f)(2) and the regulation thereunder.\nThe cases cited by the Public Staff do not persuade us to interpret Section 46(f)(2) otherwise because each of the cases completely ignores the clear requirement in the regulation to that Section that JDITC be treated as \u201ccapital supplied by common shareholders.\u201d\nIn the case of Public Service Company of New Mexico v. Federal Energy Regulatory Commission, 653 F. 2d 681 (D.C. Cir. 1981), the main issue before the court was whether capital provided by JDITC should receive the overall or common equity rate of return. The court concluded that, for purposes of determining the overall rate of return, JDITC could be treated as capital supplied by all capital suppliers in the same proportion as those suppliers existed in the capital structure of the utility, absent the credit. The court further held that excluding JDITC from the capital structure of the utility did not alter the debt/equity ratio such that the utility\u2019s interest expense deduction was increased, resulting in an additional, impermissible reduction in cost of service. No issue of imputing interest to JDITC was before the court.\nThat issue was before the court in New England Power Company v. Federal Energy Regulatory Commission, 668 F. 2d 1327 (D.C. Cir. 1981), cert. denied, --- U.S. ---, 102 S.Ct. 2928 (1982). However, in determining that the Federal Energy Regulatory Commission could require the utility to impute hypothetical interest to JDITC, the court relied on its earlier decision in Public Service Company of New Mexico, supra. Upon stating that, \u201c[t]he question in this section is whether FERC may properly treat tax credit funds in relation to interest deduction in the same way it treats tax credit funds in relation to rate of return determination,\u201d the court quoted that portion of its earlier opinion in which it had approved the Federal Energy Regulatory Commission\u2019s treatment of JDITC as capital supplied by all capital suppliers in a proportionate manner for purposes of determining the overall rate of return on capital As we have previously stated, the questions of how to treat JDITC for purposes of determining the overall rate of return on capital and for purposes of determining interest expense for ratemaking purposes are separate issues. The court in New England Power Company did not treat them as such and failed to analyze in any way the tax laws or the arguments supporting the impermissible nature of the adjustment.\nIn Union Electric Company v. Federal Energy Regulatory Commission, 668 F. 2d 389 (8th Cir. 1981), the third case cited by the Public Staff, the court again relied upon that portion of the regulation under Section 46(f)(2) which permits a ratemaking agency to assign the \u201coverall cost of capital rate (determined without regard to credit)\u201d to JDITC and ignored the remainder of the regulation. Reasoning that because the regulation allows JDITC to be \u201ctreated like other capital\u201d in one instance, the court concluded that the regulation should be interpreted to allow such treatment on the interest deduction issue as well. In our opinion, such reasoning contravenes the clear requirement of Section 46(f)(2)(A) that only a \u201cratable portion\u201d of JDITC be flowed through to customers and of Treas. Reg. Section 1.46-6(b)(3)(ii) that JDITC be treated as \u201ccapital supplied by common shareholders,\u201d and we decline to follow it.\nThe final argument advanced by the Public Staff in support of imputing hypothetical interest to JDITC is that ratepayers are entitled to the additional benefit that would enure to them as a result of imputing interest to a portion of JDITC because they supplied the capital produced by JDITC by paying rates computed without regard to the tax credit (other than the ratable portion flowed through to them). We disagree. Without regard to the credit, a utility owes a certain amount of taxes at the end of its tax year upon which its rates are based. The credit essentially forgives or returns to the utility a portion of the taxes owed by it if certain capital assets have been purchased during the tax year. As such, the capital generated by JDITC comes from the Treasury of the United States, not the ratepayers of the qualifying utility.\nBased upon the express language of Section 46(f)(2) and the regulation thereunder, as well as a consideration of the history and purpose of JDITC, that being primarily to benefit the utility so as to stimulate investment and thereby increase employment and additionally to share a ratable portion of the credit with ratepayers, we affirm the decision of the Commission to exclude all imputed interest expense related to JDITC in determining CT&T\u2019s income tax expense for ratemaking purposes.\nThe order of the Utilities Commission is\nAffirmed.\nJudges Arnold and Hill concur.", "type": "majority", "author": "JOHNSON, Judge." } ], "attorneys": [ "Paul L. Lassiter, for the North Carolina Utilities Commission \u2014 Public Staff, intervenor-appellee-appellant.", "Hunton & Williams, by Edward S. Finley, Jr., for defendant-appellant-appellee." ], "corrections": "", "head_matter": "STATE OF NORTH CAROLINA ex rel. UTILITIES COMMISSION and the PUBLIC STAFF v. CAROLINA TELEPHONE AND TELEGRAPH COMPANY STATE OF NORTH CAROLINA ex rel. UTILITIES COMMISSION and CAROLINA TELEPHONE AND TELEGRAPH COMPANY v. THE PUBLIC STAFF\nNo. 8210UC706\n(Filed 1 March 1983)\n1. Telecommunications \u00a7 1.2; Utilities Commission \u00a7 20\u2014 telephone rates \u2014 consideration of yellow page revenues and expenses\nThe Utilities Commission properly included the revenues and expenses associated with yellow page directory advertising in computing a telephone company\u2019s gross revenues and expenses for ratemaking purposes.\n2. Telecommunications \u00a7 1.2; Utilities Commission \u00a7 20\u2014 telephone rates \u2014 imputed interest expense from investment tax credit\nThe Utilities Commission properly excluded all imputed interest expense related to the Job Development Income Tax Credit in determining a telephone company\u2019s income tax expense for ratemaking purposes. I.R.C. \u00a7 46(f)(2).\nAppeal by Carolina Telephone and Telegraph Company and by the North Carolina Utilities Commission \u2014 Public Staff from an Order of the North Carolina Utilities Commission. Order entered 6 April 1982. Heard in the Court of Appeals 10 November 1982.\nCarolina Telephone and Telegraph Company (CT&T) filed an application to increase its rates and charges for telecommunications services in North Carolina on 27 August 1981. The Utilities Commission (Commission) declared the application to be a general rate case and ordered public hearings.\nFollowing public hearings on the matter, the Commission issued an order granting an annual increase in gross revenues of $15,896,783. In its order, the Commission included the expenses and revenues associated with and derived from yellow page directory advertising in the revenues and expenses of CT&T. CT&T had not included such revenues and expenses in its application on the grounds that yellow page advertising is not an integral part of telephone service and is subject to competition.\nIn its order, the Commission also excluded all imputed interest expense related to the Job Development Income Tax Credit (JDITC) in determining CT&T\u2019s income tax expense for ratemaking purposes. This treatment was the one proposed by CT&T in its application and presentation. The Public Staff had proposed that a hypothetical interest expense related to JDITC be used as a deduction in determining CT&T\u2019s income tax expense for ratemaking purposes. The treatment proposed by the Public Staff would have lowered the cost of service upon which rates are based by decreasing CT&T\u2019s tax expense for ratemaking purposes.\nCT&T has appealed to this Court on the yellow page issue, and the Public Staff has appealed on the JDITC issue.\nPaul L. Lassiter, for the North Carolina Utilities Commission \u2014 Public Staff, intervenor-appellee-appellant.\nHunton & Williams, by Edward S. Finley, Jr., for defendant-appellant-appellee." }, "file_name": "0042-01", "first_page_order": 74, "last_page_order": 84 }