BROOM, Presiding Justice, for the Court:
Next argument of PSC is that the lower court:
[E]rred in finding that it was error for the Commission to ignore the actual maintenance expense as shown by the Company for 1980, and to base its finding on the testimony of Dr. Wilson based upon the 1976 to 1979 trend.
In MPC's projections for the 1981 "test year", MPC projected $23,256,000 maintenance expense in its pro forma figures. Maintenance expense figures are a vital determination in any rate-making procedure because it is one of the accounts which is subtracted from gross revenues in order to obtain net operating income figures. When a utility establishes through evidence and testimony a requirement for a certain amount of net operating income, maintenance expense is one element which must be computed into the net operating income figure in order to determine the utility's gross revenue requirements (and hence the rates its customers will be charged).
As required by the PSC's rules of practice and procedure, Rule 7(a)(6).
PSC's order disallowed $3,177,000 of MPC's projected maintenance expense figures, reducing the amount from $23,256,000 to approximately $20,079,000. PSC found that (1) MPC's projected figures for 1981 maintenance expenses included some "nonannual" elements which PSC held were not properly includable in the test year figures; (2) PSC found that the test year figures should reflect "normalized" projections for maintenance expenses; (3) PSC found no evidence of adequate attention by MPC to labor productivity improvements; (4) PSC held that the proper calculation of maintenance expenses in a projected test year utilized for rate-making purposes was the "historically trended figures" calculation procedure used by the PSC staff in conjunction with recognition of inflationary impact upon such historical trends.
MPC appealed on this point to the chancery court which decreed that PSC's disallowance of $3,177,000 from MPC's test year maintenance projections was error. The chancellor noted that the basis of the staff witness's maintenance expense projection procedure was a historical "track" record of MPC's past maintenance expenses. Also, the chancellor noted that the staff witness admitted that the years which had been utilized in arriving at PSC's recommendations were 1976 through 1979. The chancellor held that the staff witness's failure to utilize actual maintenance expenses for 1980, which had been available to the staff witness, invalidated the witness's projection. Therefore, the chancellor reinstated MPC's original 1981 test-year maintenance expense projection figure of $23,256,000 and PSC appeals therefrom.
MPC witnesses testified in support of its maintenance expense projections. They testified that the pro forma year projection did represent a 36% increase over the 1979 maintenance expense projection but observed that this 36% increase was over a 2-year period (which in actuality represented an 18% growth rate per year). In years past this percentage of an increase in year-to-year maintenance expenses was not unusual. In 1978 the increase in maintenance expense was at a rate of 18%. MPC's witnesses also testified as to the distinction between "normal" maintenance and "annual" maintenance, and indicated that a great deal of "heavy" maintenance occurred on a regular basis, but not upon an annual basis. Therefore, they testified that such factors must be included in any maintenance expense projections.
PSC staff witnesses disagreed with the maintenance expenses proposed by MPC, and introduced testimony and exhibits which they relied on in adjusting MPC's proposed maintenance expense projection downward by $3,177,000. They testified that the adjustment to MPC's requirements projections was based upon a level of expenses and the growth of those expenses for years prior to 1979, but admitted on cross-examination that the figures used in arriving at the $3,177,000 adjustment did not include the actual 1980 maintenance expense figures.
It is important to note that in spite of the fact that the staff's own methodology has its basis in actual, historical maintenance expense figures, they did not employ the actual figures for the most recent year in arriving at the recommended adjustments to MPC's maintenance expense projections.
In rebuttal to staff witnesses' testimony, MPC's witness testified that it was improper and irresponsible to base maintenance expense projection exclusively upon the use of a mathematical formula without consideration for MPC's actual budgeting and expense forecasting procedures. He likewise testified as to the inaccuracy of the results of staff witnesses' "historically trended figures", when such method left out the actual figures for the most recent historical year. Using the staff's own technique for forecasting maintenance expense, the inclusion of the actual expense figures for 1980 results in a projection which is higher than the amount MPC actually requested.
We find that, based purely upon the testimony presented on the question of MPC's proposed maintenance expenses the PSC was in error. The selection of the appropriate method for accurately projecting maintenance figures is generally within PSC's sound discretion. See State of Mississippi, et al. v. Mississippi Public Service Commission, supra. However, it was clearly error and arbitrary for PSC to base its adjustment to the Company's maintenance expense projection upon the utilization of a methodology which, according to its own admission, did not use the actual figures for the most recent year. We reverse the chancellor's reinstatement of MPC's original request and, on remand, the historically trended analysis shall employ the most current data available.
PSC's next assignment of error is:
The Chancery Court erred in disallowing the Commission's reduction of the Company's requested cash working capital from $25,714,000 to $523,000, a reduction of $25,191,000.
A reasonably succinct definition of "working capital" was given by MPC witness Mr. H.A. Gower (partner in the independent accounting firm of Arthur Andersen):
A. "Working capital" as it is or should be used in utility rate making means the economic input of capital, in excess of the amount used to finance net utility plant, which is necessary to cover the lag from the time when costs of service are incurred until the time payment is received through rates charged to customers. . . .
Q. Is your definition of utility working capital the same as cash working capital?
A. No, it is not. It is true that on occasion the working capital allowance is referred to as cash working capital. However, this limited concept fails to consider that an investment is required in capital cost items which may not contemporaneously result in cash transactions.
Since cash working capital, as well as other working capital, constitutes a portion of investor-contributed capital, it is properly included in the rate base for the purpose of determining the return on investor capital. Therefore, it follows that any reduction in the cash working capital allowance results in a corresponding reduction in a utility's rate base which in turn reduces the gross revenue and ultimately the investors' return on capital.
In submitting proposed figures to PSC as a part of the instant rate proceeding, MPC proposed an allowance of $25,714,000 as the cash working capital component of the rate base. This figure was based upon the "45-day formula" which had been previously employed by MPC in determining the cash working capital component in all previous rate-making proceedings.
A somewhat more detailed description of the derivation and application of the "45-day formula" is presented infra.
In its findings and order, PSC found that:
Investors are entitled to earn a return not only on the fixed plant and property of the utility, but also on reasonable working capital which is investor-supplied funds needed by the utility to meet its day-to-day operating expenses. A utility must pay for certain expenses in its operations prior to recovering the full amount necessary to pay that expense in revenues from its customers.
After providing the definition of the basic rationale for the allowance of a cash working capital component in the rate base, PSC went on to describe how such a component was to be ascertained:
The amount of cash working capital needed for such expenses is determined by conducting a lead/lag study which computes the time intervals between: (1) the time that service is provided by the company and the time the company received payment for that service and, (2) the period for which various expenses are incurred by the company and the date that those expenses must be paid. These two intervals, the former of which is the payment lag and the latter of which is the expense lag are combined to reach a net interval. This interval is then multiplied
by the company's average daily expenses to determine the necessary working capital.
PSC found that MPC had based its cash working capital calculations upon the 45-day formula and that such an approach to the determination of the cash working capital component of the rate base was inappropriate. Further, PSC held that this determination had been reached on the basis of the staff witnesses' testimony.
After arriving at the above described conclusions, PSC made an extraordinarily curious finding of fact:
The Commission further finds that the staff's proposed lead/lag approach will produce a just and reasonable result for this Company in this case.
PSC found that MPC's use of the 45-day formula was based upon two erroneous assumptions: (1) that not all operations and maintenance expenses are paid on the exact date that service is rendered, and (2) not all customers pay utility bills exactly 45 days after service is rendered. PSC held that in view of these erroneous assumptions included in the traditional 45-day rule approach, a "lead/lag" study was the proper method for determining the cash working capital component of a rate base. In addition to the above described holdings, PSC's order also concurred with the staff's recommendation of taking into account the lag time in payment of deferred interest expense and deferred preferred stock dividends in offsetting the amount of cash working capital.
MPC appealed PSC's 98% reduction in their proposed cash working capital requirements. In reversing PSC's disallowance of 98% of MPC's request, the chancellor held that PSC's reduction had been based solely on the testimony of Mr. Albert Clark. The chancellor, noting that Clark did not do a "lead/lag" study of MPC's cash working capital requirements, held that since the actual figures supplied by Clark were based upon his prior experience in doing other lead/lag studies, it was incumbent upon Clark to provide (which Clark failed to produce) copies of those studies to MPC in order to substantiate his guesstimates. Further, the court held that since Clark had testified that a lead/lag study was the only authoritative method for determining the cash working capital component of a rate base, PSC improperly admitted Clark's testimony of a "phantom" lead/lag study. The chancellor very judiciously dealt with this issue and relied upon Mississippi Public Service Commission v. Mississippi Power Company, 366 So.2d 656 (Miss. 1979). In discussing the problem, the chancellor stated:
Note that in State of Mississippi v. Mississippi Public Service Commission, supra, a lead/lag study was actually performed.
In the case of
Miss. Public Service Comm. vs. Miss. Power Co., 366 So.2d 656, the Court said:
"Dr. Bicksler used printouts from the Center for Research for Security Prices, based in Chicago. These are referred to as `CRISPE tapes' and received treatment by us in
Mississippi Valley Gas, 1978, supra. Dr. Bicksler testified in that case, using CRISPE tapes. There, the company had moved for an order to direct Dr. Bicksler to `furnish the written material, documents, letters and data fed to the computer, and the questions asked and tasks assigned, to the computer, for the purpose of cross-examining Dr. Bicksler about the CRISPE tapes.' Later renewed, the motion was denied by the Commission. This Court there said as the chancellor had said, `Dr. Bicksler might have reached the right result, but in the present state of the record there is no way to tell.' Since Dr. Bicksler's testimony was largely based upon the unauthenticated tapes about which he testified, but did not produce,
the chancellor here correctly held that the Commission could not properly rely upon his testimony in this important matter, even though he gave other testimony unrelated to the tapes."
Inasmuch as the witness Clark testified (over objection) that he estimated the lags based on his experience and participating in preparation of lead/lag studies for other similar utilities followed by his statement that he had not given the Company this information, it was error for the Commission to admit the testimony or to rely upon it. His study was properly titled by the Company witness Grower as a "phantom" study.
MPC witnesses testified that the cash component of MPC's proposed rate base was determined by applying the fraction of 45/360ths (1/8th) of MPC's total annual operational and maintenance expenses. This fraction is determined on the basis of the assumption that there is an average time lag of 45 days (out of 360) between the time service is rendered to a customer and the time payment is received for such service. They further testified that this fraction was consistent with all prior MPC filings with PSC.
PSC's staff witnesses testified that the only proper way for determining a utility's cash working capital requirements was through the conducting of a detailed "lead/lag" study to determine the actual amount of lag time the utility was experiencing between the rendition of service and the actual receipt of revenues associated with such rendition of service, and recommended the use of a 25-day lag period for determining cash working capital. The staff witness testified that this recommendation was based upon "my participation in and awareness of lead/lag analyses prepared by associates and myself and several prepared by investor-owned electric utilities." Mr. Clark then testified that the prior lead/lag analyses were performed on utilities other than MPC.
With this admission, the staff witness discredited his entire subsequent testimony. A close reading of his description of the virtues of a lead/lag analysis approach to the determination of cash working capital reveals that the principal virtue of a lead/lag analysis is that it provides a precise determination of the working capital required for an individual company. By basing his lag-time figures upon other companies, the witness effectively destroyed the entire basis for doing a lead/lag analysis at all.
In rebuttal, MPC offered testimony that a lead/lag study was a complicated and expensive proposition and that the formula method was comparatively advantageous in that it was simple, easily applicable, and produced a generally accurate result. An expert for MPC testified that Mr. Clark's working capital recommendation had been based upon a "phantom study". He further testified that Mr. Clark had presumed various leads and lags based upon his experience with other companies, whereas a true lead/lag study by definition only had application to the specific company upon which it was performed.
Based solely upon the evidence adduced at the hearing before PSC, we find that the PSC's reduction in MPC's requested cash working capital requirements was error. There is no question that PSC has the authority to determine the method by which such cash working capital requirements shall be calculated. If PSC, in its expert opinion, feels that a lead/lag analysis should be performed in order to properly ascertain cash working capital requirements, such a requirement should be included as a part of its rules and regulations. In the instant case, not only does PSC's change from previous methods of determining the cash working capital requirement without notice to MPC constitute an arbitrary and capricious decision, the actual figures adopted by the Commission are not even derived from the lead/lag analysis which it so highly touts.
Upon remand, because of the peculiar nature of this feature of the cause (PSC's 98% reduction of cash working capital), further testimony on this issue may be presented by PSC's staff witnesses and by MPC, in which event such testimony shall be considered by PSC in making its decision as to cash working capital. Mississippi Public Service Commission v. Mississippi Power Co., 366 So.2d 656 (Miss. 1979); Mississippi Code Annotated § 77-3-67(4) (Supp. 1982).
PSC's next assignment of error is:
The chancery court erred in finding that it was error for the Commission (PSC) to eliminate from rate base the cost of construction work in progress (CWIP) with respect to the plant items which are not and will not be revenue producing.
MPC included in its balance sheet accounts the total of all work orders for construction work in progress (CWIP) and divided it into two components: Revenue producing — $9,550,000 Non-revenue producing — $8,804,000 The first of these represented those facilities being built to meet the increased needs of existing customers and was referred to as revenue producing. Allowance for funds used during construction (AFUDC) was computed on the amount allocated to component 1, but not to that allocated to component 2. This latter component was said to represent those projects which were non-revenue producing or non-expense reducing. An amount of $1,384,000 was said to be the total allowance for funds used during construction (AFUDC) of the revenue producing facilities and was treated as part of power company's operating income since it had use and control of the funds.
AFUDC represents interest on borrowed funds, dividends on preferred stock, and the imputed return on common stock.
PSC disallowed any CWIP being included in the rate base and eliminated AFUDC from operating income with the following language:
The primary reason CWIP should not be included in the company's rate base is that such investment is not used and useful in the rendition of electric service to rate payers. Especially where, as here, a projected test period is used, it is inappropriate to further reach beyond the end of the projected test year to include CWIP in the rate base.
PSC determined that the method proposed by MPC which would include CWIP in the rate base, while relegating AFUDC to operating income, was not a "special fact" which might merit inclusion. It also found that it was not the general practice of this jurisdiction to include CWIP in the rate base.
MPC showed a total of $18,354,000 in expenditures for CWIP during the test year. It conceded that part of this should be capitalized, but that part should be included in the current rate base in question. This was because part of the CWIP would be revenue producing and earn a return once put into service. This category of CWIP constituted component 1. However, part of the CWIP expenditure was non-revenue producing. Once it was capitalized, it would be part of the rate base, but it would not be part of the rate base currently being considered for proposed rate increase. This would mean an $8,804,000 expenditure without an immediate means of gaining a return other than depreciation. MPC did not show any data which would "break-down" of what the non-revenue producing CWIP actually consisted.
The chancellor found error in PSC's denial of the inclusion of CWIP in the rate base as it applied to the non-revenue producing component. He found that MPC had not requested a rate increase based upon revenue producing items.
We hold that the chancellor's decision was error. We have previously held that the PSC could quite reasonably exclude CWIP for a utility's test year rate base since such construction, upon completion and being placed in service, was then capitalized and includable in the rate base. See State of Mississippi, et al. v. Mississippi Public Service Commission, supra; United Gas Corporation v. Mississippi Public Service Commission, 240 Miss. 405,
127 So.2d 404 (1961); Southern Bell Telephone and Telegraph Co. v. Mississippi Public Service Commission, 237 Miss. 157, 113 So.2d 622, 653 (1959). MPC failed to define "non-revenue producing" CWIP (other than by vague examples) and likewise failed to offer a compelling justification for distinguishing "non-revenue producing" CWIP from "revenue producing" CWIP. Therefore, the chancellor erred in overruling the PSC's decision to deny all CWIP from MPC's rate base. See Southern Bell, supra, at 238, 113 So.2d at 647.
PSC's next assignment of error is:
The Chancery Court erred in finding that the amortization of benefits of the accumulated deferred income taxes should be made over the useful life of the property giving rise to the funds contrary to the determination of the Commission.
The question is whether a portion of the federal tax reserve maintained by MPC should be repaid to rate payers on an accelerated basis or held in reserve by MPC and returned over a time period congruent with the useful life of the property which gave rise to the funds initially.
When property is depreciated on an accelerated basis, MPC credits the tax benefit received to a special account in order to insure its ability to pay taxes over the property's total useful life after the full value has been depreciated. This special account is kept when deferred income taxes are included as an expense item in the overall rate base of a utility and is referred to as "comprehensive inter-period tax allocation accounting." Meanwhile, MPC has use of the funds kept in reserve for this purpose.
See Federal Power Service, Rules and Regulations, Part 104, pages 2-183.
In 1978 the tax law was changed effective in 1979. The 48% rate on corporate income over $100,000 per year was lowered to 46%, resulting in an unexpected windfall to MPC. The deferred tax account had been "over-funded." All parties involved in this matter agree that the fund's surplus should inure to the benefit of the rate payers, but disagree on how it should be done.
PSC's primary witness on this matter, Dr. Wilson, recommended that the surplus in the deferred tax account be amortized and returned to the rate payers over a period not to exceed two years. He estimated the current amount of the surplus to be $1,984,000 and that amortization over two years would result in a refund of $3,827,000 in his best judgment. He noted that the immediate removal of the current surplus amount from the rate base would result in both state and federal tax savings sufficient to cover the amount of the refund.
He called this "full normalization".
Wilson then elaborated on the documented authority for his recommendation, citing rulings by the Public Service Commissions of West Virginia, Montana and New York. West Virginia had ordered an immediate refund of the surplus rather than the two-year amortization proposed by Wilson. Montana had adopted a conditional two-year amortization. Under this plan, the utility would have two years to consult the IRS for an opinion on the tax ramifications on making an immediate or accelerated refund rather than amortizing over the useful life of the property. Absent a ruling contrary to the proposed method, the refund of the surplus would be paid with interest.
MPC's primary concern in this matter was that the IRS could construe the proposed amortization as a form of depreciation recapture. Wilson countered this concern with a quote from the New York Public Service Commission:
When the federal corporate income tax rate was reduced from 48% to 46%, an excess of $41,842,000 the company's accumulated deferred income tax account was created. . . . Staff recommended that the excess be returned over a five-year period; the CPB recommended two years; the Attorney General recommended one year. . . .
The company contended in oral argument before us that it is nonetheless possible that the IRS may proscribe the treatment recommended by staff and the
Attorney General. In that event, the company is concerned its return of the excess over a short period of time will result in loss of its eligibility for accelerated depreciation income tax benefits. We recognize the possibility that a future adverse IRS ruling could be applied retroactively to revoke the company's tax benefit. For this to occur, however, the IRS would have to take the position that the existing statute, 167(e) of the Internal Revenue Code, required at all times whatever treatment is prescribed at that time by the IRS through its interpretative regulations. We believe that the risk of this occurring is so remote that it would be wrong to delay returning to consumers the excess accumulation solely on this basis. (State of New York Public Service Commission Opinion No. 79-22 issue November 9, 1979).
Nevertheless, MPC felt that any method of refunding the surplus other than over the useful life of the property giving rise to the fund would violate § 167( l) of the Internal Revenue Code.
§ 167 of the Internal Revenue Code deals with rules and regulations as to the methods of taking depreciation benefits on business property. § 167( l) applies specifically to public utilities.
PSC adopted Wilson's recommendation for a 2-year amortization without condition. It reasoned that the over-refunded amounts could be returned as soon as possible to the rate payers who provided the funds, thus rejecting MPC's argument on how the IRS might construe the refund and the contention that this method would result in a windfall to current customers. The chancery court reversed the PSC order, citing a previous ruling involving Mississippi Power Light Company in November of 1980, as follows:
While it is the desire of the Commission to carefully consider any reasonable or proper "flow-through" adjustment which may benefit the ratepayer, care must be given to adhere to present tax laws and regulations and the possible effect of any such adjustment on the tax reserves so accumulated.
The rebuttal testimony offered by the Company supports the position that to adopt the "flow-through" adjustment recommended by the staff witness could jeopardize the entire Company reserve accumulated for deferred income taxes. Further, such an adjustment has been denied in other jurisdictions and at this time, until the issue is finally settled, the Commission is unable to accept this recommendation.
After filing its appeal, the Power Company moved to submit new authority on this issue and presented the case of Kansas Power Light Company v. State Corporation Commission, 5 Kan. App. 2d 514, 620 P.2d 329 (Kan. App. 1980), which held that it was unreasonable for the Commission to require a five-year amortization when it could jeopardize the utility's entitlement to accelerated depreciation for tax purposes. It was determined that the excess deferred tax payment should be returned to Kansas rate payers over the life of the property giving rise to the funds initially.
The Kansas court cited Re New York Telephone Company, 32 PUR 4th 353 (N.Y. 1979), but was convinced by Kansas Power Light that loss of accelerated depreciation might occur and by the fact that no one could show that Kansas Power Light would not lose it. This opinion wholly ignores the fact that the IRS responded with a letter opinion in the New York case to the Telephone Company which stated that IRS regulations do not prescribe treatment of excess created in the deferred tax reserve when a corporate tax decrease takes place. The New York Commission held that the matter had been left to the states in view of IRS's response.
Neither Kansas nor New York control this issue, but the New York holding is better supported by reason.
The proper exercise of PSC's sound discretion permits differing treatment of similar issues in different utility cases. However, in the absence of a clearly enunciated factual basis for making such a distinction between utilities, set forth in their order, such different treatment clearly constitutes arbitrary and capricious action by the PSC. Nonetheless, on the issue of the proper treatment of the excess in the reserve account in question, we hold that, in the absence of a definitive ruling by the IRS to the contrary, MPC's subscribers are entitled to the return of this excess as a matter of law. The chancellor's decision on this point is hereby reversed and the PSC's order returning this amount to the rate payers over a two-year period is reinstated. State of Mississippi, et al. v. Mississippi Public Service Commission, supra.
PSC's next assignment of error is:
The Chancery Court erred in holding that it was error for the Commission to utilize a part of the test year based upon projections and another part based on actual figures as they become available.
This issue involves a discrepancy in the "net plant" figures as proposed by MPC and as subsequently adjusted in the PSC's order. "Net plant" is a figure constituting a major portion of a utility company's rate base and represents the value of the physical generation and transmission facilities, etc. expressed as follows: Gross Plant Value (generally at cost or book) (less) — Accumulated Depreciation = Net Plant Value (this amount included in rate base). In the calculation of the Net Plant figure utilized in MPC's test year figures, the value of the net plant which is includable in the rate base is determined by taking MPC's test year projections for the average first month net plant value and the average 12th month net plant value and averaging these two values in order to determine the average net plant value of the test year for the purpose of inclusion in the rate base. This figure, plus other allowances such as working capital, are combined to form the test year rate base. In the formulation of the test year projections for first month net plant value and 12th month net plant value, it is assumed that no major plant additions or retirements are included. This assumption utilized in the projection of these figures derives from the goal of having the test year figures represent a "normalized" typical year.
MPC's projected 1981 average net electric plant value was $506,788,000. In its order, PSC reduced this amount by $3,385,000 on the basis of the staff's calculations of average net plant which utilized actual beginning values (since by the time the hearings had reached this point in time, the actual figures had become available). PSC approved this adjusted figure, holding that "the staff is persuasive in explaining why that [MPC's] approach is less accurate than the alternative available here of using an actual beginning year figure."
MPC appealed this decision of PSC to the chancery court, which disallowed PSC's adjustment to the test year net plant figures, citing FERC opinion No. 44 issued June 28, 1979, in Public Service Company of Indiana, ER 76-149 and E-9537, and Indiana Municipal Electric Association v. Federal Energy Regulatory Commission, 629 F.2d 480 (7th Cir. 1980), where the procedure of "selective utilization" of actual figures in the place of test year projections was disallowed. The chancery court held that "it was error for the Commission to utilize a part of the test year based upon projections and another part based on actual figures as they become available."
A staff witness testified that the problem inherent in such a method of calculating net plant value existed as to the verifiability of the utility's test year projections. These projections could be verified to a certain extent through either a continuing update of the test year figures or by comparing the utility's forecast with actual data. He testified that the requirement of continuing updates of a utility's test year projection could prove to be an enormous burden upon a utility. Therefore, he concluded that the most efficient and effective method for checking MPC's test year figures was to compare their test year projection with actual data as it became available.
The staff recommended that the actual plant balances for the beginning of the test year period be utilized. Accordingly, they recommended a reduction in the net plant value component of the rate base by 3.385 million dollars.
MPC's comptroller testified that the use of actual plant balances by the staff constituted a "selective substitution" of actual data in an effort to provide a more accurate cost of service study. Nonetheless, he testified that this particular technique resulted in incorrect results. He testified that there were many components involved in rate-making, and that spot adjustments to the test year projection without corresponding adjustment to others distorted the impact of those figures as related to the whole. He also noted the fact that the FERC had rejected such selective substitution.
We hold that the chancellor's decision to disallow the $3,385,000 adjustment to the net plant value includable in the rate base should be reversed. It cannot be said that PSC's action in this aspect of the case was manifestly wrong in any respect or lacking of evidentiary support.
A utility's test year projections should bear as close a resemblance to actual future figures as modern economic forecasting procedures will allow. The accuracy of the test year must be established by the utility. State of Mississippi, et al. v. Mississippi Public Service Commission, supra. Since the actual rates will be determined with reference to such projections, it seems reasonable that the interests of accuracy are furthered through the use of the most recent and precise information available. This position has substantial support in the testimony of PSC's expert witness, and we therefore hold that the chancellor erred in reversing the PSC on this issue.
PSC's next assignment of error is:
The Chancery Court erred in disallowing the Commission's ruling that the ratepayers should receive the benefit of a rate base reduction equal to the average balance of the pre-1971 accumulated deferred investment tax credits which amount to $1,757,297, and holding that such action was a violation of equal protection and contrary to the evidence in this case.
Section 38 of the Internal Revenue Code [I.R.C. § 38 (1976)] states essentially that Congress shall from time to time select certain forms of investment for which businesses may receive tax credit. Since 1962, there have been several forms of investment tax credit enacted and repealed, according to congressional discretion and the need for stimulus and growth in selected areas of the economy. The Revenue Act of 1962 did not specify how this tax credit was to be treated for the purposes of rate-making by state and federal regulatory commissions, but in 1964 the Act was amended to expressly prohibit federal regulatory agencies from using the tax credit to reduce cost of service. Until the investment tax credit was terminated in 1969, state regulatory commissions were free to determine the appropriate rate-making treatment for income tax savings resulting from the use of investment tax credit. Re: Gas Co. of New Mexico, 35 PUR 4th 106 (N.M. 1980).
In 1971, the investment tax credits enacted emphasized employment, especially the hiring of disadvantaged individuals. Congress' intent was that public utilities be able to benefit from Job Development Investment Tax Credit, should they desire to do so. The purpose of this tax credit was to provide funds which could be used to train new workers hired by a company, thereby reducing unemployment and stimulating the economy. There is no question as to whether or not post-1971 tax credits should be eliminated from the rate base. PSC eliminated only pre-1971 tax credits from the rate base, and this the chancellor reversed. PSC held that pre-1971 investment tax credits were not subject to the Internal Revenue Act of 1971, and could be eliminated from a utility's rate base.
PSC's determination is supported by the often cited case of New England Telephone and Telegraph Company v. Public Utilities Commission, 390 A.2d 8 (Me. 1978), wherein the phone company, New England, argued that the public utilities commission erred when it reduced the rate base by an amount corresponding to the pre-1971 investment tax credits. The Court disagreed as follows:
New England raises a number of objections to the Commission's deduction of unamortized pre-1971 investment tax credits from its rate base. We find these objections unpersuasive.
New England argues that the Commission's actions of reducing its rate base prevents it from earning a fair rate of return on all of its property devoted to public service. However, as the Commission emphasizes, New England's investors are entitled to a return upon only that capital which has been supplied by the investors. Accordingly, New England is entitled to no return on capital supplied by consumers through their rate payments for a tax expense not actually paid to the federal government. We hold that this determination is properly within the discretion of the Commission and is entirely reasonable under the law and the facts of this case.
New England also argues that the Commission's decision is contrary to the policy of Congress in enacting the investment tax credit. The Commission agrees that federal tax law prohibits
federal regulatory agencies from deducting these credits generated since 1964 and denies post-1971 tax credits where such credits are deducted by a federal or state regulatory agency from rate base. However, federal law is silent concerning state regulatory action with respect to pre-1971 investment tax credits. Whatever may be the federal policy and expectations with respect to other than pre-1971 investment tax credits, it does not control the Commission's actions in this case. Congress has apparently left the treatment of pre-1971 investment tax credits to the individual states. Therefore, the Commission could properly exercise its discretion and deduct such tax credits from New England's rate base.
390 A.2d at 54.
This issue was raised in State of Mississippi, et al. v. Mississippi Public Service Commission, supra, and we remanded for a determination of whether pre-1971 credit can be included in the rate base. In the instant case, the PSC had made such a determination. We reverse the holding of the chancellor and reinstate PSC's order as it applied to this issue. PSC's order is supported by both sounder reasoning and the law.
PSC next argues:
The Chancery Court erred in disallowing the Commission's reduction of rate base by the average balances of the account for property insurance reserve, the account for injuries and damages reserves and the account for customer advances for construction and in ruling same to be a violation of equal protection.
MPC's test year projections for the rate base figure, the sum total of the amount of property upon which MPC is entitled to a fair and reasonable return, included the amounts contained in three "reserve" accounts. These reserve accounts were for property insurance, liability insurance, and customer advances for construction. The two insurance reserve accounts were maintained by MPC in lieu of buying insurance policies for property and for liability purposes. It's not completely clear from the testimony exactly what customer advances for construction were.
PSC disallowed these accounts, holding that they were not properly includable in the rate base:
Customer Contributed Capital
The staff proposed that the Company's rate base be reduced by the average balance of Account 261 (Property Insurance Reserve), Account 262 (Injuries and Damages Reserve), and Account 252 (Customer Advances for Construction). As was shown by the staff's witness, Mr. Clark, these operating reserves and customer
advances are customer contributed capital that the Company has use of until such time as the reserve accounts must be debited for a loss or the advances are refunded. Mr. Clark's testimony shows that the Company fails to deduct or exclude these amounts from its rate base. This is wrong since it represents funds paid in by the Company's customers and the Company should not earn on it.
MPC appealed this adjustment of the rate base to the chancery court which held that PSC's actions in excluding these accounts from the rate base was a "violation of equal protection":
In lieu of insurance MPCo maintains reserves to cover the cost of replacement of plant items which may be damaged by a storm and a reserve for amounts MPCo may be legally obligated to pay by way of damages to persons, injuries or property damage as a result of its operations. The testimony shows that the insurance premium for complete coverage for injuries or property damage would exceed the annual amounts listed as expenses which go into these reserve accounts. In the Mississippi Power Light Company order dated November 24, 1980, the Commission found that "customer deposits and advances are not actually cost free capital . . ." The Commission now some four months later treats the Company in a different manner than Mississippi Power Light Company, without explanation. Here, again, we have one set of rules for one electric utility and a different set for another. That is, in this Court's opinion, a violation of equal protection.
We hold that the chancellor erred in reversing PSC's decision to exclude the insurance reserves from the rate base. It appears upon a reading of the record that these insurance reserves, to which contributions were made on a regular basis by MPC, constituted an expense exactly like a traditional insurance expense would be incurred if MPC maintained policies of insurance on these respective categories. If MPC did indeed have an insurance policy, that policy would not be included in the rate base. Merely because MPC, from the perspective of a sound management decision, has elected one form of "insurance" over another, does not entitle MPC to include reserves in the rate base when MPC would not be entitled to include an insurance policy. Such an insurance policy represents an expense of doing business and is not investor-contributed capital so as to allow the utility a return.
We hold likewise on the question of the customer construction advances. No evidence is presented by MPC other than the testimony that PSC had decided differently in the Mississippi Power Light Company case.
We have traditionally held that, when supported by an evidentiary basis in the testimony, customer deposits are generally includable in the rate base because in many cases the interest on such deposits is charged as an expense to shareholders. See State of Mississippi, et al. v. Mississippi Public Service Commission, supra; Mississippi Public Service Commission v. Mississippi Power Company, 366 So.2d 656, 661 (Miss. 1979); Mississippi Public Service Commission v. Mississippi Valley Gas Company, 327 So.2d 296 (Miss. 1936).
MPC's only testimony in favor of the inclusion of such amounts in the rate base was that PSC had done so in an earlier case. State of Mississippi, et al. v. Mississippi Public Service Commission, supra. By failing to put on any other evidence, they in essence are asking us to declare such amounts includable in the rate base as a matter of law. We decline to so hold. In the instant case, PSC's staff testified that the nature of the customer construction advances was that of capital contributed by customers. In the absence of any evidence on the part of MPC as to why such a statement is incorrect, we hold that the chancellor was in error in overturning PSC's ruling that such advances were improperly included in the rate base.
PSC's next assignment of error is:
The Chancery Court erred in finding that the cost of capital and the allowed
rate of return established by the Commission was unsupported by the evidence and contrary to the overwhelming weight of the evidence.
One of the primary determinations that must be made in any rate proceeding before PSC is the determination of the rate of return that will be applied to the rate base. In concise (although not necessarily precise) terms, this is PSC's determination of the amount of profit which the investors in the utility will be allowed to receive on their capital contributions to the utility. The problem which arises is how to arrive at a fair determination of an appropriate rate of return to which an investor is entitled. Based upon Blue Field Waterworks v. PSC of West Virginia, 262 U.S. 679, 43 S.Ct. 675, 67 L.Ed. 1176 (1923), and Federal Power Commission v. Hope Natural Gas Company, 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944), this "fair rate of return" has been analyzed and calculated in terms of a "cost of capital" perspective. In other words, obtaining capital, just like obtaining any other commodity or service, entails a cost. This cost takes the form of interest payments and dividends to the utilities' investors.
This "cost" to the utility for the use of investors' capital takes three separate forms: (1) debt securities, such as bonds, debentures, mortgage instruments, etc., which have a fixed rate of return and fixed maturity date, (2) preferred stock, wherein the return is fixed but the investment endures in perpetuity, and (3) common equity (or common stock) where the duration of the investment is in perpetuity and the dividend or return is determined on the basis of earnings of the utility. In the first two of these types of investor capital, the "cost" is contractually determined and therefore such capital costs are susceptible of an immediate, precise valuation. On the other hand, the "cost" of common equity is a flexible quantity contingent upon the utility's earnings.
In determining the overall cost of capital for the purposes of ascertaining the rate of return a utility is allowed to earn upon the rate base, these three types of capital costs are weighted so as to properly reflect the overall capital structure of the utility, and this weighted average, or overall capital cost, is used in arriving at the rate of return to be allowed on the rate base.
In the instant case, MPC's requested cost of equity capital was 16.04%. This cost of equity capital when properly weighted and combined with long-term interest costs and preferred stock dividends resulted in a requested rate of return on the rate base of 10.595% overall (as allocated to the retail base).
PSC's order noted that the determination of the cost of capital was important in a rate proceeding for the purposes of determining a fair rate of return. PSC recognized that this cost figure was not susceptible of precise mathematical determination but rather involved the use of "reasoned judgment in consideration of the numerous factors". PSC's order continues:
The reasonableness or unreasonableness of public utility rates is not to be determined by any definite rule or legal formula, and is not measureable with any degree of exactness, but is a question of fact calling for the exercise of sound discretion, good sense, and a fair, enlightened, and independent judgment.
PSC held that two standards were to be employed in determining whether a utility was being allowed a fair rate of return:
The standards are:
First, the return must be commensurate with returns on investment in other business enterprises having corresponding risks and uncertainties. Second, the return must be sufficient to assure confidence in the financial integrity of the business enterprise so as to maintain its credit and enable it to attract capital.
PSC, after this extensive review of the standards to be applied and of the evidence actually presented, reduced the overall rate of return on the retail rate base to 9.76%.
The order discussed the testimony of MPC expert witness, Dr. Willard Carleton, and concluded that Dr. Carleton's testimony which had recommended a cost of equity capital at approximately 16% was not credible. This conclusion was based upon the finding that Dr. Carleton's calculations had been based upon certain invalid assumptions.
The order then discussed the testimony of a securities analyst, Mr. W.J. Honan, expert witness for MPC. While recognizing the importance of credit ratings to the ability of a company to obtain debt financing, PSC concluded that Mr. Honan's testimony basically consisted of what investors would prefer from a utility, rather than what they would require, with respect to the issuance of various types of capital securities:
In fact, it is this Commission's responsibility to determine the fair rate of return
required by investors on the common equity of the Company. We are not required to determine the rate which they would
prefer. We find that this approach may be useful for Mr. Honan's purposes in portfolio management. We have difficulty using the approach in the regulatory context.
PSC's order then turns to an examination of the testimony of staff witness, Dr. Wilson. The order approved the two methods of determining an appropriate cost of capital and overall rate of return by means of (1) the discounted cash flow analysis, and (2) an earned returns comparison to other electric utilities. PSC held that Dr. Wilson's application of these two techniques had resulted in a recommended range of return on equity capital between 13.5% and 14.5%. The inclusion of the appropriately weighted cost of equity capital within this range would result in an overall cost of capital between the range of 9.76% and 10.08%. PSC's order concluded with the holding that, as a result of various mismanagement and inefficiencies relating to the Plant Daniel transaction with Gulf Power Company, PSC was going to allow MPC the lowest return on equity capital, hence the lowest rate of return in both of Dr. Wilson's recommended ranges.
The highly technical testimony that was offered by both sides on the intricacies of the discounted cash flow method for calculating cost of common equity shows the importance of reliance upon PSC's expertise in these highly technical matters. As a result, we cannot say that the PSC's reliance upon Wilson's method of calculating the cost of common equity by his own particular DCF formula was inherently wrong, in the absence of other factors. Accordingly, we reverse the chancellor's decision.
MPC made the two following cross-assignments of error:
1. The chancery court erred in affirming the action of the Public Service Commission which reduced the rate base of the appellee/cross-appellant by $28,909,000 because of a disallowance of that sum in the fuel stock pile of appellee/cross-appellant.
2. The chancery court erred in affirming the action of the Commission in reducing revenue requirements of appellee/cross-appellant because of purported savings resulting from the filing of a consolidated income tax return of the Southern Company, parent of the appellee/cross-appellant, said reduction being $1,200,000.
The first cross-assignment of error decries the reduction of the amount allocated in MPC's fuel stock account in order to assure a reliable coal supply. In September of 1979, MPC claimed that this account would require $38,247,000 to cover the book cost of fuel on hand, freight expenses, rent, commissions, incidental taxes, and other related expenses. PSC reduced this to $30,764,321. Both parties had used a 90-day average coal requirement as the basis for their computations.
During the proceeding in question, MPC presented a request of $68,187,000 for its fuel stock account. Thirteen months had elapsed since MPC's last request for a rate increase, and the recommendation for this account had increased by 81%. This was due to the new basis for computation, the "60-day name plate" computation. Need for coal was to be projected based upon what it would require to remain at peak burning capacity for 60 days. The change in the method of projecting need was said to be a more accurate reflection of the Power Company's attempt to head off numerous contingencies, such as possible coal-related strikes, bad weather, low water in the navigable rivers which supplied transport for coal, etc. However, PSC's witness pointed out that increased coal stocks during the test-year occurred due to the provision of fuel stocks for the new facility (Unit 2) at the Power Company's Plant Daniel and that construction delays caused coal supplies to increase.
The chancellor agreed with the use of the 90-day average burn method of projection used by the PSC, noting that the increase granted, $9,514,000 was a 31% increase, and that it could not be said that this was not supported by the evidence. MPC has shown no compelling reason for their change of projection methods or anything which would firmly establish the need for increasing the fuel stock account by 81%. We affirm the chancellor's holding.
The second cross-assignment of error suggests that the chancellor erred when he allowed the PSC's determination on tax savings resulting from consolidated tax returns to stand. PSC had found that these savings should inure to the benefit of the ratepayers since they were customer-contributed, cost-free capital. The chancellor agreed, citing a similar holding by the Connecticut Public Utilities Commission. Re: Connecticut Natural Gas Corporation, 37 PUR 4th 287 (1980). The same rationale was adopted by the PSC in a prior rate-hike request by the Power Company. Re: Mississippi Power Company, 36 PUR 4th 342 (1980). In finding that tax savings resulting from consolidated returns should be returned to the ratepayers, the chancellor quoted the following language from the Connecticut case:
It is patently obvious that if the Company's cost of service is not reduced by the tax savings resulting from the filing of a consolidated federal income tax return, the ratepayers are providing an outright gift to the Company and to the Company's parent and ultimately to the stockholders of the parent.
We affirm the chancellor's decision on this cross-assignment of error.
Mississippi Legal Services Coalition also took part in the hearings before the PSC and filed the following assignment of error:
The decree of the lower court was in error in that it affirmed the holding of the Mississippi Public Service Commission in that it did not have substantial evidence upon which to make findings of the impact of the adopted rates on the ability of the consumer to purchase electric power from Mississippi Power Company, and was thus an error of law and a violation of the Equal Protection Clause of the United States Constitution.
The learned chancellor, citing holdings in Ohio, Idaho and Utah, concluded that PSC held correctly and there was no merit to the contention that a study should be conducted as to the impact on consumers before PSC can consider a rate increase. We affirm the chancellor's decision on this issue.
West Jefferson Power Light Co., PUR 1933d 164 (Ohio, 1933); Mountain States Telephone Co., 22 PUR 3d 490, 496 (Idaho, 1958); Telluride Power Co. v. Public Service Com'n of Utah, 8 F. Supp. 341 (D.Utah, 1934).
Our decision in this complicated and voluminous case has been reached after meticulous consideration of highly technical evidence and experts' opinions.
This cause is remanded to the Mississippi Public Service Commission for proceedings not inconsistent with this opinion, and pursuant to Mississippi Code Annotated § 77-3-33 (1972).
AFFIRMED IN PART, REVERSED IN PART, AND REMANDED.
AS TO PART I: PATTERSON, C.J., and ROY NOBLE LEE, BOWLING, and PRATHER, JJ., concur.
AS TO PART I: BROOM, P.J., and HAWKINS and ROBERTSON, JJ., dissent.
AS TO PART II: PATTERSON, C.J., and ROY NOBLE LEE, HAWKINS, DAN M. LEE, PRATHER and ROBERTSON, JJ., concur.
AS TO PART II: DAN M. LEE, J., specially concurs as to unnumbered assignments of error 1 and 2 only of Part II.
BOWLING, HAWKINS and DAN M. LEE, JJ., specially concur.
WALKER, P.J., not participating.