-6

groups. Specifically, regulatory consistency preserves the capital formation incentive provided by accelerated depreciation whenever it can potentially be accessed through the regulatory process. Thus, where a consolidated group includes both regulated and non-regulated operations, regulatory consistency precludes the regulatory extraction of the benefit of accelerated depreciation by reducing rates on account of affiliate losses. similarly precludes depreciation benefit extraction where the non-regulated and the regulated operations reside in the same corporate entity.

It

We believe that the imposition of a regulatory consistency requirement is and has historically been an appropriate method to carry out the purposes of the normalization rules. It also, not coincidentally, preserves the effectiveness of a number of other important tax incentives in the context of regulation. Statutory incentives for low income housing, oil and gas exploration and development, alternative fuels, research and development and mineral depletion are a few of the tax incentives which regulatory consistency secures.

THE PREVALENCE OF CONSISTENCY

The theoretical basis for regulatory inconsistency is the "actual taxes paid" doctrine. Advocates of this theory hold that inconsistent adjustments are necessary to ensure that ratepayers are not charged more than the actual level of tax paid by the utility. The inquiry under this approach is "What portion of the whole tax liability should get allocated to the regulated operation?" It is a mechanical approach that does not seek to establish any relationship between the utility operation and the tax. The inquiry where there is regulatory consistency is "What amount of tax is caused by the regulated operation?" There is a not-so-subtle difference between the two. The first permits the provision of the benefits of losses to the utility's ratepayers even though the activities generating the losses were not related to the cost of service. The latter does permit the benefits of losses to accrue to the entity that generated them. The vast preponderance of regulatory jurisdictions favor consistency as the theoretically preferred method for setting rates. This is true of both the Federal Communications Commission and the Federal Energy Regulatory Commission.

The allocation of any benefits generated by non utility activities to reduce rates is illogical and gives rise to patently unfair results. Consider a consolidated tax group consisting of two electric companies providing service in different states. One corporation generates taxable income and the other a net operating loss. Under these circumstances, it is inconceivable that the ratepayers in the "loss" jurisdiction would not feel "their" utility corporation entitled to reimbursement for the benefit of the loss. Similarly, it is difficult to view the ratepayers in the "taxable" jurisdiction as being entitled to reduced rates on account of the loss of its affiliate. Reflection of the benefit of the loss in the setting of rates in the "taxable" jurisdiction amounts to blatant and inequitable cross-subsidization. The principle is no different when, instead of the "loss" affiliate being a regulated utility, it is a non-regulated enterprise with the shareholders suffering the effects of the inequity.

CONCLUSION

In conclusion, we urge this Subcommittee to advise Treasury that it has the Congressional authority to issue regulations that broadly apply the regulatory consistency requirements so as to categorize consolidated tax adjustments and disallowed cost adjustments as violations of the normalization rules. These regulations should require consistency both for purposes of computing the tax expense element of cost of service as well as

-7

in the computation of utility rate base. We further request that the Subcommittee instruct Treasury to resume its regulation project and to address this issue of vital importance to our state and industry. If Treasury fails to act directly, we request that the Subcommittee take all steps appropriate to the initiation and enactment of legislation that will provide the guidance sought.

Chairman RANGEL. Thank you, Mr. Warren.

Larry Newsome, director of tax administration, Florida Progress Corp., St. Petersburg, FL, representing the Diversified Utilities Group.

STATEMENT OF LARRY J. NEWSOME, DIRECTOR OF TAX ADMINISTRATION, FLORIDA PROGRESS CORP., ST. PETERSBURG, FL, ON BEHALF OF DIVERSIFIED UTILITIES GROUP

Mr. NEWSOME. Mr. Chairman, and committee members, my name is Larry Newsome and I am the director of tax administration for Florida Progress Corp. I am here today on behalf of the Diversified Utilities Group. DUG is a group of companies that have one or more regulated affiliates and one or more nonregulated affiliates in their group. The members of the group are the Florida Progress Corp., FPL Group, Inc., TECO Energy Inc., and Iowa-Illinois Gas & Electric Co. We appreciate the opportunity to appear before you to express our concerns and our opinions.

When the IRS withdrew its proposed regulations and closed the regulations projects one of the reasons that they stated was that they lacked explicit statutory guidance from Congress with respect to this issue. Our analysis of the law and the legislative history indicates that Congress' intent with respect to this issue was to develop a general framework and that it granted the IRS the authority to write regulations covering specific adjustments.

In our opinion, the statutory framework necessary to give the IRS the guidance that it needs to issue regulations and arrive at the correct result are presently in place.

We believe that the consistency provisions of section 168 provide that general statutory framework. Under the consistency provisions of the code there is a requirement that there be consistency between the treatment of property with respect to depreciation, tax expense, depreciation reserve, and rate base. In our opinion, the cost of service and rate base adjustments fail to meet both of the requirements of the consistency provisions and, therefore, are in violation of the code.

Although we strongly believe that the consolidated adjustments violate the consistency provisions, we are aware that the actions and inactions of Treasury and Internal Revenue Service have created a substantial amount of confusion. It may, therefore, be necessary for Congress to clarify the situation.

If this subcommittee concludes that additional guidance or clarification is necessary in this area we would respectfully like to request that such guidance make absolutely clear that the use of consolidated tax adjustments attributable to nonregulated property for the purpose of reducing cost of service or rate base constitutes a violation of the normalization provisions.

We believe that there are two fundamental reasons that this is the case. The first is that the computation of the tax expense on a stand-alone basis is essential to achieving the goals and objectives of the normalization provisions as they apply to public utility property. The fundamental reason for having normalization is capital formation. Allowing a consolidated savings adjustment defeats this purpose. We are in disagreement with Secretary Graetz' comments

that a rate base adjustment is similar to a deferred tax adjustment. The reason that we disagree with this is because deferred taxes are ratepayer provided capital and consolidated tax savings adjustment are stockholder provided capital.

The second reason is that this conclusion is consistent with the objectives behind the incentives of many of the tax provisions in the Tax Code today. That is, it supports these incentives by permitting the benefits to go to whom they are directed. That is those that are paying for them and taking the risk.

Were it not for some of the incentives in the code today, such as the energy credits and low-income housing credits, there would be little or no investment in these areas at all. Many of the diversified utilities, including members of our group, have invested heavily in these areas. It would make little or no economic sense for our stockholders to continue providing capital for these types of investment if their returns are eroded or outright taken through consolidated tax savings adjustments.

Finally, an overriding issue is the one of fairness. While it may be true that some of the losses generated by some members of an affiliated group may not be utilized currently but for the filing of a consolidated return, there is still no justification for these benefits being given to rate payers who do not share in the risk.

When a business loses money it incurs an economic detriment. If it receives tax savings as a result of those losses, the tax savings reduce the detriment, they do not extinguish it. There is no fairness in allocating tax savings to ratepayers who have taken no business risk and incurred no detriment. In every instance, no matter how it is described, it is merely a windfall that is enjoyed at the expense of those who take and pay for the risk.

In summary, DUG believes that the guidance that the IRS seeks already exists. It is found in the provisions of section 168(i)(9)(b). If additional guidance is necessary it should be to clarify that the provisions of 168(i)(9)(b) disallow consolidated tax savings adjustments. Thank you.

[The prepared statement follows:]

Good morning.

My name is Larry J. Newsome and I am the Director of Tax Administration for Florida Progress Corporation. I am testifyng today on behalf of the Diversified Utilities Group (DUG). DUG is a group of companies filing consolidated returns that have one or more regulated public utilities and one or more nonregulated affiliates. The members of the group are: Florida Progress Corporation, St. Petersburg, Florida (holding company for Florida Power Corporation); FPL Group, Inc., North Palm Beach, Florida (holding company for Florida Power & Light Company); TECO Energy, Inc., Tampa, Florida (holding company for Tampa Electric Company); and Iowa-Illinois Gas & Electric Company, Davenport, Iowa.

Background

In its statement announcing the withdrawal of the proposed regulations and the closing of the regulation project (IR-91-57), the IRS indicated that although legislation was enacted over 20 years ago and the United States Supreme Court has considered the regulatory treatment of consolidated tax benefits, Congress has not given explicit statutory guidance with respect to the tax treatment. In addition, the IRS stated that it had received comments from approximately 100 interested parties, most of them utilities with about a dozen from state regulatory bodies. None of the commentators endorsed the basic approach of the proposed regulations. Lastly, the IRS also noted that it is likely that if the regulations are finalized, they would be challenged in court. It appears that for these reasons, the IRS withdrew the proposed regulations and closed the regulation project pending Congressional guidance.

Guidance Already Exists

DUG believes that the statutory framework

necessary to give the IRS the guidance it needs to issue regulations and arrive at the correct result is presently in place. In response to a series of problems which arose in California during the late 1970's, Congress added to the Internal Revenue Code (Code) what is presently section 168 (i) (9) (B). The forerunner to this provision was added by the Highway Revenue Act of 1982. Section 168 (i) (9) (B) of the Code provides in effect that a violation of the normalization provisions occurs if, for ratemaking purposes, there is a lack of consistency relating to the treatment of property with respect to depreciation, tax expense, depreciation reserve and rate base. Some would argue that this provision is inapplicable because it only applies to public utility property, that is property subject to regulation and thus paid for by ratepayers.