(PG&E-3)
PACIFIC GAS AND ELECTRIC COMPANY
CHAPTER 10
INCOME AND PROPERTY TAXES
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A. Introduction
1. Scope and Purpose
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The purpose of this chapter is to demonstrate that Pacific Gas and
7
Electric Company’s (PG&E or the Company) expense forecast for income
8
taxes and property taxes, and its estimate of deferred tax balances for its
9
generation function, are reasonable and should be adopted by the California
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11
Public Utilities Commission (CPUC or Commission). This chapter presents
recorded income tax expense and deferred tax reserve balances for 2004 [1]
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and develops estimates of the corresponding amounts for 2005, 2006 and
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2007. This chapter also discusses prior Commission decisions that provide
14
the guidance for the calculations presented and uses the same tax
15
calculation used in the 2003 General Rate Case (GRC). The tax expense
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amounts PG&E is requesting are necessary components of the cost of
17
providing generation service to PG&E’s customers in 2007.
2. Summary of Request
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PG&E requests that the Commission adopt its 2007 forecast for income
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tax expense and deferred tax balance. Tax expense is a calculated amount
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dependent on: (1) expenditure estimates provided by other witnesses in
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this case; (2) past Commission decisions on how to perform the calculation;
23
and (3) tax laws.
PG&E further requests that the Commission adopt its 2007 forecast for
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property tax expense.
25
Table 10-1 at the end of this chapter presents the specific amounts
26
requested for non-nuclear plant and for Diablo Canyon.
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[1]
The 2004 amounts were prepared before PG&E’s tax return for 2004 was
filed. Thus, 2004 taxes are estimated based on recorded 2004 book data.
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(PG&E-3)
3. Support for Request
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PG&E’s forecast for income tax expense is reasonable because the
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3
Company:
4
Accurately reflects the tax laws in its calculation of tax expense;
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Uses Commission-mandated accounting and ratemaking methods; and
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Calculates federal income tax (FIT) and California corporate franchise tax
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(CCFT) taxable income using appropriate deductions and adjustments
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equivalent to or forecast from amounts filed in its federal and state tax
9
returns.
10
PG&E’s request for property taxes is reasonable because it is based on
11
current property tax rates and methods applied to the estimated net plant in
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service for this proceeding.
13
B. Significant Developments Since the Last GRC
Since the 2003 GRC was filed, Congress passed three tax acts. On
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May 28, 2003, President Bush signed into law the “Jobs and Growth Tax Relief
Reconciliation Act of 2003.”[2] That legislation included a provision that
17
increases the special depreciation allowance allowed in the first year from
18
30 percent, as described in the 2003 GRC, to 50 percent for property placed in
19
service after May 5, 2003 and before January 1, 2005.
15
PG&E has included an estimate of the effect of special depreciation
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allowance in its forecast of federal deferred taxes in this application. For 2007,
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there should be no impact on federal tax depreciation for generation due to the
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special depreciation allowance on additions made in 2007. There should be no
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affect on state tax depreciation because, as of the date this application, state
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law has neither conformed to the 30 percent rate nor conformed to the
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50 percent rate.
In the 2003 GRC, PG&E described how the increase in federal tax
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depreciation, the special depreciation allowance, also changed the net present
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value dynamics of contributions-in-aid-of-construction received from customers;
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and that the change caused PG&E to reduce the income tax cost component
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charged on taxable contributions. The increase of special depreciation
[2]
Public Law No. 108-027 (May 28, 2003) 117 Stat. 752.
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(PG&E-3)
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allowance to 50 percent required an additional adjustment. Accordingly, PG&E
2
filed Advice Letters 2466-G/2386-E with the Commission on June 6, 2003,
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reducing the income tax cost component charged on taxable contributions from
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27 percent to 22 percent for both electric and gas effective August 1, 2003.
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The tariff sheets attached to Advice Letters 2387-G/2243-E further provide that
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the income tax cost component charged would return to 34 percent for electric
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and 35 percent for gas as of January 1, 2005.
In 2004, the President signed two other tax bills only one of which, the
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“American Jobs Creation Act of 2004” (2004 Jobs Act), has an impact on this
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filing. The 2004 Jobs Act included a provision that allows a manufacturer’s tax
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deduction for goods manufactured and produced in the United States. The
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deduction is computed as a percentage of the net income of a taxpayer derived
from the manufacture or production of such good. [3] The rate is phased in
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beginning at 3 percent for 2005 and 2006, 6 percent in 2007-2009, and
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9 percent beginning in 2010. Production of electricity qualifies for the deduction;
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the transmission and distribution of electricity do not.
17
PG&E has included an estimate of the manufacturer’s tax deduction in its
18
forecast of federal income tax expense in this application. As of the date this
19
application, state law has not conformed to this change.
In the 2003 GRC, the State Board of Equalization (SBE) separately
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calculated the values of nuclear generation, non-nuclear generation, and
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transmission and distribution property using different indicators of value and
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different weightings for each business segment. As described below, the SBE
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now uses the same methodology in a single system-wide property assessment.
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C. Specific Modification for Income Tax Expense-Retained Plant
In the Competitive Transition Cost Decision,[4] the Commission authorized
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27
collection of the FAS 109 tax regulatory asset for all book and tax basis
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flow-through timing differences for fossil and hydro generation plant.
[3]
[4]
The provision uses the term qualified production activities income and defines
that as gross receipts, reduced by the sum of: (1) cost of goods sold that are
allocable to the receipts; (2) other deductions, expenses, or losses that are
directly allocable to such receipts; and (3) a proper share of other deductions,
expenses, and losses that are not directly allocable to such receipts or
another class of income. Internal Revenue Code (IRC) §199(c)(1).
D.97-11-074; 76 CPUC 2d 627.
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(PG&E-3)
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The 2003 GRC Settlement Agreement established a 10-year collection period
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for the remaining balance of the tax regulatory asset.
The tax regulatory asset will have an uncollected balance of $77.5 million as
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of December 31, 2006. As discussed more fully in Chapter 2 of this exhibit,
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Generation Ratemaking, PG&E requests that the tax regulatory asset at
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December 31, 2006, be amortized over six years beginning in 2007. As the
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regulatory asset is amortized, the appropriate adjustment will be made to the
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deferred tax reserve.
Exclusive of return on rate base, amortization of the tax regulatory asset
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increases revenue requirement for retained non-nuclear plant by the amount of
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the amortization.
In addition, as discussed more fully in Chapter 2 of this exhibit, Generation
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Ratemaking, PG&E plans to shut down the Hunters Point Power Plan (HPPP) in
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mid-2006. PG&E is projecting expenditures to decommission HPPP during the
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2007 GRC timeframe. It is also projecting some smaller expenditures for
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decommissioning work at Humboldt Bay Power Plant during this timeframe. For
17
tax purposes, the decommissioning expenses create a flow-through tax benefit
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in the ratemaking tax calculation.
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D. Calculation Methodology
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Tax expense is a calculated amount dependent on: (1) expenditure
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estimates provided by other witnesses in this case; (2) past Commission
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decisions on how to perform the calculation; and (3) tax laws. This section
23
provides a brief history of the development of Commission-mandated tax
24
calculations.
In the Economic Recovery Tax Act of 1981, Congress mandated that the tax
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benefit of certain expenditures made by utilities subject to cost-of-service
27
regulation should be accounted for using a “normalization” method of tax
accounting.[5] The Commission issued Order Instituting Investigation 24
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(OII 24), and later adopted normalization accounting for the specified
expenditures.[6] Other Commission decisions have ordered “flow-through” tax
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[5]
[6]
IRC § 168; 26 U.S.C.A. § 168.
D.84-05-036, mimeo p. 46, 15 CPUC2d 42, 61, Conclusion of Law No. 14.
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(PG&E-3)
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accounting for other categories of expenditures. Both of these technical terms
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are explained below.
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Where past Commission decisions mandate that expenditures be deducted
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against taxable income in the ratemaking tax calculation using the same timing
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that is used to determine book income (revenue less expenditures before tax
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expense), then the tax expense calculation is merely book income times the tax
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rate. However, often the timing is different, thus giving rise to a “book tax timing
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difference.” For example, taxing authorities typically provide depreciation lives
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and methods shorter and more accelerated than those used for book purposes,
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resulting in tax depreciation greater than book depreciation in the early years of
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an asset’s life cycle.
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Commission decisions have provided for either normalized or flow-through
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tax accounting for specific book tax timing differences to determine the amount
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of tax benefit reflected in the revenue requirement for the utility.
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Flow-through accounting uses the amount of the tax return deduction to
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determine the amount of the tax benefit reflected in the revenue requirement.
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The tax benefit reflected in the revenue requirement is equal to the cash saved
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on the return due to the deduction.
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In contrast, normalized tax accounting uses the amount of the book
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expenditure to calculate the amount of the tax benefit reflected in the revenue
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requirement. In this case, the tax benefit in rates is different from the cash
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saved due to the tax deduction. This adjustment is referred to as deferred tax
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expense. Since the tax benefit in rates is different from the cash saved on the
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return, the normalization tax accounting method usually calls for a rate base
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adjustment to provide a return on the difference. This accumulated deferred tax
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expense (deferred tax reserve) adjusts rate base.
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In the discussion of adjustments that follows, PG&E specifies when it has
28
used flow-through or normalized tax accounting and indicates if a rate base
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adjustment has been made in the case of normalization.
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E. Deductions From Taxable Book Income
The following tax adjustments are made to pre-tax book income and are
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common to the development of the FIT and CCFT taxable income shown in
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Table 10-1. In addition, adjustments unique to either FIT or CCFT tax laws are
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addressed later in this chapter.
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(PG&E-3)
1. Interest Charge Adjustment
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The interest charge adjustment provides a tax deduction for interest on
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3
debt used to finance rate base. The deduction, computed from rate base
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5
and rate of return information, is shown in Table 10-1 at the end of this
chapter. Decision 93848[7] ordered flow-through tax accounting for this
6
adjustment; PG&E has used the prescribed accounting in its showing.
2. Fiscal/Calendar Year Property Tax Adjustment
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In Decision 84-05-036,[8] the Commission recognized the book and tax
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basis timing differences between property tax accrued for financial reporting
10
purposes and property tax accrued as an income tax deduction. This timing
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difference is illustrated in Table 10-1. For financial reporting purposes,
12
property taxes are accrued for the period in which they are paid. For
13
income tax purposes, property taxes become deductible on the January 1
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15
lien date. The adjustment to book accrued property tax is shown in
Table 10-1. Decision 93848[9] provides for flow-through tax accounting for
16
this adjustment, which is the accounting used for this item in this proceeding
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and in the last GRC.
3. Operating Expense Adjustments
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In Decision 88-01-061,[10] the Commission recognized the significant
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20
changes introduced by the Tax Reform Act of 1986 (TRA 86). Many of the
21
changes require taxpayers such as PG&E to make miscellaneous
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adjustments to book income to compute taxable income. For example,
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50 percent of the business meal expense included in book income must be
24
eliminated in the computation of taxable income. Another adjustment is
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made for the Internal Revenue Code (IRC) Section 179A deduction for
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natural gas vehicles created by the National Energy Policy Act of 1992.
27
Clearing account book depreciation related to vehicles is also removed as
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an operating expense adjustment because under PG&E’s charge-back
29
accounting for these costs, vehicle depreciation is included in operating
[7]
[8]
[9]
[10]
D.93848, 7 CPUC 2d 332.
D.84-05-036, 15 CPUC 2d 42.
D.93848, supra.
D.88-01-061, 27 CPUC 2d 310.
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(PG&E-3)
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expenses, but is not tax deductible. Other miscellaneous tax adjustments to
pre-tax book income are shown in Table 10-1. Decision 93848[11] provides
3
for flow-through tax accounting for this adjustment, which is the accounting
4
used for this item in this proceeding. In addition, clearing account book
5
depreciation related to vehicles is removed as an operating expense
6
adjustment.
1
4. Vacation Pay Adjustment
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Decision 88-01-061[12] discussed the income tax effect of book and tax
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basis timing differences related to the cost of vacation pay. For financial
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10
reporting purposes, the liability is measured by the amount of vacation pay
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earned. For tax purposes, vacation pay is deductible only to the extent that
12
economic performance has occurred during the year, or will occur by
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March 15 of the year following the year of the book accrual. Economic
14
performance occurs when an employee actually takes vacation. This timing
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adjustment to pre-tax book income is shown in Table 10-1.
16
Decision 88-01-061 provides for normalized tax accounting for this
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adjustment, which is consistent with the accounting used for this item in this
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and the 2003 GRC. Since the tax effect is normalized, deferred tax
19
expense is calculated for this item.
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5. Capitalized Software Adjustment
Section 167(f)[13] of the IRC requires taxpayers to capitalize and
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depreciate certain software acquired in the open market. Section 174 of the
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IRC provides that some portion of the cost of certain self-developed
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software may be deducted currently. As in the 2003 GRC, PG&E has used
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flow-through tax accounting treatment for the amounts that are deductible
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under Section 174 and normalized tax accounting treatment for amounts
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that are capitalized under Section 167(f).
[11]
[12]
[13]
D.93848, supra.
D.88-01-061, supra.
The Omnibus Budget Reconciliation Act of 1993 (Pub. L. 103-66) added
Section 167(f) to the IRC, effective for capitalized software purchased after
August 10, 1993.
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(PG&E-3)
Decision 93848[14] provides for flow-through tax accounting for this
1
2
adjustment; the normalized tax accounting used in this case for the
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Section 167(f) portion of the adjustment is the tax accounting used in
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Decision 88-01-061 for depreciable tax basis placed in service since 1986.
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Since this tax effect is normalized, deferred tax expense is calculated for
6
this item.
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F. Development of CCFT Taxable Income
CCFT taxable income is computed in accordance with the statutory
8
requirements of the California Revenue and Taxation Code (R&TC). The
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10
starting point for the calculation is pre-tax book income. Pre-tax book income is
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uniquely calculated for the tax computation. For example, book depreciation
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and decommissioning costs are not included in pre-tax book income. Other
13
excluded items include the allowance for funds used during construction
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(AFUDC) income and interest expense.
15
Tax adjustments that are common to both FIT and CCFT are combined with
16
tax adjustments that are unique to CCFT to compute CCFT taxable income from
17
pre-tax book income. The tax adjustments that are common to both FIT and
18
CCFT are discussed in Section E above. Tax adjustments that are unique to
19
CCFT taxable income are discussed below.
20
1. CCFT Capitalized Interest Adjustment
Decision 88-01-061 discussed the requirement to capitalize interest in
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22
the tax basis of new construction. The Commission recognized timing
23
differences between the amount of interest capitalized in book basis through
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the debt portion of AFUDC and the amount of interest capitalized in tax
25
basis through compliance with Section 263A of the IRC. California
26
conformed to the requirements of IRC Section 263A through R&TC
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Section 24422.3. The net unrecovered difference between book basis
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AFUDC debt and CCFT basis in Section 24422.3 interest capitalized is
29
shown in Table 10-1 at the end of this chapter.
[14]
D.93848, supra.
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As in the 2003 GRC, PG&E used normalized tax accounting for this
2
adjustment, which complies with Option 3 of Decision 88-01-061. Since this
3
tax effect is normalized, deferred tax expense is calculated for this item.
2. CCFT Depreciation Adjustment
4
6
The R&TC specifies the tax depreciation deductibility rules for PG&E.
These rules are based on the Asset Depreciation Range (ADR)[15] and
7
Class Life System (CLS)[16] methods of depreciation. The depreciation
8
deduction shown in Table 10-1 maximizes the deduction permitted by law
9
for the plant activity forecast in this GRC. Decision 93848 provides for
5
10
flow-through tax accounting for this adjustment, which is consistent with the
11
accounting used for this item in this proceeding.
3. CCFT Removal Cost Adjustment
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The R&TC specifies the cost of removal deductibility rules for PG&E.
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14
Removal costs are incurred when plant is physically removed from service
15
(and is deductible for tax purposes when incurred). The cost of removal
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deduction shown in Table 10-1 is based on the plant retirement activity
17
forecast in this GRC. For financial reporting purposes, such costs are
18
capitalized. Thus, a tax and book basis timing difference is created.
19
Decision 93848 provides for flow-through tax accounting for this adjustment,
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which is consistent with the accounting used for this item in this proceeding.
4. CCFT Repair Allowance Adjustment
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The R&TC specifies the repair allowance deductibility rules for PG&E.
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23
The repair allowance deduction relates to all vintages of ADR property and
24
is based on the plant construction activity forecast in this GRC. For financial
25
reporting purposes, such costs are capitalized. Thus, a tax and book basis
26
timing difference is created. Decision 93848 provides for flow-through tax
27
accounting for this adjustment, which is consistent with the accounting used
28
for this item in this proceeding.
[15]
[16]
The ADR system of depreciation determines the CCFT depreciation of
property placed in service after 1970.
The CLS determines the CCFT depreciation of property placed in service
prior to 1971.
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G. Development of Federal Taxable Income
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Federal taxable income is computed in accordance with the statutory
3
requirements of the IRC. The starting point for the calculation is pre-tax book
4
income as discussed in Section E above.
Tax adjustments that are common to both FIT and CCFT are combined with
5
6
tax adjustments that are unique to FIT to compute FIT taxable income from
7
pre-tax book income. The tax adjustments that are common to both FIT and
8
CCFT are discussed in Section E above. Tax adjustments that are unique to
9
FIT taxable income are discussed below.
1. FIT State Tax Adjustment
10
For FIT return filing purposes, Section 801 of TRA 86 requires
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12
taxpayers such as PG&E to deduct CCFT on a privilege year basis (prior
13
year CCFT becomes deductible for FIT purposes when PG&E exercises its
14
franchise privilege to do business in California on the first day of each new
15
year). Thus, CCFT estimated for 2006 (income year) would be deductible
16
for federal income tax purposes on January 1, 2007 (privilege year).
17
In Decision 89-11-058, the Commission concluded that CCFT is
19
deductible for FIT purposes on a privilege year basis if the amount deducted
is on record in a Commission-adopted prior year summary of earnings.[17]
20
In this case, the prior year amount for 2006 as shown in the appropriate
21
tables in this chapter’s workpapers becomes deductible for FIT purposes in
22
2007, also shown in the tables.
18
The flow-through tax accounting used for this adjustment is consistent
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24
with the accounting used for this item in this proceeding and in the
25
2003 GRC.
2. FIT Capitalized Interest Adjustment
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A tax adjustment discussed in Decision 88-01-061 is the requirement to
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28
capitalize interest in the tax basis of new construction. The Commission
29
recognized timing differences between the amount of interest capitalized in
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book basis through the debt portion of AFUDC and the amount of interest
31
capitalized in tax basis through compliance with Section 263A of the IRC.
[17]
D.89-11-058, 33 CPUC 2d 495.
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The net unrecovered difference between book basis AFUDC debt and FIT
2
basis in Section 263A interest capitalized is shown in Table 10-1.
The normalized tax accounting used for this adjustment is consistent
3
4
with the accounting used for this item in this application and in the
5
2003 GRC and with Option 3 of Decision 88-01-061. Since this tax effect is
6
normalized, deferred tax expense is calculated for this item.
3. FIT Depreciation Adjustment
7
The IRC specifies the tax depreciation deductibility rules for PG&E.
8
10
These rules are based on the CLS, ADR, Accelerated Cost Recovery
System (ACRS)[18] and Modified Accelerated Cost Recovery System
11
(MACRS)[19] methods of depreciation. The depreciation deduction shown
12
in Table 10-1 maximizes the deduction permitted by law for the plant activity
13
forecast in this GRC.
9
Accelerated depreciation under the ACRS and MACRS methods of
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15
depreciation is permissible only if the FIT effects of life, method, and
16
salvage timing differences between the book and tax methods of recovering
17
ACRS and MACRS tax basis are normalized. In Decision 93848 and
18
Decision 88-01-061, the Commission approved normalization accounting to
19
enable PG&E to use ACRS and MACRS methods of depreciation.
The normalized tax accounting used for ACRS and MACRS property is
20
21
the same accounting used in the 2003 GRC, in accordance with
22
Decisions 93848 and 88-01-061. Since the tax effect is normalized,
23
deferred tax expense is calculated as well (See Table 10-1, line 49).
Accelerated depreciation under the ADR and CLS systems of
24
25
depreciation is permissible regardless of the tax accounting treatment of
26
book and tax basis timing differences in ratemaking. In Decision 93848, the
27
Commission ordered the use of flow-through tax accounting for such timing
28
differences.
[18]
[19]
The ACRS determines tax depreciation of property generally placed in
service from 1981 through 1986, and of some post-1986 transition property,
supplanting ADR for federal purposes.
The MACRS determines tax depreciation of property placed in service after
1986, except for property subject to ACRS rules.
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(PG&E-3)
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The flow-through tax accounting used for ADR and CLS property basis
2
timing differences is the accounting used for this item in this filing and the
3
2003 GRC in accordance with Decision 93848.
4
5
4. FIT Removal Cost Adjustment
PG&E has an established method of accounting for the costs of removal
6
as incurred. The cost of removal deduction shown in Table 10-1 is based
7
on the plant retirement activity forecast in this GRC. For financial reporting
8
purposes, such costs are capitalized. Thus, a tax and book basis timing
9
difference is created.
10
The limited flow-through income tax accounting used for the cost of
11
removal is the accounting treatment for this item in this filing and the
12
2003 GRC, in accordance with Decision 93848.
13
5. FIT Repair Allowance Adjustment
14
The IRC specifies the repair allowance deductibility rules for PG&E.
15
The repair allowance deduction relates to all vintages of ADR property and
16
is based on the plant construction activity forecast in this GRC. For financial
17
reporting purposes, such costs are capitalized. Thus, a tax and book basis
18
timing difference is created.
19
The flow-through tax accounting used for ADR property repair allowance
20
in this filing is the accounting used in the 2003 GRC, in accordance with
21
Decision 93848.
22
23
6. FIT Preferred Dividend Adjustment
This adjustment relates to a permanent difference between book and
24
tax basis. Dividends paid on preferred stock issued prior to
25
October 1, 1942, are (with limitations) deductible for federal income tax
26
purposes. Dividends paid on preferred stock issued after October 1, 1942,
27
also qualify, if the preferred stock replaced a bond or other preferred stock
28
that was issued prior to October 1, 1942. This adjustment is forecast in
29
Table 10-1. Decision 93848 provides for flow-through tax accounting for
30
this adjustment, which is the same accounting used in the 2003 GRC.
31
H. Development of Property Tax Expense
32
Estimated property taxes were developed using valuation methods
33
appropriate for cost of service regulated public utilities. The SBE uses the
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historical cost less depreciation and the capitalized earnings ability valuation
2
methods to determine PG&E's system-wide assessment. Generally, these
3
valuation methods should not result in a valuation significantly different from rate
4
base.
5
For the test year, forecasts of assessed values are determined by
6
7
developing a factor based on the relationship between the most current
assessment (fiscal year 2004/2005)[20] and the taxable historical cost less
8
depreciation for the same period. The resulting factor is applied to the
9
forecasted historical cost less depreciation to determine assessed value. Fiscal
10
period property taxes are calculated by multiplying the assessed values by a
11
composite tax rate. The composite tax rate is computed based on assessment
12
and tax data from the latest known fiscal tax period (fiscal year 2005/2006).
The final expense amount is determined using two fiscal period assessment
13
14
estimates. For example, 2007 property tax expense is comprised of the last
15
one-half of fiscal period 2006/2007, and the first one-half of fiscal period
16
2007/2008.
17
I. Tables
The following table is provided using the mandated accounting methods
18
described above for PG&E’s generation function:
19
20
21
22
TABLE 10-1
PACIFIC GAS AND ELECTRIC COMPANY
INCOME TAXES AT PROPOSED RATES, YEAR 2007
23
[20]
For property taxes, the fiscal year runs from July 1 through June 30.
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