Comments on FERC's MLP Income Tax Allowance Policy
Master Limited Partnerships (MLP) and entities representing partnership-owned pipelines, pipeline shippers, and electric utilities filed comments in response to the Federal Energy Regulatory Commission's (FERC) Notice of Inquiry (NOI) regarding a possible revision of its 2005 Income Tax Policy Statement. Representatives from liquids and natural gas pipelines expressed concerns that the removal of the income tax allowance for partnership-owned pipelines could impede the ability for these pipelines to finance future capital projects.

While the FERC has not yet given any indication of its favored course of action, it might find the voluminous expert evidence submitted in recent comments by the various MLP advocates persuasive, and could choose to pursue that course of action. That said, if FERC chooses to respond to the court-ordered remand that necessitated the NOI by eliminating the double recovery of income taxes, the overwhelming opinion of the commenters is that this should be accomplished by removing the income tax allowance for MLP-owned entities, rather than revising the discounted cash flow (DCF) methodology.

How did we get here?

On December 15, 2016, the Federal Energy Regulatory Commission (FERC) issued a Notice of Inquiry (NOI) in response to the decision of U.S. Circuit of Appeals for the District of Columbia Circuit in United Airlines, Inc. v. Federal Energy Regulatory Commission, 827 F.3d 122 (D.C. Cir. 2016). As we have previously reported in Special Report: FERC Solicits Comments on New MLP Tax Policy, the United Airlines court, in a case involving the FERC's 2005 Income Tax Policy Statement, found that the FERC had "failed to demonstrate that there is no double recovery of taxes for a partnership pipeline as a result of the income tax allowance and return on equity (ROE) determined pursuant to the DCF methodology. The court remanded the case to FERC to consider the "mechanisms for which the Commission can demonstrate that there is no double recovery."

The NOI solicited comments from industry stakeholders regarding FERC's current income tax allowance and rate of return policies. The NOI suggested that commenters consider two options to address the court's concerns about the double recovery of taxes: (1) eliminating the income tax allowance in the cost of service for MLP; or (2) adjusting the DCF return of MLPs by eliminating any double tax recovery. Initial Comments responding to the NOI were due on March 8; Reply Comments are due by April 7.  

Partnership Pipelines Seek Status Quo

About 20 substantive comments were submitted in response to the NOI. About half of the comments urged the FERC to take no action with regard to revising its tax allowance policy. These comments, submitted by MLPs and entities representing MLPs, urged the FERC to retain its current tax policy, and argued that FERC can demonstrate that the current policy does not result in a double tax recovery.  

For example, the Interstate Natural Gas Association of America (INGAA), a trade association representing natural gas transmission pipeline companies, many of which are organized as MLPs, submitted detailed comments and expert witness testimony, which INGAA asserts demonstrates that MLPs do not receive a double recovery under existing FERC policy. In particular, INGAA asserts that FERC's current policy correctly recognizes that the income tax liability incurred by MLPs is a cost attributable to providing the regulated pipeline service, and that MLPs would be disadvantaged by any change that FERC might make in response to the NOI. INGAA also asserts that its comments and evidence demonstrate that FERC's tax allowance for MLPs is comparable to the tax allowance that FERC allows on the taxable income of corporate-owned pipelines and is necessary to provide parity between the equity owners of MLPs and corporate pipelines. 

Perhaps most ominous, one industry expert provided that"...the fact that most MLPs distribute all of their available cash to their partners['] limits their ability to fund new pipeline growth projects from internally generated funds, which, in turn, raises their business risk when credit markets tighten." The potential to hinder future pipeline development may be weighted more heavily by Trump appointed Commissioners who will ultimately direct the agency's course of action upon appointment.  

A number of MLPs also submitted comments that encouraged FERC to take no action with regard to its tax policies and cited to INGAA's comments and expert testimony. For example, Dominion Resources, Inc., the general partner of Dominion Midstream Partners, L.P., urged FERC to continue its current income tax allowance and DCF methodology policies as applied to MLPs. Dominion noted that FERC's continuation of its existing policies was well supported by the expert witnesses' empirical data. 

Perhaps anticipating other commenter's views to the contrary, Dominion also stated that the FERC was free to maintain its current tax policy and to further justify its use to the court. In this regard, Dominion stated that maintaining the current tax policy was consistent with the United Airlines court's ruling as to the merits of the case, where the court held that "FERC has not provided sufficient justification for its conclusion that there is no double recovery of taxes" -- which, Dominion asserts, allows FERC to respond to the court with a better explanation for its policy permitting an MLP pipeline to recover an income tax allowance.

Pipeline Shippers - Remove the Tax Allowance

As might be expected, shippers were of an opposing view. The Liquids Shippers Group noted that "[t]here can be no reasonable doubt in light of United Airlines that double-recovery occurs, and that it is unlawful" and urged FERC to establish a new policy to eliminate the double recovery of income taxes by partnerships. The Liquids Shippers Group stated that it believed that the first option noted in the NOI, the elimination of the cost-of-service tax allowance for partnerships, was preferable to revising the DCF methodology. 

Likewise, the Natural Gas Supply Association (NGSA), a trade group representing domestic producers of natural gas, urged FERC to end the double recovery of income taxes for MLP-owned natural gas pipelines. In accord with the Liquid Shippers Group and nearly all of the other proponents of ending the double recovery, NGSA recommended the elimination of the income tax allowance for MLPs, rather than adjusting the DCF methodology. NGSA stated that adjusting the DCF methodology would be difficult and would require more lengthy adjustments than simply eliminating the income tax allowance for MLP-owned entities.

Applicability to Electric Transmission Developers
While the majority of the commenters offered decidedly strong opinions as to what FERC's actions should be in response to the court's remand, a few were agnostic on that point, and submitted comments only to ensure that FERC's response -- whatever it turns out to be -- need not include them. So, for example, an electric transmission developer submitted comments only to disabuse the FERC of the notion that the NOI applies to partnership electric utilities. This commenter noted that "the application of FERC's current DCF analysis and Income Tax Policy Statement to partnership electric utilities ensures no double recovery of federal income taxes, and ensures parity between partnerships and corporate electric utilities." Moreover, the developer explained that any action taken to revise these policies would be "unnecessary" and could have an adverse impact on such entities.
Similarly, the Edison Electric Institute advised FERC that it should limit its action on remand to the specific issues raised by the United Airlines decision, and not "make broadly applicable changes" to FERC policy on the recovery of income taxes or ROEs that affect electric utilities, given that "electric utility corporations and partnerships do not raise double recovery concerns." 

What's Next? 

The court's remand order does not set a specific deadline by which FERC must respond. The initial comments and expert testimony of the various commenters, both for and against eliminating the double recovery, included complex, voluminous and contradictory information and assertions that the FERC staff must carefully review and evaluate. The staff will no doubt need to devote considerable time to their review and evaluation of the comments. Indeed, the record is not yet complete, as Reply comments may be submitted until April 7. Once the record is complete, the FERC may choose to hold a hearing in deciding its action in response to the remand, which would take additional time.  
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