Citizens Utilities Co. v. Idaho Public Utilities Commission

739 P.2d 360, 112 Idaho 1061, 1987 Ida. LEXIS 319

• Court: Idaho Supreme Court
• Decided: June 4, 1987
• Docket: No. 16457
• Status: Published

Opinions

BISTLINE, Justice.

Citizens Utilities Company (Citizens), a corporation headquartered in Connecticut, provides electricity to the Wallace, Idaho area through its Idaho Electrical Division. The Idaho division of Citizens is not a separate utility — rather it is a division of a Connecticut corporation which operates both utility and non-utility property in other states. On June 20, 1985, Citizens filed an application for an increase in its rates and charges. Following a suspension of the effective date of the proposed rate increase, the Commission, on January 31, 1986, issued an order granting a rate increase of approximately 40 percent of the amount requested. A petition for reconsideration was filed by Citizens on February 20, 1986.

Citizens protests the Commission’s use of a hypothetical capital structure to calculate the revenue requirement for Citizens. Citizens proposed the use of the actual capital structure of 73 percent equity and 27 percent debt. The Commission staff recommended a hypothetical capital structure of 45 percent equity and 55 percent debt, asserting a debt/equity ratio of 27/73 is not an appropriate capital structure for an electric utility. The Commission actually adopted a hypothetical capital structure of 50 percent debt and 50 percent equity. The capital structure and weighted costs are utilized to calculate a required rate of return of eleven percent as per the following computation:

% of Component Total Weighted Capital Cost Cost (1) X (2)

Long-Term Debt 50.0% 9.55% 4.78%

Common Equity Series A 42.0% 12.30% 5.16%

Series B 8.0% 13.30% 1.06%

Total 100.0% 11.00% Rate of return

The adoption of a 50-50 hypothetical capital structure results in a hypothetical interest expense, which, due to the larger debt ratio, is greater than the actual interest expense. This in turn results in an adjustment of Citizens’ income tax and net income figures, which in turn results in a revenue requirement of $23,563 less than would be required were a hypothetical capital structure not utilized.¹ Citizens argues this reduction in revenue requirement is arbitrary and unsupported by the evidence in the record. This appeal followed the denial of Citizens’ petition for reconsideration.

The issue on appeal is whether the Commission erred in adopting a hypothetical capital structure rather than utilizing an actual capital structure where the utility is a division of a parent company which also owns and operates non-utility properties and utility properties in other states.

As with other cases reviewing the orders of the Commission, the scope of review is limited to a determination of “whether the Commission has regularly pursued its authority” and whether the constitutional rights of the appellant have been violated by the actions of the Commission. I.C. § 61-629; Utah Power & Light Co. v. Idaho Public Utilities Commission, 102 Idaho 282, 629 P.2d 678 (1981).

To determine whether the Commission has regularly pursued its authority, the Court must decide if the Commission acted arbitrarily when it adopted a hypothetical interest expense. The Commission’s order and findings must be supported by competent and substantial evidence. Intermountain Gas Co. v. Idaho Public Utilities Commission, 97 Idaho 113, 540 P.2d 775 (1975); Boise Water Corp. v. Idaho Public Utilities Commission, 97 Idaho 832, 555 P.2d 163 (1976).

Citizens alleges that the Commission’s adoption of the fictitious interest was arbitrary, first, as a departure from past rulings of the Commission. In previous cases, the Commission utilized hypothetical capital structures in calculating the rate of return, but utilized the actual interest expense and not a hypothetical interest expense. This departure, in and of itself, is not an arbitrary act on the part of the Commission.

“[A]n agency must at all times be free to take such steps as may be proper in the circumstances irrespective of its past decisions. Even when conditions remain the same, the administrative understanding of those conditions may change, and the agency must be free to act.” So long as the Commission enters sufficient findings to show that its action is not arbitrary and capricious, the Commission can alter its decisions. Washington Water Power Co. v. Idaho Public Utilities Commission, 101 Idaho 567, 579, 617 P.2d 1242, 1254 (1980) (quoting 2 Davis Administrative Law Treatise § 18.09 at 610 (1958)).

This Court has affirmed the Commission’s previous orders adopting a hypothetical capital structure. General Telephone Co. v. Idaho Public Utilities Commission, 109 Idaho 942, 712 P.2d 643 (1986); Citizens Utilities Co. v. Idaho Public Utilities Commission, 99 Idaho 164, 579 P.2d 110 (1978); Petition of Mountain States Telephone & Telegraph Co., 76 Idaho 474, 284 P.2d 681 (1955).

The rationale for adopting a hypothetical capital structure is either the need to impute a parent’s capital structure onto a subsidiary as in General Telephone or an attempt by the Commission to counter the effect of an equity-thick utility as in Citizens, 99 Idaho at 173-74, 579 P.2d at 119-20. Both of these rationales have as the Commission’s purpose the achievement of a proper balance between the interests of the utility investor and the utility ratepayer.

Company Adjustment Commission (2-1)

Rate Base $972,077 $914,049

Weighted Cost of Debt X 2.11% X 4.78%

Interest Expense $ 20,511 $ 43,692

Federal Tax Effect (42.455%) 8,708 18,500 9,842

State Tax Effect (7.70%) 1,579 3,364 1,785

Total Income Tax Adj. $11,627

“Perhaps the ultimate authority for imputing debt when necessary to protect ratepayers from excessive capital charges is the Supreme Court’s statement in Federal Power Commission v. Hope Natural Gas that: “The ratemaking process under the Act, i.e., the fixing of ‘just and reasonable’ rates, involves a balancing of the investor and consumer interests.” 320 U.S. 591, 603, 64 S.Ct. 281, 288, 88 L.Ed. 333 (1944). The equity investor’s stake is made less secure as the company’s debt rises, but the consumer ratepayer’s burden is alleviated. It is these conflicting interests that the Commission is to reconcile.” General Telephone, supra, 109 Idaho at 948, 712 P.2d at 649, citing accord General Tel. Co. v. Public Utility Commission, 628 S.W.2d 832, 837 (Tex.App.1982). As described in Communications Satellite Corp. v. Federal Communications Commission, 611 F.2d 883 (D.C.Cir.1977):

Ratepayers are subjected to an excessive burden when the revenues to be derived from the rates they pay have to be high enough to compensate the cost of a capital structure consisting entirely of equity financing; leveraging a capital structure with lower-costing debt relieves some of that burden. 611 F.2d at 902-03.

Citizens had a capital structure of approximately 73 percent equity compared to 27 percent debt. The Commission’s response entailed adopting a 50-50 equity to debt capital structure noting: “In this case, the Company’s [Citizens’] equity structure of 73.18% begs for close scrutiny. In fact, it is absurd on its face. This Commission has routinely adopted a hypothetical capital structure when it would be unfair to impose an unreasonably costly actual capital structure proposed by a utility.”

The hypothetical interest expense was, in the words of staff witness Terry Carlock, the result when she “followed through to use a higher debt cost related to that hypothetical capital structure and it’s appropriate to continue following through and using the interest related to that in figuring the interest cost to the Commission.” While the exact calculations utilize derived numbers representing the weighted cost of debt and the rate of return, the end number used for the interest expense is based on the amount of debt in the capital structure.

If supported by sufficient evidence, the Commission adoption of a hypothetical interest expense based upon a hypothetical capital structure is within its power. We are in agreement with the Commonwealth Court of Pennsylvania which faced a similar issue in T. W. Phillips v. Pennsylvania Public Utilities Commission, 81 Pa.Cmwlth. 205, 474 A.2d 355 (1984); and Carnegie Natural Gas v. Pennsylvania Public Utilities Commission, 61 Pa.Cmwlth. 436, 433 A.2d 938 (1981). In both cases it upheld the commission’s adoption of the hypothetical interest expense.² The commission in T.W. Phillips adopted a hypothetical capital structure due to the “atypical” nature of Phillips’ capital structure. Based upon this hypothetical capital structure, the commission imputed an income tax expense which was substantially lower than Phillips’ actual tax expense. The court stated:

[T]he Commission may, for ratemaking purposes disallow a utility’s actual income tax expense and impute an income tax expense based upon a hypothetical capital structure when a utility’s atypical capital structure causes it to incur substantially higher income taxes than it would were its capital structure arranged in a more typical fashion. Id. 433 A.2d at 362 citing Carnegie, supra.

The Commission here was faced with a similar suspect capital structure and adopted the hypothetical capital structure. As in Phillips, Citizens’ capital structure would incur a lower interest expense and higher income tax than the Commission’s more appropriately balanced structure.

Citizens argues a distinction should be made between the use of the hypothetical capital structure in calculating the rate of return and calculating the interest expense. Citizens’ position is that the effect of the hypothetical interest expense is to act as an improper adjustment to the rate of return. Citizens argues that since the actual interest expense is the amount allowable as a deduction from income taxes, a larger hypothetical interest expense creates an artificially lower income tax resulting in the rates being insufficient to recover the actual existing higher taxes.

This argument, however, is unpersuasive when viewed in light of our previous rulings on the adoption of a hypothetical capital structure. The Commission was well within its discretion when it calculated a rate of return based on this capital structure. The effect of following through the cost of the debt to the interest expense is to complete the adoption of the capital structure, the Commission noting that “to fail to carry the effect of the capital structure through to the company’s [Citizens’] results of operations would be inaccurate and would result in an inadequate revenue requirement.”

Citizens next argues that the Commission’s adoption of the hypothetical interest expense was not supported by sufficient evidence. The sufficiency of evidence on review to support the Commission’s decision was recently stated as requiring

more than a mere “scintilla” of evidence in support of the agency’s determination, id. [Local 1494 of the International Association of Firefighters v. City of Coeur d’Alene, 99 Idaho 630] at 634, 586 P.2d [1346] at 1350 [1978], though “something less than the weight of the evidence.” Consolo v. FMC, 383 U.S. 607, 620 [86 S.Ct. 1018, 1026, 16 L.Ed.2d 131] (1966). “Put simply,” we wrote, “the substantial [competent] evidence rule requires a court to determine ‘whether [the agency’s] findings of fact are reasonable.’ 4 Davis, Administrative Law Text § 29.01-02 at 525-530.” Local 1494 of the International Association of Firefighters v. City of Coeur d’Alene, 99 Idaho 630, 634, 586 P.2d 1346, 1350 (1978). Application of Hayden Pines Water Co., 111 Idaho 331, 335, 723 P.2d 875, 879 (1986).

The record reveals testimony from both the Commission staff and Citizens’ witnesses on the adoption of the interest expense as well as staff exhibits illustrating the effect of the interest expense. Staff Ex. No. 105 showed the proposed adjustment to Citizens’ interest deduction for income tax purposes and Staff Ex. No. 109 showed the calculation of the adjustment, based on the staff recommended hypothetical capital structure. The amount of evidence available to the Commission was limited, but this was due in part to Citizens’ own failure to directly address the issue of the hypothetical interest expense. The evidence the Commission did have came from both sides and presented the origin and effect of the interest expense:

In reviewing findings of fact we will sustain a Commission’s determination unless it appears that the clear weight of the evidence is against its conclusion or that the evidence is strong and persuasive that the Commission abused its discretion. Utah-Idaho Sugar v. Intermountain Gas Co., 100 Idaho 368, 376, 597 P.2d 1058, 1064 (1979).

There is substantial, competent evidence to support the Commission orders which are hereby affirmed. Costs to respondent; no attorney’s fees awarded.

DONALDSON and HUNTLEY, JJ., concur.

1 . The figure of $23,553 was arrived at by multiplying the $11,627 adjustment by the revenue conversion factor of 2.0266.

2 . This adoption is not, as interpreted by the dissent, predicated upon a finding of an abuse of management discretion. In Carnegie, the court discussed the commission's finding of the unreasonableness of the utility’s capital structure. In T.W. Phillips the court stated: "Having found that a hypothetical capital structure was appropriate for Phillips, the Commission was free to use it as the basis for imposing a hypothetical income tax expense without having to find that Phillips management had abused its discretion.” 474 A.2d at 362.

Even going so far as to require a finding of abuse of discretion may impose no greater burden. Big Run Telephone Co. v. Pennsylvania Public Utility Commission, 68 Pa.Cmwlth. 296, 449 A.2d 86 (1981), states: “An abuse is established when the evidence indicates that management has adopted a capital structure, in the absence of some compelling business reason, which because of its disproportionate nature imposes an unfair tax burden on ratepayers."