DC Circuit denies recovery of income tax allowance by oil pipeline partnership

Eversheds Sutherland (US) LLPOn July 31, 2020, the US Court of Appeals for the DC Circuit issued a per curiam opinion in SFPP L.P. v. Federal Energy Regulatory Commission, et al. The DC Circuit denied the recovery of an income tax allowance by SFPP L.P. (SFPP), a master limited partnership that holds an oil pipeline that moves oil throughout the west. SFPP had challenged decisions by FERC to deny SFPP an income tax allowance, to decline to reopen the record on that issue, and to deny SFPP’s adjustment to its index rates. Meanwhile, certain ratepayers challenged FERC’s decisions on the disposition of SFPP’s accumulated deferred income taxes (ADIT) and its allocation of litigation costs as too favorable to SFPP. Each of the four holdings in SFPP is discussed below.

Background

This SFPP decision is a sequel to the court’s decision in United Airlines, Inc., et al. v. Federal Energy Regulatory Commission.1 In United Airlines, the court addressed SFPP and a FERC policy statement that permitted SFPP to recover an income tax allowances through its cost of service charged to ratepayers. Ratepayers in United Airlines challenged the recovery of an income tax allowance by a master limited partnership on the ground that rates are computed and approved on a pre-tax basis that does not include an allowance for income taxes because a partnership is not taxable at the entity level. Ratepayers challenged the FERC policy statement as permitting carriers to recover costs from ratepayers that the carriers do not, in fact, incur. In United Airlines, the court rejected FERC’s policy statement as creating an unjustified “windfall” for SFPP’s partners and remanded the FERC policy statement for FERC “to consider these or other mechanisms for which the Commission [FERC] can demonstrate that there is no double recovery.” Prior coverage by Eversheds Sutherland of United Airlines is available at this link.

As a result of United Airlines, in a revised policy statement, FERC announced that it would no longer allow master limited partnerships to recover an income tax allowance in their cost of service. The same day that the revised policy statement was adopted, FERC denied SFPP an income tax allowance on the basis that it would result in double recovery of income tax costs.

Income tax allowance

The first issue in SFPP was whether the FERC revised policy statement that denied SFPP’s recovery of an income tax allowance in SFPP’s cost of service was lawful. SFPP argued that FERC’s revised policy statement is contrary to the court’s decision in ExxonMobil Oil Corp. v. FERC2 and that FERC was arbitrary and capricious in the application of the United Airlines decision.

The court began its analysis by noting that rates must be “just and reasonable” and that pipelines that pay income taxes are entitled to recover the costs of those taxes from ratepayers. Master limited partnerships, such as SFPP, however, incur no income tax at the entity level. Thus, FERC’s revised policy statement was vitally important. The court noted that it had previously vacated two previous FERC policy statements, quipping that the third time was the charm for FERC. The court reviewed FERC’s actions under the Administrative Procedure Act and concluded that FERC acted consistently with the court’s precedent and that such action was reasonably explained. Accordingly, the court denied SFPP’s petition for review of this issue.

Reopening the record

Following the issuance of the revised policy statement, FERC denied SFPP’s request to reopen the record on the issue of the income tax allowance. With respect to the decision not to reopen the record, the court held that FERC’s decision was neither an abuse of discretion nor an arbitrary action. In reaching this decision, the court noted that reopening is permissive, is within FERC’s discretion, and is reserved for extraordinary circumstances not present in this case.

Index rates

The third issue raised was whether FERC unlawfully required SFPP to use its originally filed index rates in its compliance filing. SFPP’s compliance filing used index rates that were slightly higher than the original index rates that SFPP had filed and FERC had accepted. FERC ordered SFPP to use its originally filed index rates, listing five reasons for holding SFPP to the originally filed index rates. Rather than address SFPP’s arguments, the court considered the five reasons given by FERC and summarily concluded that “SFPP provides no substantial basis to question that well-reasoned decision.” Thus, the court held that FERC reasonably rejected SFPP’s proposed rate adjustment. Although decided in favor of FERC, this was not the central issue in the case.

ADIT balance

The case also involved a petition by certain ratepayers, who are shippers, concerning an ADIT balance that had accumulated between 1992 and 2008.3 Following FERC’s decision on the policy statement, SFPP removed the ADIT balance from the cost of service. The ratepayers argued that the ADIT balance was overfunded as a result of the elimination of the income tax allowance and that the balance should be returned to them. The court held in favor of SFPP that ratepayers had no equitable interest or ownership in the ADIT balance and that refunding ADIT to ratepayers or continuing to exclude it from the rate base would violate the rule against retroactive ratemaking.

The ratepayers also challenged FERC’s decision to allow SFPP to recover litigation expenses related to this case over a three-year period, through a surcharge, allowing SFPP to develop it to reflect the costs incurred during the hearing, rehearing, and compliance phases. Instead, the ratepayers argued that the costs should be spread over the entire litigation and refund period—more than 11 years. The court disagreed with the ratepayers again, finding that the FERC decision was reasonable in its explanation, especially in light of the fact that 85.9% of the costs were incurred by SFPP during the three-year period covered by the FERC decision.

Next steps

SFPP has 90 days to file a petition for a writ of certiorari to the US Supreme Court. Similarly, ratepayers have 90 days to appeal the ruling on the ABIT balance. The technical issues in this case are complex. However, the court was largely able to sidestep this complexity by focusing on the administrative conduct of FERC. The four holdings in SFPP are uniform in their upholding of FERC’s administrative conduct. For this reason, we anticipate that FERC will rely on the precedent in SFPP in other ongoing and future litigation.

1 827 F.3d 122 (DC Cir. 2016).
2 487 F.3d 945, 953 (DC Cir. 2007). In Exxon, the court found that FERC’s policy of permitting master limited partnerships holding pipelines to receive an income tax allowance was “not unreasonable.”
3 ADIT represents the tax deferral (at statutory rates) attributable to the use of accelerated depreciation for federal income tax purposes and straight line depreciation for regulatory/book purposes. It reflects the timing difference of the two deductions, a difference that reverses when regulatory/book depreciation exceeds tax depreciation. By eliminating the recovery of tax expense by SFPP, the ADIT is essentially a permanent item that will not reverse and thus can be eliminated.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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