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FERC Denies Partnership Income Tax Allowance

Fortnightly Magazine - August 1995

For the first time, the Federal Energy Regulatory Commission (FERC) has issued opinions disallowing income tax allowances in the cost of service with respect to income from limited partnership interests held by individuals. In Lakehead Pipe Line Co., Ltd. Partnership, the FERC found that allowing a tax allowance for limited partnerships made up of individuals would give the investors an after-tax return on equity higher than they are entitled to (Docket Nos. IS92-27-000, et al.). The FERC explained that when partnership interests are held by corporations, the partnership is entitled to a tax allowance in its cost of service for those corporate interests because the tax cost will be passed on to the corporate owners, who incur corporate income taxes. In KansOk Partnership, the FERC said that the pipeline's highly complicated ownership structure and sparse record made it impossible to determine which partners actually paid corporate income taxes on KansOk's earnings (Docket No. PR94-3-000). Although KansOk failed to support its claim to corporate tax allowances with evidence that its partners actually will incur corporate taxes, the FERC allowed the pipeline 15 days to demonstrate that its partners are corporations and so qualify for an allowance.Meanwhile, Lakehead is aggressively exploring all strategies to acquire a full income tax allowance. Not only will it request a FERC rehearing, it is also prepared to take its case to the U.S. Court of Appeals to ensure the continued financial integrity of the partnership structure. FERC Commissioner Donald F. Santa, Jr. said the change in policy was needed because the types of partnerships are changing, but that the issues likely would be revisited.

Meanwhile, other pipelines set up as partnerships are worried enough to have a few things to say about Lakehead. Enron Liquids Pipeline, L.P. expects no adverse effects on earnings or cash flow from the decision because about 50 percent of its revenues are not regulated by the FERC. Enron also says that it charges its regulated pipelines less than what would theoretically be allowed under the FERC's cost-of-service methodology, adjusted for the anticipated impact of the loss of the tax allowance. But according to Diane Bazelides, spokeswoman for Enron and its affiliate, Northern Border Partners, L.P., the companies felt they had to respond to the investment community because Northern Borders stock dropped $2 per share in reaction to the decision. Enron Liquids shares also went down, but not as much.

Thomas Lambert, manager of investor relations for Santa Fe Pacific Pipeline Partners, L.P., says his company experienced a $3.50 loss in unit price the day after the decision, and another $2.25 after that. But he terms the loss an "overreaction," noting that Santa Fe later gained back $4. Lambert does not view the decision as favorable, however, and says Santa Fe will join with Lakehead to do whatever they can "to help the commission see what they've done." Santa Fe presently has a rate proceeding before the FERC.

Stock prices for Leviathan Gas Pipeline Partners, L.P. also dropped following the decision, from $25 a share to about $22.50. Leviathan spokesman Dennis Kunetka says that

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