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Phantom Taxes: The Big Paycheck

Fortnightly Magazine - July 1 1996

them.7 These rulings were based on a very rigid technical construction of governing statutes and regulations. State regulators should take steps to ensure that history does not repeat itself with electric industry ADFITs.

Third, ADFITs are easier to give than to receive. The IRS has rejected all efforts by state regulators to flow ADFITs through to ratepayers faster than utilities recover the cost of associated plant from ratepayers, or to permit ratepayers to recover any ADFITs associated with disallowed plant.8 At the same time, however, the IRS has approved a plan that permits a troubled utility to improve its common equity by, in essence, absolving it of its ADFIT obligation to ratepayers (specifically, its ADITCs). The IRS has also proved receptive to plans that permit shareholders to retain the benefits of ADFIT. So, although regulators cannot accelerate ratepayer recovery of ADFIT advances or flow the ADFIT benefits associated with deregulated assets through to ratepayers, they can allow utilities to renege on paying back ADFITs.

Fourth, ADFITs may be better to give than to receive. Although the issue requires further study, ADFITs might be the ideal currency with which to redeem true generation sector competition (em a currency worth more in the hands of the utilities than ratepayers:

s ADFITs act as an interest-free, long-term loan from ratepayers to shareholders. The discounted value of their anticipated payback to ratepayers is less than their stated balance sheet amounts.

s Although ratepayers have historically benefited because ADFITs reduced rate base, the shift to performance- and market-based ratemaking undermines the value of that benefit.

s Most important, the value of utility ADFIT obligations forgiven by ratepayers is probably not taxable income to utilities.

Fifth, if deregulation necessitates writing down nuclear generation plant to market value, regulators should offset any resulting shareholder obligation for "stranded assets" against ADFITs (see sidebar). This offset could also be applied to ADFITs associated with transmission and distribution plant, if the need should arise.

To argue the stranded-asset issue without putting ADFIT on the table is not only one-sided,

but ignores a solution that could benefit all parties. t

David Wise is president of WiseEnergy Inc. in Maplewood, NJ. He is a former senior attorney for Consolidated Edison Co. of New York and also spent four years as a trial attorney in the Tax Division of the Department of Justice. Mr. Wiseis incoming chair of the Federal Energy Bar Association's Tax Developments Committee.

Using ADFITs to Redeem Stranded Assets

Let's assume that nuclear utility XYZ has a net book value (i.e., original cost less depreciation) of $2.5 billion, a basis for income-tax purposes of $0, a market value under deregulation of $500 million, and ADFITs to the tune of $1 billion. XYZ's balance sheet for utility plant, at original cost, would look something like this:

Electric

Other that nuclear $6 billion

Nuclear plant $4 billion

Total: $10 billion

Less Accumulated Depreciation $3 billion

Net utility plant: $7 billion

Total: $7 billion

Capitalization and Liabilities

Capitalization

Shareholder Equity $2 billion

Long-term Debt $3 billion

ADFIT $2 billion

Total: $7 billion

If ratepayers pay