Background

In Resolution W-4356, October 24, 2002, the Commission granted PAWW a $70,137 or 56.9% rate increase, subject to refund. About a year earlier, the Commission had also granted PAWW a $47,677 or 62.3% rate increase, also subject to refund, based on a finding that such an increase was necessary to provide sufficient funds to meet PAWW's cash operating expenses with no depreciation or rate of return on rate base. The Commission noted that PAWW's last rate case was in 1991, and that PAWW operated at a loss of $56,687 in 2000. As part of its review leading up to Res. W-4356, the staff conducted two public meetings in Point Arena and prepared an extensive staff report with accompanying audit of the utility's 2000 books of account.

The City of Point Arena (City) objected to the rate increases requested by PAWW and disagreed with staff's review. At the staff's recommendation, the Commission converted this advice letter rate case to a formal proceeding in Resolution W-4356.

Among its other issues, the City differed with PAWW and staff regarding the proper ratemaking treatment of an income tax refund to PAWW from the 1990s. The staff auditor concluded from PAWW's records, that (1) the tax refund had been obtained by PAWW at its own expense, and (2) the money had been used to meet operating and maintenance expenses that utility revenue failed to cover. Accordingly, the auditor recommended the tax refund not be used to lower prospective rates. The City disagreed. In Res. W-4356, the Commission noted that "This difference of opinion can be addressed in the formal proceeding...."

On March 20, 2003, the assigned Administrative Law Judge (ALJ) convened a prehearing conference (PHC). The tax refund was among the matters discussed at the PHC, and the ALJ set a briefing schedule on the question of "whether or not this issue should be in this proceeding." The ALJ also set a procedural schedule for the remainder of this proceeding. As noted above, the rate increase proposals at issue here have been through an extensive informal review process with our staff, including an audit and a staff report. PAWW and our staff indicated at the PHC that they would rely extensively on these previously prepared analyses to make the required showing.

The tax refund has great significance for revenue requirement, with the potential of completely offsetting current rate base. Consequently, resolution of this issue is key to the scope of the subsequent portions of this proceeding. The parties have filed extensive opening and reply briefs, with accompanying documentation.

In its initial brief, PAWW provided documents (including copies of cancelled checks) showing that the net state and federal tax refund was $184,954 and that it had been received by 1995. PAWW also showed that customers did not pay any of the costs of obtaining this refund. PAWW explained that in 1993 AT&T Communications, Inc. (AT&T) agreed to fund a new water main that would enable PAWW to provide fire protection to Point Arena City Hall and High School. AT&T entered into such an agreement to promote good will with the community due to a series of construction failures, with resulting environmental degradation, when crossing streams with its fiber optic cable system. AT&T paid $660,236.79 to PAWW for the costs of the water main. At the time, AT&T and PAWW believed that federal tax law would characterize such a payment as a contribution in aid of construction, and that the payment would be taxable income to PAWW. Consequently, AT&T and PAWW agreed that AT&T would pay to PAWW the amount of the expected tax in addition to actual construction costs. PAWW then remitted the tax amount to the state and federal taxing authorities. PAWW subsequently came to believe that changes in the tax laws had resulted in this type of construction payment being no longer considered income. PAWW decided to seek a refund, and AT&T declined to participate in the effort or to share in any amounts recovered. PAWW successfully obtained state and federal refunds.

In its initial brief, the City contended that AT&T's total payment, including the amount for taxes, to PAWW should be included in PAWW's contributions in aid of construction account. For ratemaking purposes, contributions in aid of construction are an offset to ratebase, so the City's proposal would have the effect of reducing ratebase by the amount of refund. The City calculated the total refund to be about $519,000. The City also argued that the alleged misuse and disappearance of this amount from PAWW's accounts has a significant and continuing impact on the financial capability of the company to provide safe and efficient service.

In its reply brief, PAWW vigorously contested the City's calculation of the amount at issue and referred to the documents attached to its opening brief. PAWW also contended that the City's proposal to use the tax refunds as an offset to rate base would effectively deny PAWW an opportunity to earn a rate of return and would violate the rule against retroactive ratemaking.

The City, in its reply brief, alleged that PAWW had illegally removed the tax refund amount from the contributions in aid of construction account and paid it to the shareholder and affiliated businesses, and that restoring it to the account would correct this error.