4. The Commission did not err in refusing to deduct tax liability before allocating the Mid-Valley settlement proceeds.
San Gabriel challenges the Decision's holding that there is no tax liability on the gains related to the Mid-Valley settlement proceeds. (SG Reh. App., pp. 15 - 16.) San Gabriel elected to take advantage of Internal Revenue Code (IRC) section 1033, which permits in the case of involuntary conversions, that when property is converted into similar property, no gain shall be recognized. (D.07-04-046, p. 96, citing Int.Rev. Code, § 1033(a)(1).) The Decision reports that San Gabriel took advantage of this "tax avoidance provision . . . to the full extent permissible for its gains from contaminations and involuntary conversions," and notes that the purpose of IRC section 1033 is "to relieve the taxpayer of unanticipated tax liability."8 The Decision holds further:
[I]t follows that San Gabriel, having no tax liability, cannot charge the ratepayers for phantom taxes. The IRS has not challenged the tax liability; nor should we. We find there is no tax liability on the gains San Gabriel achieved from involuntary conversions and contaminations.
(D.07-04-046, pp. 96 - 97, emphasis added.) We stated our reliance on the evidentiary record9 to determine whether taxes had been paid, holding "on the facts of this case we are not deducting taxes." (D.07-04-046, p. 98.) Regarding the contamination settlement proceeds, based on the evidence developed in the proceeding, we concluded, "[t]here is no income tax." (D.07-04-046, pp. 98 - 99.)
It does not appear that San Gabriel is challenging the Decision's holding that, based on the evidence, San Gabriel did not pay or owe income tax on the gain before the allocation was calculated. Rather, San Gabriel explains:
In order not to pay federal and state income taxes immediately, San Gabriel must elect tax deferral, invest 100% of the net proceeds in replacement property, and reduce the tax basis of that property, thereby reducing the tax depreciation expense deduction in its future income tax returns.10
(SG Reh. App., pp. 16 - 17, emphasis added.) Thus, San Gabriel's claims on this topic address future tax liability.11 San Gabriel claims, "[t]he effect of IRC section 1033 is not a permanent tax exemption or avoidance, but merely a deferral of federal and state income taxes on the gain." (SG Reh. App., p. 16.)
Based on the evidentiary record, the Decision refuses to deduct an amount for taxes because San Gabriel had not paid such taxes. The Decision addresses the pre-allocation time period. We did not address the matter of who will pay future taxes related to tax depreciation expense deductions in future income tax calculations.
San Gabriel's discussion of the tax issue is largely a policy argument that seems to assume a prior unfavorable ruling on the question of future tax liability. San Gabriel argues that its shareholders will be faced with "a negative economic impact" that "will be astonishing," and that shareholders are left to pay 100% of the future income tax liability. San Gabriel also claims shareholders will pay an "out-of-pocket cost of $7.75 for every $100 recovered from polluters." (SG Reh. App., p. 17.) San Gabriel does not offer specific grounds for finding error related to these claims, but appears to base its arguments on an unstated assumption that ratepayers will not pay any part of future income tax payments related to the depreciable replacement property. It appears these arguments are based on an interpretation that the Decision has ruled on future tax consequences related to the IRC section 1033 election. The Decision does not include a ruling to that effect. Therefore, the argument is without merit.
San Gabriel's claims about future tax consequences do not identify an error in the Decision because the Decision does not address future treatment of future tax consequences. To avoid any possible confusion on this point, we will modify the Decision to state explicitly that it does not address future tax consequences of the section 1033 election.
San Gabriel also argues, in apparent acknowledgement that these tax matters can be addressed in future proceedings, that the "only question" is when ratepayers should pay their share. (SG Reh. App., p. 18, emphasis added.) This statement seems to acknowledge that Commission ratemaking procedures provide an appropriate forum for addressing tax matters when they arise.
San Gabriel argues:
"[i]f the ratepayers' obligation is deferred, those ratepayers who enjoy the benefit of the gains now will not be the same ratepayers who must, over the life of the reinvestment, cover the Company's income tax liability."
(SG Reh. App., p. 18.) San Gabriel provides no grounds for finding error based on this policy argument. We found that San Gabriel had not paid taxes and consequently we did not deduct taxes before allocating the proceeds. San Gabriel disagrees with our decision and wants us to deduct future taxes before the proceeds are allocated. As a basis for identifying error in the Decision, the above argument is without merit
San Gabriel also argues that our refusal to deduct future tax consequences conflicts with the recent gain on sale decision, which provided for allocation of after-tax gains and losses. (SG Reh. App., p. 18, citing Gain on Sale Decision [D.06-05-041], supra, p. 102, OP 25 (slip op.).) This argument misrepresents D.06-05-041, which provides the following explanation of after-tax gains:
The OIR proposed that any rule we develop here apply only to after-tax gains. In this way, if a sale caused a taxable gain, we would only allocate the net proceeds after taxes were paid.
(Id. at p. 46 (slip op.) emphasis added.) Thus, we do not include projected future tax obligations in our consideration of "after-tax gains." Decision 07-04-046 holds, and San Gabriel acknowledges, that it did not pay taxes on the gain. The phrase "after taxes were paid" does not apply to this fact situation, in which San Gabriel did not pay or owe taxes on the gain, or to San Gabriel's proposal to "allocate" tax liability before the taxes have been paid. The two decisions are not in conflict.
Further, questions related to contamination proceeds were explicitly excluded from the gain on sale proceeding. Even if D.06-05-041 supported San Gabriel's argument about deducting future income taxes from gains on sale (which it does not do) the gain on sale rulemaking proceeding explicitly did not address the matter of allocating contamination proceeds. As discussed above, it is our policy to consider contamination proceeds on a case by case basis. Again, the argument that D.07-04-046 conflicts with D.06-05-041 is without merit.
B. Rule 1 Violations
The Decision finds three violations of Rule 1 of the Commission's Rules of Practice and Procedure based on San Gabriel's failures to inform the Commission of material facts regarding the inclusion into rate base of land acquired for a new headquarters building. San Gabriel purchased the land, known as the "Tokay Avenue property," from an affiliate, Rosemead Properties, Inc. The Decision holds:
We find the company in violation of Rule 1 for three acts of omission: 1) San Gabriel did not disclose that the land they were seeking to include in ratebase was purchased from an affiliate, 2) San Gabriel did not disclose that the purchase price of the land they were seeking to place in ratebase was not based on a market price but rather based on an appraisal performed by an appraiser hired and paid for by the company, and 3) San Gabriel did not disclose the fact that the price paid by the utility was significantly above the price paid by the affiliate when it purchased this land only a year and a half earlier. For each of the three violations of Rule 1 of the Commission's Rules of Practice and Procedure we impose a fine of $20,000 for a total or $60,000.
(D.07-04-046, p. 126, FOF 88.)
San Gabriel argues that because the Commission stated the three Rule 1 violations for the first time in the final decision, it has been deprived of its right to due process. (SG Reh. App., p. 25.) There is merit in this argument. Upon reviewing the procedural history related to these violations, we are not satisfied that our procedures were sufficient regarding these issues.
Therefore, we grant a limited rehearing to consider whether San Gabriel violated Rule 1 by failing to disclose adequately in its GRC submittal, information related to its purchase of real property from an affiliate. The limited rehearing will also consider appropriate penalties if violations are found. Because we are granting rehearing, we will delete the Decision's discussion of these matters.
San Gabriel requests refund of the $60,000 in penalties that it submitted, pursuant to D.07-04-046. (D.07-04-046, p. 129, Ordering Paragraph 8.) Because a limited rehearing is being granted, this penalty amount will be subject to refund, depending on the outcome of that proceeding. Disposition of these funds will be addressed in the limited rehearing
C. Sales to CSI
San Gabriel challenges the Decision's reliance on DRA testimony regarding future sales to California Steel Industries (CSI) claiming that it is arbitrary and unlawful. (SG Reh. App., pp 33 - 35.) San Gabriel assumed in its showing that, because CSI was rehabilitating a well in order to produce its own water, it would utilize the full 1,300 acre feet of water to which it has water rights. (Ex. 10, p. 14 (McGraw/SG).) Saying that San Gabriel had not produced persuasive evidence regarding CSI's water demand, the Decision adopted DRA's recommendation to reduce by 50% San Gabriel's projected reduction in sales to CSI. (D.07-04-046, pp. 5 - 6; Ex. 45, p. 2 - 4 (DeRonne/DRA).)
San Gabriel argues that the evidentiary record does not support the Decision's adoption of DRA's proposed adjustment. (SG Reh. App., p. 34.) San Gabriel references DRA witness DeRonne's testimony in which she stated that San Gabriel had not "provided any support for the assumption that CSI will utilize its full 1,300 acre feet of water rights," and that "no information has been provided regarding the projected amounts CSI intends to self provide." (Ex. 45, pp. 2-2 - 2-3 (DeRonne/DRA).) San Gabriel argues the recommended adjustment was "arbitrary and unsubstantiated." (SG Reh. App, p. 34.)
San Gabriel cites testimony in which its General Manager recounted a meeting with CSI and characterized CSI's statements in the meeting as explaining "a business decision . . . to pump and produce their own water and utilize their 1300 acre-feet of . . . water rights." (Ex. 10, p. 14 (McGraw/SG).) San Gabriel also cites rebuttal testimony in which another San Gabriel witness testified:
There is no reason to believe they will abandon their plan after having spent nearly one million dollars to redevelop their wells.
(Ex. 21, p. 3 (LoGuidice/SG).) However, the McGraw testimony also revealed that San Gabriel was trying to retain CSI as a "full-use customer." He testified:
As explained . . . in the meeting, the company is considering options and alternatives available in order to retain CSI as a full-use customer. . . . Further discussions will take place between the company and CSI on this matter.
(Ex. 10, p. 15 (McGraw/SG).) Consistent with this, in a follow-up letter after the meeting with CSI, Mr. McGraw stated:
As Mr. LoGuidice explained Fontana Water Company remains ready, willing, and able to continue meeting all of CSI's water service needs and the company maintains sufficient water supply resources to supply water in the quantities and at the rates of flow that CSI normally requires.
(Ex.10, Attachment J (McGraw/SG) emphasis in original.)
On cross-examination, witness DeRonne explained DRA's recommendation, saying:
. . . we don't dispute the entire adjustment. We do reflect in our recommendation that CSI will begin - - the assumption is that they will begin producing and using some of their own water from their own well. Our dispute is the amount that CSI will begin to use and produce for its own consumption is unknown at this point.
(R.T., vol. 4, p. 367 (DeRonne/DRA.)
San Gabriel asserts that the DRA adjustment was arbitrary and unsubstantiated and "in clear conflict with the facts in evidence," and also that the DRA witness ignored certain factual information. (SG Reh. App., p. 34, 35.) This argument is without merit. Even if a party's testimony were arbitrary or in conflict with certain evidence, that would not be grounds for finding legal error in a Commission decision. In exercising our expertise, we weighed the evidence in the record and determined the relative merit of the evidence. In this case, we adopted DRA's recommended adjustment. Based on the evidence, we reached the conclusion that, "San Gabriel has not produced persuasive evidence regarding CSI water demand . . ." (D.07-04-046, p. 6.) As itemized above, the record reveals some uncertainty about CSI's future water demands. The claim of legal error is without merit.
San Gabriel also argues that the Decision inaccurately paraphrases DRA testimony when it says that a CSI officer contacted by DRA "could not give clear-cut information regarding amounts CSI intends to self-provide," when the witness actually said, "no information has been provided regarding the projected amounts CSI intends to self provide as compared to its owned water rights." (SG Reh. App., p. 34, citing D.07-04-046, pp. 5 - 6; Ex. 45, p. 2 - 3 (DeRonne/DRA).) We will modify the Decision to conform more closely to the DRA testimony; however, the error is harmless and, as grounds for rehearing, is without merit. Modifying the statement will not alter the Decision's outcome on this issue because the Decision cites the overall lack of "persuasive evidence," as the reason for adopting DRA's estimate. (D.07-04-046, pp. 5 - 6.) The Decision's reference to CSI does not constitute grounds for granting rehearing.
8 Under the heading, "Income Taxes," the Decision addresses gains from various sources, however, in its Application for Rehearing, San Gabriel questions only taxes related to the Mid - Valley Settlement.
9 In its opening brief DRA addressed the tax issue saying: "DRA does not recommend that the net gain be reduced for income taxes. There is no evidence that taxes have been paid, and it is Commission policy to use flow-through accounting for income taxes . . . DRA recommends that the Commission policy to use flow-through accounting for income tax purposes be adopted and zero taxes be reflected as an offset to the gain to be reflected as CIAC." (Opening Brief of the Division of Ratepayer Advocates, March 24, 2006, p. 94, emphasis added.)
10 San Gabriel includes the following footnote at this point in the text: "This begs the question of whether the Commission's treatment of the property as a contribution in aid of construction means there is no depreciable basis whatsoever and no resulting tax deductions at all - thereby leaving San Gabriel with the tax bill on all the proceeds." (SG Reh. Ap., p. 17, fn. 6.) San Gabriel does not state a position or base an allegation of error on this point.
11 In comments on the proposed decision San Gabriel explained its position as follows, "[t]he fair approach is to recognize the eventual income tax liability and . . . to allocate tax liability consistently with allocation of the net proceeds themselves . . ." (Comments of San Gabriel Valley Water Company on Proposed Decision of Administrative Law Judge Barnett, February 26, 2007, p. 7, emphasis added.)
