VIII. Taxes

A. Income Taxes

The difference in income taxes estimated for TY 2006-2007 between DRA and San Gabriel are due to the differences in revenues, expenses, and rate base, and San Gabriel's failure to reflect the impacts of the American Jobs Creation Act of 2004 on its income tax expense.

The American Jobs Creation Act of 2004 provides for a deduction equal to 3% of qualified production activities income in 2005 and 2006 and 6% of qualified production activities income in 2007 and 2008. Under the Act, the production of potable water, including the acquisition, collection, and storage of raw water, qualifies as a production activity to which the deduction is applicable. As the applicable deduction is 3% for 2006 and 6% for 2007, DRA utilized an average deduction rate for TY 2006-2007 of 4.5%. San Gabriel has estimated the percentage of its net income applicable to production activities to be 51.9%. DRA has reviewed these estimates and finds them reasonable.

The application of the 51.9% production activities factor to DRA's calculated taxable income at present rates, along with the application of the 4.5% average deduction rate, results in a $246,100 reduction to taxable income. In flowing through the impact of the 2004 Act, the 51.9% production activities factor should be applied to the ultimate taxable income for federal income taxes resulting from this case, with the average 4.5% deduction rate then applied to determine the production activities deduction for income tax purposes. This also impacts the net-to-gross multiplier, reducing the effective FIT rate to 34.18%.

San Gabriel disagreed with the application of this adjustment stating that the Commission should open an OII or Order Instituting Rulemaking (OIR) to analyze the tax legislation and IRS guidance for ratemaking purposes. DRA says the Company would have the Commission ignore this tax deduction and ignore the reduction in income taxes that will result until some unknown future date. This is neither reasonable nor appropriate. The 2004 Act is already in effect, was in effect for tax year 2005 and beyond, and includes the production of portable water as an item of qualified production income to which the deduction is applied. San Gabriel points out that the Commission did not apply the impacts of the 2004 Act in the Company's recent Los Angeles Division rate case (D.05-07-044), and that it should not deviate from its past precedent. D.05-07-044 is irrelevant in this instance. D.05-07-044 was based on TY 2004-2005. The Act is in effect for TY 2006-2007 and is a benefit that is available to San Gabriel. We adopt DRA's recommendation.

DRA calculated tax depreciation for state and federal income tax by applying the ratio of DRA's estimate of net plant to San Gabriel's estimate of net plant, to San Gabriel's tax depreciation estimate.

In calculating the interest deduction, DRA used its recommended rate base, multiplied by DRA's recommended weighted cost of debt of 3.39%. The interest deduction is determined by applying the weighted cost of debt to the final rate base. The Company has agreed that this is the correct methodology. Since DRA has reached a settlement with the Company on capital structure and rate of return, the resulting weighted cost of debt for TY 2006-2007 is 3.39% based on the average of the 2006 and 2007 weighted cost of debt presented in Joint Exhibit 85. In the Joint Comparison Exhibit, Exhibit 88, DRA's final position reflects the interest deduction based on DRA's recommended rate base and the settled upon weighted cost of debt of 3.39% for TY 2006-2007. DRA and San Gabriel are in agreement on the methodology for calculating the interest deduction for income tax purposes and on the weighed cost of debt rate to use. The only remaining difference is the rate base amounts to which the weighted cost of debt is applied.

B. Other Taxes

Taxes Other Than Income include ad valorem taxes (property tax) and payroll taxes. San Gabriel included in TY 2006 - 2007, $1,034,500 for ad valorem taxes and $491,800 for payroll taxes. DRA's recommended TY 2006-2007 ad valorem taxes are $766,200 and payroll taxes are $431,700.

DRA's ad valorem figure differs from San Gabriel's due to DRA's different rate base estimates, which are discussed later. Payroll taxes include Social Security tax, Federal Insurance Contribution Act (FICA), Federal Unemployment Tax Assessment (FUTA), and State Unemployment Tax Assessment (SUTA).

DRA's recommended TY 2006-2007 payroll tax expense is $431,700, which is $60,000 less than the amount proposed by San Gabriel. DRA's recommendation flows through the impacts of DRA's recommended adjustments to payroll. San Gabriel and DRA agree on the amount for Other Taxes except for payroll. We adopt their recommendation but will use our independent findings on payroll.