LWB of Water Division

Testifying for LWB were Gilbert C. Infante, Program and Project Supervisor in charge of the Regulatory Review Section of the Monopoly Regulation Branch, and Sung B. Han, Senior Utilities Engineer and Project Manager for this proceeding.

Infante stated that the purpose of his testimony was to clarify the record regarding the TRA and the Commission's Order Instituting Investigation which resulted in D.88-01-061. Infante participated in the OII with the Commission Public Staff Division, the predecessor to DRA. He testified that SJWC has never been expressly authorized by Commission decision to capitalize IDC either for accounting or ratemaking purposes and the TRA OII did not authorize this.

Han testified that traditionally the Commission compensated construction investment by either allowing CWIP in rate base, or by allowing capitalizing AFUDC or IDC. Between 1988 and 1995 SJWC had done both, without formal approval by the Commission. Han believes that adjusting their rate base for the effect of this is appropriate. LWB further believes that ratepayers face paying twice for the income tax liability, since CWIP in rate base must be increased by the tax effect of about 35% and when CWIP capitalized IDC, the ratepayer has to pay tax on it. The double taxing refers to different taxes and different time periods.

Regarding LWB's burden of proof to show that SJWC committed fraud and concealment in including capitalized IDC in rate base, as it alleged, Han testified that it is not necessary for LWB to demonstrate that allegation in order to adjust rate base. Therefore, the assigned administrative law judge ruled that the issues of fraud and concealment would not be considered in this proceeding in the absence of evidence of willful intent by SJWC.

Discussion

Phase 2's purpose is to determine whether capitalization of IDC in rate base does not change SJWC's revenue requirement. In another manner of saying this, the question is whether the ratepayer is neutral to SJWC's use of both CWIP and IDC on CWIP in rate base. By adopting the 1996 Stipulation, that issue is handled for post 1995 ratemaking purposes. For the 1988-1995 period that is the focus of this discussion, IDC is included in rate base and CWIP is excluded.

A short review of the history of this matter is in order, beginning with the language of D.88-01-061, which resulted from the Tax Reform Act of 1986 (TRA):


"CWSC and SJWC comment that water utilities in general have very minimal amounts in construction work in progress and that the income tax effect of the differential in interest rates applied to these small amounts of construction is de minimus [sic] but that the potential accounting requirements are staggering. CSWC [sic] and SJWC recommend that water utilities be allowed to use the same interest rate for capitalizing interest on construction for ratemaking purposes as for income tax purposes on all construction on which no AFUDC rate has been authorized. We find the proposal reasonable and will adopt such proposal for water utilities."

SJWC argues that this decision provides that CWIP need not be changed for water utilities, and it continued to do so as it had previously. With regard to IDC, since the decision ordered that the same interest rate be used for capitalizing interest on construction for ratemaking purposes as for income tax purposes, SJWC believes that this means it was also allowed to capitalize IDC into rate base.

LWB on the other hand argues that nowhere in the decision or in any Commission document are water utilities ordered or allowed to use both CWIP and IDC in rate base. The TRA decision merely specifies that the interest rate used for IDC be the same for ratemaking and for income tax purposes.

Interim D.96-07-036 dated July 17, 1996 in this proceeding ordered that SJWC establish a memorandum account to track the difference in revenues collected between using only IDC in rate base, as proposed by LWB, and using both IDC and CWIP in rate base, as SJWC had been using, for calendar years 1988 through 1995.

We have already disposed of the issue of fraud and concealment, as mentioned previously. Whether SJWC is correct on its interpretation of the TRA and D.88-01-061 is immaterial now. The only relevant issue is revenue neutrality as it affects the ratepayer. SJWC acknowledges that the company's method of compensating for using both CWIP and IDC in rate base did not fully compensate, and it is not revenue neutral. Thus, at issue is what should be done.

SJWC argues that any change to rate base now would be retroactive ratemaking. LWB argues that changes ordered to rate base for prospective rates do not constitute retroactive ratemaking, rather merely in effect true up the rate base to the level it should be. The past disadvantage to ratepayers cannot be corrected now.

We agree with LWB, that the rate base should be corrected for future ratemaking by removing the additional rate base that should not have been placed there. We do not criticize SJWC for using both CWIP and IDC in rate base in the past period, as it may have thought doing so was correct, and SJWC attempted in good faith to make the ratepayers neutral in this matter, but failed to do so completely. Nevertheless, the method used is not correct.

SJWC, LWB and CWS jointly filed a Motion for Adoption of Stipulation on July 6, 1997. The Stipulation, representing a compromise by the parties, provides for the following, upon adoption by the Commission:

The parties agree that the amount in the memorandum account relating to Ordering Paragraph 8 of D.96-07-036 is $690,100, which is the cumulative disputed amount of IDC capitalized between calendar years 1988 and 1995. If we find that SJWC is entitled to include that in rate base, then the stipulated rate base reduction would be reduced by that amount. If we find otherwise, that amount or some portion thereof would not be allowed recovery in rate base. Regardless, any rate base reduction will be accomplished by closing the memorandum account and adjusting to SJWC's balancing account accordingly by Advice Letter filing.

We will adopt the stipulation, and order the memorandum account be closed on the effective date of this decision. At that time, the CWIP of $1,945,472 is removed from rate base and IDC of $160,962 is added to rate base. For prospective rates only IDC is allowed, CWIP is not.

In considering the issue of IDC capitalized from 1988 to 1995, we note that although the adjustment clearly did not achieve the goal of making ratepayers neutral, SJWC's adjustment to its revenue requirement nevertheless accomplished some degree of compensation to ratepayers. Thus we believe that it is equitable to allow some portion of that IDC in rate base. We have a tabulation of the tax adjustments compared to the actual recorded capitalized interest for the years 1988 thorough 1995. This document, Exhibit 21, prepared at the request of the assigned Administrative Law Judge, shows that the cumulative net-of-tax adjustments for those years was $177,331, compared to the recorded capitalized interest amount of $1,705,246. Thus the adjustments totaled only about 10% of the actual amount which SJWC intended to adjust. Exhibit 21 also demonstrates that even the gross-of-tax adjustments would not have made rate payers neutral, because the adjustments were on an estimated basis, and as SJWC witness Meyer acknowledged, the estimates were reasonably close until 1992 and 1993 when the Austrian Dam Spillway Project caused the forecasted amounts to be substantially understated. That project alone accounted for $689,413 in capitalized interest, far exceeding both the actual net-of-tax adjustments, and the calculated gross-of-tax adjustments. We will use this adjustment percentage as our basis for determining the appropriate addition of IDC to rate base. Accordingly, we will allow SJWC to record 10% of the $690,100 IDC, or $69, 010 in rate base.

We will approve the Stipulation in the order that follows.

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