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03/09/87 Citizens Utilities Company v. the Illinois Commerce

March 9, 1987





504 N.E.2d 1367, 153 Ill. App. 3d 28, 105 Ill. Dec. 849 1987.IL.269

Appeal from the Circuit Court of Will County; the Hon. Herman S. Haase, Judge, presiding.


Justice Heiple delivered the opinion of the court. Barry, P.J., and Stouder, J., concur.


Citizens Utilities Company of Illinois (Citizens) appeals from a decision of the circuit court of Will County affirming two orders of the Illinois Commerce Commission (Commission). The Commission orders appealed from reduced Citizens' rate base, altered the manner in which one of Citizens' utility plants was treated for tax purposes, and denied Citizens any working capital allowance. We reverse and remand for further proceedings.

A certain amount of background information is necessary to understand the Commission's orders and our ruling in this case. As apparently is common in the water and sewer utility industry, Citizens acquired a plant which was financed and built by the developer of a subdivision. The developer deeded the plant to Citizens under a contract which obligates Citizens to make payments to the developer based on the revenues the utility company receives from its customers in the subdivision. A utility plant taken over from a developer in the manner described is known as a plant acquired by contract (contract plant).

Operating utility plants which provide service to customers are usually included in a utility's rate base and the formula used to determine the rates a utility may charge its customers. The depreciation expense associated with plants in service is usually an allowable expense for ratemaking purposes. Contract plants are treated differently, however, because they are funded by developers rather than the utility. Therefore, contract plants are not included in a utility's rate base, and depreciation expenses associated with the contract plants are not allowable expenses for ratemaking purposes.

Depreciation of contract plants is treated differently for Federal income tax purposes than it is for ratemaking purposes. Each year, Citizens Utilities Company , Citizens' parent company, files a consolidated Federal income tax return for itself and its subsidiaries, including Citizens. In calculating its taxes, CUC is allowed by Federal law to deduct depreciation expenses on all of its tangible property, including any contract plants, and thereby reduce the group's taxable income and the resulting tax expenses.

Under established principles of law, a public utility is entitled to the opportunity to earn a fair return on the property it uses to serve the public. In addition to a fair rate of return, a utility company is entitled to recoup allowable expenses through the rates it charges. Income tax expenses for utility plants, including contract plants, are in the category of allowable expenses.

With the above necessary background information, the relevant facts in this case are as follows. Citizens is a public utility which provides water and sewer service to approximately 22,000 customers in several service areas in northern Illinois. From 1958 through 1982, the Commission allowed Citizens to recover in its rates income tax expenses which were calculated as though no depreciation were claimed on the contract plant. These income tax expenses were allowed, because as previously noted, depreciation of a contract plant is not allowed for ratemaking purposes. In reality, however, CUC, Citizens' parent, was allowed to depreciate the contract plant for Federal tax purposes from 1958 through 1982 and thereby reduce its level of income taxes. Therefore, some of the income tax expenses which were charged to the ratepayers and recovered by Citizens in its rates were not in fact paid to the Federal government by CUC.

In March 1984, Citizens filed an application with the Commission seeking, inter alia, approval of the manner in which Citizens treats the Federal tax benefits associated with its contract plant. The Commission entered its order in this case on January 30, 1985. According to the Commission's calculations, between 1958 and 1982, Citizens' recovered $4.2 million more for tax expenses related to the contract plant than was ever owed or paid to the Federal government. The Commission determined that the $4.2 million in tax benefits was actually a form of cost-free capital provided by Citizens' customers. Based on this determination, the Commission ordered that the rate base used to establish Citizens' future rates be reduced by $4.2 million to prevent Citizens from earning a return on capital which was not supplied by its investors. Additionally, the Commission reduced the income tax expense allowed to Citizens in the 1983 test year by $403,432, the amount of the reduction in CUC's consolidated income tax liability which was attributable to depreciation deductions on the contract plant. Citizens' petition for rehearing was denied and Citizens appealed to the circuit court of Will County.

On April 19, 1984, Citizens filed its proposed rate schedules with the Commission. Several intervenors, including appellee village of Bolingbrook, were permitted to take part in the proceedings. During the hearings conducted by the Commission, Citizens presented evidence that, based on a formulaic calculation, it was entitled to a working capital allowance of over $600,000. Although a utility's working capital allowance can also be determined from the results of a lead-lag study, the Commission staff witness testified that he, too, used the formula method in determining Citizens' working capital needs because that was a reasonable approach to use. In fact, the staff witness used Citizens' formula to calculate the $586,724 working capital allowance he recommended to the Commission for inclusion in Citizens' rate base.

The Commission ruled on Citizens' proposed rates on March 13, 1985. The Commission denied Citizens a working capital allowance on grounds that use of the formula method for the determination of a working capital requirement was unacceptable for Citizens. The order entered by the Commission further indicated that because Citizens is a large utility, it should bear the expense of conducting a lead-lag study to demonstrate an actual need for working capital. Because ...

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