De Kamp, 042883 CAAGO, AGO 82-804

Docket Nº:AGO 82-804
Case Date:April 28, 1983
JOHN K. VAN DE KAMP Attorney General
JOHN T. MURPHY Deputy Attorney General
AGO 82-804
No. 82-804
California Attorney General Opinion
Office of the Attorney General State of California
April 28, 1983
         THE HONORABLE NORMAN S. WATERS, A MEMBER OF THE CALIFORNIA ASSEMBLY, has requested an opinion on the following question:          Is the accelerated cost recovery system (ACRS) authorized by the Economic Recovery Act of 1981 constitutional when applied to state-regulated public utilities?          CONCLUSION          The accelerated cost recovery system (ACRS) authorized by the Economic Recovery Act of 1981 is constitutional when applied to state-regulated public utilities.          ANALYSIS          Users of the products and services of a state-regulated public utility pay that utility "just and reasonable" rates set by the California Public Utilities Commission (CPUC). (Cal. Const., art. XII, § 3; Pub. Util. Code, § 451.) These rates are calculated on the basis of two major considerations: (1) determination of "cost of service," i.e., the operating expenses of the utility, and (2) determination of a "reasonable return" on the utility's investment, "which is found by multiplying its authorized rate of return by the value of property devoted to a public use (rate base)." (Southern Cal. Gas Co. v. Public Utilities Com. (1979) 23 Cal.3d 470, 474; County of San Francisco v. Public Utilities Com. (1971) 6 Cal.3d 119, 129.) As to the first consideration, federal income taxes are a part of a utility's cost of service and, as such, are passed on to the ratepayers in the ratemaking process. (Southern Cal. Gas Co. v. Public Utilities Com., supra, at p. 474.)          In August 1981, the federal Economic Recovery Tax Act of 1981 (ERTA; Pub.L. 97-34; 95 Stat. 172) was signed into law.1Among the features of this law was the establishment of an accelerated cost recovery system (ACRS) for federal income tax treatment of property placed in service after 1980. (Int. Rev. Code, § 168.) Generally, ACRS allows the cost of a tangible, depreciable capital asset ("recovery property") to be recovered over a period of time which may be shorter (thus, more rapid or accelerated) than a period based on the useful life of the asset or the income-producing life of the asset. For recovery property other than real property, the cost recovery period is determined by the asset class life (3, 5, 10 or 15 years). Such property may be written off, with corresponding yearly tax deductions, at specified percentages applied to the unadjusted basis of the property. Real property which qualifies as recovery property is assigned a 15-year cost recovery period at percentages set forth in Treasury Department regulations under specified formulas. (Int. Rev. Code, § 168(b)(2)(A) - (B).)          At the outset, our concern is with that part of the act (Int. Rev. Code, §168(e)(3)(A)) which conditions use of ACRS upon application of a "normalization" accounting procedure:
"The term 'recovery property' does not include public utility property (within the meaning of section 167(1)(3)(A))2if the taxpayer does not use a normalization method of accounting". (Emphasis added.)
         Under a normalization method the utility computes and pays its federal income tax using ACRS, thereby deducting larger depreciation allowances from current tax liability than would be allowable under a straight-line depreciation method.3However, for ratemaking purposes the utility's federal income tax is recomputed as if the straight-line method rather than the ACRS method had been used and the recomputed federal tax liability is incorporated into the tax expense component of cost of service. The difference between the actual federal tax paid and the recomputed federal tax is entered in the utility's books as a reserve for deferred taxes. (See City of Los Angeles v. Public Utilities Com. (1972) 7 Cal.3d 331, 339, fn. 3.)          On the other hand, in the ratemaking process, the utility's actual federal tax liability might be passed on to the ratepayers in the tax expense item of cost of service. This alternative to normalization is known as "flow-through."          On December 15, 1981, the CPUC issued an interim decision in case no. 93848.4The CPUC made the following findings of fact (Slip Opn., pp. 17-18):
"1. The Act [ERTA] makes a number of changes in the tax law that impact all ratepayers.
". . . . . . . . . . . . . . . . . . . . . .
"3. Under ACRS the cost of an asset is recovered over a predetermined period generally shorter than the useful life of the asset or the period the asset is

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