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| Energy Currents: "FERC Issues Order Favorable to MLPs On Income Tax Allowance" |
| December 20, 2005 |
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In a case in which Vinson & Elkins represented SFPP, L.P., the Federal Energy Regulatory Commission (FERC) issued an order on December 16, 2005, among other things, applying its "Policy Statement on Income Tax Allowances" to certain of SFPP’s interstate rates. Overall, FERC’s rulings on Income Tax Allowance (ITA) are favorable to SFPP, an oil pipeline owned by a master limited partnership (MLP).
— FERC concluded that if a partner is required to file a Form 1040 or Form 1120 return that includes partnership income or loss, the partner has an actual or potential income tax liability for the partnership meaning that the requirement alone is sufficient to carry the burden of proof for the regulated entity that an ITA will be appropriate if certain other requirements are met, as discussed below (p. 28).
— FERC adopted a presumption that corporate partners owning interests in SFPP or KMEP pay a marginal income tax rate of 35% (p. 30) and adopted a presumption of 28% marginal income tax bracket for entities other than those filing a Form 1120 and for entities deemed to have unrelated business taxable income (UBTI) (p. 32). Municipalities and other exempt entities are presumed to have a marginal income tax rate of zero. The weighted marginal income tax bracket of the different unitholders is to be used to determine the ITA (p. 34). FERC left open the opportunity to provide evidence that the income tax rate should be other than the presumptive rates (p. 32).
— FERC found that multiple levels of ownership will not foreclose the grant of an ITA as long as a partner that is subject to an actual or potential income tax level can be identified by the regulated entity (p. 33).
&mash; With respect to allocations which are different than in accordance with percentage ownership, FERC concluded that since the Policy Statement holds that any ITA should be based on the income tax imputed to the partners and any such allocations required by the IRS rationally reflect the current economic value of the assets a partner contributes, such allocations should be reflected in determining the ITA (p. 39).
— FERC concluded that it is SFPP's prerogative to allocate income and losses among its partners as it chooses as long as the maximum income tax rate imputed to individuals does not exceed the maximum corporate income tax rate (p. 43).
— FERC rejected arguments that were indirect attacks on FERC's Policy Statement, including that a partnership may not receive an ITA because it does not pay income taxes, that an ITA will result in over-recovery of a partnership's cost-of-service, that FERC created a "phantom" ITA to encourage investment, and that granting an ITA to a pass-through entity will result in ratepayer costs beyond those that are incurred through the corporate ownership form (pp. 16 and 17).
— FERC concluded that it was premature to determine if SFPP meets the Policy Statement's ITA standard and that further evidence, in the form of a compliance filing, was necessary for such a determination. Below are the guidelines for the ITA evidence:
A) SFPP must separate its partners (unitholders) into the following six categories and include supporting detail of the unitholders within each category: (1) C corporations; (2) individuals; (3) mutual funds; (4) pension funds, IRAs, Keogh Plans, and other entities that do not pay taxes but have taxpaying beneficiaries or owners; (5) entities in category (4) that may be taxpaying entities due to UBTI; and (6) exempt entities, such as municipalities. Pass-through entities should identify the nature of the entity or individual ultimately subject to an actual or potential ITA and categorize the responsible entities or individuals (p. 45).
B) SFPP must calculate the percentage of taxable partnership income imputed to each group and must develop a weighted ITA to be used in its cost of service (p. 46).
C) FERC required preparation of supporting affidavits explaining the methodology chosen and inclusion of workpapers. If a statistical approach is used, SFPP must explain why the sample is statistically valid or why any failures to meet the Order's standards are not statistically relevant.
Click here for the complete FERC order.
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Energy Currents is an online publication of the law firm of Vinson & Elkins LLP. It is intended to afford notice to our clients and friends of certain developments. It is not intended, nor should it be used, as a substitute for specific legal advice regarding particular factual situations.
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