On July 18th, the FERC issued a final ruling on proposed rules released in March 2018. As you may recall, the preliminary rules stopped MLPs’ ability to recover taxes in the rates they charge to customers on the basis that they don’t directly pay income taxes.
The final ruling modified the proposed rules in 4 main ways:
- MLPs will be permitted to eliminate Accumulated Deferred Income Tax balances, known as ADIT. By eliminating ADIT, which is a liability, the net rate base — MLPs accounting interest in their pipeline assets — is increased. Since MLP’s cash flow from a FERC regulated pipeline is a function of the size of both their investment and the allowed rate of return, removal of ADIT effectively increases the income MLPs can derive from their pipelines compared to the initial March ruling. The elimination of ADIT also removes some fears that the ADIT liability would have to be refunded to customers over time in the form of lower rates.
- MLPs do not have to immediately eliminate the tax allowance. Under 1 of 4 options provided by the FERC, pipelines are permitted to — at least temporarily — use the new tax rate in the Tax Cuts and Jobs Act.
- If income is consolidated on the tax return of its corporate parent, it is considered subject to taxation and therefore eligible to include a tax allowance. This is particularly relevant for MLPs that are owned by a C-corp.
- The capital structure allowance changed. In some cases, entities will be able to modify their capital structure to 57% equity — instead of 50% — for ratemaking. This is significant as the weighted average cost of capital is used in determining the allowable rate of return.
The ultimate impact of these changes will vary on a case-by-case basis. With that said, we believe the final ruling is a significant positive for the group as it provides clarity, mutes the impact of the preliminary proposal, and even supports higher allowed rates.