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Telecom Decision
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Ottawa, 17 July 1989
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Telecom Decision CRTC 89-9
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DEFERRED TAX LIABILITY
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I BACKGROUND
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Deferred income taxes occur when an item of revenue, expense, gain or loss is included in the computation of accounting income in one period, but in the computation of taxable income in another period. The amount of deferred income tax is calculated each period, using the effective tax rate applicable during that period. It is then carried forward from year to year. This method of calculating deferred income tax is called the deferral method.
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The federally regulated carriers are capital intensive companies that constantly acquire new plant. In order to provide an incentive for investment, the capital cost allowances permitted under the Income Tax Act provide for faster capital recovery than do methods of calculating depreciation expense for accounting purposes. As a result, some of these carriers have deferred large amounts of income tax.
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Effective 1 July 1988, the federal corporate income tax rate for general businesses was reduced from 36% to 28%. As a result, the amount of accumulated deferred tax that the carriers will have to pay has been reduced. This Deferred Tax Liability (DTL), however, was accrued and taken into account in past revenue requirement calculations at the higher tax rates. Therefore, more income tax expense was recovered through subscriber rates than the companies will now be required to pay.
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The issue of the appropriate regulatory treatment of the DTL arose during the proceeding leading to Bell Canada - 1988 Revenue Requirement, Rate Rebalancing and Revenue Settlement Issues, Telecom Decision CRTC 88-4, 17 March 1988 (Decision 88-4). In Decision 88-4, the Commission determined that it would deal with the issue in a separate proceeding.
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In November 1988, the Canadian Institute of Chartered Accountants (CICA) issued for comment an Exposure Draft concerning corporate income taxes. It is expected that CICA will, in due course, issue revised Guidelines on this subject. The Exposure Draft proposes (among other things) that, for all fiscal periods commencing on or after 1 January 1990, the DTL be measured at the tax rate then enacted as law. The Exposure Draft, however, encourages the voluntary adoption of this method (the liability method) earlier than 1 January 1990. Valuation methods similar to that proposed in the Exposure Draft have already been adopted in the United States and in the United Kingdom.
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On 18 November 1988, the Commission issued CRTC Telecom Public Notice 1988-47 (Public Notice 1988-47), calling for comment on the issue of the carriers' DTL. Specifically, the Commission asked whether, for regulatory purposes, the DTL of the carriers should be measured at enacted tax rates and, if so, what would be the appropriate regulatory treatment of any resulting change in the amount of the DTL. Bell Canada (Bell), British Columbia Telephone Company (B.C. Tel), CNCP Telecommunications (CNCP), Northwestel Inc. (Northwestel), Teleglobe Canada Inc. (Teleglobe) and Telesat Canada (Telesat) were made parties to the proceeding.
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In response to Public Notice 1988-47, the Commission received comments from: Canadian Business Telecommunications Alliance (CBTA); Consumers' Association of Canada (CAC); Government of British Columbia (BCG); Government of Ontario (Ontario); Government of Quebec (Quebec); and Yukon Government (Yukon).
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II DEFERRED TAX LIABILITY ADJUSTMENT
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A. General
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In Public Notice 1988-47, the carriers were directed to file proposals as to whether, for regulatory purposes, the DTL should be adjusted to reflect enacted tax law. The carriers were also asked to provide supporting reasons for their proposals.
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B. Positions of Parties
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All of the carriers and interveners expressed the view that the DTL should be adjusted to reflect enacted income tax rates and laws. Apart from CAC and Ontario, all parties also suggested that the adjustment await the issuance of CICA's Guidelines specifying such an adjustment. CAC and Ontario, while noting the issuance of CICA's Exposure Draft, did not make their comments contingent on the issuance of CICA's Guidelines.
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In a letter to the Commission dated 6 March 1989, Bell provided a copy of its comments to CICA on the Exposure Draft. In those comments, Bell expressed concern with the volatility in income for all companies that would result from the implementation of the recommendations in the Draft. Bell was of the opinion that the retention of the existing deferral method, perhaps with disclosure through a note to the financial statements of the effect of settling deferred taxes at current rates, would be a better solution. In the alternative, Bell proposed that the Draft be modified to accommodate, for regulated utilities, other methods of tax allocation that might be required by regulators, since, in its view, major fluctuations will be the subject of regulatory action.
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In its comments, CAC argued extensively that the taxes-payable (or flow-through) method of accounting for income tax should be adopted for rate-making purposes, instead of either the current deferral method or the proposed liability method. The taxes-payable method does not result in the accrual of deferred taxes because the income tax expense taken into account in determining the revenue requirement is the income tax actually payable.
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C. Conclusions
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The Commission's position on the use of the taxes-payable method is well established. During the proceeding leading to Inquiry into Telecommunications Carriers' Costing and Accounting Procedures Phase I: Accounting and Financial Matters, Telecom Decision CRTC 78-1, 13 January 1978, the use of flow-through tax accounting was considered and rejected in favour of the tax-allocation method. Specifically, the Commission directed that the carriers continue the deferral method of accounting for income tax. The Commission also notes that Public Notice 1988-47 sought views on whether, for regulatory purposes, the DTL of the carriers should be measured on the basis of enacted tax rates and, if so, the appropriate regulatory treatment of any resulting change in the amount of the DTL. The Commission gave no indication that it would reconsider the flow-through method of accounting for income taxes. For these reasons, the Commission has disregarded those parts of CAC's comments concerning the flow-through method of accounting for income tax.
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The Commission agrees with all of the parties to this proceeding that, for regulatory purposes, the carriers' DTL should be adjusted to reflect enacted income tax rates and laws. In the Commission's view, it is clear that, as a result of the substantial income tax rate reduction that came into effect on 1 July 1988, the DTL of most of the carriers is significantly overstated.
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The Commission does not agree with the carriers and with the majority of interveners that the Commission should not act in advance of the issuance of CICA Guidelines. In Decision 88-4, the Commission noted that, in fairness to subscribers, the question of the handling of the carriers' DTL should be resolved expeditiously, preferably in time to permit a 1989 implementation date. Nonetheless, the Commission deferred a decision on the issue until more information was available and until carriers other than Bell could be brought into the process. In so doing, the Commission noted that it would, in the near future, issue a public notice announcing a proceeding concerning the DTL. The Commission stated that it would consider any CICA Exposure Draft issued in time for that proceeding.
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As noted above, the reduction in the income tax rates applicable to the carriers has now been in effect since 1 July 1988. In addition, the liability method proposed in the Exposure Draft is straightforward and is based on tax law that is already enacted and in effect. In light of the above, the Commission considers that, having already deferred a resolution of the DTL issue, it cannot, in the interest of fairness to subscribers, further delay its decision.
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Accordingly, the carriers are directed to adjust their DTL at 1 January 1989 to reflect, for regulatory purposes, enacted tax rates and laws. The Commission directs that the amount of the adjustment, except as it relates to Telesat's earth segment services and to CNCP's services in general, be transferred to an Excess Deferred Tax Adjustment Account. The amortization of this account is discussed in greater detail in part V of this decision.
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III DIVISION OF EXCESS DTL BETWEEN SUBSCRIBERS AND SHAREHOLDERS
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A. General
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In Public Notice 1988-47, the carriers were directed to file a proposal as to the appropriate division between subscribers and shareholders of any adjustment to the amount of the DTL.
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B. Positions of Parties
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Bell and Northwestel stated that the adjustment to the DTL should be included in the companies' revenue requirements; this would benefit subscribers over the period of amortization of the adjustment.
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B.C. Tel also stated that such an adjustment should be included in the determination of the company's revenue requirement. B.C. Tel submitted that the adjustment should be recognized as quickly as possible. B.C. Tel was of the view that, if it were given sufficient flexibility, it could amortize the excess DTL over a 3-year period, without a rate reduction and without exceeding the top of the range established for its allowed rate of return on average common equity (ROE).
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B.C. Tel cited the following as justification for its position:
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(1) for a number of years, the company has earned either less than the mid-point of the allowable ROE range or below the bottom of the range;
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(2) lower revenues and a lower rate of return would reduce investor confidence; and
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(3) revenue reductions could adversely affect its interest coverage and its cost of borrowing.
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CNCP stated that the adjustment to deferred income taxes should accrue to shareholders in the form of an adjustment to retained earnings. CNCP submitted that, because it lacks monopoly power, the rates it sets are at a competitive level. In addition, stated CNCP, the public record demonstrates that unusually high returns have not accrued to its shareholders.
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Teleglobe expressed the view that the adjustment to its DTL should be allocated to two distinguishable periods:
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(1) the period 4 April 1987 to 31 December 1987; and
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(2) the period from 1 January 1988 on.
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Teleglobe submitted that the reduction in the DTL related to the earlier period should be returned to the shareholders, since the level of the company's earnings was not subject to regulatory purview at that time. Teleglobe stated that the adjustment for the latter period, however, should benefit its customers.
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Telesat submitted that, since its earth segment services operate in a competitive environment, the DTL adjustment related to those services should be credited to retained earnings, or to customers if competitive pressures so demand.
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Telesat submitted that the DTL adjustment related to space segment services can be further divided between the Anik C, Anik D and Anik E series of satellites. In Telesat's view, that portion of the adjustment related to Anik C and Anik D should be returned to its shareholders because the services will incur "losses" over the periods ending in 1990. Telesat estimated the "loss" related to Anik C services at $46.9 million and that related to Anik D services at $3.3 million. (Documentation filed more recently with the Commission indicates that the "loss" associated with Anik D is now estimated at $0.5 million over the period in question.) Telesat further proposed that the portion of the DTL adjustment related to Anik E be taken into account in developing rates for that series of satellites.
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In support of its position, Telesat stated that the approach implied by the issues raised in Public Notice 1988-47 would result in subscribers receiving "retroactive windfall adjustments". In Telesat's opinion, the Commission does not have the authority to make this type of adjustment.
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CAC, Ontario and BCG took the position that any adjustment to the DTL should flow through the revenue requirement to the benefit of subscribers. In support of this argument, CAC and Ontario noted that the excess DTL had been accumulated because excess income tax expense had been passed on to subscribers through the rates they paid.
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CBTA and Quebec generally supported the position that the adjustment to the DTL should be considered in the revenue requirement. However, CBTA submitted that, since CNCP is not regulated on a rate-of-return basis, the adjustment to its DTL should accrue to its shareholders. Quebec found acceptable CNCP's initial position that it need not comment as to the division of the excess DTL between subscribers and shareholders, provided that (1) CNCP's rate of return is not regulated by the Commission, and (2) the Commission does not set prices for CNCP's services, although those prices are submitted to the Commission and approved by it.
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Quebec suggested two guidelines for Teleglobe's and Telesat's proposals to allocate their DTL adjustments between subscribers and shareholders:
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(1) that portion of the DTL adjustment related to profits from clearly unregulated commercial operations can fairly be transferred directly to shareholders; and
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(2) a company that has not achieved the authorized rate of return on its regulated operations may be allowed to transfer all or part of its DTL adjustment directly to shareholders' equity.
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C. Conclusions
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The Commission agrees with most of the parties that, in general, the adjustment to the DTL should go to the benefit of subscribers. The carriers' income tax expenses, computed at the higher income tax rates, formed part of the carriers' past revenue requirements. Those tax expenses were passed on to subscribers in the rates paid for the carriers' services. Except as noted below, the benefit of the excess DTL should therefore be returned to subscribers. Further, the Commission finds that the benefit should go to subscribers in the form of rate reductions. Those reductions are discussed in part VI of this decision.
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The Commission finds unacceptable B.C. Tel's argument that the DTL adjustment should be made without a corresponding reduction in rates. Such an approach would minimize the benefit to subscribers of the DTL adjustment. In the Commission's view, the fact that a regulated carrier earned less than the mid-point of its allowed ROE range, or even below that range, would not justify the position adopted by B.C. Tel. The Commission strives to set an allowed ROE range that is fair to both subscribers and shareholders. Generally, the Commission sets rates that will permit a regulated company a rate of return at the mid-point of that range. However, the Commission does not guarantee shareholders that the company will earn a rate of return at or above the mid-point. By increasing its efficiency, a company can increase its rate of return up to the top of its allowed ROE range. If its earnings are below the allowed range, the company has the option, at any time, of requesting a general rate increase and a review of its revenue requirement.
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B.C. Tel submitted that a lower rate of return would reduce investor confidence in the company. However, the approach prescribed in this decision will, on average, have a minimal effect on the company's rate of return over the amortization period. B.C. Tel also argued that the revenue reductions associated with rate reductions could adversely affect its interest coverage. However, the period of amortization of the adjustment to the DTL (as outlined in part V of this decision) is such that interest coverage will be minimally affected.
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CNCP faces sufficient competition in all its operations to make it unlikely that the company could raise prices significantly without losing business (as stated in CNCP Telecommunications - Application for Exemption from Certain Regulatory Requirements, Telecom Decision CRTC 87-12, 22 September 1987). As a result, the company's rate of return has not been subjected to regulatory scrutiny in recent years. CNCP submitted that, despite the reduction in corporate tax rates, the application of the liability method will result in an increase in its DTL. In the Commission's view, the adjustment to CNCP's DTL resulting from the application of the liability method is relatively small, amounting to some $0.25 million as of 1 January 1989.
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In light of the foregoing, the Commission concludes that the adjustment to CNCP's DTL should be treated like that of any other company whose rate of return is not regulated. The Commission therefore finds that the adjustment should be absorbed by the company's shareholders.
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The Commission does not accept Teleglobe's argument that, because the company's earnings for the period 4 April 1987 to 31 December 1987 were not subject to regulation, the adjustment should be returned to shareholders. Under section 29(2) of the Teleglobe Canada Reorganization and Divestiture Act, Teleglobe tariffs in force during 1987 were deemed to have been approved by the Commission. Therefore, it cannot be said that Teleglobe operated outside of the Commission's regulatory authority during the period in question. Accordingly, the Commission considers it immaterial that a portion of the excess DTL relates to revenue earned from tariffs during 1987, as opposed to 1988.
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The Commission therefore concludes that the benefit of Teleglobe's excess DTL associated with the period 4 April 1987 to 31 December 1987, as well as with the period from 1 January 1988 on, should go to Teleglobe's customers.
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The Commission notes that, unlike the other carriers, Telesat is regulated on an individual service basis; the Commission does not establish an overall revenue requirement for Telesat. The range for Telesat's ROE for each of its space segment services is currently set at 13.5% to 15.5%.
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As previously noted, the company states that there have been "losses" for both Anik C and Anik D services. The Commission notes that the word "losses" in this context has a specific meaning. Telesat's rates are developed on the basis of economic evaluation studies. When the company speaks of "losses" for Anik C and Anik D services, it means that those services are not estimated to achieve the return projected in the related economic studies. In fact, the company estimates the rate of return on its Anik D services for the period 1984 to 1990 at about 15%.
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In Telesat Canada - Final Rates for 14/12 GHz Satellite Service and General Review of Revenue Requirements, Telecom Decision CRTC 84-9, 20 February 1984 (Decision 84-9), the Commission ruled that spare capacity should be limited and fixed for the test period in order to ensure that customers are not required to pay for unreasonably high levels of spare capacity caused by fluctuations in utilization forecasts. As a result of this determination, Telesat was precluded from seeking rate increases for 14/12 GHz space segment services in the event of a revenue shortfall arising from actual utilization being less than forecast. In the Commission's view, the "losses" noted by the company for Anik C services would be substantially reduced had the company used in its calculations the forecast utilization for the entire period, rather than incorporating available actual utilization figures.
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Since the rate of return on Telesat's space segment services is regulated, the Commission finds that the portion of the adjustment to the DTL related to those services should benefit the company's customers, not its shareholders.
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The Commission is of the view that a different regulatory treatment is required for the adjustment to the DTL related to Telesat's earth station services. Given their competitive nature, Telesat's earth station services are not subject to a maximum allowable rate of return (as set out in the Commission's letter to Telesat dated 2 December 1986).
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Since the Commission does not set a maximum allowable rate of return for Telesat's earth station services, any adjustment to the DTL related to those services should simply flow through to retained earnings and ultimately to the benefit of shareholders. The Commission therefore directs that the deferred tax adjustment related to Telesat's earth station services accrue to the benefit of Telesat's shareholders.
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Telesat argued that the Commission does not have the authority to make a retroactive adjustment that would benefit subscribers. The Commission, however, does not regard the adjustment to the DTL and any corresponding rate decrease as a "retroactive windfall adjustment", as described by Telesat. Rather, the adjustment to the DTL is more accurately described as a prospective accounting change based on current tax laws, as well as on historical events (i.e., the accumulation of deferred taxes at an income tax rate higher than the rate at which the income taxes will be paid). The adjustment to the DTL and the subsequent benefit to subscribers through reductions in future rates constitute prospective, rather than retroactive, regulation.
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In summary, the Commission directs, with respect to Bell, B.C. Tel, Northwestel, Teleglobe and Telesat's space segment services, that the adjustment to the DTL go to the benefit of subscribers. The Commission finds that any adjustment to the DTL related to Telesat's earth station services should accrue to the company's shareholders. Similarly, the Commission finds that any adjustment to CNCP's DTL should be absorbed by shareholders.
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IV OTHER ADJUSTMENTS TO DTL
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A. Positions of Parties
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The possibility of other adjustments to the DTL was not raised in Public Notice 1988-47. Only Bell and B.C. Tel commented on this issue.
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Based on its interpretation of the CICA Exposure Draft, Bell proposed two further adjustments to its DTL:
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(1) elimination of the deduction for capital losses, including those relating to the amortization of foreign currency transactions on long-term debt, which Bell estimates would reduce its DTL adjustment by $40 million; and
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(2) recording of the pre-1969 unrecorded deferred tax credits relating to the capitalized portion of service pensions, government pensions and general expenses, which Bell estimates would reduce its DTL adjustment by $26 million.
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Bell noted that, during the period 1952 to 1968 inclusive, the taxes-payable method was used for the timing differences noted in (2) above. In 1969, Bell adopted the deferral method for all timing differences. At that time, the company chose to disclose the unrecorded tax allocation balance related to the timing differences for the years prior to 1969 in a note to the financial statements, rather than to adjust its accounts to record these balances.
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In Bell's view, the purpose of the change from the deferral to the liability method, as prescribed in the CICA Exposure Draft, is to improve the measurement of the amount of tax expected to be paid on the income that has been deferred for tax purposes. Therefore, in order to be conceptually sound, the future tax payable must include the pre-1969 unrecorded referred tax balances.
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Bell estimates that the effect of setting these other adjustments off against the adjustment to the DTL arising from the reduction in the income tax rate would be a reduction in the excess DTL from $288 million to $222 million. In the company's view, it would be inappropriate to select from the Exposure Draft only those principles that recognize enacted tax rates, while ignoring the other principles affecting DTL.
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B.C. Tel proposed that, in determining the excess DTL to be included in its revenue requirement, the DTL should first be reduced in recognition of the previously incorrect accounting for income tax provisions related to the depreciation of capitalized Allowance for Funds Used During Construction. B.C. Tel estimated that the effect of setting this other adjustment off against the adjustment to the DTL arising from the reduction in the income tax rate would be a reduction in its excess DTL from $56 million to $37 million.
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B. Conclusions
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In the Commission's view, Bell has not provided the information necessary to permit it to assess the reasonableness of the company's other proposed adjustments to the DTL; nor has the Commission had the benefit of comments from the interveners or from the other carriers on the additional adjustments proposed by Bell. Furthermore, these proposed other adjustments are based on Bell's interpretation of the CICA Exposure Draft. It is not known whether Bell's interpretation is widely accepted or if it will be reflected in the Guidelines adopted by CICA.
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The Commission recognizes, however, that these other adjustments may have an impact on the amount of the excess DTL. Should CICA adopt an approach similar to Bell's interpretation, and should the Commission consider it appropriate for regulatory purposes, the Commission has the option of making further adjustments to Bell's DTL at a later date.
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In light of the above, the Commission concludes that Bell's proposed other adjustments should be excluded at this time. The Commission also concludes that the question of these other adjustments should be treated as a follow-up item to this proceeding. In this way, interested parties will have a further opportunity to comment. The Commission announces the following procedure with respect to this item.
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(1) Bell, B.C. Tel, Northwestel, Teleglobe and Telesat are made parties to this follow-up item.
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(2) Interested persons wishing to participate (interveners) must notify the Commission of their intention to do so by writing to Mr. Fernand Bélisle, Secretary General, CRTC, Ottawa, Ontario, K1A 0N2, by 14 August 1989.
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(3) The Commission will issue further directions as to procedure when CICA issues its Guidelines on Corporate Income Taxes.
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The DTL adjustment of $17.2 million that B.C. Tel proposed relates to an error that, ideally, would have been corrected in 1985. B.C. Tel is presently amortizing that adjustment over a 15-year period, in order to minimize its impact on B.C. Tel's revenue requirement.
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The Commission agrees with B.C. Tel that the adoption of the liability method provides an opportunity to correct the error. The Commission has concluded that it is fair to return any excess DTL to subscribers because that excess was accumulated out of the rates paid by subscribers. Because of an accounting error, B.C. Tel subscribers paid less than they otherwise would have, based on the application of the tax rates then in effect. Therefore, it is reasonable that the amount of theDTL to be returned to subscribers be adjusted to correct for the error. Accordingly, the Commission directs that B.C. Tel's DTL adjustment be reduced as proposed by the company.
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V AMORTIZATION PERIOD
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A. General
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In Public Notice 1988-47, the carriers were directed to file proposals as to the period over which any adjustment to the DTL should be taken into account, assuming that, for regulatory purposes, the Commission determines that the DTL is to be measured on the basis of enacted tax law.
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B. Positions of Parties
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The amortization periods proposed by the carriers varied substantially. Bell proposed the average remaining life of the company's assets, estimated to be 17 years; CNCP proposed the remaining life of the assets to which the deferred tax balances related, but did not specify any period; and Northwestel proposed the average life of the company's plant and equipment, estimated to be 15 years.
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Bell also addressed the possibility that the Commission might determine that a period shorter than the life of the assets is appropriate. Bell submitted that, should that prove to be the case, a period of 7 to 10 years would be better than a shorter period. Bell expressed concern that a short amortization period would create volatility in subscriber rates. The company noted that a long amortization period would smooth out the effects of the adjustment on subscriber rates and would ameliorate its impact on key financial ratios, in particular, interest coverage. The company stated that this amortization treatment would be consistent with the Commission's prior practice of phasing in accounting changes that could have an undue impact on revenue requirement.
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B.C. Tel proposed that the initial DTL adjustment be amortized over a period not to exceed 3 years, provided that the company was given the flexibility to recognize the adjustment without revenue decreases, subject to its ROE not exceeding the top of the allowed range. B.C. Tel added that, if it were not afforded this flexibility, a longer amortization period would be appropriate in order to minimize the risk of destabilizing effects. The company also noted that a relatively short amortization period would not have a significant adverse effect on its interest coverage ratio, provided that the company's ROE was not below the mid-point of its allowed range.
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Teleglobe proposed that the amortization period applicable to the 1988 excess DTL should be 1 to 2 years, since such a period would not be unduly punitive in its case.
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Telesat proposed that the amortization period applicable to its Anik E series of satellites should be the life of the series.
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CBTA and CAC proposed a 3-year amortization period. CBTA stated that a 3-year period would smooth the effect of the associated rate reductions. At the same time, subscribers would receive the benefit of the rate reductions as early as possible. CAC was of the view that the amortization period should be relatively short in order to maximize the possibility that the same customers who were charged the excessive amounts for income taxes in the past would receive the tax credits. CAC further proposed that the period should start in the year following a rate hearing. BCG agreed with B.C. Tel that the excess DTL should be transferred into income as quickly as possible without causing destabilizing effects. BCG accepted B.C. Tel's proposal for an amortization period of 3 years. Ontario submitted that the amortization period should be chosen so as to avoid large fluctuations in Bell's revenue requirement due solely to the change in income tax rates. Ontario proposed a 10-year period for Bell.
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Quebec proposed that the amortization period be as short as possible, provided that any resulting rate changes are minor. However, Quebec also stated that rate changes need not be so small that subscribers fail to notice them. It proposed that a minor adjustment to the DTL be amortized over 1 to 2 years, a larger adjustment over 3 to 5 years, and a major adjustment over a longer period. Quebec also proposed what it called a "levelling-off method". Under this method, the amount of the annual adjustment would be equal to the deferred portion of tax expense in any given year, with the procedure continuing until the subscribers had received the full benefit of the tax changes. Quebec estimated that this method would result in an amortization period of 4½ years. In reply argument, Bell estimated that Quebec's proposal would result in an amortization period of less than 3 years.
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C. Conclusions
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In choosing the appropriate amortization period, the Commission has attempted to reconcile three objectives that may, from time to time, conflict with each other.
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(1) The period should be short enough that subscribers quickly receive the benefit of the excess DTL, since the excess was accumulated out of rates paid by subscribers in the past. In addition, a short amortization period increases the possibility that the same customers who were charged the excess amounts for receive the tax credits.
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(2) The amortization period should not be so short as to lead to wide rate fluctuations. In particular, the Commission wishes to avoid a substantial rate increase when the amortization period ends and no further credits to the revenue requirement are available.
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(3) The excess DTL should be amortized over a period sufficiently long that the carriers' financial ratios are not adversely affected.
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In addition, the amortization period need not be the same for all the carriers. An individual carrier's circumstances may justify a different amortization period.
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In the Commission's view, an amortization period equal to the remaining or average life of the assets, as proposed by Bell, CNCP and Northwestel, would not adequately meet the objectives listed above; nor would Bell's alternative of a period of 7 to 10 years. In particular, periods as long as these would not meet the first of the Commission's objectives, i.e., that subscribers benefit quickly from the excess DTL. Conversely, the Commission believes that, under normal circumstances, the 3-year period proposed by CBTA and CAC would be too short. So short an amortization period could result in a substantial rate increase at the end of the period. In addition, the carriers' financial ratios might be adversely affected, particularly interest coverage.
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The Commission agrees with Bell that Quebec's proposed levelling-off method would result in an amortization period of less than 3 years, instead of the 4½ years estimated by Quebec. Accordingly, the Commission rejects the use of this method. The Commission also rejects B.C. Tel's proposal of a 3-year period, coupled with flexibility in the amortization of the excess DTL. The Commission considers that such an approach would minimize the benefit that might otherwise accrue to subscribers.
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After reviewing the evidence, the Commission has determined that, for Bell, B.C. Tel and Northwestel, a 5-year amortization period would be the most appropriate. The Commission therefore directs these carriers to amortize the Excess Deferred Tax Adjustment Account in 60 equal monthly amounts, commencing on the date of the rate reductions ordered in part VI of this decision.
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Unlike the above-noted carriers, CNCP's DTL will increase with the application of the liability method. In part III of this decision, the Commission determined that, because CNCP is not regulated on a rate-of-return basis, any adjustment to its DTL should be absorbed by shareholders. CNCP should therefore either amortize the adjustment to its DTL over a period of the company's choice or treat it as a retroactive adjustment as proposed in the CICA Exposure Draft.
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The Commission agrees with Teleglobe that, given the small amount of its adjustment in relation to the size of the company's total revenue, a relatively short amortization period is appropriate. Accordingly, the Commission concludes that a 2-year amortization period is suitable in Teleglobe's case. The Commission therefore directs Teleglobe to amortize the Excess Deferred Tax Adjustment Account in 24 equal monthly amounts, commencing on the date of the rate reductions ordered in part VI of this decision.
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In part III of this decision, the Commission determined that any adjustment to the DTL associated with Telesat's earth station services should be passed on to shareholders. Accordingly, the company should either amortize that portion of the Excess Deferred Tax Adjustment Account associated with earth station services over a period of its choice or treat it as a retroactive adjustment as proposed in the CICA Exposure Draft.
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As noted previously, Telesat is regulated on the basis of individual services, and not on a company-wide basis. The rates for Telesat's service groups are established using economic evaluation studies over a multi-year test period. Rates for the terrestrial carriers, on the other hand, are based on accounting costs for a single-year test period. In light of this difference, a different approach is required with respect to the amortization of the excess DTL associated with Telesat's space segment services.
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Telesat is expected to file an application in 1990 for the approval of rates, effective in early 1991, for the Anik E series of satellites. The Anik E series will eventually replace both the Anik C and Anik D series. Since Telesat will begin tranferring services from the Anik C and Anik D satellites to the Anik E series in early 1991, the excess DTL related to the Anik C and Anik D would, on the basis of Telesat's original launch schedule, have to be amortized over the period ending 31 December 1990. In the Commission's view, it would be inappropriate to amortize the entire amount of the excess DTL associated with Anik C and Anik D services over so short a period. Telesat is therefore directed to apportion the amortization of the excess DTL related to the Anik C and Anik D services between the Anik E satellites and the Anik C and Anik D satellites. Details of that apportionment are described in part VI of this decision.
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Telesat is also directed to amortize that portion of the Excess Deferred Tax Adjustment Account associated with the Anik C and the Anik D satellites in 60 equal monthly amounts, commencing 1 January 1990. Telesat is further directed to amortize that portion of the Excess Deferred Tax Adjustment Account associated with the Anik E series of satellites in 60 equal monthly amounts, commencing when the Anik E series goes into service.
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VI RATE REDUCTIONS
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Only CAC and Quebec directly addressed the issue of rate reductions related to the amortization of the excess DTL. CAC proposed that the amortization of the DTL should begin in a year following a rate hearing, in order to ensure that the amortization is offset by a reduction in consumer rates without the complications of retroactive rate adjustments. Quebec proposed that the benefit of the amortization of the excess DTL should be passed on to subscribers through tariff revisions incorporated in the determination of annual revenue requirements.
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In part III of this decision, the Commission determined that the benefit of any excess DTL, other than that associated with Telesat's earth station services and CNCP's services in general, should accrue to subscribers. In the Commission's view, the most effective method of ensuring that subscribers receive that benefit is to adjust the carriers' rates at the commencement of the amortization period. Concurrent rate reductions will, like the choice of an appropriate amortization period, help ensure that subscribers benefit quickly from any adjustment to the DTL. The Commission intends to ensure that the impact on the carriers' earnings of the rate reductions, after adjusting for financing costs and other related items, will be closely matched over the amortization period by the amount of DTL amortized. As a result, the reductions will have little effect on the carriers' rates of return over the amortization period. The rate reductions will, in effect, be rate-of-return neutral.
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In deciding how best to cvalculate rate reductions that will achieve rate-of-return neutrality over the amortization period, the Commission has taken into account the relative complexity of the alternative methods. Having weighed those alternatives, the Commission directs Bell, B.C. Tel, Northwestel and Teleglobe to calculate the required rate reductions, to take effect 2 October 1989, in accordance with the procedure described below.
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(1) For each year of the amortization period, the carrier is to calculate a base amortization amount. This amount is to equal the total amount of the excess DTL to be amortized divided by the number of years in the amortization period. The carrier is also to calculate the amount by which the yearly base amortization amount must be grossed-up in order to arrive at its pre-tax value (the grossed-up amount).
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(2) Using its estimated 1989 average cost of capital, the carrier is to calculate the cost in each year, taking into account any cumulative effects, of the financing associated with the base amortization amount described in the preceding paragraph.
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(3) The carrier is to estimate the impact of any other items, such as revenue taxes or receipts taxes, for each year of the amortization period, assuming that the grossed-up amount will be treated as a reduction in revenue.
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(4) The carrier is then to calculate the estimated net revenue reduction for each year of the amortization period, consisting of the grossed-up amount and any adjustments for financing costs or for the other items described in the previous paragraph.
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(5) The amount of the average net revenue reduction, i.e., the average of the yearly net revenue reductions calculated in paragraph 4, is then to be calculated, on the assumption that the rate reductions required to bring about such a revenue reduction would take effect for a full year beginning 1 January.
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(6) The amount by which revenues are to be reduced over the period 2 October 1989 to 31 December 1989 is to equal 1/4 of the average net revenue reduction calculated in the preceding paragraph.
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(7) Finally, the carrier is directed to propose rate reductions that will bring about the revenue reduction described in paragraph 6. Details of the implementation of these rate reductions are contained in part VII of this decision.
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Rates for Telesat's Anik C and Anik D satellites have been set by the Commission for the period ending 31 December 1990. In Decision 84-9 and in Telesat Canada - Final Rates for 6/4 GHz Satellite Service and Valuation of Plant Investment for Economic Evaluation Studies, Telecom Decision CRTC 85-11, 27 June 1985 (Decision 85-11), the Commission approved increases of 5.5% in rates for Anik C and Anik D services, respectively, effective 1 January 1990. In addition, as noted earlier, Telesat is expected to file an application in 1990 for the approval of rates, effective in early 1991, for the Anik E series of satellites. Telesat will start transferring services from the Anik C and Anik D satellites to the Anik E series in early 1991. In light of these considerations, the Commission directs Telesat to calculate its required rate reductions in accordance with the procedure described below.
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(1) The company is to reduce the scheduled 1 January 1990 rate increases by an amount equal to 1/5 of the total of the yearly reductions to revenue related to the Anik C and Anik D satellites. The yearly reductions are to be calculated in accordance with the method prescribed in paragraphs 1 to 4 on page 30 (financing costs are to be calculated using the company's estimated 1990 cost of capital).
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(2) The company is to incorporate the remaining 4/5 of the total of the yearly reductions to revenue related to the Anik C and D series of satellites into the economic evaluation study used to determine rates for the Anik E series.
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(3) The company is also to incorporate the total of the yearly reductions to revenue, calculated as prescribed in paragraphs 1 to 4 on page 30, associated with the Anik E series into the economic evaluation study used to determine the rates for the Anik E series.
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In determining the appropriate method of calculating the rate reductions required to achieve rate-of-return neutrality over the amortization period, the Commission considered the alternative of varying the amount of excess DTL amortized each year, so that the impact on the carriers, after the amortized amount was grossed-up for the income tax impact and adjusted for financing costs and other items, would be the same in each year of the amortization period. However, the Commission decided that such an approach would be overly complex and cumbersome. The difference between the two methods, in terms of impact on the carriers' rates of return, is not sufficient to justify the more complicated and burdensome approach.
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VII IMPLEMENTATION
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A. Bell, B.C. Tel, Northwestel and Teleglobe
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The Commission considers that, consistent with its treatment of excess revenues in Bell Canada - Review of Revenue Requirements for the Years 1985, 1986 and 1987, Telecom Decision CRTC 86-17, 14 October 1986, in Decision 88-4, in British Columbia Telephone Company - Revenue Requirement for the Years 1988 and 1989 and Revised Criteria for Extended Area Service, Telecom Decision CRTC 88-21, 19 December 1988 (Decision 88-21), and in Telecom Letter Decision CRTC 88-1, 6 May 1988, the net revenue reduction should be used to lower monopoly toll rates. The Commission establishes the procedure described below for the implementation of those rate reductions.
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(1) Bell, B.C. Tel, Northwestel and Teleglobe are directed to file, by 24 July 1989: (a) updated calculations of the amount of the excess DTL to be amortized and schedules of the yearly net revenue reduction (as prescribed in paragraphs 1 to 4 on page 30) in the format of Section V, Schedule 2 of 12, page 1 of 2, of Bell's submission of 27 January 1989; (b) complete details, together with the corresponding calculations, of the costs of financing for each year in the amortization period; and (c) complete details of any other pertinent adjustments to the grossed-up amortization amount required to determine the amount of the net revenue reduction. Copies are to be served on the interveners in this proceeding and on the other carriers by the same date.
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(2) Bell, B.C. Tel and Northwestel are directed to file, by 14 August 1989, two preferred rate scenarios, with a proposed effective date of 2 October 1989. One scenario is to provide only for message toll service (MTS) rate reductions; the other may provide for reductions to other monopoly toll rate schedules, as well as to MTS rates. The proposed reductions are to be of sufficient magnitude to bring about a reduction in monopoly toll contribution equal to the amount prescribed in paragraph 6 on page 31 of this decision. In determining the magnitude of the required rate reductions, Bell and B.C. Tel should use the price elasticity estimates adopted by the Commission in Telecom Decisions CRTC 88-4 and 88-21, respectively. Bell, B.C. Tel and Northwestel should also provide, by 14 August 1989, the following: (a) a description of the preferred rate scenarios; (b) the rationale for each of the preferred rate scenarios; (c) a table for each scenario, indicating by settlement (intra, adjacent, TransCanada, Canada-U.S., etc., as applicable) for each service the average price change and the associated revenue impact, together with the estimated cost impact of the rate reductions, in order to illustrate that each rate scenario will result in the required reduction in monopoly toll contribution over the period 2 October 1989 to 31 December 1989; (d) a preference as to the two rate scenarios, with supporting reasons for that preference; (e) all base revenues reprice ratios, elasticities, formulae, assumptions and all other information used to estimate the revenue reduction under each scenario over the period 2 October 1989 to 31 December 1989, as well as a description of the approach used to estimate the reduction in revenues resulting under each scenario; and (f) the revenues resulting under each scenario over the period 2 October 1989 to 31 December 1989, at the same level of disaggregation as the base revenues or demand used in the revenue impact calculations. Copies must be served on the interveners and on the other carriers by the same date.
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(3) Teleglobe is directed to file, by 14 August 1989, preferred international toll rate schedules, with a proposed effective date of 2 October 1989. The preferred rates are to bring about a reduction in net revenues equal to the amount prescribed in paragraph 6 on page 31 of this decision. Teleglobe is also directed to file, with respect to the proposed rate reductions and for the period 2 October 1989 to 31 December 1989, information similar to that provided: (1) in attachments 2 and 3 to the company's facsimile transmission, dated 23 June 1989; (2) on page 1 and in Exhibit 1 of the company's response, dated 13 June 1989, to the Commission's request in Telecom Letter Decision CRTC 89-12 for an update to response to interrogatory Teleglobe (CRTC) 30 Mar 88-605; and (3) in the company's responses to interrogatories Teleglobe (CRTC) 30 Mar 88-601 and Teleglobe (CRTC) 30 Mar 88-604. In addition, the company is to provide a description of the approach, along with all data, formulae, elasticities and assumptions, used in determining that the proposed rates will result in the required net revenue reduction, as prescribed in paragraph 6 of page 31 of this decision. Copies are to be served on the interveners and on the other carriers by the same date.
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(4) Interveners and other carriers may file comments on the submissions made pursuant to paragraphs 1 to 3, serving copies on the other interveners and on the carriers, by 28 August 1989.
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(5) Bell, B.C. Tel, Northwestel and Teleglobe may file reply comments, serving a copy on the interveners and on the other carriers, by 7 September 1989.
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(6) Where a document is to be filed or served by a specific date, the document must be actually received not merely mailed, by that date.
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B. Telesat
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(1) Telesat is directed to file, by 14 August 1989: (a) updated calculations of the excess DTL associated with the Anik C and Anik D satellites and schedules of the yearly net revenue reductions (as prescribed in paragraphs 1 to 4 on page 30) in the format of Section V, Schedule 2 of 12, page 1 of 2 of Bell's submission of 27 January 1989; (b) complete details, together with the corresponding calculations, of the costs of financing for each year in the amortization period (financing costs are to be calculated using the company's estimated 1990 cost of capital); and (c) complete details of any other pertinent adjustments to the grossed-up amortization amount required to determine the amount of the net revenue reductions. Copies are to be served on the interveners and on the other carriers by the same date.
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(2) Telesat is directed to file, by 5 September 1989, space segment rate schedules for both 6/4 GHz and 14/12 GHz RF channel services, with a proposed effective date of 1 January 1990. Copies must be served on the interveners and on the other carriers by the same date. The proposed rates are to reduce the 1 January 1990 rate increases approved in Decisions 84-9 and 85-11, as prescribed in paragraph 1 of page 32.
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(3) Interveners and other carriers may file comments on the submissions made pursuant to paragraphs 1 and 2, serving copies on Telesat and on the other interveners and carriers, by 18 September 1989.
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(4) Telesat may file reply comments, serving copies on the interveners and on the other carriers, by 2 October 1989.
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(5) Telesat is directed to file, at the time of its application for approval of rates for services to be provided over its Anik E satellites, schedules providing details similar to those in the submission made pursuant to paragraph 1, in connection with the net revenue reductions attributable to each of the Anik C, D and E series of satellites included in the economic evaluation study for the Anik E series of satellites.
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(6) When a document is to be filed or served by a specific date, the document must be actually received not merely mailed, by that date.
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VIII SUBSEQUENT ADJUSTMENTS TO DTL RESULTING FROM PERIODIC CHANGES TO INCOME TAX RATES OR LAWS
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A. Positions of Parties
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Bell, B.C. Tel and Teleglobe addressed the issue of subsequent adjustments to the DTL resulting from periodic changes to income tax rates or laws.
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Bell, in its final argument, suggested that the amortization period for such ongoing adjustments should be the same as that it had proposed for the initial adjustment, namely, the estimated average remaining life of the company's assets (approximately 17 years).
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B.C. Tel, on the other hand, submitted that initial and ongoing adjustments to the DTL are different, and should therefore be accounted for differently. B.C. Tel submitted that future adjustments should be made over a 15-year period, since the fixed assets of the company are estimated to have an average remaining life of 15 years.
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Teleglobe submitted that changes in the DTL due to a decrease or some future increase in tax rates should be amortized over a reasonable period, which could bear some relation either to the period over which the DTL account was accumulated or to the period over which the deferred taxes will be paid. In Teleglobe's view, such an approach would help prevent any unduly negative effects on its financial integrity or on rate stability.
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In CAC's view, the argument that the amortization period should match the life of the underlying assets perverts the matching concept by suggesting that one cost (income tax expense) must match another cost (generally, book depreciation expense). CAC recommended that any future adjustments to the DTL be made over a 3-year period.
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CBTA noted that, since future tax changes are likely to be increases rather than decreases, an amortization period of 15 years would be appropriate.
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Ontario submitted that, in order to avoid major fluctuations in rates, future changes in the DTL resulting from changes in the income tax rate should be amortized over a 10-year period.
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BCG accepted B.C. Tel's proposal to amortize future changes to the DTL over a 15-year period. BCG agreed with B.C. Tel that such a period would help smooth out the associated revenue requirement impacts.
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Quebec stated that, if subsequent tax changes result in excess DTL, the subscribers who paid too much for services rendered in the past should benefit as soon as possible. Quebec submitted that, in these circumstances, an amortization period of 3 to 5 years is appropriate. However, Quebec argued that, if the tax rate increases, the adjustment to the DTL should be amortized over a longer period (7 to 10 years) in order to moderate increases in the annual revenue requirements.
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B. Conclusions
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In the Commission's view, subsequent changes to income tax rates are likely to be smaller than the change currently under consideration. As a result, corresponding year-to-year adjustments to the DTL would also be smaller than the current adjustment. Therefore, a long amortization period may not be necessary for these ongoing adjustments.
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Accordingly, the Commission concludes that adjustments to deferred taxes resulting from any subsequent minor changes to income tax rates should, under normal circumstances, be taken into income in the current year. However, if any adjustment to the DTL would have a significant impact on a carrier's return on equity, a longer amortization period could be considered.
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Fernand Bélisle
Secretary General
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