ARCHIVED -  Telecom Decision CRTC 93-9

Telecom Decision

Ottawa, 23 July 1993

Telecom Decision CRTC 93-9

AGT - ISSUES RELATED TO INCOME TAXES

I BACKGROUND

Prior to 4 October 1990, telephone service in the province of Alberta was provided by the Alberta Government Telephones Commission (the AGT Commission). The AGT Commission was a Crown corporation and, as such, was exempt from federal and provincial income taxes. As a result, it never claimed Capital Cost Allowance (CCA). For accounting purposes, however, it did calculate an annual depreciation expense, which it included in the calculation of its revenue requirement.

On 24 July 1990, the Legislative Assembly of the province of Alberta passed the Alberta Government Telephones Reorganization Act, providing for the restructuring, on 4 October 1990, of the AGT Commission. TELUS Corporation (TELUS) was acquired by the Government of Alberta (Alberta) in order to act as a holding company to facilitate the privatization of the AGT Commission. Most telephone operations and assets were transferred to AGT Limited (AGT), a subsidiary of TELUS, which then came under the Commission's jurisdiction.

In preparation for the reorganization and privatization of the AGT Commission, Alberta received an Advance Income Tax Ruling from Revenue Canada (Ruling). This Ruling effectively permits TELUS and its subsidiaries (including AGT) to claim as Undepreciated Capital Cost for income tax purposes the original cost of the assets that were transferred from the AGT Commission. According to AGT's estimates, its depreciable assets had a tax basis of approximately $4.0 billion on 4 October 1990, an amount substantially exceeding the carrying (net book) value of the assets (approximately $2.2 billion) at that time. This additional CCA available from the excess of the original cost over the net book value of the assets at the time of privatization creates Additional Tax Deductions (ATDs) of approximately $1.8 billion.

Subsequent to privatization, AGT determined that, in addition to the reduction in future income tax costs arising out of the Ruling, there are a number of transactions related to the privatization and related to its operations, both before and after privatization, which it believes will further reduce its liability for income tax. In broad terms, these relate to the tax treatment of certain revenues which, while recorded for accounting purposes post-privatization, were received by the AGT Commission prior to privatization, and are therefore considered by the company to be non-taxable. The company is also of the opinion that there are certain costs which, though accrued by the AGT Commission prior to privatization, may be deductible for tax purposes by AGT. The company estimates that these further ATDs amount to approximately $0.7 billion.

The total ATDs, estimated by AGT to amount to approximately $2.5 billion, have been used to reduce the company's income tax expense to date and will also reduce its future income tax expense. In the proceeding leading to AGT Limited - Revenue Requirement for 1992, Telecom Decision CRTC 92-9, 26 May 1992, AGT stated that, in order to present a conservative view of its revenue requirement for 1992, it prepared its 1992 forecasts on the basis that the benefits arising from these ATDs should go to subscribers. However, AGT submitted that the issue of shareholder versus subscriber benefit for future years should be addressed in a separate proceeding.

In AGT Limited - Issues Related to Income Taxes, Telecom Public Notice CRTC 92-35, 9 June 1992, the Commission initiated a public proceeding to consider issues related to AGT's prospective tax position, including the following:

(1) the amount of the ATDs associated with the Ruling;

(2) the availability of further ATDs not associated with the Ruling;

(3) the calculation of available annual tax deductions;

(4) the allocation of benefits between shareholders and subscribers arising from the ATDs;

(5) the method to account for income tax expense (tax allocation or taxes payable basis);

(6) the method to account for deferred tax liability (deferral or liability method) if the tax allocation basis is used to account for income tax expense; and

(7) the impact on the company's 1993 revenue requirement.

The proceeding included the filing of evidence by AGT and by the City of Calgary (Calgary), as well as an interrogatory process and an oral hearing. The hearing was held in Calgary, Alberta, from 28 April to 30 April 1993, before Commissioners Louis R. (Bud) Sherman (Chairman of the hearing), Adrian Burns and Peter Senchuk. Calgary was the only active intervener in the proceeding.

II AMOUNT AND AVAILABILITY OF ATDs

A. General

As noted above, AGT estimates the maximum ATDs to be approximately $2.5 billion. The company stated that, due to possible future reassessments by Revenue Canada and possible subsequent appeals regarding the amount of allowable deductions for tax purposes, the amount of the ATDs may not be finalized until some time in 1996 or 1997.AGT proposed to amortize any variation from its position as filed with the Commission resulting from reassessment by Revenue Canada over a period not exceeding five years.

B. Position of AGT Regarding the Amount of ATDs

In response to interrogatory AGT(CRTC)22Dec92-1011b), the company stated, among other things, that its policy for computing income tax expense was adopted based on its concern for intergenerational equity.

In response to interrogatory AGT(CRTC)16Apr93-2010, the company submitted that, given that subscribers prior to any reassessment by Revenue Canada (pre-audit subscribers) are closer in time (and therefore in composition) to those who never paid a tax expense in rates (i.e., all subscribers before 1994), it would be equitable if the post-audit generation is, as much as possible, insulated from the intergenerational inequity that could arise if the claims for tax purposes were not used as the basis for accounting purposes. The company also stated that, since its risk-adjusted ATDs reflect its best judgment of the more likely outcome, using a more optimistic accounting method for revenue requirement purposes would impose a greater risk on the post-audit generation than the pre-audit generation.

AGT also contended that the penetration of competition, as it progresses, will be greater in the higher density areas. As a result, the company would maintain in the future a higher proportion of rural customers who would be least able to avoid, by switching to a competitor, the higher prices required to recover past and current income tax costs.

C. Legal Issue Regarding the Treatment of Reassessment by Revenue Canada

During the proceeding, the Commission invited parties to address the following issue in argument:

Assume that after reassessment by Revenue Canada, there is a difference between the amount of Additional Tax Deductions which has been utilized for past periods for revenue requirement purposes and the amount permitted by Revenue Canada. Can this difference, which would relate to prior years, be recovered from or distributed to the then current or future subscribers, or would this amount to retrospective rate-making?

If this could be done, what mechanism, if any, would be required? For example, would it be necessary for the Commission in the decision in this proceeding, to establish a "deferral account" in order to record the difference, resulting from reassessment, so as to allow for its recovery or its distribution in future years?

AGT argued that the adjustment of its rates in a future year to account for any difference between a Revenue Canada reassessment of the amount of ATDs available and the amount of ATDs accounted for in past periods is a matter of accounting methodology. Accordingly, such an adjustment would not offend the rule against retrospective rate-making. AGT cited a New Brunswick Court of Appeal case, Re New Brunswick Telephone Company, Limited (1977), 19 N.B.R. (2d) 681 (the NBTel case), in support of its position. In AGT's view, this approach is consistent with that taken by the Commission in respect to deferred tax liability in Deferred Tax Liability, Telecom Decision CRTC 89-9, 17 July 1989 (Decision 89-9).

In the alternative, should the Commission find that recovery or distribution of this difference may contribute to retrospective rate-making, AGT argued that the Commission has the power to create a deferral account for any such difference. AGT stated that the additions or reductions to its revenue requirement from the account would always be current items to be factored into rate-making. The company requested that it be permitted to make submissions on the nature of the deferral account if the Commission considers it appropriate to establish such an account.

In its argument, Calgary submitted that, if AGT were permitted to charge its subscribers a portion of the ATDs and if an adjustment to future rates is required to account for the difference resulting from a reassessment, the adjusted rates would be retrospective. To avoid concerns regarding retrospectivity, Calgary suggested that the amount of the shareholder entitlement be made interim, subject to reassessment. Alternatively, Calgary recommended that a deferral account be established. On the other hand, if subscribers had not been charged for the ATDs in past periods, Calgary submitted that there would be no concerns of retrospectivity since any adjustment to the ATDs in future years would be akin to adjustments periodically made to depreciation reserves when it is determined that depreciation related to prior periods was either over or under collected.

Calgary distinguished the NBTel case from the present situation on the basis that the additional tax payable in that case was an expense arising in the test year. Calgary argued that some of the ATDs that arose as a result of the AGT privatization transaction were used in 1990, 1991 and 1992. Finally, Calgary submitted that the analogy of the ATDs to the Commission's treatment of the deferred tax liability in Decision 89-9 is inappropriate.

In reply, AGT expanded more fully on the NBTel case, and explained that the regulator was permitted in that case to increase rates effective mid-1977 to recover the additional tax expense payable for the 1977 year. In AGT's view, the NBTel case supports the proposition that the mere fact that prospective revisions to the estimated tax expense or benefit resulting from a Revenue Canada reassessment relate to past years' revenue does not make the revisions retrospective.

The rule against retrospective rate-making that has been established in the case law precludes the Commission from setting rates to take into account the past losses or obligations or the past gains of a regulated company. In other words, consumers cannot be required to pay more or less for a service, because past consumers were charged too little or too much, in order to ensure that the public utility earned a fair and reasonable rate of return. The Commission can only set rates to meet the company's future revenue requirement.

However, in the Commission's view, any additional tax expense or credit arising from a Revenue Canada reassessment is properly characterized as a current expense or credit at the time of reassessment or as an accounting matter, rather than as a past expense or credit. Specifically, the reassessment could affect the amount of tax to be paid by the company in the year that the reassessment was made, and should therefore be regarded as a current expense or credit in that year. In addition, reassessment could necessitate accounting adjustments to AGT's deferred tax liability under the normalized method of accounting for income taxes (see Part IV below). Accordingly, the setting of AGT's rates in future years to take into account any additional expense (or credit) would not constitute retrospective rate-making; nor would it result in intergenerational inequity, any more than do other changes in accounting estimates such as those related to depreciation or deferred tax liability. Accordingly, the Commission considers that it will be able to make adjustments to AGT's rates in future years to reflect any difference between the amount of ATDs accounted for in past periods and the amount permitted by Revenue Canada in its reassessment.

The Commission notes, in passing, that making future adjustments to AGT's tax liability to correct for amounts incorrectly estimated in past periods would be consistent with the approach adopted by the Commission in two previous decisions. The Commission permitted BC TEL in Decision 89-9 and Newfoundland Tel in Newfoundland Telephone Company Limited - Revenue Requirement for the Years 1990 and 1991 and Attachment of Customer-Provided Multi-Line Terminal Equipment, Telecom Decision CRTC 90-15, 12 July 1990 (Decision 90-15), to make adjustments to their respective deferred tax liabilities to correct errors made in past years in their accounting for Allowance for Funds Used During Construction.

The Commission notes that the courts have afforded regulators a considerable degree of flexibility in choosing the most appropriate accounting method for enabling a utility to realize a fair return. For example, the courts have sanctioned the practice of establishing deferral accounts. This method enables a regulator to defer consideration of a particular item of expense or revenue that is incapable of being forecast with certainty for the test year.

Both AGT and Calgary suggested that the Commission consider establishing a deferral account as a means of addressing any concerns regarding retrospectivity. As noted above, the Commission is of the view that it can adjust future rates as necessary to account for a reassessment by Revenue Canada. The Commission notes that it is not its usual practice to establish deferral accounts with respect to accounting matters. However, given the amount of ATDs in question, the unique circumstances of this proceeding and the desirability of providing certainty for all concerned, the Commission considers it appropriate that the company establish a deferral account to record any difference that may result from a Revenue Canada reassessment. AGT is directed to establish such an account.

AGT requested that it be afforded an opportunity to make submissions on the nature of the deferral account, should the Commission adopt such an approach. The Commission is of the view that no further formal process is necessary. However, Commission staff will hold discussions with AGT in order to set up administrative and accounting procedures for the establishment and operation of the deferral account.

Finally, the Commission intends to adjust AGT's rates in future years, as necessary, to reflect any difference in the amount of ATDs used for regulatory purposes and the amount permitted by Revenue Canada.

D. Conclusions

The Commission notes that, in general, the carriers under its jurisdiction utilize, for revenue requirement purposes, amounts for tax deductions that are consistent with the amounts claimed for tax purposes. The Commission considers that, while it is possible that some ATDs may be questioned by Revenue Canada, AGT must have some degree of confidence in the acceptability of ATDs amounting to $2.5 billion, since it has consulted various experts on tax and privatization matters.

In an unregulated business, the company and its auditors would record a provision for income taxes based on a reasonable degree of certainty that the provision fairly represents current and/or future tax liabilities. In arriving at the provision for income taxes, some deductions may be excluded due to the uncertainty regarding the allowance of these deductions by Revenue Canada.

In a regulatory environment, the provision for current and/or future tax liabilities is affected by the recoverability of any questionable items through future rates. If the regulator allows the recovery of disallowed items in the future, when there is greater certainty as to their allowance or disallowance, any necessary rate adjustments can be made in the future, when the final outcome is determined, rather than the present, when the uncertainty is the greatest.

AGT stated that it plans to adjust for any differences when the 1990 taxation year becomes statute barred (in February 1996). However, AGT also stated that, even when the 1990 taxation year becomes statute barred, it does not necessarily mean that the values recorded will have been accepted by Revenue Canada. The company stated that, if these values are not settled during the audit process of the 1990 taxation year, since the tax returns filed for that year showed no taxes payable, they could be at issue in subsequent years when taxes are actually payable to Revenue Canada. Thus, the uncertainty is prolonged as to the exact amount of ATDs to use for revenue requirement purposes at this time.

The Commission agrees with the company that some uncertainty may exist in the transition to a competitive marketplace regarding the nature and extent of future competition. However, the Commission considers that this uncertainty is likely overstated by the company. Further, the uncertainty is mitigated, since the Commission intends to treat any difference resulting from a reassessment as a current year expense or credit to be recovered from or distributed to subscribers.

In light of the above, the Commission directs AGT to use an amount for the ATDs for revenue requirement purposes that is consistent with its tax returns filed or to be filed.

The Commission notes that AGT has the option of recording the same amount of income tax expense for book and regulatory purposes, since regulatory accounting practices can be taken as generally accepted accounting principles when the expenses are determined by the regulator to be recoverable through rates. Therefore, in the Commission's view, a regulatory adjustment should not be necessary.

The Commission will deal with any difference in the provision for income taxes that may arise as a result of a reassessment by Revenue Canada after AGT receives its reassessment notice for the 1990 taxation year. Any further differences resulting from subsequent taxation year reassessments, or rulings during any appeal process with respect to reassessments, will be dealt with at the time they occur.

III ALLOCATION OF BENEFITS OF THE ATDs BETWEEN SHAREHOLDER AND SUBSCRIBERS

A. General

AGT submitted that the shareholder (TELUS) is entitled to receive the benefits that flow from the utilization of the ATDs. The company stated that shareholder entitlement is founded on the basis that the ATDs are a non-utility asset to which TELUS has a property right. The company proposed that the subscribers acquire these ATDs at the value of such deductions to a third party. On this basis, AGT proposed that the shareholder entitlement to the ATDs be approximately $207 million.

In the alternative, AGT submitted that, if the Commission were to determine that the ATDs are a utility asset, TELUS should be allocated a portion of the ATDs commensurate with the premium paid by TELUS in the course of privatization. On this basis, AGT proposed that the shareholder entitlement to the ATDs be approximately $183 million.

AGT estimated that the entitlement (with interest) would be recovered over a maximum of 15 years, and proposed to recover approximately $25 million of the shareholder entitlement from subscribers in 1994.

In its evidence, Calgary submitted that, without the utility operations and assets of the AGT Commission, there would have been no ATDs. Hence, Calgary considered the ATDs to be a utility asset, the benefits of which should accrue to subscribers. Calgary also submitted that Alberta did not intend to sell the ATDs and that, contrary to AGT's assertion, TELUS did not pay above net book value for the assets of the AGT Commission. On this basis, Calgary argued that shareholders are not entitled to any of the benefits associated with the ATDs.

B. ATDs - Utility or Non-Utility Asset?

AGT argued that the ATDs are properly regarded as a non-utility asset, and cited the following factors in support of its view:

(1) no income tax expense was borne by subscribers prior to privatization;

(2) the ATDs are income tax deductions in excess of the net book value of the assets that were held by the AGT Commission, and the deductions were not useful in the provision of utility service by the AGT Commission;

(3) the Ruling was obtained and the privatization structure was developed and implemented through shareholder initiative, at a time when the AGT Commission was not regulated on a rate base/rate of return basis; and

(4) the shareholder paid a premium in order to acquire the assets and carry into effect the privatization structure required by the Ruling, and the ATDs would not have been created in other forms of privatization transactions.

In final argument, AGT acknowledged that the fourth factor supports its view that the ATDs are owned by the shareholder, but not necessarily its view that the ATDs are a non-utility asset.

In argument, Calgary stated that Alberta chose a privatization structure (1) that would allow for the maximum potential amount of ATDs, and (2) to provide a method by which these deductions could be transferred to AGT, rather than to the shareholder. Among other things, Calgary argued that the ATDs are a utility asset because they resulted from operations and assets used in the provision of telecommunications services to Albertans by the AGT Commission, a provincial Crown corporation that was ultimately owned by Alberta residents. In addition, Calgary submitted that subscribers paid a return on and of the capital invested by the AGT Commission in the telecommunications assets.

Calgary argued that purchasers of TELUS shares had no reason to expect any benefit from the ATDs. Furthermore, Calgary submitted that Alberta neither charged TELUS/AGT for the ATDs nor expected TELUS shareholders to pay for them.

In its reply, AGT asserted, among other things, that Calgary's inference that the ATDs resulted from the operations of the AGT Commission ignores the fact that the privatization and sale was a necessary condition for the creation of the ATDs. Accordingly, AGT submitted that, since the shareholder created the previously non-existent ATDs upon privatization, TELUS should not now be denied entitlement to the ATDs.

In the Commission's view, the factors listed by AGT do not support its contention that the ATDs are a non-utility asset. The Commission considers the first factor cited by AGT, that no income tax expense was borne by the subscribers of the AGT Commission, to be irrelevant. Subscribers did not bear, nor should they have borne, income tax expense through rates prior to privatization, since the AGT Commission was a Crown corporation and therefore exempt from income tax.

With regard to the second factor, the Commission also considers irrelevant the fact that the ATDs are deductions in excess of the net book value of the assets and were neither used nor useful prior to privatization. The ATDs did not come into existence until a specific privatization transaction was completed. The fact that the ATDs were not created until after the privatization merely reflects the fact that these deductions could not be created unless a specified series of transactions took place.

The Commission finds, based on the record of the proceeding, that the ATDs are dependent on the telecommunications operations and assets of the AGT Commission and that those assets were used in the provision of telecommunications services in the province of Alberta.
As to the third factor, the Commission considers the method by which the AGT Commission was regulated to be extraneous to the question. What is relevant is the fact that the assets remained those of the AGT Commission up until the privatization transaction was completed, that the existence of the assets was undeniably required in order for the ATDs to be created, and that those assets were used in the provision of telecommunications services. Further, subscribers to the AGT Commission funded the purchase of these assets through the rates they paid. The fact that an income tax expense was not included in subscriber rates prior to privatization does not affect the ownership of the assets at that time (they remained the property of the AGT Commission), or the fact that these assets were required in order to create the ATDs.

The Commission also notes that shareholders, through the company's board of directors and ultimately its management, are expected to make sound business decisions that maximize tax benefits, whether following a corporate restructuring or otherwise, and that the making of sound business decisions does not result in assets being non-utility assets.

In light of the above, the Commission finds that the ATDs are properly characterized as a utility asset.

C. Shareholder Entitlement

As noted in Part I, on 4 October 1990, all of the assets held by the AGT Commission, as agent for Alberta, were transferred to TELUS in exchange for TELUS common shares and notes payable to the AGT Commission. The notes substantially mirror the AGT Commission debentures that were held by Alberta. TELUS transferred most of the assets used in the telecommunications business of the AGT Commission to AGT in exchange for AGT share capital and interest-bearing promissory notes.

AGT stated in final argument that, in order to create the ATDs in accordance with the Ruling, the fair market value of the shares given up by TELUS to Alberta in exchange for the telephone assets included an amount over and above the net book value of the assets. The company stated that Alberta and TELUS, in effect, agreed in writing as to what the premium amount would be in the Revenue Canada schedule entitled Election on Disposition of Property By a Taxpayer to a Taxable Canadian Corporation (the election). AGT stated that, based on the election, both Alberta and TELUS agreed that the transfer of the AGT Commission's assets involved consideration of $16.53 per share, which translates to a total premium of $756 million over net book value. However, AGT stated that, to be conservative, it calculated the estimated premium paid using a lower estimate of fair market value, which it based on the subsequent (but nearly simultaneous) sale of shares to the public by Alberta. According to AGT, fair regulatory treatment required that TELUS be entitled to at least a portion of the benefits arising from the ATDs.

AGT submitted that, although the relevant transaction for the purposes of determining and valuing the shareholder entitlement to the ATDs is the transaction between the AGT Commission and TELUS, the public shareholders of TELUS would have reasonably expected to share in the benefits arising from the ATDs. First, AGT stated that, given that the Prospectus indicated that tax deductions in excess of net book value were available and identified that the share price sought by Alberta included a premium over net book value, the public shareholders would have reasonably concluded that at least part of the amount paid over net book value was for the benefits from the ATDs. Second, AGT pointed out that one of its expert witnesses stated during cross-examination by Calgary that investment houses would be aware of ordinary rate-making practices that would give shareholders the benefit of tax deductions relating to the premium paid. Third, AGT stated that public investors who were aware of the Commission's determinations in Decision 90-15 with respect to shareholder recovery of the income tax savings associated with a purchase premium would likely expect a similar determination from the Commission in this proceeding and would likely expect to receive some portion of the benefits from the ATDs. Finally, AGT pointed out that a note to the financial statements in the 1990 TELUS Annual Report indicated that the Commission, as part of its regulatory function, was expected to rule on the disposition of the tax benefits realized. As a result, the company argued, TELUS public shareholders would have expected to receive, through their ownership of TELUS shares, benefits from the ATDs at least equal to the premium paid by TELUS over the net book value of the telephone assets it acquired.

In final argument, Calgary agreed that the ATDs resulted from the privatization of the AGT Commission. However, it submitted that the substance underlying the creation of the ATDs was the telephone assets and operations of the AGT Commission. Calgary stated that, since subscribers paid a return on the original cost less accumulated depreciation and a return of capital invested (i.e., through depreciation), they were entitled to the benefits arising from the ATDs. Calgary argued that there was no information in the public documentation available at the time of the initial secondary share offering by Alberta that would lead public shareholders to expect to receive the benefits of the ATDs.

Calgary did not dispute that Alberta sold a portion of its shares in TELUS to public investors in late 1990 at $12 per share, or 12.5% more than the net book value per share. However, it submitted that the 12.5% premium does not distinguish this situation from that of any shareholder who, having acquired the shares of a public corporation, decides to sell the shares at a profit.

In reply argument, AGT stated that the net book value recorded in TELUS' 1990 financial statements for the telephone assets acquired from the AGT Commission should not be construed as the amount paid by TELUS. The company stated that this was only as a result of a particular accounting treatment used by TELUS because of the non-arm's length nature of the transaction. Moreover, AGT stated that this accounting treatment was consistent with generally accepted accounting principles.

The allocation of the benefits associated with the ATDs is a difficult regulatory issue, particularly given the lack of written agreements between the parties. The privatization and restructuring of the AGT Commission, which ultimately resulted in the issuing of TELUS shares to the general public of Alberta, was a complex process which necessarily involved a variety of unique economic, regional, social and political circumstances. In the Commission's view, the role of TELUS was vital to the successful completion of that process. Further, the Commission notes that it was this process that has given rise to the magnitude of the ATDs, which will result in substantially lower rates for subscribers than would otherwise have been the case. In light of these considerations, the Commission finds that TELUS should receive a portion of the benefits of the ATDs.

As noted above, AGT submitted that, if the Commission were to determine that the ATDs are a utility asset, TELUS should be allocated a portion of the ATDs commensurate with the premium paid by TELUS in the course of privatization. On this basis, AGT proposed that the shareholder entitlement to the ATDs be approximately $183 million. Given the magnitude of the ATDs (estimated at $2.5 billion) and in light of the determinations made above, the Commission considers that shareholder entitlement in the amount of $183 million would not be unreasonable. The Commission accepts this amount as the maximum amount of shareholder entitlement, subject to the resolution of the issues described in Section D, below. The Commission intends to rule on those issues in its decision in the proceeding related to AGT's application for general rate increases. In that decision, the Commission will also rule with respect to the final amount of the shareholder entitlement and the recovery period for that entitlement.

The special and unique circumstances referred to above are, in the Commission's view, unlikely to occur again in combination. Therefore, the Commission's determination in this proceeding should not be construed as a policy decision that would apply in other situations involving the privatization or other sale of a telephone company.

D. Legal Issues Related to Shareholder Entitlement

In Exhibit CRTC 1, the Commission requested that parties provide argument on the following matters:

(1) AGT has proposed to calculate any shareholder entitlement as of 31 December 1992 but not to pay it out until 1 January 1994. The company has argued that the Commission has jurisdiction over shareholder entitlement back to 24 January 1992, at which time the [company] requested that tax-related matters be deferred to a proceeding separate from the company's 1992 Revenue Requirement Proceeding. The company also indicated that the Commission would have the jurisdiction to determine the shareholder entitlement from the date rates are made interim. In Re: Applications for Interim Rate Increases, Interim Rates and for Use of the Rate Stabilization Reserve, Telecom Letter Decision CRTC 93-6, dated 28 April 1993, the Commission made AGT's existing rates interim, effective 1 May 1993, and invited comments on whether it can determine AGT's 1993 revenue requirement over the entire year at the time final argument is made in the proceeding to consider the company's general rate increase application.

Can the Commission allow the shareholder any entitlement to the benefits associated with the ATDs for the period 1 January 1993 to 30 April 1993, or would this amount to retrospective rate-making?

(2) In Appendix 1 to its rebuttal evidence, AGT indicates that if the ATDs are found to be a utility asset, no adjustment should be made for the ATDs used during the period 1990-92. If the Commission were to determine that the ATDs are utility assets, then would not making this adjustment lead to recovery of the shareholder entitlement beginning in 1990? If so, would that amount to retrospective rate-making?

Having received argument from both AGT and Calgary, as well as reply argument from the company, the Commission concludes that it would not be appropriate to make a determination at this time with regard to the issues described above.

As noted above, in Telecom Letter Decision CRTC 93-6, the Commission invited parties participating in the proceeding dealing with AGT's general rate increase application for 1993 and 1994 to comment at the time of final argument on whether the Commission can determine AGT's 1993 revenue requirement over the entire year, rather than just over the period after rates were made interim.

The Commission considers that the issues raised in Exhibit CRTC 1 are, for the most part, the same type of legal issue that will be considered in the context of AGT's application for a general rate increase. Accordingly, the Commission considers it appropriate to place the portion of the record of this proceeding dealing with the above issues on the record of the general rate increase proceeding. Parties to the general rate increase proceeding will have an opportunity in argument to address these issues in the context of the determinations made in this Decision, as well as the issue identified in Telecom Letter Decision CRTC 93-6. As noted above, the Commission will make determinations on these issues in its decision in the general rate increase proceeding.

IV METHOD TO ACCOUNT FOR INCOME TAXES

A. General

Timing differences between accounting income and taxable income arise when the inclusion of items of revenue and expense in the computation of accounting income and the time of their inclusion in the computation of taxable income do not coincide (for example, CCA in excess of depreciation). There are two methods that may be used to account for corporate income taxes (expense) where there are timing differences between accounting income and taxable income: the tax allocation (normalized) basis and the taxes payable (flow-through) basis.

The normalized basis relates the provision for income taxes (expense) to the accounting income for the period. Using the flow-through basis, the provision for income taxes (expense) represents the estimated amount of taxes that will actually be assessed (payable) for the period. The Canadian Institute of Chartered Accountants (CICA) recommends the normalized basis for all corporations, but recognizes that an exception may be warranted for regulated utilities under the jurisdiction of an authority that allows as an element of cost in setting rates only the amount of taxes currently payable. In Inquiry into Telecommunications Carriers' Costing and Accounting Procedures - Phase I: Accounting and Financial Matters, Telecom Decision CRTC 78-1, 13 January 1978 (Decision 78-1), the Commission directed all carriers under its jurisdiction to use the normalized basis.

With respect to the normalized basis, there are different methods that may be used to account for deferred tax liability. One method calculates the amount of income tax deferred in each period using the effective tax rate applicable during that period. This amount is then carried forward from year to year. This method is called the deferral method. The other method calculates the total amount of deferred income tax based on the enacted tax rate rather than the rate applicable at the time the deferred tax was incurred. This method is called the liability method. In Decision 89-9, the Commission directed all carriers under its jurisdiction to use the liability method.

B. Method to Account for Income Tax Expense

In its argument, AGT requested that the Commission maintain its long-standing adherence to the normalized method of accounting for income taxes. AGT further requested that the Commission not treat AGT differently from all other telephone companies in Canada by requiring it to use the flow-through method of accounting.

AGT noted that no party has suggested that Decision 78-1 was wrongly decided, or that there is substantial doubt as to the correctness of the Commission's accepted practice of the normalized method. In the absence of the above, AGT submitted that the Commission should not change its policy for the Canadian telephone industry.

AGT submitted that the present increasingly competitive environment makes it the wrong time to reconsider the normalized method of accounting for the telecommunications industry. In AGT's view, it is hard to support the future recovery test specified by the CICA with regard to the flow-through method. AGT also submitted that it is even more ill advised to put AGT alone on the flow-through method of accounting. As a matter of principle, AGT argued that all carriers under the Commission's jurisdiction should be regulated using the same accounting principles for tax purposes (i.e., normalization). In addition to this point of principle, AGT noted that it would be prejudiced under the Revenue Settlement Plan (RSP) if it were required to use the flow-through method.

AGT submitted that intergenerational inequity is minimized under the normalized method. Specifically, AGT stated that, with increased competition, the mix of its future customers will be different from the mix of existing customers. AGT submitted that flow-through accounting would result in future customers being made responsible for tax expenses incurred by AGT in providing service both to them and to previous generations of subscribers, resulting in intergenerational inequity.

In its argument, Calgary submitted that AGT should account for income taxes using the flow-through method for several reasons, including the following:

(1) official accounting pronouncements (i.e., the CICA Handbook) allow for the use of either the flow-through or normalized method for regulated enterprises;

(2) the flow-through method is a cost-based method based on taxable income (calculated using rules in the Income Tax Act), rather than on accounting income;

(3) where AGT is faced with competition, the use of the flow-through method provides the company with the opportunity to compete more strongly and capture market share in the early years, when it matters most;

(4) AGT acknowledged that its customers are better off by having reduced costs that are greater than the additional revenue AGT might receive from the RSP under the normalized method;

(5) there is a high probability that AGT will make capital expenditures in excess of depreciation into the indefinite future, which will result in an indefinite postponement of the time when amounts collected as deferred taxes are paid (the "crossover" point); and

(6) the use of the flow-through method provides the same degree of intergenerational inequity as the normalized method.

In reply argument, AGT stated that Calgary chose merely to recite its own evidence and not to reply to the company's argument. In response to some points raised by Calgary, AGT submitted that:

(1) normalized accounting is more consistent with increased competition, and overpricing future services would seriously damage AGT's ability to compete in later periods;

(2) in Decision 78-1, the Commission found that the normalized method "... best conforms to the principle of matching cost recognition with cost incurrence";

(3) Calgary's evidence regarding the crossover point relies upon extraneous information, while the company uses more pertinent information in its evidence;

(4) AGT would be placed at a serious competitive disadvantage if it alone were required to use the flow-through method; and

(5) Calgary provided no evidence to support the statement that the flow-through method provides the same degree of intergenerational inequity as the normalized method.

The Commission notes that generally accepted accounting principles permit the use of either method in the case of regulated utilities such as AGT. The Commission agrees that the use of the flow-through method would provide the company with the opportunity to compete more strongly in the early years of competition, as its income tax costs would be lower than otherwise under the normalized method. The Commission also notes that lower costs would result in greater savings than the additional revenues that the company would receive from the RSP by using the normalized method.

However, the Commission does not consider it appropriate at this time to have AGT use the flow-through method to account for income taxes. The Commission notes that the telecommunications industry is in the midst of several significant changes, in particular, the advent of competition in the long distance market. In addition, the Commission has initiated a proceeding to review the existing regulatory framework for the telephone companies and to examine whether it should be modified. While a change in the method of accounting for income taxes to the flow-through method would provide the company with a competitive advantage in the next few years, it is uncertain what impact this change would have in a more mature, competitive environment under a modified regulatory framework.

Calgary and AGT have provided conflicting evidence and views regarding the point at which depreciation will exceed CCA claimed. In addition, a significant portion of CCA claimed or to be claimed by AGT relates to the ATDs and does not have a counterpart in the calculation of accounting income. The ATDs associated with this incremental CCA will make the total CCA higher than it would otherwise be and, therefore, could artificially postpone the crossover point. Therefore, the Commission finds the evidence regarding the crossover point to be inconclusive.

Competitors in the long distance market are using, or will likely use, the normalized method to account for income taxes, and the Commission agrees that AGT could eventually be placed at a competitive disadvantage if it alone were required to use the flow-through method. The Commission also agrees that all federally regulated carriers should use the same method of accounting for income taxes.

In light of the above, the Commission considers that it would be inappropriate at this time to change the method of accounting for income tax expense for either AGT or the other federally regulated carriers. Accordingly, the Commission directs that AGT continue to use the normalized method to account for income tax expense.

C. Method to Account for Deferred Tax Liability

In its evidence, AGT stated that it accepts the Commission's current policy of employing the liability method to account for deferred tax liability, although it notes that the CICA still requires the use of the deferral method. AGT also stated that the risk associated with changes in tax rates on past timing differences could be eliminated by having the impact of unexpected changes in income tax rates deferred, with the deferred amount amortized to future periods and collected through future rates. Since these unexpected changes are beyond the control of management, AGT considered it appropriate to recover or return the impact of these changes to customers through future rates.

Consistent with its practice for other carriers, the Commission directs that AGT use the liability method to account for its deferred tax liability. With respect to the issue of periodic changes in income tax rates, the Commission stated the following in Decision 89-9:

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 [deferred tax liability] would also be smaller than the current adjustment. Therefore, a long amortization period may not be necessary for these ongoing adjustments.

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.

In the Commission's view, there has been no change in circumstances or evidence presented in this proceeding to warrant a review of the above determination. Therefore, periodic changes in income tax rates will be accounted for as prescribed in Decision 89-9.

V OTHER MATTERS

In a letter dated 26 February 1993, the Commission indicated that issues regarding rates and rate design that may result from this proceeding would be dealt with in the context of AGT's application for general rate increases. As a result of this Decision, several revisions are required to the evidence filed by AGT in the proceeding dealing with its 16 April 1993 application for general rate increases. By letter dated 23 July 1993, the Commission has directed AGT to update that evidence and has addressed supplementary interrogatories to the company.

Allan J. Darling
Secretary General