The Impact of Deferred Taxes on Utility Rate Base Growth: How a Strong Headwind to Growth Could Become a Tailwind for the Industry by 2020

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Eric Selmon

Office: +1-646-843-7200

Email: eselmon@ssrllc.com

Hugh Wynne

Office: +1-203-901-1624

Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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September 21, 2016

The Impact of Deferred Taxes on Utility Rate Base Growth:

How a Strong Headwind to Growth Could Become a Tailwind for the Industry’ by 2020

In our research note of Sept. 13, “Is This the Golden Age of Electric Utilities? A Primer on Historical and Forecast Rate Base Growth,” we analyzed utility rate base growth across the industry and at individual utilities, with the objective of identifying utilities that may be at inflection points in the growth of rate base and therefore regulated earnings. In this note we expand on a critical but often overlooked component of that analysis: the trajectory of utilities’ deferred tax liabilities. We first explain the accounting for utilities’ deferred tax liabilities and their regulatory and financial consequences. We then argue that the growth of utilities’ deferred tax liabilities can be expected to slow materially in the years ahead, accelerating the growth of regulated rate base. Indeed, by 2020, when bonus depreciation is scheduled to end under current law, utilities’ deferred tax liabilities may begin to fall, creating a significant tailwind to rate base growth. (See Exhibit 2 for a summary of these long term trends.)

  • The combination of bonus deprecation and accelerated tax depreciation drives a significant increase in deferred taxes for the electric utility industry through 2019; as a result, utilities’ total electric rate base will be 2.5% lower in 2020 than it would otherwise be.
  • Under current law, however, bonus depreciation expires in 2020, at which point we expect utilities’ deferred taxes will begin to fall. We calculate that the subsequent reduction in utilities’ deferred tax liability will add 4.6% to total electric rate base by 2025.
  • Our analysis suggests that the companies experiencing the greatest drag on rate base growth over the period 2016-20 will be AGR (for whom the increase in deferred taxes, we estimate, could be equivalent to -6.7% of rate base), ES (-7.3%), ETR (-6.2%), HE (-7.3%), PEG (-8.6%) and PPL (-5.5%).
  • The companies we expect to benefit most from the reduction in deferred taxes over the period 2021-25 are AEE (+6.0%), AVA (+6.0%), CMS (+7.5%), CNP (+6.7%), ED (+6.4%), OGE (+6.2%), PNW (+5.7%) and WEC (+8.0%).
  • For these companies, the scale of the change in deferred taxes is sufficiently large that it should be carefully assessed by analysts when projecting the growth of rate base and regulated earnings. The estimates of rate base growth published in our research note of Sept. 13th therefore incorporate the analysis of deferred taxes presented herein.

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology

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Source: FERC Form 1, company reports, SNL, SSR analysis

Exhibit 2: Estimated Annual Change in Aggregate Rate Base of U.S. Regulated Electric Utilities Attributable to Changes in Deferred Taxes (Impact on Deferred Tax Liability Due to 2016-2020 Capex in Red and Existing Plant in Blue; Combined Change in Deferred Taxes in Green)

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Source: IRS and SSR analysis

Details

Why are deferred taxes so important to utilities?

Two facts are critical to understanding the discussion in this note. First, utilities are allowed to earn a return on their rate base roughly equivalent to the weighted average cost of the debt and equity capital used to fund their investment in property, plant and equipment. Because a utility’s deferred tax liability largely represents income taxes expensed but not yet paid, and thus does not represent an outlay of capital, regulated utilities are not allowed to earn a return on the portion of their net PP&E that is funded by their deferred tax liability. As a result, rate base is generally calculated as the value of a utility’s net property, plant and equipment less the utility’s deferred tax liability.[1]

Second, because they operate in an industry characterized by persistently high levels of capital expenditures, the growth in electric utilities’ deferred tax liabilities are highly sensitive to the difference in the rate of depreciation allowed for tax purposes and that prescribed by GAAP for utilities’ financial statements. When the depreciation allowances permitted by the tax code are particularly generous relative to book depreciation, as is the case now, utilities’ deferred tax liability will increase rapidly, materially slowing growth in rate base and thus in regulated earnings.

Since 2008, bonus depreciation has been a particularly important factor in widening the gap between the rates of depreciation used for tax and book purposes. Beginning on January 1st of that year, companies were allowed to depreciate 50% of their investment in qualified property in the first year of its life. The bonus depreciation rate briefly increased to 100%, for property placed in service from September 9, 2010 through December 31, 2011, then fell back to 50% for the period 2012 through 2015. In December 2015, Congress extended 50% bonus depreciation through the end of 2017. Under current law, the bonus depreciation rate will fall to 40% in 2018 and 30% in 2019 before expiring altogether in 2020 (see Exhibit 3). Qualifying for bonus depreciation is a wide range of capital investments, including all electric utility plant,[2] pipelines used for gas transmission and distribution, and all water utility property.

Exhibit 3: Bonus Depreciation Rates by Year


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Source: Internal Revenue Service

A second equipment-related tax deduction that has taken on increased importance for utilities is the repair deduction. The IRS generally requires all investment in property to be capitalized. However, IRS regulations adopted in final form in 2013 allow businesses to deduct, rather than capitalize, the cost of repairs to property used in carrying on their trade or business. As a result of the new rules, utilities are now able to deduct for tax purposes a substantial portion of their maintenance capex. (For a summary of the IRS regulations governing the deductibility of repairs, and explanation of why utilities have been successful is categorizing their repairs as deductible, please see footnote 3 below).[3]

Finally, even in the absence of the repair deduction or bonus depreciation, accelerated depreciation for tax purposes, as permitted by the IRS’ Modified Accelerated Cost Recovery System (MACRS), can generate material differences between a utility’s tax and book depreciation. This reflects two facets of MACRS’ generous depreciation schedule for most utility assets. First, under MACRS, virtually all forms of electric and gas utility plant can be depreciated over 15 to 20 years,[4] even though their useful life for GAAP accounting purposes might be 30 to 40 years. Second, over these relatively short depreciable lives, the tax code permits accelerated depreciation of the assets, so that tax depreciation expense is particularly high in the early years of an investment’s life. As a result, over the first five years following the installation of many generation, transmission and distribution assets, MACRS depreciation charges average 6% p.a., while the GAAP depreciation rate, calculated using a 30 to 40-year life, is approximately half this level (2.5% to 3.3% p.a.). (See Exhibit 4).

Exhibit 4: GAAP and MACRS Depreciation Schedules for Electric Utility Plant with 30 to 40 Year Useful Lives

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  1. Actual average GAAP depreciation rates among utilities are generally within this range, implying a 30 and 40 year useful life for most utility plant, including generation, transmission and distribution assets.
  2. MACRS depreciation schedules extend to 20 years for transmission and distribution assets as well as steam turbine and combined cycle power plants, but only to 15 years for nuclear power plants and combustion turbine generators. Renewable generation (e.g. wind and solar) use a 5 year schedule, but at this point they remain a small portion of utility plant in service, even for the largest utility investors in renewables. MACRS adopts a half year convention, assuming plant is put in service at mid-year.

Source: IRS and SSR analysis

How these provisions of the tax code interact with the utility industry’s persistently high level of capital expenditure to slow rate base growth can be demonstrated through a simple numerical example. Consider the case of utility whose capex budget is designed to offset its depreciation expense, keeping net property, plant and equipment, a rough proxy for rate base, at a constant level. On average across all asset classes, utility depreciation rates tend to fall between 2.5% to 3.5% p.a. of gross PP&E. In the current context of 50% bonus depreciation, such a utility could write off for tax purposes half of its annual capex, or the equivalent of 1.25% to 1.75% of gross PP&E each year. Assuming a 35% tax rate, this would imply an increase in deferred taxes equivalent to ~0.4% to 0.6% of gross PP&E each year. As deferred taxes are an offset to rate base, the impact of this build-up in deferred taxes is to erode rate base, which reflects net PP&E, by a somewhat higher percentage each year.[5]

How to estimate the impact of deferred taxes

Exhibit 5 provides a simple example of the growth in the deferred tax liability of a utility that is depreciating a capital investment using the front loaded rates of depreciation permitted by 20 year MACRS, while depreciating the same investment for financial purposes over 35 years at a constant 2.9% annual rate (approximately the current industry average). For the first 20 years of the asset’s life, the depreciation charge allowed for tax purposes materially exceeds that reported on the utility’s financial statements; as a result, the utility’s cash taxes paid will be materially lower than the provision for income taxes recorded on its income statement; and this annual difference serves to increase the utility’s deferred tax liability. From year 21 on, the reverse is true; depreciation expense on the utility’s financial statements exceeds that permitted on its tax books (particularly after year 22, when tax depreciation ceases altogether); as a result, the utility’s cash taxes paid are substantially higher than the provision for income taxes on its GAAP P&L; and the deferred tax liability for that assets declines each year as a consequence.

Exhibit 5: Difference Between Annual GAAP and Tax Depreciation, and Consequent Increase and Subsequent Decrease in Deferred Tax Liability (Assumes MACRS But No Bonus Depreciation)

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Source: IRS and SSR analysis

Exhibit 6 illustrates the much more rapid increase in deferred tax liability that results from 50% bonus depreciation. In this context, half of annual capex is written off in year one.[6] Assuming a 35% tax rate, this immediately leads to a year one deferred tax liability of approximately 17.5% of plant placed in service. By contrast, in the absence of bonus depreciation, the year one deferred tax liability attributable to MACRS alone is equal only 0.3% of plant placed in service (see Exhibit 5).

Exhibit 6: Difference Between Annual GAAP and Tax Depreciation, and Consequent Increase and Subsequent Decrease in Deferred Tax Liability (Assumes MACRS and 50% Bonus Depreciation)

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Source: IRS and SSR analysis

To emphasize this point, Exhibit 7 illustrates how the impact of MACRS on a utility’s deferred tax liability in the first year of an asset’s life is dwarfed by the much larger impact of bonus depreciation (calculated at rates of 30%, 50% and 100%).

Exhibit 7: Year One Difference Between Tax and GAAP Depreciation and Consequent Increase in Deferred Tax Liability, Assuming MACRS and Various Levels of Bonus Depreciation (Expressed as a % of New Plant in Service)

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Source: IRS and SSR analysis

Finally, note that in Exhibit 5, which illustrates a case where MACRS tax depreciation rates are applied in the absence of bonus depreciation, the deferred tax liability does not begin to reverse until year 21, after which it declines quickly as tax depreciation falls to zero in year 22. By contrast, in Exhibit 6, which illustrates a case where MACRS tax depreciation rates are applied in tandem with 50% bonus depreciation, the deferred tax liability begins to reverse in year 6.[7]

The coming inflection point in utilities’ deferred tax liability

Taken together, Exhibits 5, 6 and 7 bring into focus two important points. First, bonus depreciation is far the more important than MACRS in driving the rapid increase in utilities’ deferred tax liability. Second, under 50% bonus depreciation, the year in which a utility’s deferred tax liability begins to reverse is advanced from the 21st year to the 6th year after an asset is placed in service.

As a consequence of these two facts, the drop in the rate of bonus depreciation in 2018, and its scheduled expiry in 2020, can be expected to mark a turning point in the trajectory of utilities’ deferred tax liability. From 2020 on, when bonus depreciation falls away, the rate of increase in deferred taxes attributable to new plant put in service will slow dramatically. As a result, the decrease in deferred taxes attributable to assets placed in service prior to 2020 will no longer be offset. The combined effect of these two trends will be to end the rapid increase in utilities’ net deferred tax liability, causing this headwind to rate base growth to fall away. After 2020, we calculate that utilities’ deferred tax liability may begin to fall, and thus become a tailwind to the growth of utility rate base and regulated earnings.

We share the view, variously attributed to Mark Twain, Yogi Berra and, perhaps most telling, to Nostradamus, that it is difficult to make predictions, particularly about the future. As we attempt to forecast the impact of current tax law on utilities’ future deferred tax liabilities, we note that our forecast is vulnerable on a number of counts. Utility capex in the years 2021-2025, for which no estimates are currently available, will drive some increase in deferred tax liabilities that will partly offset the reversal predicted here. Additionally, as companies close audits with the IRS for previous years or make changes to internal accounting policies, they will make adjustments to deferred tax liabilities from year to year, driving both increases and decreases in the balance. Most importantly, changes in tax policy, including the possible extension of bonus depreciation beyond 2020, could prolong the period of growth in utilities’ net deferred tax liability.

Nonetheless, under current law, bonus depreciation will drop from 50% currently to 40% in 2018, to 30% in 2019 and then fall to zero in 2020 (see Exhibit 3). This will materially slow the rate of increase in deferred taxes attributable to utility plant placed in service in 2018 and 2019. Beginning in 2020, when bonus depreciation ends, the annual increase in deferred taxes attributable to new plant in service will fall to a level reflective of MACRS depreciation alone. Simultaneously, the deferred tax liability built up over time in respect of utility assets brought into service prior to 2015 will gradually be reversed, following the pattern seen in Exhibits 5 and 6. We calculate that by 2020, in aggregate across U.S. regulated electric utilities as a group, the combination of (i) the absence of bonus depreciation, and the consequent very small increases in deferred taxes attributable to new plant in service, plus (ii) the gradual reversal of the deferred tax liability built up over time in respect of utilities’ existing plant in service, will result in a decline in the utility industry’s aggregate deferred tax liability. Because utilities’ deferred tax liabilities are an offset to rate base, this decline in the industry’s aggregate deferred tax liability will contribute to rate base growth beginning in 2020.

The impact on aggregate utility rate base of these two trends is illustrated in Exhibit 8 below. The brown columns show the negative annual contribution to utility rate base of the deferred tax liabilities booked in respect of future additions to utility plant over the period 2016-2020. As Exhibit 8 illustrates, the headwind to rate base growth from bonus depreciation on new plant placed in service diminishes significantly in 2018 and 2019 and falls away in 2020. By contrast, the blue columns show the positive annual contribution to utility rate base of the gradual reversal of the deferred tax liability accumulated historically by the utilities on their existing plant in service as of the end of 2015. The combined impact of these two trends is reflected in the green columns of Exhibit 8, which show an increase in the industry’s deferred tax liability, and thus a drag on rate base growth, through 2019, followed by a decline in the industry’s deferred tax liability, and thus a tailwind to rate base growth, commencing in 2020. (For a description of the calculations that underpin Exhibit 8, please see Appendix 1.)

Exhibit 8: Estimated Annual Change in Aggregate Rate Base of U.S. Regulated Electric Utilities Attributable to Changes in Deferred Taxes (Impact on Deferred Tax Liability Due to 2016-2020 Capex in Red and Existing Plant in Blue; Combined Change in Deferred Taxes in Green)

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Source: IRS and SSR analysis

In Exhibit 9, we show how this expected reversal in the growth of regulated utilities’ deferred tax liabilities is expected to affect the rate base growth of the individual utilities in the sector. Through the end of this decade, we expect the cumulative increase in the deferred tax liabilities of the regulated electric utilities to cause their aggregate rate base to be approximately 2.5% lower in 2020 than it would otherwise be. Most adversely affected over these years, we expect, will be AGR (for whom the expected increase in deferred taxes, we estimate, could be equivalent to approximately -7% of rate base), ES (~-7%), ETR (~-6%), HE (~-7%), PEG (~-9%) and PPL (~-6%). Over the years 2021 through 2025, by contrast, we expect the decline in the aggregate deferred tax liability of the industry to add approximately 4.6% to aggregate rate base. Benefitting most from this trend will be AEE (~6%), AVA (~6%), CMS (~7%), CNP (~7%), ED (~6%), OGE (~6%), PNW (~6%) and WEC (~8%).

It is important to note that this is a very company specific analysis and the actual changes in deferred taxes for each company is a reflection of the history of capex for many years prior.  For some companies, the rate of change in deferred taxes in the period of 2016-20 contributed to the improvement or decline in their rate of rate base growth that we highlighted in our note of Sept. 13th (Is This the Golden Age of Electric Utilities? A Primer on Historical and Forecast Rate Base Growth). ED, EIX and PCG, for example, whom we highlighted as showing significant improvement in rate base growth in the period from 2015-18 as compared with the period from 2012-15, are all in the first quintile in Exhibit 7. However, ALE, which was the bottom quintile for rate base growth, is in the second quintile for contribution from deferred taxes for 2016-20 and AGR, which was in the top quintile for rate base growth is in the bottom quintile for contribution from deferred taxes in 2016-20.

In summary, for many utilities the scale of the change in deferred taxes is sufficiently large that it should be carefully assessed by analysts when projecting the growth of rate base and regulated earnings. The estimates of rate base growth published in our research note of Sept. 13th (Is This the Golden Age of Electric Utilities? A Primer on Historical and Forecast Rate Base Growth) therefore incorporate the analysis of deferred taxes presented herein.

Exhibit 9: Estimated Change in Rate Base of U.S. Regulated Electric Utilities Attributable to Change in Deferred Tax Liability, 2016-2020 and 2021-2015 (% of Rate Base and Quintile Ranking)

Source: FERC Form 1, SNL, IRS and SSR analysis

Appendix 1

As noted in the text, the brown columns in Exhibit 8 show the negative annual contribution to utility rate base of the deferred tax liabilities booked in respect of future plant additions over the period 2016-2020. The blue columns show the positive annual contribution to aggregate electric utility rate base of the gradual reversal of the deferred tax liability accumulated historically by the utilities on their existing plant in service as of the end of 2015.

To calculate the deferred tax liabilities likely to be booked in respect of future additions to utility plant over the period 2016-2020 (the brown columns in Exhibit 8), we calculated for each regulated electric utility the amount of utility plant expected to enter service in each of these years, reflecting management’s disclosures of planned capex over this period. Based on these additions to utility plant, we estimated the expected annual increase in each utility’s deferred tax liability based upon the annual gap between (i) the rate of tax depreciation permitted under current law (combining the effect of bonus depreciation, MACRS and the repair deduction) and (ii) the average depreciation rate used by each utility in the preparation of its GAAP financial statements. This is the same calculation that underpins Exhibit 6, where the blue columns represent the annual rate of tax depreciation, and the red columns the annual rate of GAAP depreciation, in each year following the entry into service of utility plant. Our estimate of the increase in the industry’s total deferred tax liability over 2016-2025 due to additions to utility thus applies (i) the annual difference between tax and GAAP depreciation for each company in the industry to (ii) each company’s estimated annual additions to utility plant in service over the period 2016-2020 (the maximum period for which capex forecasts are available) and aggregates these annual estimates up to the industry level.

The second step was to calculate the annual change in the deferred tax liability accumulated historically by the utilities on existing plant in service as of the end of 2015. We did this separately for plant placed in service from 2008 on, i.e., after bonus depreciation became a continuous feature of the U.S. tax code, and for plant placed in service prior to 2008. For the years from 2008 on, we repeated the analysis described above based upon (i) each company’s additions to plant in service in each year and (ii) the gap between the annual rate of tax depreciation and the depreciation rate used by each company for GAAP purposes. For the years prior to 2007, when bonus depreciation was unusual, we took a different approach. We began by estimating for each utility its accumulated depreciation for tax purposes. This we did by adding the utility’s (i) accumulated depreciation for book purposes at year end 2007 to (ii) its deferred tax liability at that date divided by its tax rate. The latter calculation provides an estimate of the amount by which tax depreciation taken in respect of plant in service by year end 2007 has exceeded the book depreciation of the same assets. By dividing this estimate of accumulated depreciation for tax purposes by gross property plant and equipment, and making a simplifying assumption to treat all utility plant in service at that time as a single asset, it is possible to estimate where in the MACRS depreciation schedule each utility stood at year end 2007, on average for plant placed in service by that date. By reference to Exhibit 5, we could then estimate the annual decrease in each subsequent year of the utility’s deferred tax liability. Repeating this calculation for each utility, and aggregating the results across the industry, we estimated the annual decrease in deferred tax liability for the industry as a whole.

©2016, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

  1. Rate-regulated utilities are allowed to recover their prudently incurred cost of service in rates, including all costs to procure fuel and purchased power, operation and maintenance expense, depreciation expense, income and other taxes, and a fair return on rate base. Rate base represents the capital invested by a rate-regulated utility monopoly in the supply of a public service (e.g., electricity or gas) and in the U.S. is roughly equivalent to the net depreciated historical value of the utility’s plant, property and equipment. Rate base may be funded by common and preferred equity, long term debt and net deferred tax liabilities. On the debt portion of rate base, utilities are generally allowed to earn a return equivalent to their embedded cost of long term debt. A similar approach is to taken the recovery of the cost of preferred equity. Because a utility’s deferred tax liability largely represents income taxes expensed but not yet paid, and thus does not represent an outlay of capital, regulated utilities are not allowed to earn a return on deferred taxes. As a result, rate base is generally calculated as the net depreciated historical cost of a utility’s property, plant and equipment net of the utility’s deferred tax liability. Finally, on the portion of rate base funded with equity (a proportion set by regulators at a level deemed adequate to sustain an investment grade rating on the utility’s long term debt, and referred to as the “equity ratio”) utilities are allowed to earn a fair return (the utility’s “allowed ROE”) as determined by regulators in periodic rate cases. Given this regulatory framework, it is common for investors to estimate future utility earnings as the product of rate base, the utility’s equity ratio and its allowed ROE.
  2. The PATH Act defines qualified property to include equipment whose recovery period under the modified accelerated cost recovery system (MACRS) used by the IRS is 20 years or less; the latter category encompasses all generation, transmission, distribution and other electric utility plant.
  3. Per the IRS’ regulations, maintenance expenditures may qualify as a deductible cost of repair only if their cost is not material relative to the value of the system being repaired (e.g. <10%). In addition, to be deductible, repairs must not (i) restore the property to its original state; (ii) substantially prolong the useful life of the property repaired; or (iii) adapt the property to a new or different use. Various characteristics of utility plant militate in favor of repair costs being classified as deductible under the IRS’ rules. First, utility plant is made up of large, expensive and complex systems with multiple components; as a result, the cost of repairing individual components frequently falls below 10% of the system’s value and therefore is not deemed material. Second, repairs to the individual components of such large, complex systems do not restore the system as a whole to its original state or materially extend its useful life. Third, electric utility plant is dedicated to a single purpose, the supply of electricity; repairs will not change this. Utilities have thus been successful in deducting a significant part of their maintenance capex, particularly on their transmission and distribution networks. Utilities have been less successful in categorizing the maintenance of power plants as deductible repairs, largely because the cost of individual components of power plants, such as a boiler, turbine or generator, are often material relative to the power plant as a whole.
  4. The exception is investment in renewable generation, which can be depreciated even more rapidly under MACRS, over a five-year useful life.
  5. In fact, even if they are not growing, most utilities must invest much more than their annual depreciation expense to maintain system reliability. This reflects (i) the very long useful life of most utility plant, which is generally estimated at between 30 and 40 years; (ii) the cumulative increase in the price level since a utility’s assets were built; and (iii) the consequently higher cost of replacement capex that the historical cost of the equipment being replaced. By way of example, a portfolio of long lived generation, transmission and distribution assets may have an average age of 20 years. Even in an environment of low inflation, say 2.0% p.a. as measured by the producer price index, this would imply a cost to replace a particular piece of equipment that is at least 40% higher than the average historical cost at which similar equipment is carried on the utility’s books. Thus if depreciation expense is equivalent to 2.5% of gross PP&E p.a., replacement capex may run at 3.5% of gross PP&E. Given 50% bonus depreciation, the implication is that the utility will write off for tax purposes an amount equivalent 1.75% of gross PP&E p.a. Assuming a 35% tax rate, the consequent increase in the utility’s deferred tax liability would be equivalent to ~0.6% of gross PP&E p.a., eroding the growth of rate base, which is calculated off of net PP&E, by an even higher percentage.

    Finally, if such a utility were seeking to expand its network in real terms, for example to accommodate customer growth of 1.0% p.a., its annual capex budget would likely run at, or even above, 4.5% of gross PP&E annually. Given 50% bonus depreciation and a 35% tax rate, this rate of capital expenditure would increase deferred taxes by the equivalent of ~0.75% of gross PP&E p.a., offsetting rate base growth by a slightly higher percentage.

  6. Not only may half of annual capex be written off immediately for tax purposes, but the front-loaded depreciation rates permitted by MACRS apply to the remaining half, further adding to deferred taxes.
  7. The year in which the reversal of the deferred tax liability begin is affected by the GAAP depreciation rate used by the utility. In the example above we used a GAAP depreciation rate of 2.9%, but at 3.33% (30 year useful life), GAAP depreciation will exceed tax depreciation with 50% bonus depreciation beginning in year 4, but at 2.5% (40 year useful life) GAAP depreciation does not exceed tax depreciation, and the deferred tax liability does not begin to reverse until year 21.
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