Docket: Exhibit Number Commissioner Administrative Law Judge Public Advocates Office Witness

: : : : :

A.19-07-004 M. Genevieve Shiroma Gerald F. Kelly Mukunda Dawadi

REPORT AND RECOMMENDATIONS

ON RATE BASE AND SPECIAL REQUEST #6 and #10

Application 19-07-004

San Francisco, California February 14, 2020

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Table of Contents

CHAPTER 1: RATE BASE ...................................................................................... 1

A. INTRODUCTION ...........................................................................................................1

B. SUMMARY OF RECOMMENDATIONS .....................................................................2

C. DISCUSSION .................................................................................................................2

Allowance for Working Capital ............................................................................2

D. CONCLUSION ...............................................................................................................9

CHAPTER 2: SPECIAL REQUEST #6 ....................................................................... 10

A. INTRODUCTION .........................................................................................................10

B. SUMMARY OF RECOMMENDATIONS ...................................................................10

C. DISCUSSION ...............................................................................................................11

1) Tax on Contribution and Advances .................................................................12

2) Tax on Grants ..................................................................................................14

D. CONCLUSION .............................................................................................................16

CHAPTER 3: SPECIAL REQUEST #10 ..................................................................... 17

A. INTRODUCTION .........................................................................................................17

B. SUMMARY OF RECOMMENDATIONS ...................................................................17

C. DISCUSSION ...............................................................................................................17

D. CONCLUSION .............................................................................................................18

ATTACHMENTS: ...................................................................................................... 19

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MEMORANDUM

The Public Advocates Office at the California Public Utilities Commission

(“Public Advocates Office”) examined requests and data presented by California

American Water Company (“Cal Am”) in Application (“A.”) A.19-07-004

(“Application”) to provide the California Public Utilities Commission (“Commission”)

with recommendations that represent the interests of ratepayers for safe and reliable

service at the lowest cost. Mukunda Dawadi is the Public Advocates Office’s project lead

for this proceeding. Richard Rauschmeier is the oversight supervisor and Kerriann

Sheppard and Robyn Purchia are legal counsels.

Although every effort was made to comprehensively review, analyze, and provide

the Commission with recommendations on each ratemaking and policy aspect presented

in the Application, the absence from the Public Advocates Office’s testimony of any

particular issue does not necessarily constitute its endorsement or acceptance of the

underlying request, methodology, or policy position related to that issue.

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CHAPTER 1: RATE BASE 2

A. INTRODUCTION 3

Rate base represents the net investment in property that is necessary for 4

providing utility service.1 To incentivize and compensate investment in necessary 5

infrastructure, the rates customers pay for utility service include a return on a 6

reasonable and prudent rate base.2 In addition to tangible capital investments, rate 7

base will typically include an allowance for working capital. In the current 8

General Rate Case (“GRC”), Cal Am proposes rate base to include regulatory 9

assets comprised primarily of surcharge accounts by creating an additional 10

allowance for working capital in Test Year (“TY”) 2021 and 2022.3,4 11

This chapter presents Public Advocates Office’s review of and 12

recommendations on California American Water Company’s proposed rate base 13

for TY 2021 and 202022. Cal Am’s calculation of rate base for 2023 will not be 14

evaluated herein, as the rate base for 2023 is a formulaic calculation prescribed by 15

the current Rate Case Plan.5 16

1 The Regulation of Public Utilities, C.F. Phillips 1993, p. 315. 2 The Commission has authorized Cal Am to earn a return of 7.61%, which is comprised of 44.61% debt at a calculated cost of 5.63% and 55.39% shareholder equity at a calculated cost of 9.20% per, Fixing Cost of Capital for Calendar Years 2018, 2019 and 2020 for California Water Service Company, Decision (“D.”) 18-03-035, p. 2. 3 Direct testimony of Bahman Pourtaherian, pp. 28-29 for Cal Am’s request to include surcharge account balances in the rate base through allowance for working capital. 4 See the Direct testimony of Jayne Parker, p. 6, for Cal Am’s multiple surcharge accounts. 5 The Rate Case Plan states that all rate base items are subject to two test years and an attrition year, consistent with D.04-06-018 (Page A-19). Per footnote 6 on p. 15 of D.04-06-018, “the attrition allowance methodology provides for rate base additions in year 3 by adding the difference between test year 1 and test year 2 rate bases to the test year 2 rate base. Depreciation expense is handled in the same way.”

2

B. SUMMARY OF RECOMMENDATIONS 1

Based upon a review and analysis of Cal Am’s proposed rate base 2

calculations, the Public Advocates Office recommends the following to establish a 3

necessary, reasonable and prudent rate base for TY 2021 and 2022: 4

• The Commission should not authorize Cal Am to include surcharge 5

accounts and miscellaneous receivable amounts in calculating its allowance 6

for working capital. 7

• The Commission should remove non-expense and non-cash items, such as 8

Commission fees, franchise fees, depreciation, and deferred federal and 9

state income taxes from Cal Am’s calculation of its allowance for working 10

capital. 11

Any other differences between the Public Advocates Office’s and Cal Am’s 12

estimates of rate base amounts are primarily the result of different estimates of 13

Utility Plant in Service, which is separately analyzed and addressed by the Public 14

Advocates Office’s witnesses, Daphne Goldberg and Justin Menda.6 15

C. DISCUSSION 16

Allowance for Working Capital 17

The purpose of an allowance for working capital is to compensate investors 18

for funds permanently committed to paying operating expenses and maintaining 19

minimum bank balances in advance of offsetting revenues from customers.7 20

Working capital are the funds required for investment in materials and supplies, 21

cash required to meet current obligations, and cash required to maintain minimum 22

6 See the direct testimony of Daphne Goldberg for recorded plant and construction work in progress and the direct testimony of Justin Menda for the forecasted plant and depreciation. 7 Cal. P.U.C. Standard Practice U-16-W, p. 1-2.

3

balances.8 Cal Am’s proposed allowance for working capital is comprised of two 1

categories: operational working cash and lead lag. 2

Cal Am’s proposed allowance for working capital, both operational and 3

lead lag, includes unreasonable estimates that increase rate base and require 4

ratepayers to fund unnecessary shareholder returns. As described in the following 5

subsections, the Commission should not authorize Cal Am’s proposed addition of 6

surcharge accounts and miscellaneous receivables9 in calculating an allowance for 7

operational working capital. Similarly, the Commission should remove non-8

expense and non-cash items, such as Commission fees, estimated depreciation, 9

and estimated deferred federal and state income taxes from Cal Am’s proposed 10

allowance for working capital related to lead lag. 11

Working Capital, Operational 12

The Commission should not authorize Cal Am’s proposal to include 13

surcharge accounts (regulatory assets, net of regulatory liabilities, and 14

miscellaneous receivables) in the estimation of an allowance for operational 15

working capital for TY 2021 and 2022.10 16

Cal Am adds $11,557,610 and $9,364,937 net regulatory assets for TY 17

2021 and 2022 respectively in the allowance for working capital.11 Similarly, Cal 18

Am is proposing to include miscellaneous receivable amounts of $1,682,421 for 19

8 The Regulation of Public Utilities, C.F. Phillips 1993, p. 348. 9 Cal Am estimated miscellaneous receivables for TY 2021 are based on the recorded clearing and reconciliation of surcharge accounts, such as AFUDC amounts related to San Clemente Dam, Purchased Water tracked in balancing accounts, Coastal Water Project Surcharge tracked in regulatory asset, Contributions in-aid-of construction clearings accounts, accrual of unfunded insurance accounts, accrual of Medicare subsidy accounts, etc. 10 In addition to surcharge account balances (balancing and memorandum account balances), Cal Am’s proposal of regulatory assets also includes proposed earthquake insurance expense, pension and benefit tracker, interim rates, etc. See direct testimony of Bahman Pourtaherian, p. 28; 11 See Attachment 1 of this testimony for detail net regulatory assets by ratemaking districts.

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TY 2021 and 2021.12 Because of the inclusion of the estimated balance of 1

surcharge accounts in operational working capital, Cal Am increases its revenue 2

requirement by $1,007,566 for TY 2021 and $840,704 for TY 2022. 3

Cal Am’s proposal to add regulatory assets and regulatory liabilities 4

consists of the following:13 5

• Regulatory Asset- Consulting Fees 6 • Regulatory Asset- Water Energy Nexus Deferred Costs 7 • Regulatory Asset- Closing Costs 8 • Regulatory Asset - Low Income Program Costs 9 • Sand City Desal Plant Purchased Water Balancing Account 10 • Regulatory Asset - Purchased Power & Water Balancing Account 11 • Regulatory Asset - Authorized Balancing Account 12 • Regulatory Asset- Earthquake Insurance (3 Year Term) 13 • Regulatory Asset – ICBA (Incremental Cost Balancing Account) 14 • Regulatory Asset – Other 15 • Regulatory Liabilities – Post-Retirement Benefits Other Than Pensions 16

(PBOP) Tracker 17 • Regulatory Liabilities - Pension Tracker 18 • Regulatory Liabilities - Interim Rates 19 • Regulatory Liabilities – Other 20

Cal Am’s estimated miscellaneous receivable amount for TY 2021 and 21

2022 includes balances from mostly surcharge accounts, such as Allowance For 22

Funds Used During Construction (AFUDC) amounts related to San Clemente 23

Dam, purchased water tracked in balancing accounts, Coastal Water Project 24

surcharge tracked in regulatory asset, accrual of unfunded insurance accounts, 25

accrual of Medicare subsidy accounts, and many others.14 26

12 See Attachment 1 of this testimony for detail miscellaneous receivable amounts by ratemaking districts. 13 A.19-07-004, Cal Am RO Model Workpaper ALL_CH09_RB_WP_WCOP.xlsb, at tabs: “Proj Bal WCOP - WS5” and “OUT_Total WCOP WS6”. 14 See Attachment 2: Cal Am response to the Public Advocates Office’s Data Request #MD6-01 (estimating miscellaneous receivable amounts for TY 2021 and 2022 using transaction details as the basis).

5

Cal Am’s Proposal Creates Undue Burden on Ratepayers 1

Cal Am’s proposal to place surcharge accounts into working capital 2

unreasonably burdens ratepayers to fund hidden shareholder returns. The primary 3

purpose of surcharge accounts is to protect utilities from “unforeseen expenses, of 4

a substantial nature, beyond the utilities’ management or regulatory control.”15 5

However, Cal Am’s various proposals and forecasting methodologies in the 6

current GRC are inflating the balance of surcharge accounts while providing the 7

illusion of lower rates.16 Manipulating surcharge accounts to hide increases in 8

customers’ bills for costs , which can be reasonably estimated in the GRC, is 9

contrary to the purpose of surcharge accounts, impacts the transparency of the 10

GRC process, and creates undue burdens to ratepayers. It is unreasonable to 11

burden ratepayers by allowing shareholder returns to accumulate on Cal Am’s 12

surcharge accounts. 13

Cal Am’s Proposal Creates the Wrong Incentives 14

Cal Am’s proposal to apply a shareholder return to the outstanding balance 15

of surcharge accounts creates a financial incentive for the company to accumulate 16

larger balances in its surcharge accounts. Because the impact of recovering 17

surcharges is far less transparent to customers (and the Commission) than 18

proposals to increase base rate authorized in the GRC,17 permitting Cal Am to 19

accumulate larger balances in surcharge accounts encourages the company to 20

utilize the filing vehicles outside the GRC process. Furthermore, the mere 21

15 Cal. P.U.C., Water Div. Res. W-4294 (Nov. 29, 2001), p. 5. 16 See direct Testimony of Jayne Parker and direct testimony of Anusha Nagesh. 17 Direct Testimony Jayne Parker, p. 8, lines 3-8.

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existence of surcharge accounts reduces a utility’s incentive to operate efficiently 1

because it provides less incentive to reduce expenses.18 2

Cal Am’s Proposal has Industry-Wide Implications 3

The Commission has a long-standing practice to allow surcharge account 4

balances to accumulate interest at the 90-day commercial paper rate.19 All Class 5

A water utilities use this standard practice.20 Cal Am’s proposal to include 6

surcharge accounts in the calculation of its working capital and earn a shareholder 7

return on these account balances would represent a major shift in the 8

Commission’s existing practices that would likely need to be addressed across the 9

water utility industry. 10

Working Capital, Lead Lag 11

Cal Am estimates the portion of working capital related to lead lag for TY 12

2021 and 2022 in each rate making district by multiplying net lag days and total 13

daily expense amounts.21 However, Cal Am’s estimated daily expense amounts 14

include non-expense and non-cash items, such as Commission fees, franchise tax, 15

18 See Direct Testimony of Jayne Parker, p. 7.19 Cal. P.U.C. Standard Practice SP U-27-W, p.

10, no. 41 & p. 13, no. 54. 19 Cal. P.U.C. Standard Practice SP U-27-W, p. 10, no. 41 & p. 13, no. 54.

20 Occasionally, when authorizing creation or recovery of these accounts, the Commission

determines that specific circumstances justify allowing a rate above the 90-day commercial rate.

This can be seen in the authorization for the regulatory assets associated with Cal Am’s San

Clemente Dam account which accrues at Cal Am’s after-tax rate of return (D.12-06-040) and

Golden States Water Company’s Santa Maria memo accounts which accrue at the ten-year

Treasury note rate plus 1.5% (D.07-05-041). 21 A.19-07-004, Cal Am RO Model Workpaper “ALL_CH02_SE_RO.xlsb”, at tab: “WC Lead

Lag Calc”, Line 32.

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uncollectible accounts, depreciation, and deferred federal and state income taxes. 1

The Commission should remove these non-expense and non-cash items from Cal 2

Am’s lead lag study. 3

Cal Am estimates net lag days for TY 2021 and 2022 for each rate making 4

district by deducting weighted average expense lag days from revenue lag days 5

calculated in its lead lag study.22 Cal Am’s lead lag study is based on one year of 6

receivables and expense data ending on June 30, 2018.23 In Cal Am’s 7

methodology, lead lag days of each type of expense are estimated by counting the 8

number of days between the midpoint of the service period (accrual period) and 9

the date of payment.24 Cal Am estimates revenue lag days for each rate making 10

district by calculating and adding together three distinct components: 1) service 11

lag days; 2) billing lag days; and 3) collection lag days.25 12

Cal Am’s proposed allowance for working capital related to its lead lag 13

study is inflated as a result of including non-expense items, such as Commission 14

fees, franchise fees, as well as non-cash items, such as depreciation, uncollectible 15

accounts, and deferred federal and state income taxes.26 These items are neither 16

expenses nor cash outflows. Rather they are cash inflows to Cal Am. 17

22 A.19-07-004, Cal Am RO Model Workpaper “ALL_CH02_SE_RO.xlsb”, at tab: “WC Lead

Lag Calc”, Line 27. 23 Direct Testimony of Bahman Pourtaherian, p. 34, line 5.

24 A.19-07-004, Cal Am RO Model Workpaper “ALL_CH09_RB_WP_Lead Lag Support.xlsb”,

at tab: “EXP_Expense Lag Summary”. 25 Direct Testimony of Bahman Pourtaherian, p. 35, lines 11-13.

26 See A.19-07-004, Cal Am RO Model Workpaper “ALL_CH02_SE_RO.xlsb”, at tab: “Total

Lead Lag $”.

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For example, Commission fees and franchise fees are not Cal Am’s 1

expenses, but pass-through amounts collected from ratepayers as separate line-2

items on customers’ bills. Depreciation expense is a non-cash item and is merely 3

an accounting entry that has no relationship to Cal Am’s required working capital 4

needs. Uncollectible account is a non-cash expense (reported in accounting 5

records) and is built into setting rates. Deferred taxes are a collection of taxes 6

from ratepayers through rates. Uncollectible accounts and deferred federal and 7

state income taxes are not cash outflows for Cal Am but rather are cash inflows 8

that ratepayers pay through rates because these items are already included in 9

setting rates. 10

By including these non-expense and non-cash items in its lead lag study, 11

Cal Am has inflated its estimated rate base for TY 2021 and 2022 by 12

approximately $4 million per year, which increases the revenue requirement by 13

approximately $300,000 each year. 14

Cal Am indicates that it has calculated working capital related to lead lag 15

by using the methodology outlined in the Commission’s Standard Practice (SP) U-16

16.27 However, SP U-16 also explains in detail why utilities should only consider 17

actual expenses (or cash outlay) paid by investors to outside vendors in advance of 18

collecting revenues in working capital.28 In fact, in D.04-09-061, the Commission 19

clarified that utilities should not include depreciation in an allowance of working 20

capital calculation.29 Because non-expense and non-cash items do not become 21

27 Direct testimony of Bahman Pourtaherian, p. 33, lines 8-10.

28 Cal. P.U.C. Standard Practice U-16-W, Chapter 3, p. 1-10 & 1-11.

29 Re New Regulatory Framework for Pacific Bell and Verizon California, Inc., D.04-09-061, p.

60 – “Therefore, we clarify that for the current and future financial periods Pacific shall no longer

include depreciation in its cash working capital calculations, regardless of whether the simplified

(continued on next page)

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cash outflows for Cal Am in TY2021, the Commission should not allow Cal Am 1

to include these items (Commission fees, franchise fees, uncollectible accounts, 2

depreciation, and deferred federal and state income taxes) in the lead lag study. 3

By removing non-expense and non-cash items from Cal Am’s calculation 4

of allowance of working capital related to lead lag, revenue requirements are 5

reduced by approximately $300,000. Other differences between Cal Am’s 6

proposed and the Public Advocates Office’s recommended allowance for working 7

capital related to lead lag are due to the differences in recommended expenses, 8

which is discussed by the Public Advocates Office’s witness, Anusha Nagesh. 9

D. CONCLUSION 10

The Commission should remove all surcharge accounts and related 11

miscellaneous receivables from Cal Am’s proposed allowance for working capital. 12

The Commission should also remove non-expense and non-cash expense items 13

from Cal Am’s proposed calculation of allowance for working capital related to 14

lead lag. 15

or detailed method is employed.”

10

CHAPTER 2: SPECIAL REQUEST #6 1

A. INTRODUCTION 2

Through Special Request #6, Cal Am is seeking authorization to recover 3

federal income taxes imposed upon contributions-in-aid-of-construction 4

(“Contributions”), advances for construction (“Advances”), and grants from 5

ratepayers. This proposal would relieve the contributors from bearing the tax on 6

contributed amounts/assets.30 Currently, both contributors and ratepayers share 7

taxes on taxable Contributions; however, ratepayers bear a much smaller share of 8

the tax on the Contribution.31 Cal Am’s request would transfer the tax burden on 9

Contributions from contributors to ratepayers. This requested change the 10

Commission’s long-standing policy that the tax should be paid by those who cause 11

the tax. 12

B. SUMMARY OF RECOMMENDATIONS 13

The Commission should not authorize Cal Am to collect taxes on 14

Contribution and Advances from ratepayers as requested in Special Request #6. If 15

Cal Am does not want to recover taxes on Contribution and Advances from the 16

contributors who cause the tax, the Commission should permit Cal Am to absorb 17

the tax itself without passing it on to the ratepayers. 18

30 Direct testimony of Jeffrey Linam, pp. 67 to 70. 31 The Commission allows utilities to utilize Method to calculate federal taxes on taxable contribution and advances. Method 5 places the major portion of the tax burden on the contributor (Re Methods for Establishing the Proper Level of Expense Resulting from 1986 Tax Reform Act, D.87-09-026, p. *114 [1987 Cal. PUC LEXIS 195]).

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C. DISCUSSION 1

Cal Am is requesting the Commission authorize recovery of taxes imposed 2

upon Contributions and Advances entirely from ratepayers through rate base.32 If 3

grants are taxable, Cal Am also requests authorization to recover taxes on grants 4

through rate base.33 Cal Am seeks to apply Method 3, as described in D.87-09-5

026, to include in rate base the total taxes paid on Contribution, Advances, and 6

grants, and relieve contributors from paying taxes.34 Using proposed Method 3, 7

Cal Am calculates the rate base for taxes on Contributions as $791,021 for TY 8

2021 and $804,851 for 2022.35 9

In D.87-09-026, the Commission evaluated five alternatives (Methods 1 10

through 5) to calculate taxes on Contributions and Advances. The Commission 11

found Methods 1, 3, and 4 unreasonable because none of these methods place the 12

tax burden on the contributors.36 D.87-09-026 ordered utility companies to adopt 13

one of the methods the Commission found reasonable, either Method 5 or Method 14

2.37 However, Method 2 is restricted to only a small water company or a small 15

telephone company.38 In D.87-09-026, the Commission explained why Method 5 16

is reasonable: 17

32 Direct testimony of Jeffrey Linam, p. 67, lines 12-18. 33 Direct testimony of Jeffrey Linam, p. 67, lines 12-18. 34 Direct testimony of Jeffrey Linam, p. 68, lines 15-21. 35 See Attachment 3 of this Report. The amounts are pulled out from the Cells K46 and L46 of Cal Am’s application workpapers “ALL_CH09_RB_RO_Deferred Tax” at tabs XXX_ADIT (i.e., SDC_ADIT etc.). 36 D.87-09-026, Findings of Fact #3.

37 D.87-09-026, Ordering Paragraph #2.

38 D.87-09-026, Ordering Paragraph #2 (b).

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“Method 5 places the tax burden on the contributor but mitigates the 1 burden by requiring, in addition to the plant contribution, only the 2 present value of the future tax burden. The gross-up is calculated by 3 using the utility's incremental federal tax rate. As the payment by the 4 contributor, by definition, does not completely pay the tax, the utility 5 pays the difference, ratebases the tax on the CIAC net of gross-up, 6 and recovers the difference over time in rate of return, thus causing 7 the ratepayers to share the burden of the tax. Because the gross-up 8 amount paid by the contributor is estimated to offset the future 9 revenue requirements attributable to the tax actually paid, the 10 ratepayers are, to the extent the estimate turns out to be accurate, 11 indifferent. For contributions, Method 5 reduces the federal tax 12 burden on the contributor by approximately 48% of the burden under 13 Method 2. For refundable advances, the contributor pays the same 14 gross-up as for contributions; the utility pays the difference between 15 the contributor's share of the tax gross-up and the tax liability. The 16 utility earns a return on the tax payment through ratebasing the tax. 17 The gross-up will be refunded to the contributor and the utility will 18 recover its portion of the tax payment as the utility realizes tax 19 benefits through the deductibility of the advance refunds. Between 20 Methods 1, 3, and 5, Method 5 provides the least risk to the utility. 21 Method 5 is reasonable.”39 22

D.87-09-026 further states that Method 3 places the tax burden entirely on 23

ratepayers and results in a significantly higher cumulative revenue requirement 24

than Method 5.40 25

1) Tax on Contribution and Advances 26

Cal Am’s proposal of utilizing Method 3 in calculating federal income tax 27

on Contribution and Advances is contrary to the Commission’s long-standing 28

principle of having costs paid by the entity causing the cost. The Commission 29

evaluated and re-affirmed this principle in D.87-09-026.41 Cal Am has not 30

39 D.87-09-026, Findings of Fact #4.

40 D.87-09-026, pp. *87-88 [[1987 Cal. PUC LEXIS 195]. 41 D.87-09-026, pp. *87-88 [1987 Cal. PUC LEXIS 195].

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provided supporting reasons as to why the Commission should shift from its long-1

standing policy of applying Method 5, which protects ratepayers, to Method 3 2

which penalizes ratepayers and subsidizes contributors. 3

Cal Am states that it is concerned about increasing housing costs in 4

California.42 However, the Commission carefully evaluated this issue and 5

determined in D.87-09-026 that concerns regarding the impacts on California’s 6

housing crisis were “misdirected.”43 7

Cal Am also states that it is concerned about the continuing use of Method 8

5 because all Contribution and Advances are now taxable under the Tax Cuts and 9

Jobs Act of 2017 (“TCJA 2017”), not just a portion as was previously the case.44 10

This implies that the Commission might have adopted a different method if all 11

Contributions and Advances were taxable at the time D.87-09-026 was published. 12

However, this argument is rejected by a plain reading of D.87-09-026, which 13

assumed that all the Contributions should be considered to be taxable.45 14

For the reasons stated above, the Commission should reject Cal Am’s 15

Special Request #6 and remove $791,026 and $804,851 in taxes on Contributions 16

from the proposed TY 2021 and 2022 rate base respectively, as shown in the table 17

1-A below. Furthermore, if Cal Am no longer desires to apply the existing 18

Method 5, the Commission should allow Cal Am not collect taxes from 19

contributor and absorb the tax itself (and not pass on to ratepayers). 20

42 Direct testimony of Jeffrey Linam, pp. 69-70. 43 D.87-09-026, pp. *87-88 [1987 Cal. PUC LEXIS 195]. (under the discussion on why the Commission rejected Method 3). 44 Direct testimony of Jeffrey Linam, p. 69, lines 18-19. 45 D. 87-09-026, p. *106 [1987 Cal. PUC LEXIS 195].

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Cal Am Proposed Rate Based Taxes on Estimated 1 Contribution Amounts 2

Districts 2021 2022 San Diego County District $5,775 $5,867 Monterey County District $73,775 $74,601 Los Angeles County District $28,874 $28,874 Ventura County District $35,193 $35,193 Sacramento District $645,344 $658,251 Larkfield District $2,066 $2,066

Total Rate-Based Taxes on Contribution $791,026 $804,851

3

2) Tax on Grants 4

Cal Am requests authorization to apply Method 3 to recover the taxes it 5

pays on grants from ratepayers.46 Grants to Cal Am are normally provided by a 6

state government.47 Cal Am asserts that these grants do not ordinarily cover the 7

tax.48 8

Governmental grants were not taxable prior to the enactment of TCJA 9

201749, which amended Internal Revenue Code (“IRC”) Section 118 on December 10

27, 2018. Even though IRC Section 118(a) retains the general rule that, in the case 11

of a corporation, gross income does not include any contribution to its capital, 12

TCJA 2017 made Contributions taxable by amending IRC Section 118(b). Now, 13

any contribution by any governmental entity or civic group (other than a 14

46 Cal Am GRC Application (“A”)19-07-004, Special Request No. 6; Direct testimony of Jeffrey Linam, p. 67, lines 14-18. 47 Direct testimony of Jeffrey Linam, pp. 68-69. 48 Direct testimony of Jeffrey Linam, pp. 68-69. 49 Public Law 115-97.

15

contribution made by a shareholder) to a corporation is no longer excluded from 1

its gross income.50 2

In November 2019, United States Senator Jeanne Shaheen introduced 3

S.2942 to revise requirements for the tax exclusion for contributions to the capital 4

of a corporation. Specifically, the bill would allow regulated water utilities to 5

exclude certain amounts from taxable income.51 If this bill is adopted, grants 6

from governmental entities will not be taxable. 7

In addition, the U.S. Tax Court recently ruled that certain cash grants 8

provided to a corporate taxpayer by a state government constituted nontaxable 9

contributions.52 If states provide grants to Cal Am for similar purposes, those 10

grants may also not be taxable. 11

Given the possibility that newly introduced legislation may amend the IRC 12

and make water utilities’ grants non-taxable, as well as the U.S. Tax Court 13

decision, it is premature for the Commission to authorize Cal Am to recover taxes 14

on government grants from ratepayers. 15

Cal Am has also not indicated in its Application whether it expects to 16

receive any grants in the current GRC period (2021 to 2023) and has not provided 17

information on whether any potential governmental grants for the current GRC 18

period would be taxable. 19

If S.2942 is not passed and Cal Am’s future grants are taxable, the 20

Commission should treat taxes payable on grants as an operating expense, not rate 21

50 I.R.C. § 118, subd. (b)(2) (2017). 51 S. 2942, 116th Cong. (2019) (available at https://www.congress.gov/bill/116th-congress/senate-bill/2942). 52 Brokertec Holdings, Inc. v. Commissioner, T.C. 2019-32.

16

base items. Adding taxes on grants to rate base unreasonably burdens ratepayers 1

by forcing them to pay a return on the taxes. 2

The Commission should not authorize Cal Am’s request to apply Method 3 3

if grants are taxable. Instead, the Commission should require taxes payable on 4

grants to be recovered as an operating expense similar to how federal and state 5

income taxes are currently recovered in rates. 6

D. CONCLUSION 7

The Commission should not authorize Cal Am to utilize Method 3 to rate 8

base all the taxes on Contributions and Advances as requested in Special Request 9

#6. The request is contrary to the Commission’s long-standing principle that the 10

person who causes the tax should pay the tax. Cal Am has not provided sufficient 11

compelling reasons as to why the Commission should shift from its long-standing 12

policy of applying Method 5, which protects ratepayers, to Method 3, which 13

unreasonably burdens ratepayers. 14

In addition, Cal Am should remove estimated taxes on Contributions and 15

Advances from its results of operation model. 16

Furthermore, if Cal Am does not want to recover taxes on Contributions 17

and Advances from contributors who cause the tax, the Commission should permit 18

Cal Am to choose not to collect the tax from the contributors, absorb the tax itself, 19

and not pass tax on to the ratepayers. 20

If grants are taxable, the Commission should treat taxes payable on grants 21

as an operating expense, not as a rate base item. 22

23

17

CHAPTER 3: SPECIAL REQUEST #10 1

A. INTRODUCTION 2

Cal Am requests to incorporate any rate changes occurring while its GRC 3

Application is pending into new rates and reflect such new rates in the present 4

rates revenue for determining actual rate increase caused by the GRC 5

application.53 Cal Am’s Special Request #10 has two components: (1) the update 6

of present rate revenue with any new rates authorized, and (2) the inclusion of all 7

the rate changes after this GRC application into the revenue requirement 8

calculation for TY 2021.54 9

B. SUMMARY OF RECOMMENDATIONS 10

The Public Advocates Office does not oppose Cal Am’s Special Request 11

#10. If adopted, Cal Am’s request provides a more accurate representation and 12

separation of the impacts of the current GRC and impacts of approvals obtained in 13

other proceedings. 14

C. DISCUSSION 15

Cal Am requests to incorporate into new rates any rate changes that occur 16

while its GRC Application is pending and to reflect such rate changes in the 17

present rate revenue to determine the actual rate increase caused by A.19-07-18

004.55 Changes to Cal Am’s rates frequently occur while a GRC application is 19

pending. These changes can include various alternative rate making mechanisms, 20

53 Cal Am GRC A.19-07-004, Special Request No. 10, p. 12. 54 Direct testimony of Jeffrey Linam, p. 82, lines 12-26. 55 Cal Am GRC A.19-07-004, Special Request No. 10, p. 12; Direct testimony of Jeffrey Linam, pp. 81-82.

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such as “purchased water offsets,” “rate base offsets,” and “escalation and attrition 1

filings.” 2

When the Commission approves rate changes outside of a GRC proceeding, 3

the impacts of those changes on customers are not reflected in the pending GRC. 4

For example, a GRC that proposes to increase an average customer’s bill from $50 5

to $55 would be depicted as proposing a 10% increase. If a separate $5 increase is 6

approved while the GRC is pending, the actual impact being proposed in the GRC 7

then becomes a 9% increase from $55 to $60. 8

To better represent the impacts of a GRC and rate changes authorized while 9

a GRC is pending, the Commission should incorporate any rate changes approved 10

while a GRC is pending into the revenues and costs authorized in the GRC 11

decision. This is accomplished by accounting for both the new costs and new 12

rates that are approved outside of the GRC to the proposed costs and present rates 13

identified in the GRC. 14

D. CONCLUSION 15

The Public Advocates Office does not oppose Cal Am’s Special Request 16

#10. 17

18

19

ATTACHMENTS: 1

2

20

Attachment 1: Cal Am Proposed Net Regulatory Assets and 1

miscellaneous receivable Amounts 2

3 4 5

Cal Am Proposed Net Regulatory Assets in Allowance for Operational 6 Working Capital56 7

8 District # District Name 2021 2022

1501 CAW Corporate (2,175,895) (3,209,001) 1530 San Diego County District 797,601 736,731 1540 Monterey County District 4,085,906 3,573,003 1542 Monterey Wastewater 138,724 128,419 1550 Los Angeles County District 1,786,101 1,742,278 1551 Ventura County District 1,936,125 1,780,149 1560 Sacramento District 4,585,801 4,239,514 1561 Larkfield District 403,247 373,843

Total Net Regulatory Assets $ 11,557,610 $ 9,364,937 9 10

Cal Am Proposed Miscellaneous Receivable amounts in Allowance for 11 Operational Working Capital57 12

13 District # District Name 2021 2022

1501 CAW Corporate 1,366,997 1,366,997 1530 San Diego County District 0 0 1540 Monterey County District 264,803 264,803 1542 Monterey Wastewater 0 0 1550 Los Angeles County District (36,269) (36,269) 1551 Ventura County District 142 142 1560 Sacramento District 58,535 58,535 1561 Larkfield District 28,213 28,213

Miscellaneous Receivables $ 1,682,421 $ 1,682,421

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56 A.19-07-004, Cal Am RO Model Workpaper ALL_CH09_RB_WP_WCOP.xlsb, at tabs: “Proj Bal WCOP - WS5” and “OUT_Total WCOP WS6”. 57 A.19-07-004, Cal Am RO Model Workpaper ALL_CH09_RB_WP_WCOP.xlsb, at tabs: “Proj Bal WCOP - WS5” and “OUT_Total WCOP WS6”.

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Attachment 2: Cal Am Response to the Public Advocate’s 1

Office Data Request #MD6-01 2

3

22

1 2

23

Attachment 3: Cal Am Response to the Public Advocates 1

Office’s Data Request #MD6-02, Question 1 2

3 4 5

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Attachment 4: Witness Qualifications 1

QUALIFICATIONS AND PREPARED TESTIMONY 2 OF MUKUNDA DAWADI 3

4 Q.1 Please state your name and business address. 5 A.1 My name is Mukunda Dawadi and my business address is 505 Van Ness 6

Ave, California 94102. 7 Q.2 By whom are you employed and in what capacity? 8 A.2 I am a Public Utilities Regulatory Analyst V in the Communication and 9

Water Policy Branch of the Public Advocates Office at California Public 10 Utilities Commission. I joined the Commission in January 2014 as an 11 Auditor. 12

Q.3 Briefly describe your pertinent educational background. 13 A.3 In 2012, I received a Master’s of Science in Accountancy from California 14

State University, Los Angeles. I graduated from Tribhuvan University 15 (TU) of Nepal with a Master’s of Business Administration in 1998 and 16 Bachelor’s Degree in Business Management in 1992. 17

Q.4 Briefly describe your professional experience. 18 A.4 My experience at the Commission includes responsibility for reports on 19

General Office Expenses (excluding payroll, benefits and depreciation) in 20 Application (A.)14-01-002; Construction Work-in-Progress (CWIP), 21 Allowance of Working Cash, and Deferred Tax in A.14-07-006; Affiliated 22 Transactions, NTP&S, and Affiliate Revenue Allocation in A.15-07-015; 23 Water Revenue Adjustment Mechanism in A.15-07-019, Rate Base Items 24 and Public Advocates Office’s Results of Operation in A.15-01-002, A.16-25 07-006 and A.18-01-004; and effects of Tax Cuts and Jobs Act 2017 26 (TCJA) on Revenue Requirement in A.16-07-006 and A.18-01-004. I also 27 served as project coordinator and analyzed utilities’ Cost of Debt, Capital 28 Structure, and Risk Factors in A.17-04-001 et.al. and A.18-05-001 et.al. 29

Q.5 What is your responsibility in this proceeding? 30 A.5 I am responsible for coordinating the GRC review team and the testimony 31

on Rate Base, Special Request #6 and #10, and calculation of results of 32 operations presented in this report. 33

Q.6 Does that conclude your direct testimony? 34 A.6 Yes, it does. 35