Widespread Impacts
PwC Partner Robin Miller leads the firm’s U.S. Power & Utilities tax practice. With more than 25 years of experience, she helps utilities optimize tax outcomes and manage risk by addressing specific company issues and the wider business and regulatory environments.
With the most significant overhaul of the U.S. tax code in more than thirty years now signed into law, power and utility companies will move toward implementing the changes and evaluating the impacts it will have on their business, cash flow and capital investments.
Certain provisions of the Tax Cuts and Jobs Act are expected to have widespread impacts on the industry. One of the most notable changes is the reduction of the corporate tax rate as well as the elimination of the corporate alternative minimum tax.
The new law contains rules that may impact deductibility of interest and the accelerated cost recovery of capital assets. In the meantime, no changes were made to the dividend and capital gains rates. That means these rates remain in parity, which is also important to industry investors.
Leading up to reform, industry leaders had several key priorities that they were watching very closely. Here’s a look at three of the top issues, and what the changes could mean for the industry.
Reductions to corporate tax rate:
Effective January 1, 2018, the corporate rate dropped from 35 percent to 21 percent. Considering that income taxes are a significant component of cost of service and, therefore, utility rates, this reduction will have a meaningful near-term and positive impact on customer rates.
The tax rate reduction also reduces the amount of accumulated deferred tax, that is, the amounts companies anticipated paying in taxes in the future for timing difference deductions taken in the past. That creates excess deferred income taxes for regulated utilities that will be shared with their customers.
The new tax law generally provides for the normalization of regulated utilities’ property-related excess deferred income taxes. That is, the difference between the utility’s property deferred taxes at today’s thirty-five percent rate versus the new twenty-one percent rate.
Normalization of excess deferred income taxes generally provides regulated utilities the opportunity to reduce rates charged to customers over the book life of the property, thus avoiding sharp fluctuations in rates charged to customers as a result of the tax rate change. Utilities also have excess deferred taxes associated with nonproperty-related differences.
The normalization rules in the new law do not cover the nonproperty-related excess deferred income taxes. That means the regulatory commissions have discretion to determine the period over which the nonproperty excess deferred income taxes may flow back to customers.
Limits to interest deductibility:
The new rules generally limit the deduction for interest to the sum of interest income plus thirty percent of the ‘adjusted taxable income’ (similar to taxable EBITDA) of the taxpayer, while allowing unused deductions to be carried forward indefinitely.
For tax years after December 31, 2017 and before January 1, 2022, the limitation becomes stricter, as companies will be required to include depreciation or amortization, similar to taxable EBIT.
Regulated utilities are specifically excluded from the limitations on the deductibility of interest. Thus far, however, guidance has not been provided on the methodology to be used in allocating interest among members of consolidated groups that include regulated utilities.
Changes to the capital recovery rules:
Given the capital-intensive nature of the power and utility industry, changes to the capital recovery rules are also of great interest. The new rules generally allow non-regulated businesses to immediately write off the cost of qualified property acquired and placed in service after September 27, 2017, for five years. Then, the rules phase down full expensing by twenty percent each year for the next five years.
The tax reform act also allows the additional first-year depreciation deduction for new and used property. Similar to the interest limitation rules, certain regulated utilities are excluded from the full expensing rules. Thus, public utility property will generally be depreciated using existing or non-bonus accelerated depreciation methods, such as the Modified Accelerated Cost Recovery System.
Final thoughts:
Energy tax credits such as wind production tax credits and solar investment tax credits were largely unchanged by the tax reform changes. After initial concerns in the renewable industry about the base erosion anti-abuse tax (BEAT) provisions of the proposed bills, Congress modified them so that the renewable energy credits can be used to offset up to eighty percent of BEAT liability.
While this change does not fully alleviate the concerns of the renewable investors, it certainly landed in a better place than where it started.
The Tax Cuts and Jobs Act is the most historic tax reform enacted since the Tax Reform Act of 1986. It represents years of effort to enact a reform of U.S. tax law providing a more competitive tax system for business taxpayers and improved economic opportunities for individuals and families.
It also provides opportunities for the power and utilities industries, with companies expected to continue evaluating the effects of the new law for years to come.
