john w. hutts

EXHIBIT JWH-1

of 3

John W. Hutts GDS Associates, Inc. Principal

EDUCATION: Master of Business Administration, Georgia State University, 1990 Concentration: Finance and Decision Sciences Bachelor of Business Administration, The University of Texas at Austin, 1978. Concentration: Statistics and Operations Research

PROFESSIONAL MEMBERSHIP: American Statistical Association (ASA)

EXPERIENCE:

1986-Present GDS Associates, Inc.

GDS principal whose responsibilities include the direction of statistical services provided by GDS and supervision of supporting projecrstaff. Areas of expertise include long7term and short-term forecasting, sample design, consumer surveys, load 'research, weather normalization, database management, and decision support systems.

1980-1986 Southern Engineering Company

Responsibilities included participation and 'project management of projects focusing on statistical applications, including load forecasts and consumer surveys.

Specific Project Experience Includes:

Energy Forecasting

• Designed, implemented and currently manages load forecasting systems for fourteen electric utilities in Texas. Forecasting systems provide long-terrii (15 year) and short-term (12-month) forecasts for resource and financial planning and are supported by a network of econometric and end-use models. Consumer attitude and appliance saturation surveys are conducted every three years. Outputs of the system include load forecast reports, consumer surveys, oral/written testimony when required, and documentation to regulatory agencies.

• Developed load forecasts for electric utility systems in Alabama, Alaska, Georgia, Kentucky, Louisiana, Illinois, Indiana, Mississippi, North Carolina, Ohio, South Carolina, Texas, and Virginia. Methodologies included econometric modeling, neural networks, end-use modeling, trending, and delphi techniques.

• Performed load forecasting process audits for electric utilities in the Canadian provinces of Nova Scotia, New Brunswick, and British Columbia.

• Designed day-ahead load forecasting systems for electric utilities in Kentucky, Texas, and Louisiana. The forecasting systems automatically update historical and forecasted weather data and generate hourly load projections for up to 168 hours. Forecasting models were based on neural network systems and transferred to the clients computer systems.

• Filed testimony before state regulatory commissions regarding load forecasting issues in rate cases and integrated resource plan filings.

Statistical Services

GDS Associates, InC. • 1850 Parkway Place • Suite 800 • Marietta, GA 30067 770-425-8100 • Fax 770-426-0303 • [email protected]

Marietta, GA • Austin, TX Auburn, AL • Madison, Wl • Manchester, NH • Orlando, FL

38525224.1 4 1227

EXHIBIT JWH-1

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• Conducted load research studies and analyses for utilities in Georgia, Texas, South Carolina, and Florida.

• Filed testimony before state regulatory commissions regarding weather normalization.

• Developed a probabilistic modeling system fdr an electric cooperative in Texas to simulate market conditions with respect to fuel charges incurred under a power supply contrbct. The system was developed using Crystal Ball software, incorporates Monte Carlo simulation techniques, and provides information used for natural gas price hedging analysis. The system provides the means of analyzing the uncertainty associated with monthly fuel expense due to natural gas price volatility.

Research/Consumer Surveys

• Managed residential consumer survey projects for utilities in Texas, Colorado', South Carolina, and Alabama. Projects included questionnaire design, sample design, data cleaning, data tabulation, analysis of results, and report preparation. Developed applications software' to select stratified random sample (Dalenius/Hodges and optimum allocation), produce mailing labels, tabulate responses, and calculate confidence bands by stratum and by total sample. Software was developed using the Statistical Analysis System (SAS) software package.

• Managed various projects and consulting services provided to an Atlanta, Georgia based marketing services firm conducting research in the eetail industry. Primary areas of service included sample design, sample selection, benchmarking of results, and various unique analyses. Specific services provided include: definition of consumer market trade areas, development of survey questionnaires, implementation of data processing procedures, development of sampling methodology, interpretation of survey results, development of total portfolio benchmarks, and preparation of final survey reports. Developed a process for merging economic/demographic data (sources: U.S. Census and Bureau of Economic Analysis) with survey data. Developed models used to estimate average consumer expenditure in response to influential characteristics, including: area of residence, average household income, age, and 'gender. Managed development of comprehensive database and series of industry benchma rks.

• Managed consulting services provided to a Washington, D.C. based marketing research firm. Primary areas of service focused,on project management, statistical issues and analytical expertise regarding employee satisfaction surveys conducted for a major international hotel chain. Managed processes regarding data tabulation, interpretation of results, and reporting. Produced trend reports for surveys conducted over time. Reports and other deliverables were provided electronically via pdf files.

• Managed market research services provided to a Marietta, Georgia based research firm. Provided sampling and analytical expertise for research conducted in the commercial development, banking, and retail industries.

• Provided consumer survey services to a Marietta, Georgia based consulting firm for a series of surveys administered to banking customers at branches located throughout the north Georgia area. Provided cross-tabulations of survey results, developed local demographic and economic profiles of households located in the branch areas, and created indexes as a means of comparing banking customers to the general population.

• Managed the sample design phases for research projects performed by GDS to measure program impacts for demand-side and energy efficiency studies.

GDS Assodiates, Inc. • 1850 Parkwajt Place • Suite 800 • Marietta, GA 30067 770-425-8100 • Fax 770-426-0303 • [email protected]

38525224.1 Marietta, GA • Austin, TX • Auburn, AL • Madison, WI • Manchester, NH • Orlando, FL

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EXHIBIT JWH-1

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TRAINING SEMINARS CONDUCTED:

1. Load Forecasting Techniques: Georgia Public Service Commissiqn Staff 2. Econometric Modeling using SAS: Public Service Authority of South Carolina 3. Customer Surveys in the Retail Industry: Morris & Fellows, Inc.

GDS Associates, Inc. • 1850 Parkway Place • Suite 800 • Marietta, GA 30067 770-425-8100 • Fax 770-426-0303 • [email protected]

38525224.1

Marietta, GA • Austin, TX • Auburn, AL • Madison, WI • Manchester, NH • Orlando, FL

1229

EXHIBIT JWH-2 Page 1 of 1

PREVIOUS TESTIMONY OF JOHN W. HUTTS

Date Regulatory Agency Docket Utility Involved 05/6/2016 Georgia Public Service

Commission DOCKET NO. 40161 Georgia Power Company

02/29/2016 Texas Public Utilities Commission

DOCKET NO. 45570 Monarch Utilities I, L.P.

05/31/2013 Texas Public Utilities Commission

DOCKET NO. 41474 Sharyland Utilities, L.P.

05/10/2013 Georgia Public Service Commission

DOCKET NO. 36498 Georgia Power Company

11/21/2011 Georgia Public Service 'Commission


04/01/2011 Michigan Public Service Commission

Case No. U-16472 Detroit Edison





06/18/2010 4

Georgia Public Service Commission







Case No. U-15290 Consumers Energy

05/2002 Corporation Commission of the State of Oklahoma

Cause No. PUD 200100455

Oklahoma Gas & Electric Company


DOCKET NO. 14618-U Savannah Electric & Power Company


DOCKET NO. 14000-U Georgia Power Company


DOCKET NO. 8708_U and 8709-U

Georgia Power Company

11/15/1994 Public Utility Commission of Texas

DOCKET NO. 12065 Houston Lighting & Power

11/15/1994 Public Utility Commission of Texas

DOCKET NO. 11735 Texas Utilities Company

02/1993 Michigan Public Service Commission ,


11/1992 Michigan Public Service Commission

Case No. U-10127 Consumers Power Company

06/1986 Public Utility Commission of Texas

DOCKET NO. 6735 Wood County Electric Cooperative

38525194.2

1230


LIST OF SPONSORED/CO-SPONSORED SCHEDULES FOR JOHN W. HUTTS

SU SCHEDULE II-H-1.1 SU SCHEDULE II-H-1.2 Total SU SCHEDULE II-H-1.2 RES SU SCHEDULE II-H-1.2 SEC SM SU SCHEDULE II-H-1.2 SEC LG SU SCHEDULE II-H-1.2 PRI SU SCHEDULE II-H-1.2 TRAN SU SCHEDULE II-H-1.2 LIGHT SU SCHEDULE II-H-1..3 Total SU SCHEDULE II-H-1..3 RES SU SCHEDULE II-H-1.3 SEC SM SU SCHEDULE II-H-1.3 SEC LG SU SCHEDULE II-H-1..3 PRI SU SCHEDULE II-H-1.3 TRAN SU SCHEDULE II-H-1..3 LIGHT SU SCHEDULE II-H-1..3.1

SU SCHEDULE II-W-1.4 Total

SU SCHEDULE II-H-1.4 RES SU SCHEDULE II-H-1.4 SEC SM SU, SCHEDULE II-H-1.4, SEC LG SU SCHEDULE II-H-1.4 PRI

SU SCHEDULE II-H-1.4 TRAN

SU SCHEDULE II-H-1.4 LIGHT

SU SCHEDULE II-H-1.4 DEMAND SU SCHEDULE II-H-1.5 SU SCHEDULE II-H-2 SU SCHEDULE II-H-2.1 SU SCHEDULE II-H-2.1 RES AR SU SCHEDULE II-H-2.1 SEC SM AR SU SCHEDULE II-H-2.1 SEC LG AR SU SCHEDULE II-H-2.1 RES SU SCHEDULE II-H-2.1 SEC SM SU SCHEDULE II-H-2.1 SEC LG SU SCHEDULE II-H-2.2 RES SU SCHEDULE II-H-2.2 SEC SM SU SCHEDULE II-H-2.2 SEC LG SU SCHEDULE II-H-2.3 SU SCHEDULE II-H-3.1 SU SCHEDULE II-H-3.2 SU SCHEDULE II-H-3.3

Test Year Sales Data Monthly Sales Data - Total Company Monthly Sales bata - Residential Monthly Sales Data - Secopdary <= 10 kW ninthly Sales Data - Secondary > 10 kW Monthly §ales Data - Primary Monthly Sales Datd- Transmission Monthly Sales Data - Lighting Unmetered Test Year Coincident Peak Data - Total Company Test Year Coincident Peak Data - Residential Test Year Coincident Peak Data - Secondary <= 10kW Test Year Coincident Peak Data - Secondary > 10kW Test Year Coincident Peak Data - Primary Test Year Coincident Peak Data - Transmission Test Year Coincident Peak Data -"Lighting Unmetere'd Adjustments to the Test Year Load Data Test Year Coincident Peak Data ,4 Total Company Adjusted Test Year Coincident Peak Data - Residential Adjusted Test Year Coincident Peak Data - Secondary <= 10kW Test Year Coincident Peak Data - Secondary > 10kW Test Year Coincident Peak Data - Primary Adjusted Test Year Coincident Peak Data-- Transmission Adjusted Test Year Coincident Peak bata - Lighting Unmetered Adjusted Adjustments to Test Year Demand Adjustments to Operating Statistics Model Analysis Results Model Information - Narrative Model Information - Residential (Including AR1) Modél Information - Secondary Small (Including AR1) Model Infprmation - Secondary Large (Including AR1) Model Information - Residential Model Information - Secondary Small Model Information - Secondary Large Model Information - Residential Model Data - Secondary Small Model Data - Secondary Large Model Variables Customer Information Customer Adjustments Customer Adjustment Data

1231


SU SCHEDULE II-H-4.1.1


SU SCHEDULE II-H-4.1 .3


SU S'CHEDULE II-H-4. .5




SU SCHEDULE II-H-4.1.9 SU SCHEDULE II-H-5.1pnv 30 YR SU SCHEDULE II-H-5.1 MID 30 YR SU SCHEDULE II-H-5.1 SAN 30 YR SU SCHEDULE II-H-5.1 MCL 30 YR

SU SCHEDULE II-H-5.2 RES

SU g'CHEDULE II-H-5.2 SEC SM

SU SCHEDULE II-H-5.2 SEC SM

SU SCHEDULE II-H-5.3 SU SCHEDULE IV-J-4.1 SU SCHEDULE IV-J-4.2 SU SCHEDULE IV-J-4.3 SU SCHEDULE IV-J-4.4 SU SCHEDULE IV-J-5

Revenue Impact Data - Unadjusted Test Year Revenue Impaci Data - Revenues Adjusted with Rate Annualization Adjustments Revenue Impact Data - Revenues Adjusted with kWh CustomerAdjustments Revenue Impact Data - Revenues Adjusted with KW CustomerAdjustments Revenue ImPact Data - Revenues Adjusted with kWh Weather Adjustments Revenue Impact Data - Revenues Adjusted Nyith KW Weather Adjustments Revenue Impact Data - Revenues Associated with Other kWh Adjustments Revenue Impact Data - Revenues Associated with Other,KW Adjtistments Revenue Impact Data - Total Adjusted Revenue Weather Station Data - Dallas Fort Worth Weather Station Data - Midland. Weather Station Data - San Angelo Weather Station Data - McAllen Adjusted Weather Station Data - Residential System Weighted Average Adjusted Weather Station Data - Secondary Less Than or Equal to'10KW Adjusted Weather Station Data - Secondary Greater Than or Equal to 10KW Additional Weather Information Load Research Data - Summary Load Research Data - Transmission Data Load Research Data - Bill Frequency Analysis Load Research Data - Residential Stratum Data 1 Billing Determinants -

1232

EXHIBIT IWH-4 Page 1 of 1

SAMPLE SIZE AND PRECISION OF DE-MAND ESTIMATES

SUMMARY OF LOAD RESEARCH STUDY RESULTS

SIZE BY CLASS

,

PRECISION AND SAMPLE

d T & I 1 1 r- , 1

. CONTRIBUTION TO ERCOT 4CP

Precision of Load Estimate l Sample Size

JAN

Residential

Secondary

Small

Secondary

Large

*

Primary TransmisSion Residential

Secondary

Small

Secondary . I Large I Primary , Transmission

'

FEB 1- . MAR

A PR_

MAY

186 [ 187 JUN

JUL

4.9% 14.3% 9.0% 5 4% 0 0 % 211 180 Census

Census 5.1% 16.4% 8.7%

6.8%

6.2% 0.0% 1 187

188

187

175 203 168

AUG 4.5% 12.1% 8. 0% 0.0% r

0.0%

172 200 159 Census

SEP

OCT

'4 3% 13.2% 8 4% 8.3% 170 196 156 Census

NOV r

DEC

AVERAGE 4.7% 14.0% 8.2% 7.0% 0.0% 187 176 203 166 Census

CONTRIBUTION TO 1-HOUR

I

,

SYSTEM PEAK DEMAND

Precision of Load Estimate Sample Size

Secondary

• Residential Small

Secondary

Large Primary Transmission Residential

Secondary

Small

Secondary

Large

I I

Primary :Transmission

JAN 6.5% _ 19.9% 8.9% 4.3% 0.0% 163

193

92

184 .

144 134 Census

FEB

MAR _

APR

4.8% 13.9% 6 9% 7.6% 0.0% 195 146 Census

Census 5 8% 19.1%

19 O%

8.1% 6.7% 0.0% 192 184 195 144

7.1% 9.5% 4.1% 0.0% 188 181 193 142 Census

MAY

_

5.4% 15.5% 8.8% 6 7% 0.0% 186 183 202 169 Census

Census JUN _ JUL

5.3% 14.3% 8.7% 5 6% 0.0% 189 . I- 194 218 180

5.1% 16.4% 8.7% 6.2% 0.0% 187 175 203 168 Census

AUG

j

4.0% 16.5% 7.9% 8.4% 0.0% 188 175 203 165 Census

SEP

OCT

5.1%

6.4%

10.0% 7.9%

11 2%

3.8% 0.0% 187 170 197 156 Census

10.5% 6.7% 0.0% 185 170 190 153 Census

_ NOV

DEC

AVERAGE

6.7%

.,. 7.2%

9.3% 11.4% 7.9% 0 0% 177 132 169 , 136 Census

Census 15.1% 11.8% 7 3% 0.0% 142 113 150 116

' 5.8% 15.0% i 9.2% 6.3% 0.0% 181 163 188 151 Census •

---F ..1.. , _...... CLASS PEAK DEMAND

Precision of Load Estimate 1 Sample Size

Residential Secondary

Small Secondary

Large 1 I Primary Transmission I Residential

Secondary Small

Secondary Large Primary Transmission

JAN 6.3% 15.6% 6 3% 3.8% 0.0% 163 92 145 136 Census FEB 4 5%

5.6% 12.4% 9.0% 2.9% 0.0% 193 184 195 136 Census

MAR 14.3% 7.0% 6.0% 0.0% 192 182 . 193 145 Census APR 6.3% 19.4% ' t 7.7% 3.8% 0.0% 188 182 196 169 Census

_ MAY JUN

5.6% 17.4% 10.1% 8.2% 0.0% 186 . 183 196 169 Census 4.5% 17.1% , 8.6% 5.2% 0 0% 189 194 218 180 Census

168 1 Census JUL ...... AUG SEP

4 1% " 4.3%

17.4% 7.2% 6 9% 0.0% 187 175 203 11.7% ' .6.1% 5.1% 0.0% v 188 173 200 156

156 155 1

Census Census 4.6% 10.6% 8.0% 8.4% 0.0% 187 170 197

OCT NOV l

6.6% 25 8% 9.5% 6.8% 0.0% 187 170 190 Census 6.6% 11.1%

14.7% 6 0% 4.4% 0.0% 181 165 _ 184 148 1 Census

Census DEC 8.7% 6.9% 6.5% 0 096 155 114 . 156 124 AVERAGE 5.7% I 15 6% 7.7% 5.7% 0.0% , 183 165 189 ' 154 I Census

38525218.1

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SOAH DOCKET NO. 473-16-4051 PUC DOCKET NO. 45414

REVIEW OF THE RATES OF SHARYLAND UTILITIES, L.P., ESTABLISHMENT OF RATES FOR SHARYLAND DISTRIBUTION & TRANSMISSION SERVICES, L.L.C., AND REQUEST FOR GRANT OF A CERTIFICATE OF CONVENIENCE AND NECESSITY AND TRANSFER OF CERTIFICATE RIGHTS

BEFORE THE STATE OFFICE

OF

ADMINISTRATIVE HEARiNGS

DIRECT,TESTIMONY

OF

GREGORY S. IMHOFF

ON BEHALF OF

SHARYLAND UTILITIES, L.P.

AND

SHARYLAND DISTRIBUTION & TRANSMISSION SERVICES, L.L.C.

December 30, 2016

1234




OF

ADMINISTRATIVE HEARINGS

TABLE OF CONTENTS

PAGE

I. INTRODUCTION 1

II. PURPOSE OF TESTIMONY 2

III. THE "TRUE LEASE" REQUIREMENT UNDER APPLICABLE TAX LAWS 2

IV. APPLICATION OF THE TRUE LEASE REQUIREMENT 6

V. CONCLUSION 1 1

Direct Testimony of SOAH Docket No. 473-16-4051 Gregory S. Imhoff PUC Docket No. 45414

1235

1 DIRECT TESTIMONY OF GREGORY S. IMHOFF

2 I. INTRODUCTION

3 Q. PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.

4 A. My name is Gregory S. Imhoff My business address is 1807 Ross Avenue, 4th

5 Floor, Dallas, Texas 75201:

6 Q. BY WHOM ARE YOU EMPLOYED AND IN WHAT CAPACITY?

7 A. I am the Vice President, General Tax Counsel and Corporate Secretary for

8 Sharyland Distribution & Transmission Services, L.L.C. ("SDTS"), Transmission

9 and Distribution Company, L.L.C. ("TDC"), InfraREIT, Inc. (`InfraREIT"), and

10 Hunt Utility Services, L.L.C. ("HUS"), the 'external manager of InfraREIT.

11 Q. PLEASE DESCRIBE YOUR EDUCATIONAL QUALIFICATIONS AND

12 PROFESSIONAL EXPERIENCE.

13 A. I serve as the Vice President, General Tax Counsel, and Corporate Secretary for

14 SDTS, HUS, TDC, and InfraREIT, and am responsible for the companies tax and

15 real estate investment trust ("REIT") compliance functions. I joined Hunt Power,

16 L.P. ("Hunt Power") in 2010 as Tax Counsel. Prior to joining Hunt Power, I

17 served as the Vice President and Tax Counsel for Behringer Harvard—a private

18 equity firm specializing in the formation and operation of REITs. Before then I

19 served as the Chief Administrative Officer and Tax Counsel for Brandywine

20 Realty Trust (a REIT) and, prior to Brandywine, I was the Chief Administrative

21 Officer and Tax Counsel of Prentiss Properties Trust (a REIT). I received an

22 LL.M in Tax Law from Southern Methodist UniVersity, a J.D. from the University

23 of Notre Dame, and a B.S. in Accounting from Marquette University.

24 Q. HAVE YOU PREVIOUSLY TESTIFIED BEFORE ANY REGULATORY 25 COMMISSIONS?

26 A. No.

Direct Testimony of SOAH Docket No. 473-16-4051 1

Gregory S. Imhoff • PUC Docket No. 45414

1236

1 Q. FOR WHOM ARE YOU APPEARING ON BEHALF OF IN THIS

2 PROCEEDING?

3 A. I am appearing On behalf of SDTS and Sharyland Utilities, L.P. ("Sharylanr), the

4 Applicants in this proceeding.

5 II. PURPOSE OF TESTIMONY

6 Q. WHAT IS THE PURPOSE OF YOUR TESTIMONY IN THIS

7 PROCEEDING?

8 A. The purpose of my testimony is to address certain tax rules and policy relevant to

9 the leases betWeen SDTS and Sharyland (the "Leases"), including the requirement

10 that the Leases qualify as "true leases" for federal income tax purposes so that

11 InfraREIT can continue to qualify as a REIT.

12 Q. DO YOU SPONSOR ANY EXHIBITS? ,

13 A. No.

14 III. THE "TRUE LEASE" REQUIREMENT UNDER APPLICABLE TAX

15 LAWS

16 Q. PLEASE PROVIDE A GENERAL DESCRIPTION OF THE RELEVANT 17 REQUIREMENTS UNDER iHE TAX LAWS FOR REIT 18 QUALIFICATION.

19 A. REITs are intended to be passive investment vehicles and are generálly prohibited

20 from engaging in active operating businesses as opposed to passive ownership of

21 assets. In order to qualify as a REIT (and thereby be able to receive' a deduction

22 for certain -dividends paid tb its shareholders), a corporation must be taxable as a

23 corporation and, among other requirements, satisfy two source of income tests.

24 Section 856(c)(2) of the Internal Revenue Code of 1986, as amended (IRC"),

25 generally requkes that at least 95% of a REIT's gross income each year be

26 derived from certain property investment activities, including "rents from real

27 property," and certain other types of passive income, such as interest. and

28 dividends, and section 856(6(3) of the IRC generally requires that at least 75% of

29 a REIT's gross income each year be.derived from certain real property investment

Direct Testimony of Gregory S. Imhoff

2 SOAH Docket No. 473-16-40Š1

PUC Docket No. 45414

1237

1

activities, including "rents from real property." If a REIT fails to satisfy these

2

source of income tests, it will no longer be eligible for REIT status or be able to

3

receive a deduction for dividends paid to its shareholders (subject to any

4

applicable temporary relief provisions).

5 Q. PLEASE EXPLAIN VhIAT A "TRUE LEASE"IS.

6 A. A true lease refers to an arrafigement between two parties that, in addition to

7 being denominated as a lease, is in fact a lease for tax purposes and not some

8 other relationship. The phrase "true lease" is not defined in the IRC or in the

9 Treasury regulations promulgated thereunder: Instead, it originates from

10 interpretations issued by the Internal Revenue Service ("IRS") and court -cases

11 that establish the criteria for determining which arrangements will be treated for

12 federal income tax purposes as leases rather than as some other type of

13 arrangement.-

14 Q. IF THE ARRANGEMENT DESIGNATED AS A LEASE WAS NOT

15 DETERMINED TO BE A TRUE tEASE, THEN HOW WOULD THE

16 ARRANGEMENT BE TREATED FOR TAX PURPOSÈS?

17 A. An arrangement between two persons denominated as a lease may be properly

18 classified for tax purposes as a lease, or could actually be a sale; a management

19 contract, or a partnership for tax purposes depending upon the, specific facts and

20 circumstances: If the arrangement between SDTS and Sharyland was determined

21 not to be a true lease, then InfraREIT would not qualify as a REIT.

22 Q. WHAT ARE THE HALLMARKS OF A TRUE LEASE?

23 A. In general, a true lease transfers operating control over assets owned by the owner

24 (i.e., the landlord) to a tenant who then has the opportunity to earn a profit from

25 such operations, or also possibly suffer a loss. The -landlord retains the risk of

26 loss relative to the assets themselves.

27 Q. WHAT ARE THE HALLMARKS OF A SALE?

28 A. In general, with 'a sale, the operator bears the benefits and burdens of ownership

29 of the assets and is treated as the owner of the assets for tax purposes. The

Direct Testiniony of Gregory S. Imhoff

3 SOAH Docket No. 473-16-4051


1238

1 amount otherwise denominated as "rent" is then treated as principal and interest,

2 like one would find with seller financing.

3 Q. WHAT ARE THE HALLMARKS OF A MANAGEMENT CONTRACT?

4 A. In general, with .a management contract, the operator is a service provider

5 responsible for operating the assets at the owner's direction for a fee and does not

6 bear the operating or ownership risk over the assets.

7 Q. WHAT ARE THE HALLMARKS OF A PARTNERSHIP?

8 A. In general, with a partnership or joint venture, the owner and the operator jointly

9 own and operate the assets and share in the profits and losses Jherefrom.

10 Q. WHY IS THE TRUE LEASE REQUIREMENT RELEVAS1T TO SDTS

1 1 AND SHARYLAND?

12 A. Because IfifraREIT,-SDTS's unregulated indirect owner, is structured as a REIT,

13 income earned directly or indirectly by InfraREIT must predominately fall under

14 certain categories specified under Section 856 of the IRC (income under such

15 categories being referfed to herein as "Qualifying Income") to satisfy the source

16 of income tests described above. One of these specified categories, and the one

17 relevant to SDTS and Sharyland, is "rents froth real property." The rents under

18 the current leases between Sharyland and SDTS qualify as rents from real

19 property for this purpose. However, if the Leases were not characterized for tax

20 purposes as true leases, the "rents" under the Leases,would not be treatol as

21 "rents from real property" and InfraREIT would not be able to maintain its REIT

22 status. L

23 Q. WHAT FACTORS DO THE IRS AND THE COURTS LOOK FOR IN THE

24 ARRANGEMENT TO DETERMINE WHETHER THERE IS A TRUE

25 LEASE?

26 A. In general, when the IRS asserts ihat an agreement in the form of a lease should

27 be treated otherwise for tax purposes, the treatment of the agreement as a lease or

28 as some other arrangement (such as a sales contract, management contract, or

29 partnership) is determined for federal income tax purposes based on the substance

Direct Testimony of 4

SOAH Docket No. 473-16-4051 Gregory S. Imhoff PUC Docket No. 45414

1239

1 of the arrangement rather than the mere form of the agreement. Accordingly,

2 whether a lease should be respected as a true lease depends on an analysis of all

3 the underlying facts and circumstances. Generally, an arrangement is properly

4 treated as a lease if it transfers an interest in, possession of, and control over the

5 subject property for a prescribed period of time that is less than the useful life of

6 the property in exchange for an agreed consideration or "rent." In determining

7 whether a true lease exists, courts have considered a variety of factors, including:

8 (a) the intent of the parties; (b) the form of the agreement; (c) the degree of

9 control over the property that is retained by the property owner (e.g., whether the

10 lessee has substantial control over the operation); and (d) whether the tenant bears

11 the risk of operating loss assoCiated with the property and the landlord bears the

12 risk of damage to the property.1

13 Q. HOW DOES THE IRS DISTINGUISH BETWEEN A TRUE LEASE AND A

14 SALE?

15 A. Generally, in distinguishing between a true lease and a sale, the IRS and the

16 courts look to whether the "benefits and burdens of ownership" remain with the

17 owner, in which case the arrangement would be considered a true lease, or have

18 been transferred to the tenant, in which case the arrangement would be considered

19 a sale.2 Under a true lease, the tenant has the opportunity to earn a profit or suffer

20 a loss from possessing and operating the property whereas the owner has the

21 opportunity to earn a fair market rental during the term of the lease and to also

22 benefit from any appreciation in the value of the property or suffer from any

23 depreciation in the value of the property. In contrast, under a sale, the buyer

24 generally has the opportunity to benefit from any appreciation in the value of the

25 property or suffer from any economic depreciation in the value of the property.

I See, e.g., Amerco v. Commissioner, 82 T.C. 654 (1984); Kingsbury v. Commissioner, 65 T.C. 1068 (1976).

2 See e.g., Rev. Proc. 2001-28, 2001-1 C.B. 1156; Torres v. Commissioner, 88 T.C. 702 (1987); Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221 (1981).


Gregory S. Imhoff PUC Docket No. 45414

1240

1 Q. HOW DOES THE IRS DISTINGUISH BETWEEN A LEASE AND A

2 MANAGEMENT CONTRACT?

3 A. Generally, in distinguishing between a true lease and a management contract, the

4 iRS and the courts look to who controls the use of the property and who bears the

5 risk of operational loss in respect of such use. If such control and operational risk

6 remains with the owner, then the arrangement would generally be characterized as

7 a management contract.3 In contrast, under a true lease, such control and

8 operational risk transfers to the tenant.4

9 Q. HOW DOES THE IRS DISTINGUISH BETWEEN A LEASE AND A

10 PARTNERSHIP?

11 A. Generally, the IRS and the courts look to whether the parties jointly carry on the

12 business and divide the profits therefrom.5 If so, then the arrangement may be

13 more appropriately characterized as a partnership rather than a true lease.

14 IV. APPLICATION OF THE TRUE LEASE REQUIREMENT

15 Q. WHO DECIDES IF A LEASE IS TREATED AS A TRUE LEASE?

16 A. The taxpayer or its advisors must make the d'ecision in connection with filing the

17 taxpayer's tax returns. Ultilnately, if the IRS challenges the return position taken

18 by the taxpayer, the decision rests with the IRS and the courts. Factors underlying

19 such determinations take into consideration, among other factors, the term of the

20 lease, the stated percentage rent rate, the expected amount of percentage rent, the

21 potential for the lessee to earn a material profit or'incur a material loss, the extent

22 to which the owner bears the applicable operating expenses, and the amount of

23 operational control exercised by the owner.

3 See, e.g., Meagher v. Commissioner, T.C. Memo 1977-270 (where the court noted that rent was only due if the operator made a profit); Newman v. Commissioner, 902 F.2d 159 (2nd Cir. 1990) (where the owner, when compared to the operator, bore the risk of operating losses).

4 See, e.g., Amerco v. Commissioner, 82 T.C: 654 (1984).

5 See, e.g., Treas. Reg. § 301.7701-1(a)(2); Commissioner v. Culbertson, 337 U.S. 733, 742 (1949).



1241

1 Q. HOW IS THE TREATMENT OF THE LEASES AS TRUE LEASES

2 RELEVANT WHEN INFRAREIT RAISES EQUITY CAPITAL?

3 A. InfraREIT's ability to access capital in the equity markets on reasonable terms is

4 dependent, in large part, on InfilaREIT's continued ability to qualify as a REIT.

5. Investors desire certainty that InfraREIT currently qualifies as a REIT and is

6 expected to continue to operate as a REIT. Consequently, when issuing equity,

7 InfraREIT is required to deliver an opinion from its outside tax counsel that

8 InfraREIT has been organized in conformity with the requirements for'

9 qualification and taxation as a REIT under the IRC, and that InfraREIT's

10 proposed method of operation will enable it to continue to meet such

11 requirements. Because treatment of the Leases as true leases is a critical element

12 of InfraREIT's REIT qualification for the reasons described above, if there is a

13 material risk that the Leases are'not properly treated as true leases, InfraREIT's

14 outside tax counsel will likely not be able to deliver the necessary tax opinion. If

15 this occurred, InfraREIT would have little to no ability to raise equity capital on

16 reasonable terms.

17 - Q. HOW HAS THE TRUE LEASE REQUIREMENT BEEN SATISFIED IN

18 THE PAST?

19 A. In the past, the true lease requirement has been satisfied because SDTS and

20 Sharyland, which maintains operational control, of the assets, have negotiated

21 rents intended to provide Sharyland with approximately 3% of the projected

22 regulated return on rate base that SDTS would have been entitled to earn if it

23 owned and operated the assets instea‘ d of leasing them to Sharyland.

24 Q. HOW IS SHARYLAND PROPOSING TO SATISFY tHE TRUE LEASE

25 REQUIREMENT IN THIS CASE?

26 A. Under the 2008 Restructuring Order,6 SDTS was not obligated to obtain

27 regulatory approval of the rental payments it charged Sharyland, so SDTS and

6 Application of Sharyland Utilities, L.P. and Sharyland Distribution & Transmission Services, L.L.C. for Regulatory Approvals Pursuant to PURA §§ 14.101, 39.262, and 39.915, Docket No. 35287, Order (Jul. 21, 2008) (2008 Restructuring Order").


SOAH Docket No. 473-16-4051 Gregory S. Imhoff PUC Docket No. 45414'

1242

1 Sharyland were able to negotiate rental payments that complied with the true lease

2 requirement without Commission review. However, under the new paradigm

3 contemplated by the 'Commission's Preliminary Order in this proceeding,7 the

4 rental payments will be viewed as rates and must be approved by the

5 Commission. SDTS and Sharyland are proposing that the rental payments

6 approved by the Comrnigsion be discounted from the amount that SDTS would

7 otherwise be authorized io charge Sharyland based on traditional regulatory cost

8 of service principles, where the discount (the "3% Discount") is calculated in a

9 manner intended to provide Sharyland with approximately 3% of the projected

10 regulated return on rate base that SDTS would have been entitled to earn if it

11 owned and operated the assets instead of leasing them to Sharyland. Since the

12 rates charged to Sharyland's customers under this approach will reflect the

13 approved cost of service for SDTS without tlie 3% Discount described above,

14 Sharyland will have an opportunity to earn a profit or,suffer a loss on its operation

15 of the assets, and the Leases will meet the requirements of a true lease. Actual

16 profitability for Sharyland would depend upon, among ot'her factors, the amount

17 of revenue actually collected and its ability to control costs, maximize workplace

18 safety, and nfeet customer needs.

19 Q. WOULD THE TRUE LEASE REQUIREMENT BE MET IF SHARYLAND

20 WAS OBLIGATED TO PASS THROUGH THE 3% DISCOUNT TO

21 SHARYLAND'S CUSTOMERS?

22 A. The 3% Discount represents Sharyland's projected profits from operating the

23 'system. If the discount Was passed on to ratephyers (i.e., through a reduction in

24 the rates that Sharyland would otherwise charge), then Sharyland would not have

25 a realistic opportunity to earn a profit but would still bear the risks associated with

26 operating the systein. ;Consequently, it would not make economic sense for

27 Sharyland to continue to serve as the operator and lease the facilities. Failure to

28 approve the discount w9u1d also greatly increase the risk that the Leases would

7 Review of the Rates of Sharyland Utilities, L.P., Docket No. 45414, Preliminary Order (Oct. 10, 2016).

Direct Testimony of 8 SOAH Docket No. 473-16-4051


1243

1 not be treated as true leases and that InfraREIT would not qualify as a REIT under

2 the tax laws.

3 Q. WHY DO THE PROPOSED LEASES HAVE FOUR YEAR TERMS?

4 A. Under the REIT rules, "rents from real property" generally do not include any

5 amounts that depend in whole or in part on the income or profits derived by the

6 tenant.8 Furthermore, an amount will not qualify as "rents from real property" if,

7 'considering the lease and all the surrounding circumstances, the arrangement does

8 not conform with normal business practice but is in reality used as a means of

9 basing the rent on income or, profits.9 In light of this, it is common for tax

10 practitioners to advise RElTs to enter into longer term leases (particularly if the

11 leases will contain percentage rent provisions) to minimize the risk that the rent

12 will be deemed to be based on the income or profits of the tenant. For example, if

13 leases were renegotiated each month, the parties would have a significant view

14 into the operations of the systems fðr the coming month and would likely take that

15 into account when setting rent. Any deviations could easily be adjusted during

16 the next month's negotiations. Consequently, the rents under such monthly leases

17 might be viewed as being based on the income or profits of the tenant even if the

18 literal terms of the leases do not call for rent based on income or profits.

19 Q. ARE THERE PARTICULAR CONCERNS FROM A TAX PERSPECTIVE

20 ABOUT THE PERCENTAGE RENT COMPONENT OF THE LEASES?

21 A. Yes. Mr: D. Greg Wilks will describe the Leases and how the fixed and

22 percentage rent will be determined and the aetual rent payment wiTh be

23 calculated.1° Percefitage Rent is particularly susceptible to being vieWed as

8 Treas. Reg. § 1.856-4.

9 Id. 10 As explained by Mr. Wilks,-Base Rent will be a' fixed annual amount constituting a portion of

the lease payment approved by the Commission. Percentage Rent will be an annual amount equal to a percentage of gross revenues collected by Sharyland during the year, subject to certain adjustments, in excess of the ,Annual Percentage Rent Breakpoint for such year. The Commission will approve the Base Rent, Percentage Rent percentages,. and Annual Percentage Rent BreakPoifits in setting the lease payments in each rate case.



1244

1

targeting the income or profits of the tenant, because Percentage Rent already ties

2

the amount of rent to the success of the business to a certain extent by tracking

3

one of the primary inputs to the calculation of income. If the Leases were of a

4

shorter duration than four years, there would be an increased risk that the rents

5

under the Leases would not 'be "rents from real property" and would therefore not

6

be Qualifying Income under the REIT rules. As a result, the proposed Leases

7

have four-year terms and provide that Percentage Rent may not be changed

8

outside of a rate case.

9 Q. DO REIT RULES LIMIT THE AMOUNT OF PERCENTAGE RENT?

10 A. Neither the IRC nor Treasury regulations provide á bright line limit on percentage

11 rent. However, as mentioned above, Treasury regulations take into consideration

12 the lease and all the surrounding circumstances when determining whether the

13 arrangement is in reality a true lease, and not a mechanism for sharing the tenant's

14 income or profits. To avoid a conclusion that a lease is targeting net income, it is

15 generally accepted that, lessors should set limits on both (i) the percent of total

16 rent that is derived from percentage rent, and (ii) the percentage rent rate. To

17 achieve these objectiVes, SDTS targets 80% of the total rent in the;form of fixed

18 rent when we sign or renew a lease and we target a percentage rent rate not to

19 exceed 40%.

20 Q. WHAT HAPPENS IF THERE ARE FEWER THAN FOUR YEARS

21 BETWEEN RATE CASES?

22 A. If a rate case concludes and becomes effective within- four years of the effective

23 date of the prior rate case and the Commission changes the Percentage Rent

24 percentages or Annual Percentage Rent Breakpoints as part of that rate case (or,

25 depending' on the particular facts and circumstances at the time, the- Commission

26 changes the Base Rent as part of that rate case), then there is a risk that the parties

27 will be perceived as basing rent on Sharyland's income or profits. In such a case,

28 the rent may not be Qualifying Income.

Direct Testimony of 10 SOAH Docket No. 473-16-4051

Gregory S. Imhoff • PUC Docket No. 45414

1245

1 V. CONCLUSION

2 Q. DOES THIS CONCLUDE YOUR DIRECT TESTIMONY?

3 A. Yes, it does.



1246

AFFIDAVIT

THE STATE OF TEXAS

COUNTY OF DALLAS

BEFORE ME, the undersigned notary public, this day personally appeared Gregory S.

Imhoff, to me known, who being duly sworn according to law, deposes and says:

"My name is Gregory S. Imhoff. I am of legarage and a resident of the State of Texas. I

certify that the foregoing testimony, offered by me on behalf of SHARYLAND UTILITIES, L.P.

and SHARYLAND DISTRIBUTION & TRANSMISSION SERVICES, L.L.C. are true and

correct to the best of my knowledge and belief."

Gregory S. Imhoff

SUBSCRIBED AND SWORN TO BEFORE ME, notary public, 'on this the

day of

December 2016.

Notary ublic in and for the Stat f Texas

My Commission expires: 1- - is *abialhorwigaabodhadisidhiiiiiiiir

LISA BAILEY My Commission Expires

July 25. 2018

Piremirmmir s

1247

WORKPAPERS TO

THE DIRECT TESTIMONY OF

GREGORY S. IMHOFF

WP/Imhoff - Direct Page 1 of 1

WORKPAPERS FOR THE DIRECT TESTIMONY OF

GREGORY S. IMHOFF

this information is voluminous and is available on DVD only. See attached DVD.

I 249


REVIEW OF THE RATES OF § BEFORE THE STATE OFFICE SHARYLAND UTILITIES, L.P., ESTABLISHMENT OF RATES FOR SHARYLAND DISTRIBUTION & TRANSMISSION SERVICES, L.L.C., § OF

, AND REQUEST FOR GRANT OF A CERTIFICATE OF CONVENIENCE AND NECESSITY AND TRANSFER OF § CERTIFICATE RIGHTS § ADMINISTRATIVE HEARINGS

DIRECT TESTIMONY

AND EXHIBITS

OF

DR. MERLE ERICKSON

ON BEHALF OF

SHARYLAIND UTILITIES, L.P.

AND


December 30, 2016

1250


REVIEW OF THE RATES OF SHARYLAND UTILITIES, L.P., ESTABLISHMENT OF RATES FOR SHARYLAND DISTRIBUTION & TRANSMISSION SERVICES, L.L.C., AND REQUEST FOR GRANT OF A CERTIFICATE OF CONVENIENCE AND NECESSITY ANVTRANSFER OF CERTIFICATE RIGHTS


OF


TABLE OF CONTENTS PAGE

I. INTRODUCTION 2

II. PURPOSE OF DIRECT TESTIMONY 3

III. OVERVIEW OF TE'XAS ELECTRIC UTILITY STRUCTURES AND THEIR TAX CHARACTERISTICS 6

IV. FUNCTIONALLY THE SHARYLAND ENTITIES, INCLUDNG INFRAREIT, INC. ARE PASS-THROUGH ENTITIES 10

V. THERE IS NO PRACTICAL MEANS TO DRAW A-MEANINGFUL DISTINCTION IN THE AMOUNT OF TAX PAID BY SHARYLAND

AND OTHER TEXAS INVESTOR-OWNED ELECTRIC UTILITIES 1 3 "

VI. CONCLUSION 26

EXHIBITS

ME-1 Simplified Tax Organization Chart ME-2 Cross Texas and Wind Energy Transmission Texas Organization Charts ME-3 Comparison of After-Tax Returns

Direct Testimony and Exhibits of Merle Erickson

SOAH Docket No. 473-16-4051 PUC Docket No. 45414

1251

1 DIRECT TESTIMONY AND EXHIBITS OF DR. MERLE ERICKSON

2 I. INTRODUCTION


4 A. My name is Dr. Merle Erickson. My business address is 5807 S. Woodlawn

5 Avenue, Booth School of Business, The University of Chicago, Chicago, IL ,

6 60637.


8 A. I am employed by The University of Chicago Booth School of Business as a

9 Professor of Accounting.



12 A. I received a Bachelor of Science in Accounting from Rockhurst College in 1987,

13 a Master of Business Administration in 1989 from Arizona State University, and a

14 Ph.D. in Accounting from the University of Arizona in 1996. I am a Certified

15 Public Accountant (CPA") and have been a CPA for approximately 25 years.

16 I joined the Chicago Booth faculty in 1996, where I am responsible for

17 teaching graduate level accounting and tax courses. I also am responsible for

18 scheduling the accounting curriculum at Booth, and have had other administrative

19 duties in the past. I was an Assistant Professor of Accounting from 1996 to 1999,

20 an Associate Profes-sor of Accounting from 1999 to 2004, and have been a

21 Professor of Accounting since 2004. The courses that I teach at Booth include

22 "Taxes & Business Strategy" and several executive education courses dealing

23 with various topics relating to financial statement analysis, valuation, tax, and

24 investment planning.

25 My research interests focus on, among other topics, the effect of taxes on

26 the pricing and structuring of mergers, acquisitions, and divestitures; and the use

27 of accounting information in valuation and contracting. I also study various

28 aspects of accounting fraud, and I 'am co-author of the widely used Taxes and

29 Business Strategy textbook and the author/editor of the casebook, Cases in Tax,

Direct Testimony and Exhibits of 2 SOAH Docket No. 473-16-4051

Merle Erickson PUC Docket No. 45414

1252

1 Strategy. Additionally, I served as a co-editor of the Journal of Accounting

2 Research from 2005 to 2011. I have published more than 25 articles on

3 accounting and tax-related topics, and am a member of the Nominating

4 Committee for the Nobel Prize in Economics.

5 Since 2000, I have been an independent consultant, and in that capacity

6 have completed various accounting and financial consulting projects. I have

7 consulted on complex Generally Accepted Accounting Principles (`GAAP") and

8 tax accounting issues in a variety of contexts (e.g., metgers and acquisitions,

9 bankruptcy, capital raising, structured finance, investment planning, tax sharing

10 agreements, and tax advantaged transactions).

11 I have received several awards from the American Taxation Association

12 for my research and teaching. I have received the Outstanding Manuscript Award

13 (twice) as well as an award for teaching innovation. I have also been named one

14 of BusinesšWeek's Outstanding Faculty at the University of Chicago.

15 Q. HAVE YOU PREVIOUSLY TESTIFIED BEtiORE THE PUBLIC UTILITY

16 COMMISSION OF TEXAS (COMMISSION")?

17 A. No, I have nót.

18 Q. FOR WHOM ARE YOU TESTIFYING?

19 A. I am testifying on behalf of the Applicants, Sharyland Utilities, L.P. ("Sharyland

20 Utilities") and Sharyland Distribution & Transmission Services, L.L.C.

21 ("SDTS").

22 II. PURPOSE OF DIRECT TESTIMONY

23 Q. WHAT IS THE PURPOSE OF YOUR DIRECT TESTIMONY IN THIS

24 PROCEEDING?

25 A. The purpose of my direct testimony is to address tax policy, tax accounting, and

26 business structure issues as they relate to the federal income tax allowance

27 proposed for Sharyland's rates. When I refer to "Sharyland" in my testimony,

28 that includes both Sharyland Utilities and SDTS. I do not testify concerning

29 Texas law or Commission precedént, and rely on Sharyland -witness The

Direct Testimony and Exhibits of 3

SOAH Docket No. 473-16-4051 Merle Erickson PUC Docket No. 45414

1253

1 Honorable Scott Brister for,the proposition that pass-through electric Utilities are

2 entitled to a federal income tax allowance in their rates under Texas law.

3 Q. PLEASE SUMMARIZE YOUR TESTIMONY.

4 A. There is no significant economic or functional difference, for the.purposes of this

5 proceeding, in the tax treatment between Sharyland and other pass-through

6 entities. InfraREIT, Inc., a real estate investment trust ("REIT"), effectively is

7 taxed as a pass-through entity and there is little pracfical difference in this matter

8 in the way in which itis taxed as compared to the manner in which another pass-

9 through entity such as an S corporation, limited liability company ("LLC"), or

10 Partnership would be taxed. Thus, Sharyland's earnings will be subject to

11 taxation each year at rates up to 43.4 percent at the InfraREIT, Inc. shareholder

12 level, and the same tax rates would apply to Sharyland's earnings if. it were owned

13 by an S corporation, LLC, or Partnership.

14 An attempt to distinguish between the actual federal income taxes paid

15 under the Sliaryland structure and other Texas electric utility structures would be

16 difficult and complicated by a variety of entity and owner level tax issues. In fact,

17 if the Commission desired to determine the actual taxes paid by owners of pass-

18 through entities (including a REIt) or C corporations, it would be necessary to

19 review the entity and individual owner tax returns. Without reviewing such

20 information, it is not possible to determine the actual taxes paid.

21 Assuming that the top statutory tax rates apply and that utility rates

22 include an allowance for federal income taxes, InfraREIT, Inc. shareholders

23 would pay a tax rate and would earn afte`r-tax returns that are the same as would

24 be earned if Sharyland were owned by a similarly-situated S corporation, LLC, or

25 Partnership.

26 When comparing after-tax returns to shareholders of InfraREIT, Inc.

27 relative to the owners of a similarly-situated C corporation that hypothetically

28 owned Sharyland, InfraREIT, Inc. shareholders would earn after-tax returns that

29 are modestly better than a similarly-situated C corporation, but could also be

30 modestly worse. Similarly, the federal tax rate on the earnings of Sharyland if it



1254

1 were owned by ä C corporation would be modestly higher thaii.the federal tax rate

2 4 that applies to Sharyland owned by a REIT (but could in some situations be less).

3 Finally, if Sharyland did not receive an allowance for federal income

4 taxes, the after-tax return to InfraREIT, Inc.'s shareholders would be about 3.3

5 percentage, points lower than the after tax returns that would be earned by

6 shareholders if an S corporation, LLC, or Partnership owned Sharyland (i.e., the

7 return to InfraREIT, Inc.'s shareholders would be about 35 percent lower). If

8 InfraREIT, Inc. did not receive an allowance for federal income taxes, the after-

9 tax return to InfraREIT, Inc.'s shareholders would be about 2.6 percentage points

10 less than the after-tax return to a C corporation that owned Sharyland (i.e., the

11 return for InfraREIT, Inc.'s shareholders would be approximately 30 percent

12 lower).

13 Q. DO YOU SPONSOR ANY EXHIBITS IN THIS CASE?

14, A. Yes. I sponsor Exhibits ME-1 through ME-3, which are attached to my direct

15 testimony.

16 Q. ARE YOU SPONSORING OR CO-SPONSORING ANY SCHEDULES 17 INCLUDED AS PART OF THE RATE FILING PACKAGE IN THIS' 18 CASE?

19 A. No.

20 Q. WERE THESE EXHIBITS AND THIS TESTIMONY PREPARED BY YOU 21 OR UNDER YOUR DIRECTION?

22 A. Yes. These exhibits and this testimony were prepared by me or under my

23 direction. The information contained in these exhibits and this testimony is true

24 and correct to the best of my knowfedge and belief.



1255

1 III. OVERVIEW OF TEXAS ELECTRIC UTILITY STRUCTbRES AND

2 THEIR TAX CHARACTERISTICS

3 Q. PLEASE DESCRIBE SHARYLAND'S STRUCTURE.

4 A. As illustrated in Exhibit ME-1, Sharyland consists of an operating company-

5 Sharyland Utilities—and an asset company—SDTS. As Mr. Ralph G. Goodlet,

6 Jr. discusses, these entities are organized as follows.

7 Sharyland Utilitieš .is organized as a limited partnership, and Shary

8 Holdings, L.L.C. owns a one percent interest in Sharyland Utilities and serves as

9 its general partner. SU Investment Partners, L.P. owns a 99 percent limited

10 partnership interest in Sharyland Utilities. Both Shary Holdings, L.L.C. and SU

11 Investment Partners, L.P. are owned indirectly by ,Hunter L. Hunt of Dallas,

12 Texas, and members of his family.

13 SDTS iš a limited liability company that owns transmission and

14 distribution assets that are considered "real estate" under federal tax law.1

15 Sharyland Utilities is the managing member of'SDTS and the remainder of SDTS

16 is owned by Trarismission and Distribution Company, L.L.C. ("TDC"), which in

17 turn is wholly owned by InfraREIT Partners, LP ("Operating Partnership").

18 InfraREIT, Inc. owns approximately 72 percent of the Operating Partnership, and

19 thus is the parent company of SDTS. The remaining approximately 28 percent of

20 the Operating Partnership is owned beneficially by corporations and individuals.2*

21 InfraREIT, Inc. is taxed as a REIT under Internal Revenue Code ("I.R.C.")

22 §§ 856-860 and underlying Internal Revenue Service ("IRS") regulations. As Mr.

23 D. Greg Wilks explains, during February 2015, InfraREIT, Inc. completed its

24 initial public offering, which raised approximately $529.0 million. It trades on

In June 2007, the IRS issued Private Letter Ruling (PLR) 200725015 to InfraREIT, Inc. This PLR provided the basis for Shafy&d's restructuring and the subsequent qualification of SDTS's parent as a REIT.

2 The earnings of Sharyland would flow through to and be taxable to those individuals and entities. To simplify the testimony, hereafter I discuss InfraREIT, Inc. as if it owned 100 percent of the Operating 'Partnership and as if 100 percent of Sharyland's earnings pas-sed through to shareholders of InfraREIT, Inc.

Direct Testithony and Exhibits of 6


1256

1

the New York Stock Exchange under the 'symbol HIFR. Because it is publicly

2

traded, the shareholders of InfraREIT, Inc. will change over time.

3 Q. ARE YOU FAMILIAR WITH THE STRUCTURES OF OTHER TEXAS

4 INVESTOR-OWNED ELECTRIC UTILITIES?

5 A. Generally, yes., I understand that utilities in Texas are organized in a variety of

6 corporate structures. For example, I am aware that CenterPoint Energy Houston

7 Electric LLC (`CenterPoint"); Cross Texas Transmission LLC ("Cross Texas");

8 Electric Transmišsion Texas, LLC ("ETT"); Lone Star Transmission LLC ("Lone

9 Star"); Oncor Electric Delivery Company, LLC ("Oncor"); and Wind' Energy

10 Transmission Texas, LLC ("WETT") are structured as limited liability

11 companies. As such, they are "pass-through" or "disregarded" entities for federal

12 income tax purposes. Although those entities do not pay federal income tax

13 directly, I understand that the Commission has authorized all of these entities to

14 include an income tax allowance of 35 percent in their revenue requirement,

15 regardless of the amount of taxes actually paid by these entities.

16 Although the ultimate parent of the utilities identified as pass-through

17 entities is often a C corporation, that is not universally true. For example, the

18 June 1, 2015 Affiliate Activities report filed in.Project No. 36867 by Cross Texas

19 includes an organization chart (attached as Exhibit ME-2) that indicates that a

20 pass-through entity (LS Power Development,- LLC) is the parent entity in the

21 utility's organization chain. I also understand that WETT is a pass-through entity,

22 but it is unclear whether it is 100 percent owned by domestic C corporations.3 I

23 understand the Commission has allowed both Cross Texas and WETT to indiude

24 in theirLrates an income tax allowance of 35 percent.

25 Q. PLEASE DISCUSS THE KEY TAX CHARACTERISTICS OF

26 C CORPORATIONS AND PASS-THROUGH ENTITIES.

27 A. There are two basic types of entities that own for profit businesses: C corporations

28 and pass-through entities (which in my nomenclature include§ disregarded

3 Electric Utilities Annual Report of Affiliate Activities Pursuant to PUC Subst. R. §25.84, for 2008 and Subsequent Years, Project No. 36867, Annual Report bf Affiliate Activities for Wind Energy Transmission Texas, LLC for The Year Ended December 31, 2014 at 7 (Jun. 1, 2015).

Direct Testimony and Exhibits of 7 SOAH Docket No. 473-16-4051 Merle Erickson PUC Docket No. 45414

. 1257

1 entities). The most common types of pass-through entities are S corporations,

2 LLCs, Partnerships, and REITs.4

3 C corporation taxable income is taxed at the entity level each year, and if

4 and when a C corporation makes dividend distributions of its after-tax income,

5 those dividends are taxable to shareholders at their applicable rates. The

6 distinguishing characteristic of a pass-through entity is that the entity's earnings

7 are not taxed at the entity level, but rather are taxed at the owner leve1.5

8 Therefore, the current period taxation of the taxable income of C corporations and

9 pass-through entities varies in the party that pays that tax, and the tax rate paid by

10 the taxpayer. In the case of a C corporation, the top federal tax rate on taxable

11 income is currently-35 percent. In the case of pass-through entities, and assuming

12 the entity's taxable income is properly characterized as ordinary income, the tax

13 rate for owners of the pass-through entity is currently 39.6 percent, assuming the

14 owner is an individual investor in the top tax bracket.6 The Medicare Surtax of

15 3.8 percent can apply in addition to the 39.6 percent rate.

16 Q. PLEASE EXPLAIN THE TERM "PASS-THROUGW ENTITY.

17 A. A pass-through entity is not subject to income tax at the entity leve1.7 Rather, the

18 taxable income of the pass-through entity flows through or passes through to the

19 owners of the entity and is subject to taxation at the owner level. The mechanics

20 of the pass through of such income and the tax forms (e.g., K-1, 1099) provided

21 by the entity to owners vary somewhat across pass-through entities, but with a

4 Another common pass-through entity form is the Regulated Investment Company ("RIC"). Mutual funds in general are RICs. Sole proprietorships are also a common type of pass-through, but are usually for relatively smaller businesses.

5 As discussed elsewhere in my testirfiony, there are differences in the way in which earnings pass through to owners of different types of pass-through entities, and there are also technical differences in the manner in which the entity's earnings are ascribed to owners, and whether losses and certain other items can pass through to owners.

6 If the owner of a pass-through entity is a C corporation, the tax rate on taxable income that passes through to the owner would also be 35 percent.

7 Sometimes pass-through entities are referred to as "pass-thru," "flow through," or "conduit" entities, and these terms are often used interchangeably.

Direct Testimonyand Exhibits of 8


1258

1 few exceptions, the passing through of the entities taxable income to the owners

2 is essentially the same for 'all pass-through entities.

3 Q. PLEASE DESCRIBE THE ESSENTIAL CHARACTERISTICS OF A

4 REIT.

5 A. A REIT; such as InfraREIT, Inc., is a C corporation that has elected to be treated

6 as a REIT under federal tax law. REITs are required to invest in real estate and

7 generate their earnings primarily from real estate. In order to qualify as a REIT,

8 an entity must satisfy various tests relating to the proportion of its assets that are

9 invested in real estate and the amount of income generated from real estate-related

10 activities. In addition, the entity must distribute at least 90 percent of its taxable

11 income to shareholders. If a REIT fails to satisfy these tests, it will lose its REIT

12 status, and will be subject to tax as an ordinary C corporation.

13 Q. DO YOU CONSIDER THE REIT TO BE A MAINSTREAM

14 INVESTMENT VEHICLE?

15 A. Yes. REITs are widely used and have been widely used for several decades.

16 REITs are not considered to be exotic investment vehicles, but rather, in my

17 experience, are a standard way for investors to gain exposure to various types of

18 real estate. The benefits of REITS have been explained as follows.

19 As growth in the industry occurs, public financing will necessarily

20 come into play to enable truly large scale capital deployment.

21 Additionally, as this paper describes, the cost of capital for solar

22 power development is unnecessarily high due to current investment

23 structures. Ideally, a vehicle with a tax advantaged structure would

24 be able to be (sic) utilized, and while limited liability corporations

25 provide that benefit, they are unwieldy for raising large scale

26 public capital. REITS, which offer the benefit of pass through

27 taxation and the widespread acceptance by public investors

28 • combined with REIT regulations as they pertain to solar power

29 may provide the best option for investment, which is the subject of

30 the rest of this article.8

8 Brian McKinley, Using REITs to Invest in Utility Scale Solar Projects, 12 Cornell Real Estate Rev. Art. 10, at 64 (2014) (emphasis added), available at http://scholarship.sha.cornell.edu/cgi/viewcontent. cgi?article=1126&context=crer.

Direct Testimony and Exhibits of SOAH Docket No. 473-16-4051 Merle Erickson PUC Docket No. 45414

9

1259

1 IV. FUNCTIONALLY THE SHARYLAND ENTITIES, INCLUDING

2 INFRAREIT, INC. ARE PASS-THROUGH ENTITIES

3 Q. IS SHARYLAND UTILITIES A PASS-THROUGH ENTITY?

4 A. Yes. Sharyland Utilities is a limited partnership. It is owned by intermediate

5 pass-through entities (Shary Holdings, L.L.C. and SU InVestment Partners, L.P.)

6 ahd ultimately by members of the Hunt family. This is a pass-through structure.

7 Q. ARE THERE PASS-THROUGH ENTITIES IN THE SDTS OWNERSHIP

8 CHAIN?

9 A. Yes, SDTS, TDC, and the Operating Partnership are pass-through entities., SDTS

10 is a limited liability company, and'as such its income flows through to its owners,

11 including TDC. Similarly, TDC is a limited liability company that flows through

12 its income to its 100 percent owner, the Operating Partnership. And the

13 Operating Partnership is a limited partnership that passes through its income to its

14 owners. Beneficial owners include InfraREIT, Inc. and, as described alSove,

15 certain other entities and individuals that are taxpayers.

16 Functionally and economically, InfraREIT, Inc.—the REIT entity in

17 Sharyland s structure—provides the same pass-through treatment as

18 S corporations, LLCs, and Partnerships. It does so by paying dividends equal to

19 at least 90 percent of its taxable income to its owners, where that income is taxed

20 at the shareholders' marginal tax rate.9 Although there are certain differences

21 between each of these entities,19 in terms of their basic tax treatment, I chnsider

22 all of these entities to be pass-through entities, and I refer to them that way in my

23 teaching of both MBAs and executives.

9 If InfraREIT, Inc. does not meet this 90 percent distribution requirement, it will not qualify as a REIT and will have to pay taxes at C corporation rates on its taxable income.

10 For example, a partnership allows special allocations of gains and losses, and provides for multiple classes of ownership (limited partner, general partner, etc.). An S corporation passes gains and losses through to shareholders in proportion to their share ownership, special allocations are not allowed and S corporations can only have one class of stock. REITs cannot pass through losses, while other pass-through entities can pass through losses.

Direct Testimony and Exhibits of 10 SOAIII Docket No. 473-16-4051


1260

'1 Q. ARE REITS COMMONLY VIEWED AS PASS-THROUGH ENTITIES?

2 A. Yes. Economically and conceptually, REITs are pass-through entities and are

3 widely referred to in that way. To illustrate,

4 • "Even though REIT taxation is often referred to as a flow-through or

5 conduit tax regime, it does not incorporate complex allocation rules

6 comparable to those found in the partnership tax rules."11

7 • "In contrast, a host of 'flow through entities generally are nontaxable at

8 the entity level and are taxed only at the investor level, including REITs,

9 ,S corporations, partnerships, limited liability partnerships (LLPs) and

10 limited liability companies (LLCs) . . . REITs are flow-through entities yet

11 can trade on major exchanges like corporations."12

12 • "In addition, special rules apply to certain types of pas's-through entities

13 including S corporations, regulated investment companies, real estate

14 investment trusts, cooperatives, and housing cooperatives."13

15 • "In fact, the vast majority of businesses in America are not C corporations,

16 but rather are pass-through entities, such as partnerships, sole,

17 proprietorships, limited liability companies ("LLCs"), and S corporations.

18 Other less common types of business form, such as Real Estate Investment

19 Trusts ("REITs") and Master Limited Partnerships ("MLPs"), are also

20 often considered pass-through or "flow-through" enterprises. While

11 Bradley Borden, Reforming REIT Taxation (Or Not), 53 Hous. L. Rev. 1, at 47 (2015).

12 Austan Goolsbee & Edward Maydew, Taxes and Organizational Form: The Case of REIT Spin-offs, The National Tax Journal, Vol. LV, No. 3 at 442 (Sept. 2002).

13 Joint Committee on TaxatiOn, Federal Income Tax Treatment of Pass-Through Entities (Including a Description of H.R. 1658, H.R. 2571, H.R.`3397, and H.R. 4448 (JCS-13-86) at 2 (Jun. 9, 1986)). The Joint Committee on Taxation is described.as follows, available at https://www.jct.gov/about-us/overview.html:

The Joint Committee on Taxation is a nonpartisan cornmittee of the United States Congress, originally established under the Revenue Act of 1926. The Joint Committee operates with an experienced professional staff of Ph.D. economists, attorneys, and accountants, who assist Members of the majority and minority parties in both houses of Congress on tax legislation.

The Joint Committee is chaired on a rotating basis by the Chairman of the 'Senate Finance Committee and the Chairman of the House Ways and Means Committee. ...

The Joint Committee Staff interacts with Membeis of Congress, Members of the tax-writing committees, and their staff on a confidential basis and enjoys a high-level of trust from both sides of the political aisle and in both houses of Congress. Because the Joint Committee Staff is independent, tax-focused, and involved in all stages of the tax legislative process, the staff is able to ensure consistency as tax bills move through committees to the floor of each chamber, and to a House-Senate conference committee.

Direct Testimony and Exhibits of SOAH Docket No. 473-16-4051 11 Merle Erickson PUC Docket No. 45414

1261

1 various types of pass-through entities have different characteristics, they

2 share one basic attribute: the fact that business income is mot taxed at the

3 entity level but rather is passed through to shareholders who are taxed at

4 tthe individual tax rates."14 '

5 Q. HAVE REITS BEEN REFERRED TO AS PASS-THROUGH, CONDUIT,

6 OR PASS-THRU ENTITIES IN CERTAIN INSTANCES BY THE IRS AND

7 IN THE INTERNAL REVENUE CObE?.

8 A. Yes. While there are teChnical differences between REITs and other pass-through

9 entities, both the Internal Revenue 'Code and ,the IRS refer to REITs as pass-

10 through or pass-thru entities in certain instances. For example, the IRS has stated:

11 , This notice provides interim guidance relating to excess inclusion

12 income of pass-through entities, particularly real estate investment

13 trusts (REITs).15

14 Similarly, U.S. Treasury Regu_lations under Section 301.7701(i)-1

15 Definition of a taxable mortgage pool, define REITs as pass-throughs like

16 S corporatioris and partnerships:

17 (3) Equity interests in pass-through arrangements. The equity

18 interest of an entity in a partnership, S sorporation, trust, REIT, or

19 other pass-through arrangement is deemed to have the same

20 composition as the entity's share of the aš'sets of the pass-through'

21 arrangement.

14 U. S. Senate Committee on Finance, The Business Income Tax Bipartisan Tax Working Group Report at 22 (2015), available at http.://www.finance.senate.gov/imo/media/doc/The%20Business%20 Income%20Bipartisan%20Tax%20Working%20Group%20Report.pdf.

15 Internal Revenue Bulletin: 200646 Notice 2006-97 (Nov. 13, 2006), available at haps ://www. irs. gov/irb/2006-46 JRB/ar14.html.

Direct Testimony and Exhibits of SbAH Docket No. 473-16-4051 Merle Erickson PUC Docket No. 45414

12

1262

1 Finally, Internal Revenue Code § 1 — Tax imposed specifies, as follows,

2 with respect to the definition of a pass-thru entity:

3 (10)- PASS-THRU ENTITY DEFINED For purposes of this

4 subsection, the term "pass-thru entity means—.

5 (A) a regulated investment company;

6 (B) a real estate investment trust;

7 (C) an S corporation;

8 (D) a partnership;

9 (E) an estate or trust;

10 (F) a common trust fund; and

11 (G) a qualified electing fund (as defined in section 1295).16

12 V. THERE IS NO PRACTICAL MEANS TO liRAW A MEANINGFUL

13 DISTINCTION IN THE AMOUNT OF TAX PAID'BY SHARYLAND

14 AND OTHER TEXAS INVESTOR-OWNED ELECTRIC UTILITIES

15 Q. IS IT REASONABLE e TO ATTÊMPT TO USE PUBLICLY AVAILABLE

16 INFOIWATION TO DISTINGUISH BETWEEN ACTUAL TAXES PAID

17 UNDER THE SHARYLAND STRUCTURE AND THOSE PAID BY

18 OTHER TEXAS-OWNED UTILITIES?

19 A. No. For the reasons that I explain below, an attempt to distinguish between the

20 actual federal income taxes paid under the Sharyland structure and other Texas

21 electric utility structures based on publicly available information would be

22 difficult and complicated by a variety of entity and owner level tax issues. For

23 example, a C corporation's actual tax liabilities could be complicated by a number

24 of factors (such as consolidated tax returns, Alternative Minimum Taxes, tax

25 credits, net operating loss carryforwards, and book/tax differences arising from

26 acquisition accounting, stock option accountihg, etc.) at the entity level arid then

27 again at the shareholder leve1.17 Similarly, for pass-through entities, various

; 16 I.R.C. § 1(h)(10). See also, the IRS instructions for the REIT tax return (Form 1120-REIT),

which summarizes the time needed to prepare tax returns for "Taxpayer Burden for Entities Taxed As Pass-Through Corporations." The IRS includes in the category of "Entities Taxed as Pass-Through Corporations" those entities filing Form 1120-REIT (REITs) as well as S corporations filing Form 1120-S. 2015 Instructions for Form 1120-REIT, available at https://www.irs.gov/pub/irs-pdf/i1120rei.pdf.

17 The complexity associated with estimating the tax liabilities of a public C corporation are well known. See, e.g., Michelle Hanlon, What Can We Infer about a Firm's Taxable Income from Its Financial Statements? National Tax Journal, Vol. LVI, No. 4 (Dec. 2003).


13

1263

1 shareholder tax issues would create complexity in determining the actual taxes

2 paid.

3 In fact, if the Commission desired to determine the actual taxes paid by

4 owners of pass-through entities (including a REIT) or C corporations, it would be

5 necessary to review the entity and individual owner tax returns. In some cases,

6 there may be direct owners of utilities that are structured as pass-through entities,

7 and as a result, it would be necessary to trace the utilities earnings upstream to an

8 ultimately taxable or tax-exempt owner. Without reviewing such information, it

9 is not possible to determine the actual taxes paid. This is true because each

10 investor owner may have tax attributes that influence the taxation of the income

11 that they realize from various investments, and the same is true of a C corporation

12 that owns a utility. Owners of REITs/S corporations/LLCs/Partnerships, as well

13 as owners of C corporations, may include a variety of shareholders with different

14 tax rates and tax circumstances. Furthermore, for publicly-traded entities, share

15 ownership can change frequently and therefore tracking the tax liabilities of the

16 changing owners would be difficult.

17 Q. ARE SHARYLAND'S EARNINGS ULTIMATELY TAXED IN A

18 MANNER THAT IS SIGNIFICANTLY DIFFERENT THAN HOW THOSE

19 EARNINGS WOULD BE TAXED IF SHARYLAND WERE OWNED BY

20 AN S CORPORATION, LLC, OR PARTNERSHIP?

21 A. No. There is no significant economic or functional difference, for the purposes of

22 this proceeding, in the tax treatment between Sharyland and other pass-through

23 entities. Sharyland is a limited partnership and SDTS is a double member LLC.

24 Consequently, they both will be disregarded or pass-through entities for federal

25 income tax purposes. Ultimately, a portion of the earnings of Sharyland will pass

26 through to InfraREIT, Inc., and those earnings will then be passed through to

27 InfraREIT, Inc.'s owners. If Sharyland were owned by another pass-through

28 entity (e.g., an S corporation, LLC, or Partnership), the earnings of Sharyland

29 would pass through to the owners of that entity similar to the way they pass

30 through to InfraREIT, Inc.'s shareholders.

Direct Testimony and Exhibits of 4 SOAH Docket No. 473-16-4051 1 Merle Erickson PUC Docket No. 45414

1264

1 Q. IN YOUR OPINION, FROM A TAX ACCOUNTING AND TAX POLICY

2 PERSPECTIVE, ARE THE "TAXES REQUIRED TO BE PAID" ON THE

3 UTILITY INCOME OF SHARYLAND ECONOMICALLY

4 INESCAPABLE SIMILAR TO THE TAX SITUATION IN SUBURBAN?

5 A. Yes. The utility income realized by Sharyland will be taxable at the InfraREIT,

6 Inc. shareholder level, and diat taxation will occur in the year in which such utility

7 income is earned.18 As I understand the facts, this is effectively identical to the

8 tax situation faced by the owners of the S corporation in the Subin-ban19 case.

9 Economically and from a tax accounting and tax policy perspective, there is little

10 or no difference in the tax treatment of InfraREIT, Inc. relative to an

11 S corporation, LLC, or Partnership in this matter.

12 Q. IS IT ACCURATE- TO SAY THAT NO FEDERAL INCOME TAX IS PAID

13 UNDER A REIT STRUCTURE?

14 A. No. Assertions that the Sharyland structure avoids federal income taxes are

15 incorrect. Taxes will be paid on Sharyland's earnings. 'If the REIT distributes its

16 taxable income to its shareholders, there is generally no income tax at the REIT

17 level. However, REIT shareholders paý income tax at their marginal tax rates on

18 all of the REIT's income which effectively passes through the REIT and is

19 taxable to Ahose shareholders. The REIT earnings are immediately taxable to

20 shareholders, and there is no deferral of the taxation.

21 It is simply incorrect to assert that the earnings of a REIT are never taxed

22 because there is no income tax at the REIT level (assuming 100 percent of the

23 REIT's taxable income is distributed). The appropriate way to evaluate the

24 taxation of a REIT and other similarly taxed pass-throughs is based on the tax

25 effects at the entity and owner level. The Joint Committee on Taxation similarly

26 stated in this regard:

27 Along with other factors, the choice of entity may be influenced by

28 the tax burden on income earned in that form. ... A proper analysis

18 Any taxable income that is not distributed would be taxed at 'the InfraREIT, Inc. level.

19 See Suburban Util. Corp. v. Pub. Util. Comm 'n of Tex., 652 S.W.2d 358, 364 (Tex. 1983).


SOAH Thicket No. 473-16-4051, Merle Erickson PUC Docket No. 45414

1265

1 of the tax burden includes the effect of taxation of income not only

2 at the entity level, but also at the investor/owner 1eve1.2°

3

Moreover, the tax rate that applies to the earnings of a REIT can be higher

4

than the tax rate that applies to the earnings of a C corporation. This is true

5 because REIT, shareholder tax rates can be higher than the corporate tax rate.

6 Consistent with that notion, an article in the Houston Law Review concluded:

7 The REIT distribution requirement can fesult in REIT taxable

8 income being subject to a higher effective tax rate than corporate

9 taxable income.21

10 Taken together, while REITs reduce or eliminate the corporate level tax, they

11 often increase the amount of shareholder taxes and accelerate the payment of

12 shareholder level taxes.

13 Q. DOES A REIT ELIMINATE "DOUBLE TAXATION?"

14 A. Generally, yes. A REIT eliminates the double taxation of dividend income if the

15 REIT distributes its taxable income to the owners of the REIT.22 Dividends paid

16 by a C corporation are subject to double taxation—once at the C corporation level

17 and once at the shareholder level.

18 Q. IS THE ELIMINATION OF DOUBLE TAXATION VIA THE REIT

19 STRUCTURE UNIQUE IN TEXAS UTILITIES, OR HAVE OTHER

20 UTILITIES ALSO UTILIZED STRUCTURES THAT ELIMINATE

21 DOUBLE TAXATION?

22 A. It is my understanding that other Texas utilities have utilized structures that

23 eliminate or eliminated double taXation. For example, I understand that Cross

24 Texas is an LLC, which therefore eliminates double taxatiori of its income.

25 Additionally, the utility in Suburban was an S corporation and S corporations

26 generally eliminate double taxation.

20 Joint Committee on Taxation, Selected Issues Relating to Choice of Business Entity at 54 (Mar. 5, 2012).

_

21 Bradley Borden, Reforming REIT Taxation (Or Not), 53 Hous. L. Rev. 1, at 46 (2015). See also, McRae Thompson, C Corporation to REIT Conversions, Alvarez & Marsal, LLC at 1 (Nov. 12, 2015), available at http://www.alvarezandmarsal.com/c-corporation-reit-conversions.

22 If the REIT retains 10 percent or less of its taxable income, that retained income is taked at the REIT level, while the distributed income is passed through to and taxed at the shareholder level.

Direct Testimony and Exhibits of 16 SOAH Docket No. 473-16-4051 Merle Erickson PUC Docket No. 45414

1266

1 Q. CAN THE TAX RATE ON INFRAREIT, INC.'S SHAREHOLDERS BE

2 HIGHER ,THAN THE CORPORATE TAX RATE ON

3 C CORPORATIONS?

4 A. Yes. It is well known that some C corporations have effective tax rates that are

5 significantly less than 35 percent. In fact, a 2013 U.S. Government

6 Accountability Office (GAO") report estimated that profitable U.S. corporations

7 had an ,average effective tax rate of between ahout 13 percent and 17 percent.23 A

8 similar 2016 GAO report reaches approximately the same conclusion about the

9 average tax rate of profitable U.S. corporation's, concluding as follows:

10 For tax years 2008 to 2012, profitable large U.S. corporations paid,

11 on average, U.S. federal income taxes amounting to about 14

12 pertent of the pretax net income that they reported in their

13 financial statements (for those entities included in their tax

14 returns).24

15 Second, while the top tax ,rate on C corporations is 35 percent, the top

16 income tax rate on individual InfrakEIT, Inc. investors wlio would receive

17 dividends is currently 39.6 percent and there is also a 3.8 percent Medicare Surtax

18 on some individual investors, for a total potential tax rate on InfraREIT, Inc.

19 individual shareholders of about 43.4 percent. However, like C corporation tax

20 rates, the tax rate on InfraREIT, Inc. shareholders could be less than the top

21 statutory rate, and for some shareholders their tax rates may be Iess than 39.6

22 percent.25

23 Government Accountability Office, Corporate Income Tax, Effective Tax Rates Can Differ Significantly from the Statutory Rate (May 2013). The report concludes that:

For tax year 2010 (the more recent information available), profitable U.S. corporations that filed a Schedule M-3 paid U.S. federal income taxes amounting to about 13 percent of the pretax worldwide income that they reported in their financial statements (for those entities included in their tax returns).

24 Government Accountability Office, Corporate Income Tax, Most Large Profitable U.S. Corporations Paid Tax but Effective Tax Rates Differed Significantly from the Statutory Rate at Introduction (Mar. 2016).

25 As discussed elsewhere, some institutional investors holding InfraREIT, Inc. shares may be tax exempt, while other institutional investors are pass-through-type entities such as mutual funds, or tax deferred entities.


SOAH Docket No. 473-1.6-4051 Meile Erickson PUC Docket No. 45414

1267

1 Q. DOES THE SHARYLAND STRUCTURE RESULT IN A WINDFALL

2 FROM RATEPAYERS TO INFRAREIT, INC. AND ITS OWNERS

3 BECAUSE INFRAREIT, INC. IS TAX EXEMPT AND ITS EARNINGS

4 WILL NEVER BE TAXED?

5 A. No. The notion that InfraREIT, Inc.'s earnings somehow escape taxation, and

6 therefore its shareholders receive a windfall, is incorrect. InfraREIT, Inc.'s

7 owners are responsible for paying tax on its earnings, and the tax rates on

8 InfraREIT, Inc.'s owners are *the same as the tax ' rates faced by owners of

9 S corporations, LLCs, and Partnerships and comparable to the tax rates on

10 C corporations.

11 Sharylarid's earnings would be taxed in the same manner.if SDTS were

12 owned by an S corporation, LLC, or Partnership instead of a REIT. Thus, there is

13 no wiridfall to InfraREIT, Inc. and its shareholders compared to s other widely

14 accepted pass-througfi entities. Furthermore, assuming that the top statutory tax

15 rates apply to C corporations and InfraREIT, Inc.'s shareholders, there is not a

16 substantial difference in tax rate on the earnings of the C corporation and

17 InfraREIT, Inc. In fact, under some assumptions 'and fact patterns,* the REIT

18 structure could result in more taxes paid than would be paid by a C corporation.

19 In Table 1 below, I present the hypothetical after-tax- returns to, and the

20 taxes paid by, REIT Alareholders (i.e., InfraREIT, Inc.) as compared to

21 shareholders of a similarly-situated S corporation, LLC, or Partnership. I then

22 make the comparison between a REIT and a similarly-situated C corporatiOn.

23 Because a REIT is functionally a pass-through entity, I first compare the

24 after-tax returns of a ufility owned by a REIT to tlie after-tax returns of a utility

25 owned by an S ebrporatiori, LLC, or Partnership. For such a utility, federal

income tax is not paid at the utility/eritity level but instead is paid by the entity's

27 owners. I assume the top marginal tax rates apply to the shareholders of the REIT

28 and the S corporation, LLC, or Partnership (39.6 percent on ordinary income). I

29 also assume a ,100 percent dividend payout ratio for the REIT. As Table 1

30 indicates, the returns to the REIT shareholders (Panel A) and the returns to the

31 S corporation, LLC, or Partnership owners (Panel B) are both approximately 9.3

32 percent when the REIT and the other pass-through' entity owner utility's rates Direct Testimony and Exhibits of



, 1268

29

approach.

Direct Testimony and Exhibits of Merle Erickson

The single period computation here is based on the fact that rates are s' et using a test year

19 SOAH Docket No. 473-16-4051 PUC Docket No. 45414

1 include a federal income tax allowance at 35 percent. Furthermore, the total tak

-2 rate on the earnings of the REIt (39.6 percent) is the same a's the total tax rate on

3 the earnings of the S corporation, LLC, or Partnership. Finally, the toial federal

4 income taxes paid ($60.92) under the REIT structure are the same as the total

5 taxes paid under an. S corporation, LLC, or Partnership structure.26 It is my

6 understanding that an income tax allowance for federal income taxes was

7 . approved for an S corporation in the Suburban case.

8 Turning next to a comparison of a REIT to a C corporation, I assume the

9 top marginal tax rates apply to the C corporation (35 percent) and shareholders of

10 the C corporation and the REIT (39.6 percent on ordinary income and 20 percent

11 on dividends). I also assume a 100 percent dividend payout ratio for the REIT

12 and a 66.88 percent dividend, payout ratio for the C corporation.27 Panel C of

13 Table 1 presents the C corporation analysis.

14 Under these assumptions, Tabfe 1 indicates that the after-tax return to the

15 C corporation is about 8.7 percent and to REIT shareholders is about 9.3

16 percent.28 Therefore, under this set of assumptions, ownership of the utility by a

17 REIT rather than a C corporation results in higher shareholder after-tax returns of

18 about 0.6 percent.29 When comparing the total tax rate for the REIT to the

19 C corporation, the tax rate on the REIT is 39.6 percent while for the

20 C corporation, the tax rate is 43.7 percent, so the tax rate on the REIT is about 4.1

21 percent lower than the tax rate on the C corporation. The total taxes paid under

22 the REIT structure are $60.92, while under the C corporation structure, total taxes

23 paid are $67.22. However, if I include the 3.8 percent Medicare Surtax irr the

• 26 If I include the 3.8 percent Medicare Surtax in individual investor tax rates as described previously, the after-tax return under the REIT structure (Panel A) and under the S corporation/LIC/ Partnership structure (Panel B) is abOut 8.7 percent.

' 27 I have utilized the 66.88 percent paybut ratio that Mr. Robert B. Hevert testifies is, the long- ' term historical payout ratio for electric utilities.

28 In the tabufation, I assume that the C corporation pays out 66.88 percent of its after tax taxable income as a dividend. If the C corporation paid out 100 percent of its after tax income as a dividend, the after-tax return to the C corporation would be 8 percent.

1269

1 shareholder ordinary income and dividend tax rates, then the after-tax return to

2 the C corporation is 8.4 percent and the after-tax return to the REIT is about 8.7

3 percent for a difference in aftet-tax returns of about 0.3 percent. Furthermore, the

4 tax rate that applies to the earnings of the C corporation is approximately 45.3

5 percent, and the tax rate that applies to the earnings of the REIT is about 43.4

6 percent. Therefore, under this analysis, the difference in the total tax rate between

7 the C corporation and the REIT is less than 2 p;ercent.

Table 1: Comparison of After-Tax Returns to Alternative Organizational Forms - Federal IncoMe Tax Allowance For Each Entity Type

Assumed Facts/Inputs:

Intended ROE 10.0% tc 35.0%

Federal Income Tax Rate 35.0% tth 39.6%

Gross Up for Federal Income Tax 153.8% tthv 20.0% Pre-tax ROE 15.4% REIT Payout Ratio 100.0% Equity Investment $1,000 C Corporation Payout Ratio 66.88%

Panel A: UtiliO, Owned by a REIT

REIT REIT Tax After Tax After Pre-tax REIT Taxable Level on REIT Total Return To Total Tax Return Dividend Income Tax Dividends Taxes Paid REIT Owners Tax Rate Return

8

$153.85 $153.85 $0.00 $0.00 $60.92 $60.92 $92.93 39.6% 9.3%

Panel B: Utility Owned by an S Corporation, LLC or Partnerhsip

S-Corp., LLC, Owner Tax After Tax After Pre-tax P-Ship, Level on Entity Total Return To Total Tax Return Tax Earnings Taxes Paid Owners Tax Rate Return

$153.85 , $0.00 $60.92 $60.92 $92.93 39.6% 9.3%

Panel C: Utility Owned by a C Corporation

After Shareholder Tax Rate After Pre-tax Corporate Corporate Dividend Dividend Total Corporate Total Tax Return Tax Tax Distribution Tax Taxes Paid Only Tax Rate Return

$153.85 $53.85 $100.00 $66.88 $13.38 $67.22 35.0% 43.7% 8.7%

9 In sum, the REIT produces the same after-tax returns as a similarly-

10 situated S corporation, LLC, or Partnership and,the tax rate and total taxes paid on

11 the earnings of the REIT are the same as they would be on an S corporation, LLC

12 or Partnership. A REIT produces modestly better after-tax returns than a

13 C corporation and depending on the specific circumstances could produce worse

14 after-tax returns. Similarly, the tax rate and taxes paid on the earnings of a utility

15 owned by a REIT are modestly lower than the tax rate and taxes paid on the

16 earnings of a similarly-situated C corporation (but could be slightly higher



1270

1 depending on the circumstances). I have provided a graphical illustration oT these

2 results in Exhibit ME-3.

3 This latter conclusion is similar to the conclusion reached' by others that

4 have analyzed the taxation of C corporations relative to REITs. For example, an

5 article in the Houston Law Review concluded:

6 The REIT di'stribution requirement can result in REIT taxable

7 incoine being subject to a higher effective tax rate than corporate

8 taxable income."

9 Similarly, another article in the Florida Tax Review stated:

10 This suggests that REIT shareholders enjoy a 6.67 percentage point

11 advantage over corporate shareholders if a corporation distributes

12 100 percent of its after-tax income. If the corporation distributes

13 only 25 percent of its taxable income, however, the REIT

14 shareholders suffer a 2.85 percentage point tax disadvantage. This

15 is a counterintuitive aspect of REIT taxation that other reporters,

16 commentators, and analysts appear to overlook. ... If a

17 corporation's dividend-payout ratio is 25 percent or less under the

18 current assumptions, income from real estate is subject to the

19 lowest tax rate if held by the corporation. This counterintuitive

20 result obtains because corporations are taxed at a lower rate than

21 individuals, corporations do not distribute 100 percent of their

22 after-tax taxable income, REIT dividends are subject to the highest

23 tax rate, and REITs are subject to a distribution requirement.31

24 A recent article in Taxes The Tax Magdzine explains the same economic logic that

25 leads to the conclusion that the corporate tax savings of a REIT are offset by the

26 increased taxes on REIT owners as follows:

27 Consequently, because REITs do not offer deferral to their

28 shareholders (income is distributed rather than sheltered in

29 corporate solution), increased revenue from increased taxes on

30 distributions to shareholders mitigates entity-level tax reductions.32

3° Bradley Borden, Reforming REIT Taxation (Or Not), 53 Hous. L. Rev. 1, at 46 (2015).

31 Bradley Borden, Rethinking the Tax-Revenue Effect of REIT Taxation, 17 Fla. Tax Rei. 527, at 544, 546 (2015) (emphasis added). The article goes on to note that additional complicating factors can influence the comparison of REITs to C corporations.

32' David F. Levy, Nickolas P. Gianou, and Kevin M. Jones, Modern REITs and the Corporate Tax: Thoughts on the Scope of the Corporate Tax and Rationalizing Our System of Taxing Collective Investment Vehicles, Taxes The Tax Magazine, at 217, 245 (Mar. 2016) (emphasis added).



1271

1 Q. IF SHARYLAND DID NOT RECEIVE AN INCOME TAX ALLOWANCE

2 IN ITS RATES, WHAT WOULD BE THE EFFECT ON ITS OWNERS'

3 AFTER-TAX RETURNS COMPAIiED TO AN S CORPORATION, LLC,

4 OR PARTNERSHIP AND COMPARED TO A C CORPORATION?

5 A. If Sharyland's rates did not include an income tax allowance, the returns earned

6 by InfraREIT, Inc.'s investors would be well belo'w the returns earned by

7 investors in a similarly-situated S corporation, LLC, or Partnership. Moreover,

8 the after-tax returns earned by InfraREIT, Inc.'s investor would be well below

9 those earned by shareholders of a similarly-situated C corporation.

10 In Table 2 below, I compare a utility owned by a REIT (i.e., InfraREIT,

11 Inc.) with a utility owned by a similarly-situated S Corporation, LLC, or

12 Partnership under the assumption that the S Corporation/LLC/Partnership-owned

13 utility receives a federal income tax allowance at 35 percent, and the InfraREIT,

14 Inc.-owned utility does not. I again assume the top marginal corporate and

15 inaividual tax rates apply to the relevant type of income. As Panels A and B of

16 Table 2 indicate, under this scenario, InfraREIT, Inc.'s shareholders returns are

17 6.0 percent while the return to shareholders of the S corporation/LLC/Partnership

18 are 9.3 percent. Therefore, the analysis in Table 2 indicates that if Sharyland does

19 not receive,the federal income tax allowance, the after-tax return to its owners is

20 less than the after-tax return to an investor in a similarly-situated

21 S corporation/LLC/Partnership by about 3.3 percentage points.33

22 I also compare InfraREIT, Inc.'s shareholder after-tax returns (Panel A) to'

23 the after-tax returns of owners of a similarly-situated C corporation-owned utility

24 in Panel C. I assume that the C corporation utility receives an adjustment in its

25 rates for the federal income tax allowance, but that Sharyland does not. As the

26 tabulation indicates, InfraREIT Inc.'s shareholders'' after-tax return is about 2.6

27 percentage points less than the after-tax return of the C corporation

28 shareholders.34

33 If I include the 3.8 perceht Medicare Surtax in individual investor tax rates as described previously, the after-tax return under the S corporation/LLC/Partnership structure (Panel B) is about 8.7 percent which is about 3 percent higher than the after-tax return under the REIT structure.

34 Amounts presented in the tabulation are rounded to one digit. If I include the 3.8 percent Medicare Surtax in individual investor tax rates as described previously, the after-tax return to the

Direct Testimony.and Exhibits of 22


1272

Assumed Facts/Inputs:

Intended ROE 10.0% tc 35.0%

Federal Income Tax (FIT) Rate ' 35.0% to, 39.6%

Gross Up for Federal Income Tax 153.8% 'Lily 20.0% Pre-tax ROE 15.4% REIT Payout Ratio 100.0% Equity Investment $1,000 C Corporation Payout Ratio 66.88%

Panel A: Utili0 Owned by a REIT with No Federal Income Tax Allowance

REIT REIT Tax After Tax After ?, Pre-tax REIT Taxable Level on REIT Total Return. To Total , Tax Return Dividend Income Tax Dividends Taxes Paid REIT Owners Tax Rate Return

$100.00 $100.00 $0.00 $0.00 $39.60 $39.60 $60.40 39.6% 6.0%

Panel B: Utility Owned by an S Corporation, LLC or Partnerhsip

S-Corp., LLC, Owner Tax After Tax After Pre-tax P-Ship, Level ori Entity Total Return To Total - Tax Return Tax Earnings Taxes Paid Owners Tax Rate Return

$153.85 $0.00 $60.92 $60.92 $92.93 39.6% 9.3%

Panel C: Utili0 Owned by a C Corporation

After Shareholder Tax Rate After Pre-tax Corporate Corporate Dividend Dividend Total Corporate Total Tax Return Tax Tax Distribution - Tax Taxes Paid Only Tax Rate Return

$153.85 $53.85 $100.00 $66.88 $13.38 $67.22 35.0% 43.7% 8.7%

Table 2: Comparison of After-Tax Returns to Alternative Organizational Forms - No Federal Income Tax Allowance For the REIT

1

2

3 In a sense, omitting the federal income tax allowance froin the utility

4 owned by InfraREIT, Inc.'s pre-tax return is similar to treating the InfraREIT, Inc.

5 shares'as if they were tax exempt bonds. However, because dividends/returns on

6 those shares are not tax exempt, shareholders of InfraREIT, Inc. realize

7 substantially lower returns _ than a similarly-situated S corporation, LLC,

8 Partnership, or C corporation 'when Sharyland's return does not include the

9 federatincome tax allowance.

lo Q. ARE THE CURRENT PERIOD TAX LIABILITIES ON TAXABLE

11 INCOME EARNED BY AN S CORPORATION, LLC, AND

12 PARTNERSHIP SIMILAR TO THE CURRENT PERIOD LIABILITIES

13 ON TAXABLE INCOME EARNED BY A REIT?

14 A. Yes. Other than some technical rules about the way in which g'ains and losses are

15 allocated, ' the ability to claim certain -losses and certaiii other technical

C corporation (Panel C) is about 8.4 percent and the after-tax return to the REIT (Panel A) is about 5.7 percent. In the tabulation, I assume that the C corporation pays out 65 percent of its taxable income as a dividend. If the C corporation paid out 100 percent of its after-tax income as a dividend, the after-tax return to the C corporation would be about 7.6 percent.


23

1273

1 differences, the earnings of S corporations, Partnerships, LLCs, and REITs flow

2 thrdugh to the oivners of those entities.

3 Q. IS IT CORRECT TO ASSERT THAT RETURNS TO INSTITUTIONAL

4 INVESTORS ARE TAXED AT A ZERO PERCENT TAX RATE?

5 A. No. Some institutional investors åre pass-through-type entities. For example, a

6 mutual fund that owns a utility would pass the taxable income from the utility to

7 holders of the mutual fund shares. Pension typeinstitutional investors do not pay

8 tax currently, but when monies are distributed to the pension's beneficiaries, those

9 monies are taxed at the beneficiary's marginal tax rates on ordinary income,

10 which are currently 39.6 percerit fdr the lop bracket (again there may be an

11 additional 3.8 percent MediCare Surtax).35 While certain types of institutional

12 investors, such as college endowment funds, are tax-exempt many institutional

13 investors are not tax-exempt, but rather they are either taxed as pass-throughs or

14 taxation on their income is deferred until distributions are made to beneficiaries.

15 Q. DO PASS-THROUGH ENTITIES OTHER THAN REITS PAY LITTLE IF

16 ANY FEDERAL INCOME TAX AT THE ENTITY LEVEL?

17 A. S corporations, LLCs, and Partnerships do not in general pay federal income tax

18 at the entity level, which is similar or identical to the amount of federal tax paid'

19 by a REIT.

20 Q. ARE THE SO-CALLED "FEDERAL TAX SAVINGS" THAT RESULT

21 FROM A REIT PAYING DIVIDENDS SIMILAR OR ECONOMICALLY

22 EQUIVALENT TO THE FEDERAL TAX SAVINGS THAT ' RESULT

23 FROM S CORPORATIONS, LLCS, AND PARTNERSHIPS PASSING

24 THROUGH THEIR EARNINGS DIRECTLY TO OWNERS?

25 A. Yes. They are the same federal tax savings. The way in whi'ch entity level

26 taxation at the'REIT level is transferred to shareholders is through the payment of

27 '` the dividends (and the tax deduction for those dividend payments), which are

28 required at, a minimum 90 percent rate. For • other pass-throughs such as

29 S corporations, LLCs, or Partnerships, the entity's taxable income passes through

30 directly to owners with or without such 90 percent distributions. r The distinction

35 See, e.g., I.R.C. §§ 61(a)(11), 402(a) and 408(d)(1).

Direct Testimony and EXhibits of Merle Erickson

SOAH Docket No. 473-1g-4051 PUC Docket No. 45414

24

1274

1 between the dividends paid deduction for a REIT and the direct flow through of

2 income for other pass-throughs is not economically meaningful.36

3 , Q. IF S CORPORATIONS PROVIDE ESSENTIALLY THE SAME TAX

4 TREATMENT AS A REIT, THEN WHAT PROHIBITS INFRAREIT,'INC.

5 FROM SIMPLY BEING AN S CORPORATION?

6 A. S corporations do not provide the same access to capital markets that REITS do

7 because REITS can be publicly traded, but S corporations cannot. Furthermore,

8 S corporations can only have 100 shareholders, and they must be individual

9 investors, while no such limits on REITs exist. In sum, REITs are an investment

10 vehicle that provides much greater access to capital markets than S corporations

11 (and certain other pass-through entities).

12 Q. IF SHARYLAND'S RATES INCLUDE AN ALLOWANCE FOR INCOME

13 TAXES, WOULD THE PAYMENT OF SUCH ALLOWANCE BY

14 SHARYLAND'S CUSTOMERS BE FOR A TAX LIABILITY THAT

15 WOULD NEVER EXIST?

16 A. No. That is incorrect. Assuming that InfraREIT, Inc. distributes 100 percent of

17 its taxable income each year as Mr. Wilks testifies tlfat it has done and intends to

18 do, there will be little or no tax liability at the InfraREIT, Inc. level on the rate.

19 payments associated with the income tax allowance. However, the owners of

20 InfraREIT, Inc. will be subject to tax liabilities upon receipt of the payment of the

21 InfraREIT, Inc. dividends, and as noted previously, taxation could be levied at

22 rates up to and in excess of 40 percent. Therefore, InfraREIT, Inc.'s shareholders

23 will pay tax on Sharyland's earnings.

36 U. S. Senate Committee on Finance, The Business Income Tax Bipartisan .Working Group Report (July 2015) at 59 n.17 makes the same point:

Unlike partnerships, entities like REITs are formed as corporations and are subject to special distribution rules. For instance, a REIT is required to distribute 90 percent of its income in the form of shareholder dividends. Thus, although the mechanism for getting to a single layer of taxation is diffe'rent than partnerships, the result—taxation only et the ownership level—is the same.



1275

1 Q. ASSUMING A REIT IS NOT A PASS-THROUGH ENTITY BUT RATHER

2 IS TAXED LIKE A C CORPORATION, IS THE TAX ON THE REIT'S

3 EARNINGS PROPERLY CONSIDERED TO BE 3.5 PERCENT OR EVEN

4 0 PERCENT?

5 A. First, I disagree with the premise that a REIT is not a pass-through for the reasons

6 noted above. Nonetheless, its earnings are taxable at the owner level and at the

7 owner's ordinary income tax rates. This is true because a REIT is required to pay

8 at least 90 percent of its taxable income out to shareholders as a dividend and that

9 dividend will be taxable to those shareholders. While the REIT gets a deduction

10 for the dividends paid, the dividend constitutes taxable income in an equal amount

11 for the shareholder who receives the dividend. Therefore, the dividend paid by

12 the REIT is a mechanism that shifts taxation of the REIT's earnings from the

13 entity to the shareholder. As noted above, the tax rate that applies to that dividend

14 income at the shareholder level can be higher than the tax rate that would have

15 applied had the REIT been taxable as a C corporation. In sum, it is not correct or

16 reasonable to conclude that the tax rate on a REIT's earnings is 3.5 percent or 0

17 percent.

18 VI. CONCLUSION

19 Q. PLEASE SUMMARIZE YOUR TESTIMONY.

20 A. There is no significant economic or functional difference, for the purposes of ,this

21 proceeding, in the tax treatment between Sharyland and other pass-through

22 entities. InfraREIT, Inc. is effectively taxed as a pass-through entity and there is

23 little practical difference in this matter in the way in which InfraREIT, Inc. is

24 taxed as compared to the manner in which another pass-through entity such as an

25 S corporation, LLC, or Partnership would be taxed. Thus, Sharyland's earnings

26 will be subject to taxation each year at rates up to 43.4 percent at the InfraREIT,

27 Inc. shareholder level, and the same tax rate would apply to Sharyland's earnings

28 if it were owned by an S corporation, LLC, or Partnership.

29 An attempt to distinguish between the actual federal income taxes paid

30 under the Sharyland structure and other Texas electric utility structures would be



1276

1 difficult and complicated by a variety of entity and own& level tax issues. In fact,

2 if the Commission desired to determine the actual taxes paid by owners of pass-

3 through entities (including REITs) or C corporations, it would be necessary to

4 review the entity and individual owner tax returns. Without reviewing such

5 information, it is not possible to determine the actual 'taxes paid.

„.6 Assuming that the top statutory tax rates apply and that utility rates

7 include an allowance for federal income taxes, InfraREIT, Inc. shareholders

8 would pay a tax rate and would earn after-tax returns that are the same as would

9 be earned if Sharyland were owned by a similarly-situated S corporation, LLC, or

10 Partnership.

11 When comparing after-tax returns to shareholders of InfraREIT, Inc.

12 relative to the owners of a similarly-situated C corporation that hypothetically

13 owned Sharyland, InfraREIT, Inc. shareholders would earn after-tax returns that

14 are modestly better than a similarly-situated C corporation, but could also be

15 modestly worse. Similarly, the federal tax rate on the earnings of Sharyland if it

16 were owned by a C corporation would be modestly higher than the federal tax rate

17 that applies to Sharyland owned by a REIT (but could in some situations be less).

18 Finally, if InfraREIT, Inc. did not receive an allowance for federal income

19 taxes, the after-tax return to IrifraREIT, Inc.'s shareholders would be about 3.3

20 percentage points lower than the after-tax returns that would be earned by

21 shareholders if an S corporation, LLC, or Partnership owned Sharyland (i.e., the

22 return to InfraREIT, Inc.'s shareholders would be approximately '35 percent

23 lower). If InfraREIT, Inc. did not receive an allowance for federal income taxes,

24 the after-tax return to InfraREIT, Inc.'s shareholders would be about 2.6

25 percentage points less than the after-tax return to a C corporation that owned

26 Sharyland (i.e., the return for InfraREIT, Inc.'s shareholders would be

27 approximately 30 percent lower).

28 Q. DOES THIS CONCLUDE YOUR DIRECT TESTIMONY?

29 A. Yes, it does.



,,1277

4 My Commission expires:

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!'"A"16-4r1.041hailittazzellii6Uk, OFFICIAL SEAL

Notary Public - State of lßtriošs Mv rornnission Eaares

iemqe.erqrNr.iep

AFFIDAVIT OF MERLE ERICKSON

THE STATE OF Illinois

COUNTY OF

This day, Merle Erickson, the affiant, appeared in person before me, a notary public, who

knows the affiant to be the person whose signature appears below. The affiant stated under oath:

My name is Merle Erickson. I am of legal age and a resident of the State of Illinois. The

foregoing testimony and exhibits offered by me are true and correct, and the opinions stated

therein are, to the best of my knowledge and belief, accurate, true and correct.

/11411, r.41z54.9 Merle Erickson

SUBSCRIBED AND SWORN TO BEFORE ME, notary palic, on this the day of

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1284


§ § § § § § § § §



OF


DIRECT TESTIMONY

OF

SCOTT A. BRISTER ,

ON BEHALF OF

SHARYLAND UtILITIES, L.P.

AND


December 30, 2016

1285

SOAH DOCKET NO. 473:16-4051 PUC DOCKET NO. 45414



OF



I. INTRODUCTION 1

II. PURPOSE AND FACTUAL BASES OF TESTIMONY 2

III. OpINION REGARDING SHARYCAND'S FEDERAL INCOME TAX ALLOWANCE 4

IV. DISCUSSION OF FACTORS SUPPORTING MY OPINION REGARDING SHARYLAND'S FEDERAL INCOME TAX ALLOWANCE 4

A. The Applicability of income Tax Allowances to Pass-Through Entities 4

B. Analysis Concerning the Amount of Tax Allowances for Pass-Through Entities 7

C. The 2013 Amendments to PURA §' 36.060(a) 10

D. Consistency and Uniformity in the Application of Agency Rules 12

V. CONCLUSION 13

Direct Testimony SOAH Docket No. 473-16-4051 of Scott A. Brister

PUC Docket No. 45414 1286

1

DIRECT TESTIMONY

2

OF SCOTT A. BRISTER

3 I. INTRODUCTION


5 A. My name is Scott A. Brister. My business address is 111 Congress Avenue, Suite

6 1700, Austin, Texas 78701.


8 A. I am a partner at the law firm of Andrews Kurth LLP.



11 A. I obtained a Bachelor of Arts Degree in History from Mike University in 1977

12 and a law degree from Harvard Law School in 1980. After law school, I clerked

13 for Chief Justice Joe Greenhill of the Texas Supitme Court for one year, then

14 worked as a litigation attorney for Andrews Kurth LLP in Houston, Texas.

15 From 1989 to 2009, I served as a judge at all levels of the Teicas Wurt

16 system: six years on the Texas Supreme Court, three years as Justice and Chief

17 Justice of the First and Fourteenth Courts of Appeals respectively, and 11 year§ as

18 Judge on the 234th Digtrict Court. During those years, I presided over 670 trials to

19 verdict and authored more than 600 appellate opinions, including 122 opinionš of

20 the Texas Supreme Court.

21 I am board-certified in civil appellate, civil trial, and personal injury trial

22 law. I previously served on the Supreme Court Advisory Committee and on the

23 Supreme Court Jury Task Force. I was a co-author of Texas Pretrial Practice and

24 have written law review articles in the Baylor, Oak Brook, South Texas, and St.

25 Mary's law reviews.

26 Q. HAVE. YOU PREVIOUSLY TESTIFIED BEFORE THIS COMMISSION?

27 A. No, I have not.

Direct Testimony of

PUC Docket No.,45414 Scott A. Brister

SOAH Docket No. 473716-4051 1287

1 II. PURPOSE AND FACTUAL BASES OF TESTIMONY

2 Q. WHAT IS THE PURPOSE OF YOUR TESTIMONY?

3 A. I have been asked to state my opinions regarding the availability and amount of

4 the federal income tax allowance (ITA-) the Applicants may be entitled to in this

5 rate proceeding before the Public Utility Commission of Texas (`Commission").

6 Reaching those opinions required me to apply state law and regulations to the

7 facts of the Applicants business. I have listed below my analysis regarding the

8 laws and facts so the validity of my opinions can be evaluated.

9 Q. WHAT IS YOUR UNDERSTANDING OF THE APPLICANTS'

10 OWNERSHIP STRUCTURE?

11 A. Based on information provided to me, I understand Sharyland Utilities, L.P.

12 ("Sharyland") is an operating company that provides regulated electric

13 transmission and distribution services using assets leased from Sharyland

14 Distribution & Transmission Services, L.L.C. (SDTS").

15 I understand Sharyland is organized as a limited partnership, with Shary

16 Holdings, L.L.C. serving as its general partner with an ownership interest of one

17 percent, and SU Investment Partners, L.P. serving as a limited partner with an

18 ownership interest of 99 percent.

19 I also understand SDTS is a limited liability company that owns

20 transmission and distribution assets that are considered "real estate" under federal

21 tax law. Sharyland is the managing member of SDTS, but all of the economic

22 interest in SDTS is owned by Transmission and Distribution Company, L.L.C.,

23 which in turn is wholly owned by InfraREIT Partners, LP. Approximately 72

24 percent of InfraREIT Partners, LP is owned by InfraREIT, Inc. (a corporation

25 publicly traded on the New York Stock Exchange), and the remaining ownership

26 interest of approximately 28 percent is beneficially owned by entities taxed as C

27 corporations and by individuals.

Direct Testimony of Scott A. Brister

2 PUC Docket No. 45414

SOAH Docket No. 473-16-4051 1288

1 Q. DO YOU UNDERSTAND INFRAREIT, INC. TO BE A "PASS-

2 THROUGW ENTITY?

3 A. Yes. I have reviewed the testimony of Professor Erickson and understand that

4 InfraREIT, Inc. is organized as a Real Estate Investment Trust ("REIT") and

5 therefore is ftinctionally and economically a pass-through entity.

6 Q. ARE FEDERAL INCOME TAXES IMPOSED ON SHARYLAND AND

7 SDTS?

8 A. It is my understanding that neither Sharyland nor SDTŠ pay federal income taxes,

9 as both are organized as pass-through entities.1 But as with other pass-through

10 entities, the ultimate owners of each entity pay applicable taxes on amounts

11 distributed by Sharyland and SDTS. More specifically; it is my understanding

12 that: (1) Sharyland's ultimate owners pay taxes on Sharyland's income at varying

13 rates depending, on the taxpayers involved; (2) SDTS's indirect minority

14 beneficial owners include individuals and affiliates of Hunt Consolidated, Inc.,

15 which pay taxes' on SDTS's income at applicable indiidual tax rates or as

16 C corporations under the Internal Revenue Code; and (3) distributions made by

17 SDTS's indirect majority owner, InfraREIT, Inc., are taxed as ordinary income to

18 its owners.

• 19 Q. WHAT IS YOUR UNDERSTANDING OF SHARYLAND'S CURRENT

20 RATES WITH RESPECT TO AN INCOME TAX ALLOWANCE?

21 A. It is my understanding that Sharyland's current rates, established by a previous

22 rate proceeding settled in 2013, include an ITA. I also understand that Sharyland

23 has been collecting Commission-approved rates including an ITA since its rates

24 were first approved by the Commission in 2000.

1 I understand from Dr. Merle Erickson's testimony that a pass through entity for tax purposes includes such entities as disregarded entities.


PUC Docket No: 45414 Scott A. Brister SOAH Docket No. 473-16-4051

1289

1

III. OPINION REGARDING SHARYLAND'S FEDERAL

2

INCOME TAX ALLOWANCE

3 Q. PLEASE SUMMARIZE YOUR OPINION ON WHETHER

4 SHARYLAND'S AND SDTS'S RATES SHOULD INCLUDE A FEDERAL

5 INCOME TAX ALLOWANCE.

6 A. In my opinion, the facts of Sharyland's and SDTS's ownership structures require

7 an ITA component in their rates equal to that customarily granted to other

8 investor-owned electric utilities regardless of their organizational structure. In my

9 opinion, denial or reduction of the standard ITA to Sharyland or SDTS would

10 result in rates that are not just and reasonable and would be arbitrary. Further,

11 denial or reduction of the standard ITA to Sharyland or SDTS would. create

12 difficulty in attracting necessary capital to maintain their capital investment plan

13 in Texas. The analysis and reasons supporting these opinions are stated below.

, 14 Iv. DISCUSSION OF FACTORS SUPPORTING MY OPINION REGARDING . 15 SHARYLAND'S FEDERAL INCOME TAX ALLOWANCE

t

16 A. The Applicability of Income Tax Allowances to Pass-Through Entities

17 Q. PLEASE EXPLAIN THE BASIS OF YOUR OPINION THAT DENIAL OF

18 THE STANDARD INCOME TAX ALLOWANCE WOULD RESULT IN A

19 RATE THAT IS NOT JUST AND REASONABLE.

20 A. My opinion is based on the fact that federal income taxes must be paid on

21 revenues distributed by pass-through entities like Sharyland and SDTS, so a just

22 and reasonable rate must include an ITA. The fact that SDTS is partially and

23 indirectly owned by a REIT (InfraREIT, Inc.) does not change my opinion,

24 because, as Professor Erickson explained in his testimony, a REIT is a pass-

25 through entity. State law requires that utility rates be 'sufficient to cover

26 reasonable and necessary expenses plus a reasonable return on invested capital.

27 Tex. Util. Code ("PURA") § 36.051. Since non-investor owned, tax-exempt

28 utilities do not pay federal income taxes, an ITA would not represent a necessary

29 expense for them. But for all other utilities and owners, such as Sharyland,



SOAH Docket No. 473-16-4051 1290

1 SDTS, and other investor-owned pass-through entities thaf do pay income taxes,

• 2 investors will look for a reasonable return on capital net of thos'e taxes.2 Thus, my

3 opinions are based on the conclusion that reasonable rates for a utility structured

4 as a pass-through ,entity must include an ITA as a reasonable and neces-sary

. 5 expense.3 Failing to provide an income tax allowance for Sharyland or SDTS

6 because of their ownership structures would :treat them as the equivalent of-tax-

7 exempt utilifies.' Singling out Sharyland or SDTS as the sole investor-Owned

8 utilities to be accorded treatment substantially similar to a tax-exempt utility

9 would be, in my Opinion; arbitrary and contrary to Texas law.

10 Q. DOES , YOUR UNDERSTANDING APPLY :TO ALL UTILITIE

11 STRUCTURED AS PASS-THROUGH ENTITIES?.

12 A. Yes. The Texas Supreme Court held in 1983 that, although a utility was

13 structured as a Subchapter S corporation that paid rio taxes directly, it was

14 nevertheless entitled to an ITA in its rates because those taxes were passed

15 through to, but still payable by, its shareholders.4 As the Court mentioned, the

16 "fundamental inquiry is not,limited to technical distinctions, but is determined by

17 practical economic facts."5 Thus, so long as a utility's upstream owners are

18 subjéct to federal income taxes, this same rule applies regardless pf the parficular

19 type of pas-through entity or the number of upstream owners.6

20 Q. ARE YOU AWARE THAT THE COMMISSION HAS PERMITTED

21 OTHER PASS-THROUGH ENTITIES TO RECOVER AN INCOME .TAX • 22 ALLOWANCE?

23 A. Yes. I am aware that the Commission has approved ITAs for other pass-through

24 utilities by applying the standalone method and the standalone corporate tax rate.

2 See, e.g., Galveston Elec. Co. v. City of Galveston, 258 U.S. 388, 399 (1922).

3 See Pub. Util. 'Comm 'n v. GTE7Sw. Inc., 901 S.W.2d 401, 409 (Tex. 1995) ("One of the 'reasonable and necessary operating expenses which a utility incurs is federal income tax.").

4 See Suburban Util. Corp. v. Pub. Utility Comm 'n of Tex., 652 S.W.2d 358, 364 (Tex. 1983).

5 Suburban Util. Corp. v. Pub. Util. Comm 'n of Tex., 652 S.W.2d 358, 363 (Tex. 1983) (quoting Moyston v. NM Pub. Serv. Comm 'n, 412 P.2d 849, 850 (N.M. 1966)).

6 See State of Tex. 's Agencies and Inst. of Higher Learning v. Pub. Util. Comm 'n of Tex., 450 S.W.3d 615, 649 n.24 (Tex. ApP. —Austin 2014, pet. filed).

Direct Testimony of • PUC Docket No. 45414 5 Scott A. Brister SOAH Docket No. 473-16-4051

1291

1 Q. PLEASE DISCUSS THE COMMISSION'S INCOME TAX ALLOWANCE

2 TREATMENT FOR PASS-THROUGH UTILITIES.

3 A. In 2001, the Commission approved an ITA for Sharyland based on the standalone

4 method.7

5 In 2007, the Commission set rates for Electric Transmission Texas, LLC

6 using the standalone method and applying the standalone corporate tax rate.8

7 In 2008, the Commission set Oncor Electric Delivery CMnpany, LLC's

8 (Oncor") rates based on the standalone "method.9 The Commission requested

9 additional briefing on the application of Suburban to Oncor, a bass-through entity, ;

10 and ultimately found that Suburban required an ITA.1° The Third Court of

11 Appeals, applying Suburban, upheld the Commission's decision:•

12 Within this same issue, The Alliance and Steering Committee

13 complain that because Oncor is taxed as a partnership and pays no

14 taxes itself, no income-tax expense at all shOuld have been

15 included in its cost of service. The supreme court has rejected this

16 argument. See Suburban Util. Corp. v. Public Util. Comm'n, 652

17 rS .W.2d 358, 364 (Tex. 1983) (even though sub chapter-S

18 corporation pays no taxes itself, taxes its shareholders pay are

19 "inescapable business outlays" that are recove-rable in rates).11

20 In 2013, the Commission approVed an ITA for Cross Texas Transmission,

21 LLC based on the standalone method and applying the standalone corporate tax

22 rate.12

Application of Sharyland Utilities, L.P. for Approval of Unbundled Cost of Service Rate Pursuant to PURA § 39.201 and Public Utility Commission Substantive Rule § 25.344, Docket No. 22348, Order at 90 (Finding of Fact No. 27) (Oct. 4, 2001).

8 Application of Electric Transmission Texas, LLC for a Certificate of Convenience and Necessity, for Regulatory Approvals, and Initial Rates, Docket No. 33734, Order on Rehearing at 17 (Finding of Fact Nos. 64-65) and Schedule V (Dec. 21, 2007).

9 Application of Oncor Electric Delivery Company, LLC for Authority to Change Rates, Docket No. 35717, Order on Rehearing at 25 (Finding of Fact No. 1.28E) (Nov. 30, 2009).

10 Id. at 6-8.

11 State of Tex.'s Agencies and Inst. of Higher Learning v. Pub. Util. Comm 'n of Tex., 450 S.W.3d 615, 649 n.24 (Tex. App.—Austin 2014, pet. filed). -1

12 Application of Cross Texas Transmission, LLC to Establišh Initial Rates and Tariffs, Docket No. 40604, Order at 5 (Finding of Fact No. 26) & 8 (Conclusion of Law No. 7) (Jan. 16, 2013).



SOAH Docket No. 473-16-4051 1292

1 In 2013, the Commission approved an ITA for Lone Star Transmission,

2 LLC based on the standalone method and applying the standalone corporate tax

3 rate.13

4 In 2015, the Commission,approved an ITA for Wind Energy Transmission

5 Texas, LLC based on the standalone method at the standalone corporate tax rate.14

6 Q. BASED ON YOUR ANALYSIS, WHAT IS YOUR OPINION ON

7 WHETHER SHARYLAND'S AND SDTS'S RATES MUST INCLUDE AN

8 INCOME TAX ALLOWANCE?

9 A. Applying current rules and regulations to the facts at hand, and in light of prior

10 Commission decisions, it is my opinion that Sharyland's and SDTS's rates must

11 include, an ITA. Sharyland and SDTS, like other limited partnerships and limited

12 liability companies, are 'treated as pass-through entities for tax purposes.

13 According to Professor Erickson, InfraREIT, Inc. is also functionally a pass-

14 through entity. As such, InfraREIT, Inc.—the'same as other pass-through entities

15 like LLCs or limited partnerships—passes through all or almost all of the income

16 it receives, as well the obligation to pay taxes associated with that income.

17 InfraREIT, Inc.'s upstream investors ultimately -must pay those taxes and take

18 them into account in determining whether their investment is providing a

19 reasonable i•ate of return.

B. Analysis Concerning the Amount of Tax Allowances for Pass-

21 Through Entities

22 Q. DO YOU HAVE AN OPINION REGARDING WHEiHER THE INCOME

23 TAX- ALLOWANCE FOR TAXABLE AND PASS-THROUGH ENTITIES

24 • SHOULD BE UNIFORM?

25 A. Yes. For the reasons stated below, the ITA included in a utility's reasonable rates

26 must be uniform, regardless of whether the utility is a taxable or pass-through

13 Application of Lone Star Transmission, LLC, for Authority to Est. Interim and Final Rates and Tariffs, Docket No. 40020, Order on Rehearing at 19 (Finding of Fact No. 125) & Schedule V at A5 (Feb. 12, 2013).

14 Application of Wind Energy Transmission, Texas LLC for Authority to Change Rates and Tarijfs, Docket No. 44746, Order at 4 (Finding of Fact No. 22) & 6 (Conclusion of Law No. 11) (Sept. 25, 2015).

Direct Testimony of Scbtt A. Brister


SOAH Docket No. 473-16-4051 1293

1 entity, and regardless of the individual tax situations of a utility's upstream

2 owners.

3 Q. DOES YOUR ANALYSIS CONSIDER THE ACTUAL TAXES PAID BY

4 UPSTREAM OWNERS?

5 A. No. Setting a just and reasonable rate is always based on projections and

6 estimates, and the ITA component of it is a hypothetical figure that differs from

7 actual taxes paid.15 Accordingly, it is clear that actual taxes do not determine a

8 utility's ITA.16 Thus, my conclusion is that an ITA analysis must be uniform

9 across utility entities and not based on considerations of actual taxes paid.

10 Q. PLEASE EXPLAIN YOUR OPINION ABOUT THE COMMISSION'S

1 1 DISCRETION TO ADJUST AN INCOME TAX ALLOWANCE FOR THE

12 TAX BENEFITS OF PASS-THROUGH ENTITIES.

13 A. I do not believe the Commission has discretion to reduce or eliminate an ITA to

14 reflect assumed tax benefits associated with a particular pass-through entity in an

15 individual rate proceeding. In my opinion, any other rule would require the

16 Commission to exceed its regulatory authority in the following respects.

17 Separation ofpowers. First, any different rule would raise separation-of-

18 powers problems. Tax policy is for the legislative branches of government, not

19 state administrative agencies.17 For political and policy reasons, Congress has

20 granted tax exemptions for many entities (e.g., colleges, churches, pension funds,

21 and political parties) and tax deductions for inky expenses (e.g., charitable gifts,

22 local-government bonds, and liome mortgages). Among those exemptions are

23 pass-through treatment for some kinds of entities formed under state law but not

24 others. The legislative policies underlying these exemptions would be frustrated

15 See GTE—Sw. Inc., 901 S.W.2d at 411.

16 See id.; Pub. Util. Comm 'n v. Tex. Util. Elec. Co., 935 S.W.2d 109, 110 (Tex. 1997); Gulf States Util. Co. v. Pub. Util. Comm 'n, 947 S.W.2d 887, 892 (Tex. 1997); State of Tex. 's Agencies and Inst. of Higher Learning, 450 S.W.3d at 649 n.24.

17 See TracFone Wireless, Inc. v. Comm 'n on State Emergency Commc'ns, 397 S.W.3d 173, 176 (Tex. 2013) ("Tax policy gap-filling—specifically, deciding who is taxed—is best left to legislators-, not courts or agencies.").


PUC Docket No. 45414 Scott A. Brister SOAH Docket No. 473-16-4051

1294 '

1 if the Commission is able to counteract them by lowering utility rates to reduce or

2 cancel them whenever such entities invest in a utility.

3 State law. Second, the Texas Legislature amended the Texas Utilities

4 Code in 2013 to prohibit the Commission from using tax benefits to decrease a '

5 utility's rates unless they directly relate to expenses ihcluded in those rates.18 The

6 expenses in forming and maintaining the REIT structure are borne solely by

7 SDTS's owners and 'investors, not ratepayers. I understand that when Sharyland

8 sought to restructure its business as a REIT, it agreed as ,part of a Restructuring

9 Order19 that costs of restructuring or issuing stock would not increase its rates

10 absent a demonstrable net benefit to ,ratepayers. If the Commission were to

11 reduce Sharyland's , and SDTS's rates based on tax benefits from the REIT

12 restructuring even though the related restructuring and maintenance costs have not

13 been funded by ratepayers, the statutory policy coupling tax benefits with the

14 related costs in utility rates would be frustrated.

15 Q. DO YOU HAVE AN OPINION CONCERNING WHETHER THE

16 COMMISSION HAS DISCRETION TO ADJUST AN INCOME TAX

17 ALLOWANCE FOR THE TAX SITUATIONS OF UPSTREAM OWNERS?

18 A. Yeš. I do nót see how the Commission can adjust a standard ITA analysis to

19 reflect the individual tax situations of upstream owners of a utility. In my

26 opinion, doing so would incur the following intractable problems that would

21 exceed the Commission's statutory authority.

22 Discovery from upstream owners. The Commission has statutory

23 authority to demand financial disclosure from regulated entities, but demanding

24 financial disclosure from private owners of those entities is another matter.2°

25 Texas Legislators and courts have, generally disfavored allowing uncontrolled

18 See PURA § 36.060(a).

19 Application of Sharyland Utilities, L.P. and Sharyland Distribution & Transmission Services, L.L.C. for Regulatory Approvals Pursuant to PURA §,¢ 14.101, 39.262, and 39.915, Docket No. 35287, Order (Jul. 21, 2008).

29 See, e.g., Liberty Mut. Ins. Co. v. Adcock, 412 S.W.3d 492, 494 (Tex. 2013) ("[A]n agency has no authority to 'exercise what is effectively a new power, or a power contradictory to the statute, on the theory such as the power is expedient for administrative purposes.).



SOAH Docket No. 473-16-4051 1295

1 discovery and disclosure of federal income tax returns.21 Absent statutory

2 authority for the Commission to require such disclosure, I do not believe financial

3 data from all upstream investors will be available to the extent needed to calculate

4 an ITA based thereon.22

5 Misallocation of taxes and distributions. Even if tax data from all

6 upstream investors could be obtained, the share of revenues distributed to each

7 investor likely cannot be matched to it. What a utility distributes each year to

8 each investor is determined by its governing charters and board; uhless that

9 amount exactly matches the federal taxes each will pay, the dollars paid by

10 ratepayers to reimburse income taxes will not actually go to those who pay them.

11 As a simplified example, if a utility has two 50-percent owners, one in a 40-

12 percent tax bracket and one whose income never exceeds its deductions, setting

13 an ITA at 20 percent drid distributing the resulting revenues on a 50-50 basis to its

14 owners would allocate half of the ITA to the owner who pays no taxes and half to

15 the owner who pays them all. It would be virtually impossible for the

16 Commission to match ITAs to the tax circumstances of each utility's ultimate

17 owners.

18 Q. WHAT IS YOUR OPINION ABOUT THE AMOUNT OF INCOME TAX

19 ALLOWANCE A REASONABLE RATE MUST INCLUDE?

20 A. Applying this analysis to the facts at hand, it is my opinion that Sharyland's and

21 SDTS's rates must include an rtA that is uniform with the ITA that would apply

22 if they were standalone C corporations.

23 C. The 2013 Amendments to PURA 4 36.060(a)

24 Q. DID THE 2013 AMENDMENT OF PURA § 36.060(a) CHANGE THE WAY

25

INCOME TAX ALLOWANCES ARE CALCULATED?

26 A. Yes. The Legislature 'amended PURA § 36.060(a) in 2013 to delete the

27 reqUirement that an ITA be adjusted to reflect a "fair share" of savings that would

21 See, e.g., Tex. Tax Code § 22.27; Hall v. Lawlis, 907 S.W.2d 493, 494-95 (Tex. 1995).

22 See City of Houston v. Rhule, 417 S.W.3d 440, 442 (Tex. 2013) ("Administrative agencies may exercise only powers conferred upon them by 'clear and express statutory language.).



SOAH Docket No. 473-16-4051 1296

1

have been realized had a hypothetical consolidated income tax return been filed

2

by a utility eligible to do so. In its place, the Legislature mandated that an ITA

3

should be calculated as if the utility were a standalone entitY, limiting tax benefits

4

that reduce an ITA to those arising from expenses or investments included in a

5

utility's rates or rate base.

6 Q. DID THE LEGISLATURE INTEND FOR PURA § 36.060 TO BE APPLIED

7 TO ALL UTILITIES?

8 A. Yes. When'the Legislature passed SB 1364 in 2013, Sharyland and SDTS .were

9, operating within a REIT structure. Neither the Legislative history nor the text of

10 the amendrnent indicates that Sharyland, SDTS, or any other pass-thfough,utility

11 should be treated differently from other utilities in Texas.

12 Q. IS THAT AMENDMEN't CONSISTENT WITH' YOUR OPINION THAT

13 SHARYLAND'S AND SDTS'S RATES MUST INCLUDE AN INCOME

14 TAX ALLOWANCE?

15 A. Yes. According to the legislative history, supporters of the amendment to Section

16 36.060(a) wanted to "make Texas utilities more attractive to investors by ensuring

17 that a utility could retain the anticipated tax benefits," and argued that "[e]lectric

18 utifities should not be penalized for using common and legal tax and accounting

19 principles."23 Investors who consider making an investment in a Texas utility

20 necessarily take all federal income taxes into account, even if the utility itself is a

21 pass-through entity for income tax purposes. My opinion that Sharyland's and

22- SDTS's rates must include ah ITA even though they de pass-through entities is

23 thus consistent with the intent of the 2013 amendment.

24 Q. IS THAT AMENDMENT CONSISTENT WITH YOUR OPINION THAT

25 INCOME TAX ALLOWANCES SHOULD BE UNIFORM ACROSS

26 DIFFERENT ENTITIES?

27 A. Yes. According to the legislative history, disputes about tailoring an JTA for each

28 utility's rates have long been "one of the most contentious and co' mplex issues

23 House Research Organization, Bill Analysis at 4, Tex. S.B. 1364, 83rd ,Leg., R.S. (2013), available at http://www.hro.house.state.tx.us/pdf/ba83r/sb1364.pdftMavpaues=0.



1297

1 from rate cases."24 Supporters of the 2013 amendment pointed out that

2 "[d]ebating those issue§ involves attorneys, accountants, and experts witnesses,"

3 and that "the cost of fighting over this arcane issue is passed back Ao

4 ratepayers."25 My opinion that the rate used for an ITA should be standard

5 regardless of the circumstances and actual taxes of each individual investor is thus

6 consistent with the intent of the 2013 amendment to simplify the process of

7 assigning the ITA component of rate proceedings. Like the standard deduction

8 allowed for personal incothe taxes, the Legislature has the,authority to decide as a

9 matter of r:olicy that usifig a standard measure is more reasonable and efficient

10 than incurring the costs of determining an ITA tailored to the circumstances of

11 individual upstredm investors in every rate case.

12 Q. IN YOUR OPINION, SHOULD THE COMMISSION SET AN INCOME

13 TAX ALLOWANCE CONSISTENT WITH PURA § 36.060?

14- A. Yes. PURA is the Commission's governing stitute. In addition, the

15 Commission's regulations, as set forth in the Texas Administrative Code, provide

16 that "fflederal income taxes shall be computed according to the proVisions of the

17 Public Utility Regulatory Act § 36.060. 26

18 D. Consistency and Uniformity in the Application'of Agency Rules

19 Q. DOES THE COMMISSION'S APPROVAL OF SHARYLAND'S

20 REORGANIZATION TO BECOME A REIT SUPPORT YOUR

21 CONCLUSIONS?

22 A. Yes. I understand the Commission approved Sharyland's restructuring in Docket

23 No. 35287, which anticipated Sharylan'd forming a REIT.27 In that order,

24 Sharyland comthitted that its wholesale and retail rates for Sharyland would, be

25 determined using the same methodology that would have been utilized if the

26 restructuring had never occurred. Reorganizing a utility is obviously a

24 Id.

25 Id.

26 16 Tex. Admin. Code § 25.231(b)(1)(D).

27 Docket No. 35287, Order.



1298

1

cumbersome and expensive proceSs. Sharyland and SDTS reasonably relied on

2

that previous proceeding in conducting their affairs and the Commission's past

3

practices in filing this proceeding. That reliance should not be frustrated absent

4

some indication of disapproval from the Legislature.28 As the 2013 améndment

5

indicates no such disapproval, but rather indicates concern about rate-setting rules

6

that are neither predictable nor transparent, the amendment is consistent with the

7

assumptions and conclusions I have made.

8

V. CONCLUSION

9 Q. DOES THIS CONCLUDE YO'UR DIRECT TESTIMONY?

10 A. Yes.

28 See Sexton v. Mount Olivet Cemetery Ass'n, 720 S.W.2d 129-, 141 (Tex. App.—Austin 1986, writ ref'd n.r.e.).



SOAH Docket No. 473-16-4051 1299

AFFIDAVIT OF SCOTT A. BRISTER

THE STATE OF TEXAS

COUNTY OF TRAVIS

This day, Scott A. Brister, the affiant, appeared in person before me, a notary public, who

knows the affiant to be the person whose signature appears below. The affiant stated under oath:

My name is Scott A. Brister. I am of legal age and a residerit of the State of Texas. The

foregoing testimony offered by me is true and correct, and the opinions stated therein are, to the

best of my knowledge and belief, accurate, true and correct.

ScottA. Brister

SUBSCRIBED AND SWORN TO BEFORE ME, notary public, on this the e-ol'kday of

December 2016.

Notary Public, State of Texas

My Commission expires:

l0 Z. 01 b JACGUEUNE R RILEY ROTARY ID #124115MMI My Commission Sykes

March 10, 2020

38519456.2

1300

SOAH DOCKET N . 473-16-4051 PUC DOCKET O. 45414



OF


§ § § § § § § § §

DIRECT TES IMONY

AND EXHI ITS

OF

JAMES W. D NIEL

ON BEHA OF

SHARYLAND UTI ITIES, L.P.

AND

SHARYLAND DISTRIBÜTION & TRANSMISSION SERVICES, L.L.C.

I

December 30, 2016

1301


REVWW OF THE RATES OF SHARYLAND UTILITIES, L.P., ESTABLISHMENT OF RATES FOR SHARYLAND DISTRIBUTION & TRANSMISSION SERVICES, L.L.C., AND REQUEST FOR GRANT OF A CERTIFICATE OF CONVENIENCE AND NECESSITY AND TRANSFER OF CERTIFICATE RIGHTS


OF



I. INTRODUCTION 1

II. PURPOSE OF DIRECT TESTIMONY 3

III. UNBUNDLED CLASS COST OF SERVICE STUDY 6

A: FUNCTIONALIZATION AND CLASSIFICATION 7

B. DETERMINATION OF CUSTOMER CLASSES 8

C. ALLOCATION FACTORS 9

D. COMPARISON OF CUSTOMER CLASS RESULTS 12

IV. RETAIL CLASS RATE DESIGN 13

A. RESIDENTIAL CLASS 14

B. SECONDARY LESS THAN OR EQUAL TO 10 KW C4ASS 16

C. SECONDARY GREATER THAN 10 KW CLASS 17

D. PRIMARY CLASS 20

E. RETAIL TRANSMISSION SERVICE CLASS 21

F. LIGHTING CLASS 21

G. OTHER RATE DESIGN ISSUES 22

V. SHARYLAND'S WHOLESALE TRANSMISSION COST OF SERVICE 22

VI. TRANSMISSION COST RECOVERY AND RIDER TCRF 24

Direct Testimony and Exhibits of SOAH Docket No. 473-16-4051 James W. Daniel PUC Docket No. 45414

1302

VII. SHARYLAND'S TARIFF FOR RETAIL DELIVERY SERVICE 25

VIII. SHARYLAND'S TARIFF FOR WHOLESALE TRANSMISSION SERVICE 30

IX. SDTS'S TARIFF FOR LEASING TRANSMISSION AND DISTRIBUTION

FACILITIES 34

X. CONCLUSION 35

EXHIBITS

JWD-1 JWD-2 JWD-3 JWD-4 JWD-5 JWD-6

Prior Testimony of James W. Daniel . List of Sponsored/Co-Sponsored Schedules of James W: Daniel Rate Comparisons for All Customer Classes Sharyland Tariff for Retail Delivery Service Sharyland Tariff for Wholesale Transmissidn Service SDTS Tariff for Eeasing Transmission and Distribution Facilities

Direct Testimony and Ekhibits of ii SOAH Docket No. 473-16-4051

James W. Daniel PUC Docket No. 45414

1303

DIRECT TESTIMONY AND EXHIBITS OF JAMES W. DANIEL

1 I. INTRODUCTION


3 A. My name is James W. Daniel. My business address is 919 Congress Avenue,

Suite 800, Austin, Texas 78701.

5 Q., PLEASE OUTLINE YOUR FORMAL EDUCATION.

6' A. I received the degree of Bachelor of Science from the Georgia Institute of

7 Technology in 1973 with a major in economics.

8 Q. WHAT IS YOUR PRESENT,POSITION?

9 A. I am a Vice President of the firm GDS Associates, Inc. ("GDS") and Manager of

• 10 GDS's office in Austin, Texas.

11 Q. PLEASE STATE YOUR PROFESSIONAL EXPERIENCE.

12 A. From July 1974 through September 1979 and from August 198Š through February

13 1986, I was employed by Southerntngineering Company. During that time, I

14 participated in the preparation of economic analyses regarding afternative power

15 supply sources and generation and transmission feasibilitY studies for rural

16 electric cooperatives. I participated in wholesale, and retail rate contract

17 negotiations with investor-owned and publicly-owned utilities, prepared cost of

18 service studies on investor-owned and publicly-owned utilifies, and prepared and

19 submitted testimony and exhibits in utility rate and other regulatory proceedings

20 on behalf of publicly-owned utilities, industrial customers, associations, and

21 government agencies. From October 1979 through July 1983, I was employed as

22 a. Public Utility Consultant by R.W. Beck and Associates. During that time, I

23 participated in rate studies for publicly-owned electric, gas, water, and wastewater

24 utilities. My primary responsibility was the development of, revenue

25 requirements, cost of service, and rate design studies as well as the preparation

26 and submittal of testimony and exhibits in utility rate proceedings on behalf of

27 publicly-owned utilities,industrial customers,.and other Customer groups. Since

Direct Testimony and Exhibits of SOAH Docket No. 473-16-4051 1


1304

1 February 1986, I have held the position of Manager of GDS's office' in Austin,

2 Texas. In April 2000, I Was elected as a Vice President of GDS. While at GDS, I

3 have provided testimony in numerous regulatory proceedings inVolving electric,

4 natural gas, and water utilities, and I have participated in generic rulemaking

5 proceedings. I have prepared retail rate studies on behalf of publicly-owned,

6 utilities, and I have prepared utility valuation analyses. I have also prepared

7 economic feasibility studies, and I have procured and contracted for wholesale

8 • and retail energy supplies.

9 Q. WOULD YOU PLEASE DESCRIBE GDS? 1

10 A. GDS is an engineering and consulting firm with offices in Marietta, Georgia;

11 Austin, Texas; Auburn, Alabama; Manchester, New Hampshire; Madison,

12 Wisconsin; and Orlando, Florida. GDS has over 160 emPloyees with

13 backgrounds in engineering, accounting, management, economics, finance, and

14 statistics. GDS provides rate and regulatory consulting services in the electric,

15 natural gas, water, storm, and telephone utility industries. GDS also provides a

16 variety of other services in the electric utility industry including power supply

17 planning, 'generation support services, energy procurement ana contracting,

18 energy efficiency program development, financial analysis, load forecasting; and

19 statistical services. Our clients are primarily privately-owned utilities, publicly-

20 owned utilities, municipalities, customers of investor-owned utilities, groups or

21 associations of customers, and government agencies.

22 Q. HAVE YOU PREVIOUSLY TESTIFIED BEFORE ANY REGULATORY

23 COMMISSIONS?

24 A. I have testified many times before regulatory commissions. A complete list of

25 regulatory proceedings in wnich I have presented expert testimony is provided as

Exhibit JWD-1.

27 Q. ON WHOSE BEHALF ARE YOU TESTIFYING IN THIS PROCEEDING?

28 A. I am testifying on behalf of the Applicants, Sharyland Utilities, L.P.

29 ("Sharyland") and Sharyland Distribution & Transmission Services, L.L.C.

30 ("SDTS"). Direct Testimony and Exhibits of



1305

1 Q. PLEASE DESCRIBE SHARYLAND.

2 A. Sharyland is a Texas-based utility that provides electric transmission and

3 distribution ("T&D") services in the Electric Reliability Council of Texas

4 ("ERCOT") electricity market. ,Sharyland has four geographically separated

5 divisions. The Stanton, Brady, and Celeste ('SBC") divisions were acquired in

July 2010 from Cap Rock Energy Corporafion (Cap Rock"). The McAllen

7 division is located in South Texas between the cities of McAllen and Mission. On

8 December 31, 2015, the McAllen division served approximately 3,000 metered

9 accounts.

10 Q. PLEASE DESCRIBE SDTS.

11 A. SDTS owns the T&D assets that Sharyland operates. SDTS is an electric utility

12 that was created during the restructuring of Sharyland, which was approved by the

13 Commission in 2008 in Docket No. 35287.1 Consistent With the final order in

14 Docket No. 35287, Sharyland transferred its ownership interests in its T&D assets

15 to the newly-formed SDTS. SDTS leases the T&D assets back to Sharyland,

16 which operates the assets to serve Sharyland's retail and wholesale customers. In

17 short, SDTS is the asset company whereas Sharyland is the operating company.

18 The Applicants have operated in accordance with the Docket No. 35287 final

19 order over the last eight years.

20 II. PURPOSE OF DIRECT TESTIMONY

21 Q. PLEASE DESCRIBE THE BACKGROUND AND PURPOSE OF THIS

22 AMENDED APPLICATION.

23 A. This case establishes rates for both Sharyland and SDTS. The goal of this

24 proceeding is to (1) set a rate that SDTS charges to Sharyland for leasing T&D

Application of Sharyland Utilities, L.P. and Sharyland Distribution & Transmission Services, L.L.C. for Regulatory Approvals Pursuant to PURA §§ 14.101, 39.262, and 39.915, Docket No. 35287, Order (Jul. 21, 2008).

Direct TestiMony and Exhibits of 3

SOAH Docket No. 473-16-4051 James W. Daniel PUC Docket No. 45414

1306

1 assets, and (2) to set the retail •and wholesale rates• that will be charged to

2 Sharyland's customers.

3 To provide some background, as part of the approved stipulation in

4 Sharyland's last rate case, Docket No. 41474,2 Sharyland was required to file a

5 system-wide rate case prior to July 1,. 2016. In Docket No. 45414,3 the

6 Commission ordered Sharyland to file this system-wide rate case on or befote

7 April 30, 2016, and Sharyland filed an application for a rate change on April 29,

8 2016 ("Original Application"). In the Original Application, Sharyland sought

9 approval of system-wide unbundled retail delivery rates. In addition, Sharyland

10 sought to establish revised wholesale transmission service'rates.

11 The Original Application was filed consistent with the ratemaking model

12 approved in the Docket No. 35287 final order. That order provided that

13 Sharyland's wholesale and rdtail rates would be determined using the

14 methodology that would have been utilized had the restructuring never occurred,

15 the rates being based on the combined books and records of Sharyland and SDTS.

16 However, in the Preliminary Order in this proceeding, the Commission'

17 determined that each Applicant's cost of service must be evaluated separately to

18 ensure that each utility is earning a reasonable return on its invested capital used

19 and useful in providing service over its reasonable and necessary operating

20 expenses. Further, the Commission determined that the lease payments that

21 Sharyland pays to SDTS for operation of the T&D assets must be approved by the

22 Commission as SDTS's rates.

23 Consistent with the Preliminary Order, the Amended Application includes

24 two modified rate filing packages ("RFPs"), one for Sharyland and one for SDTS.

25 The cost of service as set forth in SDTS's RFP will be used to set the rates (i.e.,

26 lease payments) that SDTS will charge its cinly customer, Sharyland. Sharyland's

2 Application of Sharyland Utilities, L.P. to Establish Retail Delivery Rates, Approve Ta/V for Retail Delivery Service, and Adjust Wholesale Transmission Rate, Docket No. 41474, Order (Jan. 23, 2014).

3 Review of the Rates of Sharyland Utilities, L.P., Docket No. 45414, Order Requiring Rate Fling Package (Dec. 4, 2015).



1307

1 RFP—which has been amended from the Commission's standard version to

2 include two additional columns detailing the separate costs of service for each

3 Applicant—will be used to set the retail and wholesale rates charged to

4 Sharyland's customers.

5 Q. CAN YOU PLEASE SUMMARIZE YOUR TESTIMONY?

6 A. Yes. My primary task was to determine and design the retail and wholesale rates

7 that will be charged to Sharyland's customers, which are based on the summed

8 costs of service of Sharyland and SDTS. I 'have organized my testimony to

9 address the'following topics:

10 • AllocatiOn of the SDTS and Sharyland revenue requirements to the

1 1 customer classes through a class cost of service study;

12 • The design of the proposed retail class delivery rates;

13 • Sharyland's Tariff for Retail Delivery Service, including certain new and

14 existing riders;

15 • Sharyland's proposed wholesale transmission service rates and

16 Sharyland's Tariff for Wholesale Transmission Service, including certain

17 new and existing riders; and

18 • SDTS's Tariff for Leasing Transmission and Distribution Facilities to

19 Sharyland.

20 Q. ARE YOU SPONSORING OR CO-SPONSORING ANY SCHEDULES

21 INCLUDED AS PART OF THE RATE FILING. PACKAGE IN THIS

22 CASE?

23 A. Yes. Exhibit JWD-2 lists the schedules that I sponsor or co-sponsor.

24 Q. WAS THIS TESTIMONY AND THE RELATED EXHIBITS AND 25 SCHEDULES PREPARED BY YOU OR UNDER YOUR DIRECTION?

26 A. Yes. The information contained in these exhibits, schedules, and this testimony

27 was prepared by me or under my direction and is true and correct to the best of

28 my knowledge and belief.



1308

1 III. UNBUNDLED CLASS COST OF SERVICE STUDY

2 Q. WHAT REVENUE REQUIREMENT DID YOU USE TO DETERMINE

3 AND DESIGN THE RATES SHARYLAND WILL CHARGE ITS

4 WHOLESALE AND RETAIL CUSTOMERS?

5 A. As discuss'ed above, Sharyland's rates are based on the summed costs of service

6 of Sharylarid and SDTS. This allows the Applicants total cost of service to be

7 recovered from the wholesale and retail electric customers that are served, similar

8 to any other electric utility in Texas.

9 Q. DID YOU PREPARE AN UNBUNDLED CLASS COST OF SE.RVICE

1 0 STUDY (COSS") FOR THE COMBINED SHARYLAND SVSTEM?

1 1 A. Yes, the unbundled class COSS for the Sharyland system, including SDTS, is

12 presented in SU Schedule The stipulation and order in Sharyland's

13 previous rate case requires Sharyland to file system-wide rates in this case.4 An

14 unbundled COSS provides class-allocated costs for the unbundled functions. For

15 the Sharyland COSS, I have unbundled costs into the following ffinctions:

16 transmission, distribution, metering, and customer service. The results of the

17 COSS provide the basis for system-wide retail rates.

18 Q. PLEASE BRIEFLY DESCRIBE THE PURPOSE OF A COSS?

19 A. The primary purpose of a COSS is to determine the portion of the utility's retail

20 cost of service or revenue requirement that should be borne by each customer

21 class absent other, factors that may be• appropriate to consider. Each cost

22 component of ,the utility's total cost of service is ,either directly assigned or

23 allocated to the various customer classes. The results are then considered to

24 determine the level of revenues needed to be recovered from rates for each

25 customer class.

26 The results of the. COSS will also provide important „informafion for

27 designing rates. In addition, an unbundled COSS will allow one to develop rates

28 by function, e.g., by transmission, distribution, or customer service. The' COSS

4 Docket No. 41474, Order at 7, Finding of Fact No. 35(g)(i).



1309

1 will also be used to develop the cost of service for wholesale transmission service

2

at distribution voltage delivery levels. P.

3 Q. WHAT ARE THE BASIC STEPS FOR PREPARING A CLASS COSS?

4 A. A COSS is typically developed . in three distinct steps. First, the*,various

5 components of the utility's overall revenue requirements are assigned to their

6 functional use, e.g., transmission, distribution, metering and billing, and customer

7 service. N'ext, the functionalized costs are classified base& on cost causation

8 factors to the cost categories of fixed or capacity-related, variable or energy-

9 related, ana customer-related. Finally, the classified costs are directly assigned or

10 allocated to customer classes using allocation factors developed for each

11 classified cost category. Various methodologies or approaches exist for

12 conducting each step in the COSS process.

13 A. Functionalization and Classification

14 Q. PLEASE EXPLAIN HOW YOU FUNCTIONALIZEb SHARYLAND'S

15 COSTS INTO THE TRANSMISSION, DISTRIBUTION, METERING,

16 AND CUSTOMER SERVICE FUNCTIONS.

17 A. The Commission has approved an Investor-Owned Utilities ("IOU")

18 Transmission & Distribution Cost of Service Rate Filing Package (IOU-T&D

19 COS-RFP") for use in preparing rate applications. That package includes

20 instructions for utilities to follow in functionalizing certain costs. To the extent

21 possible, the prescribed functionalization follows the FERC uniform system of

22 accounts. Next, any other costs that can be directly assigned have been directly

23 assigned to the appropriate function. FOr functionalizing the remaining costs, I

24 have either used the default functionalization described in Schedule F of the IOU-

25 T&D COS-RFP instructions or I have used a Sharyland-specific functionalization.

26 When I have used a Sharyland-specific functionalization factor, I have

27 demonstrated the appropriateness of that functionalization factor in the

28 workpapers to SU Schedule II-F.,

Direct Testimony and Exhibits of James W. Daniel



1310

1 Q. ONCE THE COSTS WERE FUNCTIONALIZED, HOW DID YOU

2 CLASSIFY THEM INTO ENERGY-RELATED, DEMAND-RELATED, OR

3 CUSTOMER-RELATED COSTS?

4 A. As an unbundled utility no longer providing power upply serVices, Sharyland

5 will have very little cost that is energy-related. All of the transmission function

6 costs are demand-related. These transmission functional costs are ihe basis for

7 Sharyland's transmission cost of service ("TCOS") and will be 'recovered through -

8 the proposed wholesale transmission service access charge. For Sharyland's

9 distribution function costs, some will be classified as demand-related and some

10 will be classified as customer-related. Customer-related distribution costs are

11 generally those costs that are related to or driven by the number of customers

12 'served. Examples of customer-related costs are meters, meter reading expenses,

13 and customer accounting expenses. The remaining distribution costs are fixed

14 and primarily incurred to meet peak demands. These costs are classified as

15 demand-related and would include cost items such as substation transformers,

16 conductors, and poles. All of the meter function and customer service function

17 costs are customer-related.

18 B. Determination of Customer Classes

7- 19 Q. HOW MANY CURRENT CUSTOMER CLASSES DOES SHARYLAND

20 HAVE?

A. Sharyland currently has -six customer classes in the SBC divisions. These are the

22 six standard ciistomer classes prescribed in the IOU-T&D COS-RFP. Îhe

23 McAllen division only has four customer classes. There is only one Secondary

24 Service catomer clas's (instead of the two standard Secondary Service classes)

25 and there is no retail transmission service customer class.

26 Q. HOW WERE CUSTOMERS IN THE MCALLEN DIVISION'S EXISTING

27 SECONDARY SERVICE CLASS REGROUPED INTO THE TWO

28 STANDARD SECONDARY SERVICE CUSTOMER CLASSES?

29 A. A customer migration study was developed to regroup the customers into the two

30 standard customer classes. Each McAllen Secondary Service customer in tlie

31 billing database was reviewed and given a designation that identified which of the Direct Testimony and Exhibits of



1311

1 two standard Secondary Service customer classes that it belongs in. The billing

2 data by customer was then sorted so that all customers were grouped into the

3 appropriate customer class. The results of the McAllen Secondary customer

4 migration study are provided in my workpapers.

5 Q. WERE ANY ADJUSTMENTS MADE TO THE SBC DIVISION

6 CUSTOMER CLASSES?

7 A. Yes. In July 2016, the Oversight & Enforcement Division of the Commission

8 (O&E Staff) initiated an investigation to examine how customers of Sharyland

9 were being - transitioned from the Secondary Less Than or Equal to 10 kW rate

10 schedule (also referred to as "Small Secondary") to the Secondary Greater Than

11 10 kW rate schedule (also referred to as "Large Secondary"). Based on that

12 investigation and discussions with O&E Staff, Sharyland revised how it

13 transitions customers from the Small Secondary to Large Secondary rate

14 schedule, and is providing refunds to customers who were not transitioned

15 consistent with the revised process and moving those customers back to the Small

16 Secondary class. The Test Year billing determinants and class demands have

17 been adjusted to reflect these customer reclassifications. In addition; a known and

18 measurable change has been made to reflect the switch of two primary meter

19 entrance (PME") customers from the Primary Service customer class to the

20 Transmission Service customer class and to reflect load increases of those

21 customers. Both of these adjustments are discussed in greater detail in the direct

22 testimony of Mr. John Hutts.

23 C. Allocation Factors

24 Q. PLEASE DESCRIBE THE ALLOCATION FACTORS YOU USED FOR

25 ALLOCATING THE MAJOR COST COMPONENTS IN THE CLASS

26 COSS.

27 A. For allocating demand-related costs, I have primarily used two allocation factors.

28 For allocating demand-related transmission costs, I have used the ERCOT four

29 coincident peak ("4CP") demand allocation methodology. For allocating

30 demand-related distribution costs, I have used a customer class non-coincident


SOAH Docker No. 473-16-4051 James W. Daniel PUC Docket No. 45414

1312

1 peak (NCP") demand allocation methodology. Customer-related costs were

2, allocated using either an allocation factor based on the number of customers in

3 each customer class or an allocation factor based on the number of customers

4 weighted by the cost of meters used for that customer class.

5 Q. PLEASE EXPLAIN WHY YOU ARE PROPOSING TO USE THE ERCOT

6 4CP DEMAND ALLOCATION METHODOLOGY TO ALLOCATE

7 TRANSMISSION COSTS.

8 A. The transmission costs to be recovered from Sharyland's retail customers are the

9 ERCOT transmission charges from other transmission utilities in ERCOT. These

10 charges are based on Sharyland's total system ERCOT 4CPs. Therefore, it is

11 logical that these transmission costs be allocated to the customer classes based on

12 each class's contribution to Sharyland's total system ERCOT 4CP. The class 4CP

13 allocation factor will be included in the new transmission cost recovery factor

14 (TCRF") Rider.

15 Q. PLEASE 'EXPLAIN WHY YOU USED A CLASS NCP DEMAND

16 ALLOCATION METHODOLOGY TO ALLOCATE DEMAND-RELATED

17 DISTRIBUTION COSTS?

18 A. Sharyland's distribution system must be capable of serving the maximum peak

19 demand of each customer. Since all customers do not peak at the same time or

20 month, the use of a class NCP demand allocation methodology will reflect the

21 diversity between the customer peak demands of the customers in the class. The

22 use of a class NCP demand allocation methodology reflects the cost causation for

23 the investment in Sharyland's distribution system. All customer classes were

24 allocated primary voltage distribution facilities based on the class NCP demand

25 allocation factor. Only those classes receiving service at secondary voltage were

26 allocated secondary voltage distribution facilities.

27 Q. WHAT COSTS WERE ALLOCATED USING THE CUSTOMER-BASED

28 ALLOCATION FACTORS?

29 A. One example, as previously mentioned, is the investment in meters, which was

30 allocated using the weighted-number-of-customers allocation factor. Another



1313

1 example would be customer service expenses, which were allocated to classes

2 based on the number of customers in each class.

3 Q. WERE OTHER ALLOCATION FACTORS USED FOR ALLOCATING

4 LESS SIGNIFICANT COSTS?

5 A. Yes, for example, a revenue allocation factor based on class base rate revenues

6 was used to allocate revenue-related costs such as franchise fees.

7 Q. DID THE COSS MODEL CALCULATE "INTERNAL" ALLOCATION

8 FACTORS FOR ALLOCATING CERTAIN COSTS?

9 A. Yes, for example, an allocation factor calculated by the model based on the net

10 plant allocated to each class was used to allocate several cost items such as

11 depreciation expenses. Another example of an internally-developed allocation

12 factor would be the payroll allocation factor which was used to allocate some

13 administrative and general ("A&G") expenses.

14 Q. DID YOU DIRECTLY ASSIGN ANY COSTS TO RETAIL CUSTOMER

15 CLASSES?

16 A. Yes. Street lighting costs have been directly assigned to the Lighting customer

17 class.

18 Q. HOW DID YOU ALLOCATE COSTS ASSOCIATED WITH LINES

19 OWNED AND OPERATED BY SHARYLAND THAT ARE LOCATED

20 BEHIND THE CUSTOMERS METERS?

21 A. Per the stipulation in Docket No. 41474,5 the cost of these lines'have been treated

22 like all other lines and allocated to customer classes based on the appropriate

23 allocation factors.

5 Id. at 9, Finding of Fact No. 35(1).

Direct Testimony and Exhibits of SOAH Docket No. 473-16-4051 11


1314

Table 1 Retail Class Cost of Service Comparison

Current Base Raie Cost-Based Increase/(Decrease)

Amount Percent

Residential $ 27,661,130 $ 28,782,020 $ 1,120,889 1 4%

Secondary < 10 kW 9,148,917 8,166,150 (982,767Y -11%

Secondary > kW 33,084,385 26,242,360 (6,842,024) -21%

Primary 29,241,435 36,589,244 7,347,809 25%

Transmission 211,306 161,597 (49,709)' -24%

Lighting 403,541 1,204,778 801,237 I 199%

Total $ 99,750,714 $ 101,146,149 1 $ 1,395,435 j 1.40%

1 D. CoMparisoh of Customer Class Results

2 Q. WOULD YOU PLEASE DESCRIBE THE RESULTS OF THE CLASS 3 COSS?

4 A. The overall results are summarized on SU Schedule This schedule also

provides a summary of the unbundled costs fen- each customer class. The class

6 COSS determines the overall cost of service for the customer classes previously

7 identified. It also compares each class's cost of service to the class's unbundled

8 current rate revenues. Table 1 below provides a summary of that comparison:

9 Q. ARE THE RETAIL DELIVERY RATES SET FORTH IN THE 10

APPLICATION SET TO RECOVER THE CLASS COST OF SERVICE?

11 A. Yes. As part of the stipulation in the prior rate case, Docket No. 41474, the

12 parties to that'docket agreed to support rates in this rate case that would be cost

13 based, i.e., the customer class rates would be set at r a level that recovers the

14 classes cost of service.6

15 Q. ARE THERE ANY REVISIONS TO THE 'CLASS COST OF SERVICE 16 STUDY FILED IN THE ORIGINAL APPLICATION ON APRIL 29, 2016?

17 A. Yes, all of the revisions mentioned in the direct testimony of Sharyland's

18 witnesses will impact the costs allocated to the customer classes in the class

6 Id. at 7, Finding of Fact No. 35(g)(ii).

Direct Testimony and Exhibits of James W. Daiiiel

12 SOAH Docket No. 473-16-405 i


1315

1 COSS. In addition, two revisions to the weighted 'meter alldcation factor results

2 'in a significant shift in the allocated class revenue requirements, especially for the

3 residential and primary service customer classes. The first revision is to reduCe

4 the number of residential customers used to develop the meter 'allocation factor

5 per the response to SLCG Request for Information (RFI") No. 2-20. As

6 discussed in that RFI response, the number of residential customers in the

7 McAllen division was inadvertently includeetwice in the calculation of the

8 weighted meter allocation factor. The second revision is to update the current

9 meter costs for some types of meters per the response to TIEC RFI No. 1-14. One

10 of the updated meter costs resulted in a significant reduction in the current cost of

11 a meter type that is used primarily for service to residential•customers.

12 IV. RETAIL CLASS RATE. DESIGN

13 Q. PLEASE DESCRIBE THE RATE STRUCTURES FOR THE

14 COMMISSION'S STANDARD RATE SCHEDULES FOR RETAIL

15 DELIVERY SERVICE.

16 A. The historically-approved rate structutes for the first five classes discussed above

17 incAude the following charges: Monthly Customer Charge, Monthly Metering

18 Charge, Transmission Charge, and Distribution Chatge. The distribution charge

19 for the Residential and Small Secondary Service classes will be a charge per

20 kilowatt-hour ("kWh"): The distribution charge for the Large Secondary,

21 Primary, and Transmission classes will be a charge per kilowatt ("kW"). As I will

22 discuss later in my direct teštimony, the Lighting Service rate schedule includes a

23 distribution charge that is a fixed monthly amount and varies by type and size of

24 street light;3 For the .proposed system-wide rates, Sharyland is proposing to

25 recover all of its retail transmission-related costs through the TCRF factors so

26 there is no separate transmission-related rate.

27 Q. HOW DID YOU DESIGN THE PROPOSED RATES?

28 A. I designed the propbsed rates by using the embedded class COSS as a starting

29 point. Next, I considered the current rate levels and customer bill impacts

30 assuming rates are set equal to unit costs; i.e., are cost-based. In instances where



1316

1 cost-baSed rates caused significantly disparate customer bill- impacts, I adjusted

2 the intraclass rate design to the extent practical to address this concern.

3 Q. HAS THE COMMISSION GENERALLY SUPPORTED CbST-BASED

4 RATES FOR TRANSMISSION AND DISTRIBUTION UTILITIES

5 OPERATING IN THE ERCOT COMPETITIVE MARKET?

6 A. Generally, yes. Cost-based rates in which interclass revenue subsidies are entirely

7 eliminated or substantially reduced so that relative rates of retUrn are one (or "at

8 unity," or "equalized"), or close to one, have been the Commission's stated

9 objective in a number of transmission grid distribution utility ("TDU") rate

10 proceedings. However, the Commission has also supported moderating rate

11 increases to aVoid rate shock.'

12 A. Residential Class

13 Q. PLEASE DESCRIBE HOW YOU DESIGNED THE PROPOSED RATES

14 FOR THE RESIDENTIAL SERViCE RATE SCHEDULE.

15 A. The COSS produces a cost-based revenue requirement for the Residential Serviée

16 class of $28,782,020. I next determined the proposed level of the meter and

17 customer service charges. Based on the results of the COSS, if these charges

18 were set equal to the cost-based amounts, the total- of the monthly fixed _charges

-19 would increase from $10.00 per month (in the SBC divisions) to approximately

20 $13.87 per month. In order to moderate customer bill impacts, and maintain the

21 objective of reducing the average Residential customer charges (other than the

22 TCRF), I recommend that the monthly fixed charge remain at $10.00 per month..

23 The initial propošed Residential distribution system charge was then designed to

24 recover the remaining Residential revenue requirement amount. This would

7 See Application of CenterPoint Electric Delivery Company, LLC for Authority to Change Rates, Docket No. 38339, Order at 33, Finding of Fact No. 175 (May 12, 2011); see also Application of Entergy Gulf States Power, Inc. for Approval of its Transition to Competition Plan and the Tariffs Implementing the Plan and for the Authority to Reconcile Fuel Costs, to Set Revised Fuel Factors, and to Recover a Surcharge for Underrecovered Fuel Costs, Docket No. 16705, Order on Rehearing at 99, Finding of Fact No. 245 (Sept. 4, 1998); Application of AEP Texas Central for Authority to Change Rates, Docket No. 28840, Order at 50 (Aug. 15, 2005); Application of Oncor Electric Delivery Company, LLC for Authority to Change Rates, Docket No. 35717, Order on Rehearing at 29 (Nov. 30, 2009).



1317

Table 2

Re s ide ntial Se rvice Co mparis on - SBC Divis ions

Dis tribution Monthly Monthly Monthly Fixed Charge

Custome r Charge Mete ring Charge Charge (per kWh)

Current Rate $ 5.69 $ $ 10.00 1 $ C-0669 Cost-Based Rate 10.57

4.31i 3.30 $ 13.87 i 0.057418

Proposed Rate ' 5.69 4.31 $ 10.00 ' 0.060317

Residential Rate Impacts (T&D Utility Costs Only)

Monthly Us age (kWh Current Rates Proposed Rates Incre as e / De cre as e

500 41.33j $ 40.16 (1 .18).' -2.85% 1,000 72.67 70.32 (2.35) -3.24% 1,333* 93.54 90.40 (3.14) -3.35% 1,500 104.00 100.47 (3.53); -3.39% 2,000 135.34, 130.63 (4.70) -3.48%

*Average Residential Usage

1

result in a base rate (customer charge, meter charge; and distribution system

2

charge) decrease compared tö current base rates of $3.14, or 3.35%, for an

3

average Residential customer in the SBC division.8

4 Q. PLEASE PROVIDE TABLES COMPARING THE CURRENT, COST- S BASED AND PROPOSED RATES AND RESIDENTIAL BILL IMPACTS.

6 A. Tables 2 and 3 below provide a comparison of the current rates, cost based rates,

7 and proposed rates, and the bill impacts for customers at the identified usage

8 levels. Table 2 is for the SBC divisions and Table 3 is for the McAllen division.

8 Average residential usage is 1,333 kWhs per month.



1318

Table 3

Residential Service Comparison - McAllen Division

Distribution Monthly Monthly Monthly Fixed Charge

Customer Charge Metering Charge Charge (per kWh)

Current Rate •

3.19 Cost-Based Rate

r

10.57 Proposed Rate 5.69

Residential Rate Impacts (T&D Utility Costs Only)

, Increase / Decrease

$ 3.5-51 7 $ 6.74 L$ 3.30 13.87

0.035981 0.057418

4.31 10.00 0.060317

Monthly Usage (kWh Current Rates Proposed Rates

500 $ 24.73 $ 40.16 1,000 42.73 70.32 1,333* 54.71 90.40 1,500 60.72 100.47 2, 000 _ 78.72 130.63_.

*Average Monthly Usage

$ %

15.42 i 62.36% 27.59 64.57%

65.23% 35.691 39.75 65.47% 51.92 65.96%_

1

i

1 Q. DO YOU HAVE ANY COMMENTS REGARDING THE CURRENT AND

2 PROPOSED RETAIL RATES FOR THE MCALLEN DIVISION?

3 A. Yes. The current rates for the McAllen division have been in place for years and

4 are based on a rate cap calculation rather than on the cost of service for that

5 division. In addition, the formula included in the McAllen division's TCRF Rider

6 has been in place since 2001. Moving the McAllen customers to cost of service

7 rates and updating the TCRF formula necessitates the substantial increase

8 reflected in Table 3 above. Because of these two factors, the rate impacts for the

9 McAllen division customers are greater than the impacts for the Sharyland SBC

10 division customers.

11 B. Secondary Service Less Than or Equal to 10 kW Class

12 Q. PLEASE DESCRIBE HOW YOU DES1GNED THE PROPOSED RATES

13 FOR THE SECONDARY SERVICE LESS THAN OR EQUAL TO 10 KW

14 RATE SCHEDULE.

15 A. The proposed rates for the Secondary Service Less Than or Ecjual to 10 kW rate

16 schedule were calculated by dividing the functional costs (customer service,

17 metering, and distribution) allocated and assigned to the class by the adjusted

18 class billing units (SU Schedule II-H-4.1.9). Table 4 provides a comparison of

Direct Testimony and Exhibits of James W. Daniel 16

SOAH Docket No. 473-16-4051 PUC Docket No. 45414

P

1319

Current Rate I $ _ 9.53 $ 13.17 Proposed Rate 10.56 7.46

22.70 $ 0.051640 18.02 0.048616

Table 4

Se condary Small Se rvice Comparis on - SBC Divis ions

Distribution Monthly Monthly Monthly Fixed Charge

Customer Charge Metering Charge Charge (per kWh)

Secondary Small Rate Impacts (T&D Utility Costs Only) Increase / Decrease

Monthly Usage (kWh) Current Rates Propose d Rate s

500 42.33 $ (6.19) -12.76%

675* 57.56 50.84 I (6.72): -11.68%

1,000

n48.52

74.34 66.64 , (7.70): -10.36%

1,500 100.16 90.94 -9.20%

2,000 125.98 115.25 (10.73)r -8.52%


1 the current and proposed rates and the bill impacts for customers at the identified

2 usage levels.

3 C. Secondary Service Greater Than 10 kW Class


5 FOR THE SECONDARY SERWCE GREATER THAN 10 KW RATE

6 SCHEDULE.

7 A. Like the proposed rates for the Small Secondary rate schedule, the proposed rates

8 for the Secondary Service Greater Than 10 kW rate schedule were calculated by

9 dividing the functional costs (customer service, metering, and distribution)

10 allocated and assigne& to the class by the adjusted class billing units (SU

11 Schedule 11-11-4.1.9). Table 5 provides a comparison of the current and proposed

12 rates and the bill impacts for customers at the identified demand and usage levels.

13 Q. ARE YOU ALSO PROPOSING A SEPARATE DISTRIBUTION CHARGE

14 FOR CUSTOMERS WITH LOAD FACTORS OF 25 PERCENT OR LESS?

15 A. Yes. In the current rate schedule, customers with load factors less than or equal to

16 25% are exempted from thé 80% demand ratchet but pay a higher distribution

17 system charge per kW. In the proposed rate schedule, I am proposing to continue

18 this same rate structure for the customers with load' factors of 25 percent or less.

Direct Testimony and Exhibits of 17 SOAH Docket No: 473-16-4051


1320

Table 5 Secondary Large Non-IDR Service Conmaris on - SBC Divisions

Monthly Monthly Monthly Fixed Customer Charge Metering Charge Charge

Distribution Charge

(per kW)

Current Rate (< 25% LF) Current Rate (> 26% LF) Proposed Rate (< 25% LF) Proposed Rate (> 26% LF)

16.71 24.53 41.24 $ 16.71 24.53 41.24

13.4] 12.29

10.61 13.12 23.72 10.98 10.61 13.12 23.72 9.96

Secondary Large Rate Impacts (T&D Utility Costs Only) 1 . Increase / Decrease

NCP Demand Current Rates Proposed Rates

15 kW (c25% LF) 243:29 .4 (54.80; ! -22.55% 20 kW (>25% LF)* 287.04

$ 218

28.

2 835

(64.19)i -22.36%

25 kW (>25% LF) 348.49 272.63 (75.86)i

-21.77%

•30 kW (>25% LF)... 409.94. ) 322.42, J87.52) -21.35%


1 For these customers, the distribution charge would be reduced from the current

2 rate of $13.47 per kW to $10.98 per kW.

Q. HAVE YOU ALSO DEVELOPED A TRANSFORMER CREDIT FOR THE SECONDARY CUSTOMERS THAT' OWN THE TRANSFORMER AT THEIR DELIVERY POINT?

7 A. Yes. Per the stipulation in Docket No. 41474,9 I have developed a cost-based

transfOrmer credit. To determine the amount of the transformer credit, I ie-ran the

9 COSS without any transformer-related cosIs allocated to the two Secondary

10 voltage customer classes. I then gubtracted the unif costs of the, distribution

11 function for the two ,Secondary classes from the comparable unit costs in the

12 COSS in Schedule I, which includes the' transformer-related costs. The difference

13 is the cost-based transformer Credit that I recommend be approved in this

14 proceeding. These transformer credits arb $0.011297 per kWh f'or the Small

15 Secondary class and $1.95 per kW-for the Large Secondary class. This compares

16 to the $0.005251 per kWh and the $1.87 per kW transformer credits included in

17 the cliTrCnt tariff, which were part of the stipulation idDocket No. 41474.

9 Docket N9. 41474, Order at 10, Finding of Fact No. 35(o)(ii).


SOAH Docket No. 473-16-4051 1


3

4 5 6

1321

1 Q. ARE YOU ALSO PROPOSING AN OPTIONAL LARGE SECONDARY

2 RATE STRUCTURE THAT WOULD BE AVAILABLE TO CHURCHE§?

3 A. Yes.

4 Q. PLEASE EXPLAIN THE REASON FOR THE PROPOSED OPTIONAL

5 RATE STRUCTURE FOR CHURCHES.

6 A. Sharyland has experienced a number of complaints from churches in its service

7 territory since the transition to the competitive retail electric market in May 2014..

8 Prior to the transition, churches were served under Sharyland's General Service

9 rate class which wag billed solely on an energy usage or kWh basis. Following

10 the transition to the compeiitive market, churches received service under -one of

11 the Secondary rate classes. Church customers in the Small Secondary rate class

12 are still billed based on an energy usage basis. However, church customers in the

13 Large Secondary rate class are billed based upon demand or on a kW basis.

14 Some churches have complained that the billing structure based Upon

15 demand charges has created a financial hardship. For example, one church used

16 less than 780 kWh, but had a demand of nearly 40 kW, which resulted in a bill for

17 delivery service of over $600 based upon Sharyland's current rafes. Had delivery

18 been based upon an energy charge, the tesulting bill would have been much

19 lower.

20 Many churches only operate for a few hours on the 'Weekend, i.e., during

21 off-peak periods, and do not contribute to the customer class NCP demands used

22 to allocate distribution-related costs. In order to provide some financial relief for

23 churches, and to reflect this cost causation difference, I am proposing an optional

24 distribution charge rate structure for churches receiving service under the Large

25 Secondary Service rate schedule.

26 Q. PLEASE EXPLAIN HOW YOU I DEVELOPED THIS PROPOSED

27 OPTIONAL RATE STRUCTURE FOR CHURCHES.

28 A. The proposed optional distribution rate is an energy-based rate. The energy rate

29 was calculated by dividing the total distribution function revenue requirement

30 allocated to the Large Secondary class by the total kWh used by the class. This

31 optional church rate is cost-based and similar to how the Residential and Small Direct Testimony and Exhibits of

9 SOAH Docket No. 473-16-4051 1 James W. Daniel PUC Docket No. 45414

1322

29.93 J

$ 628.60 10.40

10.06 $ 19.87 11.14 617.46

8.71

Table 6 Primary Service IDR Comparison- SBC Divisions

Distribution Monthly Monihly Mo*nthly Fixed Charge "-

Customer Charge Mete ring Charge Charge (per kW)

Current Rate Proposed Rate

Primary Service IDR Rate Impacts (T&D Utility Costs Only) Increase / Decrease


2,500 21,-179.93 26,618.71 4,838.78 22.22% 5,000 43,529.93 52,608.82 9,078.89 20.86% 10,000 87,029.93 104,589.04 17,559.11 20.18% 15,000 _ 130,529.91i 156,569.26 26,039.33 19.95%

1 Secondary Service distribution charges are determined. -In the example noted

2 above with current proposed rates, a demand-based distribution charge would

3 result in a cost of approximately $400 for 40 kW, 'but the cost-based energy, rate

-4 .with 780 kWh for the distribution charge would result in a bill of approximately

5 $30.

6 D. Primary Class


8 FOR THE PRIMARY SERVICE RATE SCHEDULE.

9 A. Like the proposed rates for the Secondary Service rate schedules, the proposed

10 rates for the Primary Service rate schedule were calculated by dividing the

11 functional costs (customer service, metering, and distribution) allocated and

12 assigned to the class by the adjusted "class billing units (SU Schedule II-H-4.1.9).

13

Table 6 provides a comparison of the current and proposed rates and the bill

14

impacts for customers at the identified demand levels.

Direct Testimony and Exhibits of James W. Daniel



1323

Table 7 Trans mis s ion Se rvice Comparison - SB C Divis ions

Monthly Monthly Monthly Fixed Charge Customer Charge Metering Charge Charge (per kW)

amoralo r

163.22 1 $ • 0.08 623.50 ; 0.08

Current Rate Proposed Rate

64.06 9.81

99.16 613.69

Transmission Service Rate Impacts (T&D Utility Costs Only) Increase


1,000 2,000 3,000 4,000 5,000

243.22 323.22 403.22 483.22 ' 563.22

704.02 460.80 1

784.54 I 461.32i 865.07 461.85

945.59 462.37

1,026.11 462.89

189.46% 142.73% 114.54% 95.68% 82.19% I

1 E. Retail Transmission Service Class

2 Q. PLEASE DESCRIBE HOW YOU DESIGNED THE PROPOSED RATES 3 FOR THE TRANSMISSION SERVICE RATE SCHEDULE.

4 A. The cost-based rates for the retail Transmission Service rate schedule were

5 calculated by dividing the functional costs (customer service, metering, and

6 distribution) allocated and assigned to the class by the adjusted class billing units •

7 (SU Schedule II-H-4.1.9). Table 7 provides a comparison of the current and the

8 proposed rates and bill impacts for customers at the identified demand levels.

9 F. Lighting Class


1 1 FOR THE LIGHTING SERVICE RATE SCHEDULE.

12 A. Currently, the Lighting rate schedules for the McAllen division and the SBC

13 divisions have distinctly different street light types and sizes. For example, the

14 McAllen division serves a planned community with specific requirements for

15 street lighting types and fixtures. Also, since the distribution system is mostly

16 underground, there are requirements for street lighting poles as well. None of

17 these street lights are currently offered in the other Sharyland divisions. To

18 accommodate these differences, I have proposed rates for "Standarr street lights

19 and for "Ornamental" street lights.



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1 G. Other Rate Design Issues

2 Q. WOULD YOU LIKE TO DISCUSS ANY OTHER RETAIL RATE DESIGN

3 ISSUES?

4 A. Yes. In the prior Sharyland rate case there were no interval data recorder (IDR")

5 meters in place in the SBC divisions. Since the 2013 rate case, Sharyland has

6 installed IDR meters for approximately 90 customers in the SBC divisions.

7 Therefore, in this case we are proposing new intra-class rates for IDR-metered

8 customers. The proposed rate schedules for the Large Secondary and Primary

9 Service classes reflect these new IDR-related meter and TCRF charges.

10 Q. HAVE YOU PROVIDED A SUMMARY OF THE RATES YOU PROPOSE

11 THE COMMISSION APPROVE?

12 A. Yes. SU Schedule IV-J-7.2 summarizes the proposed cUstomer class rates:

13 Q. HAVE YOU PREPARED RATE COMPARISONS FOR ALL CUSTOMER

14 CLASSES?

15 A. I have developed rate comparisons for the four major customer classes. These

16 rate comparisons are providal in my Exhibit JWD-3.

17 V. SHARYLAND'S WHOLESALE TRANSMISSION COST OF SERVICE

18 Q. PLEASE EXPLAIN HOW YOU DEVELOPED THE TEST YEAR

19 WHOLESALE TCOS.

20 A. The total Test Year (calendar year ending 2015) TCOS amount of $145,439,164

21 is shown on SU Schedule I-A-1. I have followed the Comthission's RFP

22 instructions and schedules to determine Sharyland's TCOS.

23 Q. HOW HAVE THE COSTS ASSOCIATED WITH DISTRIBUTION

24 SUBSTATIONS BEEN FUNCTIONALIZED BETWEEN TRANSMISSION

25 AND DISTRIBUTION?

26 A. The assignment of the transmission-related portion of substations .included in

27 distribution substations is based upon an analysis of the components of each

28 substation. Generally, if the substation component is located on the high voltage

29 side of the substation's transformer(s), it is included in TCOS. Once this analysis

30 is completed, Sharyland then books the cost of the transmission-related Direct Testimony and Exhibits of

22 SOAH Docket No. 473-16-4051 James W. Daniel PUC Docket No. 45414

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1 components of the substatiim in Account 353. The costs of the distribution-

2 related components of the substation are booked in Account 362. A portion of

3 any common costs such as land are assigned to both accounts. Mr. Mark D.

4 Meyer is testifying as to the substation plant investment assignment analysis.

5 Other distribution substation-related costs, such as operation and maintenance

6 expenses and depreciation expenses, are split between the transmission and

7 distribution functions based on the percentage of the substation plant investment

8 assigned to the transmission function and to the distribution function.

9 Q. HOW WERE THE OTHER COSTS THAT CANNOT BE DIRECTLY

10 ASSIGNED TO TCOS ASSIGNED TO THE TRANSMISSION

11 FUNCTION?

12 A. Many of these other costs are functionalized to TCOS and to the retail delivery

13 cost functions based on functionalization factors internally calculated by the RFP

14 schedules. For example, tile property insurance expense included in FERC

15 Account No. 924 is functionalized based on the functionalized total net plant in

16 service, which is provided on SU Schedule II-B.

17, Q. DOES SHARYLAND PROVIDE WHOLESALE DISTRIBUTION

18 SUBSTATION SERVICE?

19 A. Yes. Sharyland provides wholesale distribution substation service to the City of

20 Farmersville. The current rate for this service was approved by the Commission

21 in Docket No. 43955.1° Sharyland is proposing new rates for this wholesale

22 delivery service.

23 Q. HOW DID YOU DEVELOP THE PROPOSED WHOLESALE

24 DISTRIBUTION SUBSTATION SERVICE?

25 A. The facilities used to provide this service are known, easily identified, and were

26 directly assigned. Expenses related to these facilities, e.g., operation and

27 maintenance expenses and other taxes, are based on average system costs., The

10 Application of.sharyland Utilities, L.P. for Approval of Rate for Wholesale Transmission at Distribution Level Voltage, Docket No. 43955, Order (May 6, 2015).



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john w. hutts

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