                                           In the
                         Missouri Court of Appeals
                                   Western District

                                                
 IN THE MATTER OF THE PETITION                  
 OF MISSOURI-AMERICAN WATER                     
 COMPANY FOR APPROVAL TO
 ESTABLISH AN INFRASTRUCTURE                    
 SYSTEM REPLACEMENT                             
 SURCHARGE (ISRS),                                 WD82514
                                                
                  Appellant,                       OPINION FILED:
                                                
 v.                                                NOVEMBER 19, 2019
                                                
 PUBLIC SERVICE COMMISSION OF                   
 MISSOURI,                                      
                                                
                 Respondent.                    
                                                


                         Appeal from the Public Service Commission

      Before Division Three: Alok Ahuja, Presiding Judge, Gary D. Witt, Judge, and
                              Anthony Rex Gabbert, Judge

       Missouri-American Water Company (“MAWC”) appeals the Public Service Commission

of Missouri’s (Commission) order approving the company’s Infrastructure System Replacement

Surcharge for the MAWC’s eligible infrastructure projects for the period from January 1, 2018,

through September 30, 2018. MAWC asserts two points on appeal that the Commission did not

find in MAWC’s favor. First, MAWC contends the Commission erred in concluding that sufficient

evidence was not presented to demonstrate that a deferred tax asset was incurred in 2018, arguing

the Commission’s order is unreasonable and arbitrary because it jeopardizes MAWC’s eligibility
to utilize accelerated depreciation and is not supported by substantial and competent evidence on

the whole record as to the impact of the eligible infrastructure system replacements. Second,

MAWC contends that the Commission erred in issuing an order not reflecting the deferred tax

asset identified by MAWC, and the order is unlawful because it focused on MAWC as a whole and

failed to recognize the accumulated deferred income taxes specifically associated with the eligible

infrastructure system replacements as required by Section 393.10001. We affirm.

                              Factual Background and Procedural History

       MAWC is a “public utility” and “water corporation” pursuant to Section 386.020 and is

subject to the jurisdiction and supervision of the Commission as provided by law. MAWC serves

retail water customers throughout the state, including the majority of St. Louis County. MAWC is

wholly owned by its parent company American Water Works. The Commission is the state agency

responsible for the regulation of public utilities, including water corporations, in Missouri. §

386.250.1.

       Water corporations are permitted to recover eligible infrastructure system replacement

costs outside of a general rate case through an Infrastructure System Replacement Surcharge

(ISRS) on customer bills.

                [A]n approved ISRS can be collected only for three years at the most, at
       which point it then terminates (unless a new rate case is pending). Thereafter, the
       [utility] has to file revised rate schedules to reset the ISRS to zero upon resolution
       of a general rate case. [§ 393.1006.6(1)]. The [utility] may then seek to establish
       a new ISRS by filing a petition pursuant to section [393.1003].

              Collectively, the ISRS statutes permit the [utility] to make single-issue rate
       increases between general rate cases in order to timely recover its costs for certain
       government-mandated infrastructure projects without the time and expense
       required to prepare and file a general rate case, while, at the same time, limiting the


       1
           All statutory references are to the Revised Statutes of Missouri, 2016, unless otherwise noted.

                                                           2
       collection of the ISRS surcharge to three years to prevent its unlimited use outside
       of a general rate case.

In re Laclede Gas Co., 417 S.W.3d 815, 821-822 (Mo. App. 2014). MAWC’s most recent general

rate case, NO-WR-2017-0285, resulted in the establishment of new rates which became effective

May 2018. Because issues surrounding MAWC’s previous ISRS were addressed and incorporated

into that general rate case, the previous ISRS was reset to zero.

       On August 20, 2018, MAWC filed “MAWC’s Petition to Establish an Infrastructure System

Replacement Surcharge & Motion for Approval of Customer Notice” with the Commission.

Therein, MAWC requested an ISRS for its St. Louis County service territory to recover eligible

costs incurred for infrastructure system replacements made during the period from January 1, 2018,

through September 30, 2018. This was MAWC’s first ISRS filing since MAWC’s general rate

case NO-WR-2017-0285. MAWC attached supporting information to its petition including

documentation identifying the type of addition, utility account, work order description, addition

amount, depreciation rate, accumulated depreciation, and depreciation expense.          MAWC’s

supporting documentation also contained a proposed amount for accumulated deferred income tax.

In that calculation, MAWC included what it characterized as a deferred tax asset relating to an

assumed net operating loss (NOL) for 2018 in the amount of $9,577,697.

       The Commission directed Commission Staff (Staff) to examine MAWC’s application and

submit a report/recommendation in accordance with Sections 393.1000 to 393.1006. On October

19, 2018, Staff submitted a recommendation regarding MAWC’s application. Staff recommended

removing the deferred tax asset from MAWC’s ISRS calculation because it was not an NOL

resulting from the 2018 ISRS period. Staff’s recommended removal of the deferred tax asset

resulted in a reduction of $866,917 to the MAWC’s recoverable ISRS costs; Staff’s recommended


                                                 3
ISRS revenue requirement was $6,377,959.             MAWC objected to Staff’s recommendation.

Whether an NOL existed and, if so, what impact it had on the ISRS was MAWC’s only

disagreement with Staff’s recommendations.

        After review, the Commission made factual findings which included: 1) Only costs directly

associated with the qualifying ISRS plant that became in-service during the nine months of the

2018 ISRS Period should be reflected in ISRS rates, 2) An NOL results when a utility does not

have enough taxable income to utilize all of the tax deductions to which it would otherwise be

entitled. The amount of the unused deductions is the NOL. An NOL is a tax return adjustment

and not a regulatory item, 3) MAWC has an NOL carryover from prior years, 4) No net amount of

net operating loss has been generated for income tax purposes by MAWC on an aggregate basis

since January 1, 2018, the beginning of the 2018 ISRS Period, 5) IRS Private Letter Rulings cited

by MAWC address time periods in which the utility in question was generating NOL amounts, 6)

MAWC did not generate any NOL in the 2018 ISRS Period, 7) MAWC projects it will be able to

reflect all of its net accelerated depreciation benefits associated with ISRS plant additions on its

books during the next two years without the need to record any new offsetting NOL amount, 8)

MAWC’s NOL as of December 31, 2017, is reflected in MAWC’s base rates as a result of

MAWC’s last general rate case, and 9) A taxpayer cannot utilize an NOL carryforward amount

from a prior tax year without first exhausting all of the deductions available for the current tax

year.

        The Commission concluded MAWC had not provided evidence to support that it would

generate an NOL in 2018, and the evidence showed MAWC was generating more revenue for 2018

than expenses qualifying for deductions. The Commission found that MAWC would be utilizing

prior NOL carryovers to offset its taxable income in 2018 and 2019, but would not be generating

                                                 4
a new NOL. The Commission found that, because MAWC was expected to have taxable income

in 2018, it was reasonable to conclude that MAWC would not be generating an NOL during the

2018 ISRS Period at issue. The Commission concluded, “In short, although the ISRS statute

requires recognition of ADIT [accumulated deferred income taxes], which might include reflection

of an NOL, we cannot allow MAWC to reduce its ADIT balance to reflect an NOL that does not

exist.” The Commission found that, since there was not an NOL in the 2018 ISRS Period, the

question of whether an NOL was associated with the proposed ISRS was moot. The Commission

concluded MAWC had complied with the requirements of the applicable ISRS statutes to authorize

use of an ISRS, however, the recovery should not include an NOL; consequently, MAWC would

be permitted to establish an ISRS to recover ISRS surcharges in the amount of $6,377,959.

       MAWC filed a timely application for rehearing which was denied. This appeal follows.

                                      Standard of Review

       Pursuant to section 386.510, the appellate standard of review of a Public Service

Commission order is two-pronged: first, the reviewing court must determine whether the

Commission’s order is lawful; second, the court must determine whether the order is reasonable.

Matter of Missouri-American Water Company, 516 S.W.3d 823, 827 (Mo. banc 2003) (internal

citations omitted). We presume the Commission’s order is valid, and the appellant has the burden

of proving that the order is unlawful or unreasonable. Id. We review questions of law de novo.

Id. An order is lawful if statutory authority for its issuance exits. Id. An order is reasonable if

supported by substantial, competent evidence on the whole record and is not arbitrary, capricious,

or an abuse of discretion. Id. “We consider the evidence, along with all reasonable supporting

inferences, in the light most favorable to the Commission’s order.” State ex rel. Public Counsel v.

Missouri Public Service Com’n, 289 S.W.3d 240, 246-247 (Mo. App. W.D. 2009). If the evidence

                                                5
supports two conflicting conclusions, we defer to the Commission’s factual findings. Id. Pursuant

to Section 386.430, the burden of proof is on the party seeking to set aside the Commission’s order

to show by clear and satisfactory evidence that the order is unlawful or unreasonable.

                                                       Point I

        In its first point on appeal, MAWC contends the Commission erred in concluding sufficient

evidence was not presented to demonstrate that an NOL was incurred by MAWC in 2018. MAWC

argues this error resulted in an unreasonable, arbitrary order because it jeopardizes MAWC’s

eligibility to utilize accelerated depreciation and is not supported by substantial and competent

evidence on the whole record as to the impact of the eligible infrastructure system replacements.

        We find that, the majority of MAWC’s argument in Point I focuses not on evidence

supporting that an NOL was incurred in 2018 but, rather, the potential impact to MAWC and

customers of the failure of the Commission to include, pursuant to Section 393.1000, an NOL in

its calculations. We find these arguments relevant only if there was an NOL that should have been

included in the calculations.2

        With regard to the existence of an NOL for the relevant ISRS time period, MAWC explains:

               The Deferred Tax asset included by the Company was created by the Net
        Operating Loss associated with the subject ISRS investments. This Deferred Tax
        asset occurs because of the various tax deductions related to those specific
        investments. The Company included depreciation and interest expense that

        2
            A not-supported-by-substantial-evidence challenge requires completion of three sequential steps:

        (1) identify a challenged factual proposition, the existence of which is necessary to sustain the
            judgment;
        (2) identify all of the favorable evidence in the record supporting the existence of that proposition;
            and,
        (3) demonstrate why that favorable evidence, when considered along with the reasonable
            inferences drawn from that evidence, does not have probative force upon the proposition such
            that the trier of fact could not reasonably decide the existence of the proposition.

Houston v. Crider, 317 S.W.3d 178, 187 (Mo. App. 2010).

                                                          6
       occurred during the ISRS period, accelerated depreciation, and the repairs
       deduction. These large deductions, taken against no revenue (there is no new
       revenue since general rates were set in MAWC’s last rate case), create a large NOL.
       This NOL is multiplied by the effective tax rate to determine the Deferred Tax asset
       to include in the ISRS rate base.

MAWC contends that the Commission’s findings of fact, that no net amount of net operating loss

was generated for income tax purposes on an aggregate basis since the beginning of the 2018 ISRS

Period and MAWC did not generate any NOL in the 2018 ISRS Period, is disputed by the evidence

because the evidence shows that the NOL balance increases between May 2018 and June 2018.

       We find that the relevant time period for determining whether an NOL was incurred is the

entirety of the ISRS time period, not one month out of the entirety of the time period, and the

Commissions’ findings are supported by evidence in the record showing that no net operating loss

was generated on an aggregate basis for that time period.

       The testimony of Lisa Ferguson was relied on by the Commission. Ferguson explained

accumulated deferred income taxes and how they are determined as follows:

               A utility’s deferred tax reserve balance represents, in effect, a net
       prepayment of income taxes by a company’s customers in rates prior to actual
       payment to the taxing authorities. MAWC may deduct depreciation expense on an
       accelerated basis for income tax purposes. Depreciation expense used for income
       taxes paid by MAWC is higher than depreciation expense used for rate making
       purposes. This results in what is referred to as a ‘book-tax timing difference,’ and
       creates a deferral of income taxes to the future. The net credit balance in the
       deferred tax reserve represents a source of cost-free funds; therefore, rate base is
       reduced by the deferred tax reserve balance to avoid having customers pay a return
       on funds that are provided cost-free to the company. Since the level of book
       depreciation expense is lower than the level of accelerated tax depreciation expense
       used for income tax purposes, customers are typically required to pay higher costs
       for income taxes in rates than MAWC will actually pay to the Internal Revenue
       Service (IRS). The difference in income taxes paid by the utility to the IRS and
       those amounts collected by the utility from its customers through rates are
       ‘accumulated’ to recognize the future tax liability that will eventually be paid to the
       IRS. In cases where a utility incurs an NOL the accumulated deferred income tax
       (ADIT) balance is then offset by that NOL due to the fact that the utility did not
       have enough taxable income to utilize all of its available deductions.

                                                 7
Ferguson testified that, the amount of deferred tax associated with MAWC’s ISRS petition was

determined by the sum of the tax timing differences (deductions) for repairs and accelerated

depreciation applied to the investment for the ISRS period. The deferred tax liability arrived at by

Staff was not contested by MAWC. In MAWC’s calculation, however, MAWC then offsets the

deferred tax liability by imputing an NOL. MAWC calculated the NOL used to offset the deferred

tax liability by summing the tax timing differences related to repairs and accelerated depreciation

with depreciation expense and interest expense, and then subtracting those reductions from zero.

The zero represents the revenue MAWC has yet to recover in regard to the ISRS investment,

thereby creating a “hypothetical” net operating loss amount.

       Ferguson testified that a hypothetical net operating loss amount is not appropriate for

recovery in an ISRS rate calculation. Ferguson explained that, if MAWC’s methodology is used,

“the existence of a net operating loss will always result from the calculation, whether the utility is

actually recording an NOL amount on its books or not.” Ferguson explained that, in Missouri, a

utility must place investment in-service prior to obtaining recovery rates. Recovery can be sought

as MAWC did on an interim basis through an ISRS filing, or through permanent rates as part of a

general rate case filing. Because MAWC cannot receive ISRS revenue related to an investment

until new rates are put in effect after a ruling on an ISRS request, the utility assumes zero revenue

in the ISRS calculation.

       Ferguson explained that MAWC was not currently generating an NOL.                     MAWC

accumulated previous NOL’s through December 31, 2017, the balance of which were included in

MAWC’s base rates as an offset to its accumulated deferred income tax as a result of its last general

rate case. Ferguson reasoned that, therefore, for the ISRS period of January 1, 2018, through


                                                  8
September 30, 2018, there would have to be an incremental increase in MAWC’s ongoing NOL

balances directly related to ISRS plant additions for an NOL to be eligible for inclusion in the ISRS

ratemaking calculation. MAWC’s records show that the NOL balance decreased over time in 2018,

and was expected to continue to do so.

       MAWC does not file a standalone tax return; it files a consolidated tax return with parent

company American Water Works. MAWC witness John R. Wilde, Assistant Vice President of Tax

for MAWC’s parent company, American Water Works, testified that the company would generate

less of an NOL starting in 2019 and probably no NOL by the end of 2020. The evidence showed

that the beginning NOL Deferred Tax Asset Balance in January of 2018 was $31,464,998. The

ending NOL Deferred Tax Asset Balance in September 2018 was $21,183,942. The evidence

confirmed that MAWC expected to use prior NOL balances in 2018 and 2019 because taxable

income was projected for those years.

       Wilde argued that the NOL reflected in MAWC’s calculation was not hypothetical. He

testified, “It’s stated on the tax return, each of the previous years all the way back before 2008. It

won’t be fully utilized based on estimates today until 2019, 2020.” He testified that the 2018 tax

return would ultimately show an NOL because deductions would be higher than federal taxable

income which would be zero. Wilde contended that failure to include an NOL calculation was in

violation of tax normalization rules and a finding by the IRS that a company violated tax

normalization rules or a consent decree could cause the loss of significant tax benefits. He

admitted, however, that the company would have to believe a violation occurred and report that

violation; he stated that the Commission could also report a violation. Wilde indicated that

American Water Works had an NOL carryover balance of $148 million on December 31, 2017,

and that balance would be reduced by $92.1 million by December 31, 2018. He agreed that if the

                                                  9
company did not have net operating loss carry-forward from prior years, MAWC would have

taxable income. He agreed that a company cannot utilize an NOL carryover prior to exhausting

all of the deductions for the current tax year. He testified that MAWC expected American Water

Works to be able to reflect all of the available accelerated depreciation tax deductions associated

with the 2018 ISRS plant additions on American Water’s 2018 tax returns.

          MAWC witness Brian LaGrand (“rates director” for MAWC) testified that the overall

balance of MAWC’s NOL carry-forward deferred tax asset declined since year end 2017 and was

projected to continue to do so past September 2018. LaGrand testified that passage of the Tax

Cuts and Jobs Act of 2017 precluded the use of bonus depreciation by utility companies, and that

the use of bonus depreciation had been a large driver for utility companies to be in net operating

loss situations. LaGrand agreed that the exclusion of bonus depreciation would have the opposite

effect.

          Rebuttal witness John S. Riley, a Public Utility Accountant III for the Office of Public

Counsel, testified that he disagreed with Wilde’s testimony that failure to include a net operating

loss in the ISRS calculation would cause a normalization penalty with the IRS. He explained that

normalization is the difference between accelerated depreciation and straight-line depreciation in

regulatory revenues, resulting in a deferred tax representing the difference between the two. He

testified, “So a net operating loss isn’t something you really need to consider when you’re talking

about normalization violations.” Riley disagreed with Wilde’s conclusion that recognition of

accumulated deferred income taxes requires recognition of both the deferred income tax liabilities

and the deferred income tax assets. He stated that there is no deferred tax asset in a strict regulatory

accounting format and “to say that you have to combine these two is a little bit of a stretch because

I contend that a net operating loss is a tax item not a regulatory item.” He stated that accumulated

                                                  10
deferred income tax in the Uniform System of Accounts is a liability account, not an asset. Riley

testified that he was familiar with a private letter ruling by the IRS, entered into evidence as Exhibit

No. 7, wherein a company had asked the IRS if deferred income tax should be offset with a net

operating loss. The letter ruling said that the NOL carryover was taken into account and was not

included and did not need to be included in the deferred tax balance.

        Mark Oligschlaeger, manager of the auditing department for the Missouri Public Service

Commission, also disagreed with LaGrand’s and Wilde’s testimony concerning the NOL issue in

the ISRS. He considered their proposed inclusion of a hypothetical NOL deferred tax asset

unreasonable on its own terms, concluding that such was not in any way mandated by the IRS tax

normalization rules. He testified further:

                 A utility that is in a position of using prior NOL to offset taxable income by
        mathematical necessity is able to reflect all of its current accelerated depreciation
        tax deductions on its tax returns going forward. As a result, it will receive the full
        financial benefits of such deductions. Because these benefits are provided to the
        utility in customer rates through collection of deferred income taxes, the resulting
        accumulated deferred income tax balance must be included in rate base without
        offset in order to provide ratepayers a return on capital they provide to the utility.

In arguing that the IRS Code does not support MAWC’s position, Oligschlaeger testified:

                 The tax normalization rules embedded within the IRS Code clearly state
        that the existence of NOLs can be a relevant consideration in assessing whether a
        utility is in compliance with the rules. However, the Code specifies that NOLs may
        be relevant in two specific situations. First, when the utility is unable to reflect all
        of its accelerated depreciation tax deductions in its tax returns, thus creating a new
        NOL. And second, when a utility’s balance of an already existing NOL deferred
        tax asset increases due to the Company’s continuing inability to reflect all available
        tax deductions on its returns.

                However, neither situation applies to Missouri-American during this
        particular ISRS period. So far in 2018, MAWC has not generated any new NOL in
        the aggregate and as a result its existing NOL balance has been decreasing, not
        increasing. Since MAWC is not currently generating any additional amount of
        NOL in aggregate, no violation of the tax normalization rules is at risk in this case.


                                                  11
Oligschlaeger testified that none of the private letter rulings of the IRS cited by MAWC were

relevant to MAWC’s financial and taxable position as, unlike MAWC, all of the utilities in question

were generating NOL amounts. Oligschlaeger testified that MAWC’s position on NOL ratemaking

was inconsistent with the intent and theory behind the IRS tax normalization rules because it would

lead to customers not being compensated for capital provided by them to MAWC in the form of

deferred income taxes.

       On appeal, MAWC disagrees with the Commission’s conclusions and argues that “the

fundamental error of the Commission is that it assumed such an offset to taxable income without

specifically addressing the issue of normalization and without addressing the unopposed evidence

of MAWC’s inability to benefit from the deductions resulting from the eligible infrastructure

system replacements.” Yet, the Commission heard evidence from all sides regarding these issues

and found that there was “no legal support for MAWC’s position that an exclusion of an NOL

would violate normalization requirements of the IRS Code.” Hence, we cannot agree that the

Commission did not specifically consider and address this issue. The private letter rulings relied

upon by MAWC are not binding precedent and MAWC does not dispute the Commission’s finding

that all of the rulings relied upon by MAWC involved situations where NOLs were actually

generated, not hypothetically generated.

       Nevertheless, MAWC asks this court to find that disallowing inclusion of its proposed NOL

is inconsistent with the purpose behind the normalized method of accounting because customers

receive the benefit of the tax deduction now, through a lower ISRS rate, even though the Company




                                                12
is unable to benefit from those tax deductions at this time.3 We cannot readily agree.

        The record shows that it is undisputed by the parties that, under the IRS Code, a company

is allowed to deduct certain costs against income for tax purposes at different times than when it

is allowed to reflect the same costs as a reduction to income for financial reporting purposes. This

is referred to as “timing differences.” It is also undisputed that a timing difference that results in

significant financial benefits to companies is the ability of companies to use “accelerated

depreciation” deductions for tax purposes under the IRS Code. The parties agree that, for

ratemaking purposes, under the normalization method, the tax benefits associated with timing

differences are retained by the utility for a period of time before being passed on to ratepayers.

Tax normalization is applied by collecting income tax expense amounts in rates calculated as if the

particular tax deduction or treatment was not available to the utility. Customers end up paying an

amount of income tax expense in rates that exceeds the utilities’ actual current income tax

liabilities. The excess payments are charged to deferred income tax expense accounts. These

excess payments represent capital that the utilities can use for a period of time and is thereby

considered “cost-free” funds.




        3
            MAWC also references a 2010 consent agreement MAWC entered with the IRS which authorized the
Company’s requested Change in Accounting Method to allow utilization of a repairs deduction method. MAWC
states that, “If the Company did not agree to the terms, then it would not have been allowed the additional repairs
deduction on its tax returns. One of the requirements of that consent agreement is that MAWC use a normalize method
of accounting, even though a tax repairs deductions is not otherwise specifically subject to []the tax normalization
rules.” Yet, the Consent Agreement states that, at the time the Company requested to change its method of accounting
for repair and maintenance costs, the Company capitalized the repair and maintenance costs and recovered those “as
prescribed by §168(a).” 26 U.S. Code § 168 does not apply to “[a]ny public utility property (within the meaning of
subsection (i)(10)) if the taxpayer does not use a normalization method of accounting.” 26 U.S. Code § 168(f). This
suggests that MAWC was already using a normalization method of accounting at the time of the Consent Agreement
and that it was not a new requirement imposed by the Consent Agreement. Further, receipt of the tax benefit of
accelerated depreciation requires tax normalization for ratemaking purposes, and the record shows that MAWC was
also accelerating depreciation prior to the Consent Agreement.


                                                        13
       MAWC argues that an ISRS allows a utility to recover costs for certain infrastructure

investments between general rate cases in order to incentivize utilities to invest in such

infrastructure between general rate cases. MAWC argues that the intent of Congress in creating

the normalization rules is to provide the utility an interest free source of funds to invest in utility

property. (Citing IRS Revenue Proc. 2017-47, p.2). IRS Revenue Proc. 2017-47 states that one

objective of the normalization rules is to preserve the utility’s incentive to invest through

enactment of the Investment Tax Credit and accelerated depreciation. “Recognizing that public

utility rates are set based on the utility’s costs incurred to provide the utility service, including

federal income tax expense, Congress enacted a set of rules to assure that some or all of the value

of the incentives it provided for capital investment would not be diverted from investment by

utilities to lower prices for consumption by customers of utilities.” Id.

       Here, MAWC continues to accelerate depreciation. MAWC witness Wilde testified that

MAWC expected American Water to be able to reflect all of the available accelerated depreciation

tax deductions associated with the 2018 ISRS plant additions on American Water’s 2018 tax

returns. Hence, MAWC will realize the benefits of this tax deduction. The real question posed by

MAWC is whether, in enacting normalization rules, Congress intended for zero revenue to be

imputed in ISRS computations so that a net operating loss for that investment will result, leading

to increased customer rates following ISRS proceedings so as to provide additional cost-free funds

to the utility. We cannot answer this question in the affirmative with the record before us. Because

it is undisputed that normalization resulted in cost-free investment funds being provided to the

utility long before the ISRS application at issue, we cannot say that failure to impute an NOL in

this ISRS proceeding thwarts the purpose of normalization.            Theoretically, incentive funds

previously received by the company are being used for this ISRS investment. Further, through the

                                                  14
ISRS process, the utility will still recover costs on the investment even if incentive funds are used

to support the investment.

        Collectively, the ISRS statutes permit the gas company [or water company] to make
        single-issue rate increases between general rate cases in order to timely recover its
        costs for certain … infrastructure projects without the time and expense required to
        prepare and file a general rate case, while, at the same time, limiting the collection
        of the ISRS surcharge to three years to prevent its unlimited use outside of a general
        rate case.

In re Laclede Gas Co., 417 S.W.3d at 821-822. Additionally, “[a]fter the PSC's initial approval of

an ISRS, the water corporation can file for permission to make periodic adjustments to the ISRS

to update the amount of the surcharge being collected.” Agnew v. Missouri-American Water

Company, 567 S.W.3d 652, 656 (Mo. App. 2018) (citing § 393.1006.5(2)).

        We find the Commission’s determination that no NOL was incurred by MAWC in the

relevant 2018 time period supported by substantial, competent evidence on the whole record and,

therefore, reasonable.4 MAWC’s first point on appeal is denied.

                                                  Point II

        In its second point on appeal, MAWC contends the Commission erred in not reflecting the

NOL identified by MAWC in its order arguing the order is unlawful because it focuses on the

company as a whole and fails to recognize the accumulated deferred income taxes specifically

associated with the eligible infrastructure system replacements as required by Section 393.1000.

MAWC argues that the Commission’s conclusions regarding MAWC not having an NOL in 2018

are irrelevant to the requirements of Section 393.1000(1)(a) which defines “Appropriate Pretax

Revenues” in part as:



     4
       MAWC appears to dispute only the reasonableness of the Commission’s order, not its lawfulness, in
MAWC’s first point on appeal.

                                                     15
       the revenues necessary to produce net operating income equal to: (a) The water
       corporation’s weighted cost of capital multiplied by the net original cost of eligible
       infrastructure system replacements, including recognition of accumulated deferred
       income taxes and accumulated depreciation associated with eligible infrastructure
       system replacements which are included in a currently effective ISRS.

(Emphasis added). MAWC argues that the Commission focuses on the tax status of MAWC as a

whole which necessarily means that MAWC’s investment tax impacts beyond the eligible

infrastructures system replacements were considered. MAWC argues that the Commission ignored

evidence provided by MAWC that relates specifically to the eligible infrastructure replacements.

       MAWC does not dispute the Commission’s finding that, “An NOL is a tax return

adjustment and not a regulatory item.” MAWC files a consolidated tax return with its parent

corporation, American Water Works. In MAWC’s response to Data Request No. 0005 regarding

“NOL Detail” and the question, “Is MAWC currently expected to generate additional NOL

amounts in 2018 and 2019 on an aggregate basis, or to use prior NOLs to offset taxable income in

2018 and 2019 in the aggregate?” MAWC stated:

               MAWC expects to use prior NOLs in 2018 and 2019 because it is part of its
       parent company’s, American Water Works (AWW), consolidated group which
       projects income for those tax years. AWW projects to use approximately $391
       million in 2018 and approximately $320 million in 2019. NOL usage is allocated
       based on an individual company’s NOL carryforward as a percentage of the total
       group’s NOL carryforward balance. For 2018, MAWC is estimated to be allocated
       approximately $56 million, which when tax-effected will reduce the deferred tax
       asset by approximately $11.7 million. For 2019, MAWC is estimated to be
       allocated approximately $45 million, which when tax-effected will reduce the
       deferred tax asset by approximately $9.5 million.

(Schedule LMF-d4). MAWC witness John Wilde testified that tax returns for 2018 would not be

filed until 2019. When asked, “An NOL is not attached to any certain infrastructure, any particular

asset?” he responded, “You’re correct with that.” Public Counsel’s tax expert John Riley testified

similarly, stating that, in contrast to identifying deferred tax liability to an asset, “an NOL is not


                                                 16
asset specific and cannot be tied to any specific ISRS qualifying or non-ISRS qualifying

infrastructure investment.”

       In response to Staff Data Request No. 0005, MAWC acknowledged that it expected to use

prior NOL balances in 2018 and 2019 because the consolidated tax group was projecting taxable

income for those years. MAWC also provided monthly balances of MAWC’s NOL deferred tax

asset starting December 31, 2017, thorough the most current available, and provided projected

monthly balances through December 31, 2019. (Schedule LMF-d3). These balances were

MAWC’s and the parent corporation’s estimates as to MAWC’s NOL Deferred Tax Asset balances

separate from the parent company. Yet, these NOL carryovers are technically not MAWC specific

because they are allocated to MAWC on a percentage basis from the parent company’s overall

NOL tally.

       The Commission found that MAWC provided no evidence to support that it would have an

NOL in 2018, and the evidence showed that, because MAWC was generating more revenue for

2018 than it was generating expenses qualifying for deductions, MAWC would be utilizing prior

NOL carryovers to offset its taxable income in 2018 and 2019. The Commission found that,

because no NOL was generated during the 2018 ISRS Period, the question of whether an NOL is

associated with the proposed ISRS is moot. We agree. Had there been evidence of an NOL,

Section 393.1000 would have necessarily required inquiry into whether the NOL generated could

be linked to eligible infrastructure system replacements.

       The statutory language requires recognition of “accumulated” deferred income taxes.

MAWC’s NOL deferred tax asset balance as of year-end 2017 was reflected in MAWC’s base rates

following the general rate case. MAWC evidence showed that no NOL had been generated after

that time, nor was any expected to be generated during the January 1, 2018 through September 30,

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2018 time frame. MAWC’s proposal to include an NOL amount in the ISRS was based on the

theory that the addition of ISRS plant to MAWC’s rate base without immediate receipt of new

revenues reduced its taxable income below the level that would result if the ISRS plant addition

had not been made. MAWC claimed this delayed the rate at which MAWC could utilize prior

accumulated NOLs as a carry-forward against future taxable income. Yet, direct rate recovery of

investment by a utility can only occur after that investment is in service; it must be used and useful.

State ex rel. Union Electric Co. v. Public Service Commission, 765 S.W.2d 618, 622 (Mo. App.

1988). Applying incremental tax deductions associated with new plant investments to zero

incremental revenue creates a hypothetical net operating loss but does not show whether the utility

is actually generating an NOL associated with that investment.

       The Commission heard MAWC’s evidence regarding delayed use of prior accumulated

NOLs as a result of the plant additions but found the evidence that MAWC was not generating or

booking any actual NOL during the ISRS period most compelling. Because MAWC’s calculations

regarding alleged NOLs associated with the specific plant improvements were hypothetical, we

cannot agree that the Commission’s reliance on actual data from MAWC which reflects that

MAWC as a whole, with the specific plant improvements incorporated into that data, accumulated

no NOL during the relevant time period was in error. MAWC had the burden of proof regarding

the amount of deferred income taxes associated with eligible infrastructure system replacements

being accumulated during the relevant time period.

       The Commission’s order which evaluated MAWC’s total NOL data in reaching the

conclusion that no NOL was accumulated during the ISRS Period was not unlawful. Deferred

income taxes and depreciation associated with eligible infrastructure system replacements were

not excluded from the ISRS computation. MAWC’s second point on appeal is denied.

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                                        Conclusion

       The Commission’s order is affirmed.




                                                  Anthony Rex Gabbert, Judge


All concur.




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