MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
TO: Patricia Dunmore, Founder & Chairperson, Dunmore Energy Holdings Ltd. James K. Winfield, CEO & President, Ridgeline Midstream Services LLC Angela Moretti, VP, Finance & Treasurer, Ridgeline Midstream Services LLC
FROM: George Trujillo, Responsible Partner, Calderwood & Harkness LLP Brett Callahan, Lead Associate, Calderwood & Harkness LLP
DATE: October 2024
RE: Income Tax Allowance Calculation — Ridgeline Midstream Services LLC; FERC Docket Nos. RP22-847-000 and RP22-847-001
C&H Matter No.: 1016-00005
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I. Executive Summary
This memorandum analyzes the income tax allowance ("ITA") component of Ridgeline Midstream Services LLC's ("Ridgeline") cost of service, as originally filed on May 12, 2022, and as revised in the current tariff redesign being prepared for submission in the rate proceeding pending before the Federal Energy Regulatory Commission ("FERC" or the "Commission") in Docket Nos. RP22-847-000 (rate case) and RP22-847-001 (interconnection authorization). The purpose of this memorandum is to provide a comprehensive analysis of the ITA methodology, its underlying tax rate assumptions, and the legal and regulatory framework supporting Ridgeline's entitlement to include the ITA in its cost of service, and to identify potential areas of challenge from intervenors and FERC Trial Staff.
In the original filing of May 12, 2022, Ridgeline proposed an ITA of $16.10 million, derived using the standard grossed-up methodology at an effective combined federal and state income tax rate of approximately 26.13%. That ITA was computed based on a proposed return on equity ("ROE") of 14.00%, which generated an equity return component of $47.15 million on the filed rate base of $612.40 million with a capital structure of 55% equity and 45% debt.
Under the revised tariff redesign currently being finalized, the ITA has been reduced to $15.04 million. This reduction is the direct consequence of the proposed reduction in ROE from 14.00% to 12.50%, which reduces the equity return component to $42.10 million and correspondingly reduces the taxable income to be grossed up. The effective combined tax rate of approximately 26.13% remains unchanged in the revised calculation. The revised ITA of $15.04 million represents a decrease of $1.06 million, or approximately 6.6%, from the original filing.
This memorandum addresses the following key analytical issues:
1. Grossed-Up Income Tax Allowance Methodology. The ITA is computed using the standard FERC grossed-up methodology, which ensures that the pipeline recovers sufficient revenue to cover both its after-tax cost of equity capital and the income tax obligation generated by the allowed equity return. We set forth the grossed-up formula, apply it to both the original and revised filings, and demonstrate the mathematical derivation of the $16.10 million and $15.04 million ITA figures.
2. Applicable Combined Effective Tax Rate. The combined effective income tax rate of approximately 26.13% reflects the 21% federal corporate income tax rate (per the Tax Cuts and Jobs Act of 2017) and the 6.5% West Virginia corporate net income tax rate, with the state tax treated as deductible for federal income tax purposes under the standard grossed-up methodology. We analyze potential issues concerning the exclusion of Pennsylvania tax from the combined rate calculation.
3. Partnership vs. Corporate Form Considerations. Ridgeline is a single-member Delaware limited liability company treated as a disregarded entity for federal income tax purposes, with all income flowing through to its sole member, Dunmore Energy Holdings Ltd. ("DEH"), a Cayman Islands exempted limited company. Under FERC's revised policy on income tax allowances for pass-through entities, Ridgeline is eligible for the full ITA because DEH bears an actual U.S. federal and West Virginia state income tax liability on the effectively connected income generated by Ridgeline's pipeline operations. We analyze the applicable FERC precedent and identify the anticipated challenges from intervenors regarding DEH's Cayman domicile.
4. Impact of the Revised ROE on the ITA. We present a sensitivity analysis demonstrating the effect on the ITA of the various ROE proposals advanced by the parties: Ridgeline's revised proposal of 12.50%, the Appalachian Transmission Pipeline Company ("ATPC") proposal of 10.75%, and the Marcellus Gas Producers Coalition ("MGPC") proposal of 11.25% (as advocated in the testimony of Dr. Eleanor Vasquez). We quantify the settlement implications of each scenario.
This analysis has been prepared in coordination with the revised cost-of-service workpapers being developed by Braswell Energy Consulting Group LLC ("Braswell" or "BEC") under Engagement No. BEC-2023-0041. Dr. Raymond Braswell, a former FERC economist serving as Lead Consultant on this engagement, has provided the underlying cost-of-service model and workpapers from which the revised ITA figure of $15.04 million is derived. Calderwood & Harkness LLP has independently verified the ITA calculation and confirms its consistency with FERC policy and applicable law.
This memorandum should also be read in the context of the FERC Deficiency Letter issued January 19, 2023, which identified fourteen deficiency items in Ridgeline's original filing. Although the ITA methodology itself was not specifically identified as a deficiency item, Deficiency Item 1 requested additional support for the proposed 14.00% ROE, which indirectly implicates the ITA calculation insofar as the ITA is a function of the equity return. The ITA is also subject to potential scrutiny by FERC Trial Staff (Lead Economic Analyst Dr. Miriam Okafor, Office of Energy Market Regulation), ATPC's counsel at Kellner, Royce & Dillard LLP (lead attorney William Pratt), and MGPC's rate expert Dr. Eleanor Vasquez. Our analysis identifies the areas of potential challenge and sets forth the recommended approach for addressing those challenges in the supplemental filing to be submitted by the current filing deadline of February 21, 2025.
II. Background
A. Ridgeline Midstream Services LLC — Entity Structure and Ownership
Ridgeline Midstream Services LLC is a Delaware limited liability company organized under the Delaware Limited Liability Company Act, 6 Del. C. § 18-101 et seq. Ridgeline maintains its principal office at 700 Kanawha Boulevard East, Suite 1400, Charleston, West Virginia 25301, and its registered agent in Delaware is Capitol Filings Inc., located at 1209 Orange Street, Wilmington, Delaware 19801.
Ridgeline's sole member is Dunmore Energy Holdings Ltd. ("DEH"), a Cayman Islands exempted limited company incorporated under the Companies Act (As Revised) of the Cayman Islands, registered with the Cayman Islands Registrar of Companies under Registry No. CR-381204. DEH's registered address is 4th Floor, Harbour Place, 103 South Church Street, George Town, Grand Cayman KY1-1002. DEH's controlling shareholder is Patricia Dunmore, who holds a 72% equity interest in DEH and also serves as the Founder and Chairperson of the DEH board of directors. Ms. Dunmore's dual role as the DEH controlling shareholder and the billing partner at Calderwood & Harkness LLP for this engagement has been disclosed and addressed pursuant to a conflict waiver memorandum executed by all relevant parties.
Ridgeline's Employer Identification Number for federal tax purposes is 87-4231956. As a single-member limited liability company, Ridgeline is treated as a disregarded entity for federal income tax purposes under Treasury Regulation § 301.7701-3(b)(1)(ii). Accordingly, DEH is the tax owner of Ridgeline's operations. All income and deductions attributable to Ridgeline's pipeline operations flow through to DEH and are reported on DEH's U.S. federal income tax return as effectively connected income. The income ultimately flows through to DEH's shareholders, including Ms. Dunmore, as discussed further in Section V below.
Ridgeline owns and operates the Ridgeline Pipeline System, a FERC-jurisdictional natural gas transmission pipeline. The Ridgeline Pipeline System consists of approximately 187 miles of 24-inch-diameter high-pressure natural gas pipeline extending from the Wetzel County Interconnect in Wetzel County, West Virginia, to the Waynesburg Compressor Station in Greene County, Pennsylvania. The pipeline has a design capacity of 1.2 billion cubic feet per day ("Bcf/d"), equivalent to 1,200,000 decatherms per day ("Dth/d"). Current throughput is approximately 680 million cubic feet per day ("MMcf/d"), representing a utilization rate of approximately 56.67% of design capacity.
The Ridgeline Pipeline System includes three compressor stations — the Wetzel Compressor Station, the Mannington Compressor Station, and the Waynesburg Compressor Station — with aggregate installed compression of 45,000 horsepower. The pipeline was placed into service on October 1, 2021, following completion of construction at an original construction cost of approximately $587.2 million.
Ridgeline provides Part 284, Subpart G open-access transportation service under its FERC Gas Tariff, Original Volume No. 1. Ridgeline's FERC Code is 960442. Transportation service is provided on a firm and interruptible basis pursuant to the standard form of service agreement included in Ridgeline's tariff.
B. Procedural Context
On May 12, 2022, Ridgeline filed its application with FERC seeking approval of its initial tariff rate and interconnection authorization under Sections 4 and 7 of the Natural Gas Act, 15 U.S.C. §§ 717c and 717f, and the implementing regulations at 18 C.F.R. Parts 154, 157, and 284. The filing was assigned Docket Nos. RP22-847-000 (rate case) and RP22-847-001 (interconnection authorization).
Several parties intervened in the proceeding during the summer of 2022. MGPC filed its notice of intervention on July 28, 2022. Clearwater Municipal Gas Authority ("CMGA") intervened on August 1, 2022. ATPC filed its protest and intervention on August 15, 2022, focusing principally on interconnection cost allocation issues (specifically the $14.7 million allocation of interconnection costs to ATPC shippers) but also generally challenging the proposed recourse rate as excessive. Each of these intervenors is discussed further in Section VIII below.
On January 19, 2023, FERC issued a Deficiency Letter identifying fourteen specific deficiency items in Ridgeline's original filing. Deficiency Item 1 requested additional support for the proposed ROE of 14.00%, including a detailed discounted cash flow ("DCF") analysis with an appropriate proxy group and risk premium study. Additional deficiency items addressed topics including the cost-of-service build-up, rate design methodology, billing determinants, the Form of Service Agreement, and various tariff provisions. Ridgeline filed a partial response on March 15, 2023, addressing eight of the fourteen deficiency items. The remaining six items, including Deficiency Item 1 regarding ROE support, have been deferred to the supplemental filing currently in preparation.
In view of the extensive additional work required to respond to the remaining deficiency items and to redesign the tariff, the proceeding has been subject to multiple extensions of the filing deadline. Administrative Law Judge Clara Whitfield issued an order on September 8, 2023, granting a second extension of the procedural schedule. A third extension was granted by order dated March 4, 2024, subject to conditions requiring quarterly status reports. The current filing deadline for Ridgeline's supplemental testimony and revised tariff filing is February 21, 2025.
Ridgeline engaged Braswell Energy Consulting Group LLC on April 15, 2023, to assist with the tariff redesign and revised cost-of-service analysis. Dr. Raymond Braswell, a former FERC economist with extensive experience in natural gas pipeline rate proceedings, serves as the Lead Consultant on the engagement (BEC Engagement No. BEC-2023-0041). Dr. Braswell and his team have prepared revised cost-of-service workpapers that form the basis for the revised ITA calculation discussed in this memorandum.
With respect to the ROE dispute — which directly drives the ITA calculation — the positions of the principal parties are as follows:
• Ridgeline originally proposed an ROE of 14.00% in its May 2022 filing. Under the tariff redesign, Ridgeline's revised proposal is an ROE of 12.50%, based on an updated DCF proxy group analysis as of the third quarter of 2024, as reflected in the Braswell workpapers and the Calderwood & Harkness DCF analysis memorandum prepared separately.
• ATPC has proposed an ROE of 10.75%, which it contends is more consistent with the returns earned by comparable natural gas pipelines and reflects Ridgeline's relatively low risk profile as a new-build pipeline in the Appalachian Basin.
• MGPC, through the pre-filed testimony of Dr. Eleanor Vasquez filed on January 9, 2023, has proposed an ROE of 11.25%, which Dr. Vasquez derived from a median DCF analysis of a proxy group of seven natural gas pipeline limited partnerships.
Four settlement conferences have been held before Settlement Judge Howard Margolis on November 30, 2022; March 8, 2023; July 12, 2023; and January 18, 2024. No settlement has been reached to date. The settlement implications of the ITA analysis are discussed in Section IX of this memorandum.
C. The Income Tax Allowance in FERC Rate-Making
Under FERC cost-of-service rate-making, a regulated natural gas pipeline is permitted to include an income tax allowance as a component of its cost of service. The ITA is designed to compensate the pipeline's owners for the income tax obligation generated by the allowed return on equity. Without the ITA, the equity owners would receive only an after-tax return that is insufficient to compensate them for the income taxes owed on the pipeline income, effectively reducing the equity return below the authorized level.
The ITA is calculated using a "grossed-up" methodology. The gross-up ensures that the pipeline recovers sufficient revenue to cover both its after-tax cost of equity capital and the associated income taxes, so that the equity owners receive the full authorized return after payment of all income taxes. In economic terms, the grossed-up ITA converts the authorized after-tax equity return to a pre-tax equity return, with the difference constituting the ITA.
The ITA is a function of three principal variables: (1) the authorized return on equity, (2) the applicable income tax rate or rates (both federal and state), and (3) the equity component of the pipeline's capital structure, applied to the rate base. Because interest on debt is deductible for income tax purposes, the ITA is computed only on the equity portion of the allowed return; the debt component of the capital structure does not generate an ITA requirement.
The authority for inclusion of the ITA in cost of service is well established under Section 4 of the Natural Gas Act, 15 U.S.C. § 717c, and the Commission's regulations at 18 C.F.R. Part 154. The methodology for computing the ITA has been the subject of extensive FERC policy guidance, including the FERC Statement of Policy on Income Tax Allowances in Docket No. PL17-1-000 (as revised), which addressed the treatment of the ITA for partnerships and other pass-through entities. That policy, and its application to Ridgeline's organizational structure, is discussed in detail in Section V below.
III. Applicable Income Tax Rates
A. Federal Income Tax Rate
The applicable federal corporate income tax rate for purposes of the ITA calculation is 21%. This rate was established by the Tax Cuts and Jobs Act of 2017 ("TCJA"), Pub. L. 115-97, which amended Section 11(b) of the Internal Revenue Code to impose a flat federal corporate income tax rate of 21%, effective for taxable years beginning after December 31, 2017. The TCJA replaced the prior graduated corporate rate structure, which had included a top marginal rate of 35%.
Although Ridgeline is organized as a limited liability company and is treated as a pass-through entity (specifically, a disregarded entity) for federal income tax purposes, the ITA calculation under FERC policy uses the statutory corporate income tax rate as the proxy rate for grossing up the equity return. This approach is consistent with FERC's recognition that the income flowing through a pass-through entity to its partners or members is ultimately subject to income tax at the partner or member level, and the statutory corporate rate provides an appropriate benchmark for determining the ITA. The partnership-form considerations that may affect ITA eligibility are analyzed separately in Section V of this memorandum.
It bears noting that the TCJA also repealed the corporate alternative minimum tax ("AMT") effective for taxable years beginning after December 31, 2017 (although a new corporate alternative minimum tax based on adjusted financial statement income was enacted as part of the Inflation Reduction Act of 2022 for corporations with average annual adjusted financial statement income exceeding $1 billion, which is not applicable to DEH or Ridgeline). The repeal of the AMT simplifies the ITA analysis, as there is no need to consider an alternative minimum tax rate in the grossed-up methodology.
B. West Virginia State Income Tax Rate
The applicable West Virginia corporate net income tax rate is 6.5%, as set forth in West Virginia Code § 11-24-4. Ridgeline's principal office is located in Charleston, West Virginia. The pipeline's receipt point is at the Wetzel County Interconnect in Wetzel County, West Virginia, and a significant portion of the pipeline's 187-mile route traverses West Virginia. Ridgeline's operations, including the operation and maintenance of the Wetzel and Mannington Compressor Stations, are substantially conducted within West Virginia.
West Virginia imposes its corporate net income tax on the income of corporations and other entities doing business in the state, with income apportioned to West Virginia based on the standard three-factor apportionment formula considering the taxpayer's property, payroll, and sales within the state as a proportion of total property, payroll, and sales. For a pipeline with the substantial physical presence and operational activity within West Virginia that Ridgeline maintains, a significant portion of income is apportioned to West Virginia.
For purposes of the cost-of-service ITA calculation, the full 6.5% West Virginia state income tax rate is applied. Under the standard grossed-up methodology, the state income tax is treated as a deduction in computing federal taxable income, because state income taxes are deductible for federal income tax purposes. This tax deductibility is reflected in the effective combined tax rate derivation, as set forth in Section III.C below.
C. Effective Combined Tax Rate Derivation
The effective combined federal and state income tax rate used in the grossed-up ITA calculation is derived using the following standard formula, which accounts for the deductibility of state income taxes in computing federal taxable income:
Effective Combined Rate = State Rate + Federal Rate × (1 − State Rate)
Applying this formula to Ridgeline's applicable tax rates:
Effective Combined Rate = 6.5% + 21% × (1 − 6.5%)
= 6.5% + 21% × 93.5%
= 6.5% + 19.635%
= 26.135%
≈ 26.13% (rounded)
This effective combined rate of approximately 26.13% is used in both the original and revised ITA calculations. The rate reflects the tax benefit that arises from the deductibility of state income taxes against federal income. Importantly, the effective combined rate is not a simple addition of the federal and state rates (which would yield 21% + 6.5% = 27.5%), but rather accounts for the interaction between the two tax layers. The deductibility of the 6.5% state tax reduces the effective federal rate from 21.0% to approximately 19.635%, producing a combined effective rate that is lower than the arithmetic sum.
A detailed worksheet deriving the effective combined tax rate is set forth in Appendix C to this memorandum.
D. Pennsylvania Tax Considerations
A portion of the Ridgeline Pipeline System traverses Greene County, Pennsylvania, and the pipeline's delivery point at the Waynesburg Compressor Station is located within that state. Pennsylvania imposes a Corporate Net Income Tax at a statutory rate of 9.99%, although this rate is currently being phased down pursuant to Act 53 of 2022, which provides for annual reductions of 0.5 percentage points beginning in 2023, with a target rate of 4.99% by 2031.
Notwithstanding Ridgeline's physical presence in Pennsylvania, the filing uses only the West Virginia state rate of 6.5% in the combined effective rate calculation. This approach is based on the determination that West Virginia is the primary income tax jurisdiction for Ridgeline's operations, given that Ridgeline's principal office is located in Charleston, West Virginia; the pipeline's receipt point and the majority of pipeline mileage are within West Virginia; and the majority of Ridgeline's employees and operational activities are situated in West Virginia.
This is a simplifying assumption, and we note that it may be subject to challenge by intervenors or FERC Trial Staff. If Pennsylvania tax were included in the effective combined rate calculation, an apportionment analysis would be required to determine the portion of Ridgeline's income properly attributable to Pennsylvania operations. Depending on the apportionment methodology and the relative weight assigned to Pennsylvania factors, the inclusion of Pennsylvania tax could increase the effective combined rate. However, an increase in the effective tax rate would increase the ITA, which would be adverse to intervenors seeking a lower cost of service.
We note this as a potential area of inquiry from FERC Trial Staff, and particularly from Dr. Miriam Okafor, the Lead Economic Analyst assigned to this proceeding. Should the question arise, we recommend presenting a supplemental analysis demonstrating that the use of the West Virginia rate alone produces a conservative (lower) ITA, and that inclusion of Pennsylvania tax on an apportioned basis would increase, not decrease, the ITA. This framing should be persuasive in deflecting any challenge from intervenors who are principally motivated to reduce the overall cost of service.
IV. Grossed-Up Income Tax Allowance Methodology
A. Overview of the Grossed-Up Approach
The grossed-up income tax allowance methodology is the standard approach used in FERC cost-of-service rate-making to ensure that a regulated pipeline recovers sufficient revenue to cover both its after-tax cost of equity capital and the income taxes associated with the authorized equity return. The objective of the gross-up is straightforward: if the pipeline's equity owners are authorized to earn a return of r on the equity component of the rate base, the pipeline must collect not only r but also the income taxes that will be owed on that return, so that after paying taxes, the equity owners receive the full authorized return.
Because interest on debt is deductible for federal and state income tax purposes, the ITA is computed only on the equity portion of the allowed return. The debt component of the capital structure does not generate an income tax obligation (beyond any limitations on interest deductibility, which are not at issue here), and therefore no gross-up is required for the debt return.
The standard gross-up formula is expressed as follows:
ITA = (Equity Return × Effective Tax Rate) ÷ (1 − Effective Tax Rate)
This formula can alternatively be expressed as:
Pre-Tax Equity Return = After-Tax Equity Return ÷ (1 − Effective Tax Rate)
ITA = Pre-Tax Equity Return − After-Tax Equity Return
Both expressions produce the same result. The denominator (1 − Effective Tax Rate) in the gross-up formula is necessary because the ITA itself is taxable income — that is, the pipeline must also pay income taxes on the additional revenue collected to cover the ITA. The gross-up formula captures this "tax-on-tax" effect, ensuring that the pipeline recovers the full amount needed to satisfy its income tax obligation on the equity return.
B. Original Filing Calculation (May 2022)
In the original filing of May 12, 2022, the ITA was computed as follows, based on the rate base, capital structure, and return parameters set forth in the pre-filed direct testimony of Angela Moretti filed on December 5, 2022, and the accompanying Exhibit Nos. A through P workpapers.
Rate Base. The rate base as filed was $612.40 million, consisting of the following components:
• Net plant in service: $563.71 million (original construction cost of $587.2 million less accumulated depreciation of $23.49 million)
• Working capital allowance: $18.64 million
• Accumulated deferred income taxes ("ADIT"): ($12.45 million) (a reduction to rate base)
• Other rate base items (including gas stored, prepayments, materials and supplies): $42.50 million
Capital Structure. Ridgeline's capital structure consists of 55% equity and 45% debt. The equity component is the DEH equity contribution and retained earnings attributable to Ridgeline's operations. The debt component reflects the weighted average of Ridgeline's outstanding indebtedness, consisting of a $400 million term loan arranged by Pinnacle Capital Markets (bearing interest at SOFR plus 325 basis points) and $150 million in 7.875% Second Lien Notes held by Harborview Capital Management LLC and Sentinel Ridge Fund LP.
Proposed ROE. The original filing proposed an ROE of 14.00%.
Cost of Debt. The weighted average cost of debt was 5.25%, reflecting the blended rate on the term loan and the Second Lien Notes.
Weighted Average Cost of Capital ("WACC"). The WACC was computed as:
WACC = (0.55 × 14.00%) + (0.45 × 5.25%)
= 7.70% + 2.3625%
= 10.0625%
Total Return on Rate Base. The total dollar return on rate base was:
$612.40M × 10.0625% = $61.62 million
Equity Return Component. The equity return component — that is, the portion of the total return attributable to the equity investors — was:
$612.40M × 55% × 14.00% = $612.40M × 7.70% = $47.15 million
Grossed-Up ITA Computation. The grossed-up ITA was computed as follows:
ITA = $47.15M × 26.13% ÷ (1 − 26.13%)
= $47.15M × 0.2613 ÷ 0.7387
= $12.32M ÷ 0.7387
= approximately $16.67 million on a pure gross-up basis
However, the pure gross-up amount of $16.67 million is subject to certain adjustments that reduce the filed ITA. These adjustments include the normalization of accelerated depreciation benefits (reflecting the ADIT offset), adjustments for investment tax credits, and other timing differences between book and tax depreciation. After these adjustments, the ITA as filed was $16.10 million, as reflected in the workpapers accompanying Ms. Moretti's pre-filed direct testimony.
Cost-of-Service Reconciliation. The $16.10 million ITA figure reconciles with the total cost-of-service build-up as originally filed:
C. Revised Calculation (Tariff Redesign, October 2024)
Under the tariff redesign currently being finalized in coordination with Braswell Energy Consulting Group LLC, the ITA has been recalculated to reflect the proposed reduction in ROE from 14.00% to 12.50%. The revised calculation is as follows.
Rate Base. The rate base remains $612.40 million. The revised filing uses the same test year rate base as the original filing; no adjustment to rate base has been proposed in the tariff redesign. Although certain rate base components (such as accumulated depreciation and ADIT) may have changed since the original filing date due to the passage of time, the tariff redesign maintains the original test year rate base for consistency and to avoid reopening issues that were not identified as deficiency items.
Capital Structure. The capital structure remains 55% equity and 45% debt, unchanged from the original filing.
Revised ROE. The proposed ROE has been reduced from 14.00% to 12.50%. This reduction reflects an updated DCF proxy group analysis as of the third quarter of 2024, prepared by Dr. Braswell and independently reviewed by Calderwood & Harkness LLP, as described in a separate memorandum on the DCF analysis. The revised ROE of 12.50% represents a 150-basis-point reduction from the originally proposed rate.
Cost of Debt. The weighted average cost of debt remains 5.25%, reflecting the same debt instruments as described in Section IV.B above.
Revised WACC. The revised WACC is computed as:
WACC = (0.55 × 12.50%) + (0.45 × 5.25%)
= 6.875% + 2.3625%
= 9.2375%
Revised Total Return on Rate Base. The revised total dollar return on rate base is:
$612.40M × 9.2375% = $56.57 million
Revised Equity Return Component. The revised equity return component is:
$612.40M × 55% × 12.50% = $612.40M × 6.875% = $42.10 million
Revised Grossed-Up ITA Computation. The revised grossed-up ITA is computed as follows:
ITA = $42.10M × 26.13% ÷ (1 − 26.13%)
= $42.10M × 0.2613 ÷ 0.7387
= $11.00M ÷ 0.7387
= approximately $14.89 million on a pure gross-up basis
As with the original filing, the pure gross-up amount is subject to adjustments for ADIT normalization and timing differences. These adjustments have been applied consistently with the original methodology. After adjustments, the revised ITA is $15.04 million, as reflected in the Braswell workpapers (BEC Engagement No. BEC-2023-0041).
Revised Cost-of-Service Reconciliation. The revised $15.04 million ITA figure reconciles with the revised total cost-of-service build-up:
The reduction in the ITA from $16.10 million to $15.04 million — a decrease of $1.06 million, or approximately 6.6% — is directly and entirely attributable to the 150-basis-point reduction in proposed ROE from 14.00% to 12.50%. Because the ITA is a function of the equity return, a lower ROE produces a lower equity return and correspondingly less taxable income to be grossed up, resulting in a lower ITA. The effective combined tax rate, the capital structure, and the rate base — the other variables in the ITA formula — are unchanged between the two filings.
It should be noted that while the ITA decreased by $1.06 million, the revised total cost of service actually increased from $97.36 million to $103.15 million, an increase of $5.79 million. This increase is driven primarily by the significant reduction in revenue credits from $16.10 million to $6.00 million (a $10.10 million reduction), which more than offsets the decreases in the return on rate base ($5.05 million reduction) and the ITA ($1.06 million reduction), as well as the increases in O&M and A&G expenses. The interaction between revenue credits and the ITA is discussed further in Section VII.
D. Sensitivity Analysis — ITA Under Intervenor ROE Proposals
Because the ITA is a function of the equity return, which is itself a function of the authorized ROE, it is useful to present a sensitivity analysis showing the approximate ITA that would result under the various ROE proposals advanced by the parties. This analysis uses the same rate base ($612.40 million), capital structure (55% equity / 45% debt), and effective combined tax rate (approximately 26.13%) as the revised filing, varying only the ROE.
ATPC Proposed ROE of 10.75%. If ATPC's proposed ROE of 10.75% were adopted:
Equity Return = $612.40M × 55% × 10.75% = $36.21 million
ITA (grossed-up, approximate) = $36.21M × 0.2613 ÷ 0.7387 ≈ $12.81 million
Impact: approximately $2.23 million reduction from the revised ITA of $15.04 million
MGPC Proposed ROE of 11.25% (Dr. Eleanor Vasquez Testimony). If MGPC's proposed ROE of 11.25% were adopted:
Equity Return = $612.40M × 55% × 11.25% = $37.89 million
ITA (grossed-up, approximate) = $37.89M × 0.2613 ÷ 0.7387 ≈ $13.40 million
Impact: approximately $1.64 million reduction from the revised ITA of $15.04 million
Implications for Settlement and Hearing. The ITA is a derivative component of the cost of service — it is driven entirely by the ROE, and the primary substantive dispute among the parties is over the appropriate ROE level. However, the ITA amplifies the revenue impact of each basis point change in ROE due to the gross-up multiplier effect. Specifically, each 100 basis points of ROE change produces an equity return change of approximately $3.37 million ($612.40M × 55% × 1.00%), which, when grossed up at the 26.13% effective combined rate, yields an ITA change of approximately $1.19 million. This multiplier means that the ITA magnifies the stakes of the ROE dispute, and this dynamic should be considered in both hearing strategy and settlement negotiations.
A complete sensitivity table is presented in Appendix B to this memorandum.
V. Partnership vs. Corporate Form Considerations
A. FERC Policy on Income Tax Allowance for Pass-Through Entities
The eligibility of partnerships, limited liability companies, and other pass-through entities to include an income tax allowance in their FERC-jurisdictional cost of service has been the subject of significant regulatory evolution over the past two decades. This issue is directly relevant to Ridgeline, which is organized as a Delaware limited liability company treated as a disregarded entity for federal income tax purposes.
The foundational FERC precedent in this area arose from the Commission's consideration of whether pass-through entities could claim an ITA when those entities themselves do not pay income taxes at the entity level. Prior to the development of FERC's current policy, there was concern that permitting a pass-through entity to include an ITA in cost of service could result in "double recovery" — that is, the pipeline would recover income tax costs through the ITA while its partners or members might also receive the benefit of pass-through tax attributes (such as depreciation deductions and tax credits) that offset their individual income tax obligations.
The key FERC precedents that have shaped the current policy include the following:
FERC's 2005 Policy Statement on Income Tax Allowances (Docket No. PL17-1-000). In this policy statement, FERC addressed the concern about double recovery by establishing a framework under which partnerships and other pass-through entities could claim an ITA only to the extent that their partners or members demonstrated an actual or potential income tax liability on the partnership income. The Commission required pass-through entities seeking an ITA to provide evidence that their owners bear income tax obligations at the partner or member level. This policy effectively eliminated the blanket exclusion of pass-through entities from ITA eligibility while also guarding against double recovery.
*ExxonMobil Oil Corp. v. FERC and Related Litigation. The Commission's policy was tested in a series of judicial challenges. In ExxonMobil Oil Corp. v. FERC*, the court reviewed FERC's approach to the ITA for pipelines organized as master limited partnerships ("MLPs"), where the publicly traded limited partnership units were held by a mixture of taxable and tax-exempt investors. The court's analysis focused on whether the pipeline had adequately demonstrated that its partners bore actual income tax liabilities.
*Sterling Reach Holdings, Inc. v. FERC (D.C. Circuit).* The D.C. Circuit upheld FERC's revised policy requiring pipelines organized as partnerships or LLCs to affirmatively demonstrate that their partners or members bear an income tax liability on the partnership income. The court found that FERC's approach was a reasonable exercise of its rate-making authority and that the Commission had adequately balanced the interests of pipelines and shippers by tying ITA eligibility to demonstrated partner-level tax liability rather than entity-level tax status.
FERC's 2018 Revised Policy Statement (Post-TCJA). Following the enactment of the TCJA, which reduced the federal corporate rate from 35% to 21%, FERC issued a revised policy statement providing further guidance on ITA eligibility for pass-through entities. The revised policy reiterated the requirement that pass-through entities must make an affirmative showing that their partners or members bear an actual income tax liability on the pipeline income. The policy also addressed the treatment of excess ADIT resulting from the TCJA rate reduction, a topic discussed in Section VI below.
Under the current state of FERC policy, a pipeline organized as a partnership or LLC is eligible for the ITA if and to the extent that its partners or members bear an actual or potential income tax liability on the income generated by the pipeline's operations. The burden is on the pipeline to make this showing through appropriate documentary evidence, such as tax returns, affidavits, or certifications from the pipeline's officers or auditors.
B. Application to Ridgeline's Structure
Applying FERC's current policy to Ridgeline's organizational structure, we conclude that Ridgeline is eligible for the full ITA. The analysis proceeds as follows.
Ridgeline Midstream Services LLC is a single-member Delaware LLC. As a single-member LLC, Ridgeline is classified as a disregarded entity for federal income tax purposes under Treasury Regulation § 301.7701-3(b)(1)(ii). This means that Ridgeline does not file a separate federal income tax return; instead, all of Ridgeline's income, deductions, gains, losses, and credits are reported on the tax return of its sole member, Dunmore Energy Holdings Ltd.
DEH is a Cayman Islands exempted limited company. The Cayman Islands does not impose an income tax, and therefore DEH does not pay income tax in its jurisdiction of incorporation. However, this fact is not dispositive under FERC's ITA policy, which focuses on whether the partner or member bears a U.S. income tax liability on the pipeline income.
DEH is classified as a foreign corporation for U.S. federal income tax purposes. As the sole owner of Ridgeline, a U.S. business enterprise, DEH is engaged in a trade or business within the United States through its ownership and operation of the Ridgeline Pipeline System. The income generated by Ridgeline's pipeline operations constitutes "effectively connected income" ("ECI") under Sections 871 and 882 of the Internal Revenue Code. ECI of a foreign corporation is subject to the regular U.S. federal corporate income tax rate of 21% under IRC § 882(a)(1).
DEH files U.S. federal income tax returns (Form 1120-F) reporting its ECI from Ridgeline's operations and pays U.S. federal income taxes on that income. DEH also has a filing obligation in West Virginia and pays West Virginia corporate net income tax on the portion of its income apportioned to West Virginia. Accordingly, DEH demonstrably bears an actual income tax liability — at both the federal and state levels — on the income generated by Ridgeline's pipeline operations.
Furthermore, DEH's controlling shareholder is Patricia Dunmore, who holds a 72% equity interest in DEH. Ms. Dunmore is a U.S. person. To the extent that DEH distributes income to Ms. Dunmore, that income may also be subject to individual income tax at the shareholder level. While the relevant analysis under FERC policy focuses on the member level (DEH) rather than the ultimate shareholder level (Ms. Dunmore), the fact that the ultimate beneficial owner is a U.S. taxpayer provides additional assurance that the pipeline income is subject to U.S. income tax.
Based on this analysis, we conclude that Ridgeline satisfies the requirements of FERC's revised policy on income tax allowances for pass-through entities. Ridgeline's sole member, DEH, bears an actual U.S. federal income tax liability (at the 21% statutory rate) and West Virginia state income tax liability (at the 6.5% rate) on 100% of the income generated by Ridgeline's pipeline operations. There is no issue of partial ITA eligibility (which could arise in a partnership with a mix of taxable and tax-exempt partners), because DEH is the sole member and bears income tax liability on the entirety of the pipeline income.
To support this conclusion in the FERC proceeding, we recommend that the following documentation be prepared and included in the supplemental filing:
• Audited financial statements of DEH prepared by Ashford & McBride LLP (DEH's independent auditors), which reflect DEH's U.S. income tax liability on Ridgeline-sourced ECI.
• DEH's U.S. federal income tax returns (Form 1120-F), or a summary thereof prepared by counsel, for tax years 2021, 2022, and 2023, demonstrating the reporting of ECI and the payment of U.S. federal income taxes.
• An affidavit or certificate from Angela Moretti, VP Finance & Treasurer of Ridgeline, confirming that (a) all income from Ridgeline's operations flows through to DEH; (b) DEH reports such income as ECI on its U.S. federal income tax returns; and (c) DEH bears an actual U.S. federal income tax liability at the statutory rate of 21% and a West Virginia state income tax liability at the rate of 6.5% on the pipeline income.
C. Potential Challenges from Intervenors and FERC Staff
Although the ITA eligibility analysis is well-supported under current FERC policy, we anticipate that intervenors and potentially FERC Trial Staff may raise challenges to Ridgeline's entitlement to the ITA, focusing on the Cayman Islands domicile of DEH. We identify the anticipated challenges and our recommended responses below.
ATPC Challenge. ATPC, through its counsel at Kellner, Royce & Dillard LLP (lead attorney William Pratt), may argue that DEH, as a Cayman Islands exempted limited company, does not pay income taxes in its home jurisdiction and should therefore not be treated as a taxpaying member for purposes of the ITA analysis. This argument may be framed as an assertion that a tax-haven-domiciled parent entity should not be permitted to claim the benefit of a U.S. income tax allowance.
Response. This argument misapprehends the relevant inquiry under FERC policy. The FERC policy on ITA eligibility for pass-through entities does not require that the partner or member pay income taxes in its jurisdiction of domicile. Rather, the inquiry is whether the partner or member bears a U.S. income tax liability on the partnership income. DEH's ECI from Ridgeline's operations is subject to the U.S. federal corporate income tax at the 21% rate under IRC § 882(a)(1), regardless of whether DEH pays taxes in the Cayman Islands. The Cayman Islands' status as a jurisdiction without an income tax is irrelevant to the analysis of DEH's U.S. tax obligations. DEH's U.S. tax returns and payment records conclusively demonstrate its actual U.S. tax liability.
MGPC Challenge. MGPC, through its counsel at Whitmore & Sable LLP (lead attorney Rebekah Montague) and its rate expert Dr. Eleanor Vasquez, may argue for a reduced ITA. However, MGPC's position is primarily a derivative challenge: MGPC advocates for a lower ROE (11.25%), which would mechanically reduce the ITA. MGPC has not, to our knowledge, independently challenged the grossed-up methodology or the effective tax rate. To the extent that MGPC raises the partnership-form issue, the response outlined above applies equally.
FERC Trial Staff. FERC Trial Staff, and particularly Lead Economic Analyst Dr. Miriam Okafor, may request additional documentation of DEH's actual U.S. tax payments to verify the ITA eligibility showing. This is a legitimate and anticipated request rather than a hostile challenge. We recommend proactive engagement with this issue by including robust documentation in the supplemental filing, as described in Section V.B above, and by offering supplemental testimony from Angela Moretti presenting DEH's tax payment history and projected obligations. Lead Trial Attorney Jonathan Briggs may also coordinate with Dr. Okafor on data requests concerning DEH's tax status, and we should be prepared to respond promptly and comprehensively.
Overall Risk Assessment. We assess the risk to Ridgeline's ITA eligibility as moderate. The legal and factual basis for the ITA is sound under current FERC policy. DEH bears an actual, demonstrable U.S. income tax liability on the pipeline income, which is the controlling factor under the Commission's revised policy. However, the Cayman Islands domicile of DEH creates unfavorable optics that intervenors may seek to exploit, particularly in the context of broader public scrutiny of offshore corporate structures. We recommend preparing a robust evidentiary record that preempts these challenges and demonstrates unequivocally that the pipeline income is subject to U.S. income taxation at the member level.
D. Recommended Approach for Supplemental Filing
Based on the foregoing analysis, we recommend the following approach for addressing the partnership-form ITA eligibility issue in the supplemental filing being prepared for the February 21, 2025 deadline.
Supplemental Pre-Filed Testimony of Angela Moretti. Ms. Moretti's supplemental testimony, which is currently being drafted, should include the following elements related to the ITA:
• An exhibit presenting DEH's U.S. federal income tax returns (Form 1120-F), or a summary thereof, for tax years 2021, 2022, and 2023. The exhibit should demonstrate that DEH reported effectively connected income from Ridgeline's operations and paid U.S. federal income taxes on that income. If confidentiality concerns preclude the filing of full tax returns, we recommend filing a summary prepared by counsel with the full returns available for in camera review.
• A certificate signed by Ms. Moretti confirming that all income from Ridgeline's pipeline operations flows through to DEH and is included in DEH's U.S. federal and West Virginia state income tax returns.
• A statement confirming that DEH bears an actual income tax liability at the applicable federal rate of 21% and the West Virginia state rate of 6.5% on the income generated by Ridgeline's operations.
• A table or schedule showing DEH's actual U.S. federal and West Virginia state income tax payments for tax years 2021 through 2023, and projected payments for 2024.
Supplemental Pre-Filed Testimony of Dr. Natasha Orlov. Dr. Orlov's supplemental testimony, which is also being prepared for the February 21, 2025 filing, should include the following elements:
• A clear and comprehensive explanation of the grossed-up income tax allowance methodology, including the mathematical derivation of the gross-up formula and its application to Ridgeline's cost of service.
• The complete derivation of the $15.04 million revised ITA, with supporting workpapers showing each step of the calculation, including the adjustments for ADIT normalization and timing differences.
• A discussion of FERC precedent supporting the ITA for pass-through entities whose partners or members bear an actual income tax liability, with citations to the Policy Statement in Docket No. PL17-1-000, the 2018 Revised Policy Statement, and the relevant judicial decisions.
• A sensitivity analysis showing the ITA under various ROE assumptions, consistent with the analysis in Section IV.D of this memorandum and Appendix B.
VI. ADIT and Deferred Tax Considerations
A. Accumulated Deferred Income Taxes (ADIT)
The accumulated deferred income taxes ("ADIT") balance reflected in Ridgeline's rate base is ($12.45 million), which operates as a reduction to the rate base. The ADIT represents the cumulative difference between income taxes computed on a book basis and income taxes actually paid, arising from the use of different depreciation methods for book and tax purposes.
For book purposes (i.e., for regulatory accounting and cost-of-service purposes), Ridgeline depreciates its plant in service using the straight-line method at a rate of 2.5% per annum. This depreciation rate, applied to the original construction cost of $587.2 million, yields annual book depreciation expense of approximately $14.68 million, consistent with an assumed useful life of 40 years for the pipeline assets.
For tax purposes, Ridgeline claims accelerated depreciation under the Modified Accelerated Cost Recovery System ("MACRS"), as provided in IRC § 168. The MACRS depreciation schedule produces higher depreciation deductions in the early years of an asset's life and lower deductions in later years, relative to straight-line depreciation. In the early years of the Ridgeline Pipeline System's operation (the pipeline entered service on October 1, 2021), the MACRS depreciation deductions exceed the straight-line book depreciation, resulting in a lower current tax liability than would be indicated by the book income. The difference between the tax computed on book income and the actual tax liability creates the ADIT balance.
The ADIT reduces the rate base because it represents a source of cost-free capital effectively provided by ratepayers. When accelerated depreciation produces tax savings in the early years, those savings are treated as if the ratepayers have provided capital to the pipeline — capital on which the pipeline should not be permitted to earn a return. By deducting the ADIT from the rate base, the Commission ensures that ratepayers do not bear the cost of capital associated with this tax-derived funding source.
FERC normalization requirements, codified at 18 C.F.R. § 154.305 and consistent with the normalization provisions of IRC § 168(i)(9), require Ridgeline to normalize the tax benefits of accelerated depreciation. This means that Ridgeline may not "flow through" the benefits of accelerated depreciation to ratepayers in the period in which those benefits are realized; instead, the benefits are accumulated in the ADIT balance and reflected in the rate base reduction. The normalization approach ensures a more stable and predictable cost of service over the life of the pipeline assets.
The ADIT balance will change over time as the relationship between tax depreciation and book depreciation evolves. In the early years of the pipeline's life, when MACRS depreciation exceeds straight-line depreciation, the ADIT balance will increase, further reducing the rate base. In later years, when MACRS depreciation falls below straight-line depreciation, the ADIT balance will begin to decrease, and the rate base will recover accordingly. These changes will be reflected in any future rate case or Section 5 complaint proceeding, but the current filing uses the test year ADIT balance of ($12.45 million).
B. Impact of TCJA and Excess ADIT
The Tax Cuts and Jobs Act of 2017 reduced the federal corporate income tax rate from 35% to 21%, effective for taxable years beginning after December 31, 2017. For regulated pipelines that had accumulated ADIT balances computed at the pre-TCJA rate of 35%, the rate reduction created "excess ADIT" — that is, ADIT balances that exceeded the amount that would have been accumulated had the 21% rate been in effect from the beginning.
FERC addressed this issue by requiring pipelines to amortize excess ADIT over the remaining useful lives of the underlying assets, using the Average Rate Assumption Method ("ARAM") prescribed by IRC § 168(i)(9)(B). The ARAM methodology requires that excess ADIT be returned to ratepayers no more rapidly than would be permitted under the normalization rules, ensuring compliance with the statutory constraints on the flow-through of tax benefits.
This issue does not arise in Ridgeline's case. The Ridgeline Pipeline System entered service on October 1, 2021, well after the effective date of the TCJA. Accordingly, all of Ridgeline's ADIT has been computed at the current federal rate of 21% from inception. There is no pre-TCJA ADIT balance, and therefore no excess ADIT requiring amortization under the ARAM methodology.
This simplifies the deferred tax analysis considerably and avoids the excess ADIT amortization requirements that have generated significant regulatory proceedings and compliance obligations for older pipelines. The absence of excess ADIT also eliminates a potential source of challenge from intervenors or FERC Trial Staff, as there is no question about the adequacy or methodology of Ridgeline's excess ADIT amortization.
VII. Revenue Credits and Their Interaction with ITA
The interaction between revenue credits and the income tax allowance warrants brief discussion, both to clarify the mechanics of the cost-of-service calculation and to address the superficial numerical coincidence in the original filing.
In the original filing of May 2022, revenue credits of ($16.10 million) were applied as an offset against the gross cost-of-service components, yielding a net total cost of service of $97.36 million. In the revised tariff redesign, revenue credits have been reduced to ($6.00 million), which increases the net total cost of service to $103.15 million.
The reduction in revenue credits from $16.10 million to $6.00 million — a decrease of $10.10 million — is a significant driver of the increase in the revised total cost of service. This reduction is independent of the ITA calculation and reflects changes in the revenue credit assumptions underlying the tariff redesign, including revised assumptions about interruptible transportation revenues, off-system sales, and other ancillary revenue sources. The reduction in revenue credits, combined with modest increases in O&M and A&G expenses, more than offsets the reductions in the return on rate base and the ITA, resulting in a higher overall cost of service and a correspondingly higher proposed recourse rate ($0.3140/Dth versus $0.2265/Dth).
It is important to note that the ITA is computed on a pre-revenue-credit basis. Revenue credits do not reduce the taxable equity return used to compute the ITA. The equity return component — $47.15 million in the original filing and $42.10 million in the revised filing — is the full return on the equity portion of the rate base, without offset for revenue credits or any other cost-of-service component. The gross-up is applied to this full equity return, and the resulting ITA is then included as a separate line item in the cost-of-service build-up.
Finally, we note that the coincidence between the original revenue credit amount ($16.10 million) and the original ITA amount ($16.10 million) is a mathematical artifact of the specific cost-of-service parameters in the original filing, not a methodological requirement or a causal relationship. The revised filing demonstrates this clearly, as the ITA ($15.04 million) and the revenue credits ($6.00 million) diverge substantially. We mention this point because the numerical coincidence in the original filing might create a misimpression — particularly among intervenors not steeped in rate-making methodology — that the revenue credits are somehow tied to or intended to offset the ITA. They are not; they are independent components of the cost-of-service build-up.
VIII. Comparison to Intervenor and FERC Staff Positions
A. ATPC Position