Private Equity Funds

Private Equity Funds

June 01, 2005

PRIVATE EQUITY FUNDS that want to own utilities or invest in transmission projects should find it easier to do so after a new policy statement by the Federal Energy Regulatory Commission in May.

Utilities pass through the taxes they pay to their customers in rates.

However, the question comes up if the utility is owned by a partnership — which is how a private equity fund might own it — whether any tax expense can be passed through, since partnerships do not pay income taxes. Rather, each partner pays taxes directly on his share of the partnership income.

FERC said on May 4 that it can see “no rational reason to limit the income tax allowance to public utility income earned by a corporation.” It said it would allow partnerships to pass through taxes paid by their partners in rates for utility service, provided the partners have an “actual or potential income tax liability.” Private equity funds often have pension funds and other tax exempt investors. The agency said that in such cases where partners do not all have the same tax exposure, taxes should be passed through at a blended rate.

The agency did not say what happens in cases where the partners do not pay any taxes in fact because of net operating losses or tax credits. The issue is whether there is at least a “potential” income tax liability in such cases that can be included in rates. It said these issues should be sorted out in individual rate proceedings.

The FERC policy statement is relevant mainly to transmission projects since the rates for interstate transmission are set by the federal government. The ability of electric distribution companies to pass through taxes in rates is still a matter left to individual state commissions.

The issue became a focus of attention recently in Oregon where the Texas Pacific Group made a bid to acquire Portland General from Enron. Newspapers reported that Portland General had included a tax component in rates even though, after Enron purchased it, its tax results were reported on Enron consolidated tax returns on which Enron paid little or no taxes.

Keith Martin