The federal government has asked the Supreme Court to resolve "a fundamental issue potentially affecting the tax liabilities of all public utilities."
But its friend-of-the-court brief -- in a case involving a purported collision between a 3-to-2 decision of the California Public Utilities Commission and Treasury Department tax rulings -- is sharply disputed.
Whatever California does in regulating its two largest telephone companies "is not binding in any way on other states," the cities contend.
The PUC decision, upheld last July by the state's highest tribunal, involved the accounting methods prescribed for the phone companies in connection with provisions in the Internal Revenue Code for:
Accelerated depreciation, in which an asset's value is written off at a rate greater in the early years than in the late years of its life.
Investment tax credit, which is a credit against tax equal to a percentage of the value of eligible goods placed in service in a year's time.
The key issue now in dispute, says Solicitor General Wade H. McCree Jr., is whether the PUC decision preserved the eligibility of the companies for accelerated depreciation and the investment tax credit for federal income-tax purposes.
The companies, Pacifc Telephone and Telegraph, a Bell System affilitate, and General Telphone, told the court that if the PUC is allowed to prevail, their combined liability for back taxes would be at least $1 billion and their possible ultimate liability at least $2 billion.
Pacific and General each filed a petition for Surpreme Court review. McCree also made a plea for review in a "Memorandum for the United States."
Unlike the companies and the government, the PUC argued that the PUC argued that the decision has no broad, national significance because it applies "only" to Pacific and General, and arose because they "imprudently and obstinately" refused to adopt proper accounting methods.
"Predictions of a bandwagon effect are mere supposition," the commission said. Nonetheless, it told the Supreme Court that "confusions and uncertainties cry out for an early resolution."
While the PUC recommended review, the three cities urged denial, along with rejection of "the plea of the solicitor general on behalf of the utilities." McCree's memo "solely represents the interests of Pacific and General, the cities charged. He "may have heartfelt concern" for utilities such as the two phone companies but, they said, "This concern is not an interest of the United States."
The Communications Workers of America, AFL-CLO, urged review. If Pacific alone loses, the CWA asserted, it would have to lay off 12,500 of its 55,500 employes.
The commission, dismissing predictions of disaster as routine in cases such as this, accused the companies of using "scare tactics."
McCree wrote that as matters now stand the companies "are simultaneously subject to the rate-making orders of the commission and the assertion of massive federal income tax deficiencies... in accordance with the Treasury's rulings."
If Supreme Court review is declined, and, in a separate tax proceeding, Treasury's urlings ultimately are upheld, the companies "would suffer the burden of lower rates (based on the assumption of eligibility for federal tax benefits" and disallowance of those tax benefits," McCree said.
Moreover, he added, if the PUC position stands and the Treasury doesn't budge, the California position "is likely to be followed by other state regulatory bodies to the detriment of similarly situated public utilities." He added: "The United States' belief that the continued existence of this conflict between the Treasury and the state regulatory commissions threatens to work an enormous hardship upon the public utilities scetor of the economy and to disrupt the stability of the capital markets as affected utilites must undertake borrowings to meet these large-scale federal tax obligations."
This evoked a stinging response from the three cities. "There is no conflict," they said. "The IRS is not challenging the PUC in any tribunal. The PUC is not challenging the IRS in any tribunal. The IRS is not challenging Pacific or Gereral in any tribunal."
Turning to McCree's reference to "similarly situated" companies outside of California, the cities suggested that they would have resason for concern only if they, like Pacific and General, also has engaged in alleged "managerial imprudence and obstinancy."
The case dates to 1969, when Congress became concerned by the loss of tax revenues occasioned by the combined effect of accelerated depreciation (leading to lower rates, and therefore, lower gross tax revenues).
And so, in that year's Tax Reform Act, Congress put into the code a provision that if a utility wanted to adopt accelerated depreciation for the first time, it must, for rate-making purposes, use the "normalization" method of accounting.
The normalization method, designed to avoid giving a utility's present customers the benefits of tax eferral attributable to accelerated depreciation, and to make the deferred taxes available for plant modernization, requires a utility to deposit in a deferred tax reserve account the difference between taxes actually paid and the higher taxes reflected as a cost of service for rate-making purposes.