Hydro One Ltd.‘s main operating utility has successfully argued that hundreds of millions in tax savings should flow directly to the company’s shareholders, with ratepayers receiving none of the benefit.
The utility has been battling its regulator, the Ontario Energy Board, since 2017 over who should get tax benefits from its initial public offering of stock in 2015. Hydro One disagreed with decisions by the regulator’s review panels and took its dispute to the courts.
In a ruling this week, Ontario Divisional Court supported Hydro One and ordered the Ontario Energy Board to convene a panel that will correct its past errors and - presumably - rule for the utility.
If Hydro One ultimately prevails, it could gain an $885-million tax asset that should add $50-million to $60-million to its annual cash flow for 15 to 20 years, IA Securities analyst Elias Foscolos said on Friday in a research note.
OEB spokeswoman Lynn Ramsay said it would not be appropriate to comment because the matter has been returned for re-consideration. Hydro One spokeswoman Nancy Clark would not comment in detail, but said: “We are awaiting next steps from the Ontario Energy Board.”
The issue arose from the 2015 initial public offering of Hydro One, in which Ontario sold a majority stake to the public.
Before the IPO, Hydro One Networks Inc., the operating utility, was not required to pay federal and provincial corporate income tax. Instead, it made equivalent “payments in lieu” of taxes (PILs) to the Ontario Electricity Financial Corp., an entity created when the province restructured the former Ontario Hydro in 1998.
The IPO ended its privileged tax status, and required a $2.27-billion “departure tax” to compensate for ending PILs. Hydro One Networks Inc. funded the payment with a pre-IPO stock sale to its parent company, and ultimately to the province, according to the Divisional Court opinion.
Once Hydro One did the IPO, it lost its tax-free status and paid the departure penalty. It was as if, for tax purposes, the company had been sold, the Divisional Court opinion explains. And it was allowed to increase the value of its assets on its balance sheet. That, in turn, allowed for higher annual tax deductions as it writes down the new, higher value of its assets.
Hydro One argued that because it – rather than ratepayers – funded the departure tax, it was entitled to 100 per cent of future tax benefits the IPO created. The departure tax is unrelated to the provision of electricity service, Hydro One said, and the cost and its related benefits shouldn’t be considered when setting rates.
The OEB argued that the province had discretion in how the departure tax would fall on Hydro One Networks, and it wasn’t a true cost because Hydro One paid it by getting the money from the province via the stock sale. The OEB used a “sales and payments” methodology to say that 38 per cent of the tax benefit should flow to Hydro One’s customers via reduced rates.
Much of this week’s Divisional Court opinion relates to the judges’ views on errors in matters of law as the OEB’s administrative panels dealt with Hydro One’s arguments, some embracing them, some rejecting them. But at the core, the Divisional Court panel affirmed that the departure tax was a “true cost.”
“I ... agree with the submissions of [Hydro One Networks] that no portion of the future tax savings should be allocated to ratepayers when the evidence is clear [Hydro One Networks] paid all of its costs under the stand-alone utility principle,” says the ruling signed by Justice Todd Ducharme.
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