In a proceeding involving SFPP, L.P. (SFPP), an interstate refined petroleum products pipeline, the U.S. Federal Energy Regulatory Commission (FERC) issued an order on February 17, 2011, (Opinion No. 511) providing the FERC’s first substantive decision in three years on the issue of the entitlement of MLP-owned pipelines to an income tax allowance. Given shipper challenges to the FERC’s income tax allowance policy as applied to MLP-owned pipelines, such as SFPP, the FERC analyzed whether it should revise its current policy permitting MLP-owned pipelines to recover in rates an allowance for income taxes. Following a thorough analysis of this issue, the FERC confirmed that MLP-owned pipelines are entitled to an income tax allowance.

The FERC also, for the first time, thoroughly explored efforts by certain shippers to eliminate indirectly the income tax allowance for MLP-owned pipelines. In particular, the FERC rejected shipper claims that there is a double recovery of the income tax allowance in the allowed return that must be eliminated through a reduction in the pipeline’s rate of return on equity. The FERC also rejected claims that the tax deferral benefits enjoyed by MLP unitholders should be transferred to ratepayers through a reduction in the pipeline’s rates.

In connection with its rulings regarding the income tax allowance, the FERC revisited the legislative history of Section 7704 of the Internal Revenue Code, which provides favorable tax treatment to MLPs. In so doing, the FERC concluded that Congress intended to encourage pipeline investment by authorizing favorable tax treatment for MLPs and found that providing an income tax allowance to MLP-owned pipelines achieves this legislative intent. The favorable income tax allowance rulings for MLP-owned pipelines in Opinion No. 511 will likely be challenged on rehearing and, absent settlement, will likely be appealed by the shippers. Opinion No. 511 is available here.

For more information, please contact Vinson & Elkins lawyers Michelle Boudreaux or Bert Tabor. Visit our website to learn more about V&E's Energy Regulation practice, or e-mail one of the practice contacts.