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State Department of Assessments and Taxation v. Baltimore Gas & Electric Company

March 22, 2013


State Department of Assessments and Taxation v. Baltimore Gas & Electric Company, No. 14, September Term 2012

Tax Law - State and Local Taxes - Franchise Tax - Effect of Electricity Deregulation and Rate Stabilization. Under Maryland law, a public service company that provides electric power to customers has a state-recognized monopoly for the delivery of electric power within its service area and also competes with alternative suppliers to supply the electricity that it delivers to its customers. The franchise tax imposed on a public service company's revenues from the delivery of electricity is not affected by a statutory "rate stabilization plan" designed to moderate anticipated rate increases in the company's charges for the supply of electricity. Accordingly, even though the credits and charges that implement the plan were to appear on the distribution portion of a customer's bill in order to be "nonbypassable" and not distort the competitive market for the supply of electricity, they do not relate to the company's distribution activities and should not be included in the computation of its franchise tax liability.

Bell, C.J. Harrell Battaglia Greene Adkins Barbera McDonald, JJ.

Opinion by McDonald, J.

As a public utility holding a State-sanctioned monopoly on the distribution of electric power in its service area, Baltimore Gas & Electric Company ("BGE") is subject to the State franchise tax, a gross-receipts tax levied against revenue from that activity. BGE also supplies some of the electric power that it distributes - a sphere in which it once also enjoyed a monopoly but now faces competition as a result of relatively recent State legislation designed to introduce competition into the market for the supply of electric power. This effort to introduce competition into this segment of the electricity market, in the hope that competition will benefit consumers, is sometimes referred to as de-regulation legislation.

To facilitate the transition to a competitive market for the supply of electricity, the Legislature first temporarily capped BGE's rates for the supply of electricity and later provided that consumers would receive certain credits over the period of a year to mitigate a large projected increase in those rates - credits that would be available regardless of the electricity supplier actually selected by the consumer, in order to preserve a level playing field in that market. The cost of the credits was financed by the issuance of bonds to be repaid through charges that are billed to customers over a 10-year period. The overall scheme involving credits, charges, and bond financing is known as the rate stabilization plan.

This case concerns whether, in establishing the rate stabilization plan for purposes of the transition to a competitive market for the supply of electricity, the Legislature either intentionally or inadvertently provided for the credits and charges to affect BGE's franchise tax liability - the tax related to its monopoly delivery activities unaffected by the deregulation legislation. In our view, it did not.


Public Utilities and the Franchise TaX

Public Service Companies

A public utility is a natural monopoly when it is "obviously uneconomical" to have more than one provider of a particular service or commodity.*fn1 The only question is who will operate that monopoly. In many instances, State and local governments make that choice by awarding a "franchise" to a particular company. The state-sanctioned monopolist is then subject to special government oversight and, in some cases, special taxes.

In Maryland, utilities are regulated under the rubric of "public service companies." See Maryland Code, Public Utilities Article ("PU"), §1-101(x). Electric companies are one species of public service company and are closely regulated in certain respects by the Public Service Commission ("PSC"). PU §1-101(h), (x); PU §7-101 et seq. Respondent BGE, founded in 1816, is a Maryland corporation that provides gas and electric service to 1.8 million customers in the State and is subject to that regulatory regime.

Franchise TaX

Beginning with charter taxes on railroads in the 1830s,*fn2 taxes on the gross receipts of public utilities were widely adopted across the country. Such a tax is often referred to as a "franchise tax" as it is viewed as compensation to the public for the legal and property rights that a utility enjoys as a result of its franchise.*fn3 Franchise taxes have thus traditionally been related (in theory, at least) to the state-sanctioned monopolistic activities of a public utility.*fn4

For well over a century, Maryland has imposed an annual franchise tax on public service companies. See Chapter 559, §1, Laws of Maryland 1890, codified as subsequently amended at Maryland Code, Tax-General Article ("TG"), §8-401 et seq. With respect to an electric utility, the franchise tax is calculated in part as a percentage (2%) of the gross receipts the electric company derives from business in Maryland.*fn5 TG §8-403. The franchise tax is administered by the State Department of Assessments and Taxation ("Department"), the Petitioner in this case. TG §§1-101(g), 8-408.

The Department has provided some direction in regulation for the computation of the tax. Taxable gross receipts for distribution are derived from "all revenues included in the operating revenue accounts as prescribed by the Federal Energy Regulation Commission ["FERC"]." COMAR Amounts that utilities report to FERC are thus an important starting point in the computation of the tax. Those figures are to be adjusted if "otherwise specified by Maryland law or regulation." Id. In addition, certain amounts are to be excluded from the figure for taxable gross receipts, as provided in the franchise tax law. COMAR

Deregulation of the Supply of Electricity - 1999

The provision of electric power to a customer may be conceived of as the supply of a commodity - electric power - and a service - the delivery of that power to the end user. BGE's electricity rates include charges for both electricity supply, sometimes also referred to as the sale of electricity, and electricity distribution, which is the transmission of electricity through a power grid or other delivery infrastructure to the customer. Prior to 2000, both the sale and delivery of electricity were components of one regulated rate, set by the PSC and charged by BGE as the sole provider of electric power to customers in its service area.

Separating Supply from Distribution

In the 1970s and 1980s, there was a movement to restructure electric utilities inspired by "increased faith in the ability of markets to achieve efficient outcomes through competition and reduced faith in the ability of governments to achieve efficient outcomes through regulation or production of service." Spence, Can Law Manage Competitive Energy Markets?, 93 Cornell L. Rev. 765, 770 (2008). "[E]conomists began to challenge the premise that the provision of energy service is a natural monopoly at all.... Delivery - transmission and distribution service - is a natural monopoly because the construction of duplicate delivery networks ... is often inefficient. The production (and sale) of energy, however, is not a natural monopoly. We can unbundle production (and sales) from distribution so that buyers ... can choose their energy supplier even if they must take delivery service from a monopoly provider." Id. at 772. That view led to the restructuring of the market for electricity in Maryland in the late 1990s. Van Nostrand, Constitutional Limitations on the Ability of States to Rehabilitate Their Failed Electric Utility Restructuring Plans, 31 Seattle U. L. Rev. 593, 610-19 (2008) (describing restructuring of electricity industry in several states, including Maryland).

In 1999, the General Assembly enacted legislation to convert the market for the supply of electric power in the State from a regulated monopolistic market to a less regulated, competitive one. Chapter 3, Laws of Maryland 1999. Under the de-regulation scheme, there are multiple competing suppliers of electric power - the supply component. Regardless of the supplier selected by a customer, electric power is distributed to the customer through the utility with the franchise for the particular service area - the distribution component. The various electric suppliers set their own rates for the supply of electricity. An electric utility is obliged to continue to offer to supply electricity within its service area - a provision known as "standard offer service" or "SOS" - for customers who, for a variety of reasons, do not obtain service from an alternative supplier or who affirmatively choose standard offer service. PU §7-510(c). Rates for standard offer service are set through a competitive bidding process and approved by the PSC. Id. Distribution rates remain regulated, as before, by the PSC.

As a result of the 1999 de-regulation law, BGE remained responsible for the distribution of electricity within its service area, although it would now be one of multiple suppliers of electricity. To temporarily ease the burden of the transition on consumers, the General Assembly temporarily capped BGE's charges for the supply of electricity - a cap that was set to expire in 2006.*fn6

Limiting the Franchise Tax to Distribution Revenues

At the same time that it de-regulated the supply of electricity, the Legislature amended the franchise tax statute to eliminate application of that tax to revenues from the supply of electricity and to apply it only to electricity distribution revenues - i.e., those derived from a utility's remaining monopoly. See Chapters 5, 6, Laws of Maryland 1999. In particular, the statute was amended to state that the franchise tax is assessed against public service companies that are "engaged in the transmission, distribution, or delivery of electricity or natural gas" in the State. TG §8-402(a)(2). In addition, the definition of "gross receipts" subject to the tax was amended to include gross charges "for the transmission, distribution, or delivery of electricity or natural gas or for distribution or delivery-related services," but not "gross charges from the sale of electricity or natural gas." TG §8-401(c)(5)(i)(1), (ii)(1). As a result, the franchise tax now applies to BGE's charges for the distribution, but not the supply, of electricity. In setting the distribution rate that BGE may charge, the PSC accounts for BGE's liability for the franchise tax and embeds that cost in the rate. BGE therefore recovers the cost of the franchise tax in the distribution charges paid by its customers.

Rate Stabilization Plan - 2006

The anticipated benefits of the de-regulation legislation were slow to emerge. One commentator has described the aftermath: "When [de-regulation plans] were implemented, the general pattern ... included an initial rate reduction for various customer classes, followed by a multiyear rate freeze. The expected result was that during the rate freeze period, competition would develop and power costs would decline over time, so that upon expiration of the rate freeze, rates would not change, or would perhaps even decline. For the most part, however, the anticipated competition did not develop. Moreover, during the same period, the cost of generating power increased significantly, due primarily to increases in the costs of the underlying fuel sources. When the anticipated benefits of competition failed to ...

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