SECURITIES AND EXCHANGE COMMISSION
(Release No. 35-27845; 70-9555)
Dominion Resources, Inc., et al.
Supplemental Order Authorizing Tax Allocation Agreement; Reservation of Jurisdiction
May 13, 2004
Dominion Resources, Inc. ("DRI"), a registered holding company located in Richmond, Virginia, has, on behalf of itself and its utility and nonutility subsidiaries1, filed a post-effective amendment with the Securities and Exchange Commission ("Commission") under section 12(b) of the Public Utility Holding Company Act, as amended ("Act") and rules 45(a) and 54 under the Act to a previously submitted application-declaration ("Application"). The Commission issued a notice of the filing of the Application on March 2, 2001 (HCAR No. 27352).
By simultaneous orders issued on December 15, 1999 (HCAR No. 27113) ("Merger Order") and (HCAR No. 27112) ("Initial Financing Order"),2 the Commission, among other things, approved DRI's financing of the acquisition of and merger with Consolidated Natural Gas Company ("CNG"), also a registered public utility holding company, which became a wholly owned subsidiary public utility holding company of DRI ("Merger"). Under the Merger Order's authority, DRI acquired all of the outstanding shares of CNG common stock at an aggregate purchase price of approximately $6.4 billion, consisting of approximately 87 million shares of DRI common stock and $2.9 billion in cash. Additionally, DRI shareholders exchanged approximately 33 million shares of DRI common stock for approximately $1.4 billion. By subsequent order dated May 24, 2001 (HCAR No. 27406) ("Order"), the Commission, among other things, authorized DRI and its subsidiaries to engage in an external and intrasystem financing program, through December 31, 2004, to raise funds related to the CNG acquisition ("Acquisition Debt")3 and reserved jurisdiction over DRI's proposed tax allocation agreement ("Agreement"), pending completion of the record.4
Initially, DRI financed the acquisition of CNG with bridge financing arrangements consisting of a $3.5 billion commercial paper program supported by a short-term credit facility and the private placement of $1 billion of short-term money market notes ("Bridge Financing"). In January 2001, DRI issued $1.3 billion of Facility Debt under the Initial Financing Order, consisting of $300 million of its 8.4% Capital Securities, due January 2031 and $1 billion of 2-year fixed-rate 6% notes, to refinance a portion of the Bridge Financing. Subsequently, on September 30, 2002, DRI permanently financed approximately $2.98 billion of the remaining Bridge Financing not previously paid down. DRI refunded the remaining Bridge Financing using the proceeds from the issuance and sale of the following Facility Debt:
$700 million of 10-year fixed rate 8.125% notes
$700 million of 5-year fixed rate 7.625% notes
$400 million of 3-year notes fixed rate 7.60% notes
$250 million of 14-year fixed rate 7.82% remarketable notes
$520 million of 10-year fixed rate 5.7% notes
$413 million of Premium Income Equity Securities
At December 31, 2003 the total Acquisition Debt amounted to approximately $4.3 billion. DRI's interest expense related to Acquisition Debt for the years ended December 31, 2000, 2001, 2002 and 2003 was approximately $152.4 million, $303.8 million, $308 million and $249.3 million, respectively.
II. Tax Allocation Agreement
DRI now requests that the Commission issue a supplemental order releasing jurisdiction over its proposal to enter into the Agreement with each of its subsidiaries, under section 12(b) of the Act and rule 45(a) of the Act. Under section 12(b) of the Act, it is unlawful for any registered holding company or subsidiary to lend or in any manner extend its credit to or indemnify any company in the same holding-company system "in contravention of such rules and regulations or orders as the Commission deems necessary or appropriate in the public interest or for the protection of investors or consumers or to prevent the circumvention of the provisions of this title or the rules, regulations, or orders…." Rule 45(a) of the Act generally prohibits any registered holding company or subsidiary company from, directly or indirectly, lending or in any manner extending its credit to, indemnifying, or making any donation or capital contribution to, any company in the same holding company system, except under the authority of a Commission order. Rule 45(c) provides, however, that approval under rule 45(a) is not required for the filing of a consolidated tax return under a tax allocation agreement between eligible associate companies in a registered holding company system that complies with rule 45(c). To the extent that a tax allocation agreement does not comply with the requirements of Rule 45(c), the Commission under section 12(b) and rule 45(a) must approve it.
As provided by rule 45(c)(2)(ii), under the Agreement the system's consolidated income tax obligations will be allocated among all of the associate companies based on each company's separate return tax liability or refund, provided that no associate company will be liable for income taxes in an amount that would exceed its "separate return tax," as computed under rule 45(c)(1) of the Act. Separately, however, the Agreement provides that any tax benefits associated with Acquisition Debt will be assigned to DRI only and not allocated to DRI's subsidiaries, as contemplated by rule 45(c)(5), which would be required in order for the Commission to approve the Agreement under rule 45(c)'s "safe harbor" procedure. Although the allocation of the tax benefits to DRI is inconsistent with the requirements of rule 45(c), DRI contends that the Agreement is consistent with the Commission's treatment of holding company expenses generally, such that the Commission should authorize DRI and its subsidiary companies to enter into the proposed Agreement, under section 12(b) and rule 45(a).5
The Agreement assigns to DRI, not to DRI's subsidiaries as contemplated by rule 45(c), the tax benefits of the Acquisition Debt. The parties agreed to this arrangement because DRI alone is obligated on this debt, which is unsecured. The Agreement will not cause any tax group member to be allocated a larger portion of the consolidated tax liability nor will the allocable share of any DRI subsidiary exceed its separate return tax. Therefore, the proposed Agreement will not misallocate consolidated tax benefits, which was identified by Congress as one of the abuses requiring remedial action under the Act.6
DRI currently meets all of the conditions of rule 53(a), except for rule 53(a)(1), which limits DRI's "aggregate investment" in exempt wholesale generators ("EWGs"), as defined in section 32 of the Act, and foreign utility companies ("FUCOs"), as defined in section 33 of the Act, to 50% of the system's "consolidated retained earnings," provided that none of the adverse conditions specified in Rule 53(b) exist ("Safe Harbor Limitation"). DRI states that as of December 31, 2003, DRI's "aggregate investment", as defined in rule 53(a)(1), in EWGs and FUCOs, was approximately $3.7 billion. As of the same date, its "average consolidated retained earnings," also defined in rule 53(a)(1), were approximately $1.6 billion for the previous four quarters. The investment amount, therefore, exceeds the Safe Harbor Limitation contained in the rule.
However, regarding rule 53(a)(1), the Commission determined that DRI investments in EWGs and FUCOs in amounts not exceeding 100% of its "average consolidated retained earnings," plus $4.5 billion ("Investment Limitation"), would not have either of the adverse effects described in rule 53(c) (HCAR No. 27485; December 28, 2001) ("Rule 53(c) Order").7 At December 31, 2003, DRI's average consolidated retained earnings were approximately $1.6 billion, so that DRI's $3.7 billion aggregate investment in EWGs and FUCOs remains below the Investment Limitation. DRI continues to be in compliance with the other provisions of rule 53(a) and none of the conditions enumerated in rule 53(b) exist.
The Rule 53(c) Order was predicated, in part, on an assessment of DRI's overall financial condition, which considered DRI's consolidated capitalization ratio and its retained earnings, both of which have improved since the date of the order. In the aggregate, DRI's investments have been profitable for all quarterly periods ending March 31, 2000 through December 31, 2003. As of September 30, 2001, the most recent period for which financial statements were evaluated for the Rule 53(c) Order, DRI's consolidated capitalization consisted of 33.4 % common equity, 6.4% preferred stock and 60.2% debt, including long and short-term debt. As of December 31, 2003, the consolidated capitalization ratios of DRI, with consolidated debt including all short-term debt and non-recourse debt of its EWGs and FUCOs, were 36% common equity, 1% preferred stock and 63% long and short-term debt. DRI states that its EWG and FUCO investments contributed positively to its consolidated earnings since the Rule 53(c) Order.
Fees and expenses in the estimated amount of $25,000 are expected to be incurred in connection with the proposed transactions. The Virginia State Corporation Commission has approved the proposed Agreement. No other state or federal Commission has jurisdiction over the proposed Agreement.
Due notice of the filing of the Application has been given in the manner prescribed in rule 23 under the Act, and no hearing has been requested of or ordered by the Commission. On the basis of the facts in the record, it is found that the applicable standards of the Act and the rules under the Act are satisfied, and that no adverse findings are necessary.
IT IS ORDERED that jurisdiction is released over the proposed Agreement; and
IT IS FURTHER ORDERED, under the applicable provisions of the Act and the rules under the Act, that the Application as it relates to the Agreement be granted and permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24 under the Act and provided that Applicants will supplement the quarterly reports required to be filed under rule 24 to include: 1.) the applicable terms and conditions prescribed in the Order and subsequently by Commission order dated December 28, 2001 (HCAR No. 27485); and 2.) annual reports, following each quarter in which a consolidated tax return is filed, containing information showing the calculation of the portion of DRI's loss that is attributable to interest expense on Acquisition Debt and the actual allocation of federal income tax liability to each member of the consolidated tax group, and
IT IS FURTHER ORDERED, that jurisdiction continues to be reserved, pending completion of the record, over 1.) DRI's request to invest more than the sum of 100% of its consolidated retained earnings, plus $4.5 billion in EWGs and FUCOs from the proceeds of financings or by way of guarantees, up to the Application's requested approval of the EWG/FUCO investment limit of the sum of 100% of the consolidated retained earnings, plus $8 billion; and 2.) any effect under the Act of the recharacterization of rate base assets of Virginia Electric and Power Company as "eligible facilities" and the transfer of those assets to EWG affiliates.
For the Commission, by the Division of Investment Management, pursuant to delegated authority.
J. Lynn Taylor
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