NOTE 4 REGULATORY

In December 2016, FERC issued a Notice of Inquiry (NOI) Regarding the Commission’s Policy for Recovery of Income Tax Costs (Docket No. PL17-1-000) requesting initial comments regarding how to address any “double recovery” resulting from FERC’s current income tax allowance and rate of return policies that had been in effect since 2005.

Docket No. PL17-1-000 is a direct response to United Airlines, Inc., et al. v. FERC (United), a decision issued by the U.S. Court of Appeals for the District of Columbia Circuit in July 2016 in which the D.C. Circuit directed FERC to explain how a pass-through entity such as an MLP receiving a tax allowance and a return on equity derived from the discounted cash flow (DCF) methodology did not result in “double recovery” of taxes.

On December 22, 2017, the President of the United States signed into law H.R.1, originally known as the Tax Cuts and Jobs Act (the “2017 Tax Act”). This legislation provides for major changes to U.S. corporate federal tax law including a reduction of the federal corporate income tax rate. We are a non-taxable limited partnership for federal income tax purposes, and federal income taxes owed as a result of our earnings are the responsibility of our partners, therefore no amounts have been recorded in the Partnership’s financial statements with respect to federal income taxes as a result of the 2017 Tax Act.

On March 15, 2018, FERC issued (1) a Revised Policy Statement on Treatment of Income Taxes (Revised Policy Statement) to address the treatment of income taxes for ratemaking purposes for MLPs, (2) a Notice of Proposed Rulemaking (NOPR) proposing interstate pipelines file a one-time report to quantify the impact of the federal income tax rate reduction and the Revised Policy Statement could have on a pipeline’s Return on Equity (ROE) assuming a single-issue adjustment to a pipeline’s rates, and (3) an NOI seeking comment on how FERC should address changes related to accumulated deferred income taxes (ADIT) and bonus depreciation. On July 18, 2018, FERC issued (1) an Order on Rehearing of the Revised Policy Statement (Order on Rehearing) dismissing rehearing requests related to the Revised Policy Statement and (2) a Final Rule adopting and revising procedures from, and clarifying aspects of, the NOPR (collectively, the “2018 FERC Actions”). The Final Rule became effective on September 13, 2018, and is subject to requests for further rehearing and clarification. Each is further described below.

FERC Revised Policy Statement on Income Tax Allowance Cost Recovery in MLP Pipeline Rates

The Revised Policy Statement changes FERC’s long-standing policy allowing income tax amounts to be included in rates subject to cost-of-service rate regulation for pipelines owned by an MLP. The Revised Policy Statement creates a presumption that entities whose earnings are not taxed through a corporation should not be permitted to recover an income tax allowance in their regulated cost-of-service rates.

On July 18, 2018, FERC dismissed requests for rehearing and provided clarification of the Revised Policy Statement. In this Order on Rehearing, FERC noted that an MLP is not automatically precluded in a future proceeding from arguing and providing evidentiary support that it is entitled to an income tax allowance in its cost-of-service rates. Additionally, FERC provided guidance with regard to ADIT for MLP pipelines and other pass through entities. FERC found that to the extent an entity’s income tax allowance should be eliminated from rates, it must also eliminate its existing ADIT balance from its rate base. As a result, the Revised Policy Statement also precludes the recognition and subsequent amortization of any related regulatory assets or liabilities that might have otherwise impacted rates charged to customers as the refund or collection of excess or deficient deferred income tax assets or liabilities.

Final Rule on Tax Law Changes for Interstate Natural Gas Companies

The Final Rule established a schedule by which interstate pipelines must either (i) file a new uncontested rate settlement or (ii) file a one-time report, called FERC Form No. 501-G, that quantifies the isolated rate impact of the 2017 Tax Act on FERC regulated pipelines and the impact of the Revised Policy Statement on pipelines held by MLPs. Pipelines filing the one-time report will have four options:

Option 1: make a limited Natural Gas Act (NGA) Section 4 filing to reduce its rates by the reduction in its cost of service shown in its FERC Form No. 501-G. For any pipeline electing this option, FERC guarantees a three-year moratorium on NGA Section 5 rate investigations if the pipeline’s FERC Form 501-G shows the pipeline’s estimated ROE as being 12 percent or less. Under the Final Rule and notwithstanding the Revised Policy Statement, a pipeline organized as an MLP is not required to eliminate its income tax allowance but, instead, can reduce its rates to reflect the reduction in the maximum corporate tax rate. Alternatively, the MLP pipeline can eliminate its tax allowance, along with its ADIT used for rate-making purposes. In situations where the ADIT balance is a liability, this elimination would have the effect of increasing the pipeline’s rate base used for rate-making purposes;

Option 2: commit to file either a pre-packaged uncontested rate settlement or a general Section 4 rate case if it believes that using the limited Section 4 option will not result in just and reasonable rates. If the pipeline commits to file either by December 31, 2018, FERC will not initiate a Section 5 investigation of its rates prior to that date;

Option 3: file a statement explaining its rationale for why it does not believe the pipeline’s rates must change; and

Option 4: take no other action. FERC would then consider whether to initiate a Section 5 investigation of any pipeline that has not submitted a limited Section 4 rate filing or committed to file a general Section 4 rate case.

NOI Regarding the Effect of the 2017 Tax Act on Commission-Jurisdictional Rates

In the NOI, FERC sought comments to determine what additional action as a result of the 2017 Tax Act, if any, is required by FERC related to the ADIT that were reserved in anticipation of being paid to the Internal Revenue Service (IRS), but which no longer accurately reflect the future income tax liability. The NOI also sought comments on the elimination of bonus depreciation for regulated natural gas pipelines and other effects of the 2017 Tax Act on regulated rates or earnings.

As noted above, FERC’s Order on Rehearing provided guidance with regard to ADIT for MLP pipelines, finding that if an MLP pipeline’s income tax allowance is eliminated from its cost-of-service rates, then its existing ADIT balance used for rate-making purposes should also be eliminated from its cost-of-service rates.

Filings required by the Final Rule

On October 16, 2018, GTN filed a rate settlement with FERC to address the changes proposed by the 2018 FERC Actions within its rates via an amendment to its prior settlement in 2015 (2018 GTN Settlement). The 2018 GTN Settlement will decrease GTN’s existing maximum transportation rates by 10 percent effective January 1, 2019 until December 31, 2019. The existing maximum rates will decrease by an additional 6.6 percent for the period January 1, 2020 through December 31, 2021. GTN is required to have new rates in effect on January 1, 2022. These reductions will replace the eight percent rate reduction in GTN’s reservation rates in 2020 agreed upon as part of GTN’s last settlement in 2015. Furthermore, GTN and its customers have agreed upon a moratorium on further rate changes prior to January 1, 2022, providing a greater degree of regulatory certainty for GTN going forward. These new rates will reflect an elimination of tax allowance previously recovered in rates along with ADIT for rate-making purposes. The uncontested settlement, subject to approval by the FERC, will relieve GTN of its obligation to file a Form 501-G.

As part of the 2018 GTN Settlement, GTN has also agreed to issue a refund of approximately $10 million allocated amongst firm customers from January 1, 2018 to October 31, 2018 (2018 GTN Rate Refund). As a result of this, at September 30, 2018, the Partnership established a $9 million provision for this revenue sharing as an offset against revenue in the income statement and recognized the corresponding refund liability classified as a provision for revenue sharing in the balance sheet.

On October 11, 2018, North Baja elected to make a limited NGA Section 4 filing to reduce its maximum recourse rates by approximately 11 percent, which is the percentage reduction in the cost of service shown in North Baja’s concurrent FERC Form No. 501-G (Option 1). The 11 percent reduction is not expected to have a material impact in North Baja’s results as a significant portion of its contracts are negotiated rate arrangements.

On October 12, 2018, Iroquois requested a waiver of its requirement to file a Form 501-G from FERC based on its existing moratorium precluding rate changes prior to September 2020.

PNGTS and Bison filed their respective FERC Form No. 501-Gs on October 11, 2018 and November 8, 2018, respectively, along with an explanation why no rate change is needed (Option 3).

The Partnership’s remaining assets, Northern Border, Great Lakes and Tuscarora, are scheduled to file their respective FERC Form No. 501-Gs by December 6, 2018. Thus, the Partnership anticipates finalizing its regulatory approach for all of the Partnership’s assets by the end of the 2018.

Impairment Considerations

As noted under Note 2, the preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions with respect to values or conditions, which cannot be known with certainty, that affect the reported amount of assets and liabilities at the date of the financial statements. Although we believe these estimates and assumptions are reasonable, actual results could differ.

We review property, plant and equipment and equity investments for impairment whenever events or changes in circumstances indicate the carrying value of the asset may not be recoverable.

Goodwill is tested for impairment on an annual basis or more frequently if events or changes in circumstances indicate the possibility of impairment. We can initially make this assessment based on qualitative factors. If we conclude that it is not more likely than not that the fair value of the reporting unit is less than its carrying value, an impairment test is not performed.

We continue to monitor developments following the Final Rule on the 2018 FERC Actions. We will incorporate results to date, future filings for the Partnership’s assets and FERC’s responses to others in the industry into our annual goodwill impairment test as well as our normal review of property, plant and equipment and equity investments for recoverability.

At September 30, 2018, the goodwill and the equity method goodwill balances related to Tuscarora and Great Lakes amounted to $82 million and $260 million (December 31, 2017- $82 million and $260 million), respectively. Additionally, the estimated fair values of Tuscarora and our investment in Great Lakes exceeded their carrying values by less than 10 percent in its most recent valuation. There is a risk that the goodwill balances related to Tuscarora and Great Lakes could be negatively impacted by the 2018 FERC Actions, once finalized or by other changes in management’s estimates of fair value resulting in an impairment charge.