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FAQ – Tariff Methodology for the Setting of Pipeline Tariffs – IDMS 46306
Frequently Asked Questions: Tariff Methodology for the Setting of Petroleum Pipeline Tariffs
2nd June 2010
Answers and guidance to Frequently Asked Questions are provided as per the following outline. Glossary of Terms and Abbreviations C - Claw-back adjustments CPI - Consumer Price Index D - Depreciation. The charge (normal depreciation and amortisation on
the write-up) for the tariff period under review E - Expenses. Maintenance and operating expenses for the tariff period
under review. F - Approved revenue addition to meet debt obligations RAB - Regulatory Asset Base T - Tax. Flow-through and notional tax options WACC - Weighted Average Cost of Capital
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RAB Question 1 Why are assets re-valued?
Answer 1.1 Regulation 4(6)(e)1 stipulates that the value of the regulatory asset base
(RAB) is to be on an inflation-adjusted base. The inflation adjustment is
calculated by trending the original cost on an annual basis with the CPI to
give the trended original cost (TOC). The TOC value therefore reflects the
nominal value of the regulatory asset base (RAB).
1.2 The return on the RAB is calculated in real terms on the nominal value of
the RAB.
1.3 The result of applying a real return on a nominal RAB is that tariffs become
back-loaded. Back-loading of tariffs implies that tariff levels will increase in
real terms over time. This approach ensures that tariffs do not deflate in real
terms as the asset ages but keep up with the trend of inflation. (This is also
discussed in 4.1.)
1.4 The back-loading of tariffs also reflects the economic reality of prices
generally becoming inflated over time and will therefore counter the effect of
huge price increases when new assets replace old assets.
1.5 The way to calculate the TOC value of the RAB (inclusive of depreciation
and amortisation of the write-up) is demonstrated in Table 1.5 below. This
table is also published on the NERSA website.
1 see Government Notice R342, Government Gazette No. 30905 of 4 April 2008.
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Table 1.5: Calculation of TOC value of RAB (inclusive of depreciation and amortisation of the write-up)
Trending of asset value (TOC)
Formula for year 2
(column "C")
A B C D E F G H I J K
1 Tariff period 0 1 2 3 4 5 6 7 8 9 10 2 Remaining asset useful life 10 9 8 7 6 5 4 3 2 1 3 Depreciated original cost b/f +B3-B4 100.00 90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 4 Depreciation (historic) +$B$3/$B$2 10.00 10.00 10.00 10.00 10.00 10.00 10.00 10.00 10.00 10.00
5 Depreciated original cost (V-d) RAB bal c/f +C3-C4 90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 0.00
6 7 Inflation write-up balance 8 Inflation write-up bal b/f +B12 0.00 4.50 8.20 11.03 12.93 13.81 13.60 12.21 9.55 5.51
9 Current period inflation write-up +B13*$A$9 5.00% 5.00 4.73 4.41 4.05 3.65 3.19 2.68 2.11 1.48 0.78
10 Write-up balance on which WACC should be earned =SUM(C8:C9) 5.00 9.23 12.61 15.09 16.58 17.00 16.28 14.32 11.03 6.29
11 Amortisation of write-up +C10/C2 0.50 1.03 1.58 2.16 2.76 3.40 4.07 4.77 5.51 6.29
12 Write-up bal net of amortisation carried forward =C10-C11 4.50 8.20 11.03 12.93 13.81 13.60 12.21 9.55 5.51 0.00
13 TOC closing balance (c/f) =C5+C12 100.00 94.50 88.20 81.03 72.93 63.81 53.60 42.21 29.55 15.51 0.00
14 TOC opening balance (b/f) balance to inflate +B13 100.00 94.50 88.20 81.03 72.93 63.81 53.60 42.21 29.55 15.51
15 Total amount on which WACC should be earned =+C3+C10 105.00 99.23 92.61 85.09 76.58 67.00 56.28 44.32 31.03 16.29
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Question 2 Why is the TOC not applied to the working capital component of the RAB-formula?
Answer 2.1 Working capital resets itself each year and therefore there is an automatic
annual adjustment for inflation in the components of working capital.
2.2 If a multi-year tariff application is submitted, the working capital (W) should
be inflated with the forward looking CPI assumptions.
Question 3 Why is a deferred tax liability deducted and a deferred tax asset added to the RAB in
the RAB formula?
Answer 3.1 A deferred tax liability represents a temporary return of capital on which no
return is allowed and therefore it is deducted from the RAB. As the licensee
starts repaying the deferred taxation to the Receiver of Revenue, the
deduction from the RAB reduces.
3.2 A deferred tax asset represents additional capital investment. The NERSA
tax formula (paragraph 7.3 of the Tariff Methodology for the Setting of
Petroelum Pipeline Tariffs – hereinafter ‘the Methodology’) assumes the
cash “to be received” from the fiscus, but the actual cash flow benefit from
the fiscus materialises only in later years and therefore a return would be
allowed on this investment. Deferred tax assets arise mostly as a result of
assessed taxation losses not utilised and carried forward.
3.3 The deferred taxation liabilities and assets are not trended.
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 5 of 28
WACC
Question 4
Why is a real WACC and not a nominal WACC applied?
Answer 4.1 As explained under question 1, Regulation 4(6)(e) stipulates that the value of
the RAB has to reflect an inflation-adjusted value. Because the nominal value
of the RAB is used, a real rate of return is used (as reflected in the real
weighted average cost of capital - WACC). This requirement is also stipulated
in section 28(3)(c) of the Petroleum Pipelines Act 2003 (Act No. 60 of 2003).
4.2 Inflation is added to the asset base (RAB) and is therefore “taken out” of the
nominal return (WACC). Nominal returns on real assets would constitute a
double count of CPI and thus “real returns” are used.
Question 5 What is to be understood by the following two statements? i) Section 28(3)(c) of the Petroleum Pipelines Act 2003 (Act No. 60 of 2003):
(3) The tariffs set or approved by the Authority must enable the licensee to-
(c) make a profit commensurate with the risk
and
ii) Section 4(6) of the Regulations made in terms of the Petroleum Pipelines Act (see Government
Notice R432, Government Gazette No. 30905 of 04 April 2008):
(6) The allowed revenue to be derived from tariffs contemplated in sub-regulation (2) must
include:
a) reasonable operating expenses
b) reasonable maintenance expenses
c) depreciation expenses
d) reasonable working capital
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e) reasonable real return on the regulatory asset base which should be
determined on the assets’ inflation-adjusted cost less accumulated
depreciation; and
f) other applicable obligations.
Answer 5.1 The reasonable return relates to the return earned by the licensee on the RAB
and not to the return earned by an equity investor on the RAB. Sub-regulation
(2) refers to an “efficient licensee” and not an equity holder as an entity different
from the licensee.
5.2 In view of the fact that the regulation does not stipulate that the “profit
commensurate with risk” is to be earned in each year, it is taken that the “profit”
(return) is to be earned over the total life of the asset. This profit relates to the
profit of the licensee on the RAB and not to the profit of an equity investor as a
separate construct.
5.3 The actual return that will be earned by the equity investor each year is a
function of the capital structure of the licensee. If the funding structure of the
licensee requires the debt funding to be repaid earlier or faster than the life of
the asset, it is viewed that the equity holder has chosen to become a “patient
capital” investor. The “patient capital” investor will therefore wait for the debt
capital to be repaid before the full return on equity can be earned.
5.4 Figure 5.4(i) and figure 5.4(ii) below demonstrate the effect on the annual
returns on equity under the following two scenarios (patient capital investor):
a) debt tenure of 10 years; and
b) debt tenure of 25 years
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Figure 5.4(i): ROE per annum (debt = 10 years) ROE per annum (10 years debt)
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
1 2 3 4 5 6 7 8 9 10 11
Years
RO
E %
Notional TAX with Deferred Tax adjusted to RAB Required ROE Flow-through actual tax
ROE per annum (10 year debt)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Years
RO
E %
Notional TAX with Deferred Tax adjusted to RAB Flow-through actual tax Required ROE
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Figure 5.4(ii): ROE per annum (debt = 25 years)
ROE per annum (25 years debt)
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
1 2 3 4 5 6 7 8 9 10 11
Years
RO
E %
Notional TAX with Deferred Tax adjusted to RAB Required ROE Flow-through actual tax
ROE per annum (25 year debt)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Years
RO
E %
Notional TAX with Deferred Tax adjusted to RAB Flow-through actual tax Required ROE Note 1. Once the debt has been paid off, the equity starts “catching up” (around years
6-8) and the actual return to equity is at higher levels. The higher levels of
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equity returns reflect the “catching up” of returns that should have been
earned in previous years but were forfeited because of having to pay off debt
(“patient capital”).
2. The conversion of the RAB to a nominal value (TOC) and the subsequent real
WACC that is to be earned on the nominal value result in the “addition” of CPI
values to the asset base that do not match the “reduction” of the value of the
return in earlier years, because the return is calculated in real terms. The
returns in earlier years are lower as it takes time for the TOC effect to catch
up with the real return effect. Over the life of the asset, the return equalises
out.
3. Note that a minimum debt level of 30 per cent is assumed as per paragraph
5.5 of the Methodology.
WACC – Beta
Question 6
Why is a beta derived from international companies used in relation to the conditions
of the local market?
Answer
6.1 There are no suitable comparative companies listed on the local markets.
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Question 7 What are the criteria for selecting the betas of specific companies as a proxy for local
companies?
Answer 7.1 In 2008/9 when the decision on proxy companies was taken, companies were
chosen that:
a) operate in the pipeline industry (or at least partly in the pipeline industry);
b) are smaller in size as they are considered to be more on par with the
South African companies;
c) have a high debt ratio to try and represent the start-up business of a
potential new entrant to the market as well as an existing operator who is
embarking on huge investments (under such circumstances companies
normally reflect high debt ratios);
d) have higher operating margins to more closely represent the higher
inflation environment in the South African market at the time.
Note 1. Some of the companies selected also appeared on the list of companies
utilised by Transnet in their tariff application for 2008/9.
2. The criteria for selecting companies will be determined by the outcome
of the beta study which is currently being undertaken by NERSA.
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Question 8 When are adjustments to the industry beta allowable?
Answer 8.1 In the past, the following aspects were considered for adjusting the beta of a
company:
a) size of a company relative to the size of companies on the
Johannesburg Stock Exchange (JSE)
b) construction and start-up requirements
c) instruments available for obtaining capital
d) private versus state-owned entities.
8.2 Decisions regarding the above aspects were taken by NERSA after assessing
the company at the time of making a tariff determination. Decisions were
taken by applying regulatory discretion and judgement. Direction will be
obtained on how to quantify such decisions relative to other players in the
industry as part of the beta study which is currently being undertaken by
NERSA.
Question 9 At what frequency and over which period was data on the beta value of proxy
companies collected? Has a statistical correction factor been applied to the values of
the beta?
Answer 9.1 The tariff Methodology stipulates that the beta value that will be applied in
tariff determinations has to be a beta that has been determined and published
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on NERSA’s website 12 months prior to a tariff determination. (NERSA has
published the value of the beta as part of the RfD for the Transnet 2008/9
tariff determination.)
9.2 At the time of publishing the beta value, no comments from any stakeholder
were received on the frequency of data, the period over which data had been
collected or the application of a correction factor. These areas have only
recently been discussed within the industry and are in the process of being
attended to as part of the beta study that is currently being undertaken by
NERSA.
Question 10 Why is Zacks used as a supplier of beta data on proxy companies?
Answer 10.1 A wide variety of sources is used for the determination of betas in the South
African market. The following suppliers seem to be popular :
• Zacks
• McGregor
• Bloomberg
• Cadiz Financial Risk Services
• Reuters / Factiva
10.2 At the time of selecting a supplier, the Zacks website was found to have
sufficient data on the proxy companies and data could be obtained without
subscription.
10.3 The Methodology of determining the beta values by the respective suppliers
was not challenged and the value of the betas was taken at face value.
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10.4 A decision about which supplier to use for providing beta values will be based
on the outcome of the beta study currently being undertaken by NERSA.
WACC – The Market Return (MR)
Question 11
What are the criteria for using either of the following two market indices: the All Share
index or the Financial and Industrials?
Answer
11.1 In practice there is no index that accurately measures the total return of the
market portfolio. The lack of availability of weekly or monthly return data for all
asset classes requires the use of equity indices as a proxy for the market.
11.2 The All Share index is considered to be biased towards particular sectors and
therefore the Financial and Industrial indices have been considered as a more
appropriate measure for the petroleum pipeline industry.
11.3 The decision on which market index to use will be determined by the outcome
of the beta study currently being undertaken by NERSA.
Question 12 Why is a post-tax market return (MR) used for determining the MRP?
Answer
12.1 The market returns (MR) as represented by the various JSE indices reflect
earnings after taxation has been provided for (i.e. data is presented on an
after-tax basis). In South Africa there is currently no dividend tax paid as
secondary tax on companies (STC) on dividends is paid by the company and
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not shareholders. The earnings attributable to shareholders are therefore
presented on an after-tax basis (income tax and STC).
12.2 No adjustment for Capital Gains tax is made as it is assumed that the equity
return holders will hold the investment to maturity and therefore the total
return index (TRI) is used.
12.3 There are flaws and challenges inherent in converting the “post-tax” market
return (MR) as a basis and converting it to a “pre-tax” market return (MR) by
grossing it up with the tax rate. This method is thus not used by NERSA.
12.4 As the Allowable Revenue formula treats Taxation as a separate “operational”
item (T), the WACC calculations are ALL performed on a post-tax basis.
WACC – The Risk-free rate (Rf)
Question 13 Why is the post-tax Risk-free rate (Rfpost-tax) used and not the pre-tax Risk-free rate
(Rfpre--tax)?
Answer 13.1 The tariff Methodology consistently treats all values on a post-tax real basis
because Tax is treated as a separate item (T) in the formula to determine
allowable revenue. In this way the impact of all tax-related matters (burdens as
well as benefits) is reflected separately and all tax-related WACC components
are treated on a post-tax basis.
13.2 In the taxation formula – notional and “new” flow-through tax – all components
which do not carry a tax deduction are grossed up to allow for the tax shield.
The tax which is needed to be provided for is therefore included in the tax
allowance.
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Question 14 Why are government bonds with a maturity of ten years or longer used?
Answer 14.1 In selecting a government security as an acceptable proxy for the risk-free rate,
thought was given to the maturity of the security and the possible influences on
the market risk premium (MRP) to be used in the WACC calculation.
14.2 In the South African environment one of the following two common approaches
is normally used. The maturity of the risk-free instrument is matched to:
• the profile of the cash flows (life of the asset); or
• an assumed investor horizon of seven to ten years.
14.3 An investor in pipeline infrastructure normally has a long-term investment
horizon of at least ten years. A maturity of less than ten years is considered to
be subject to short-term fluctuations in the economic environment which could
impact on the volatility and validity of this measure for the industry if taken over
a short term.
14.4 Longer term investment instruments are also more in line with the 25-year
market return (MR) data used in calculating the WACC.
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WACC – Cost of debt (Kd)
Question 15
Why is the real cost of debt (Kd) used and not the nominal cost of debt?
Answer 15.1 The inflation adjustment in the cost of debt (Kd) is “taken out” as this is
“replaced” with the trending of the full value (V-d) of the original cost to give the
nominal value (TOC) of the RAB.
15.2 Nominal returns on real assets would constitute a double count of CPI and
therefore “real returns” are used.
Question 16
Under what scenario will equity investors be in a position to earn their full return as
embedded in the Ke portion of the WACC?
Answer
16.1 The reasonable return relates to the return on the asset for the licensee and not
for the equity investors. The actual return that will be earned by the equity
investor is a function of the capital structure of the licensee as was explained
under question 5. If the funding structures of the licensee require the debt
funding to be repaid earlier or faster, it is viewed that the equity holder has
chosen to become a “patient capital” investor. The “patient capital” investor will
wait for the debt capital to be repaid before he receives his required return.
16.2 The conversion of the asset base (V-d) to a nominal value (TOC) and the
subsequent conversion of WACC into real WACC results in the “addition” of
CPI to the asset that does not “match” the “reduction” of the rate in earlier
years. Therefore the returns in earlier years are lower as it takes time for the
TOC effect to catch up with the real return effect. Once the catch up has taken
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place (around years 6-8), the return will be superior (See graphs in question 5
above).
Question 17 Does the post-tax WACC not allow the entity enough allowable revenue to pay back
its debt which is payable in nominal terms because the WACC (Ke & Kd) is provided
for only on a post tax real basis?
Answer 17.1 No. The tax shield in the Kd is provided for in the tax formula where the post-
tax Kd is grossed up with the tax shield portion of the Kd. This ensures a pre-
tax Kd is provided for in the allowable return to match the payment of the
financing costs in nominal values. (See formula in paragraph 7.3 of
Methodology.)
17.2 In Tables 17.3(i) and 17.3(ii) below the calculation of tax (as per the tax formula
in the tariff Methodology) is demonstrated. For each component which is
taxable, a gross-up at the existing tax rate is performed. Tax allowances are
therefore provided for in these grossed-up balances and will be included in the
total balance of the allowable revenue.
17.3 As can be seen from Table 17.3(i), the grossing up of balances also applies to
the cost of debt (Kd) to ensure the tax shield on the Kd is properly accounted
and provided for.
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Table 17.3(i): Treatment of WACC with Notional Tax
Allowable Revenue = (RAB x WACC) + E + T + D + F ± C. RAB WACC E D (historic)
D (amortisation of write-up)
T taxation) Total
allowable revenue
WACC = [Rf + (MRP*beta)*eq] + [Kd*debt] Ke Kd WACC Gearing 51% 49% Transnet NERSA decision (returns %) 9.52% 3.47% 6.56% Transnet NERSA decision value (R million) 105.00 5.10 1.78 6.88 3.00 4.00 0.20 14.08 NPBT excl tax allowance = { (RAB*WACC) + E + D + F ±C} - {E + D(historic) }.
0.00 0.00 0.00 (3.00) (4.00) (7.00) NPBT excl tax allowance 5.10 1.78 6.88 0.00 0.00 0.20 0.00 7.08 Taxation (gross up and notional tax) 1.98 0.69 2.68 0.00 0.00 0.08 2.75 2.75 Add back tax deductions 0.00 0.00 0.00 3.00 4.00 0.00 0.00 7.00 Total revenue including notional tax 7.08 2.48 9.56 3.00 4.00 0.28 2.75 16.84
All these WACC components are
not deducted to arrive at a taxable income before tax allowance. They first become grossed up. By grossing up and then adding a notional tax allowance, they all effectively become pre-tax. The applicant therefore receives the tax which he is going to pay to the fiscus.
These components are tax deductible and there-fore do not need a tax shield.
The argument sometimes is that the amortisation of the write-up (effectively to counter for the "loss" of CPI
in the conversion of nominal rates to real rates) is affecting the after-tax returns. This component is also awarded a tax shield in the calculation and the applicant receives the tax allowance it needs to pay the fiscus. There is obviously a time delay.
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 19 of 28
Table 17.3(ii): Treatment of WACC with flow-through tax
Allowable Revenue = (RAB x WACC) + E + T + D + F + C RAB WACC E
D & wear & tear
(historic)
D (amortisation of write-up)
T(taxation) Total
allowable revenue
WACC=[Rf+(MRP*beta)*eq]+[Kd*debt] Ke Kd WACC Gearing 51% 49% Returns % 9.52% 3.47% 6.56%
Returns (R million) 105.00 5.10 1.78 6.88 3.00 4.00 0.20 14.08
NPBT excl tax allowance={(RAB*WACC)+E+D(historic & write-up)+F+-C}-{E+wear & tear allowance (historic) +Kd(nominal)} 0.00 (5.88) 0.00 (3.00) (10.00) (13.00) NPBT excl tax allowance 5.10 (4.10) 6.88 0.00 (6.00) 0.20 0.00 1.08 Taxation (gross-up and notional tax) 1.98 (1.59) 0.39 0.00 (2.33) 0.08 (1.87) (1.87) Add back tax deductions 0.00 5.88 0.00 3.00 10.00 0.00 0.00 13.00 Total revenue including flow- through tax with tax shield on Kd
7.08 0.19 7.27 3.00 1.67 0.28 (1.87) 12.22
All these WACC components (except Kd) are
not deducted to arrive at a taxable income before tax allowance. By grossing up and then
adding a notional tax allowance, they all effectively become pre-tax. The applicant
therefore receives the tax which he is going to pay. Tax shield on Kd not given.
These components are tax deductable and therefore do not need a tax shield.
The argument is sometimes that the amortisation of the write-up (effectively to counter for the "loss" of CPI in the conversion of nominal rates to real rates) is affecting the after-tax returns. This component is also awarded a tax shield in the calculation.
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 20 of 28
Question 18 Why is Vanilla WACCreal (pre-tax Kd and post-tax Ke) not used instead of grossing up the
post-tax Kd to ensure that the tax shield of the Kd is provided for in the before tax allowable
revenue?
Answer 18.1 Vanilla WACC is a calculation where the cost of equity (Ke) is post-tax and the cost of
debt (Kd) is pre-tax.
18.2 The taxation component for the cost of debt is “given” to the investor by allowing the
“tax shield” in the calculation of taxation allowance (T) as is demonstrated in the
above Table 17.3(i) and Table 17.3(ii).
18.3 The Vanilla WACCreal results in a higher return relative to the notional or flow-through
(with tax shield) options and therefore it is not utilised by NERSA. This is
demonstrated in the published model in the TAB “flow-through Vanilla” where the
return achieved is 15.5 per cent which is higher than the 15 per cent required return.
EXPENSES
Question 19 When will the claw-back be applied?
Answer 19.1 In the tariff application following the release of audited financial statements of the
applicant.
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 21 of 28
TAX
Choice between two different tax approaches
Question 20 How is the tax calculated under the following scenarios?
• Flow-through tax
• Notional tax
Answer Flow-through tax 20.1 Section 7.2 of the Methodology states that it is the actual tax paid by the entity and
this is allowed as a tax allowance.
20.2 This would not be a beneficial option for the licensee to choose as it does not award
the tax shield of the Kd nor does it award the benefits of accelerated wear and tear or
deferred taxation.
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Table 20.1: Formula and example to determine the tax when a flow-through approach is followed
Formula and example for paragraph 7.2
Tax={(NPBT excl tax allowance)/(1-Tr)}*Tr NPBT excl tax allowance = {(RAB*WACC)+E+D(historic & write-up)+F+-C}-{E+wear & tear allowance (historic) +Kd(nominal)}
Ke a 5.10 Kd(real) b 1.78 WACC c=a+b 6.88
E d 3.00 D (historic) e 4.00
D (write-up) ee 0.20
Wear and tear allowance eee 10.00
F f 0 C [Claw-back excluding tax claw-back] g -
Allowable revenue before tax allowance h=c+d+e+ee+f+g 14.08 Tr j 28%
Kd (nominal) n 5.88 NPBT excl tax
allowance={(RAB*WACC)+E+D(historic & write-up)+F+-C}-{E+wear & tear allowance (historic)
+Kd(nominal)} Note that interest is deducted as a actual tax calculation is performed
k=h-d-eee-n
(4.80)
Allowable revenue pre-tax 14.08 Tax={(NPBT excl tax allowance)/(1-
Tr)}*Tr l={k/(1-j)}*j (1.87)
Total allowable revenue m=h+l 12.22 Test tax rate l/(k+l) 28%
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The penalty for choosing the flow-through option is demonstrated in Table 20.2 below: Table 20.2: The effect of using flow-through tax-
Allowable Revenue = (RAB x WACC) + E + T + D + F + C RAB WACC E
D & wear and tear (historic)
D (amortisation of write-up)
T(taxation) Total
allowable revenue
WACC=[Rf+(MRP*beta)*eq]+[Kd*debt] Ke Kd WACC Gearing 51% 49% Returns % 9.52% 3.47% 6.56%
Returns (R million) 105.00 5.10 1.78 6.88 3.00 4.00 0.20 14.08
NPBT excl tax allowance={(RAB*WACC)+E+D(historic & write-up)+F+-C}-{E+wear & tear allowance (historic) +Kd(nominal)} 0.00 (5.88) 0.00 (3.00) (10.00) (13.00) NPBT excl tax allowance 5.10 (4.10) 6.88 0.00 (6.00) 0.20 0.00 1.08 Taxation (gross-up & notional tax) 1.98 (1.59) 0.39 0.00 (2.33) 0.08 (1.87) (1.87) Add back tax deductions 0.00 5.88 0.00 3.00 10.00 0.00 0.00 13.00 Total revenue including flow-through tax with tax shield on Kd
7.08 0.19 7.27 3.00 1.67 0.28 (1.87) 12.22
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 24 of 28
Notional tax: 20.3 The calculation is to be done by using the formula as demonstrated in Table 20.3. Table 20.3: Formula and example to determine the
tax when a notional tax approach is followed
Tax = { (NPBT excl tax allowance) / (1-Tr)}*Tr
NPBT excl tax allowance={(RAB*WACC) + E + D(historic & write-up) + F ± - C} - {E + D(historic) }
Ke a 5.10 Kd(real) b 1.78 WACC c=a+b 6.88 E d 3.00 D (historic) e 4.00 D (write-up) ee 0.20 F f 0 C [Claw-back excluding tax claw-back] g -
Allowable revenue before tax allowance h=c+d+e+ee+f+g 14.08
Tr j 28%
NPBT excl tax allowance = { (RAB*WACC) + E + D + F ± C} - {E+D(historic)} [Note interest and amortisation of write-up is not deducted to allow tax shield.]
k=h-d-e 7.08
Allowable revenue pre-tax h 14.08
Tax = { (NPBT excl tax allowance) / (1-Tr) }*Tr l={k/(1-j)}*j 2.75
l Allowable revenue m=h+l 16.84 Test tax rate l/(k+l) 28.%
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 25 of 28
The effect of the notional tax formula and the “tax shield” is demonstrated in Table 20.4 below. Table 20.4: The effect of using notional tax
Allowable Revenue = (RAB x WACC) + E + T + D + F + C RAB WACC E
D (histori
c)
D (amortisat
ion of write-up)
T(taxation)
Total allowabl
e revenue
WACC=[Rf+(MRP*beta)*eq]+[Kd*debt] Ke Kd WACC Gearing 51% 49% Returns % 9.52% 3.47% 6.56%
Returns (R million)
105.00
5.10
1.78
6.88
3.00
4.00 0.20
14.08
NPBT excl tax allowance={(RAB*WACC)+E+D+F+-C}-{E+D(historic)}
0.00 0.00 0.00 (3.00) (4.00) (7.00)
NPBT excl tax allowance 5.10 1.78 6.88 0.00 0.00 0.20 0.00 7.08 Taxation (gross-up and notional tax) 1.98 0.69 2.68 0.00 0.00 0.08 2.75 2.75 Add back tax deductions 0.00 0.00 0.00 3.00 4.00 0.00 0.00 7.00 Total revenue including notional tax 7.08 2.48 9.56 3.00 4.00 0.28 2.75 16.84 Note 1. The tax formula for section 7.3 will be added to the Methodology. In the meantime
NERSA is – and has been – applying the formulas as set out above.
Tax – deferred tax (dtax)
Question 21 Why is the deferred tax asset / liability not included in the RAB formula when the flow-
through tax option is chosen?
Answer 21.1 Deferred tax liabilities do not arise relative to the allowable revenue awarded when
the flow-through approach is taken because it is merely a timing issue of when the
tax will be paid and therefore it is not deducted in the RAB formula.
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 26 of 28
21.2 Deferred tax assets arising from tax losses in earlier years are not added in the RAB
formula to counteract the previously “competitive advantage” enjoyed by the entity
because of this asset class.
Note 1. NERSA has published a model on its website with the intention of
demonstrating the various options and scenarios by way of testing the target
cost of equity by the outcome of the internal rate of return (IRR) of cash flows
to investors.
2. The model published also proves that if deferred taxation assets are not added
back to RAB, the required IRR is not achieved.
3. More notes on the published model are provided as closing remarks at the end
of this section on Frequently Asked Questions.
DEPRECIATION
Question 22 How is depreciation and amortisation of the write-up portion calculated?
Answer
22.1 See example in Question 1 (Table 1.5) above.
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 27 of 28
CLAW-BACK Question 23
When are claw-backs applied? Answer 23.1 For the tariff period following the availability of audited financial statements of the
applicant.
F-FACTOR
Question 24 How is the F-factor calculated and how will it be recovered?
Answer Details are provided in Section 9 of the Methodology.
Notes on the model published on NERSA’s website. NERSA has published a model on the website with the intention of demonstrating the
various options and scenarios by way of testing the target cost of equity by the outcome of
the internal rate of return (IRR) of cash flows to investors. High level notes pertaining to the
various “worksheet tabs” are presented below:
1. Base case – The model presents a base case scenario using the notional tax
option where no adjustments are made for deferred taxation to the regulatory
asset base (RAB).
FAQ – Tariff Methodology for the Setting of Petroleum Pipeline Tariffs – IDMS 46306 Page 28 of 28
2. Notional tax – This is the notional tax option with the deferred taxation adjusted in
RAB. Note that IRR is higher than targeted as the actual tax and deferred tax cash
flows practically lag one year.
3. Flow-through using Vanilla WACC – This represents a flow-through option but
with the cost of debt (Kd) pre tax. This means that the tax shield on the cost of
debt (Kd) is not allowed in the tax calculation as the tax is already included in the
pre-tax rate. Also note that the “achieved IRR” in this option is higher (15.50 per
cent) than the targeted 15 per cent, which is why this option is not followed
.
4. Flow-through actual – This is the flow-through option as defined in the
Methodology (paragraph 7.1) actual payments. As can be seen, the resultant IRR
is below the target IRR of 15 per cent which is a result of the tax shield on cost of
debt not allowed. For this reason NERSA is going to use the “tax formula flow-
through” to calculate the tax allowance under this tax option.
5. Tax formula notional – This demonstrates the tax formula for year 1 of the model
and also demonstrates the tax shield for each component of allowable revenue.
6. Graphs – The model also has “worksheet tabs” comparing, by way of data or
graphs, the differences between the various tax options (flow-through and notional
tax) and tenures of debt (10 years versus 25 years).