Hamilton Souetheastern Utilities, Inc. v. Indiana Utility Regulatory Commission Indiana Office of Utility Consumer Counselor and Apartment Association of Indiana, Inc.

FILED
Sep 28 2017, 10:23 am

CLERK
Indiana Supreme Court
Court of Appeals
and Tax Court

FOR APPELLANT ATTORNEYS FOR APPELLEES
Randolph L. Seger William Fine
Brian W. Welch Daniel M. LeVay
Michael T. Griffiths Scott C. Franson
Bingham Greenebaum Doll, LLP Abby Gray
Indianapolis, Indiana Indiana Office of Utility Consumer
Counselor
Indianapolis, Indiana
Beth E. Heline
Jeremy Comeau
Patricia C. McMath
Indiana Utility Regulatory
Commission
Indianapolis, Indiana

IN THE
COURT OF APPEALS OF INDIANA

Hamilton Southeastern Utilities, September 28, 2017
Inc., Court of Appeals Case No.
Appellant-Petitioner, 93A02-1612-EX-2742
Appeal from the Indiana Utility
v. Regulatory Commission
The Honorable Aaron A. Schmoll,
Indiana Utility Regulatory Senior Administrative Law Judge
Commission; Indiana Office of Trial Court Cause No. 44683
Utility Consumer Counselor;
and Apartment Association of
Indiana, Inc.,
Appellees-Respondents/Statutory
Parties and Intervenors.

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 Riley, Judge

STATEMENT OF THE CASE
[1] Appellant/Cross-Appellee-Petitioner, Hamilton Southeastern Utilities, Inc.

(HSE), appeals the Order of the Indiana Utility Regulatory Commission

(Commission), in which the Commission authorized a 1.17% increase in HSE’s

rate for sewer utility service.

[2] We affirm in part, reverse in part, and remand.

ISSUES
[3] HSE raises six issues on appeal, which we consolidate and restate as the

following two issues:

(1) Whether the Commission erred by excluding certain expenses from the

calculation of HSE’s utility rate; and

(2) Whether the Commission erred by approving an excessive system

development charge in one of HSE’s service areas.

[4] On cross-appeal, Appellee/Cross-Appellant-Respondent, the Indiana Office of

Utility Consumer Counselor (OUCC), raises one additional issue, which we

restate as: Whether the Commission erred by including income tax liability in

its calculation of HSE’s utility rate.

FACTS AND PROCEDURAL HISTORY
[5] HSE was founded in 1988 and is a for-profit public utility that provides “sewage

collections and treatment services.” (HSE Exh. 4—Non-Conf. Exh. Vol. II, p.

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 5). HSE “is the largest investor owned sewer utility in” Indiana and currently

serves more than 20,000 customers in Hamilton County, Indiana. (OUCC

Exh. 2—Non-Conf. Exh. Vol. IV, p. 57). As a public utility, HSE is subject to

regulation by the Commission.

[6] Since its inception, HSE has relied on an affiliate company, Sanitary

Management & Engineering Company, Inc. (SAMCO), to carry out the

operation, maintenance, and engineering functions of HSE’s sewage

operations. HSE and SAMCO are governed by the same set of board members

and have the same shareholders. HSE itself has only seven full-time employees

to perform management and billing tasks. HSE and SAMCO operate pursuant

to a Utility Services Agreement, which has been filed with the Commission as

required by statute for affiliate contracts. Under the Utility Services Agreement,

SAMCO bills HSE an hourly rate for services, which rates are annually

negotiated by HSE and SAMCO. The Utility Services Agreement also provides

that SAMCO is entitled to a 10% management fee for procuring equipment,

supplies, and subcontractors on behalf of HSE. In addition to HSE, SAMCO

services nineteen other clients. However, maintaining and operating HSE’s

sewage system comprises approximately 50% to 60% of SAMCO’s business,

and some SAMCO employees spend all of their time working on HSE’s system.

[7] In a 2010 rate case, the Commission authorized HSE to charge a flat monthly

rate of $34.63 per single family equivalent dwelling unit (EDU). In establishing

this rate, the Commission approved a 9.8% rate of return for HSE. At some

point, largely due to aging equipment, HSE began to experience “operational

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 issues” that resulted in significant increased maintenance and operating

expenses. (HSE Exh. 4—Non. Conf. Exh. Vol. II, p. 9). In 2013, a sewage

overflow situation necessitated involvement by the Indiana Department of

Environmental Management (IDEM). As a result, HSE entered into an agreed

order with IDEM, which required HSE to implement a maintenance and

operation plan for its entire system. Since the establishment of its current rates,

HSE has expended “more than $11 million on system repairs and

maintenance.” (HSE Exh. 4—Non-Conf. Exh. Vol. II, p. 8). In order “to

ensure a safe and reliable system,” HSE anticipates that the increased

maintenance and operating costs will continue for the foreseeable future. (HSE

Exh. 4—Non-Conf. Exh. Vol. II, p. 10).

[8] Because of the added expenses, HSE “achieved an average rate of return of just

1.9%” between 2009 and 2015, even though the Commission had approved a

9.8% rate of return. (HSE Exh. 4—Non-Conf. Exh. Vol. II, p. 10).

Accordingly, on September 24, 2015, under Cause No. 44683, HSE filed a

Verified Petition and Notice of Intent to File in Accordance with Minimum

Standard Filing Requirements, seeking authority from the Commission “to

increase its rates and charges for the sewage disposal utility service it renders to

the public and for other related relief.” (Appellant’s App. Vol. II, p. 36).

Specifically, HSE sought an across-the-board rate increase of 8.42% to produce

additional revenues of $997,041 per year. This increase would amount to a

monthly rate increase of $2.92 per EDU, for a monthly wastewater treatment

bill of $37.55 per EDU.

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[9] HSE also requested, in relevant part, an increase to its system development

charge (SDC) of $450 in all of its service areas. “All new development pays

$2,400 [or $3,200 in the Flatfork Creek area, which is subject to an additional

surcharge,] per EDU” to help fund the costs of capital projects. (HSE Exh. 3—

Non-Conf. Exh. Vol. I, p. 172). Thus, HSE requested the approval of a $2,850

SDC for all areas except Flatfork Creek, where it requested an SDC of $3,650.

“SDCs provide a reasonable means of ensuring that existing retail customers do

not subsidize the cost of new development.” (HSE Exh. 3—Non-Conf. Exh.

Vol. I, p. 173). A portion of each SDC that HSE collects is also paid to either

the City of Fishers or the City of Noblesville for a wastewater treatment plant

capacity fee. 1

[10] On February 24, 2016, the Commission conducted a hearing. HSE presented

evidence from various accounting/utility experts, as well as the president of the

company, to support its proposed rate increase. In response, the OUCC, which

is a state agency that represents the interests of “ratepayers, consumers, and the

public” in utility matters, presented its own calculations and requested that the

Commission decrease HSE’s existing rates by 14.01%. Ind. Code §§ 8-1-1.1-4, -

5.1(e). While the OUCC agreed with some of HSE’s proposed adjustments, it

advocated for a rate reduction based on, in large part, its belief that HSE could

operate more economically by eliminating its relationship with SAMCO in lieu

1
In its petition for a rate increase, HSE also sought authority to charge a monthly fee for its new FOG (fats,
oils, and grease) management rules, as well as other miscellaneous changes to its tariff. However, the
Commission’s decisions on these issues are not before us on appeal.

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 of performing those necessary tasks with in-house employees. After reaching

certain stipulations with the OUCC, HSE ultimately reduced its requested rate

increase to 6.27%.

[11] On November 9, 2016, the Commission issued its Order, authorizing HSE “to

increase its rates and charges for sewer utility service by 1.17%, or $139,305.”

(Appellant’s App. Vol. II, p. 34). According to the Commission, such an

increase would result in a monthly charge to customers of $35.04 per EDU and

would provide a 9.60% rate of return to HSE. In relevant part, the Commission

based its rate determination on a finding that expenses related to SAMCO

should be eliminated from HSE’s working capital allowance; the Commission

also declined to include SAMCO’s 10% management fee and a 3% increase to

SAMCO’s contracted operating costs. However, contrary to the proposal

advanced by the OUCC, the Commission determined that HSE could recover

its income tax liability (which is passed through to and paid by its shareholders)

in its rates. As to HSE’s request regarding its SDC, the Commission approved

a $450 increase for all service areas.

[12] On November 29, 2016, HSE filed a Petition for Reconsideration and

Clarification. However, rather than waiting for the Commission to rule on this

petition, on December 9, 2016, HSE filed a Notice of Appeal. The

Commission never ruled on HSE’s reconsideration petition prior to this court

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 assuming jurisdiction. HSE now appeals, and the OUCC cross-appeals.

Additional facts will be provided as necessary. 2

DISCUSSION AND DECISION
I. Motion to Dismiss

[13] In its Notice of Appeal, HSE identified the Commission as an

appellee/statutory party. However, on May 9, 2017, HSE filed a motion to

dismiss the Commission from this appeal, clarifying that it had “mistakenly

identified the Commission as a party on appeal.” (HSE’s Motion to Dismiss, p.

4). HSE argued that the Commission was an improper party as it “acted as a

fact-finding administrative tribunal, hearing evidence from the opposing parties,

and rendering its Order purportedly based on the evidence.” (HSE’s Motion to

Dismiss, p. 2).

[14] Nevertheless, on June 9, 2017, the Commission filed an appellate brief, in

which it responded to HSE’s claims of error and argued that the findings of its

final Order were justified. In response to HSE’s motion to have it dismissed as

a party to the appeal, the Commission contended that it is a proper party

because this “case is not akin to a controversy between two parties.”

(Commission’s Br. p. 16). Rather, the Commission claimed to have been acting

2
On December 30, 2015, by order of the Commission, the Indiana Apartment Association, “a statewide
trade organization” that represents the interests of several “multi-family housing units within HSE’s service
territory,” intervened in the proceeding. (Appellant’s App. Vol. II, p. 47). The Apartment Association
challenged HSE’s billing methodologies with respect to multi-family housing units; however, the
Commission ultimately found HSE’s billing practices to be reasonable in this regard. The Apartment
Association does not participate in this appeal.

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 in a legislative, not judicial, capacity in determining a proper utility rate. Thus,

the Commission asserted that

as an executive branch administrative agency acting in the public
interest[,] [it] should be able to defend that its orders are in the
public interest. It therefore brings a perspective useful to the
Court of Appeals that may be helpful to proper resolution of the
issues on this appeal and should be allowed to remain as an
appellee.

(Commission’s Br. p. 18).

[15] “The Indiana General Assembly created the [Commission] primarily as an

impartial fact-finding body with the technical expertise to administer the

regulatory scheme devised by the legislature.” Duke Energy Ind., Inc. v. Office of

Util. Consumer Counselor, 983 N.E.2d 160, 164 (Ind. Ct. App. 2012) (citing I.C. §

8-1-1-5(a)). “The Commission cannot act in the role either of a proponent or

opponent on any issue to be decided by it.” Id. (citing I.C. § 8-1-1-5(a)).

Rather, the Commission’s role “is to ensure that public utilities provide

constant, reliable, and efficient service to the citizens of Indiana.” Id.

[16] In City of Terre Haute v. Terre Haute Water Works Corp., 180 N.E.2d 110, 111 (Ind.

App. 1962), In Banc, this court held that it was improper to name the

Commission as a party to the appeal on a rate-making decision it had rendered.

The Terre Haute court stated that the Commission

is a fact-finding administrative tribunal which acts in a quasi-
judicial capacity. When there are two opposing parties before it,
as here, its action in making findings and issuing an order

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 deemed detrimental by one of the parties is similar to that of a
court which makes a decision determining a controversy between
adverse parties. A court is never a party to an appeal from its
decision.

Id. More recently, in Citizens Action Coal. of Ind., Inc. v. Indianapolis Power & Light

Co., 74 N.E.3d 554, 557 n.2 (Ind. Ct. App. 2017), our court granted a motion to

dismiss the Commission as a party on appeal, stating that “[b]ecause the

Commission acted as a fact-finding administrative tribunal and no statute or

administrative provision expressly makes the Commission a party on appeal, it

is not a proper party on appeal from its own decision.”

[17] The Commission cites two cases in support of its contention that this court has

previously allowed the Commission to participate as a party in judicial review

of the Commission’s own orders. See NIPSCO Indus. Grp. v. N. Ind. Pub. Serv.

Co., 31 N.E.3d 1 (Ind. Ct. App. 2015), and Duke Energy Ind. Inc., 983 N.E.2d at

160. 3 Although the Commission was a named party in these appeals, these

decisions did not address the merits of whether the Commission was a proper

appellate party and, thus, offer little value to the Commission’s position.

[18] The Commission further contends that the present rate case did not involve “a

controversy between two adverse parties.” (Commission’s Br. p. 17).

Specifically, the Commission asserts that the OUCC cannot be considered an

3
The Commission cites a third case, Citizens Action Coal. of Ind., Inc. v. N. Ind. Pub. Serv. Co., 804 N.E.2d 289
(Ind. Ct. App. 2004); however, we see nothing to indicate that the Commission appeared as a party in that
appeal.

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 adverse party because it agreed with HSE “on a number of issues.”

(Commission’s Br. p. 17). Moreover, the Commission points out that it would

have had to consider and rule on HSE’s rate request regardless of whether the

OUCC had posed any opposition; thus, “it is not accurate to consider a rate

case before an administrative body the same as a complaint or petition of one

party against another.” (Commission’s Br. p. 17).

[19] We recognize that the Commission acts in a legislative, rather than judicial,

capacity with respect to rate-making, and the General Assembly “has seen fit to

establish a [C]omission for the express purpose of hearing evidence and

balancing and weighing the many complicated factors which must be taken into

consideration in setting utility rates.” Citizens Action Coal. of Ind., Inc., 74

N.E.3d at 564. Nevertheless, the Commission is obligated to be “an impartial

fact-finding body” in “all controversial proceedings heard by it.” I.C. § 8-1-1-

5(a). Here, HSE sought an initial rate increase of 8.42%, which it subsequently

agreed to reduce to 6.27%, whereas the OUCC presented evidence in an effort

to convince the Commission to decrease HSE’s existing rates by 14.01%.

Additionally, the Indiana Apartment Association appeared as an intervenor to

challenge HSE’s billing practices with respect to multi-family housing units in

HSE’s service area. Although the Commission wields wide discretion in

determining an appropriate rate, it cannot be said that the parties appearing

before the Commission did not advocate for competing interests. Furthermore,

we find that the Commission’s Order should speak for itself, without the need

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 to further rationalize its decision to our court. Accordingly, the Commission is

not a proper party on appeal from its own decision and should be dismissed. 4

II. Standard of Review

[20] Judicial review of the Commission’s decisions is governed by Indiana Code

section 8-1-3-1, which provides that

[a]ny person, firm, association, corporation, limited liability
company, city, town or public utility adversely affected by any
final decision, ruling, or order of the [C]ommission may, within
thirty (30) days from the date of entry of such decision, ruling, or
order, appeal to the court of appeals of Indiana for errors of law
under the same terms and conditions as govern appeals in
ordinary civil actions, except as otherwise provided in this
chapter and with the right in the losing party or parties in the
court of appeals to apply to the supreme court for a petition to
transfer the cause to said supreme court as in other cases. An
assignment of errors that the decision, ruling, or order of the
[C]ommission is contrary to law shall be sufficient to present
both the sufficiency of the facts found to sustain the decision,
ruling, or order, and the sufficiency of the evidence to sustain the
finding of facts upon which it was rendered.

[21] More specifically, our review is two-tiered:

On the first level, it requires a review of whether there is
substantial evidence in light of the whole record to support the
Commission’s findings of basic fact. Such determinations of
basic fact are reviewed under a substantial evidence standard,
meaning the order will stand unless no substantial evidence

4
A separate order granting HSE’s motion to dismiss the Commission as a party to this appeal will be issued
simultaneously with this decision.

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 supports it. In substantial evidence review, “the appellate court
neither reweighs the evidence nor assesses the credibility of
witnesses and considers only the evidence most favorable to the
[Commission’s] findings.” The Commission’s order is
conclusive and binding unless (1) the evidence on which the
Commission based its findings was devoid of probative value; (2)
the quantum of legitimate evidence was so proportionately
meager as to lead to the conviction that the finding does not rest
upon a rational basis; (3) the result of the hearing before the
Commission was substantially influenced by improper
considerations; (4) there was not substantial evidence supporting
the findings of the Commission; (5) the order of the Commission
is fraudulent, unreasonable, or arbitrary. This list of exceptions is
not exclusive.

At the second level, the order must contain specific findings on
all the factual determinations material to its ultimate conclusions.
McClain [v. Review Bd. of Ind. Dep’t of Workforce Dev., 693 N.E.2d
1314, 1317-18 (Ind. 1998),] described the judicial task on this
score as reviewing conclusions of ultimate facts for
reasonableness, the deference of which is based on the amount of
expertise exercised by the agency. Insofar as the order involves a
subject within the Commission’s special competence, courts
should give it greater deference. If the subject is outside the
Commission’s expertise, courts give it less deference. In either
case[,] courts may examine the logic of inferences drawn and any
rule of law that may drive the result. Additionally, an agency
action is always subject to review as contrary to law, but this
constitutionally preserved review is limited to whether the
Commission stayed within its jurisdiction and conformed to the
statutory standard and legal principles involved in producing its
decision, ruling, or order.

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 Citizens Action Coalition of Ind., Inc., 74 N.E.3d at 562-63 (internal citations

omitted) (quoting N. Ind. Pub. Serv. v. U.S. Steel, 907 N.E.2d 1012, 1016 (Ind.

2009)).

[22] The Commission’s “authority ‘includes implicit powers necessary to effectuate

the statutory regulatory scheme.’” United States Gypsum, Inc. v. Ind. Gas Co., 735

N.E.2d 790, 795 (Ind. 2000) (quoting Office of Util. Consumer Counselor v. Pub.

Serv. Co., 608 N.E.2d 1362, 1363-64 (Ind. 1993)). As a legislative creation, the

Commission is limited to exercising “that power which has been conferred

upon it by statute.” Citizens Action Coal. of Ind., Inc., 74 N.E.3d at 562. With

respect to matters within its jurisdiction, it is well established that the

Commission “enjoys wide discretion.” Id. at 565. We will not override the

Commission’s findings and decision simply “because we might reach a contrary

opinion on the same evidence.” Id. The party challenging the Commission’s

decision bears the burden of showing there is insufficient evidence in the record

to support the Commission’s findings; it is not enough to “merely cite to other

evidence of record which would support a determination more favorable to

their position.” Id. at 565-66.

III. Utility Rate Determination

[23] It is a well-established “basic legislative policy that questions of rate-making

methodology are best consigned to the Commission’s expertise.” Id. at 562. In

rate cases, “the Commission’s primary objective is to establish a level of rates

and charges that will permit the utility to meet its operating expenses plus a

return on investment which will compensate its investors.” Id. “In determining

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 fair rates, the Commission considers a representative level of anticipated

revenues and expenses and the property employed by the utility to provide

service to its customers.” United States Gypsum, Inc., 735 N.E.2d at 798. When

the Commission “determines that a utility’s rates have become unjust and

unreasonable, it may modify them by ordering just and reasonable rates to be

charged prospectively.” Id. Because the “rate-setting procedure is

comprehensive[,] the Commission must examine every aspect of the utility’s

operations and the economic environment in which the utility functions to

ensure that the data it has received are representative of operating conditions

that will, or should, prevail in future years.” Id. (internal quotation marks

omitted).

A. SAMCO Fees

[24] HSE first challenges the Commission’s exclusion of certain SAMCO-related

expenses from its rate calculation. In August of 2015, HSE and SAMCO

negotiated a 3% increase to SAMCO’s contracted billing rates, and the affiliate

Utility Services Agreement entitles SAMCO to a 10% management fee for

procuring materials and subcontractors. In its Order, the Commission

determined that HSE was not permitted to recover either the 3% contract

increase or the 10% management fee through its utility rate. Specifically, the

Commission found:

As noted by the OUCC, [the National Association of Regulatory
Utility Commissioners (NARUC)] guidelines call for affiliate
pricing to be at market price, or the fully allocated cost,
whichever is lower. Here, HSE presented evidence that shows

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 SAMCO’s rates are at or below the rates charged by other similar
firms, but presented no evidence concerning what SAMCO’s
fully allocated cost actually is. While we agree with HSE that the
OUCC’s 20% ($690,506) downward adjustment is arbitrary, the
Commission would note that it is HSE, not the OUCC, which
has the burden to prove its costs are reasonable. Because HSE
failed to produce any evidence concerning SAMCO’s fully
allocated cost, the Commission is unable to determine whether
the market prices charged by SAMCO, while at or below costs of
its competitors, are at or below SAMCO’s fully allocated cost.

Similarly, while the 10% management fee may be customary in
the industry, SAMCO has failed to provide any evidence of what
the actual fully allocated management cost is. In the absence of
any evidence of actual cost, we decline to include the proposed
management fee in rates.

Despite the failure to provide fully allocated cost information, we
decline to deny recovery of all SAMCO-related expenses.
Regardless of what entity performs the services tasked to
SAMCO, those services are reasonable and necessary to the
provision of utility service. The issue is the level of expense that
should be approved in light of the evidence of record. Because
HSE failed to demonstrate SAMCO’s fully allocated costs, the
Commission declines to approve [HSE’s] proposed $115,498
($54,728+$60,770) 3% increase in its contract operations cost
with SAMCO, and accepts the OUCC’s proposed $62,330 10%
management fee reduction. Accordingly, we find SAMCO’s pro
forma Contract Services-Other expenses are at $2,003,649 and its
pro forma Contract Services-Engineering expenses are
$1,822,762.

In its next rate case, we direct HSE to offer evidence supporting
SAMCO’s fully allocated cost so that the Commission may
determine the appropriate level of SAMCO expenses that should
be included in HSE’s rates. Further, we direct HSE to file with

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 the Commission all current affiliate agreements within 30 days of
the date of this Order.

(Appellant’s App. Vol. II, p. 27).

[25] NARUC “has issued guidelines for cost allocations and affiliate transactions.”

(OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 38). These guidelines “are

intended to provide guidance to jurisdictional regulatory authorities and

regulated utilities and their affiliates in the development of procedures and

recording of transactions for services and products between a regulated entity

and affiliates.” (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 171). NARUC

recommends that “[g]enerally, the price for services, products and the use of

assets provided by a non-regulated affiliate to a regulated affiliate should be at

the lower of fully allocated cost or prevailing market prices. Under appropriate

circumstances, prices could be based on incremental cost, or other pricing

mechanism as determined by the regulator.” (OUCC Exh. 1—Non-Conf. Exh.

Vol. III, p. 174).

[26] Evidence presented at the hearing indicates that in HSE’s prior rate case, the

Commission found SAMCO’s rates to be reasonable based on evidence of

SAMCO’s “market rates for its services” without regard to evidence of

SAMCO’s fully allocated costs. (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p.

40). By suddenly shifting course in the present case and requiring compliance

with the standard suggested by NARUC, HSE now contends that the

Commission engaged in improper rulemaking contrary to the Administrative

Rules and Procedures Act. However, we need not consider whether the
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 Commission has attempted to promulgate a new rule without going through the

appropriate channels because we agree with HSE’s alternative argument that

the Commission acted arbitrarily. See Citizens Action Coalition of Ind., Inc., 74

N.E.3d at 563 (noting that the Commission’s order is binding unless it is

arbitrary) (quoting N. Ind. Pub. Serv., 907 N.E.2d at 1016). We are mindful of

the Commission’s broad discretion and responsibility for considering all aspects

of a utility’s operations to determine a just and reasonable rate. United States

Gypsum, Inc., 735 N.E.2d at 798; see I.C. § 8-1-2-4. Nevertheless, the

Commission’s unexplained reliance on a heretofore unapplied standard

recommended by NARUC renders its decision arbitrary. See BLACK’S LAW

DICTIONARY 112 (8th ed. 2004) (defining “arbitrary” as “[d]epending on

individual discretion . . . rather than by fixed rules, procedures, or law”).

[27] In Cellco Partnership v. Ind. Utility Regulatory Comm’n, 810 N.E.2d 1137, 1144

(Ind. Ct. App. 2004), the Commission departed from its own precedent

concerning the confidentiality of certain data. Our court found no error in the

Commission’s decision “to take a different approach” because the

Commission’s findings made it clear that the Commission had “fully examined

the issues” of the case and clearly explained why it had decided inconsistently

with its own prior orders. Id. See also Ind. Bell Tel. Co. v. Ind. Util. Regulatory

Comm’n, 810 N.E.2d 1179, 1186 (Ind. Ct. App. 2004) (“We note that an agency

may change its course and is not forever bound by prior policy or precedent.

That is, where a policy or precedent is flawed and needs to be changed, the

agency may change the course as long as it explains the reasons for doing so.”),

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 trans. denied. Here, the Commission found that the evidence established that

SAMCO’s rates are “at or below the” prevailing market rates, and that its

management fee is “customary in the industry.” (Appellant’s App. Vol. II, p.

27). Even though this type of evidence was sufficient to establish the

reasonableness of SAMCO’s charges in HSE’s prior rate case, the Commission

failed to explain its decision to now adhere to the standard advocated by

NARUC that the test for reasonableness is the lower of fully allocated cost or

prevailing market prices. Moreover, although the OUCC presented vague

evidence indicating that the Commission has “approved affiliate guidelines and

cost allocation guidelines” in other utility cases, there is no evidence that it has

previously enforced NARUC guidelines in this manner. Accordingly, we

reverse the Commission with respect to the SAMCO fees and remand for either

additional support for its decision or a recalculation of HSE’s rate.

B. Working Capital Allowance

[28] HSE also claims that the Commission erroneously excluded SAMCO’s charges

from its calculation of a working capital allowance. “Cash working capital

represents the funds needed to be invested in the utility to give the utility the

financial wherewithal to pay reasonable [operating and management] expenses

in the ordinary course of business prior to recovery in rates.” (Appellant’s App.

Vol. II, p. 15). “In other words, working capital is the money a utility must use

to provide utility service before it receives payment for that service.” (OUCC

Exh. 1—Non-Conf. Exh. Vol. III, p. 24). “Working capital is considered an

investment necessary for providing utility service and is included in rate base for

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 investor-owned utilities.” (OUCC Exh. 1—Non-Conf. Exh. Vol. III, pp. 24-

25).

[29] In this case, HSE calculated its working capital by using the Federal Energy

Regulatory Commission’s (FERC) 45-day methodology, which the

Commission has previously approved.

The FERC 45 day formula method calculates a percentage of
operating expenses as the estimate of the working capital
requirements for a utility. This method assumes the difference
between the lead/lag periods[5] . . . is 45 days and calculates
12.5% (45 days/360 days) of adjusted annual operating expenses
as cash working capital. This methodology typically adjusts
operating expenses for those items known to be paid after the
receipt of revenues or paid “in arrears.” The advantage of the
formula method is that it is quick and inexpensive and has
generally been thought to be a reasonable estimate of what a
lead/lag study would produce without the related expense of a
lead/lag study.

(OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 26). HSE requested “an

allowance for 45 days capital in the amount of $813,089.” (HSE Exh. 3—Non-

Conf. Exh. Vol. I, p. 169). However, the OUCC, in addition to arguing about

the impropriety of the FERC 45-day methodology, sought the removal of

5
A lead/lag study “measures the differences between (1) the time services are rendered until the revenues for
that service are received, and (2) the time expenses are incurred until those expenses are paid.” (OUCC Exh.
1—Non-Conf. Exh. Vol. III, p. 25).

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 SAMCO’s charges from the working capital calculation. In particular, the

OUCC’s evidence provided that

[t]he fees and cost reimbursements HSE pays to SAMCO are
generally billed at the end of the month and paid during the
subsequent month. Therefore, SAMCO charges are paid in
arrears when HSE has begun receiving revenues from its
customers. There is no lag between when the expense is paid and
when revenues are received. Therefore, there is no need to
include these costs in the calculation of working capital.

(OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 27).

[30] Although it approved the FERC 45-day methodology, the Commission

otherwise agreed with the OUCC and found:

The reason that purchased utility expenses have been removed in
accordance with the 45-day method is that such services are
payable after utility customers make payment for the utility
service that utilized the expense. For affiliate expenses such as
those at issue here, we see little reason to require ratepayers to
provide a return to the shareholders when the shareholders are on
both sides of the transaction, especially in light of our concerns
over the cost of the SAMCO services . . . . There is no reason that
SAMCO could not adjust billing cycles so that SAMCO bills
would be payable after customer payments were received by
HSE. Ultimately, we agree with the OUCC that SAMCO
expenses should be removed from HSE’s working capital
calculation.

(Appellant’s App. Vol. II, p. 16). After removing SAMCO expenses and

making other adjustments, the Commission determined that HSE’s “revised

working capital allowance is $111,779.” (Appellant’s App. Vol. II, p. 16). HSE

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 now asserts that the Commission improperly “disallowed the SAMCO charges

because of HSE’s purported failure to provide evidence of SAMCO’s ‘fully

allocated cost’ information and its unwarranted assumption that SAMCO could

simply delay billing HSE.” (HSE’s Br. p. 48).

[31] In HSE’s prior rate case, the Commission approved SAMCO’s charges in

HSE’s working capital. However, based on the OUCC’s testimony in the

present case, the Commission found that SAMCO’s “services are payable after

utility customers make payment for the utility service that utilized the expense.”

(Appellant’s App. Vol. II, p. 16). As described by the OUCC, the FERC 45-day

methodology “adjusts operating expenses for those items known to be paid . . .

in arrears.” (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 26). During rebuttal,

HSE simply argued that “[t]he OUCC’s proposal for working capital is

completely unreasonable for a utility even a fraction of the size of HSE.” (HSE

Exh. 7—Non-Conf. Exh. Vol. IV, pp. 107-08). HSE also noted that

“everything is paid in arrears, but so are the revenues. The revenues are billed

in arrears and collected in arrears also, so there still has to be money to—you

can’t operate with no money in the bank.” (Tr. Vol. II, pp. 18-19).

[32] Notwithstanding the Commission’s other findings relating to its concerns about

SAMCO’s excessive cost or its ability to adjust its billing cycle, there is evidence

to support the Commission’s determination that SAMCO’s expenses are paid in

arrears. To find otherwise would amount to reweighing the evidence.

Accordingly, we find no error in the Commission’s decision to exclude

SAMCO’s charges from the calculation of HSE’s working capital.

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 III. System Development Charge

[33] Upon HSE’s request, the Commission granted a $450 increase to HSE’s SDC in

all service areas. This amounted to a total of $2,850 per EDU for most areas

and $3,650 for the Flatfork Creek area. As HSE explained, the Flatfork Creek

area required a higher SDC because the developer was entitled to an $800

surcharge “until 1750 EDUs are developed in the . . . area.” (HSE Exh. 3—

Non-Conf. Exh. Vol. I, p. 164). The OUCC agreed with the SDC increase.

[34] After the parties had presented their evidence, on May 17, 2016, HSE filed its

Submission of Exceptions and Reply Brief in response to the OUCC’s proposed

order for the Commission. In its Exceptions and Reply Brief, HSE stated:

In October 2015, after HSE filed this rate proceeding, HSE’s
commitment to the seller of the Flatfork utility to pay $800 for
each EDU developed in the Flatfork [area] w[as] satisfied, and
HSE stopped collecting the $800 supplemental SDC in the
Flatfork [area]. Therefore, Section 14 of HSE’s Proposed Order
submitted to the Commission on April 1, 2016, should be
changed to reflect that the $800 supplemental SDC in the
Flatfork . . . area is no longer being collected, and that the tariff
filed in this rate matter should reflect a uniform SDC of $2,850
per EDU in all service areas of HSE, including the Flatfork . . .
area.

(Appellant’s App. Vol. III, p. 39).

[35] HSE now argues “that the Commission erred in approving an SDC of $3,650

per EDU for the Flatfork Creek service area when HSE only sought an SDC of

$2,850 per EDU.” (HSE’s Br. p. 52). However, as the OUCC points out,

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 HSE’s Exceptions and Reply Brief “is argument of counsel and is not evidence

that was entered into the record.” (OUCC’s Br. p. 46). While we certainly

recognize that HSE should not be collecting excessive fees, it cannot be said

that the Commission somehow erred by relying on the evidence that was

properly before it.

IV. Cross-Appeal: Inclusion of Income Taxes in Rate Calculation

[36] The OUCC claims that the Commission erred by allowing HSE to recover

income taxes in its rates. During the hearing, evidence was presented that HSE

is organized as an S Corporation. Thus, “[f]or federal and state income tax

purposes, the shareholders of HSE have consented to have HSE’s income taxed

directly to them.” (HSE Exh. 2—Non-Conf. Exh. Vol. I, p. 125). “In lieu of

HSE paying taxes, the shareholders of an S Corporation are taxed on their

proportionate share of the company’s taxable income at each individual

shareholder’s respective tax rate.” (HSE Exh. 2—Non-Conf. Exh. Vol. I, pp.

125-26). Accordingly, the OUCC insists that “authorizing HSE to include any

state or federal income tax liability in its revenue requirement means HSE will

be allowed an expense HSE will never incur.” (OUCC’s Br. p. 46).

[37] The Commission must “establish a level of rates and charges sufficient to allow

the utility to meet its operating expenses as well as a return on investment to

compensate its investors.” South Haven Waterworks v. Office of Util. Consumer

Counselor, 621 N.E.2d 653, 654 (Ind. Ct. App. 1993). “Operating costs

represent one component in the equation to determine the utility’s total revenue

requirement[,]” and “[t]he taxes paid by a utility are included within its

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 operating costs.” Id. In the absence of an “adjustment for taxes, operating

expenses will be lower resulting in a lower total revenue requirement.” Id. at

654-55.

[38] Although HSE’s tax liability is passed through to its shareholders, the

Commission has previously recognized “the benefits of S Corporations as

compared to C Corporations” because “the S Corporation structure tends to

benefit both shareholders and ratepayers, under current tax laws, by avoiding

higher C Corporation tax rates.” (HSE Exh. 2—Non-Conf. Exh. Vol. I, pp.

127-28). As HSE explained, if, in the calculation of its rates, it were prohibited

from including the tax liability that its shareholders incur, it “would inevitably

convert to a . . . C [C]orporation” so that it could recover its tax expense. (HSE

Exh. 8—Non-Conf. Exh. Vol. IV, p. 136). This would result in HSE paying

higher taxes, “and in turn, HSE’s customers would pay more tax expense.”

(HSE Exh. 8—Non-Conf. Exh. Vol. IV, p. 137). In the present case, the

Commission found:

We previously addressed treatment of S-Corporation taxes in
Cause No. 43761, and decline the OUCC’s invitation to
reconsider our conclusion in that Cause, with the exception of
the appropriate federal rate applicable to each shareholder. HSE
included in its cost of service calculation an effective income tax
rate based upon the Commission’s methodology approved in
Cause No. 43761. In that proceeding, the Commission found the
appropriate method to determine actual federal income taxes is
based on the individual shareholder’s rates used by the Internal
Revenue Service during the test year as if no other income is
earned by the shareholder. Using the Commission’s approved
methodology from Cause No. 43761, HSE calculated a

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 combined federal and state tax rate of 27.43% to be used in its
cost of service calculations.

During the hearing, the OUCC established that HSE’s
shareholders have differing filing statuses, such as married filing
jointly. In Cause No. 43761, it appears that the Commission
calculated HSE’s tax rate using the tax rates applicable for single
filing status. We find that it would be more appropriate to use
the actual filing status of each HSE shareholder to calculate the
tax rate. In doing so, HSE’s combined federal and state tax rate
shall be 26.82%.

(Appellant’s App. Vol. II, p. 29).

[39] In South Haven, 621 N.E.2d at 655, this court determined that the utility, an S-

Corporation, was “not entitled to an adjustment to operating expenses” based

on its purported income tax. Although the South Haven court recognized that

the utility itself does not incur a tax liability, it did not hold that S-Corporations

are precluded from recovering the tax liability that is passed through to

shareholders in its rates. Id. Rather, there was no evidence presented that the

utility’s “shareholders actually paid income taxes attributable to income from

[the utility] during the test year or at any other time. The adjustment for

income tax expenses of a corporation is available only when the corporation

can demonstrate that taxes were actually paid.” Id. Without evidence of the

actual taxes paid, the South Haven court determined that to assign a certain tax

liability as an operating expense incurred by the utility “would be speculative,

arbitrary, hypothetical and unsupported by the record.” Id.

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[40] Conversely, in the present case, evidence was presented that the shareholders of

HSE actually paid income taxes at their personal rates for income attributable

to HSE. The Commission clearly recognized that ratepayers would be

subjected to higher rates to compensate for increased operating costs if the

utility had to pay the higher tax rates of a C Corporation. The Commission

exercised its discretion to calculate a just and reasonable rate. Therefore, we

find no error in the Commission’s determination that HSE may recover, as part

of its operating costs, the income taxes its shareholders actually paid.

CONCLUSION
[41] Based on the foregoing, we conclude that the Commission is not a proper party

to this appeal and is hereby dismissed. We further conclude that the

Commission acted arbitrarily in excluding HSE’s affiliate expenses (the 3%

contract increase and 10% management fee) from HSE’s rate calculation by

relying on the NARUC guidelines without explanation; however, the

Commission was within its discretion to consider the evidence and exclude the

paid-in-arrears affiliate expenses from HSE’s calculation of working capital. In

addition, we conclude that the Commission did not err in its conclusion

regarding HSE’s SDC based on the evidence presented. Finally, the

Commission properly permitted HSE to recover its passed-through income tax

liability in its rates.

[42] Affirmed in part, reversed in part, and remanded.

[43] Robb, J. and Pyle, J. concur

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