These three cases involve petitions for review of certain orders and opinions of the Federal Power Commission. They were filed pursuant to Section 19(b) of the Natural Gas Act, 15 U.S.C.A. 717r(b).1 Upon joint motion of all parties, the cases were ordered consolidated for all purposes of this review. There are two principal issues which, for simplicity, will be referred to as (1) the 'cost' issue; and (2) the 'tax' issue.

The facts surrounding the 'cost' issue may be summarized as follows: Petitioner, Florida Gas Transmission Company (FGT), which owns and operates natural gas pipeline facilities extending from Texas to and trhoughout Florida, is successor in interest to the Houston Texas Gas and Oil Company (Houtex), which was organized during the 1950's to build and operate a natural gas pipeline. In order to finance the project, houtex sold an aggregate of approximately 37.5% Of its stock to four engineering and construction firms.2 It then entered into an agreement with the firms whereby they would perform specified services necessary to construct the pipeline and be compensated 'at the going rate' for such work. Houtex thereafter applied to the Federal Power Commission for a Certificate of Public Convenience and Necessity. The Commission reviewed all the facts relating to the project and stated the following:

'Finally, it appears that the labor necessary for consrruction of the facilities of Houston Gas will be furnished by three construction companies, the president of each of which is an official and director of Houston Gas and that two of these construction companies own blocks of Houston Gas stock. Furthermore, a member of the firm of engineers which will supervise the construction and operation of the pipeline is also a vice president and director of Houston Gas. While as we have already stated, the cost of the proposed facilities appears to be reasonable, in view of this fact, this cost will be carefully scrutinized in any future proceeding dealing with accounting or rates of Houston Gas * * *.'

At a subsequent rate determination hearing, the Commission refused to consider as part of Houtex' 'cost-of-service' the profits it paid to the four firms for their services because of the so-called 'no-profits-to-affiliates' rule. Opinion 431, 31 FPC 1402, 1403 (1964).

The facts surrounding the 'tax' issue may be summarized as follows: FGT is also successor in interest to the Coastal Transmission Corporation (Coastal) which between 1958 and 1961 filed consolidated income tax returns with its parent corporation and fellow subsidiaries pursuant to the provisions of the Internal Revenue Code of 1954.4 Although Coastal itself realized taxable income during this period, it incurred no actual tax liability because substantial losses from the other members of the corporate family were included in the return. During the same aforementioned rate proceeding, the Commission also refused to consider those taxes Coastal would have paid, had it filed a separate return, as part of its 'cost-of-service.' 31 FPC 1402, 1410 (1964).

Subsequent to the rate hearing, the Commission denied FGT's Motion for Rehearing, Opinion 431-A, 32 FPC 518 (1964), and Motion to Re-open the Record for introduction of further evidence, Opinion 431-B, 32 FPC 908 (1964). Florida Public Utilities Commission intervened and aligened itself with FGT.

At the outset, we can readily dispose of the 'tax' issue with our recent decision in United Gas Pipe Line Company v. FPC, 357 F.2d 230 (5 Cir. 1966), in which we adopted the rule of the Tenth Circuit, as set forth in Cities Service Gas Co. v. FPC, 337 F.2d 97 (10 Cir. 1964), that the federal taxes which a gas transmission company would have paid, but for a consolidated return, are properly to be included in the 'cost-of-service' during rate determinations. Therefore, the order of the Commission denying Coastal's practice of accuring federal income taxes must be vacated.

As to the 'cost' issue, the following extracts from the Commission's opinion in this case reveal the crux of its position:

'We think that our rule against profits to affiliates precludes allowing their (the firms) profits in the plant accounts of Houston Texas. The noprofits-to-affiliates rule goes far back in Commission history. See for example Alabama Power Co., 1 FPC 25, 39, aff'd. Alabama Power Co. v. McNinch (68 App.D.C. 132), 94 F.2d 601 (CADC 1937); Louisville Hydro-Electric Company, 1 FPC 130, 133, aff'd. Louisville Gas & Electric Co. v. F.P.C., 129 F.2d 126 (CA6 1942), cert. den. 318 U.S. 761 (63 S. Ct. 559, 87 L. Ed. 1133). The basis of this rule is that a profit made by an enterprise dealing with itself does not represent cost.' 'To prevent the evils which have been the subject of past proceedings the rule against profits to affiliates must be sufficiently broad to cover fact as well as form.' 'The purpose of the rule is to prevent insiders taking advantage of their position and creating costs which are not subject to the check of ordinary business relationships. CF., Section 10 of the Clayton Act, 15 U.S.C. 20. We do not think that some particular percentage of stock or of common officers or directors can be allowed to be determinative of whether the rule should apply, although these factors are relevant to determine when a relationship exists that calls for application of the exclusionary rule. That the contractors or promoters could not have dictated policies or ordered the execution of contracts if all other interests had chosen to oppose them cannot validate a relationship which by its very nature and history precludes unhampered bargaining, especially if the contractors or promoters were, as here, clearly dominant when the original contracts were agreed upon. If control exists, sufficient to dominate the execution of the contracts in the face of united opposition, that makes the rule automatically applicable; but our inquiry is not at an end if we conclude that the insider's influence resulting in the contract is or became somewhat less than this degree of control.' 31 FPC 1402 at 1407.

Petitioners contend that (1) the Commission is estopped from deleting 'reasonable profits' from Houtex' cost-of-service because of its pronouncements during the previous certification proceedings to the effect that the projected costs (including profits to the firms) of the project appeared to be 'reasonable'; and (2) the 'no-profits-to-affiliates' rule is inappicable where, as here, neither party 'controlled' the other. They seek to have the Commission's orders vacated and the case remanded with instructions to investigate the 'reasonableness' of the profits without application of any 'automatic' exclusion.

The majority opinion of the Commission framed the issue as to cost in the following language:

'On the first question there is an issue as to whether there was an affiliation between Houston Texas and the engineering and construction firms, and, if so, whether that part of the pipeline costs representing profits to these firms should be eliminated from the company's plant accounts. There is also a subsidiary question as to whether the profits should not be reduced by certain overhead costs of the construction firms.'

In its brief filed on this petition for review, the Commission takes the position that it did not operate according to the 'no-profits-to-affiliates rule' and that any reference thereto constituted legal shorthand for a 'rule' of law that promoters of a corporation stand sn a fiduciary relationship to it and that only such utility rates should be approved which will provide the company an opportunity to realize a reasonable return. Accordingly, it is contended that the question presented can be answered without reference to any 'rule' or without use of the word 'affiliate.' Moreover, the Commission denies the petitioners' assertion that it ruled 'automatically' or 'without factual inquiry.'

Section 6(a) of the Natural Gas Act, 15 U.S.C.A. 717e(a), gives the Commission authority to 'ascertain the actual legitimate cost of property of every natural-gas company' when determining cost-of-service as it relates to rate-making. In the past-- as indicated by the Commission opinion printed in part above-- the Commission has excluded from 'actual legitimate cost' those profits paid by a company to any other with which it is, either directly or indirectly, in a 'control' relationship.5 This practice has become known as the 'no-profits-to-affiliates' rule. The rationale behind the rule is relatively simple and highly pragmatic. If the relationship between two contracting parties is so close that they lose their individual identity and are, in fact, one, there can be no 'actual legitimate cost' involved in the payments of profits, since it would be tantamount to a company's paying itself a profit for interdepartmental services. See, e.g., St. Croix Falls Minnesota Improvement Co., et al., supra; Alabama Power Company, 1 FPC 25, 29, aff'd Alabama Power Company v. McNinch, 68 App.D.C. 132, 94 F.2d 601 (1937).

Here, of course, it is undisputed that neither Houtex nor the engineering and construction group actually controlled the other. There was admittedly an interlocking directorate (four 'firm' men on Houtex' board of nine) and an intermingling of interests. While it may be true that the dealings between the parties involved did not meet the strictest standards required by 'arm's length bargaining,' it is not contended that they lost their true identity or that the relationship was such as to make them one.6 Arm's length bargaining is a general term. There is no substantial contention that the transactions in question were consummated under conditions of collusion, fraud, gross neglect or undue influence. Unquestionably, FGT will have to carry the burden of justifying the reasonableness of the claimed costs, if 'reasonableness' is a proper sufject of inquiry under the facts and circumstances present. In our view, the record conclusively establishes that each of the principals involved was a clearly 'identifiable' and independent entity, pursuing its individual business objectives at all times. Therefore, to apply the 'noprofits-to-affiliates' rule to this set of circumstances, the Commission had to expand its traditional meaning, if not indeed create an entirely new rule.7

Control is always a vital element to consider and determine. See Western Dist. Co. v. Public Service Comm. of Kansas, 285 U.S. 119, 52 S. Ct. 283, 76 L. Ed. 655 (1932); Smith v. Illinois Bell Telephone Company, 282 U.S. 133, 51 S. Ct. 65, 75 L. Ed. 255 (1930); Louisville Hydro-Electric Co., 1 FPC 130 (1933), affd sub. nom. Louisville Gas & Electric Co. v. FPC, 129 F.2d 126 (6 Cir. 1942), cert. den. 318 U.S. 761, 63 S. Ct. 559, 87 L. Ed. 1133. Mere influence arising out of business relationships where control is not present is not a proper standard. In any event, the Commission has the unquestioned right and power to investigate the reasonableness of the costs at issue with the usual thoroughness and expertise characteristic of its procedure and accounting methods; and undoubtedly such costs should and will be scrutinized with meticulous care.

As to the term 'actual legitimate cost,' the Commission interpreted the similar provisions of the Federal Water Power Act (now the Federal Power Act, 16 U.S.C.A. 797(b)) in Louisville Hydro-Electric Co., 1 FPC 130, 139 (1933), to mean that costs 'must be (1) 'actual', that is, real and bona fide, as distinguished from fictitious or fabricated, whether by intercorporate dealings or otherwise; and (2) legitimate meaning not coerced, collusive, fraudulent, or unreasonable * * *.'

We fail to see why the profits in the instant case so clearly exceed the bounds of the definition the Commission itself has already set as to require automatic exclusion from cost-of-service. The profits were 'actual' because in reality they flowed from one independent party to another. There was no 'fiction' involved in their payment, as is true in case of payment to a subsidiary or parent. Furthermore, such costs were 'legitimate' to the extent they were necessary. It would be unrealistic to assume that the engineering and construction firms would or could have done the work for Houtex without a profit, since together they never did own more than two-fifths of that company.8 Whether or not the profits were 'reasonable' is a decision the Commission must make without applying the 'no-profits-to-affiliates' rule.9

For the reasons stated above, the Order of the Federal Power Commission excluding from Houtex' cost-of-service the profits paid to the engineering and construction firms must be vacated.

In view of our decision, we deem it unnecessary to consider petitioners' contention as to the 'res judicata' effect of the Commission's prior order relating to the 'reasonableness' of projected costs. Nor is it necessary to review the Commission's denial of petitioners' Motion for Rehearing or Motion to Re-Open the record to present further evidence.

Reversed and remanded to the Federal Power Commission for further consideration and proceedings consistent with this opinion.