Legal Alerts Mar 3, 2015

Court Strikes Down Surcharge on Utility Users Imposed Under a Franchise Agreement

Surcharge Collected for General Revenue Purposes Under a Franchise Agreement must be Approved by Voters

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A surcharge on electric utility bills collected by a power company pursuant to a franchise agreement and remitted to the city for general revenue purposes is a tax, a California Appellate Court has found. Because the city did not receive voter approval for the surcharge, it is an illegal tax, the court found.

The opinion in Jacks v. The City of Santa Barbara analyzes the validity of a 1 percent surcharge on customer bills collected by Southern California Edison and used by the City of Santa Barbara for general revenue use. In 1994 SCE and the City entered into negotiations to renew SCE’s franchise agreement to provide electric utility services within the City. The expiring agreement and subsequent extensions required SCE to pay the City a franchise fee of one percent of SCE’s gross annual receipts for electricity sold within the City. The proposed new franchise agreement required SCE to pay a franchise fee of 2 percent. One percent of the franchise fee revenue was proposed to be deposited into two City funds: half of the 1 percent to the City’s undergrounding utility projects fund and the remaining half to the City’s general fund.

In responding to the proposed increase in the franchise fee, SCE requested, and the City agreed, that imposition of the additional one percent would be contingent on the Public Utilities Commission authorizing it as a “surcharge.” The City agreed and the new franchise agreement was approved by both parties in 1999. In 2005, the PUC approved the surcharge and SCE began to collect it on customers’ electric bills. In 2009, the City reallocated the entire surcharge revenue to its general fund.

The surcharge was never submitted to the voters of the City for approval. The plaintiff challenged the surcharge as an invalid tax. The City asserted that the surcharge is part of the franchise fee paid by SCE and, as such, is not a tax.

The trial court considered whether the surcharge was a tax in accordance with Proposition 218 and Proposition 26. Proposition 218 was approved by the voters in 1996 and amended the California Constitution to require that any general tax be approved by a majority of the qualified voters participating in the election, and any special tax be approved by a two-thirds vote of the qualified electors voting in the election. Proposition 26, passed in 2010, amended the law to  provide a new definition of the term “tax.” Under this new definition, a tax means any fee or charge imposed by a local government agency unless it qualifies as one of seven exceptions. The trial court concluded that the surcharge is part of the franchise fee and is not a tax under Proposition 218. The court further found, however, that the fee was a tax under Proposition 26, but that the definition of tax under Proposition 26 was not retrospective to the 1999 franchise agreement in which surcharge was approved.

The Court of Appeal held that the sole issue is whether the 1 percent surcharge is a tax subject to Proposition 218’s voter approval requirement or a franchise fee that may be imposed by the City without voter consent. The court noted that its inquiry begins with a determination of what the primary purpose of the fee is. If revenue is the primary purpose, and compensation for the franchise is merely incidental, the imposition is a tax. Here, the franchise agreement treats the 1 percent surcharge differently than the 1 percent franchise fee. The 1 percent franchise fee is for the purpose of compensating the City for allowing SCE a right of way to purvey electricity. The 1 percent surcharge is, in effect, a utility user tax imposed to generate revenue for general purposes of the City. As such, it is a tax under Proposition 218 and is subject to voter approval.

If you have any questions about this case or how it may impact your agency, please contact the attorney author of this legal alert listed to the right in the firm’s Public Finance practice group, or your BB&K attorney.

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