Legal Alerts Jul 05, 2017

Surcharge on Utility Users Imposed Under a Franchise Agreement is Not a Tax

California Supreme Court Holds Surcharge for Franchise Rights Not Subject to Voter Approval if Reasonably Related to Value of Franchise

Surcharge on Utility Users Imposed Under a Franchise Agreement is Not a Tax

In an opinion anxiously awaited by many cities, the California Supreme Court held that a 1 percent surcharge on electric utility bills paid by Southern California Edison to the City of Santa Barbara, which were used for general revenue purposes, is not a tax. The Court found last week that the surcharge was imposed for the privilege of using City property in connection with the delivery of electricity and that the right to use public streets or rights of way is a property interest that is not limited by California Constitution article XIII C (approved pursuant to Proposition 218 and Proposition 26). The amount of the charge, however, must bear a reasonable relationship to the value of the property interests transferred.
 
In Jacks v. City of Santa Barbara, the plaintiff challenged a 1 percent surcharge imposed on electric utility customers under SCE’s franchise agreement with the City. In 1994, SCE and the City entered into negotiations to renew SCE’s franchise agreement. The expiring agreement and subsequent extensions required SCE to pay the City a franchise fee of 1 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 to the City’s underground utility projects fund and the remaining half to the City’s general fund.
 
SCE requested, and the City agreed, that imposition of the additional 1 percent franchise fee would be contingent on the Public Utilities Commission authorizing it as a “surcharge.” 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 plaintiff challenged the surcharge as an invalid tax that had not been approved by the voters. The City asserted that the surcharge is part of the franchise fee paid by SCE and, as such, is not a tax subject to voter approval.
 
Because the franchise agreement treated the franchise fee and the surcharge differently, the Second District Court of Appeal held that the franchise fee compensated the City for the use of public rights of way, while the surcharge was, in effect, a utility user tax imposed to generate revenue for general City purposes. As such, the appellate court determined that the surcharge was a utility users tax subject to voter approval pursuant to Article XIII C. The Supreme Court disagreed.
 
The Supreme Court held that charges that constitute compensation for the use of government property are not subject to Article XIII C’s voter approval requirements and a local agency may spend the compensation it receives for whatever purposes it chooses. The fact that the surcharge is recovered by utility customers and remitted to the City, in this instance pursuant to the franchise agreement rather than a unilateral decision by SCE, does not alter the substance of the surcharge as a fee for use of government property.
 
Significantly, the Court did place some limitations on the amount of the charge that may be imposed. The Court noted that a franchise to use public streets or rights of way is a form of property interest and a franchise fee is the purchase price of the franchise. The Court held that to constitute compensation for a property interest, the amount of the charge must bear a reasonable relationship to the value of the property interest — in this case, the value of the franchise. To the extent that a franchise fee exceeds any reasonable value of the franchise, the excess portion is a tax. The Court acknowledged that determining the value of a franchise may present difficulties, but noted that the value may be based on bona fide negotiations or other indicia of worth.
 
If you have any questions about this case or how it may impact your agency, please contact the authors of this Legal Alert listed to the right in the firm’s Public Finance or Special Districts practice groups, or your BB&K attorney.
 
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