Legal Alerts Aug 27, 2018

Transfer of Electric Utility Revenues to City’s General Fund is not a Tax Under Proposition 26

Supreme Court Reverses Court of Appeal

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A city’s annual budgetary transfer from its electric utility to its general fund, referred to as a payment in lieu of taxes and known as PILOT, is an electric utility cost and not an exaction subject to Proposition 26, the California Supreme Court held today. The Court did not have to determine whether the PILOT was a reasonable cost of the electric utility, because the electric utility had sufficient non-rate revenue to cover the cost of the PILOT. In addition, because the PILOT itself is not subject to Proposition 26, the Court did not opine on whether the PILOT predated Proposition 26 for the purpose of determining whether it was “grandfathered-in.”  
 
The City of Redding operates an electric utility. The City’s electric utility revenues are accounted for separately from the City’s general fund revenues. The City makes an annual budgetary transfer from its electric utility fund to its general fund. The annual transfer (i.e., the PILOT) is established at a rate to equate as nearly as practicable to the tax a private utility would have to pay the City in ad valorem taxes, and was designed to compensate the general fund for the costs of services that other city departments provide to the utility. The PILOT is calculated with each biennial budget and, as a budget line item, subject to annual discretionary reauthorization by the City Council.  
   
California voters approved Proposition 26 in 2010, which amended provisions of article XIII C of the California Constitution governing the imposition of local government taxes by providing a new definition of the term “tax.” For local governments, this narrow definition defines “tax” to mean any levy, charge or exaction of any kind imposed by a local government, except for seven specifically identified exceptions. One such exception is for a fee to cover the reasonable costs of providing a government service, such as electric service. Fees and charges adopted or increased after Proposition 26 was enacted that do not meet one of these seven exceptions are redefined as taxes subject to voter approval. Fees and charges predating Proposition 26 that have not since been increased are “grandfathered-in” and not subject to the Proposition. Proposition 26 shifted the burden to local agencies to show that an exaction subject to Proposition 26 is not a tax.
 
In December 2010, the City approved a rate increase to its electric service fees. While the methodology for calculating the PILOT was left unchanged, a group of citizens challenged the City’s PILOT as a tax. The trial court ruled in the City’s favor, but an appellate court reversed.
 
The Supreme Court granted review, limited to the following questions:

  1. whether the PILOT is a tax under Proposition 26,
  2. whether the PILOT is exempt from the definition of a tax because it does not exceed the reasonable costs of providing electric service, and
  3. whether the PILOT predates, and is therefore exempt from, Proposition 26.

 
The Supreme Court made clear the distinction between the costs for operating the electric utility, of which the PILOT is one, and the rates imposed on electric customers. Finding that rates imposed on customers, and not the costs of providing the service, such as the PILOT transfer, are subject to Proposition 26’s requirements. The Court determined that the PILOT is not an exaction subject to Proposition 26.
 
The Court did not have to determine whether the PILOT was a fee that does not exceed the reasonable cost of providing electric service, or whether the PILOT was grandfathered in. The only remaining question was whether the PILOT itself was a reasonable cost of service. In this instance, since the electric utility had more than enough non-rate revenue to cover the PILOT, and was in fact required to use non-rate revenue to meet all of its expenses, the Court did not analyze whether the PILOT was a reasonable cost of the electric utility.
 
Citizens for Fair REU Rates v. City of Redding, along with the Court of Appeal’s decision earlier this year in Webb v. City of Riverside, provide important clarity on electric utility fund transfers under Proposition 26. These cases confirm that inter-fund transfers are not exactions in and of themselves, but rather, costs of the utility. Local governments with electric fund transfers need only show that the transfer is either a reasonable cost to the electric utility, or can be paid for with non-rate revenue.  
 
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 Special Districts practice group, or your BB&K attorney.

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