IV. Questions Posed in the OIR
In the OIR, we tentatively suggested that several guidelines apply to gain on sale determinations, and asked for the parties' comment on our initial proposals. Primary among our suggestions was that we establish a specific percentage allocation of gain on sale (e.g., 20%) that would give utilities between 5% and 50% of the gain on sale under normal circumstances, with the remainder allocated to ratepayers. In unusual cases, we suggested considering the issue on a case-by-case basis.
In the sections that follow, we set forth our suggested outcomes from the OIR, discuss the parties' input, and come to a conclusion about the rules to apply to utility asset sales.
A. General Gain on Sale Questions
With regard to gains on sale, the OIR proposed the following outcomes and sought comment:
1. The guidelines we develop in this proceeding should apply to the allocation of both gains and losses upon the sale of a capital asset.
2. The allocation should vary directly, holding everything else constant, with the assumption of the financial risk of the investment.
3. While it is important to ensure that ratepayers are not harmed by the sale of the asset, or that they are compensated if they are, it is equally important to recognize who has borne the burden of the financial risk of the investment.
4. For the majority of cases, ratepayers have borne most of the financial risk and have paid for the asset. Thus, it will be typical for most of the gain to be allocated to the ratepayer. The burden of the financial risk should be a primary consideration whenever the gain is allocated between ratepayer and shareholder.
5. There should be no difference in the treatment of depreciable and non-depreciable assets (land) for the purpose of allocating the gain. If land that has been taken out of rate base is sold, an allocation of the gain or loss should be assessed consistent with the risk that has been shared between the ratepayer and shareholder.
6. The Uniform System of Accounts (USOA) is useful for the accounting and recording of a transaction, but it is not useful in the determination of how the gain is to be allocated.
7. The allocation of the gain on sale standards should provide an incentive to encourage prudent management of utility assets.
8. The allocation should be applied to after-tax gains only.
We also proposed that our decision in this proceeding supersede any prior contrary interpretations of the proper allocation of gains on sale. We address each of these questions in detail below.
B. Water Gains on Sale - Pub. Util. Code § 789
The OIR also asked for input from water companies on how to interpret the Water Utility Infrastructure Improvement Act of 1995, § 789 et seq. Section 789 provides that a water corporation shall invest the "net proceeds" of the sale of real property in water system infrastructure that is used and useful for utility service. The OIR stated, "We wish to determine in this proceeding whether § 789 applies to this real property or whether water utility shareholders can enjoy a return only on assets that were the product of shareholder investment."4
The OIR asked for comment on whether water utility shareholders should receive gains pursuant to § 789 when the utility acquires the property being sold without paying for it. We noted the following examples: (1) facilities paid for by company ratepayers, (2) facilities constructed in the 1980s and 1990s with state-provided low interest loans under the Safe Drinking Water Bond Act (SDWBA) and the State Revolving Fund, (3) water assets that developers or other entities pay for as contributions in aid of construction, and (4) state grant funds from Proposition 505 proceeds to construct water utility infrastructure in low-income areas.
We also asked the following questions regarding gains on sale from water utility assets:
1. If according to § 790, the full gain is included as rate base, should there be any safeguards against "churning" of assets by utility management in order to increase rate base? What should these safeguards be?
2. In order to reconcile §§ 790 and 851, at what point do we require the utility to file an application? If the utility files a § 851 application at the time of the sale and the Commission approves the sale, what must the utility file at the end of the eight years, if anything, to reconcile the net proceeds?
3. What amount, if any, of the gains from non-shareholder investment (i.e., developer contributions in aid of construction) should be included in rate base?
We address the gain on sale issues particular to water utilities in a separate section of this decision. Unless otherwise stated, we also intend the answers to the generic gain on sale questions to apply to water utilities.
C. Notice of Utility Assets Taken Out of Service - Pub. Util. Code § 455.5
The OIR asked affected utilities to comment on how we should enforce § 455.5. That statute requires that utilities report periodically to this Commission whenever any portion of an "electric, gas, heat, or water generation or production facility" is out of service, and immediately when a portion of such facility has been out of service for nine consecutive months. Section 455.5 states, in pertinent part:
(a) In establishing rates for any electrical, gas, heat, or water corporation, the commission may eliminate consideration of the value of any portion of any electric, gas, heat, or water generation or production facility which, after having been placed in service, remains out of service for nine or more consecutive months, and may disallow any expenses related to that facility . . . .
(b) Every electrical, gas, heat, and water corporation shall periodically, as required by the commission, report to the commission on the status of any portion of any electric, gas, heat, or water generation or production facility which is out of service and shall immediately notify the commission when any portion of the facility has been out of service for nine consecutive months.
(c) Within 45 days of receiving the notification specified in subdivision (b), the commission shall institute an investigation to determine whether to reduce the rates of the corporation to reflect the portion of the electric, gas, heat, or water generation or production facility which is out of service. . . .
We proposed in the OIR to require utilities with electrical, gas, heat, or water generation or production facilities to inform the Commission about any such facility or portion thereof taken out of service the previous calendar year. We also proposed that these utilities be required to estimate the effect of this action on their revenue requirement and rate base.
Section 455.5(f) notes that an "electric, gas, heat, or water generation or production facility includes only such a facility that the commission determines to be a major facility." (Emphasis added.) The OIR suggested a definition of a "major facility" as any asset with an initial acquisition price of $500,000 or more. The OIR also suggested that the Commission require reporting regarding any facility whose entirety meets this dollar threshold, even if the portion out of service cost less.
We address this issue in detail below.
D. Commission Approval of Sales
Finally, we asked parties to comment on whether, pursuant to Pub. Util. Code § 851, we could prohibit a public utility from selling any capital asset for which it had not filed an Advice Letter and to render void any sale not complying with this rule. We find that this question is beyond the scope of this rulemaking, and do not reach a finding on the permission a utility must receive to sell capital assets.
4 See, e.g., Alisal Water Corp., D.90-09-044, mimeo., p. 11, quoted in California Water Service Company, D.94-02-045, mimeo., p. 14, 53 CPUC 2d 287 (1994), ("[U]tilities should earn a return only on the money they invest, absent extreme circumstances not present [here]. We found this policy superior to one which would allow utilities to earn a return on someone else's investment, whether it be plant [paid] for by the customers of the mutual water company being acquired, by customer donations, or by any other means.").
5 Water Security, Clean Drinking Water, Coastal and Beach Protection Act of 2002 (Water Code, Division 26.5), passed by the California voters in the November 2002 general election, signed into law in August 2003 and immediately effective. We have another rulemaking related to Proposition 50, R.04-09-002, and defer Proposition 50 issues to that proceeding.
