6. Gain on Sale of State Grant-Funded Plant
6.1 Overview
In order to ensure that private water utilities do not receive a gain on the sale of state grant-funded plant, parties generally proposed rules whereby the utility would return sales proceeds to the funding agency. These funds would then be available for future public projects.
We take a different approach. We design our rules here to ensure that the plant sold retains its public interest integrity, i.e., no private company or its shareholders profit in any way and the public retains the benefit of a cost-free financed plant. We can accomplish this if the selling and purchasing water companies are both under the Commission's regulation. We can also ensure this if the purchasing entity is a public water agency. Only in the instance where the purchaser is an entity other than a private or municipal water provider do we find need for the selling utility to return all sales proceeds to the funding agency, or to an equivalent public agency if the original funding agency no longer exists or is unable to accept remittance.
In order to ensure the Commission has prior review and approval over all grant funded plant, we shall require water utilities to notify the Director of the Water Division and the Director of the Division of Ratepayer Advocates 30 days prior to the disposition and encumbrance of all grant-funded plant.15
These rules apply to property such as land, plant, or water rights. In determining the proceeds in each of the following types of sales, the cost of disposal shall be deducted from the amount received in arriving at the final amount received. The OIR raises the issue of intellectual property, the example being grant funds used for the purpose of conducting a study. In cases such as this, the Commission should individually review the matter in the utility's general rate case, or by separate application if requested.
6.2 Sale to a Regulated Water Utility
We find our objectives are best met by adopting the following rule to apply to the transfer of an asset, district, or total utility to another Commission-regulated water utility. If the asset to be transferred has been paid for with grant funds in whole or in part, the transferring utility may not receive compensation for that portion of the asset that has been funded with grant funds, and the purchasing utility shall record a non-ratebase asset in Account 266; the non-grant-funded portion of the asset, if any, should transfer at fair market value, pursuant to Section 2720.
An earlier Commission decision gives guidance on how to preserve the public interest integrity of grant-funded plant that is sold to another regulated water utility. In D.98-11-019 (Lucerne Water Company acquired by Dominguez Water Corporation), the "fair market value" is based on the value of land and "company funded plant assets"16 - non-utility funded plant such as Contributions17 and advances are not included in the valuation. This decision also defines the value of "non-rate-based assets"18 such as those funded with Contributions and Safe Drinking Water Bond Act (SDWBA) loans at their existing book value on the books of the selling utility. Since these items are not included in the valuation of a water utility's "fair market value," the selling utility receives no compensation at the disposal of contributed plant. The purchasing utility does not earn a return on either the existing book value or any premium to account for market value at the time of acquisition, since the contributed plant is recorded at its existing cost (not inflated for market value at the time of sale) in Contributions, which is deducted in the calculation of rate base.
Performing the fair market valuation of a single asset, a district, or a total utility without giving monetary consideration for the portion funded by contributions (including grant-funded plant) is appropriate since the selling utility did not expend its own funds for the contributed portion of the plant and therefore should not be reimbursed for or profit from its sale.
The portion of the asset disposed of that has been funded with non-grant funds shall be accounted for in accordance with the USOA Account 100-1 - Utility Plant in Service, 19 and included in the determination of the "fair market value," using the amount paid to the selling company for the non-grant-funded plant as the value of the plant recorded by the purchasing company. A gain shall be earned by the selling company on non-grant-funded plant and a return may be earned by the purchasing company on non-grant-funded plant.20
We next consider the sale of plant that is wholly financed from grants. Based on the valuation discussed above, the plant would not be included in the valuation of the company. On the books of the selling company, Account 266 shall be reduced by the depreciated book value of the asset, and no compensation shall be recorded since no payment shall be received for the grant-funded plant that has been disposed of. On the books of the purchasing company, both Account 100-1 and Account 266-01 shall be increased by that same depreciated book value so that no return is earned on the grant-funded asset by the purchasing company.
In its comments, Park raises a concern that the disposition of utility plant for no cost would be in violation of Sections 2718-2720, because those code sections require that assets acquired by a utility that are included in rate base be valued at fair market value. Since assets funded with grant funds are not part of rate base, the requirements of this code section do not apply.
When grant-funded plant is sold as part of the sale of a district or a total utility, the valuation of the district or total utility shall not include the value of grant-funded plant In that way, the value of these non-rate base items are not included in the determination of the payment to the selling company or the value of the rate base acquired by the purchasing utility. And, consistent with D.98-11-019, the grant-funded plant would be recorded on the books of the purchasing utility at its depreciated book value, not its fair market value. In the case of the sale of the utility itself, the same rules apply as for a district.21
15 This is in addition to the existing Section 851 requirements for plant that is used and useful.
16 D.98-11-019, p. 9.
17 As we have discussed earlier, government provided funds, such as Proposition 50 grant funds are categorized as Contributions by this Commission and the USOA.
18 D.98-11-019, p. 12.
19 See Account 392, Utility Plant Sold, Instruction 12 and 12F.
20 As an example, we consider an asset owned by Utility F that was funded 50% with Proposition 50 grant funds and 50% with utility funds. It is sold to Utility G for $6,000. The original total book value of the asset was $2,000,000, with $1,000,000 funded with Proposition 50 grant funds and $1,000,000 funded with utility funds. The depreciated value of the asset is $10,000 ($5,000 attributable to the Proposition 50 grant funds and $5,000 attributable to non-Proposition 50 funds). Utility F shall recognize a gain of $1,000 on the non-Proposition 50 funded plant. Utility G would record the total asset value of $11,000 in Account 100-1 - Utility Plant in Service ($6,000 for non-Proposition 50 funded asset at the price it paid and $5,000 for Proposition 50 grant-funded plant at its current depreciated book value), and a Credit to Account 266-01 of $5,000 (the depreciated book value). In this way, Utility G earns a return on the non-Proposition 50 grant-funded plant of $6,000 only ($11,000 - $5,000).
21 For example, Utility A decides to sell one of its three districts (call it District X) to Utility B. District X includes Proposition 50 grant-funded plant with a depreciated value of $50,000. Valuation of the district shall not include the Proposition 50 grant-funded plant. Therefore, not only does Utility A not receive payment for the depreciated book value of the Proposition 50 grant-funded plant, it receives no gain on its disposition, either. Utility B must record the Proposition 50 grant-funded plant at the depreciated book value of the seller ($50,000) in Account 100-1 and Account 266. Since the selling utility did not receive payment for the Proposition 50 plant, it receives no gain or reimbursement for the book value of the Proposition 50 plant. Since Utility B records the Proposition 50 plant it has acquired in Account 266 at its depreciated book value, no return is earned by it.
