XV. Allocation of the Gain or Loss from
the Sale of Utility Property

The allocation of the gain or loss on the sale of utility asset for utilities subject to cost-of-service regulation is determined by D.06-05-041. However, R.04-09-003, the proceeding that set these policies, referred gain-on-sale issues for telecommunications utilities subject to NRF regulation to this proceeding.

Current Commission policies applied to Verizon provide that gains on the sale of assets other than land go to shareholders.⁸²¹ Gains from the sale of land are allocated according to a formula adopted in a settlement:

Gains on the sale of Verizon's land and assets are treated for regulatory purposes in three ways, depending on the type of property being sold. First, gains on the sale of land have been subject to the terms of the settlement agreement in D.93-09-038. Second, gains on the sale of depreciable assets are accounted for in accordance with FCC Part 32, with no impact on net income. Third, gains on the sale of distribution systems, such as entire exchanges, are recorded as miscellaneous operating income.⁸²²

With the elimination of shareable earnings for Verizon, the net effect is that all gains on sale of land acquired since the start of NRF are returned to shareholders, while the gains on the sale acquired before the start of NRF are split between shareholders and ratepayers according to the formula contained in Appendix B of D.93-09-038.

For AT&T, under current NRF policies, one hundred percent of the gain or loss of utility property are provided to shareholders, with one exception. That exception pertains to the allocation of the gain from the sale of land purchased prior to the adoption of NRF. Pursuant to a settlement between DRA and Pacific Bell adopted in D.94-06-011, the Commission has treated gains-on-sale pursuant to a complicated schedule based on the amount of time an asset has been in ratebase and the amount of time it has been out of ratebase.⁸²³ For land assets acquired after the start of NRF, the gain on the sale of land is booked "above the line" and subject to earnings sharing. With the elimination of sharing, all gains from the sale of land acquired after the start of NRF are returned to shareholders.

A. Position of Parties

Verizon recommends that the Commission end the NRF era gain-on-sale policies.⁸²⁴ It argues that it should be treated no differently than its competitors, due to the competitive risks in the market today and the OIR's goal of competitive neutrality.⁸²⁵ Verizon also cites many cases in support of its argument that gains or losses on asset sales should be allocated to the shareholders who have borne the risks of the investments.⁸²⁶ According to Verizon, "[s]hareholders bear all the risks associated with investment; accordingly, they should retain the gains or bear any losses from the sale of assets."⁸²⁷ Verizon adds that between the settlement in 1993 and 2004, the sale of land produced a gain for distribution to ratepayers in only one year.⁸²⁸

AT&T states that, in NRF, the Commission "correctly shifted the risks of investment in long-lived infrastructure facilities to the ILEC shareholders."⁸²⁹ According to AT&T, our current treatment of gains on sales of land, however, is at odds with the fundamental shift of risk from ratepayers to shareholders under NRF.⁸³⁰ Accordingly, AT&T urges removal of any requirement to allocate gains or losses on the sale of assets to ratepayers.⁸³¹ The ILEC argues that risks borne by shareholders are "greater than ever," and gains on the sale of all assets should accrue to shareholders.⁸³² AT&T adds that any vestigal requirement to allocate gains to ratepayers skews investment decisions, creates disincentives to efficiently manage assets, and penalizes efficient investment.⁸³³

Citizens and SureWest state that there is "broad agreement" that gains on sale should be allocated to shareholders.⁸³⁴

DRA presented a set of reforms that combined new regulations with the elimination of requirements for sharing gain on sale. As part of this package DRA states that the Commission should eliminate the remaining gain on sale requirement as long as rates are frozen for stand-alone residential and business basic services.⁸³⁵ DRA reasons that "a regulatory framework that allows ILECs to keep gains-on-sale while guaranteeing the availability of stand-alone residential and business basic services at current prices is much more pro-ratepayer than a framework that allows the ILECs to retain gains-on-sale while at the same time allowing them to raise basic service prices at will."⁸³⁶

Similarly, TURN and DOD/FEA contend that gains from the sale of pre-NRF assets should be allocated to ratepayers.⁸³⁷ TURN argues that the ILECs' proposals fail to properly balance risk with reward:

While the Respondent ILECs are more than happy to appropriate the benefits of the ratepayers' risk taking, they also request that ratepayers continue to bear risk through a rate-of-return style revenue neutrality mechanism which will keep the companies "whole" should they face any access charge reductions while local exchange rates are subject to caps.⁸³⁸

DOD/FEA concludes that if an ILEC applies for an increase in basic rates under its regulatory proposal, then the ILEC "should be required to reflect an imputation of . . . and the gain on sale of rate base assets acquired prior to the implementation of the New Regulatory Framework (`NRF')."⁸³⁹

B. Discussion: All Gains or Losses from Sale of Utility Property Should Accrue to Shareholders

The link between costs and rates was broken nearly twenty years ago with the adoption of NRF. In only one situation has the Commission allocated any gain on sale to ratepayers: the sale of land acquired prior to the adoption of NRF. With the passage of time, more and more utility property falls into the area in which all gains or losses are allocated to shareholders. Even for land acquired prior to the adoption of NRF, the incumbent utilities have assumed all financial and operating risks that accrue to owners for the last twenty years.

Adopting a policy that allocates all gains or losses to shareholders will simplify the regulatory program and make it consistent with the economic principle that those who bear the risk should reap the rewards. We expect this reform will have a minimal impact on ratepayers. As Verizon's review of its records makes clear, under current rules, little gain is allocated to ratepayers despite complex calculations following a negotiated allocation rule, and elaborate record-keeping requirements.

We further note that the companies with which the ILECs compete retain all gains or losses from the sale of their utility property. Thus, adopting a policy that allocates one hundred percent of all gains and/or losses from the sale of property by ILECS to their shareholders will place ILECs on an even footing with their competitors. This reform serves our interests in promoting fair competition between communications providers.

In summary, allocating to ILEC shareholders one hundred percent of gains and losses from the sale of ILEC assets is a modest revision of current rules, which already apply this policy to property acquired in the last twenty years. Such a policy will have minimal impact on rates and is in harmony with the principle that those who bear the risk should reap the reward. Finally, such a policy is consistent with the rules under which carriers competing with ILECs now operate. Each of these reasons provides a rational basis for our decision to allocate all gains and losses from the sale of property by ILECs to shareholders.

⁸²¹ Declaration of Phillip R. Cleverly at 11 (May 31, 2005) (testifying on behalf of Verizon) (hereinafter "Cleverly Opening Comments").

Id.

⁸²² Id.

⁸²³ The settlement concerning the allocation of gain-on-sale is contained in Appendix B of Application of GTE California Incorporated (U 1002 C) for review of the operations of the incentive-based regulatory framework adopted in Decision 89-10-031; In the Matter of the Application of Pacific Bell (U 1001 C), a corporation, for review of the regulatory framework adopted in Decision 89-10-031; And Related Matters, D.94-06-011, 55 CPUC2d 1 (1994), 1994 Cal. PUC LEXIS 456. In relevant part, it sets out the following schedule:

Pre-NRF Purchased Land

· Pre-NRF: 100% of GSL [Gain on the Sale of Land] not previously recognized in the attrition mechanism should be returned to ratepayers through a rate adjustment in the next annual Price Cap Filing.

· 1990-1993: 100% of GSL should be returned to ratepayers through one-time Price Cap rate adjustments in the annual Price Cap filings.

· 1994-1996: A prorated amount of the GSL should be returned to ratepayers through one-time rate adjustments in the annual Price Cap filings using a method based on the relative years that a parcel was held prior to NRF in plant-in-service to its total operating service life. For example, if a land parcel purchased in 1981 was sold in 1995, 60% or 9/15th's of the GSL should be accrued to ratepayers. The residual prorated amount not returned to ratepayers should be treated ATL for Shareable Earnings consideration.

· 1997 & Beyond: 50% of pre-NRF GSL should be returned directly to ratepayers as one-time rate adjustments in the annual Price Cap filings. The remaining 50% should go to shareholders.

Post-NRF Purchased Land

· All GSL should be treated ATL [Above the Line] for Shareable Earnings consideration.

⁸²⁴ Verizon Reply Brief at 19.

⁸²⁵ Id. at 19-20.

⁸²⁶ Verizon Reply Brief at pp. 19-21. See, e.g., Board of Public Utility Commissioners v. New York Telephone, 271 U.S. 23, 31-32 (1926) ("Customers pay for service, not for the property used to render it. . . . By paying bills for service they do not acquire any interest, legal or equitable, in the property used for their convenience or in the funds of the company. Property paid for out of moneys received for services belongs to the company."); Maine Water Co. v. PUC, 482 A.2d 443 (ME 1984) (ratepayers have "no rationally supportable claim to any flow-through of the benefit of the gain the Company realized in selling [its properties]"); Appeal of Nashua, 435 A.2d 1126 (NH 1981) ("profits from the sale of fixed capital belong to the stockholders rather than the ratepayers"); Boise Water Corp. v. Idaho PUC, 578 P.2d 1089 (ID 1978) (ratepayers are not entitled to reap the rewards or losses on the sale or transfer of utility land).

XV. Allocation of the Gain or Loss from the Sale of Utility Property

A. Position of Parties

B. Discussion: All Gains or Losses from Sale of Utility Property Should Accrue to Shareholders

XV. Allocation of the Gain or Loss from
the Sale of Utility Property