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If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of ) TCI TKR of Houston, Inc. ) ) Appeals of Local Rate Orders of Cities of:) ) Alvin, Texas ) CUID TX0750; File No. CSB-A-0320 El Lago, Texas ) CUID TX0511; File No. CSB-A-0314 Friendswood, Texas ) CUID TX0751; File No. CSB-A-0325 La Marque, Texas ) CUID TX0514; File No. CSB-A-0333 League City, Texas ) CUID TX0509; File No. CSB-A-0337 Nassau Bay, Texas ) CUID TX0756; File No. CSB-A-0332 Seabrook, Texas ) CUID TX0515; File No. CSB-A-0341 Taylor Lake Village, Texas ) CUID TX0838; File No. CSB-A-0315 Texas City, Texas ) CUID TX0424; File No. CSB-A-0316 Webster, Texas ) CUID TX0854; File No. CSB-A-0323 CONSOLIDATED MEMORANDUM OPINION AND ORDER ON RECONSIDERATION Adopted: May 28, 1998 Released: June 1, 1998 By the Acting Chief, Cable Services Bureau: I. INTRODUCTION 1. In this Order, we address the Petition for Reconsideration filed by TCI-TKR of Houston, Inc. ("TCI"), filed on January 13, 1997, with respect to the Texas communities captioned above, pursuant to section 1.106 of the Commission's rules. By its petition, TCI seeks further review of the Cable Services Bureau's (Bureau) consolidated order, released on December 13, 1996, TCI TKR of Houston, Inc., ("Bureau Order") which had denied and remanded the local cable rate appeals taken by TCI from the orders entered by the local franchising authorities ("Cities"). Those contested rate orders had reduced the equipment and basic service rates proposed by TCI in its FCC Form 1205 and Form 1240 filings. In its appeals, TCI had sought reversal of the Cities' rate orders on the principal grounds that the Cities had erroneously rejected TCI's treatment of unfunded deferred taxes on its 1205 filings, that error also occurred when the Cities rejected TCI's treatment of the Texas corporate franchise tax as a state income tax on Form 1205, and finally, that the Cities had erred in their disposition of TCI's optional inside wiring plan, which the operator claimed was not subject to rate regulation. The Cities have filed their opposition to each of TCI's assertions, and TCI has replied. 2. On these particular issues, the Bureau had determined that the rate orders of the Cities were not inconsistent with Commission regulation, nor unreasonable, and that the Cities' actions were supported by the record. After reviewing the pleadings and the record, we conclude that TCI's petition for reconsideration of the Bureau Order should be denied. II. BACKGROUND 3. The Cable Television Consumer Protection and Competition Act of 1992 ("1992 Act") provides that where competition is absent, cable rates are to be regulated to protect subscribers. The 1992 Act and the Commission's rules require that regulated equipment and installation services, including inside wiring, be offered to subscribers at rate levels that reflect operators' actual costs. Operators initially were required to unbundle their charges for equipment and installation from their rates for programming services to ensure that their equipment and installation rates reflected actual costs. Charges that were bundled with programming rates prior to regulation should now appear as separately calculated and itemized charges. III. TCI'S PETITION FOR RECONSIDERATION 4. In its petition for reconsideration, TCI continues to contest the Bureau treatment of its unfunded deferred taxes, claiming simply that TCI's subscribers never were charged, nor did they fund, the operator's deferred income tax account prior to the introduction of regulation. TCI takes issue with the Bureau's resolution of the question and rejection of TCI's modified methodology, claiming that the Bureau's adherence to such a practice could inadvertently leave the operator exposed to a sizable and undeserving refund liability. The Bureau therefore should revise its order, TCI maintains, and instruct the Cities to place TCI's reasonable approach into effect. 5. TCI further contends that the Bureau erred in its disposition of the Texas corporate franchise tax. TCI stresses that the Bureau should allow the operator to capitalize, rather than expense, the item on its Form 1205. TCI states that the tax is the functional equivalent to a state income tax and thus should be recorded along with the other related costs on Schedules A and C. The Bureau order had denied TCI such treatment but did not preclude the tax entry from being recovered as an expense under Schedule B. 6. Finally, TCI maintains that the Bureau was mistaken in ruling that operators may offer inside wiring maintenance plans for subscriber-owned wiring only on a regulated basis. TCI believes that the Bureau's rational is inconsistent with the principles and goals underlying cable rate regulation. TCI complains that inside wiring plans should not be regulated under circumstances where an operator offers another regulated option, such as the as-needed hourly service charge ("HSC"), or other competitive alternatives are readily available to the subscriber. IV. UNFUNDED DEFERRED TAXES 7. In computing its rates for converters on Schedule C of FCC Form 1205, TCI included in Line J, "Depreciation Expense," an amount representing the amortization of "unfunded deferred taxes." The Cities rejected this entry on the grounds that the Commission's rules do not permit operators to claim such an expense. TCI asserts that the Cities' actions were unreasonable because the Commission has recognized that operators are entitled to recover unfunded deferred taxes. Moreover, TCI maintains that it is merely attempting to recoup unfunded deferred taxes that the operator had not taken into ratemaking consideration at the time of the advent of rate regulation. TCI contends, therefore, that it is trying to correct this deficiency by amortizing the deferred tax balance in existence on the date of initial regulation as an expense over the remaining useful lives of the related assets. With the allowance of such an expense entry, TCI believes that its subscribers should fund the deferred tax account for which the Form 1205 already credits them and that this "regulatory symmetry" should be retroactively approved. For the reasons explained below, we reaffirm that the Cities interpreted the Commission's rules correctly and acted reasonably in rejecting TCI's unfunded deferred tax expense claim. 8. Deferred income taxes represent the tax benefit enjoyed by regulated entities that depreciate rate base assets on an accelerated basis for tax purposes, but that establish rates based on the regulatory presumption that rate base assets are depreciated on a straight-line basis. Straight-line depreciation results in a longer depreciation schedule than does an accelerated depreciation method. Initially, when rates are calculated using straight-line depreciation, the presumed tax liability for regulatory purposes exceeds the actual tax liability that results from the operator's use of accelerated depreciation for tax purposes. Eventually, the operator's use of a shorter depreciation schedule for tax purposes than for regulatory purposes will have the reverse effect. The initial "savings" that results from the use of a shorter depreciation schedule for tax purposes than for regulatory purposes is referred to as deferred taxes because the tax liability is deferred to a later date. Cable rates are calculated as if the operator were subject to the tax liability that would result from the use of a straight-line depreciation schedule. As a result, the operator using straight-line asset depreciation for regulatory purposes and accelerated depreciation for tax purposes receives revenues from subscribers today for an income tax liability that it will not incur until a later date. In the early years, this difference in depreciation methodologies will result in an over-collection of revenues the operator needs to pay its current tax liability. These excess revenues are viewed as subscriber-provided funds, which are available to the operator at no cost to fund the future payment of its deferred taxes. The Form 1205 addresses the over- recovery of revenues by requiring operators to deduct deferred tax balances from the equipment rate base. Consequently, rates are reduced by an amount equal to the deferred taxes multiplied by the rate of return on the rate base. We earlier explained this aspect of the Form 1205: The requirement to reduce the rate base by [the deferred tax balance] is premised on the assumption that the operator has included the tax expense in its rates even though the amount was not payable to taxing authorities. In these instances, since the operator has use of these "no cost funds" provided by the ratepayer, an adjustment is made to the rate base for an appropriate reduction to the revenue requirement. 9. TCI claims that its existing deferred tax balance is "unfunded" because prior to the effective date of rate regulation it did not calculate its rates to recover any excess revenues to fund the future payment of deferred taxes; rather, it collected from subscribers only the amount it needed to pay then-current actual tax liability. TCI's so-called unfunded deferred tax balance represents the difference between TCI's actual tax liability prior to regulation, which it recovered from subscribers, and TCI's hypothetical regulatory tax liability during the same period, which purportedly it did not seek to recover from subscribers. According to TCI, the Commission assumed when it designed Form 393, which operators used to establish initial regulated programming and equipment rates, that all operators had already included deferred taxes in rates before they became subject to rate regulation. TCI argues that because it did not include deferred taxes in calculating rates prior to regulation, it was penalized by the Form 393 requirement that it deduct deferred taxes from its rate base. TCI states that the Commission later determined that this aspect of the Form 393 was incorrect and attempted to remedy its error. Asserting that the Commission's remedy was inadequate, TCI now seeks to redress the alleged discrepancy by amortizing its so-called unfunded deferred tax balance over a period of years by treating a portion of the balance as an expense on its Form 1205. 10. TCI is correct that the Commission modified its initial approach to deferred taxes. Initially, the Commission required operators to reduce the regulated rate base by the total deferred taxes associated with the rate base investment. Subsequently, we modified that rule to require the reduction of the rate base by deferred taxes accrued only since the date the operator became subject to rate regulation. Stating that the deduction we first required was "premised on the regulatory presumption that rates reflect the operator's use of straight-line depreciation," we concluded that the presumption was not valid in the absence of rate regulation. Accordingly, we modified our approach to require operators to deduct deferred taxes from rate base only to the extent the deferred taxes were accrued and became payable after the operator became subject to rate regulation. Under the modified approach, we have permitted operators to deduct their pre-regulation deferred tax balance from their current deferred tax balance before they deduct deferred taxes from rate base. This results in a smaller deduction to rate base and, correspondingly, a larger overall return amount. "Because [the operator] may earn a return on those revenues until it actually incurs the tax liability [the Commission] require[s] that this amount, the deferred tax liability, be deducted from the ratebase so as to preclude a double recovery." 11. The Cities applied our rules correctly and ruled reasonably when they rejected TCI's attempt to recover deferred taxes as an amortized expense. Our rules do not provide the remedy TCI seeks, and the local rate appeal process is not the proper vehicle for TCI to seek modification of our rules. Moreover, TCI offers no factual support for its claim that prior to regulation it collected from subscribers only the amount needed to pay its then-current tax liability. In addition, TCI's depreciation practices and rate design methods prior to regulation were matters entirely within TCI's control and discretion. The Commission's prescribed deferred tax treatment addresses TCI's concern that the Form 393 required it to subtract its deferred tax balance from the rate base: TCI and other operators are no longer required to deduct taxes accrued before the operator became subject to rate regulation. Consequently, the treatment TCI seeks for the alleged unfunded deferred tax liability would allow it to recover for future tax liability without the corresponding adjustment to its rate base. Subscribers should not be required to pay a penalty or subsidize TCI's future tax liability simply because TCI used accounting and rate design methods prior to regulation that TCI now wishes to revise. On this record, we find that TCI has neither sustained its burden of demonstrating the reasonableness of its rates nor demonstrated that the Cities acted inconsistently with the Commission's rules. TCI's request for reconsideration on this issue is, therefore, denied. V. TEXAS CORPORATE FRANCHISE TAX 12. TCI continues to insist that the Texas corporate franchise tax is essentially, if not functionally, the equivalent of a state income tax. TCI therefore claims that it should be permitted to include the tax in its gross-up calculations reported on Schedule A of its Form 1205. Schedule A is utilized to calculate the annual cost of equipment and permits an operator to garner a return on investment that is "grossed up" or adjusted to account for the operator's payment of federal and state income taxes. Schedule B collects the operator's annual expenses for the installation and maintenance of cable facilities, including "other taxes." 13. On TCI's initial appeal, we determined that, although the franchise tax was measured by the higher of a corporation's capital or income calculation, the tax was not exclusively based on income, and consequently could not be approved as a state income tax liability under Commission regulations. Upon further consideration of TCI's argument, we still disagree with its analysis that the Texas levy constitutes, on its face, a state income tax subject to recovery under Schedule A. 14. In this connection, the Supreme Court of Texas recently addressed a somewhat similar contention, advanced as a challenge to the constitutionality of the Texas corporate franchise tax statute, on the basis that the State had utilized the franchise tax mechanism to impose retroactively a "new corporate income tax." In rejecting the challenge, the Court specially noted the critical difference between a direct tax on property, such as income, and the Texas corporate franchise tax. The Court explained that: A direct tax on property is paid simply because the taxpayer owns [or earns] the property at a given time. The franchise tax, however, is an excise tax levied as payment for the privilege of doing business during the year in which the tax is levied. With this authoritative guidance, we can hardly fault the Cities in their interpretation of the corporate franchise tax at issue as construed under Texas law or find that the Cities rejection of TCI's treatment of that tax on its Form 1205 was unreasonable. Under Commission regulations, rate orders entered by local franchising authorities are not accorded de novo review and ordinarily will be sustained provided a reasonable basis exists for the Cities' action. 15. We find that it was not unreasonable for the Cities to disallow TCI's treatment of the Texas corporate franchise tax as an includible gross-up item on Schedule A of its Form 1205. As we pointed out earlier in this proceeding, however, TCI should not be precluded from the recovery of the corporate franchise tax actually paid and may be entitled to include the Texas corporate franchise tax as a permissible entry in its equipment computations calculated on Schedule B of its Form 1205. We clarify that the Cities should allow TCI to show that it is entitled to recover these taxes on Schedule B. Accordingly, we remand this matter for resolution consistent with the terms of this order. VI. OPTIONAL INSIDE WIRING MAINTENANCE PLAN 16. The Bureau Order concluded that the regulatory treatment of inside wiring and costs associated with its maintenance depends on who owns the wiring. Where subscribers own their inside wiring, as in these cases, TCI may offer a separate wire maintenance service, but the rates would be subject to review by the City and must be determined in accordance with the Commission's regulations for pricing equipment service contracts and hourly rates for as-needed service. The Bureau Order concluded that the Cities had correctly applied Commission rules to TCI's inside wiring maintenance plans. 17. TCI argues against regulation of its inside wiring maintenance plan for subscriber-owned wiring. TCI contends that the pricing rule for equipment service contracts set forth in Section 76.923(i) of the Commission's rules is inapplicable because TCI offers a regulated alternative, i.e., the as-needed, HSC-based option, and because subscribers also can obtain inside wiring maintenance services from third-party contractors or perform the maintenance work themselves. According to TCI, unregulated treatment of its inside wiring maintenance plan would be consistent with the Commission's determinations in other matters. In support of its argument, TCI relies first on the Commission's determination that equipment sales are not subject to price regulation under Section 76.923(i) when the same equipment is offered under a regulated lease rate. TCI next asserts that the Commission's rationale for permitting market-based pricing of new product tiers ("NPTs") also justifies a finding that its inside wiring maintenance plan should not be regulated. Finally, TCI finds support for its position in the Bureau's decision not to regulate A/B switches in SBC Media Ventures, Inc. ("SBC"). 18. As explained in TCI of Southeast Mississippi, the 1992 Act required the Commission to establish standards to ensure that equipment would be available on the basis of actual cost. The legislative history concerning the home wiring provisions in the 1992 Act indicates that Congress wanted the Commission to "adopt policies that will protect consumers against the imposition of unnecessary charges, for example, for home wiring maintenance." In establishing initial rate regulations pursuant to the 1992 Act, the Commission implemented the law by establishing standards governing operators' rates for equipment service plans when operators sell equipment to subscribers. The statutory directive to ensure that equipment rates reflect actual costs and the specific reference to "home wiring maintenance" in the legislative history of the 1992 Act give premise to the Commission's responsibility to ensure that the rates for inside wiring maintenance plans reflect the law's standard. This includes circumstances in which another form of service, such as an HSC-based charge, is available. Inside wiring maintenance fees in excess of actual cost are the type of "unnecessary charges" Congress sought to prevent. The Commission's cost-based pricing formula for equipment service contracts is directed to fulfilling the law's mandate. 19. We do not agree that the exemption from price regulation for certain equipment sales justifies a similar exemption for inside wiring maintenance plans. The Commission determined in adopting its rate regulations that the sale of equipment to subscribers will be exempt from price regulation under Section 76.923(i) if the same equipment is available from the operator on a leased, i.e., regulated, basis. In such cases, the subscriber would have a comparable regulated alternative to the unregulated equipment sale. A service contract for the maintenance and repair of equipment is not comparable to an as-needed maintenance fee based on a regulated HSC. A maintenance agreement is similar to an insurance contract. It is designed to protect subscribers from incurring essentially unquantifiable costs for service provided on an as-needed basis. Subscriber purchase of equipment, in contrast, is a close substitute for a lease rate. By multiplying the lease rate by the number of months the subscriber plans to use the equipment in question and comparing the result to the sales price and the estimated life of the equipment, the subscriber can readily ascertain the relative costs and benefits of leasing versus purchasing the equipment. Comparing the relative costs and benefits of purchasing an inside wiring maintenance plan versus relying on the HSC is a difficult, if not amorphous, task. The analysis requires a subscriber to make assumptions about future events that even the cable operator may be unable to predict reliably for a particular subscriber, such as the capability of the wire to withstand a number of elements. The two forms of maintenance service are not comparable. It cannot be said that a regulated, HSC-based charge parallels the unregulated inside wiring maintenance plan. 20. TCI's reliance on the regulatory treatment of NPTs in support of its argument that inside wiring maintenance plans should not be regulated is misplaced. NPTs are cable programming service tiers ("CPSTs") subject to the statutory requirement that rates not be unreasonable. Because NPTs compete for subscribers against the BST and other CPSTs, the Commission determined that, if certain conditions are met, market forces would operate to ensure that NPT rates would be consistent with the statutory standard. The conditions are specified in the Commission's rules. In contrast, equipment rates are to be cost-based. TCI has not shown that its maintenance plan is, or is intended to be, based on the actual cost of the service. TCI has not shown how competitive pressures from the service alternatives it references will ensure that an inside wiring maintenance plan will be offered in compliance with the statutory standard. 21. TCI argues that the existence of competitive alternatives to its inside wiring maintenance plan justifies an exemption from the Commission's rule governing service contract rates. TCI essentially proposes that we apply an effective competition test to the market for inside wiring maintenance services. Citing SBC, TCI states that an effective competition rationale supported the finding that the sale of A/B switches should not be subject to price regulation. 22. SBC does not support TCI's argument. The decision in SBC turned on an analysis of the nature of the equipment and the statutory definition at issue. We concluded that the sale of A/B switches is not subject to price regulation because A/B switches are not equipment "that is used to receive the basic service tier." Rather, they are equipment used to turn off the basic service tier and instead receive over-the-air broadcasts. They do not fall within the scope of Section 76.923 of the Commission's rules, and, more broadly, Section 623 of the Communications Act of 1934, which impose price regulation only on equipment that is used to receive the basic service tier. While we observed in SBC that alternative sources of A/B switches existed, the conclusion that A/B switches are not subject to price regulation was premised on the finding that A/B switches are not within the scope of Section 76.923 of the Commission's rules. 23. Our cost-based formula for equipment rates, which includes a reasonable profit, results in rates that are "comparable to those that would exist in a competitive environment." Cost-based pricing of equipment service contracts is appropriate regardless of whether an operator also offers to perform maintenance and repair work on an as-needed basis at an hourly rate equal to the HSC. Even if competitive alternatives to TCI's inside wiring maintenance plan were to be considered, there is no basis on the record to deregulate the rates for TCI's service offering. TCI has not provided persuasive evidence that its proffered alternatives--the rate-regulated, as-needed HSC option; the third-party option; and the self-repair option--will provide competitive pressures affecting the price of TCI's inside wiring maintenance plan and ensuring that the price will be consistent with the statutory requirement that equipment rates be based on actual cost. We affirm that rates for inside wiring maintenance plans for subscriber-owned wiring must be determined in accordance with Commission regulations and are subject to local franchising authority review and approval. VII. ORDERING CLAUSES 24. Accordingly, IT IS ORDERED that the Petition for Reconsideration of TCI TKR of Houston, Inc. regarding the above-listed Cities IS DENIED. 25. This action is taken by the Acting Chief, Cable Services Bureau, pursuant to authority delegated by Sections 0.321 and 1.106 of the Commission's rules. FEDERAL COMMUNICATIONS COMMISSION John E. Logan Acting Chief, Cable Services Bureau