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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 ) ) Accounting Treatment of ) AAD 97-49 Payments Made by the ) Puerto Rico Telephone Company ) and the Puerto Rico Communications ) Corporation to the Puerto Rico ) Department of Treasury ) MEMORANDUM OPINION AND ORDER Adopted: March 26, 1997 Released: March 26, 1997 By the Chief, Common Carrier Bureau: I. INTRODUCTION 1. On March 6, 1996, the Puerto Rico Telephone Company ("PRTC") filed a petition for reconsideration of the Common Carrier Bureau's ("Bureau's") PRTC Disallowance Order. In that Order, the Bureau found that certain payments made by PRTC to the Puerto Rico Department of the Treasury in connection with the sale of its affiliate Telefonica Larga Distancia ("TLD") were not properly recorded as operating taxes under Part 32 rules and thus were ineligible for purposes of computing Universal Service Fund ("USF") support payments and interstate access settlements from the National Exchange Carrier Association ("NECA"). The Bureau found that Payments in Lieu of Taxes by a government-owned corporation may only be recorded as an operating tax if they do not exceed amounts that would be recorded by a private company. In its petition, PRTC seeks reconsideration of that finding. For reasons stated below, we deny the PRTC petition and affirm the findings of our previous order. II. BACKGROUND 2. PRTC is an incumbent local exchange carrier ("ILEC") wholly owned by the Puerto Rico Telephone Authority ("PRTA"), an entity formed by the Commonwealth of Puerto Rico ("Commonwealth"). As a government entity, PRTA is exempt from the payment of taxes to the Puerto Rico government and as a subsidiary of PRTA, PRTC is also exempt from the payment of taxes. The Commonwealth requires, however, PRTA or its subsidiary PRTC to make "Payments in Lieu of Taxes" to the Puerto Rico Department of the Treasury. The Commonwealth requires two forms of Payments in Lieu of Taxes: (1) "Payment in Lieu of Taxes I," a payment similar to property taxes, and (2) "Payment in Lieu of Taxes II," a payment that serves as gross receipts tax. According to Commonwealth law, a "Payment in Lieu Taxes II" must amount to no less than $20 million or 4% of PRTC's gross income. PRTA's Governing Board, however, may at its discretion, approve a payment in excess of 4% of the gross income if PRTC's financial condition allows it to do so. 3. In 1993, PRTC made Payments in Lieu of Taxes I and Payments in Lieu of Taxes II of $22,260,639 and $101,696,702, respectively for the 1992 tax year. PRTC made an initial Payment in Lieu of Taxes II of $20 million. On March 25, 1993, PRTA's Governing Board authorized PRTC to make an additional payment of $80 million Payment in Lieu of Taxes II for the 1992 tax year to be paid on July 1, 1993. This additional payment equaled the net proceeds of the December 22, 1992 sale of PRTC's long distance affiliate, TLD, to Telefonica de Espana. On June 24, 1993, PRTA's Governing Board raised PRTC's additional Payment in Lieu of Taxes II to $81,696,702. 4. PRTC sought to treat the additional payments as operating taxes for purposes of computing its interstate access charge settlements, including its USF assistance draw. PRTC would thereby increase its interstate access charge settlements by approximately $16 million, including $6.4 million for USF. By a series of letters, NECA questioned the categorization of these payments as operating taxes, requested additional documentation from PRTC, and asked that PRTC request Commission review of the accounting entries. In response, PRTC provided NECA with extensive documentation demonstrating that the additional payments had been made pursuant to Commonwealth statutes. Subsequently, PRTC requested that the Bureau recognize the additional Payment in Lieu of Taxes II as operating taxes, so it could be included in PRTC's interstate access settlements. 5. In an April 28, 1995 letter, the Bureau informed PRTC that the Commission would permit PRTC's additional Payment in Lieu of Taxes II to be treated as operating taxes for USF and interstate access settlement calculations to the extent that those amounts were calculated using tax rates no greater than rates normally applied to non-Commonwealth owned or affiliated companies operating in Puerto Rico. By a May 30, 1995 letter, PRTC responded. In that letter, PRTC submitted calculations based on hypothetical tax obligations that PRTC would have paid if it operated as a private enterprise in Puerto Rico. Reviewing the calculations, the Bureau determined that PRTC had mistakenly calculated the hypothetical municipal license tax. PRTC recalculated and revised its submission. On February 5, 1996, the Bureau released the PRTC Disallowance Orderin response to PRTC's May 30th letter. 6. In the PRTC Disallowance Order, the Bureau allowed the entire 1992 Payment in Lieu of Taxes I to be recorded as an operating tax, and allowed approximately 20% of the Payment in Lieu of Taxes II to be recorded in Account 7240, Operating Other Taxes, and treated as operating taxes for USF and interstate settlement purposes. The Bureau refused to allow PRTC to treat as operating taxes the remainder of PRTC's 1992 Payment in Lieu of Taxes II. The Bureau determined that the remaining amount should be charged to Account 4550, Retained Earnings. The Bureau found that the additional Payment in Lieu of Taxes II should not be recorded as an operating tax because that would result in gross receipts taxes for a government-owned corporation that greatly exceeds gross receipts taxes that would be paid by private enterprises. The Bureau reaffirmed its earlier conclusion that Payments in Lieu of Taxes II by a government-owned corporation can only qualify for recording in the Operating Tax Accounts (Accounts 7200 through 7250 of the Uniform System of Accounts or "USOA"), if "the payments are calculated using rates that do not exceed tax rates applicable to private enterprises operating in the jurisdiction . . ." The Bureau also stated, "[a] payment in excess of amount calculated in accordance with this standard is in most cases a dividend paid by a government-owned corporation to its owner. . ." The Bureau concluded, therefore, that the additional payment was not an operating tax, rather, the payment was "akin to a dividend to be paid out of earnings" and "is inconsistent with our interpretation of the USOA." 7. The Bureau determined that because PRTC is owned and operated by the Commonwealth of Puerto Rico, the "Commonwealth is effectively taxing itself through the transfer of funds from its ILECs while simultaneously charging the interstate revenue pool for an interstate contribution to support its levy." The Bureau found, therefore, that the additional payments were not made at arms-length, which is characteristic of government taxation of private enterprises. Finally, the Bureau concluded that its decision in the PRTC Disallowance Order "applies to all future amounts claimed by PRTC as operating taxes for USF and interstate access settlement purposes, i.e., PRTC may not claim for USF and interstate access settlement purposes payments in lieu of taxes in excess of those amounts that they would have paid if they were operating as private, non-Commonwealth-owned ILECs." It is this last conclusion that PRTC now asks the Bureau to reconsider. III. POSITIONS OF THE PARTIES A. PRTC Petition 8. PRTC does not contest our prior decision that it may not record as operating taxes the $80 million associated with the sale of its long distance affiliate. In its petition, PRTC argues that, even though its overall tax burden is less than that of private corporation doing business in Puerto Rico, the Bureau's accounting interpretation of what payments qualify as operating taxes will not enable PRTC to fully recover its tax burden. Using projected 1996 financial results, PRTC estimates that it would pay a total of $74 million to the Commonwealth, consisting of $30 million in Payments in Lieu of Taxes I (property taxes) and $44 million in Payments in Lieu of Taxes II (gross receipts taxes). It estimates that a private corporation with the same financial results would pay the Commonwealth $147 million, consisting of $60 million in property taxes, $25 million in gross receipts taxes, and $62 million in income taxes. PRTC concedes that its projected 1996 Payment in Lieu of Taxes I is not at issue. PRTC contends, however, that, under the Bureau's accounting interpretation of the USOA, of the $74 million it will pay to the Commonwealth, PRTC would be able to recover only $55 million, consisting of $30 million in Payments in Lieu of Taxes I and $25 million in Payments in Lieu of Taxes II. 9. PRTC argues that if the Bureau were to label the Payments in Lieu of Taxes II differently, the payments would be recoverable. PRTC also argues that the Bureau's ruling improperly "second-guesses the decision of the Puerto Rico legislature as to how best recover tax revenues from the otherwise-exempt PRTC," and "precludes full recovery of PRTC's Payment in Lieu of Taxes II." Finally, PRTC argues that the failure of the Bureau to permit recovery of the full amount of Payment in Lieu of Taxes II is "confiscatory in violation of Section 201 of the Communications Act and the Fifth Amendment of the United States." B. AT&T Opposition 10. On March 20, 1996, AT&T filed an opposition to PRTC's petition for reconsideration. AT&T asserts that the Bureau's PRTC Disallowance Order correctly found that in determining the qualification of payments as operating taxes "the proper yardstick is the tax liability that would be incurred by private parties in an arms length transaction." AT&T also asserts that PRTC's reconsideration petition "itself miscategorizes almost half of its projected 1996 payments." AT&T argues that PRTC may not properly claim $62 million in corporate income taxes because it does not make Payments in Lieu of Taxes based on net income, and PRTC has no amounts that could be properly recorded in Account 7230, Operating state and local income taxes, as would be the case with tax on a private entity. AT&T states "PRTC's excess payments to the Commonwealth cannot qualify for accounting treatment as taxes under the Commission rules and PRTC's petition for reconsideration of the PRTC Disallowance Order should be denied." IV. DISCUSSION 11. We are not persuaded by PRTC's claims that the Bureau incorrectly labelled the taxes and improperly "second-guessed" the Puerto Rico legislature on Puerto Rican tax issues. The objective of Part 32 of the Commission's rules is not to deny or permit recovery of payments; rather, it is to ensure that carriers properly record payments in the appropriate accounts. In the PRTC Disallowance Order, we concluded that "whether or not the carriers can claim these payments as taxes for reimbursement under USF and interstate access settlement programs, depends on whether such payments can properly be recorded as operating taxes in Accounts 7200 through 7250." 12. We agree with PRTC's assertions that our interpretation of the USOA precludes full recovery of Payments in Lieu of Taxes II. We do not agree, however, that our interpretation violates Section 201 of the Act. Section 201 requires that the Commission ensure that all charges, terms, and conditions for services be just and reasonable. Because PRTC is owned and operated by the Commonwealth, the Payments in Lieu of Taxes that it makes to the Puerto Rican government amount to the Commonwealth's taxing itself. In permitting a Payment in Lieu of Taxes made by a government entity to be treated as an operating expense, the Bureau requires that the government- affiliated carrier demonstrate that payments do not exceed those made by a private entity and are not discretionary in nature. Without this interpretation, a government-owned corporation could arbitrarily increase its Payments in Lieu of Taxes at any time. Unlike taxes, however, such payments would not have been anticipated and included in calculations of USF and access pool revenues. If a government-owned corporation were permitted to recover these excess amounts as operating taxes, it could arbitrarily increase its own revenue from the USF and access pools at the expense of other pool participants or contributors to universal service support mechanisms. The Bureau's interpretation, therefore, is designed to protect ratepayers and prevent arbitrary accounting treatment of tax payments that would improperly increase the USF draw of a recipient. We conclude, therefore, that the Bureau's interpretation is consistent with both the letter and spirit of section 201. 13. PRTC claims that our interpretation results in a taking and violates the Fifth Amendment. We do not agree. Our decision that excess Payments in Lieu of Taxes may not be recorded in Account 7240 does not constitute a taking in violation of the Fifth Amendment because the end result is legitimate and the means rational. When it adopted its accounting interpretation of payments that qualify as operating taxes for recording in Account 7240, the Bureau compared the treatment of tax payments made by a private corporation to Payments in Lieu of Taxes made by a government-owned corporation. The Bureau determined that Payments in Lieu of Taxes must be calculated using tax rates no greater than rates normally applied to private corporations. The Bureau's standard strikes a reasonable balance between allowance and total disallowance for accounting treatment of such payments. Thus, the Bureau's interpretation permits PRTC to record payments as operating expenses and legitimately recover expenses through USF assistance and access settlement payments. Additionally, in the PRTC Disallowance Order, the Bureau encouraged PRTC and other parties to file a request for an interpretation pursuant to 32.17, Interpretation of Accounts, if there were any doubt as to applicability of the Bureau's interpretation of the USOA to the PRTC and PRTA. We conclude that our action does not violate the Fifth Amendment because PRTC received just compensation. 14. In view of the foregoing, we find that there is no good cause for reconsideration of the accounting treatment of amounts for Payments in Lieu of Taxes II. We affirm our earlier conclusion. We conclude, therefore, that any disallowance of an amount claimed by a carrier as operating taxes results not from labeling, but from the carrier's ability to record that amount properly in the appropriate tax account. Using PRTC's 1996 projections, we agree with PRTC that it may properly record $30 million in Payments in Lieu of Taxes I and $25 million of its Payment in Lieu of Taxes II in Account 7240, Operating other taxes because neither amount exceeds taxes that private corporations would have to pay. We find, however, PRTC may not record the additional $19 million Payment in Lieu of Taxes II because, this amount is more than the assessed Account 7240 entries used to record both property and gross receipts taxes. Although PRTC must make this payment, this amount exceeds gross receipts taxes that would be paid by a private corporation. We conclude that treatment of this excess amount as an operating tax for USF and interstate access settlement calculations "would be inconsistent with our interpretation of the USOA." Accordingly, we deny PRTC's petition for reconsideration. IV. ORDERING CLAUSE 15. Accordingly, IT IS ORDERED, pursuant to Sections 4(i), 5(c), 201-205, 218, and 220 and of the Communications Act of 1934, as amended, 47 U.S.C.  154(i), 155(c), 201-205, 218, 220 and Sections 0.91 and 0.291, of the Commission's Rules, 47 C.F.R.  0.91 and 0.291, that the Petition for Reconsideration filed by Puerto Rico Telephone Company IS DENIED. FEDERAL COMMUNICATIONS COMMISSION Regina M. Keeney Chief, Common Carrier Bureau