January 29, 2015 -- Client Alert
On January 20, 2015, the Third District Court of Appeal issued one of few published decisions interpreting Proposition 26. The Court in Citizens for Fair REU Rates et al. v. City of Redding (Third District Court of Appeals Case No. C071906, decided January 20, 2015), held that the City of Redding’s Electrical Utility’s payment to the City in lieu of taxes (PILOT) is subject to Proposition 26 and that the City did not meet its burden to establish cost of service restrictions mandated by Proposition 26. The Redding decision does not reject PILOTs as a matter of law, but holds that an agency does not meet its burden to establish compliance with the cost restrictions of Proposition 26 by relying solely on a PILOT rate that matches the ad valorem tax rate.
Proposition 26 Applies to City’s PILOT
The Court denied the City’s argument that its PILOT was grandfathered in prior to the passage of Proposition 26 in November 2010. The City did not adopt the PILOT pursuant to an ordinance, but instead, approved a budget every two years that included the PILOT. Relying upon the California Supreme Court’s decision in Howard Jarvis Taxpayers’ Association v. City of La Habra (2001) 25 Cal.4th 809, 823, the Court reasoned that the fact that the City has never separately adopted the PILOT does not relieve the PILOT of Proposition 26’s requirements. Every imposition of PILOT is a violation in the Court’s view.
The Court also denied the City’s argument that the PILOT is not a “tax,” because it is not “imposed” on electric utility customers as they are voluntary customers of the utility. The Court concluded that “[a] tax does not lose its revenue-generating character because there is a theoretical but unrealistic way to escape the tax’s purview.” In other words, the fact that the customers could theoretically choose alternative supplies such as solar, does not mean the electric rates are not “imposed” in the same way as other taxes.
Proposition 26 Requires a Cost of Service Analysis Beyond a Comparison to the Equivalent Ad Valorem Taxes
Proposition 26 defines “tax” broadly to include every type of exaction, with the exception of seven categories specifically provided therein. The burden is on the agency to demonstrate in court that it falls under one of the specific exceptions. The City of Redding argued that its PILOT is exempted under the exception for a:
“…charge imposed for a specific government service or product provided directly to the payor that is not provided to those not charged, and which does not exceed the reasonable costs to the local government of providing the service or product.” (Article XIII C, section 1, subd. (e)(2) [emphasis added].)
The Court concluded that the City did not meet its burden of showing that the PILOT does not exceed the reasonable costs to the City of providing its services to the Electric Utility. Because the lower court accepted as a matter of law the practice of matching the PILOT rate to the ad valorem tax, the Court of Appeal concluded the case must be remanded to the trial court for a review of the administrative record. On remand, the City of Redding still has the opportunity to show that its administrative record supports its assertion that the PILOT reflects the City’s reasonable costs to provide electric service.
The Court’s Holding Is Consistent with Its Prior Proposition 218 Analysis
The Redding decision applies the same analysis the Third District applied in Howard Jarvis Taxpayers’ Association v. City of Roseville (2002) 97 Cal.App.4th 637, under Proposition 218. There, the Court held that a flat percentage fee by the City on its water, sewer, and refuse collection utilities was not sufficient to meet the City’s burden under Proposition 218 to establish its rates are limited to the cost of providing its services to the utilities. In Proposition 26, as in Proposition 218, the agencies have the burden of proof to establish cost restrictions and the Third District has concluded that more is required to meet that burden than a flat percentage fee or a fee matching the ad valorem rate.
Public agencies that transfer funds between enterprise funds for utilities subject to either Proposition 218 or Proposition 26 should take note of the latest decision and consult with legal counsel. It may be time for a review of the administrative record adopting each of those transfers.
For further information, please contact Patricia J. Quilizapa, Anita Luck, Wesley A. Miliband, Lindsay M. Tabaian, Miles P. Hogan, Christina M. Burrows, or Brian Daly from Aleshire & Wynder, LLP’s Water & Public Finance Practice Groups at (949) 223-1170.
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