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HomeMy WebLinkAboutProposed Utilities Tax Law ChangeTHOMAS C. PALMER ATTORNEY AT LAW P.O. BOX 145,1037 MAIN STREET, SEBASTIAN, FLORIDA 32958 305-589-7550 March 20, 1986 TO: Mayor L. Gene Harris Re: Request from General Development Dear Gene: Enclosed is a packet of papers that was mailed to me from General Development. This request asks you -to mail a letter to U.S Senators Chiles and Hawkins opposing certain proposed changes to a Federal Tax Law which would require private utilities to include contributions in aid of construction as income and -to prohibit industrial development bonds to be used for private utilities. These proposed changes will not effect municipal owned utilities. The proposed changes are part of the Federal Government's austierity program. This request has no legal ramifications regarding the City of Sebastian and any decision by you to mail or not to mail such a letter requires no comment from me. If you would like a further briefing of the effect of the proposed changes on private utilities, I will be happy to inform you of what I know. Thomas C. Palmer encl We need your assistance concerning sections 701 and 908. These sections deal with Industrial Development Bonds and Contributions in aid of construction. If these sections pass in their present form, there will be an adverse economic impact on GDU. The information in the packet provides sufficient data for the preparation of letters for signature of Mayors and City and County Commissioners. We need as many letters as possible sent to the individual Congressmen and Senators Chiles and Hawkins in support of a repeal or modification to these adverse portions. Time is of the essence. If at all possible the letters should be in the mail not later than March 7, 1986. Please call if I can be of further assistance. i Cal Landau CL/mpr. PS: A draft letter for the officials' use is enclosed. We wanted to give you something for them to work with; however, the background data has in depth analysis that would be useful to flesh out the letter. CL. VM1POVO. � Yj �7�lTu Q Co., 7t� m2545 Date Dear It has come to my attention that the tax Reform Act of 1985 contains certain provisions which would impact investor-owned water and sewer utilities. Specifically, I am referring to provisions of HR 3838 which -would make contributions in aid of construction taxable and would eliminate Industrial Development Bonds as a tax exempt source of financing water treatment facilities. Both of these provisions have the potential for substantially increasing the cost of utility service in our community. As (fill in appropriate position) increasing costs of utility services. clean water and the protection of pressure on utility costs to continue I am very concerned about the With the continued emphasis on our environment, I expect the to escalate. I urge you to oppose these elements of the legislation. We need to do everything we can to try to assure the most economic delivery of utilities whether private or public. It makes little sense to create a financial burden on the customer who deals with a private utility rather than a public one. Sincerely, EPP3844A t GENERAL DEVELOPMENT CORPORATION ISSUES BEFORE U.S. CONGRESS In late 1985, The House passed a bill (HR 3838) calling for reform of certain Tax Laws. The Senate will consider this legislation as it writes its own tax bill this spring. The Senate Bill and the House Bill will be combined for consideration in conference committee this summer. All political observers we talked to expect some form of tax reform bill to be passed and sent to the President by the end of 1986. There are three items in this legislation that are potentially harmful to our Company. We have an opportunity to influence the shape of this legislation during the next two months and again in the conference committee. To be successful, we will need the support of the members of the Senate Finance Committee and the House Ways and Means Committee. U.S.Senator Lawton Chiles, the ranking Democrat on the budget committee and a key member of the Senate leadership, can be very helpful to us in this process. It is important that he understands, in a general sense, the impact these issues have on the Company. Our problem issues: 1. RECOGNITION OF INSTALLMENT INCOME Under current law, gain from certain sales of property in exchange for which the seller receives deferred payments, may be reported on the installment method, unless the taxpayer elects otherwise. The purpose for permitting the reporting of gain under the installment method is to tax the income from a deferred payment sale at the time the taxpayer receives the cash from which the taxes are to be paid. The bill passed by the House reflects the philosophy of the majority of the House Ways and Means Committee which said that a taxpayer who borrows against an installment obligation is not faced with the liquidity problem that installment reporting generally is intended to alleviate, at least to the extent of the amount borrowed. Dan Rostenkowski, Chairman of the House Ways and Means Committee, has described the current situation (whereby a Company can borrow against installment obligations without paying tax on the loan as income) a "sham." UNDER THE BILL PASSED BY THE HOUSE (HR3838) if installment obligations are pledged as collateral for a loan, all or a portion of the proceeds of the loan generally are treated as a payment received on the obligation and therefore is taxable as same. 2. CONTRIBUTIONS IN AID OF CONSTRUCTION Under current law, regulated public utilities can exclude from income certain amounts received for capital expansion. These contributions in aid of construction reduce the basis of the constructed assets for depreciation and ITC purposes. The bill passed by the House (HR3838) says that contributions received after December 31, 1985 will be included in income and will increase the depreciable basis of the constructed asset. 3. INDUSTR1At DEVELOPMENT BONDS Under current law, water and waste water treatment facilities would come under the cap of IDBs, but would continue to be allowed tax exempt financing within that restriction. HR3838 would prohibit the use of bonds to finance water treat- ment facilities built and operated by private developers. A number of Senators support a less restricted use of IDBS and would favor the removal of the cap on their use for capital expansion of GDU (an effort being made by our Lobbyists). HR3838 would scuttle this initiative. OUTLINE OF ADVERSE IMPACT OF H.R. 3838, "THE TAX REFORM ACT OF 1985" ON GENERAL DEVELOPMENT CORPORATION I. Three sections of H.R. 3838, if enacted into law, would each significantly adversely impact General Development Corporation ("GDC"): 1. Section 701 of H.R. 3838 which would make extensive changes in the tax exempt bond area. 2. Section 908 of H.R. 3838 which would repeal section 118(b) of the Internal Revenue Code of 1954 (the "Code") which provides for nontaxable treatment of contributions in aid of construction ("CIAC") to regulated electric, gas, water and sewer public utilities. 3. Section 903 of H.R. 3838 which would effectively repeal the installment method of accounting to the extent of the principal amount of a taxpayer's debt that is secured by actual pledges of the taxpayer's installment method deferred payment obligations or that is "deemed" to be secured by such installment obligations. II. Two of these sections of H.R. 3838, sections 701 and 908, would apply to General Development Utilities, Inc. ("GDU"), a wholly-owned regulated public utility subsidiary of GDC engaged principally in providing essential water and sewer services to the public in the Florida communities that it serves. These two sections of H.R. 3838 would not only significantly adversely affect GDU, but also would each have an enormously adverse impact on the state of Florida, because they each present substantial obstacles to capital formation by privately -owned regulated water and sewer public utilities. The two provisions together are draconian in their impact on the privatization of vital public services in Florida that is essential to meet the demand generated by the explosive growth that Florida is experiencing. Sections 701 and 908 of H.R. 3838 are summarized below: 1. The following two portions of sections 701 of H.R. 3838 would seriously adversely impact GDU: (a) Section 701(b) would radically depart from existing law by requiring government ownership of water utility facilities in order for those facilities to be eligible for tax exempt - 2 - industrial revenue bond financing. This would directly adversely affect GDU by barring it from all access to tax exempt financing for water facilities needed to provide essential water service to the public in the communities that it serves in Florida. (b) Section 701(b) would also continue on a more restrictive basis the state volume limitations first enacted in the Tax Reform Act of 1984 and would continue to apply these limitations to water and sewer utilities, but continue to exclude certain airport, dock and wharf facilities from these limitations. Water and sewer facilities were in 1984, and remain today, no less vital and essential public service facilities than airports, docks and wharves. Accordingly, water and sewer facilities should have been excluded from the state volume limitations enacted in 1984 because investor -owner regulated water and sewer public utilties are providing essential public services that otherwise would have to be furnished by state or local governments. The 1984 error should now be rectified by excluding water and sewer facilities from any state volume limitations in any new tax reform legislation. 2. Section 908 of H.R. 3838 would drastically inhibit capital formation on a very targeted basis by repealing section 118(b) of Code which is a codifi- cation of the long-standing tax principle that CIAC made to a regulated public utility for the purpose of expanding or extending the utility's facilities is a nontaxable contribution to the capital of the utility. At best, requiring CIAC to be included in GDU's income would result in much higher water and sewer costs for its customers, reductions in service to its existing customers, and curtailment of the plant expansions and main line extensions that are needed to provide vital water and sewer services to the public in the areas that GDU serves. At worst, repealing the current law treatment of CIAC as a nontaxable contribution to capital would risk the economic viability of GDU. If any repeal of section 118(b) were to be limited solely to the less capital intensive electric and gas utilities, the revenue loss from retaining section 118(b) for water and sewer utilities (as compared to treating CIAC as income) is minor, particularly as compared to the predictable significant adverse consequences of treating CIRC made to water and sewer utilities as income. - 3 - III. Section 903 of H.R. 3838, dealing with the pledging of installment method deferred payment obligations, could have a devastating impact on GDC. 1. GDC sells homesite lots to customers pursuant to non- recourse land sales contracts providing for payment over 10 years of the contract price for the lot and interest on the deferred payments. 2. For both financial accounting and federal income tax purposes, GDC reports its gross profit from its deferred payment sales of homesite lots on the installment method. Under the installment method of accounting, GDC does not include in income for tax purposes the entire gross profit on the sale of the homesite lot in the year of sale. Rather, as each payment is received from a homesite purchaser, GDC includes in income for tax purposes a proportionate part of the gross profit on the sale. 3. On September 6, 1985, GDC entered into two seven year revolving credit term loan agreements, one provides GDC initially with up to $130 million in credit and a declining amount of credit each year therafter during the term of the agreement. The other provides GDC with up to $20 million in credit. A substantial part of the collateral security under the $130 million loan agreement and the entire collateral security under the $20 million loan agreements is a continuing pledge of GDC's homesite installment method deferred payment receivables. GDC has drawn as much as $112 million under these loan agreements to date. 4. GDC would be severely adversely impacted by the acceleration of income on its installment method deferred payment receivables that would occur under section 903 of H.R. 3838 if it is enacted in its present form. GDC will promptly submit a memorandum summarizing the adverse effects on GDC of the proposed pledging of installment obligations rules and the significant technical problems inherent in section 903 of H.R. 3838 as applied to GDC's facts. POSITION OF GENERAL DEVELOPMENT CORPORATION WITH RESPECT TO SECTION 701, EXEMPT FACILITY INDUSTRIAL DEVELOPMENT BONDS, OF H.R. 3838, "THE TAX REFORM ACT OF 1985" Description of Existing Law and H.R. 3838 Changes Title VII of H.R. 3838 would make extensive changes in the tax-exempt bond area. If enacted as law in its present form, the proposal in Title VII of H.R. 3838 which would have the greatest impact on General Development Utilities, Inc. ("GDU") would be Section 701 of the bill. In a radical change from present law, Section 701 of H.R. 3838 would exclude from tax-exempt financing facilities for the furnishing of water if such facilities are not owned by or on behalf of a governmental unit. Under existing section 103(b)(4)(G) of the Internal Revenue Code of 1954 (the "Code"), facilities for the furnishing of water are treated as "exempt activities" and qualify for tax-exempt industrial development bond ("IDB") financing, if (a) the water is or will be made available on reasonable demand to the general public (including electric utility, industrial, agricultural, or commercial users), and (b) either the facilities are operated by a governmental unit or the rates for the furnishing or sale of water have been established or approved by a State or local governmental unit (including a public service or public utility commission). Section 701(b) of H.R. 3838 would change this rule and would confine the availability of tax-exempt financing to governmentally -owned water facilities, although it continues - 2 - tax-exempt financing for certain other activities without governmental ownership, including sewage facilities, solid waste disposal facilities, and qualified residential rental projects. (See "Sec. 142 Exempt Facility Bond", which would be added by Sec. 701(b) of H.R. 3838.) The Tax Reform Act of 1984 introduced a limitation on the aggregate volume of private activity bonds (with certain exceptions, but not excepting bonds to finance water or sewer facilities) that each State can issue annually. The revised, unified volume cap included in H.R. 3838 continues to apply to water and sewer facilities, but does not apply to certain airport, dock, and wharf facility bonds. (See "Sec. 145 Volume Cap", which would also be added by Sec. 701(b) of H.R. 3838.) Description of GDU's Business GDU is an investor-owned, regulated public utility company which furnishes water and sewer services to the public in various parts of Florida. At present, GDU serves over 51,000 water and sewer customers in eight different communities. It now has 23 central water and sewer plants and over 1,900 miles of water and sewer main lines. In most if not all of the communities where it operates, GDU is providing a vital and essential public service which the local government is unwilling or unable to provide. Although the sole stockholder of GDU is General Development Corporation ("GDC"), a major land developer in the State of Florida, GDU does not exclusively nor even primarily serve GDC I - 3 - developments. On the contrary, fully 75% of its connections are attributable to outside commercial development and non -GDC single- and multi -family residential customers. Water and sewer utilities -- GDU's principal operations -- are highly capital intensive, so much so that they probably are the most capital intensive utilities requiring, for example, a significantly greater investment per dollar of revenue than electric utilities. Generally, water and sewer utilities have $3 invested in fixed assets for every $1 of annual revenue received. Increased Federal and State compliance requirements to provide environmental protection facilities are expected to make this ratio even greater. Rate regulatory authorities allow the utility to recover directly from its customers the interest that it pays. Consequently, the lower the amount of interest paid by GDU to secure its financing, the greater the direct benefit to the consumer in terms of rates paid for service. GDU is mandated by statute as a regulated public utility to provide quality service at a reasonable cost. As such it has aggressively pursued all opportunities available to obtain its capital requirements at the lowest possible cost. Since 1980, GDU has been financing a substantial portion of the cost of construction of its facilities through the use of IDBS under the existing exempt activities bond provisions of the Code. MW Discussion GDU and its customers will be adversely impacted if H.R. 3838 should be enacted in a form which prevents GDU from qualifying for any additional tax-exempt financing for its water facilities. GDU's cost of capital would increase dramatically, and of necessity, this increase would have to be reflected in much higher water rates for its customers and/or in reduced ability to serve its existing customers and curtailment of the further extension of its water service facilities that is needed to meet the growth in the areas it serves. GDU believes that privately owned water and sewer facilities provide an essential public service nationwide, and particularly in the state of Florida. The high and rapid growth in Florida has resulted in a large proportion of these essential public services being provided by privately -owned regulated public utilities. The benefits of increasingly moving toward privatization of essential public services is dramatically demonstrated by the Florida experience, where private companies are providing service to assist local governments to meet the growth demands which are inevitable in this State. To limit the availability of funding by precluding the use of tax-exempt financing for water facilities of investor-owned regulated public utilities is highly inequitable and would prove to be counterproductive to the interests of the taxpayer -consumers. - 5 - Accordingly, for the same reasons that H.R. 3838 continues tax-exempt financing for nongovernmentally owned sewage treatment and solid waste disposal facilities, any legislation ultimately enacted in this area should also continue the availability of such financing for water facilities of nongovernmentally-owned regulated public utilities. Florida's water supply is especially vulnerable to contamination. A substantial number of hazardous waste sites have been identified in the state, giving rise to concern for the quality of ground water. There is an increasing awareness of, and increasing Federal and State regulation of, ground and surface water quality and potential hazardous waste pollution of the vital resources of the State and the Nation. Water utilities generally, and specifically investor-owned regulated public utilities that provide a public water supply, can and do serve not only as the first available detector of potential ground water contamination but also as a provider of required treatment to remove any unacceptable substances. As such they can and do perform an equally vital public health and welfare purpose as sewage treatment facilities. Therefore, it is urged that in any tax reform bill drafted and reported by the Senate Finance Committee, both facilities for the furnishing of water that are owned by privately -owned regulated public utilities and by government-owned utilities, sewage facilities, and solid waste disposal facilities should all continue to be treated as exempt facilities that serve an - 6 - important and special public interest and, as such, remain entitled to the benefits of tax-exempt financing. Moreover, because all involve essential public services, it is also urged that all three (water, sewage and solid waste disposal facilities) not be subject to any unified volume limitation included in such legislation. The case for such exclusion is equal to, if not better than, the case for excluding certain airport, dock, and wharf facilities (which H.R. 3838 would exclude from the unified volume limitation.) It POSITION OF GENERAL DEVELOPMENT CORPORATION WITH RESPECT TO SECTION 908, CONTRIBUTIONS IN AID OF CONSTRUCTION, OF H.R. 3838, "THE TAX REFORM ACT OF 1985" Description of Existing Law and H.R. 3838 Repeal Existing section 118(a) of the Internal Revenue Code of 1954 (the "Code") excludes from a corporation's gross income contributions to the capital of the corporation. For approxi- mately 50 years prior to 1976, federal income tax laws had been interpreted by both the courts and the Internal Revenue Service to allow regulated public utilities, including water and sewer utilities, to treat certain nonshareholder contributions of money and property in aid of construction ("CIAC") as contribu- tions to capital which, therefore, were excludable from gross income under section 118(a) of the Code and its predecessor provisions. In response to a reversal by the Internal Revenue Service in 1975 of its long-standing position as to the treat- ment of CIAC as nontaxable capital contributions, Congress enacted section 118(b) of the Code as part of the Tax Reform Act of 1976. Section 118(b), in essence, codified the treatment of CIAC made to regulated water and sewer public utilities as contributions to capital excludable from gross income. In the Revenue Act of 1978, section 118(b) of the Code was extended to also apply to regulated gas and electric public utilities. It - 2 - Under section 118(b) of the Code as enacted in 1976, receipt of cash or property by a regulated utility furnishing water and sewer services to the public is treated as a nontaxable capital contribution if: (1) The amount received constitutes a "contribution in aid of construction" which is defined in proposed regulations under section 118(b) of the Code as "an item or amount contributed to a regulated public utility which provides water or sewerage disposal services to the extent that the purpose of the contribution is to provide for the expansion, improvement, or replacement of the utility's water or sewerage disposal facilities". (2) The amount is not a fee paid by a utility customer to make the connection from the main water or sewer lines to the customer's property. (3) Certain tests are met that are designed to ensure that the purpose motivating the contribution is fulfilled -- i.e., that the contribution is in fact used to acquire or construct water or sewer facilities used in the regulated public utility's trade or business of furnishing water or sewer services to its customers. Significantly, since CIAC is excluded from gross income for federal income tax purposes as a capital contribution, section 118(b) of the Code also stipulates that: - 3 - (1) Any facility contributed as CIRC or purchased or constructed with CIAC must be excluded from the regulated public utility's rate base for ratemaking purposes so that the utility does not earn any economic return on facilities funded by CIRC. (2) The tax basis of any facility contributed as CIRC or purchased or constructed with CIAC shall be zero so that no depreciation, other deduction, or investment or other credit is allowable with respect to any facility funded by CIAC. If enacted into law, section 908 of H.R. 3838 would repudiate the long-standing treatment of CIAC as nontaxable capital contributions by requiring the inclusion in income of amounts received after December 31, 1985 of "any contribution in aid of construction or any contribution as a customer or potential customer". Description of Business of General Development Utilities, Inc. General Development Utilities, Inc. ("GDU") is an investor-owned, regulated public utility company which furnishes water and sewer services to the public in various parts of Florida. At present, GDU serves over 51,000 water and sewer customers in eight different communities. It now has 23 central water and sewer plants and over 1,900 miles of water and sewer main lines. - 4 - In most if not all of the communities where it operates, GDU is providing a vital and essential public service which the local government is unwilling or unable to provide. Although the sole stockholder of GDU is General Development Corporation ("GDC"), a major land developer in the State of Florida, GDU does not exclusively nor even primarily serve GDC develop- ments. On the contrary, fully 75% of its connections are attributable to outside commercial development and non -GDC single-family and multi -family residential customers. The water and sewer rates that GDU is permitted to charge, the rules for extending service to new customers, and the amount of CIAO GDU may collect are regulated by either the State of Florida Public Service Commission ("FPSC"), or local county or municipal governments. Although rate regulation differs somewhat from jurisdiction to jurisdiction, all follow a similar formula. GDU and all other investor-owned regulated public water and sewer utilities are entitled to earn such revenues as are needed to recoup operating expenses and taxes, pay fixed capital costs, and realize a reasonable rate of return on shareholder equity. Securing regulatory approval for a substantial rate increase or a change in other rules generally takes from 12 to 18 months from the time the application for a change is filed. During that period, any additional costs sought to be absorbed through an increase in rates must be borne by the utility, and, of course, a desired - 5 - increase in rates may be denied or granted only in part by the regulatory authorities who often are under significant political and community pressure to resist increases in already high utility rates. Water and sewer utilities -- GDU's principal operations -- are highly capital intensive, so much so that they probably are the most capital intensive utilities requiring, for example, a significantly greater investment per dollar of revenue than electric utilities. Generally, water and sewer utilities have $3 invested in fixed assets for every $1 of annual revenue received. Increased Federal and State compliance requirements to provide environmental protection facilities are expected to make this ratio even greater. The rate of expansion of the plant capacity and the main lines of GDU's water and sewer systems and the rate of increase in the capital requirements for funding such expansion are dictated largely by the rate of growth in the area served by the particular system and the proximity of such growth to existing water mains and sewage collection facilities. The amount of capital required to provide these essential public water and sewer services has increased in magnitude in recent years not only as a result of explosive growth in the areas that GDU serves, but also because of increased construction costs of water and sewer facilities and increased state -federal environmental regulatory requirements. M-� GDU receives CIAC earmarked for expansion of plant and pumping capacity and extension of transmission and distri- bution main lines from two principal nonshareholder sources. One source is parties who purchase unimproved lots from GDC under ten-year installment contracts. Pursuant to various state requirements, CIAC paid by lot purchasers is placed in escrow accounts to be released to GDU in stages as construction of the water or sewer facilities progresses in a given service area or platted unit. The other principal source of CIRC is builders and developers who wish to obtain water and sewer services for homes or commercial buildings which they are constructing. In all cases, in accordance with section 118(b), charges made by GDU for installing water meters and running service lines from the main lines to the customers' property are not treated as CIAC. The amounts which GDU may collect as CIAC for increases in plant capacity and extensions of main lines are determined periodically by the FPSC or local regulatory authority following a thorough review of data relating to the cost of improvements already in place and the anticipated cost of future expansion. The CIAC charges are set by the FPSC or local regulatory authority at a level which is designed to cover part, but not all, of the total cost of the system. GDU is expected to cover the remaining cost with its own funds. 11 - 7 - Discussion The legislative history to Section 908 of H.R. 3838 provides some valuable insights. Most of the provisions of H.R. 3838 were selected from proposals contained in three principal tax reform proposal documents: (1) the November, 1984 report by the Treasury Department to the President styled "Tax Reform For Fairness, Simplicity, and Economic Growth"; (2) the May, 1985 proposals submitted to Congress by President Reagan styled "The President's Tax Proposals to the Congress for Fairness, Growth, and Simplicity"; and (3) the September 26, 1985 tax reform options prepared by the Staff of the Joint Committee on Taxation styled "Tax Reform Proposals In Connection With Committee On Ways And Means Markup". None of these documents suggested a repeal of section 118(b) of the Code or any other changes to the nontaxable treatment of CIRC. Chairman Rostenkowski of the Committee on Ways and Means divided the Committee into "task forces" to make recommendations to the full Committee with respect to specified substantive areas. The task force dealing with accounting issues initiated the proposal to reverse the long-standing tax treatment of CIAC without prior notice. The task force's proposal was adopted by the Committee on Ways and Means on November 6, 1985 shortly after it was proposed by the task force. Thus, there was no advance opportunity for Members of the Committee on Ways and � Means or other Congressmen or Congresswomen to evaluate the merit of the task force's proposal or to evaluate the drastic impact this extraordinary reversal of the tax treatment of CIRC would have on regulated water and sewer public utilities, their taxpayer -customers, and the state and local agencies responsible for regulating water and sewer utilities. The Report of the Committee on Ways and Means on H.R. 3838 explains the Committee's reason for treating as income CIRC made to regulated electric, gas, water and sewer public utilities as follows: "The committee believes that all payments that are made to a utility either to encourage, or as a prerequisite for, the provision of services should be treated as income of the utility and not as a contribution to the capital of the utility. The committee believes that present law allows amounts that represent prepayments for services to be received by corporate regulated public utilities without the inclusion of such payments in gross income." [H. Rep. No. 426, 99th Cong., 1st Sess. 643- 644 (1985).] The validity of this hastily made conclusion is suspect since it is contrary to the tax treatment accorded CIAC by the courts for more than 50 years prior to the enactment in 1976 of section 118(b) of the Code and contrary to the tax treatment that has continued since 1976 in codified form under section 118(b). The ultimate effect of the Committee's conclusion is to disregard the long-standing tax law principle that nonshare- holders can make capital contributions to corporations that are neither gifts nor payments for goods or services, and, - 9 - therefore, are nontaxable contributions to capital. The United States Supreme Court's most recent expression of the test for determining when a transfer of property or money to a corpora- tion by a nonshareholder is a capital contribution is set forth in U.S. v. Chicago, Burlington and Ouincy Railroad, 412 U.S. 401 (1973). The Supreme Court's criteria embody essentially two components. First, the contribution cannot be "a direct payment for a specific, quantifiable service provided for the transferor by the transferee" and, therefore, "must become a permanent part of the transferee's working capital structure". Second, the contribution must result in more than a marginal benefit to the transferee corporation. See 412 U.S. at 413. Contributions to add plant, increase plant capacity, or extend main lines clearly satisfy these criteria and constitute nontaxable CIAO. Such contributions should be distinguished from connection fees paid by utility customers for metered connections of their property to water or sewer main lines that arguably fail this test (and that Congress excluded from CIAC treatment in 1976), and from other customary charges for the actual furnishing of water or sewer services that definitely fail this test. In any event, after careful deliberation Congress concluded in 1976 when enacting section 118(b) that: "These increased taxes [that would result from treat- ing CIAC made to water and sewer utilities as taxable income) will ultimately result in higher charges to - 10 - utility customers. Since such increased charges must be approved by public utility commissions, the working capital of the utilities may be substantially reduced resulting in delays in furnishing service and curtail- ment of expansion of service. Further, the immediate inclusion of such contributions in income causes a mismatching of income and related expense since the utility must increase income in the year in which the contributions are received, even though most of the expenses attributable to those facilities will not arise until subsequent years. The committee believes that treatment of contri- butions in aid of construction by water and sewage disposal utilities should be continued by providing that contributions in aid of construction received by such utilities from an existing or potential customer, a builder or developer, a governmental body, or any other person will constitute a contribution to capital." [S. Rep. No. 938, 94th Cong., 2d Sess. 435 (1976).] Nothing has occurred since 1976 to justify any change in the decision Congress made in 1976 to codify the long-standing tax treatment of CIRC made to regulated water and sewer public utilities as nontaxable contributions to capital. To the contrary, CIAC remains a critical element in financing new plant, increases in plant capacity, and extension of main lines of regulated water and sewer utilities serving the public. This is particularly true in areas of high and rapid growth, such as in Florida, where a large proportion of these essential public services is being provided by privately -owned regulated public utilities. The benefits of increasingly moving toward privatization of essential public services has been dramatically demonstrated by the Florida experience, where private companies are of necessity providing public services and thereby it assisting local governments to meet the growth demands which are inevitable in Florida. Certainly such a targeted inhibiting of capital formation through a repeal of section 118(b) of the Code as to regulated water and sewer public utilities cannot be good public policy. Since CIAC is excluded from the regulated water or sewer public utility's rate base, it is not the utility, but rather all its taxpayer -customers who benefit from CIAC through lower rates and through plant increases and main line extensions that otherwise would not be made. Thus, if CIAC made to regulated water and sewer public utilities is no longer treated as nontaxable contributions to capital, the additional tax cost will ultimately directly burden all the taxpayer -customers of the utility. GDU would be forced to seek substantially higher water and sewer rates and greater CIAC. Appointed and elected regulators, already subject to significant pressures because of high utility rates, would in many circumstances deny or only partially grant the requested rate relief and high level of CIAC that would be required, thereby severely impacting the financial condition of a utility providing essential and otherwise unavailable water and sewer services to the public. In such circumstances, at a minimum, GDU's ability to serve its existing water and sewer customers would be reduced and it would be forced to curtail the further plant expansion and main line extensions that are needed to meet the explosive growth in s - 12 - the areas it serves. The effects will be the same with respect to the customers and service areas of many other privately - owned regulated utilities that provide water and sewer services to the public. Since repeal of section 118(b) of the Code would not affect publicly -owned water and sewer utilities, treating CIAC made to water and sewer utilities as income will result in higher rates for customers of privately -owned regulated water and sewer utilities than for customers of publicly -owned water and sewer utilities. Ultimately, the effects described above of treating CIAC as income could threaten the survival of privately -owned regulated public utilities as part of the water and sewer utility industry. Table IV -2 of the Report of the Committee on Ways and Means on H.R. 3838 estimates the revenue gain that would result from treating CIRC made to regulated electric, gas, water and sewer public utilities as income as compared to current law's treat- ment of such CIAC as nontaxable capital contributions. Table IV -2 estimates such revenue gain for fiscal years 1986, 1987, 1988, 1989 and 1990 to be $88 million, $128 million, $108 million, $99 million, and $91 million, respectively. See H. Rep. No. 426, 99th Cong., 1st Sess. 72 (1985). It is particularly noteworthy with respect to these revenue estimates that when section 118(b) of the Code was enacted in 1976, the Conference Report on the Tax Reform Act of 1976 estimated the revenue loss from continuing to treat CIAC made to regulated 0 - 13 - water and sewer public utilities as nontaxable contributions to capital as compared to treating such CIAC as income to be only $16 million in fiscal 1977 and only $11 million in each fiscal year 1978 through 1981. See H. Rep. No. 1515, 94th Cong., 2d Sess. 636 (1976). However, the revenue loss attributable to the extension of section 118(b) of the Code to CIAC made to regulated gas and electric public utilities as compared to treating such CIAC as income was estimated in the Conference Report on the Revenue Act of 1978 to be $50 million for fiscal 1980 and $100 million for each fiscal year 1981 through 1983. See H. Rep. No. 1800, 95th Cong., 2d Sess. 306 (1978). In the same vein, in his testimony in August, 1978 in connection with a bill to extend section 118(b) of the Code to regulated gas and electric public utilities, then Deputy Assistant Secretary of the Treasury Halpern stated that: "The relief [of section 118(b) of the Code] was limited [in 19761 to water and sewerage utilities because it was felt that they were more significantly affected than were other utilities. Moreover, the revenue loss, measured from a base which treated contributions as taxable income, was manageable if confined to water and sewerage facilities, but could be as high as $200 million if gas and electric utilities were included." Consequently, any revenue loss of any magnitude is attributable to the 1978 extension of section 118(b) to regulated electric and gas utilities, and preserving the existing tax treatment solely for CIAC made to the highly capital intensive regulated J f. - 14 - water and sewer public utilities would involve a very modest and "manageable" revenue loss as compared to treating such CIAC as income. In summary: (1) the conclusion reached by the Committee on Ways and Means that CIAC is in fact a form of income is errone- ous; (2) frustrating capital formation by treating as income CIRC made to highly capital intensive regulated water and sewer public utilities will at best result in higher costs to their taxpayer -customers and curtailment of needed plant expansion and main line extensions, and at worst constitute the death knell for many privately -owned providers of these essential public services; and (3) the revenue effect estimates that Congress used in evaluating the enactment of section 118(b) of the Code in 1976 and its extension to electric and gas utilities in 1978 demonstrate that repealing the nontaxable treatment of CIAC made solely to water and sewer utilities will raise little revenue -- unquestionably so little revenue that it becomes glaringly obvious that it is bad public policy in general and bad tax policy in particular to impose higher costs on taxpayer - consumers, curtail needed expansion of water and sewer facilities, and risk the survival of many providers of these vital public services by repealing section 118(b) as to regulated water and sewer public utilities. Accordingly, it is urged with respect to any tax reform bill drafted and reported by the Senate Finance Committee that there be no repeal of section 118(b) of the Code, or, alterna- 1 4 w - 15 - tively, that any repeal of section 118(b) not extend to regu- lated utilities providing water and sewer services to the public -- i.e., that any repeal of section 118(b) be limited solely to gas and electric utilities.