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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 ) CUID No. PA2499 (Doylestown) ) Suburban Cable TV, Inc. ) ) Complaint Regarding ) Cable Programming Services Tier Rates ) and ) Petition for Reconsideration ) ) ORDER ON RECONSIDERATION AND RATE ORDER Adopted: September 19, 1997 Released: September 22, 1997 By the Chief, Cable Services Bureau: 1. In this Order we consider a complaint against the April 1, 1997 rate increase of the above- referenced operator ("Operator") for its cable programming services tier ("CPST") in the community referenced above. We have already issued an order in which we found that Operator's rates in effect prior to May 15, 1994 were unreasonable ("Prior Order"). On July 12, 1995, Operator filed a timely Petition for Reconsideration and Petition for Stay of our Prior Order. On August 17, 1995, we granted Operator's Petition for Stay. Subsequently, we issued an order finding Operator's CPST rates in effect after May 14, 1994 to be reasonable. In this Order, we address Operator's Petition for Reconsideration of our Prior Order and the reasonableness of Operator's April 1, 1997 rate increase. 2. Under the Communications Act, the Commission is authorized to review the CPST rates of cable systems not subject to effective competition to ensure that rates charged are not unreasonable. The Telecommunications Act of 1996 ("1996 Act") and our rules implementing the legislation ("Interim Rules"), require that a complaint against the CPST rate be filed with the Commission by a local franchising authority ("LFA") that has received more than one subscriber complaint. 3. The LFA for the franchise area referenced above filed a complaint with the Commission on June 24, 1997. The LFA verified that it received more than one subscriber complaint for the franchise area and that the first valid complaint was received by the LFA on April 7, 1997. The filing of a complete and timely complaint triggers an obligation upon the cable operator to file a justification of its CPST rates. The Operator has the burden of demonstrating that the CPST rates complained about are reasonable. If the Commission finds a rate to be unreasonable, it shall determine the correct rate and any refund liability. 4. Operators may justify their rates on an annual basis using FCC Form 1240 to reflect reasonably certain and quantifiable changes in external costs, inflation, and the number of regulated channels that are projected for the twelve months following the rate change. Any incurred cost that is not projected may be accrued with interest and added to rates at a later time. 5. In our Prior Order, we found that Operator did not correctly account for its income tax expense. Operator confirmed that it is a tax-paying entity but did not include the full allowance for federal income taxes applicable to the return on its investment in property, plant and equipment associated with the provision, installation, and servicing of customer premises equipment. We therefore recalculated the federal income tax allowance on the basis of a 34 percent corporate tax rate. Application of the gross-up principle to a 34 percent tax rate led to an allowance for federal income taxes at .51515 of the return on investment allowed. Application of the grossed-up tax provision resulted in an increase in the federal tax provision on Schedule A and Schedule C, increasing the monthly equipment cost unbundled by Operator and thereby causing a decrease in its MPR for its CPST. 6. We also found that Operator calculated its MPR on the basis of 23 CPST channels, whereas the channel line-up provided by Operator showed only 22 CPST channels. We therefore reduced the number of channels used in calculating the MPR. Because Operator failed to demonstrate that its price for the CPST was reasonable, we set a price for the tier, incorporating the adjustments discussed above. In doing so, we recalculated Operator's Inflation Adjustment Factor in Form 393, Part II, Worksheet 1, on the basis of the most accurate data then currently available for the date as to which Operator filed. Operator calculated the Inflation Adjustment Factor as of the end of October 1993 using data released on December 1, 1993. On July 29, 1994, the U.S. Department of Commerce released corrected inflation data including Gross National Product Price Index ("GNP-PI") figures of 122.3 for the third quarter of 1992 and 125.7 for the third quarter of 1993. Using these GNP-PI figures, we calculated an Inflation Adjustment Factor through October 1993, the base date Operator used in justifying its rates. We concluded in our Prior Order that Operator justified a revised MPR of $11.04 for its CPST for the period from December 14, 1993, the date the Commission received the first valid complaint against Operator's CPST rate, to May 14, 1994. 7. In its Petition for Reconsideration ("Petition"), Operator argues that the Commission erred when imputing normalized taxes to its customer equipment costs prior to unbundling those costs from its service rates. Operator claims that it calculated its FCC Form 393 equipment costs based on actual fiscal year 1992 data and, during 1992 and at least ten years prior, it paid no income taxes. Operator argues that the grossed-up tax entry based on a 34 percent corporate income tax rate is arbitrary, capricious, contrary to law and inconsistent with the assumptions underlying the benchmark rate methodology. 8. The primary objective of the benchmark methodology is to ensure that maximum permitted rates are reasonable, which means that the rates are not higher than the rates operators would charge if they were subject to effective competition. If operators are unable to justify their rates using the benchmark methodology, the Commission permits them, as an alternative, to file cost-of-service rate justifications based upon actual cost data. The benchmark rate applicable to operators choosing to submit FCC Form 393 is essentially an average rate per channel based on a survey the Commission conducted of charges for both cable services and cable equipment by competitive cable systems; and, as such, it provides a surrogate method of allowing for full cost recovery for cable operations. The benchmark methodology is predicated on cost normalization, i.e., the development and use of average cost schedules based on the average September 30, 1992 rates of systems subject to effective competition. Consistent with the Commission's reliance on the average rates charged by operators subject to competition is a persuasion that these rates permit a full recovery of the average costs incurred by those operators, including a reasonable return on investment and taxes payable. The survey-reported charges for service installation and customer equipment were bundled in with the charges for cable services in determining the benchmark rates. 9. Because the benchmark rates are equipment-bundled averages, they are expected to provide adequate recovery of an operator's total revenue requirement needed to cover all capital and operating costs, including the full recovery of costs associated with service installation and customer equipment. Once the proper benchmark rate for full recovery of cable services costs and equipment costs is determined for a system, the operator's equipment portion is unbundled based on its actual cost for installation and customer equipment. The result is that the full benchmark is effectively broken down for each operator into two separate elements -- one for services and one for equipment. The total recovery expected from the unbundled charges for services plus the actual-cost-determined unbundled charges for equipment and installation is exactly the same as would be expected from the operator's benchmark rate before unbundling. 10. Failure to unbundle all of the costs of customer equipment would effectively result in a portion of such costs remaining in the rates for cable services. Accordingly, our review of CPST rate submissions requires the complete unbundling of the equipment costs from the benchmark rates. Operators may price their equipment to include all of such costs, including our provision for income taxes using the grossed-up statutory income tax rate, or they may choose to charge less than that amount. In either case, we believe that the entire cost must be unbundled from the service rates. 11. We addressed the issue of normalized tax obligations when we first issued guidelines for completing FCC Form 393. Those guidelines specifically addressed the question of whether tax-paying entities such as corporations were required to calculate income tax expense based on the statutory rate. Upon reconsideration of our Rate Order, we affirmed the applicability of that standard. Operator's argument implies that it should be permitted to choose between normalized and actual cost reporting depending on which proves more advantageous. We reject this notion. Indeed, it would be capricious, arbitrary and inconsistent if the Commission were to build normalized taxes into the pricing of tier offerings, yet unbundle actual taxes attributable to equipment costs. Since operators may recover the full equipment cost portion, such amounts when added in with the unbundled benchmark service rate will provide for full recovery of operating costs. 12. The application of the full income tax provision in the manner allowed is a standard approach under ratemaking methodology to provide for income taxes on a normalized basis. Tax normalization is a common practice throughout regulated industries and has extensive historical precedent. The approach effectively recognizes that the incurring of an income tax liability and the timing of the payment are often not the same. Moreover, operators vary widely in their accounting for interest and taxes. Accounting for all of these considerations by permitting actual tax reporting would produce erratic results. The outcome would be at odds with the benchmark objective of consistent pricing for comparable services. 13. Tax normalization applied in the aggregate, i.e. for the purpose of calculating channel and equipment rates, allows debt-laden cable operators higher tax allowances than they would receive absent tax normalization. This led the majority of commentators to advocate a preference for tax normalization during our rulemaking comment period. To allow operators to arbitrarily substitute actual tax data simply because they perceive a benefit would unduly complicate the rate setting process. Operator's argument that the recalculation of Operator's equipment basket results in a greater revenue reduction than contemplated by the Commission's benchmark rate methodology mistakenly relies upon an assertion of zero actual tax expense. For the purposes of benchmark rate setting, Operator's actual tax experience is irrelevant. The benchmark rate methodology contemplates the unbundling of normalized taxes. For all of these reasons, we reject Operator's argument. 14. In its Petition, Operator also argues that the recalculation of inflation was arbitrary and capricious because its result would differ depending on the time of review. As stated above, we recalculated the inflation adjustment factor using corrected inflation data released by the Department of Commerce on July 29, 1994. This issue was raised by Cencom Cable Income Partners II, L.P. in the Commission's Decision in Cencom Cable Income Partners II, L.P. ("Cencom"). In Cencom, the Commission explained its policy regarding refreshing inflation: The Commission is charged with protecting subscribers from paying unreasonable CPST rates, while also providing system operators with a fair return. Accurate information, including accurate inflation information, is central to setting an initial regulated rate that meets the standard. Thus, the Commission requires that data used in setting a rate be refreshed with the most current data available when an operator's rates become regulated and are justified. Because final inflation data for the period addressed in rate justifications may not be available when a justification is filed, the Commission directs operators to estimate inflation by using the most recently available inflation data published on an interim basis in the Commerce "Survey of Current Business" at Table 7.3, Line 5. The Bureau practice when reviewing rate justifications is to verify that the operator has used this inflation data. The Bureau also determines whether the other information in the rate justification is correct, and on the basis of the inflation and other information in the form, including any corrections, whether the operator's rate meets the statutory requirement that the rate not be unreasonable. The Bureau does not find a rate unreasonable solely because more accurate inflation data has become available by the time it makes its review. This would churn rates, causing significant administrative expenses to operators and confusion to subscribers. However, if a rate is unreasonable on its face or has to be adjusted for reasons other than the availability of a more accurate inflation figure, e.g., because the operator failed to provide correct information in its rate justification or failed to complete its rate justification form correctly, the Bureau recalculates the maximum permitted rate using the most accurate inflation information available, rather than earlier estimates. This practice is consistent with 47 C.F.R.  76.922(b)(9)(iii), which provides: [I]f the rates charged by a cable operator are not justified by an analysis based on the data available at the time it initially adjusted its rates, the cable operator must adjust its rates in accordance with the most accurate data available at the time of the analysis. [footnotes in original] 15. Because we find that our action in our Prior Order is consistent with the Commission's holding in Cencom, we reject Operator's argument regarding the adjustment of the Inflation Adjustment Factor. In accordance with the Commission's decision in Cencom, however, we will adjust Line 124 (Adjustment Time Period) of Operator's FCC Form 393 from thirteen to fifteen months. 16. Finally, Operator argues that we should reconsider our calculation of the MPR based on 22 CPST channels. Operator submitted additional information and we accept that information and make the change accordingly. The adjustments to the inflation time period and the channel count resulted in a revised MPR of $11.35 rather than Operator's MPR of $11.50. Because Operator's actual CPST rate of $12.15, effective September 1993, exceeds its revised MPR of $11.35, we find Operator's actual rate of $12.15, for the period December 14, 1993 through May 14, 1994, to be unreasonable. 17. Upon review of Operator's FCC Form 1240 for the projected period April 1, 1997 through March 31, 1998, we corrected Operator's inflation factor at Worksheet 1 and Line C3 to 1.0171 and at Line C5 to 1.0222 to reflect the inflation factor for the second quarter of 1996 released by the Commission in November 1996. This adjustment resulted in a revised maximum permitted rate ("MPR") of $16.65 rather than Operator's MPR of $16.68. Because Operator's actual CPST rate of $16.65, effective April 1, 1997, does not exceed its revised MPR, we find Operator's actual CPST rate of $16.65 to be reasonable. 18. Accordingly, IT IS ORDERED, pursuant to Section 1.106 of the Commission's rules, 47 C.F.R.  1.106, that the Petition for Reconsideration filed by Operator is GRANTED IN PART AND DENIED IN PART TO THE EXTENT INDICATED HEREIN. 19. IT IS FURTHER ORDERED, that In The Matter of Suburban Cable TV Co., Inc., 10 FCC Rcd 6498 (1995) IS VACATED IN PART AND AFFIRMED IN PART TO THE EXTENT INDICATED HEREIN. 20. IT IS FURTHER ORDERED, that the Stay, granted in The Matter of Battlefield Cable TV Co., et al., 10 FCC Rcd 10591 (1995), to the extent it pertains to the franchise area referenced above, IS TERMINATED. 21. IT IS FURTHER ORDERED, pursuant to Section 0.321 of the Commission's rules, 47 C.F.R.  0.321, that the CPST rate of $12.15, charged by Operator in the franchise area referenced above during the period December 14, 1993, the initial date of regulation, through May 14, 1994, IS UNREASONABLE. 22. IT IS FURTHER ORDERED, pursuant to Section 0.321 of the Commission's rules, 47 C.F.R.  0.321, that the CPST rate of $16.65, charged by Operator in the franchise area referenced above, effective April 1, 1997, IS REASONABLE. 23. IT IS FURTHER ORDERED, pursuant to Section 76.961 of the Commission's rules, 47 C.F.R.  76.961, that Operator shall refund to subscribers in the franchise area referenced above that portion of the amount paid in excess of the maximum permitted CPST rate of $11.35 per month (plus franchise fees), plus interest to the date of the refund, for the period December 14, 1993 through May 14, 1994. 24. IT IS FURTHER ORDERED that Operator shall promptly determine the overcharges to CPST subscribers for the stated periods, and shall within 30 days of the release of this Order, file a report with the Chief, Cable Services Bureau, stating the cumulative refund amount so determined (including franchise fees and interest), describing the calculation thereof, and describing its plan to implement the refund within 60 days of Commission approval of the plan. 25. IT IS FURTHER ORDERED, pursuant to Section 0.321 of the Commission's rules, 47 C.F.R.  0.321, that Operator take into account our FCC Form 1240 adjustments when calculating its maximum permitted rate and performing the true-up calculation on its next FCC Form 1240. 26. IT IS FURTHER ORDERED, pursuant to Section 0.321 of the Commission's rules, 47 C.F.R.  0.321, that the complaint against the April 1, 1997 rate increase IS DENIED. FEDERAL COMMUNICATIONS COMMISSION Meredith J. Jones Chief, Cable Services Bureau