by Jonathan Gerth, vice president of tax and auditing services, Avenu
The options for public entities to collect franchise fees vary from state to state, but the fair and consistent collection of fees is important no matter where your community is located. When utility companies, in particular, are noncompliant with their franchise agreements, the effect on local budgets can be significant.
To ensure collection of proper franchise revenue, it helps to understand that a franchise fee is the “rent” paid for the use of public rights of way. These negotiated costs allow utility companies (telecommunications, natural gas, electricity, water, and solid waste) to access structures like transmission towers, sewage systems, and roads. They differ from taxes because they are negotiated with the local agency and not determined by the legislature.
Franchise fees typically make up 5 to 7 percent of budgeted revenue, and sometimes up to 10 percent. Less than full compliance has a long-lasting effect on revenue, especially because agreement terms often last 15 to 25 years. The compounding of multi-year missed revenues is dramatic.
Noncompliance occurs with fee-on-fee use, which is essentially passing charges onto consumers that are not delivered back to the local government. It also happens when there is obsolete language used to work around certain requirements. Consider these steps that localities can take to address noncompliance:
1. Calculate how much you’re owed.
Number of households x average monthly bill x 12 = average annual gross receipts (AAGR).
AGRR x franchise fee percentage (typically 5%) = estimated franchise fee revenue.
How far apart is the estimated revenue from your actual revenue? If it’s a lot, it’s worth investigating.
2. Be aware of loopholes.
The shift from landlines and cable to broadband Internet and the Internet Tax Freedom Act of 1998 has created uncertainty around taxation of Internet access and modems. Also, the ever-evolving tech industry means a continuous introduction of new terms and products. Telecom companies can pair this with outdated contract language so that they don’t pay franchise fees on new technology and services. Confront them when they claim that the contract language does not specify a service. Also, review agreements and ordinances to determine if the agency needs to update language.
3. Conduct an audit.
Conduct audits often enough to identify issues before they get out of hand. Avenu recommends 3-year, 5-year, or 6-year audit periods depending on the situation. These could be conducted in-house; however, an agency will need to have the resources, including time and ideally legal counsel, to address claims of nondisclosure agreements and potential pushback. Many agencies simply don’t have the resources or knowledge of what to look for to conduct a successful audit. The franchisees are often in a much stronger position with industry experts and deep legal resources.
Having an expert who has compliance auditing experience can be helpful. You might need to find missing funds and also deal with potential challenges that an entity can respond with (sometimes including the threat of legal action). A third-party expert can assist with maintaining a relationship between an agency and a utility and help a community collect what it is owed.
In the end, having compliance is about more than just revenue. It’s leveling the playing field and being fair to all parties. By reducing competitive advantages, managers are providing a fair market for residents and helping a community thrive.
Shoring Up Local Government Revenues. This 2014 article looks at ways local governments could increase revenues after the Great Recession.
Planning a Financial Future. In this 2017 PM article, the focus was on financial forecasting and how it can help communities of all sizes.
ICMA Volunteers Share Leading Practices for Revenue Generation. A 2018 article highlighted the work ICMA volunters were doing overseas to share best practices on revenue generation.