ARCHIVED -  Telecom Decision CRTC 93-12

Ottawa, 30 August 1993

Telecom Decision CRTC 93-12

BELL CANADA - REVENUE REQUIREMENTS FOR 1993 AND 1994

Table of Contents

OVERVIEW

I INTRODUCTION

A. General Rate Increase Application

B. Public Hearing

II CONSTRUCTION PROGRAM

A. The 1993 CPR View and Update

B. View-over-View Comparisons

C. Process Considerations

D. Contested Expenditures

E. Conclusions

III EXTENSION OF SERVICE

IV STRUCTURAL CHANGES AND INTERCORPORATE TRANSACTIONS

A. Bell Sygma Restructuring

B. WorldLinx Telecommunications

C. Purchases from Northern Telecom Limited

V ACCOUNTING MATTERS

A. Analog Switching Equipment

B. Voluntary Termination Incentive Plan

C. Accounting for Software

VI REGULATORY ADJUSTMENTS

A. Incremental Compensation for Temporarily Transferred Employees and Adjustment for Loss on Dissolution of Bell Canada D-V Inc.

B. Calculation of the Required Return on Non-Integral Investments

VII OPERATING EXPENSES

A. General

B. Revenue Generation Initiatives

C. Competitive Response

D. Research and Development

E. Productivity and Forecasting of Expenses

F. Conclusions

VIII OPERATING REVENUES

A. General

B. May Update

C. Market Share Loss

D. Uncollectible Revenues

E. Flow-through Rate for Overseas Revenues

F. Conclusions

IX FINANCIAL ISSUES

A. Introduction

B. Techniques for Estimating Cost of Equity

C. Risk and Capital Structure

D. Conclusions

X REVENUE REQUIREMENT

A. Revenue Requirement Methodology

B. Revenue Requirements for 1993 and 1994

XI COMMUNITY CALLING PLAN

XII 9-1-1 PUBLIC EMERGENCY REPORTING SERVICE AND BELL ONTARIO NEUTRAL ANSWER SERVICE

A. General

B. Rates

C. Rebates

D. 9-l-l PERS Standard Agreement

E. Bell Neutral Answer Service

F. BNAS Standard Agreement

G. Filing of Tariffs

XIII PHASE III COMPETITIVE TERMINAL - MULTILINE AND DATA CATEGORY

XIV TARIFF REVISIONS

A. Calling Card Surcharges

B. Competitive Terminal - Multiline and Data

C. Direct-Inward-Dialing

D. Basic Local Service

E. Disposition of Interim Tariffs

DISSENT OF COMMISSIONER GAIL SCOTT

OVERVIEW

(Note: This overview is provided for the convenience of the reader and does not constitute part of the Decision. For details and reasons for the conclusions, the reader is referred to the various parts of the Decision.)

A. The Application and Hearing

On 5 February 1993, Bell filed an application for a general rate increase. Bell's application included implementation of a proposed Community Calling Plan in Toronto, Ottawa-Hull and Montréal. Alternate rates of a more traditional nature were also set out, should the Commission not accept the Community Calling Plan. In April, Bell announced that it would delay implementation of the Community Calling Plan until 1994 and that it would be seeking approval of its Alternate Plan rates.

Bell requested that the Commission set rates that would allow the company to achieve regulated returns on average common equity (ROE) of 12.25% in 1993 and 12.75% in 1994. Bell indicated that, to achieve these ROEs, it would require rate increases to generate additional revenues of $315 million in 1993 and $520 million in 1994.

A public hearing was held in Hull, Quebec, from 17 May to 11 June 1993, before Commissioners Louis R. (Bud) Sherman (Chairman of the hearing), Fernand Bélisle, David Colville, Edward A. Ross and Gail Scott.

B. Financial Issues

The Commission concluded that Bell's ROE range for the test period should be set at 11% to 12%. Further, it found that the company's proposal to move towards a 55% common equity ratio appears reasonable at this time.

C. Revenue Requirements

The Commission found that, in setting rates in 1993, it can legally allow the recovery of a revenue shortfall or the elimination of revenue surplus only for the period following the date when existing rates were made interim, i.e., from 1 April 1993. The Commission concluded that a company's revenue surplus or shortfall for a given year should be determined using the proration method in cases where a final decision on an application cannot be released before 1 January of that year and an interim order is not in place effective that date.

The Commission estimated that, after incorporating the various adjustments described in the Decision, Bell will earn at existing rates a regulated ROE of 11.5% in 1993 and 11.6% in 1994. The Commission therefore found that the company required no increase in revenues and no general increase in rates in either 1993 or 1994.

D. Structural Changes

The Commission supported the concept both of Bell Sygma and of WorldLinx. However, for the purposes of assessing Bell's revenue requirements, the Commission found that it would have been necessary to make regulatory adjustments. At the hearing, Bell advised the Commission that it would not proceed with the transactions, should the Commission make such a finding. The Commission therefore assessed Bell's revenue requirements on the assumption that the company will not be proceeding with either transaction. The Commission specified supporting information that the company is to file, should it proceed in future with transactions similar to those proposed.

E. Community Calling Plan

The Commission denied Bell's proposal for a Community Calling Plan. The Commission was of the view that the proposal represented an unacceptable departure from the principles applicable to the creation of expanded toll-free calling areas.

F. 9-1-1 PERS

The Commission found the introduction of 9-1-1 PERS to be in the public interest.

Among other rates, the Commission approved a rate of $0.32 for 9-1-1 PERS for Residence and Business Primary Exchange Service equipped for outward local calling. The rates approved reflect company-wide rate averaging.

The Commission found acceptable Bell's approach with respect to rebates for existing 9-1-1 service components.

The Commission agreed with Bell that a standard form 9-1-1 PERS agreement is appropriate. However, the Commission set out proposals with respect to the amendment or deletion of certain provisions and invited parties to the proceeding to submit comments.

Bell was directed to submit an economic study for a Bell Neutral Answer Service in Quebec. The Ontario Neutral Answer Service filing will be dealt with after this study is filed.

The Commission also set out proposed amendments and deletions to the Bell Neutral Answer Service agreement and invited parties to comment.

G. Operating Expenses

The Commission reduced Bell's 1993 and 1994 operating expense forecasts by approximately $20 million and $141 million, respectively (see the table in Section F of Part VII).

H. Operating Revenues

The Commission increased Bell's revenue forecasts for 1993 and 1994 by $153 million and $275 million, respectively. These adjustments were due primarily to the Commission's findings with respect to Bell's forecasts of market share loss to long distance competitors.

I. Tariff Revisions

Among other things, the Commission expressed the view that increases for some CT-MD products and services would yield the company additional revenues and that CT-MD revenue- generating initiatives are appropriate.

The Commission indicated that it favours approaches to modifying local rates, such as the consolidation of rate groups, that recognize costs and changes in value of service.

J. Other Matters

The Commission found Bell's 1993 View of the construction program, as updated, reasonable.

The Commission continued to have concerns with respect to the number of communities not scheduled for service and encouraged Bell to pursue extension of service in a more aggressive manner.

The Commission concluded that there would not be any benefit in establishing a proceeding to review the Northern Telecom Limited Supply Agreement at this time.

The Commission agreed with Bell that its undepreciated investment in analog switching equipment should be written off in 1993 and 1994. However, the Commission decreased Bell's proposed depreciation expense for analog switching equipment by $35 million in 1993 and increased it by the same amount in 1994.

The Commission accepted Bell's proposal to expense the Voluntary Termination Incentive Plan expenses in the year the plan is offered.

The Commission found Bell's policy for the capitalization of transmission software and general and administrative application software to be reasonable and appropriate.

The Commission concluded that, commencing in 1993, it would be appropriate to calculate both the required return on non-integral investments and the average common equity adjusted for regulatory purposes without an adjustment for "Accumulated Annual Difference - Prior Years".

I INTRODUCTION

A. General Rate Increase Application

On 5 February 1993, Bell Canada (Bell) filed an application for a general rate increase that it proposed be implemented in three stages. An initial interim increase was proposed for 1 April 1993, a second increase to take effect on a final basis on 1 September 1993 and a further increase for certain subscribers to take effect on a final basis on 1 November 1993. Bell also filed evidence with respect to its 1993 and 1994 revenue requirements and responses to an initial set of interrogatories from the Commission. Bell's application included implementation of a proposed Community Calling Plan (CCP) in Toronto and Ottawa-Hull for 1 September 1993 and in Montreal for 1 November 1993. However, the company also set out an Alternate Plan for rate increases, should the Commission not accept the CCP.

On 30 March 1993, the Commission issued Interim Rate Increases, 1993, Telecom Letter Decision CRTC 93-5, (Letter Decision 93-5), denying Bell's proposal for interim rate increases effective 1 April 1993. However, the Commission made interim, effective 1 April 1993, all existing rates approved prior to that date.

On 7 April 1993, Bell announced, among other things, that it would delay the proposed CCP until 1994. Bell stated that, with the deferral of the CCP, it would be seeking approval of the Alternate Plan rates set out in its application.

On 7 May 1993, Bell filed an update to its evidence entitled Bell Canada - Summary of Principal Variations from the January View of 1993 and 1994 (the May Update). In this submission, Bell advised that it was not proposing specific rates for 1993 or 1994. Rather, Bell proposed that, based on the evidence before it, the Commission set rates of its own motion that could be expected to generate revenues sufficient to provide it with an appropriate regulated return on average common equity (ROE).

B. Public Hearing

A public hearing was held in Hull, Quebec, from 17 May to 11 June 1993, before Commissioners Louis R. (Bud) Sherman (Chairman of the hearing), Fernand Bélisle, David Colville, Edward A. Ross and Gail Scott.

The hearing was conducted in two phases. The first phase provided interested parties with an opportunity to make submissions in an informal setting. The second and formal phase of the hearing involved the presentation of evidence, cross-examination on that evidence, and argument.

The following interveners appeared or were represented during the formal phase of the public hearing: Association of Competitive Telecommunications Suppliers (ACTS), Association des Consommateurs du Québec Inc., Call-Net Telecommunications Ltd. (Call-Net), Canadian Association of Petroleum Producers (CAPP), Canadian Business Telecommunications Alliance, Competitors Heralding Options in Communications Everywhere, Communauté urbaine de Montréal and Union des municipalités du Québec (CUM/UMQ), Corporation of the County of Essex (Essex), Mr. Carlyle Gilmour, Government of Ontario (Ontario), Government of Quebec (Quebec), Inter-Cité 2000 Inc., National Anti-Poverty Organization and Consumers' Association of Canada (NAPO/CAC), One Voice Seniors Network (Canada) Inc., Rogers Cable T.V. Limited, Téléphone Guèvremont Inc. (Guèvremont), Regional Municipality of Peel and Regional Municipality of Ottawa-Carleton (Peel/OC), Regional Municipality of York (York), Telecommunications Terminal Systems and Unitel Communications Inc. (Unitel).

II CONSTRUCTION PROGRAM

A. The 1993 CPR View and Update

Bell filed its proposed construction program on 5 February 1993 (the 1993 CPR View). Bell projected expenditures of $10.84 billion for the five years 1993 to 1997, inclusive, down from the $11.91 billion for the five years of the 1992 CPR View. The following table summarizes these expenditures (in millions of dollars) by category.

Year/Année 1993 1994 1995 1996 1997

Usage Category

Demand (65%) 1345.8 1361.5 1392.0 1476.0 1489.0

Programs (20%) 396.6 378.4 495.0 421.0 439.0

Replacement (6%) 132.5 129.1 133.0 136.0 142.0

Support (9%) 173.2 166.8 198.0 212.0 222.0
------ ------ ------ ------ ------

Total (100%) 2048.1 2035.8 2218.0 2245.0 2292.0

Note: Percentages (rounded) are compiled from five-year totals for each category.

In letters dated 28 April and 7 May 1993, the company proposed cutting capital expenditures by some $190 million and provided six additional views for 1993 and 1994, based on different assumptions regarding rates, the CCP and its forecasts for 1993 and 1994. Expenditures for the CCP in 1993 and 1994 were removed from the plan. The only new view relevant to assessing reasonableness incorporates Bell's May update and the Alternate Plan rates set out in its application of 5 February 1993. This view is referred to as the 1993 CPR View Update.

The 1993 CPR View Update outlined both an anticipated increase in network access services (NAS) gain and changes to the construction program from the 1993 CPR View. Bell stated that the projected demand increase reflects a faster than expected growth in residence gain since the fourth quarter of 1992 in both Ontario and Quebec. After adjustments to all categories, the net variation from the 1993 CPR View was a decrease of $172 million. Bell made no change to the total for 1994, although there were changes to all categories.

Bell stated that it had reduced its projected spending in consideration of the continued financial deterioration of the company, subject to:

(1) achieving the reduction in 1993, given normal provisioning lags, customer commitments, and increased demand over the 1993 CPR View;

(2) reducing Replacement and Support to the lowest possible level without cancelling contracts or placing undue pressure on maintenance expense;

(3) maintaining the level of Program funding, except for certain specified programs, in order to achieve associated expense reductions; and

(4) mitigating adverse customer impacts.

Bell pointed out that the capital reduction may postpone service provision in 28 unserved communities and delay service upgrades to a small number of subscribers.

The following table shows the change in forecast expenditures (in millions of dollars) between the 1993 CPR View and the 1993 CPR View Update for the first two years of the plan:

1993 1994
------ ------
Demand

1993 CPR View 1993 1345.8 1361.5
1993 CPR View Update 1246.0 1312.0

Programs

1993 CPR View 396.6 378.4
1993 CPR View Update 370.6 391.9

Replacement and Support

1993 CPR View 305.7 295.9
1993 CPR View Update 259.7 331.9

Total

1993 CPR View 2048.1 2035.8
1993 CPR View Update 1876.3 2035.8

B. View-over-View Comparisons

Bell stated that the recent economic recession has significantly reduced NAS net gain. Hence, levels of average in-service NAS are considerably lower than might reasonably have been expected a few years ago. Bell stated that, although it expects NAS gain to recover, it anticipates that the in-service base will continue to be well below earlier expectations. Bell expects the NAS total to increase from approximately 9.1 million in 1992 to 10.6 million in 1997.

Bell stated that it expects the Long Distance Message Increase during the years 1993 through 1996 to be significantly lower than anticipated in the 1992 CPR View.

Bell's demand forecasts for 1993 and 1994 were significantly lower in the 1993 CPR View Update than in the 1992 CPR View Update. The decreases in the various categories were 8% in Demand, 30% in Programs and 19% in Replacement and Support, amounting to 12% overall.

The total expenditures for the original 1993 CPR View for the common years 1993 to 1996 were $1.2 billion lower than the original 1992 CPR View. Bell explained that the difference stemmed principally from reductions due to a lower estimate of inflation, the reorganization involving Bell Sygma Inc. (Bell Sygma), a Programs category volume decrease and the proposal regarding inside wire, offset by increases flowing from a revised accounting treatment of general purpose computer and transmission system software and a forecast increase in switching machine software.

C. Process Considerations

Ontario stated that, for many years, it has been concerned with the appropriate sizing of the construction program relative to the financial capacity of the company. Ontario submitted that Bell's aggressive program of modernization, which Ontario considers entirely appropriate, has, for the years 1992 to 1994, apparently outstripped the company's revenue generating capacity. Ontario stated that the actual expenditures for 1992 reached a record level, well above the 1992 CPR View. Ontario submitted that acceleration of switching equipment modernization (SEM) has substantially increased projected depreciation and interest expense.

Ontario stated that assessment of the company's ability to finance the total program has been deemed outside the scope of the CPR. Ontario posited that all the elements of the construction program can be individually reasonable, but the budget total may be inappropriate. Ontario suggested that, in aggressively advancing SEM in 1991 and 1992, Bell may have failed to give sufficient priority to the effect on rates in the short term. Ontario submitted that, in order to offset a possible 1992 over-commitment, the Commission should direct Bell to reassess its construction program and defer certain items, including switching modernization. Ontario also suggested that the Commission consider adding the filing of a limited amount of financial data to substantiate the financial reasonableness of the total construction program.

Bell stated that, in any given year, the construction program must balance demonstrated requirements against the company's ability to finance those requirements. Bell indicated that further significant downward adjustments will be necessary for 1993 and 1994 if it cannot achieve its proposed rates of return.

The Commission is satisfied with Bell's ongoing capital management process. Accordingly, Ontario's request to direct the company to reassess its 1993 CPR View Update is denied.

Ontario pointed out that rates for new services are set pursuant to Phase II procedures, which require the filing of supporting economic studies that include causally related costs, while the CPR enables identification of changes to the resources included in such studies. Ontario requested that the Commission expand the CPR process to examine the links between tariffs and the CPR.

Ontario stated that, in this proceeding, it examined the Digital and Analog Remote Test System 2 (DARTS 2) program, which provides testing for certain new digital services. Ontario submitted that, if the tariff filings for these services had not incorporated causal testing costs, the tariffs should be reconsidered. Bell advised that the cost studies supporting the introduction of the particular services cited by Ontario had assumed existing test systems. In light of Bell's statement, the Commission considers it unnecessary to revisit the tariffs.

Quebec submitted that certain of Bell's explanations in this proceeding imply that future CPRs will increasingly require the participation of representatives of Bell's Quebec and Ontario operating divisions to explain the strategies and decisions in each region.

As announced in letters dated 21 and 22 July 1993, the Commission intends to determine the appropriate scope and nature of the CPR in the Regulatory Framework proceeding (see Telecom Public Notice CRTC 92-78, 16 December 1992). Quebec's concern, as well as Ontario's proposal regarding financial information and links to tariff filings, will be considered in that proceeding, and comments made in this proceeding with respect to these matters will be taken into account.

D. Contested Expenditures

Unitel noted that the exchange facility cost/demand ratio has risen sharply from the 1992 CPR View. Unitel was specifically concerned with a projected increase of $311 per NAS net gain for network survivability and network enhancements in 1993, which amounts to some $70 million in capital expenditures in 1993. Unitel submitted that such expenditures are discretionary and that Bell did not provide sufficient information to justify them or produce any studies to indicate that customers are willing to pay more for survivability. Unitel submitted that the associated expenditures should be disallowed.

Bell stated that increased expenditures for survivability continue a trend due to higher customer expectations and that they include projects such as new switching centres for Rideau and Caniff, as well as a peripheral upgrade for DMS switches.

The Commission is aware that network reliability is becoming increasingly important as network component capacities grow and businesses increasingly employ electronic data transfer. Furthermore, sensitivity to this issue has been heightened by major outages in the United States. The Commission accepts the need for increased expenditures to enhance reliability.

Unitel noted Bell's statement that two reasons for a third high density intertoll route west are numerous bulk leases and increased long distance calling. Unitel pointed out that this is inconsistent with reduced long distance volumes and revenues due to competition. Unitel submitted that this inconsistency indicates poor forecasting, and that local subscribers should not be required to pay for forecasting mistakes.

Bell provided a substantial amount of information supporting its decision to build this third intertoll route west, including demand forecasts, reliability standards, the five main factors underlying the demand forecast, and a summary of the technological alternatives. The Commission is satisfied that the building of this route has been adequately justified.

E. Conclusions

The Commission finds Bell's 1993 View of the construction program, as modified by the 1993 CPR View Update, reasonable.

III EXTENSION OF SERVICE

In the 1990, 1991 and 1992 CPRs, the Commission examined the extension of service by Bell to unserved and underserved areas in Ontario and Quebec. In its decisions in the 1990 and 1991 Bell CPRs, the Commission expressed concern with respect to the number of communities not scheduled for service. By letter dated 13 May 1992, the Commission directed Bell to file a comprehensive report on all unserved and underserved areas. In October 1992, Bell filed the Access Report (the report). Ontario filed comments on the report, to which Bell filed a reply.

In Bell Canada - 1992 Construction Program Review, Telecom Decision CRTC 93-4, 16 April 1993, the Commission announced that it would review service extension in Bell's general rate increase proceeding.

In May 1993, Bell revised the service extension plans set out in the report, indicating that service had been extended to 43 communities since October 1992. In its revised plan, Bell identified 268 unserved communities and 16 underserved communities. Of the unserved communities identified, 92 have 30 dwellings or more, with over 70% of these being seasonal in nature.

Ontario submitted that the Commission should take community needs as well as economic costs into account in interpreting Bell's obligation to serve. It suggested that Bell should pursue the extension of service to unserved communities more aggressively and that Bell should address extension of service to unserved communities through a special program.

Bell noted that, while it does extend service to unserved communities, its obligation to do so under the Bell Canada Act does not extend to the communities identified in the report. Bell emphasized that a "community" for the purpose of the inventory of underserved/unserved areas in the report is a cluster of dwellings. Further, in its view, the fact that the majority of the unserved locations consist of seasonal dwellings should be borne in mind when more aggressive service extension would either increase subsidization by the general body of subscribers or require greater acceptance by individual subscribers of the costs of serving them.

Bell stated that it must increasingly emphasize business considerations when deciding whether to extend its operating territory to include locations that cannot, for the foreseeable future, be served on any reasonable economic basis. With respect to Ontario's suggestion that extension of service should be addressed through a separate program, Bell indicated that service extension imposes a burden on the general body of subscribers because of the much higher than normal costs per subscriber served.

The Commission continues to have concerns with respect to the number of communities not scheduled for service and encourages Bell to pursue extension of service in a more aggressive manner, with particular focus placed on unserved permanent communities.

The Commission directs Bell to file an annual report providing an update of the progress made to achieve the objective of extending service to unserved communities. This report should, as well, identify new unserved communities.

IV STRUCTURAL CHANGES AND INTERCORPORATE TRANSACTIONS

A. Bell Sygma Restructuring

On 19 November 1992, Bell filed documents regarding proposed transactions by which it would transfer certain assets and outsource certain activities to three new subsidiaries, Bell Sygma, Bell Sygma Systems Management Inc. (BSSM) and Bell Sygma Telecom Solutions Inc. (BSTS).

On 30 December 1992, the Commission granted interim approval to Bell's sale of the assets in question, pursuant to subsection 11(2) of the Bell Canada Act.

In Bell Canada - Proposed Transfer of Assets to Bell Sygma Subsidiaries and Related Transactions, Telecom Public Notice CRTC 93-10, 25 January 1993, the Commission initiated a proceeding to consider: (1) whether the proposed asset disposition is in the public interest and, if so, under what terms and conditions, if any, final approval should be granted, and (2) whether, as a result of the proposed asset sale and related transactions, adjustments are necessary for revenue requirement purposes. In Bell Canada - Amended Procedures re Proposed Transfer of Assets to Bell Sygma Subsidiaries and Related Transactions, Telecom Public Notice CRTC 93-29, 8 March 1993, the Commission stated that it would consider the application in this general rate increase proceeding.

In oral reply argument, counsel for Bell stated the following:

 If the proposed intercorporate transactions for WorldLinx and Sygma are not acceptable to the Commission as proposed, Mr. Chairman, then, with regret, I am instructed to inform you that the company will not carry on with the proposed transactions, and I am requesting that the revenue requirement and rates for Bell Canada be set accordingly.

 In such an event, the company may consider its options and determine if it can subsequently structure viable transactions which would then be submitted for Commission review, as required, in accordance with the Commission's directions.

The Commission supports the concept of Bell Sygma in principle. However, in order to address the proposed transactions for the purposes of assessing the company's revenue requirements, the Commission finds that it would be necessary to make regulatory adjustments. In so finding, the Commission is mindful of Bell's argument that the overall transaction must be considered. However, the Commission is not persuaded that Bell has demonstrated that the proposed transactions, in the aggregate, reflect either fair market value or a reasonable proxy therefor. For example, the evidence indicates that the fair market value of the Don Mills and Dorval Data Centres significantly exceeds the net book value at which these assets were transferred.

Absent (1) any formal studies comparing the "in house" cost of carrying out the services in question versus the cost of outsourcing such services, and (2) any independent appraisals ascertaining that the overall transaction represents fair market value for the going concern, the Commission is unable to assure itself, for the purposes of assessing the company's revenue requirements, that any benefits of the BSTS License and Development Services Agreement, the BSSM Data Processing Services Agreement, and other related agreements outweigh the drawbacks of the transaction, such as the apparent transfer at less than fair market value of the real estate assets.

Further, in the Commission's view, any assessment of the fair market value of the overall transaction must also consider the value of transferred employees, whether those employees are transferred either temporarily or permanently. The Commission does not accept Bell's interpretation of its previous decisions as implying that there is no need for the company to charge its affiliates for the permanent transfer of employees.

The Commission also notes the comparison between the proposed Bell Sygma and SHL Systemhouse (SHL) transactions presented in Section 5.4 of Unitel's argument. This comparison shows the value of the two transactions to be $232 million and $414 million, respectively. The Commission notes Bell's argument that the SHL transaction was never consummated and therefore should not be compared with the Bell Sygma transaction. However, the Commission is of the view that there are sufficient similarities between the two transactions that a comparison of their values at least provides a further indication that the Bell Sygma asset transfer is undervalued.

In light of the foregoing, the Commission has assessed Bell's revenue requirements on the assumption that the company will not be proceeding with the transactions related to Bell Sygma. If Bell proceeds with any similar transactions, whether before or after the new Telecommunications Act comes into effect, the company is directed to file with the Commission all related agreements, as well as an assessment of the revenue requirement impact, with supporting detail, for the ensuing ten-year period.

Further, in any such transactions, the Commission will expect Bell to comply with the pricing principles established in Bell Canada - Review of Revenue Requirements for the Years 1985, 1986 and 1987, Telecom Decision CRTC 86-17, 14 October 1986 (Decision 86-17). The company is also to provide the Commission with the following information:

(1) an independent third party appraisal, showing that the business, as a going concern, is being transferred at fair market value (this appraisal should consider factors such as the value of transferred employees and the value of royalties to be derived from the licensing of Bell intellectual property); and

(2) formal studies comparing the cost of providing a service "in house" with the cost of outsourcing such a service.

In addition, in any future agreements to license Bell intellectual property, the Commission will expect the company either to specify the royalties to be paid or to set out formally the factors to be considered in negotiating royalty payments to Bell. Such factors should reflect the company's Intercorporate Pricing Policy, which states that "all royalty arrangements within the [BCE Inc. (BCE)] group will be based on rates which are fair and reasonable and consistent with normal business practices."

In the event that Bell proceeds with any similar transactions, the Commission will reassess the impact on the company's revenue requirement at the time that it files the related agreements and other specified information, as directed above.

B. WorldLinx Telecommunications

On 25 January 1993, Bell filed documents regarding the proposed detariffing of certain enhanced services and the transfer of the assets and personnel associated with the management and marketing of these services to WorldLinx Telecommunications Inc. (WorldLinx).

By letter dated 25 February 1993, the Commission denied interim approval of the proposed detariffing and asset transfer. In Bell Canada - Proposed Transfer of Assets to WorldLinx Telecommunications Inc. and Related Matters, Telecom Public Notice CRTC 93-28, 5 March 1993, the Commission invited comment in this general rate increase proceeding on, among other things: (1) whether the proposed asset transfer to WorldLinx and the detariffing of the services in question are in the public interest and, if so, under what terms and conditions, if any, approval should be granted, and (2) whether, as a result of the proposed asset disposition, adjustments are necessary for revenue requirement purposes.

As noted above, counsel for Bell stated in oral reply argument that the company would not proceed with the proposed intercorporate transactions for WorldLinx if those transactions were not acceptable to the Commission as proposed.

As with Bell Sygma, the Commission supports the concept of WorldLinx, in principle. However, because the company has made no attempt to determine either the fair market value of the business as a going concern, or even the fair market value of individual assets, the Commission cannot satisfy itself that the proposed transfer has been appropriately priced. For example, in the Commission's view, valuing software based only on future licensing opportunities undervalues the software transferred, since such an approach does not take into consideration the inherent value of the software in enabling an enhanced service provider to carry on its primary business.

In addition, the Commission reiterates the position set out in the previous Section that any assessment of the fair market value of the overall transaction must consider the value of both permanently and temporarily transferred employees.

In light of the foregoing, the Commission cannot accept the terms and conditions of the WorldLinx transactions, as proposed, for the purpose of assessing the company's revenue requirements.

In any future cases regarding the transfer of enhanced services to an affiliated company, the Commission will expect Bell to comply with the pricing principles established in Decision 86-17. Consistent with the directions set out above with respect to Bell Sygma, if Bell proceeds with any transaction similar to the WorldLinx proposal, the company is to provide the Commission with an independent third party appraisal, showing that the business, as a going concern, is being transferred at fair market value. That appraisal should consider, among other factors, the value of transferred employees.

In Enhanced Services, Telecom Decision CRTC 84-18, 12 July 1984, the Commission stated that it "would be concerned about the selective removal to a separate affiliate of only those enhanced services which had been successfully established in the market." In the Commission's view, this concern remains valid. Accordingly, with respect to transactions similar to the proposed WorldLinx transaction, the Commission agrees with Call-Net that (1) Bell should transfer all similar or related products or none at all and should not thereafter develop similar products internally, and (2) product development related to the divested business should take place only in that structurally separated business.

C. Purchases from Northern Telecom Limited

ACTS, the only intervener to address this issue, expressed concerns with respect to the Northern Telecom Limited (NTL) Supply Agreement. ACTS argued that the Commission should conduct a review of the agreement before granting Bell any rate increases, or, at the very least, require Bell to expand the price comparison audit methodology to all of NTL's North American transactions.

In support of its proposal, ACTS argued that: (1) purchases of goods and services from NTL constitute a significant portion of Bell's total purchases; (2) Bell has treated the NTL Supply Agreement as containing a requirement on its part to provide NTL with an opportunity of first proposal, although the language of the Supply Agreement does not necessarily lead to such a conclusion; (3) the decision of the Restrictive Trade Practices Commission and Bell Canada - Northern Telecom Price Comparison, Telecom Decision CRTC 84-23, 5 October 1984 (Decision 84-23), were made in an environment fundamentally different from that which exists today and there is now no reason to protect NTL through a preferred supply arrangement with Bell; and (4) there are a number of ways in which Bell subscribers could be harmed by the fact that NTL has an opportunity of first proposal, which harm would not be disclosed by the price comparison audit.

Bell argued that the issues raised by ACTS are either unsubstantiated or contradicted by a review of the record. Bell argued that the Bell/NTL relationship has been examined in depth in past regulatory proceedings, and that the Commission both confirmed that it is not harmful to subscribers and prescribed requirements (notably, in Decision 84-23) to satisfy itself on an ongoing basis in this regard. Bell argued that the evidence with respect to its cost levels in comparison to those of other major North American carriers confirms the fundamental benefit of the Bell/NTL relationship. Bell suggested that the question to be asked is whether the record of this proceeding justifies a different approach. Bell submitted that it does not.

The Commission has considered the submissions of ACTS and Bell and is not persuaded that there would be any useful purpose in establishing a proceeding to review the NTL Supply Agreement at this time. Further, the Commission does not consider it appropriate to expand the price comparison audit methodology to include all of NTL's North American transactions.

V ACCOUNTING MATTERS

A. Analog Switching Equipment

By letter dated 12 May 1992, Bell informed the Commission that full conversion to local digital switching would take place by the end of 1994 and that this would have the effect of advancing the SEM program by three years. Accordingly, under the Equal Life Group depreciation method, approximately $340 million of undepreciated investment in switching equipment would have to be recovered in the amounts of approximately $230 million in 1993 and approximately $110 million in 1994.

In order to minimize fluctuations in net earnings, Bell requested that it be permitted to depreciate the $340 million of investment by approximately $170 million in each of 1993 and 1994. This would result in an increase in depreciation expense for the analog equipment of $30 million in 1993 and $84 million in 1994 over the amounts projected before the advancement of the SEM program.

Bell argued that it would be inconsistent with Generally Accepted Accounting Principles to write off the undepreciated amount past 1994 and that it would transfer the burden of capital recovery for retired assets to future customers. In addition, to postpone the capital recovery beyond 1994 would destroy the principle of matching capital recovery with capital consumption as closely as possible. Bell also expressed concern that its business risk would be affected by the quality of earnings inherent in its accounting and reporting practices.

In reply argument, Bell stated that substantial NTL price discounts had driven its decision to advance the SEM program. Bell stressed that the capital recovery approach should be maintained, as depreciation expense has long been recognized to be a legitimate cost of carrying on business and, consequently, a legitimate revenue requirement to be recovered from ratepayers.

Recognizing that the assets in question will be retired by the end of 1994, the Commission agrees with Bell that the undepreciated amount of the investment in these assets should be written off in 1993 and 1994. However, the Commission has adjusted the amount of depreciation to be taken in each year in order to moderate fluctuations in net earnings and, in conjunction with other adjustments made in this Decision, to enable the company to achieve a regulated ROE near the midpoint of the approved range in each of 1993 and 1994. Specifically, the Commission considers it appropriate to decrease Bell's proposed depreciation expense for analog switching equipment by $35 million in 1993 and increase it by the same amount in 1994.

B. Voluntary Termination Incentive Plan

Since 1992, Bell has recognized costs associated with Voluntary Termination Incentive Plans (VTIPs) in the year in which the plans are offered to employees. Early Retirement Incentive Plans (ERIPs) instituted after 1992 are also expensed. ERIPs instituted prior to 1992 are being amortized over 17 years.

Bell cited Abstract EIC-23 of the Emerging Issues Committee of the Canadian Institute of Chartered Accountants, dated 21 January 1991, as the basis for charging all special termination benefits as an expense.

In reply argument, Bell pointed out that, "with the potential frequency of VTIPs, the amortization would simply cause a bow wave of costs to be recovered in an increasingly uncertain future." Bell further cautioned that, by pushing costs out into the future, recoverability and quality of earnings become somewhat difficult.

Based on the potential frequency of VTIPs and the amount of the 1993 VTIP ($86 million) in relation to Bell's revenue requirement, the Commission accepts Bell's accounting treatment, i.e., the expensing of VTIP expenditures in the year the plan is offered.

C. Accounting for Software

In Accounting for Switching Machine Software Expenditures, Telecom Decision CRTC 91-14, 27 September 1991 (Decision 91-14), and in Telecom Order CRTC 92-135, 6 February 1992, the telephone companies were directed to capitalize switching machine application software acquired after 1 January 1992 and to amortize the costs over five years.

In its Memorandum on the Construction Program, Bell stated that, because it is becoming increasingly difficult to differentiate between switching and transmission equipment and, accordingly, between the associated software, it had extended the accounting treatment set out in Decision 91-14 to transmission software expenditures (i.e., the company is capitalizing items with a value over $500,000 and amortizing the costs over five years). Bell instituted this accounting change effective 1 January 1992. Bell also adopted the policy of capitalizing externally purchased general administration application software over $500,000, and the associated customization costs, effective 1 January 1992. Bell amortizes these costs on a straight-line basis over five years.

The Commission has reviewed Bell's policies with respect to general and administrative application software and transmission software costs and finds them to be reasonable and appropriate.

VI REGULATORY ADJUSTMENTS

A. Incremental Compensation for Temporarily Transferred Employees and Adjustment for Loss on Dissolution of Bell Canada D-V Inc.

Bell included in its calculation of average common equity adjusted for regulatory purposes $13 million for "Incremental Compensation for Temporarily Transferred Employees - Prior Years" and $6 million for an adjustment for "Loss on Dissolution of Bell Canada D-V Inc."

In response to interrogatory Bell(CRTC)19May93-4407, the company noted that these adjustments permanently increase the company's average common equity adjusted for regulatory purposes due to adjustments to regulated net income that occurred in the past. Bell also noted that the elimination of these adjustments would slightly lower its revenue requirement. However, the company agreed to the elimination of these adjustments to simplify its financial statements for regulatory purposes.

The Commission agrees with Bell that the removal of these adjustments would simplify the company's financial statements for regulatory purposes. Further, the Commission sees no justification for continuing to include them in the calculation of regulated common equity. Accordingly, the Commission has eliminated the adjustments. The revenue requirement reduction resulting from this determination is approximately $4 million in each of 1993 and 1994.

B. Calculation of the Required Return on Non-Integral Investments

In the determination of the required return on non-integral investments, a line item entitled "Accumulated Annual Difference - Prior Years" is included in the calculation of the total equity investment base. This line item, which reflects the accumulated shortfall of earnings from non-integral investments in previous years, is also included in the calculation of the company's average common equity adjusted for regulatory purposes.

In interrogatory Bell(CRTC)22Mar93-1445, the company was asked to provide its views on the merits of calculating the required return on non-integral investments and the average common equity adjusted for regulatory purposes without this line item. Bell advised that, in its view, the current procedure is complex, exaggerates the investment and unduly penalizes the shareholders. Bell advised that the elimination of this line item would allow its investment base for regulatory purposes to track the actual investments on its books, while protecting subscribers from return shortfalls in current non-integral investments.

The Commission agrees with Bell, and concludes that it is appropriate, beginning in 1993, to calculate both the required return on non-integral investments and the average common equity adjusted for regulatory purposes without an adjustment for "Accumulated Annual Difference - Prior Years".

This determination results in a revenue requirement reduction of approximately $1 million for 1993 and $3 million for 1994.

The required rate of return on non-integral investments will continue to be set two percentage points higher than the midpoint of the allowed ROE range (11.0% to 12.0%). Thus, for the test years, the required rate is 13.5%.

Consistent with its findings in Part IV, the Commission has excluded the deemed return on the investments related to the Bell Sygma subsidiaries to account for the fact that Bell will not be proceeding with the Bell Sygma transactions.