ARCHIVED -  Telecom Decision CRTC 98-3

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Decision

Ottawa, 17 March 1998

Telecom Decision CRTC 98-3

REGULATORY TREATMENT OF THE ASSET WRITE-UP RESULTING FROM THE PURCHASE OF LE TÉLÉPHONE BON-CONSEIL INC. BY LE TÉLÉPHONE GUÈVREMONT INC.

Reference: 8636-G1-01/97

I INTRODUCTION

A. Background

On 20 December 1984, la Régie des services publics du Québec (later, la Régie des télécommunications du Québec) (the Régie)) held a public hearing to consider an application by Le Téléphone Guèvremont Inc. to purchase the shares of and amalgamate with Le Téléphone Bon-Conseil Inc. (Bon-Conseil). At the hearing, the Régie verbally approved the merger of Le Téléphone Guèvremont Inc. and Bon-Conseil which was to take effect 1 January 1985. The approval of the merger was subsequently reiterated in Decision R.S.P. 84-050-A, dated 6 September 1985 (Decision R.S.P. 84-050-A). The Régie ruled in that Decision that the newly merged company of Téléphone Guèvremont Inc. (Guèvremont) was to record the transaction for regulatory purposes at historical cost of Bon-Conseil’s assets.

Guèvremont disputed the Régie’s ruling to record the transaction at historical cost and recorded the acquisition of Bon-Conseil at market value. This dispute led to Guèvremont challenging the Régie’s jurisdiction in the Courts which resulted in the Supreme Court of Canada’s decision in Attorney-General of Quebec et al. v. Téléphone Guèvremont Inc., 26 April 1994, recognizing that jurisdiction over the independent telephone companies in Canada was with the Commission.

The purchase price negotiated for Bon-Conseil’s shares by Le Téléphone Guèvremont Inc. was $2.1 million, which was $1.3 million in excess of the net book value of $0.8 million. The write-up was allocated to Bon-Conseil’s capital assets and amortized over the life of the various categories of assets. As of 31 December 1995, the unamortized portion of the asset write-up in Guèvremont’s accounting records was approximately $0.4 million. The transaction was funded almost entirely through a preferred share offering which was then subsequently converted to common share equity.

B. Proceeding to Determine the Regulatory Treatment of the Asset Write-up

In Regulatory Framework for the Independent Telephone Companies in Quebec and Ontario (Except Ontario Northland Transportation Commission, Québec-Téléphone and Télébec ltée), Telecom Decision CRTC 96-6, 7 August 1996 (Decision 96-6), the Commission directed Guèvremont, in light of the fact that the company is not a member of the Société d’administration des tarifs d’accès des télécommunicateurs (SATAT), to show cause within 30 days of that Decision, as to why the company’s 1995 and 1996 Carrier Access Tariffs (CATs) should not be finalized at the levels proposed by SATAT on behalf of participating Association des compagnies de téléphone du Québec Inc. (ACTQ) CAT members.

In its response dated 6 September 1996, Guèvremont requested that the company’s 1995 CAT remain at the then current interim level of $0.1791 per minute. The $0.1791 per minute rate was the interim 1994 CAT approved in Telecom Order CRTC 95-75, 26 January 1995, for the ACTQ CAT participating members based on the Commission and Line Haul Agreement between ACTQ members and Bell Canada (Bell), and subsequently approved in Telecom Order CRTC 95-558, 11 May 1995, on an interim basis for all small Quebec independent telephone companies, including Guèvremont, effective 1 June 1995.

Guèvremont further requested approval of a new 1996 interim CAT based on calculations that, among other things, assumed that the merger was accounted for at market value. Guèvremont stated that it did not participate in establishing the SATAT members’ 1995 and interim 1996 CATs and that implementing these rates would cause serious prejudice to Guèvremont. Furthermore, Guèvremont stated that the CAT methodology established in Decision 96-6 does not permit the company to recover from Bell, or any other interexchange carrier, the retroactive contribution due and necessary to obtain its authorized rate of return.

On 7 October 1996, in response to Guèvremont’s submission, Bell requested that the Commission finalize Guèvremont’s CATs based on the Régie’s decision. Bell submitted that the integration of an artificial value of the assets acquired from Bon-Conseil, in the CAT calculation, would only perpetuate the erroneous financial results.

On 18 October 1996, in reply comments, Guèvremont noted that the Commission had not explicitly or implicitly ratified the Régie’s decision. Guèvremont submitted that, should the Commission decide to re-examine the validity of the Régie’s decision, it should establish a public process to do so.

By letter dated 14 February 1997, the Commission noted that finalization of the CATs from 1995 onward would be directly affected, among other things, by the regulatory treatment of the asset write-up. The Commission determined that, until the issue of the asset write-up was resolved, Guèvremont’s 1995 CAT would remain interim at the then current level of $0.1791 per minute and the 1996 CAT would be set on an interim basis at $ 0.1014 per minute which is the interim 1996 CAT based on Phase III costs approved for the SATAT members in Decision 96-6. The interim 1996 CAT was to remain in effect on an interim basis for 1997. In a separate letter dated 14 February 1997, the Commission initiated a proceeding to determine the regulatory treatment relating to the amount paid over net book value resulting from the purchase of Bon-Conseil by Le Téléphone Guèvremont Inc.

Guèvremont, Bell and Télébec ltée (Télébec) were made parties to this proceeding. Guèvremont and Bell filed comments. Guèvremont filed reply comments.

In Newfoundland Telephone Company Limited - Revenue Requirement for the Years 1990 and 1991 and Attachment of Customer-Provided Multi-Line Terminal Equipment, Telecom Decision CRTC 90-15, 12 July 1990 (Decision 90-15), the Commission concluded that allowing any excess of purchase price over the original cost in the rate base with the resulting impact on the revenue requirement could only be justified if it was found to be in the public interest to do so. As part of this proceeding, in order to assess whether it was in the public interest to include the asset write-up in the rate base, the Commission requested Guèvremont to address the following factors enunciated in Decision 90-15:

(1) whether the purchase and sale was negotiated on an arm’s length basis;

(2) whether productivity gains and efficiency improvements will be realized and operating expenses reduced;

(3) whether tangible benefits accrued to subscribers, e.g., improved service or lower rates;

(4) the basis on which the company acquired was regulated up to the time of the purchase and sale and whether the rates it was charging were just and reasonable; and

(5) whether there are unique circumstances that warrant special consideration.

II ASSESSMENT OF THE PUBLIC INTEREST

A. Arm’s Length Basis

Guèvremont submitted that the transaction between Le Téléphone Guèvremont Inc. and Bon-Conseil was negotiated on an arm’s length basis, as none of the shareholders of Bon-Conseil, directly or through a holding company, at the time of purchase, were shareholders, administrators or officers of Le Téléphone Guèvremont Inc. and vice versa. Guèvremont argued that its position is supported by the definitions of associate and affiliate as set out in subsections 2(1) and (2) of the Canada Business Corporations Act, R.S.C., 1985, c. C-44 and the Securities Act, L.R.Q., c. V-1.1.

Further, Guèvremont submitted that, notwithstanding that the transaction was performed between related parties as the principal shareholder of Le Téléphone Guèvremont Inc. and the principal shareholder of Bon-Conseil are brothers, the transaction was deemed, pursuant to subparagraph 251(2)(c)(ii) and section 69 of the Income Tax Act to have been negotiated on an arm’s length basis as it was performed at fair market value and did not confer undue privileges on the parties.

Guèvremont stated that it was requesting the same treatment as that given to other telephone companies in similar situations noting that the Commission has never refused to recognize the purchase price paid by a company for the acquisition of another company merely because a transaction was completed by related parties. In that regard, Guèvremont noted that in British Columbia Telephone Company - Proposed Acquisition of GTE Automatic Electric (Canada) Ltd. and of Microtel Pacific Research Limited, Telecom Decision CRTC 79-17, 18 September 1979, the Commission assessed the proposed acquisition by the related parties. Guèvremont stated that the Commission refused to recognize the purchase price for regulatory purposes, not because the transaction was negotiated on a non-arm’s length basis or that the price paid exceeded historical costs, but rather that there was no reliable data to establish the true value of GTE Automatic Electric (Canada) Ltd.

In support of the fair market value incurred for Bon-Conseil’s shares, Guèvremont submitted that the fair market value of Bon-Conseil’s fixed assets had been previously established through a similar offer submitted by Télébec and a similar offer submitted by Sogetel inc. (Sogetel). Guèvremont noted that an offer by Télébec in 1984 to purchase Bon-Conseil’s assets for $4 million (with a corresponding asset write-up of about $1.3 million) was supported by an independent technical and economic study conducted by Bell to determine the reasonableness of the price sought by the principal shareholder, Mr. Jean-Marie Guèvremont, for the sale of Bon-Conseil’s assets.

In addition, Guèvremont stated that, given the fair market value of the transaction was not disputed by Bell, the non-arm’s length issue was moot.

Bell confirmed that, based on the offers from Télébec and Sogetel to purchase Bon-Conseil, it did not dispute the fair market value of the transaction which led to the merger of Bon-Conseil and Le Téléphone Guèvremont Inc. However, Bell submitted that the purchase of Bon-Conseil by Le Téléphone Guèvremont Inc. was a non-arm’s length transaction as the two brothers that owned the two predecessor companies are the same ones that now own the merged company and therefore the asset write-up should not be allowed for regulatory purposes.

The purpose of assessing whether the transaction was concluded on an arm’s length basis is to ensure that the value attributed to the assets was not artificially inflated and that the objectives of the transaction itself were not distorted.

The Commission notes that the fact that the parties involved in the 1 January 1985 acquisition are brothers raises the question of whether the transaction was conducted on an arm’s length basis.

Based on the previous offers by Télébec and Sogetel to purchase Bon-Conseil and on Bell’s submission that it did not dispute the fair market value, the Commission notes that the transaction value is not a contentious issue in this proceeding.

However, the Commission notes that the overall objectives of the related parties’ transaction raise concerns, as there was minimal new capital funding. Further, a similar offer by Sogetel to purchase the shares of Bon-Conseil had been earlier denied by the Régie whereby the regulator noted the possible impact on rates of allowing the proposed asset write-up for regulatory purposes.

B. Productivity Gains, Efficiency Improvements and Reduction of Operating Expenses

Guèvremont submitted that productivity gains and efficiency improvements have been realized as a result of the merger, including the modernization of the networks, centralization of accounting and informatics activities, consolidation of equipment and more efficient use of the work force.

To support its position, Guèvremont filed an analysis of the net operating expense (excluding depreciation other than depreciation associated with the asset write-up and interest expenses) reductions for the years 1985 to 1987. Based on this analysis, Guèvremont indicated that total net savings of $237,323 in constant 1984 dollars, or $51,756 in actual dollars, were realized as a result of the merger in the form of reduced operating expenses for the years 1985, 1986 and 1987. Guèvremont argued that these savings reduced the impact of rate increases for subscribers and provided a direct advantage for Bell, as each dollar saved by Guèvremont increased its net income, thereby reducing the settlement owed by Bell.

Guèvremont also submitted that, as a result of the merger, the company’s operating expenses per network access service (NAS) decreased by more than 10% in 1985 and remained below its 1984 level in 1986. The company also provided a comparison of operating expenditures per NAS, over the period 1984 to 1989, for Guèvremont and other telephone companies with comparable NAS growth rates, particularly Téléphone Milot inc. (Milot) and La Compagnie de Téléphone de Warwick (Warwick). Guèvremont noted that its operating expenditures had increased at a slower rate than operating expenditures for Warwick and Milot. Based on this comparison, Guèvremont concluded that its level of efficiency was superior to that of Warwick and Milot.

Bell stated that, in justifying cost savings, Guèvremont excluded the expenses associated with depreciation and interest from its operating expense analysis. Bell recalculated Guèvremont’s cost savings and estimated the reduction of operating expenses. Bell found that comparing total expenses (including all depreciation and interest expenses) from 1984 to total expenses in 1985, resulted in cost savings of only $17,081 in the first year following the amalgamation as opposed to Guèvremont’s estimation of $55,547. In addition, Bell submitted that, over the eleven-year period (1984-1994), Guèvremont’s operating expenses had increased by 72%, which is comparable to an average increase of 73.6% for other Quebec independent telephone companies.

Bell further submitted that including the asset write-up of $1.3 million in Guèvremont’s rate base would not only increase the yearly depreciation expense, but would also increase the revenue requirement due to the impact of the class G preferred shares used to finance this transaction. Bell stated that these preferred shares earn a dividend of 13.55% before tax each year. Bell noted that, in addition, dividends have been paid in the form of stock dividends which require dividend payments on top of the dividends, year over year.

In reply, Guèvremont questioned the relevance of Bell’s submission comparing operating expenses for Guèvremont to those of all other Quebec independents which may have NAS levels that are different from Guèvremont. In addition, Guèvremont submitted that it is unfair to include in this comparison all the depreciation and interest charges as the company undertook, as early as 1986, substantial investment in its network through bank loans which resulted in a large increase in depreciation and interest charges.

Guèvremont disagreed with Bell’s calculation of the company’s operating expenses and provided further analysis of its operating expenses trend. Based on Bell’s calculations over the period of 1984 to 1994, Guèvremont amended the calculated yearly reduction in operating expenses to reflect the following downward operating expenses adjustments: (1) lower depreciation expenses and interest charges relating to its modernization program; (2) elimination of the professional and legal costs relating to the dispute with the Régie and Bell; and (3) a deduction for the additional interest expense due to Bell’s non-payment of compensation. With these adjustments, Guèvremont concluded that over the eleven-year period its operating expenses calculated in actual dollars grew by 11% (corresponding to a 21% decrease calculated in 1984 constant dollars) as opposed to the 72% increase stated by Bell. In addition, in comparing its expenses with other independent telephone companies, Guèvremont argued that only Milot and Warwick could be used for benchmarking as these two companies had NAS levels comparable to Guèvremont. On this basis, Guèvremont concluded that the growth in its operating expenses, adjusted for (2) and (3) above, over the eleven-year period, was 29% calculated in actual dollars which was still much lower than the growth rate experienced by Milot and Warwick of 108% and 88%, respectively.

The purpose of assessing whether there are productivity gains, efficiency improvements and reduction of operating expenses, from the merger, is to ensure that subscribers do not incur the additional costs arising from recording the assets above their historical cost.

The assessment of any revenue requirement impact is based on an actual, not constant, dollar basis. Therefore, in determining the net benefits to subscribers of the merger, the Commission finds that Guèvremont’s analysis of its operating expenses in 1984 constant dollars is not appropriate.

Further, the Commission considers that, as Guèvremont did not undertake any detailed studies to isolate and quantify productivity gains and efficiency improvements relating directly to the merger, Guèvremont’s suggestion that changes to its operating expenses over the years 1985 to 1987 resulted solely from the merger is unfounded. Moreover, even if Guèvremont’s approach were used, extending its expense reduction analysis beyond 1987 would demonstrate additional costs, as the reductions in operating expenses would not offset the additional depreciation expenses related to the asset write-up during those years.

In addition, the Commission notes that, in its approach to quantify the net benefits over the years 1985 to 1987, Guèvremont excluded the cost associated with funding the asset write-up through preferred shares. After incorporating the cost of funding associated with the asset write-up into Guèvremont’s methodology of estimating the net benefits, the Commission considers that there would have been net costs to subscribers for the three years following the merger. Furthermore, starting in 1988, the financing expenses related to the asset write-up would have increased since the company declared common stock dividends on the shares used to fund the transaction.

Considering the size of Guèvremont’s asset base relative to the magnitude of the asset write-up, the Commission is of the view that it is highly improbable that Guèvremont could have achieved productivity gains or efficiency improvements sufficient to cover the additional costs associated with the asset write-up over the life of the assets.

The Commission concludes that Guèvremont’s assessment of the benefits and costs associated with the asset write-up is incomplete and that the company has not demonstrated that any reduction in operating expenses due to the merger would outweigh the additional costs to Guèvremont’s subscribers through rate increases or increases in Bell’s revenue settlement payments.

C. Tangible Benefits to Subscribers

Guèvremont submitted that there were tangible benefits that accrued to subscribers as a result of the productivity gains and efficiency improvements due to the merger, which included customer service improvements, lower rates than otherwise if Bon-Conseil had been purchased by Télébec, integration of discount and bonus plans offered by Bell and the offering of the new services.

Bell submitted that, while the Régie approved the merger for the expected benefits that would accrue to subscribers, it denied in Decision R.S.P. 84-050-A the inclusion of the asset write-up for regulatory purposes. Bell further noted that this denial was confirmed years later in Decision RT 88-045-C/90-006-C.

The purpose of the tangible benefits criterion is to evaluate whether there has been any net productivity gains and efficiency improvements, as elaborated in the previous Section, or any other result from the transaction that have been beneficial to subscribers.

In approving the merger in Decision R.S.P. 84-050-A, the Régie expected that benefits from the transaction would accrue to subscribers. The Commission notes that some benefits may have accrued to subscribers from the merger but finds, as discussed in the previous Section, that any expense reductions resulting from the merger do not outweigh the additional expenses from including the asset write-up in the rate base. In addition, as stated in Part III, Section B, any funding of the asset write-up by subsidy flows from outside the company would be unfair and inappropriate.

D. Basis of Regulation of Acquired Company and Rates Charged

Guèvremont submitted that, at the time of the acquisition, Bon-Conseil was regulated by the Régie on a rate of return on common equity based on historical costs and that rates charged by Bon-Conseil were monitored and approved by the Régie. However, Guèvremont indicated that the rates approved for Bon-Conseil were lower than those approved for Télébec and Sogetel.

The purpose of considering the basis on which the acquired company was regulated before the amalgamation is to determine if the inclusion of the asset write-up could constitute a circumvention of the form of regulation to which it was subject.

The Commission notes that, prior to amalgamation, both Bon-Conseil and Le Téléphone Guèvremont Inc. were subject to earnings regulation using historical cost and it was on that basis that the Régie established whether each company’s rates were just and reasonable. This situation is different from the circumstances with respect to the asset write-up relating to Teleglobe Canada Inc. (Teleglobe), as discussed below in Part III, Section A, whereby prior to privatization Teleglobe was not subject to the statutory requirement that rates be just and reasonable.

E. Unique Circumstances

Guèvremont submitted that there are unique circumstances which warrant special consideration in assessing the public interest. In that regard, the company noted that, prior to the amalgamation, both Le Téléphone Guèvremont Inc. and Bon-Conseil required extensive modernization of their networks. Guèvremont stated, however, that since both companies had high debt ratios and weak liquidity, the individual companies could not foresee obtaining financing from the banks to modernize their respective networks. With the merger and the revaluation of Bon-Conseil’s assets at market value, Guèvremont stated that the new company was able to improve its capital structure and obtain the necessary financing to modernize the network. The company further stated that the purchase of Bon-Conseil by Le Téléphone Guèvremont inc. through the transfer of preferred shares of the merged company, payable at a later date, permitted the acquisition without affecting Guèvremont’s liquidity.

Guèvremont argued that the company would not have proceeded with the transaction without expecting to recover its investment, receive a return on Bon-Conseil’s fair market value and concurrently improve its debt ratio.

Bell submitted that Guèvremont failed to meet the requirements of Decision 90-15 to assess the public interest. Therefore, Bell recommended that the asset write-up not be endorsed by the Commission particularly in view of the fact that such a transaction, if approved, could result in significant adverse financial impact on Bell.

Bell noted that, should the Commission approve Guèvremont’s application, other independent telephone companies in similar situations may also wish to increase their asset base artificially, for regulatory purposes, to Bell’s detriment.

In reply, Guèvremont indicated that none of the other Quebec independent telephone companies are in a position similar to that of Bon-Conseil and Le Téléphone Guèvremont Inc., as these two companies were the only ones that were owned and controlled by brothers.

This last factor enunciated in Decision 90-15 takes into account any unique circumstances which may warrant special consideration in assessing the public interest.

The Commission is of the view that Guèvremont’s claim that the individual companies were unable to obtain financing from the banks to modernize their networks without the merger and the revaluation of Bon-Conseil’s assets at fair market value does not constitute, in itself, unique circumstances warranting special consideration. The Commission notes that new capital funding could have been found from other sources, in order for the company to reduce its debt ratio and improve its liquidity.

III OTHER CONSIDERATIONS

A. Similar Transactions

In addition to the Terra Nova Telecommunications Inc. acquisition (Decision 90-15), Guèvremont referred to various other Commission decisions which the company considered were relevant to support its position of including the asset write-up in the rate base.

Guèvremont submitted that in Telecom Order CRTC 96-181, 26 February 1996 (Order 96-181), regarding a dispute between Québec-Téléphone and Sogetel over revenue settlement for toll traffic originating and/or terminating in Sogetel's territory and carried on Québec-Téléphone's network, the Commission had not analyzed the net benefits for the subscribers and the shareholders resulting from the acquisition and the revaluation of Téléphone Daaquam Inc.’s assets by Sogetel. Guèvremont further noted that the Commission merely examined the reasonableness of the acquisition costs in order to reach its decision. In view of this, Guèvremont stated that, in addition to its evidence substantiating that it met all the factors outlined in Decision 90-15, Guèvremont also considered that it should receive the same treatment as Sogetel in Order 96-181.

Guèvremont noted that in Teleglobe Canada Inc. - Regulation after the Transitional Period, Telecom Decision CRTC 91-21, 19 December 1991 (Decision 91-21), the Commission found it appropriate to leave the remainder of the gross-up in Teleglobe’s asset base for the purpose of determining its revenue requirement after the transitional period.

Guèvremont also referred to decisions from the Régie to support its position to include the asset write-up in its rate base. Guèvremont claimed that the circumstances surrounding the Guèvremont merger and the revaluation of Bon-Conseil’s assets were similar to those surrounding some of the acquisitions made by Télébec when it was regulated by the Régie. Guèvremont submitted that Télébec recorded these acquisitions at fair market value and therefore requested similar treatment to that received by Télébec in similar circumstances. Guèvremont submitted that refusing to give similar treatment to Guèvremont would not only affect the nature of the 1985 acquisition and merger transaction, but would also be discriminatory towards the company.

In response to a Commission interrogatory, Télébec stated that when purchasing small telephone companies that did not have accounting records, Télébec performed a reconstruction of the cost. Télébec submitted that the market value was not used for this purpose.

In Order 96-181, the Commission ordered that the expenditures associated with the acquisition of Téléphone Daaquam be allowed for purposes of determining the 1995 revenue settlement between Québec-Téléphone and Sogetel. The Commission made its determination on the basis that the excess of purchase price over the historical cost was considered to be minimal and had an insignificant impact on the revenue requirement. The Commission considered that any efficiency improvements to be realized from the merger would most certainly result in cost savings that would exceed the revenue requirement impact from including the minimal excess of purchase price over the historical cost. Accordingly, the Commission considers that the circumstances of that case are different from those in the present case.

The Commission notes that the circumstances regarding the treatment of the asset write-up for Teleglobe in Decision 91-21 were substantially different from that of Guèvremont. In this regard, the Commission notes that, on 2 April 1987, the Governor in Council issued, pursuant to section 30 of the Teleglobe Canada Reorganization and Divestiture Act, the Direction to the CRTC on the Regulation of the New Corporation Resulting from the Reorganization of Teleglobe (the Direction) establishing the basis of regulation of Teleglobe for the transitional period from 1 January 1988 to 31 December 1991. The Direction instructed the Commission, among other things, to accept for the purpose of calculating Teleglobe's revenue requirement a new balance sheet on which the net fixed assets were 140% of the net historical book value. Prior to the Direction, Teleglobe’s rates were set on the basis of Government policy, rather than on the basis of a statutory requirement that rates be just and reasonable, and did not necessarily reflect costs incurred in the provision of service. Accordingly, following the transitional period, there was no framework within which to establish whether the inclusion of the gross-up in Teleglobe's rate base would result in customers paying through future rates the cost of assets already paid for through past rates. Therefore, the Commission concludes that the gross-up in Teleglobe’s asset base cannot be used as a precedent in assessing the Bon-Conseil asset write-up.

Further, with respect to the previous Commission decisions noted by Guèvremont, the Commission notes that there were different circumstances leading to these decisions which were evaluated on a case by case basis.

B. Impact of Write-Up

In response to a Commission interrogatory, Guèvremont submitted that, for regulatory purposes, the inclusion of the asset write-up resulting from the merger of Bon-Conseil and Le Téléphone Guèvremont Inc. would only have a negligible impact on Bell’s subscribers. Guèvremont also indicated that the increased compensation due to the inclusion of the asset write-up payable by Bell would not only be allocated to Bell’s subscribers but to all of the subscribers of the Stentor Resource Centre Inc. member companies as toll revenues are distributed amongst those companies on the basis of a CAT.

Guèvremont further submitted that, without the merger, the settlement payments required for each of the two entities would have been much higher than settlement payments for the merged entity as demonstrated by the net savings of $237,323 (in 1984 dollars) realized for years 1985 to 1987. Consequently, Guèvremont stated that the contribution assumed by Bell’s subscribers would have been much higher if the merger had not occurred.

Guèvremont claimed that fairness to shareholders is very important in this case. According to Guèvremont, a refusal to accept the accounting treatment used by the company would (1) have a negative impact on the value of shares issued to Mr. Jean-Marie Guèvremont, principal shareholder of Bon-Conseil, as partial payment for the acquisition of Bon-Conseil and (2) penalize other shareholders of Guèvremont as they would not receive a return on a large portion of the investment made for the acquisition of Bon-Conseil. Guèvremont further submitted that the shareholders have not personally gained from the merger and that ten years later, Guèvremont is still not in a position to pay the redemption price on the shares issued to Mr. Jean-Marie Guèvremont in lieu of a cash payment for the acquisition of Bon-Conseil.

Guèvremont submitted that the serious financial implications of not accepting the accounting treatment of the asset write-up go against the objectives of the Canadian telecommunications policy set out in section 7 of the Telecommunications Act (the Act). As such, Guèvremont stated that the purchase of Bon-Conseil at fair market value permitted the two merged companies to continue their operations and therefore contributed to the objectives set out in the Act.

Guèvremont further submitted that the impact of the accounting treatment used by Guèvremont, at the time of the merger, is almost extinguished as the majority of the assets transferred at the time of the merger are fully amortized. Therefore, Guèvremont noted that a decision to accept the asset write-up would have a large retroactive impact but would have a much smaller impact in the future.

As set out in Part II, Section B of this Decision, the Commission finds that the expense reductions submitted by Guèvremont did not offset the additional costs associated with the asset write-up. Therefore, the Commission concludes that including the asset write-up in the rate base, would result in an increase in Guèvremont’s revenue requirement.

The Commission considers that any funding of the asset write-up, resulting from an increase in Guèvremont’s revenue requirement, by subsidy flows from outside of the company would be unfair and inappropriate in an environment that has evolved from a monopoly to the current competitive toll market. The Commission also considers that the elimination or reduction of subsidy flows is more paramount today than it was at the time of Decision 90-15.

The Commission notes that the related parties are still shareholders of the merged company and that they are not precluded from selling, in the future, these assets to a third party to receive fair market value.

IV CONCLUSION

Under rate of return regulation, the Commission generally requires that the value of a company’s assets be set at the historical net book value. Under this form of regulation, the Commission establishes an appropriate revenue requirement calculated by determining, among other things, appropriate depreciation expense, interest on long-term debt, the return on shareholder’s equity and associated income tax. Since the valuation of a company’s assets is reflected in the calculations noted above, the valuation directly affects a company’s revenue requirement. Under earnings regulation, it is the revenue requirement that determines the level of rates to be paid by subscribers. Thus, proper valuation of fixed assets is critical to the process of ensuring that rates are just and reasonable.

When ownership of a company changes, the transaction may result in a valuation of fixed assets that is in excess of net book value. With the merger of two telephone companies, each regulated on a rate of return basis, any write-up of assets above net book value raises regulatory concern that the new shareholders should not recover, through future rates, costs of assets already paid for by subscribers in the form of past rates. As a result, in past decisions the Commission has concluded that allowing any excess value over the original cost in the rate base and allowing the resulting increased depreciation expense, cost of capital and required earnings, could only be justified if it was found to be in the public interest to do so.

Based on all the considerations set out in Parts II and III above, which include an analysis of the factors enunciated in Decision 90-15 for assessing the public interest, the Commission concludes that it would not be in the public interest to include any of the asset write-up in determining Guèvremont’s revenue requirement. Therefore, the Commission denies, for regulatory purposes, Guèvremont’s request to include the market value of Bon-Conseil’s assets within its rate base.

The Commission directs Guèvremont to submit, by 90 days from the date of this Decision, financial statements for 1995, 1996 and 1997 which exclude, for regulatory purposes, the asset write-up, the accumulated depreciation as well as any funding of the asset write-up. The company is to provide all details and underlying assumptions used in arriving at these financial statements. The Commission will issue shortly a public notice to finalize the company’s CATs for the years 1995, 1996 and 1997 which will incorporate the findings regarding the regulatory treatment prescribed in this Decision.

Laura M. Talbot-Allan
Secretary General

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