LOS ANGELES — An adverse appellate court ruling in a Redding, Calif. case could lead to increased financial pressure for cities that transfer revenue from electric utilities to general operating funds, Fitch Ratings said in a report.

The Third District Court of Appeal ruled on Jan. 20 that the city of Redding's electric system payments in lieu of taxes (PILOTs) constitute a tax and, therefore, require two-thirds voter approval to remain in place.

"If the decision from this court stands, or if the case is upheld by the state Supreme Court, it would remove an important income stream from the city of Redding's general fund," Fitch analysts said in a Feb. 11 report. "We believe this decision could lead to similar lawsuits in other locations."

The appeals court remanded the case back to the trial court for an evidentiary hearing.

The appellate court decision would require two-thirds voter approval under Proposition 26 for the PILOTs to remain in place unless Redding can demonstrate that the transfers recover costs associated with providing electric service.

The appeals court denied the city's argument that the PILOT was grandfathered in prior to the passage of Proposition 26, which more broadly defined what constitutes a tax with fewer exclusions. It also denied the city's argument that the PILOT is not a tax, because it is not imposed on electric utility customers as they are voluntary customers of the utility.

Proposition 26 has an exemption that allows charges imposed by government that do not exceed the reasonable costs to the local government of providing the service or product. The appeals court found that the city has not shown it meets that exception.

In fiscal 2014, Redding's electric fund PILOT accounted for 7.8% of general fund revenues and transfers in, according to Fitch.

As electric system transfers account for a significant amount of general fund inflows in a number of other California cities, including Glendale, Lodi, Los Angeles, Pasadena and Riverside; Fitch believes a trend of similar legal actions could become a rating sensitivity in the coming years for those cities.

Fitch also noted that momentum to limit utility transfers for general government purposes has been building for decades starting with Proposition 218 that passed in 1996. It required new fees or taxes levied by local governments to receive two-thirds voter approval but excluded electric and gas rates.

Proposition 218 and a subsequent ruling by the California Supreme Court in 2006 successfully limited utility transfers not related to cost recovery. Then in 2010, Proposition 26 passed, which more broadly defines taxes with fewer exclusions.

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