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Kentucky Supreme Court Strikes Down Provision of State’s Telecommunications Tax

The Kentucky Supreme Court recently held a portion of the state’s Multichannel Video Programming and Communications Services Tax (the “Telecommunications Tax” or “Telecom Tax”), which prohibits a Kentucky political subdivision from levying and collecting franchise fees or taxes on services subject to the Telecom Tax, is unconstitutional as applied to cities.[1]  The Court upheld the remainder of the Telecom Tax as constitutional.

The Telecom Tax, enacted by the General Assembly in 2005 and codified at KRS §§ 136.600 through 136.660, imposes a 3% excise tax on all retail purchases of multichannel video programming (“MVP”) services, as well as a 2.4% tax on the gross revenues received by all providers of MVP services and a 1.3% tax on the gross revenues received by providers of communications services.  KRS § 136.660(1)(a)-(c), the Telecom Tax’s “Prohibition Provision”, prohibits local governments from levying or collecting franchise fees or taxes from MVP and communications service providers.  MVP and communications service providers are entitled to a credit against the Telecom Tax for any franchise fees actually paid. Id. at (5).

Historically, cities and some counties required cable and telecommunications companies to obtain their consent to place their facilities in the public rights-of-way. Section 163 of the Kentucky Constitution provides that no utilities shall be permitted to lay their facilities within the public rights-of-way within a city or town without the consent of their legislative bodies (i.e., a “franchise”). Section 164 limits local franchises to a twenty year term and requires local governments to award franchises to the “highest and best bidder” pursuant to a public bidding process. Local governments historically imposed franchise fees (typically a percentage of gross revenues derived within the jurisdiction) as compensation for the grant of these rights.

The Telecom Tax regime was intended to hold local governments harmless from the loss of franchise fee revenue as a result of the Prohibition Provision. A portion of the state Telecom Tax revenue is allocated and distributed to local governments that previously levied franchise fees or taxes pursuant to a revenue sharing formula. KRS §§ 136.648 through 136.656. Good intentions notwithstanding, those distributions proved 17% less than historical franchise fee collections. After several unsuccessful attempts to amend the Telecom Tax distribution formula, cities sought relief from the courts.

In 2011, the Kentucky League of Cities, Inc. and several cities in the Commonwealth (the “Cities”) filed a declaratory judgment action against the Finance and Administration Cabinet (the “Cabinet”) and state officials alleging that the Telecom Tax violated Sections 163 and 164 of the Kentucky Constitution insofar as it prohibits cities from collecting franchise fees from MVP and communications service providers. In response, the Cabinet and the Kentucky CATV Association, Inc. (the “Association”), an intervening defendant, argued that Sections 163 and 164 neither explicitly nor implicitly provide municipalities the power to collect franchise fees. The Association also argued Section 181 of the Kentucky Constitution reserves to the General Assembly the power to prohibit municipalities from collecting franchise fees.

Relying upon legislative history, the Court held the framers of the Kentucky Constitution intended municipalities to have the power to grant franchises and to collect fees in exchange for the granting of those franchises. The Court found the Proceedings and Debates in the Constitutional Convention of 1890 made it clear Sections 163 and 164 were intended to provide for municipal benefit via the sale of franchises. According to the Court, by granting municipalities the ability to enter into a franchise agreement, the Constitution affords municipalities the full range of contract law, including the ability to receive consideration in exchange for the performance of the contract. The Court also held that while Section 181 grants the General Assembly the right to delegate (or not to delegate) to municipalities the authority to collect “license fees on franchises”, a city’s power to collect franchise fees for the use of its public rights-of-way is delegated by the Constitution, not the General Assembly.

[1] Kentucky CATV Ass’n, Inc. v. City of Florence et al., Case Nos. 2015-SC-000178-DG and 2015-SC-000181-DG (Ky. June 15, 2017) (to be published).