"34. Section 412 of title 2 of the Canal Zone Code recognizes depreciation as a cost of operation of the Canal properly charged to tolls and there is nothing in the statute or the legislative history that shows an intent of Congress to exclude the assets in question from depreciation charges. "35. It is our view that it is sound accounting to depreciate the cost of these assets. Accordingly, the 1974 estimates reflect depreciation of the assets commencing with July 1, 1973, at an annual rate of 2-2%. The recording of depreciation will in itself have no effect on the Company's cash position." The excerpts from the hearings previously quoted show: (1) the statement that "there is nothing in the statute or the legislative history that shows an intent of Congress to exclude the assets in question from depreciation charges" is not accurate; and (2) GAO's opinion that "a change in legislation is not necessary" is contrary to GAO's testimony before Congress in 1956 and at other times cited previously. Governor Parker and Mr. Steers also testified at pages 1148-49 about the new changes: "There is a question from time to time in the Congress. Our Board of Directors after reviewing this situation this last winter directed us to go ahead and start depreciation of these assets over a 40-year period beginning with fiscal year 1974." Mr. Steers added: "The action which has been taken by the Board, which has the full concurrence of the GAO, will provide, and properly so, for the recovery of these costs in the toll rate structure of the Panama Canal." No questions were asked by the Committee about the lawful authority to commence these new policies, and no reference to such authority was given by Canal Company witnesses. SENATE APPROPRIATIONS COMMITTEE HEARINGS, APRIL 19, 1973 Chairman Robert Byrd noted (Hearings, p. 25): "On page 2, there are identified in the narrative certain assets having an original cost of $331.8 million, which had previously not been depreciated. "Please give some insight into the nature of these assets and the basis for depreciation." Governor Parker: "The assets are essentially features of the original canal construction; excavation of channels, fills and embankments, and land acquisition costs which were not put in our depreciation base in times past. "Whether or not these items should be included in our depreciation base has been a subject of controversy or discussion through the years. "The GAO has consistently recommended that they be included. "This year our Board of Directors authorized us to add them to our depreciation base for fiscal year 1974, adding to the cost of operations somewhat over $8 million." No further disucssion occurred. PANAMA CANAL SUBCOMMITTEE HEARINGS, JULY 17, 1973 Excerpts from these hearings quoted previously show that Governor Parker discussed a possible tolls increase, but did not discuss any changes in accounting policy, the action of the Board of Directors the previous winter approving these policies, or the impact of the new policies on tolls. According to Subcommittee Chairman Leggett, "subjects to be covered [during the Hearings] include importance of the canal to shipping interests, current commodities, and products transported and future for these and others, adequacy of the canal and problems encountered in its use, future shipping requirements for the canal to the year 2000, and effects of current tolls structure with considerations as to revision of tolls." (Hearings, p. 1). ARTHUR ANDERSEN & CO. LETTER, AUGUST 24, 1973 This letter was a review of proposed changes in accounting policies "scheduled to be finally approved by the Board of Directors on October 30, 1973".17 One topic addressed by the letter is that "accounting policies should comply with legal requirements". Quoting section 412(b) of the Canal Zone Code, the 17 Although the new accounting changes were not approved until October 1973, and were not published in the Federal Register until November 23, 1973, they became effective July 1, 1973, the first day of FY 1974. "tolls formula", Arthur Andersen contended that this "section requires the Company to set tolls to recover all costs." (Emphasis added). This statement is not correct as a matter of law. The statute does not provide for recovery of "all costs", but only for certain costs. If Arthur Andersen were correct, interest during construction could be assessed against tolls. Section 412(e) of the Canal Zone Code specifically prohibits this. The letter adds: "It is our understanding that, under applicable provisions of law, both the adoption of accounting principles and the setting of tolls rates are subject to the discretionary authority of the Company whose management is vested in its Board of Directors." Again this statement is not legally correct. The Company does not have unlimited discretion, but is limited by applicable law. If Arthur Andersen were correct, and if the Company could depreciate or amortize nondepreciable items in the exercise of discretion, then no reason for legislation to authorize this action existed. Yet both the Company and GAO repeatedly acknowledged the need for legislation, and supported bills which would permit this depreciation. Furthermore, the Supreme Court in the Grace Line case specifically rejected unlimited authority in the Canal Company, finding the Company a creature of Congress and of the Executive. As noted in the excerpts from hearings in 1956, the IRS refused (and to our knowledge has never agreed) to find that these actions would be legally permissible. The 1956 Senate Interstate and Foreign Commerce Committee Report found the actions inconsistent with existing IRS regulations. This letter also refers to the report by Arthur Andersen & Co. of April 30, 1972, entitled “Accounting for the Cost of Excavations." This change in accounting, according to the letter, "should have been effective in 1973. However, the time required to clear the policy with the Congress of the United States precluded the implementation in that year". We are unaware of any instance to the present time when the Congress of the United States specifically "cleared" this policy. The only times the appropriate legislative committees clearly faced the policy, they rejected it (see excerpts from 1956 House and Senate hearings, quoted previously). NOTICE OF ACCOUNTING CHANGES, NOVEMBER 23, 1973 The Canal Company Directors approved the changes in accounting policy in October 30, 1973. They appeared in the Federal Register on November 23, 1973 (38 Fed. Reg. 32293). The Notice stated: "The application of generally accepted accounting principles to the Panama Canal Company, a rate-regulated public utility established by Congress, determines the manner in which costs are recognized in the setting of toll rates." After quoting the tolls formula in section 412 (b), the Company listed the accounting changes, including: "12. The costs of land, titles, treaty rights, canal excavation, fills, and embankments, and cost for widening, deepening, and straightening the channel through fiscal year 1973, are depreciated over a 40-year life beginning with fiscal year 1974." The Notice gave no legal authority for this action. PROPOSAL TO INCREASE TOLLS, DECEMBER 15, 1973 The Canal Company on December 15, 1973 issued its Proposal To Increase Tolls by 19.7%. The Proposal contains a section on "Construction and Application of the Tolls Formula", with references to the origin of the Canal Company in 1951 (citing the House Report), to the Grace Line case, and to the 1960 hearings before the Panama Canal Subcommittee on the Panama Canal Toll Formula (H.R. 8983 and H.R. 10968) excerpted in the previous portion of this memorandum. The Proposal made no reference to any prior hearings on legislation to amortize or depreciate nondepreciable items (1956 House and Senate hearings), to the repeated efforts and statements of the Canal Company to obtain this legislation, and to the absence of legislative bodies to pass it. The paragraph on new expenses resulting from this policy reads: "The increase of $10.1 million in depreciation expense from 1973 to 1975 consists principally of depreciation on Canal excavations and certain other assets initiated in 1974, following the inclusion of such depreciation in the budget approved by the Congress for that year. This depreciation will amount to some $8.3 million a year. The depreciation of these assets was recommended by the Comptroller General of the United States." (Proposal, pp. 11-12) Appendix A to the Proposal contains a section entitled "Construction and Application of the Tolls Formula". (Proposal, pp. 45-47). It is divided into two sections "judicial construction" and "legislative construction". The "judicial construction" contains three paragraphs, one for the decision of each court in the Grace Lines case. The "legislative construction" (5 paragraphs) cites only the 1960 Hearings on H.R. 8983 and H.R. 10968. The excerpts quoted by the Canal Company do not include the testimony of Governor Potter at page 14 of those Hearings: "The canal is being amortized except for the so-called nondepreciables, $280 million worth of them. They are the excavation itself, the land on which the excavation sets, and I believe the locks. They, by act of this Congress, are considered as nondepreciables." (Emphasis added) The Proposal does not refer to any of the other hearings, previously excerpted, in its "legislative construction" of the tolls formula. Indeed, this discussion in the Proposal contains no reference at all to depreciation or amortization of nondepreciable items. CARRIER COMMENTS/TESTIMONY, FEBRUARY-MARCH 1974 Sea-Land's comments on the proposed tolls increase, filed February 1, 1974, questioned the depreciation of excavations, titles, treaties, etc.: "Section 412 of Title 2 of the Canal Zone Code [tolls formula] defines items to be properly included in costs of operation. Depreciation as defined therein applies to facilities and appurtenances related to maintenance and operation of the canal. The section contains no provision for recovery of original construction costs." (Comments, p. 20). Sea-Land (and also AIMS) again raised the legal justification for the accounting changes in public testimony before a panel of Canal Company directors on March 5, 1974: "Research reveals the Company has sought without success to depreciate these items in the past. Congress repeatedly rejected the proposal." No mmber of the panel commented. The report, if any, of the directors after comments and public hearings was not furnished to the carriers. The full tolls increase was approved. The depreciation of nondepreciable items continued. HOUSE TRANSPORTATION APPROPRIATIONS SUBCOMMITTEE HEARINGS, The following discussions of the change in depreciation policy occurred between Chairman McFall and Governor Parker Hearings, pp. 827-28): Mr. McFALL. "In last year's hearings we questioned the change in your depreciation policy. At that time you indicated that this cost would be included in any study evaluating toll rates. You also stated, however, that, 'I am not suggesting that we will necessarily recommend a toll increase.' "In view of the fact that you did recommend a substantial toll increase, approximately 20 percent, perhaps we should take another look at this matter. Prior to fiscal year 1974, your interpretation of the Canal Zone Code did not provide for depreciation on titles, treaty rights, excavation of channels, harbors, basins and other works which originally cost $331.2 million. Why did you decide to change your policy on this matter?" General PARKER. "As you have noted from my testimony last year, the Company's Board of Directors had approved at that time some changes in accounting policies which were reflected for the first time in those estimates. As you have indicated again, these costs have not heretofore been depreciated. "The question of depreciating these assets has been under varying degrees of consideration for some time. It was raised again periodically by the Comptroller General, for example in his May 4, 1972 report to Congress on the examination of the financial statement and more recently in his latest report of March 6, 1974. Copies of these reports from the Comptroller General are in your files and available to the committee." Mr. McFALL. "Would you tell us briefly what the Comptroller General has said?" General PARKER. "The Comptroller General has consistently taken the position that these assets should be depreciated. In his audit report for 1971 and 1970 he said: "GAO believes that the assets in question-excavation, embankments, fills, and related facilities-are limited-purpose land assets whose utility diminishes or terminates as the utility of the canal diminishes and that their costs should be depreciated or amortized. GAO believes that a change in legislation is not necessary to permit the Company to administratively determine the effective date of depreciation or amortization of these assets for the purpose of including the costs relative thereto in its financial statements." Mr. McFALL. "Your reply, then, would be that you are complying with the recommendation of the Comptroller General as far as including these depreciation costs in your tolls; is that correct?" General PARKER. "Yes, but not for that reason alone. Our Board of Directors feels, after consideration of the subject, that proper business types of accounting would require these assets to be depreciated over some period of time, so it is not simply because we have a recommendation from the GAO." Governor Parker received permission "to put our tolls proposal in the record because the figures on the amount of depreciation we have utilized and the entire basis for the tolls is spelled out rather clearly there." As noted previously, the Proposal contains not one word of the position of the Canal Company and GAO for legislation to institute this policy, and no reference to any Congressional hearings on the matter. Chairman McFall and Governor Parker also discussed the reason for the 40-year period at Hearings, p. 876: Mr. McFALL. "Over how many years will the canal be depreciated?" General PARKER. "We are talking about those assets which we have not previously depreciated, such as channels and embankments. It was the feeling of the Board of Directors that they would approve a depreciation period of 40 years which seemed a reasonable length of time." Mr. McFALL. "Why was 40 years selected? Is this time period in any way related to the administration's position on giving away the canal?" General PARKER. "It was not specifically linked to that. It has no connection with treaty discussions at all. It seemed like a reasonable period for recovery of the costs involved." Mr. McFALL. "Can you tell us any of the reasons that make it reasonable?" General PARKER. "It happens to coincide with close to 100-year life of the canal. That perhaps in itself is not necessarily logic or a strong point, but it provides for a rate of recovery of those costs each year which seems consistent with the funds necessary to continue to maintain and operate the canal. It is a period short enough to give reasonable chance of recovery and long enough to minimize its impact on costs. "The situation here, Mr. Chairman, is somewhat similar to the situation of the railroads which got into some financial difficulty because a number of their assets were not in fact depreciated over times. Trackage and the right-of-way was considered nondepreciable. These items were not put into the cost base of the railroads. As a result they were not generating funds through their revenues to pay for these costs. There is somewhat of a parallel here." On May 9, 1974, Sea-Land and AIMS testified before the Appropriations Subcommittee and challenged the legal basis for depreciating excavations, titles, treaties, etc. Sea-Land's witness testified: "Sea-Land contends that the tolls formula requiring that toll rates cover costs of maintaining and operating the Panama Canal, plus interest and depreciation on these items, does not authorize the inclusion of expenses from the construction of the canal. The depreciation of these tangible and intangible items has been repeatedly rejected by the Congress.18 The period selected-40 years-is arbitrary at best. It is difficult to believe that the period between the United States and Panama regarding the future status of the Canal. The Company's alleged reason for depreciation of these items is it no longer considers it appropriate to assume that these assets have indefinite economic lives.' The company offers no reason why, after 60 years of operation these assets 18 "These items were not considered depreciable by the Congress when it established the Panama Canal Company in 1950. For twenty years, the Company has been seeking to include these items as expenses recoverable from tolls. and the Congress has refused to authorize it. See Operations of the Panama Canal Company and Canal Zone Government, Hearings before the Panama Canal Subcommittee of the Merchnt Marine and Fisheries Committee. House of Representatives, 83rd Cong., 2d Sess. (July-July 1954), p. 10" (Footnote in testimony). now assume definite economic lives. Further, it is not clear that the amount depreciated has been reduced by previous payments to the Treasury in excess of the annual break-even needs of the Panama Canal Company and its predecessors. These payments have exceeded $40 million in the past 20 years, and tens of millions of dollars during the prior 40 years." APPROPRIATIONS REPORT TO HOUSE, JUNE 19, 1974 When the 1974 appropriations bill came before the House, Chairman McFall suggested that "the legislative committee should consider whether this change is related to possible treaty modifications. We also feel that the part of the toll increase related to depreciation costs should not be implemented until the legislative committee has approved this change in policy.” Although the legislative committee has not approved the change in policy, the full tolls increase was implemented. CHAIRMAN SULLIVAN/SECRETARY CALLAWAY CORRESPONDENCE, JUNE 1974 We understand that Chairman Sullivan inquired in writing of then Army Secretary Callaway about the changes in depreciation policy. We further understand that the Secretary's reply made no reference to previous positions of the Canal Company and GAO of the need for legislation, and of unsuccessful efforts to obtain it. SEA-LAND/GAO CORRESPONDENCE, JULY 1974 On July 1, 1974, Sea-Land counsel sent a letter to Comptroller General Staats, questioning the authority for amortizing or depreciating nondepreciable items, establishing reserves for bad debts, and assessing against tolls costs of the S.S. CRISTOBAL (Attachment A to this Memorandum). The GAO acknowledged the letter on July 24, 1974 (Attachment B). No other reply was ever received. HON. ELMER B. STAATS, LAW OFFICES RAGAN & MASON, Comptroller General, General Accounting Office, Re: Panama Canal Tolls Increase. DEAR MR. STAATS: We understand the Comptroller General has been requested to review the lawfulness of the charges and expenses assessed against tolls by the Panama Canal Company which have been used to support a 19.7 percent tolls increase. The following statement is presented on behalf of Sea-Land Service, Inc. Sea-Land, the largest containership operator in the world, is engaged in transportation in the intercoastal, offshore and foreign commerce of the United States, and for these services often transits the Canal paying hundreds of thousands of dollars in tolls annually. Sea-Land has opposed the tolls increase because of its serious impact on Sea-Land's services, especially its intercoastal service and because Sea-Land believes that the proposed increase is unlawful under the statutory tolls formula and otherwise unsupportable. Sea-Land has submitted statements to the Canal Company, and has testified before the Canal Company and the House Appropriations Committee in opposition to the increase. The largest single new annual expense of the Canal Company is an item of $8.4 million resulting from the depreciation of lands, embankments, excavations, and other items associated with construction of the Canal, plus title, treaty rights, etc., all of which heretofore have been deemed non-depreciable items. Despite repeated requests by the Canal Company and numerous bills to allow depreciation of these items, Congress has never passed the necessary enabling legislation. Under section 411 of Title 2 of the Panama Canal Code, the Panama Canal Company is authorized to prescribe tolls for use of the Canal “subject to section 412 of this title." Section 412 (b), the statutory tolls formula, provides: "Tolls shall be prescribed at rates calculated to cover, as nearly as practicable, all costs of maintaining and operating the Panama Canal together with the facilities and appurtenances related thereto, including interest and depreciation, and an appropriate share of the net costs of operation of the agency known as the Canal Zone Government..." (Emphasis added). |