Department of Aviation Air Cargo Fee Performance Audit

Department of Aviation Air Cargo Fee Performance Audit December 2009 Office of the Auditor Audit Services Division City and County of Denver Dennis J. Gallagher Auditor

The Auditor of the City and County of Denver is independently elected by the citizens of Denver. He is responsible for examining and evaluating the operations of City agencies for the purpose of ensuring the proper and efficient use of City resources and providing other audit services and information to City Council, the Mayor and the public to improve all aspects of Denver s government. He also chairs the City s Audit Committee and oversees the City s Comprehensive Annual Financial Report (CAFR). The Audit Committee is chaired by the Auditor and consists of seven members. The Audit Committee assists the Auditor in his oversight responsibilities of the integrity of the City s finances and operations, including the integrity of the City s financial statements. The Audit Committee is structured in a manner that ensures the independent oversight of City operations, thereby enhancing citizen confidence and avoiding any appearance of a conflict of interest. Audit Committee Dennis Gallagher Robert Haddock Charles Husted Timothy O Brien Maurice Goodgaine Jeffrey Hart Bonney Lopez Audit Staff John Carlson, Deputy Director, JD, CIA, CICA Marcus Richardson, Internal Audit Supervisor, CICA Mary Mutchler, Senior Auditor, CICA Jessica Quintana, Senior Auditor You can obtain free copies of this report by contacting us at: Office of the Auditor 201 W. Colfax Avenue, Dept. 705 Denver CO, 80202 (720) 913-5000 Fax (720) 913-5026 Or view an electronic copy by visiting our website at: www.denvergov.org/auditor

City and County of Denver Dennis J. Gallagher Auditor 201 West Colfax Ave., Dept. 705 Denver, Colorado 80202 720-913-5000 FAX 720-913-5247 www.denvergov.org/auditor December 17, 2009 Ms. Kim Day, Manager Department of Aviation City and County of Denver Dear Ms. Day: Attached is the Auditor s Office Audit Services Division s report of their audit of the Department of Aviation s Air Cargo Fee Compliance for the year ended December 31, 2008. The purpose of the audit was to determine if all air cargo contracts were current, fees charged to all air cargo carriers were appropriate, the Aviation Fuel Tax Reimbursement was dispersed appropriately, and whether internal controls in place were adequate. Audit work determined the DIA allocation of an approximately $10.7 million Aviation Fuel Tax Reimbursement received from the State to certain signatory airlines was inappropriate and non-compliant with state law and the year-end utility charge reconciliations were inaccurate. I know that the issues raised in our audit did not occur under your management however, I am very disappointed in your response to our findings and recommendations. Rather than acknowledging the impropriety and illegality of the disbursements and addressing the issue of collection of the money owed, your response provides no basis for disagreeing with our findings. Simply put the $10.7 million in rebates was disbursed in violation of state statutes but your response avoids addressing that issue directly. During the audit and the response period our auditors sought documentation supporting the decision to disburse this money in the manner it was. This was never provided. Your response states that it was a legal decision yet no such opinion from an attorney was ever provided. Is there no legal opinion? If there is, why have you not provided it? You maintain that the FAA allows these kinds of disbursements yet these funds are state funds not governed by the FAA. The state rebates these funds to DIA, and their disbursement is strictly bound by state statute. Statute is very clear with regard to this: Disbursements to airlines through any means is prohibited. Moreover, your response only speaks to tracking rebate money due DIA from the state, it does not address the critical issue of tracking how that rebate money is spent by DIA in order to comply with state statute. I am extremely disappointed that you have chosen to use smoke and mirrors in your response to avoid what must be done. I know it may be difficult to attempt to collect funds from the airlines that had illegal disbursements but it is what must be done; and to avoid acknowledging the impropriety compounds the error. To promote open, accountable, efficient and effective government by performing impartial reviews and other audit services that provide objective and useful information to improve decision making by management and the people. We will monitor and report on recommendations and progress towards their implementation.

Ms. Kim Day, Manager December 17, 2009 Page Two I have been pleased with your performance since assuming management of DIA and your efforts to reform elements of the airport that need it, but I am saddened by your response to this audit. In this case, the citizens of Denver deserve better. If you have any questions, please call Kip Memmott, Director of Audit Services, at 720-913-5029. Sincerely, Dennis J. Gallagher Auditor DJG/mkm cc: Honorable John Hickenlooper, Mayor Honorable Members of City Council Members of Audit Committee Ms. Roxane White, Chief of Staff Mr. Claude Pumilla, Chief Financial Officer Mr. David T. Roberts, Chief Services Officer Mr. David Fine, City Attorney Ms. Lauri Dannemiller, City Council Executive Staff Director Ms. Beth Machann, Controller Mr. Patrick Heck, Deputy Manager of Aviation, Revenue Management and Business Development

City and County of Denver Dennis J. Gallagher Auditor 201 West Colfax Ave., Dept. 705 Denver, Colorado 80202 720-913-5000, FAX 720-913-5247 www.denvergov.org/auditor AUDITOR S REPORT We have completed an audit of the Department of Aviation s Air Cargo Fee Compliance for the period January 1, 2008 through December 31, 2008. The purpose of the audit was to examine and assess the contract and fee compliance for each of the air cargo carriers operating at Denver International Airport. In addition, audit work reviewed the appropriateness of the allocation of the Aviation Fuel Tax Reimbursement to various airlines operating at Denver International Airport. This performance audit is authorized pursuant to the City and County of Denver Charter, Article V, Part 2, Section 1, General Powers and Duties of Auditor, and was conducted in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. The audit revealed the DIA allocation of an approximately $10.7 million Aviation Fuel Tax Reimbursement received from the State to certain signatory airlines was inappropriate and noncompliant with State law and the year-end utility charge reconciliations were inaccurate. No material weaknesses were identified regarding air cargo carrier compliance with contracts or associated fees. We extend our appreciation to personnel from the Department of Aviation and air cargo carriers who assisted and cooperated with us during the audit. Audit Services Division Kip Memmott, MA, CGAP, CICA Director of Audit Services To promote open, accountable, efficient and effective government by performing impartial reviews and other audit services that provide objective and useful information to improve decision making by management and the people. We will monitor and report on recommendations and progress towards their implementation.

TABLE OF CONTENTS EXECUTIVE SUMMARY 1 Inappropriate Allocation of a $10.7M State Aviation Fuel Tax Reimbursement 1 Year-End Utility Charge Reconciliations Were Inaccurate 1 INTRODUCTION & BACKGROUND 2 Air Cargo Operations at Denver International Airport 2 The Aviation Fuel Tax Reimbursement (AFTR) 3 SCOPE 4 OBJECTIVE 4 METHODOLOGY 4 FINDING 1 5 Inappropriate Allocation of a $10.7M State Aviation Fuel Tax Reimbursement 5 RECOMMENDATIONS 7 FINDING 2 8 Inaccurate Year-End Utility Charge Reconciliations 8 RECOMMENDATIONS 8 APPENDIX A: AFTR Refunds 9 AGENCY RESPONSE 10

EXECUTIVE SUMMARY Inappropriate Allocation of a $10.7M State Aviation Fuel Tax Reimbursement DIA inappropriately allocated an Aviation Fuel Tax Reimbursement (AFTR) received from the State in 2008 totaling approximately $10.7 Million to certain signatory airlines. Colorado Revised Statutes specify the AFTR should only be used for aviation purposes and cannot be used for airline subsidies. In addition to violating state law, this inappropriate allocation deprived DIA of valuable funds during a time when the City is experiencing severe economic duress. Further, even if this type of allocation were allowed by law, the manner in which DIA allocated these funds was inequitable since only signatory airlines received them. Year-End Utility Charge Reconciliations Were Inaccurate Audit work determined that DIA performed the utilities year end reconciliation process (referred to as the true-up) incorrectly. Although DIA calculated and invoiced a monthly estimate for utility City and State Sales Taxes, the year end true-up did not include those fees collected in the reconciliation. This error led to overcharging the air cargo carriers (FedEx, UPS and DHL) for their total utility costs. Upon notification of the error, DIA corrected the reconciliation immediately for 2008 as well as 2007 charges and provided credits to the impacted airlines. Page 1 Office of the Auditor

INTRODUCTION & BACKGROUND & BACKGROUND Air Cargo Operations at Denver International Airport Air cargo carriers transport property, cargo, and mail over a network of routes throughout the United States and abroad. Air cargo poundage decreased at Denver International Airport (DIA) during 2008 with a total of 553,459 pounds compared to 589,402 pounds in 2007 and 621,655 pounds in 2006. The following air cargo carriers operated at DIA in 2008: Federal Express Corporation (FedEx) Key Lime Air Corporation Ameriflight United Parcel Service, Company (UPS) ABX Air, Inc. Kalitta Air DHL Express (USA), Inc. (Airborne Express, Inc. operates as DHL) Air Transport International Air cargo fees and charges are based on usage. DIA estimates rates for usage and bills each airline accordingly. The air cargo contracts (or Airport Use and Cargo Facilities Lease Agreements) and the DIA Rules and Regulations contain the guidelines for air cargo fees and charges. The types and description of fees paid by air cargo carriers are as follows: Landing Fees A charge is assessed for each landed plane based on the maximum allowable weight for each aircraft and billed according to contractual agreements; Utility Charges DIA annually estimates a monthly utility charge for each carrier occupying building space (currently only UPS, FedEx, and DHL occupy space) ; Facilities Ground Rent DIA annually estimates a monthly rent charge based on square footage leased; Ramp and Apron Rent DIA annually estimates a monthly rent charge based on square footage leased; Building Rent DIA annually estimates a monthly rent charge based on square footage leased; General Service Equipment (GSE) Fees DIA annually estimates a monthly rent charge based on square footage leased; and City and County of Denver Page 2

Other Fees and Charges DIA bases other fees such as Vehicle Permit Fees, ID Badge Charges, Fingerprinting Charges, Cargo Shuttle Bus Charges, or Interest Charges on direct utilization. All landing fee, rent, and GSE fee rates are estimated at the beginning of the year and released publicly within Section 120 of the Denver Municipal Airport Rules and Regulations. Landing Fees and Cargo Building Rent is based on whether the carrier is considered signatory or non-signatory. Signatory carriers receive a discounted rate. For a cargo carrier to be classified as signatory, it must have a signed contract for a minimum of five years; lease a minimum of 2,875 square feet of cargo building space or lease preferential parking of a minimum of 33,000 square feet; or operate as a cargo feeder, 1 affiliate or successor of a host carrier from the host carrier s preferential apron. In 2008, air cargo carriers generated more than $8.2 Million in revenue for DIA from the various fees. The Aviation Fuel Tax Reimbursement (AFTR) The State of Colorado collects an excise tax on all aviation gasoline and jet fuel. The Colorado Department of Revenue states, Aviation fuel taxes are collected on aviation gasoline (0.06 per gallon) and aviation jet fuel (0.04 per gallon). The tax is due and collected at the wholesale level when fuel is acquired at the terminal or imported into Colorado for gasoline, aviation and special fuel products. 2 In addition, the State charges a 2.9% sales tax on aviation fuel. The Department of Revenue collects excise and sales taxes and deposits the funds into the Aviation Fund. The Division of Aeronautics then disperses the funds back to the airports in accordance with Colorado Revised Statute (CRS) 43-10-110. That statue provides that: The board shall transfer from the fund, on a 1 A cargo feeder is an airline which contracts to transport cargo, freight or mail for a cargo carrier. 2 Colorado Department of Revenue (Division of Taxation), Gasoline and Special Fuel Distributors, Colorado Department of Revenue, http://www.colorado.gov/cs/satellite/revenue/revx/1211533940744?rendermode=preview (accessed June 22, 2009). Page 3 Office of the Auditor

monthly basis, to the airport operating fund of the governmental entity operating the public accessible airport an amount equal to sixty-five percent of any sales and use taxes collected by the state on aviation fuel sold for use at such airport 3 Article X Section 18 of the Colorado Constitution authorizes CRS 43-10-110. Both Article X and CRS 43-10-110 require that these funds should only be used for aviation purposes. 4 In the State s 2008 fiscal year, DIA received more than $33.6 Million in AFTR funds. SCOPE The audit of the Air Cargo Fee Compliance covered the period January 1, 2008 through December 31, 2008. The audit focused on air cargo carriers operating at Denver International Airport. The audit did not review cargo carriers who also transport passengers. OBJECTIVE Our audit objectives included: Determining whether air cargo carriers and the Department of Aviation comply with airport contract requirements and DIA rules and regulations; Assessing the appropriateness of the Aviation Fuel Tax Reimbursement (AFTR) distributions to certain airlines; and Verifying the accuracy of charges to air cargo carriers and the cash receipts applied to those charges. METHODOLOGY We utilized multiple methodologies to achieve audit objectives. These evidence gathering techniques included, but were not limited to: Reviewing the Airport Use and Facilities Lease Agreement and permits for Air cargo carriers; Reviewing the Department s Rules and Regulations as well as other legal requirements; Performing a physical inspection of each of the air cargo carrier building and rental space; 3 C.R.S. 43 10 110 (2003). 4 Colo Const, Art X, 18. Any taxes imposed upon aviation fuel shall be used exclusively for aviation purposes. City and County of Denver Page 4

Determining if all charges to the air cargo carriers were appropriate and in compliance with all contracts; Tracing all cash receipts to source documents; and Reviewing year-end reconciliations to ensure accuracy. Audit work relied on documents from the Department of Aviation s Pulse Landing Fee Management Program and AMS Advantage accounting system to determine fees billed and paid. FINDING 1 Inappropriate Allocation of a $10.7M State Aviation Fuel Tax Reimbursement In 2008, the State refunded $10,746,100 Denver International Airport (DIA) as an Aviation Fuel Tax Reimbursement (AFTR) adjustment. This adjustment was due to the City because two fuel providers omitted filing tax form DR1510 to the State for the years 2004 through 2007. As a result of a State audit, the identified refund was given to DIA in a lump-sum payment by the State s Aeronautics Division. DIA inappropriately allocated these funds back to the airlines. DIA accounted for the AFTR funds as a revenue account. This means that the funds were not separately expensed allowing the airport to allocate the money to signatory airlines based on the airport s revenue-sharing practice. The comingling of these funds was noncompliant with accounting and reporting requirements identified by state law. DIA previously used the AFTR funds for airport operations such as snow removal. However, DIA allocated this one time reimbursement via credit memos based on the aviation fuel usage for the refund period. 5 The allocation only included signatory, non-international airlines which were in operation at the time of the allocation. It did not include international airlines because they purchase bonded fuel and therefore do not pay the aviation fuel tax. However, non-signatory airlines that do pay this tax did not receive an allocation. Airline Total Refund Percent of AFTR United Airlines/UAX $5,297,000 49.29% Frontier $2,117,500 19.70% SkyWest $667,600 6.21% Delta $338,900 3.15% American Airlines $314,800 2.93% 5 The top five refunds are shown in this table. For a complete listing of refunds see Appendix A on page 9. Page 5 Office of the Auditor

This allocation violates Colorado Revised Statute (CRS) 43-10-110 and the Colorado Constitution, which dictate that these funds are to be used only for aviation purposes by the recipients of the funds from the State. The State provides additional details regarding the appropriate use of these funds, illustrated by CRS 43-10-102 (3) as follows: (3)(a) Aviation purposes means any objective that provides direct and indirect benefits to the state aviation system and includes, but is not limited to: (I) Any work involved in constructing, planning, or repairing a public access airport or portion thereof and may include any work involved in constructing or maintaining access roads; (II) The removal, lowering, relocation, and marking and lighting of any hazard to the safe operation of aircraft utilizing federal rules and regulations as guidelines for determining such hazards; (III) The acquisition of navigational aids used by aircraft landing at or taking off from such airport; (IV) The acquisition of safety equipment necessary for the enhancement of the state aviation system; (V) Any research study, proposal, or plan for the expansion, location, or distribution of aviation facilities or resources that are directly related to the state aviation system; (VI) The promotion of economic development which is related to the promotion, development, operation, or maintenance of the state aviation system; (VII) Any acquisition of land, of any interest therein, or of any easement through or other interest in airspace, including land for future airport development, which is necessary to permit any such work or to remove, mitigate, prevent, or limit the establishment of any hazard to the save operation of aircraft; and (VIII) Any informal education or training made available to the public concerning aviation in the state or any informational materials for dissemination to the public concerning aviation. (b) Subsidization of airlines is expressly prohibited as an aviation purpose except for the promotion and marketing of air service at airport facilities. 6 The State has had some degree of difficulty in identifying exactly what constitutes a subsidy under section 3(b) of CRS 43-10-102. The Aeronautics Division requested a legal opinion from the State Attorney s Office, who provided the following definition,...based on this definition, it is my opinion that monies from the Colorado Aviation Fund may not be given directly to an airline, as a refund or otherwise, except for the promotion and marketing of air service at 6 C.R.S. 43 10 102 (3) (2000). City and County of Denver Page 6

airport facilities. However, so long as monies were not provided directly to airlines, it does not appear that the use of monies from the Fund to offset airport fees constitutes a subsidy. In this case, monies were provided directly to the airlines in the form of credits. Airlines have complete control over how these credits are utilized unless the airlines are delinquent in their payments. In addition, during 2008 CRS 43-10-110 also required each entity receiving the funds to submit an annual report to the division providing information concerning the aviation purposes for which the moneys have been used. 7 Audit work determined that DIA did not submit annual reports to the State s Division of Aeronautics. Because the funds were combined into the revenue account, DIA did not separately account for how the AFTR funds were spent and were therefore unable to identify how these specific funds were utilized. With the passage of House Bill 09-1066 in 2009, AFTR recipients are no longer required to submit annual reports to the State. However, recipients are still required to utilize the funds only for aviation purposes as described above. While no legal sanctions exist for non-compliance, the State s Aeronautics Division stated that compliance may be reviewed when determining grant funding opportunities. House Bill 09-1066 eliminated the grant restrictions for Denver which means that DIA is now eligible to compete for State grant funding. Therefore, DIA must ensure compliance with State laws in order to remain competitive for future grant funding opportunities from the State s Division of Aeronautics. This includes identifying and monitoring how AFTR funds are utilized to ensure compliance with State law. In addition to violating State law, this inappropriate allocation deprived DIA of valuable funds during a time when the City is experiencing severe economic duress. Further, even if this type of allocation were allowed by law, the manner in which DIA allocated these funds was inequitable since only signatory airlines received them. RECOMMENDATIONS 1. In order for DIA to remain compliant with state law and continue in good standing with the Colorado Aeronautic Division s Colorado Discretionary Aviation Grant program, we recommend that the Department working with its legal counsel, immediately seek reimbursement of the $10.7 million back from the air carriers which received these funds and reallocate those funds for aviation purposes as described in C.R.S. 43-10-102(3). 2. The Department should establish policies and procedures to separately account for AFTR funds. This will ensure that AFTR funds are accounted for and used only for aviation purposes. 7 C.R.S. 43 10 110 (2)(b) (2004). Page 7 Office of the Auditor

FINDING 2 Inaccurate Year-End Utility Charge Reconciliations DIA invoices all fees to the air cargo carriers based on an estimate. At the end of the year, DIA reviews actual operating costs and determines actual charges which are then compared to the estimated invoice amounts for all signatory airlines. From this comparison, DIA calculates any amounts owed to the airline, or to the airport. This reconciliation process is referred to as the "true-up." DIA performs utility charge true-ups separately from other airport charges, typically near the beginning of the year. Audit work reviewed all true-ups for 2008 and determined that DIA performed the utilities true-up incorrectly. Although DIA invoiced and collected a monthly estimate for utility city and state sales taxes, the year end true-up did not include those fees collected in the reconciliation. This error led to overcharging the air cargo carriers (FedEx, UPS and DHL) for their total utilities costs. For example, the following table depicts the differences for one airline: Actual Initial Reconciliation (First True-Up) Difference (Corrected True-Up) Total Amount Paid $271,656 $252,000 $19,656 Less Actual Due $182,132 $182,132-0- Total Credit Due $89,524 $69,868 $19,656 The error was simply overlooked when the true-up was performed. However, there are no written policies and procedures in place for this true-up process. In addition, it appears as though no management review occurred for the utilities true-up process. Upon notification of the error, DIA recalculated the year-end reconciliation for 2008 utilities charges which led to an additional credit to three air cargo carriers totaling $34,330. Audit work determined that the corrected reconciliation accounted for the sales taxes appropriately. RECOMMENDATIONS 3. Year-end reconciliation policies and procedures for utility charges should be documented and the year-end true-up process should include management review. City and County of Denver Page 8

APPENDIX A: AFTR Refunds Airline Total Refund Percent of AFTR United Airlines/UAX $5,297,000 49.29% Frontier $2,117,500 19.70% SkyWest $667,600 6.21% Delta $338,900 3.15% American Airlines $314,800 2.93% US Airways/America West $297,900 2.77% Continental $236,100 2.20% Federal Express $193,900 1.80% Alaska $186,600 1.74% Southwest 176,300 1.64% Great Lakes $156,500 1.46% Mesa $151,700 1.41% Northwest/Pinnacle $145,700 1.36% United Parcel Service $123,000 1.14% Shuttle America $72,200.67% JetBlue Airways $67,900.63% DHL Airways $47,400.44% Trans States $45,600.42% Midwest Express $44,500.41% GoJet Airlines $28,100.26% Comair $13,700.13% ABX Air $13,500.13% Key Lime Air $9,700.09% Total AFTR $10,746,100 100% Page 9 Office of the Auditor

AGENCY RESPONSE City and County of Denver Page 10

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