MINNESTOTA – Tax Court Rejects Sales Comparison and Cost Approaches in Valuing Pipeline, Relying Solely on Income Approach

Enbridge Energy owns and operates pipelines that transport crude oil and other petroleum products across a number of states, including Minnesota. In Minnesota, Enbridge Energy’s pipeline system crosses portions of 13 counties. Enbridge appealed the January 2012, 2013, and 2014 assessments of its property.

Unlike real property in Minnesota, which is typically valued and assessed by the taxing jurisdiction in which it is located, the personal (operating) property of pipelines, electric utilities, and railroads is valued and assessed by the Commissioner of Revenue, regardless of where in Minnesota the property is located. The Commissioner typically values the personal property of pipelines, utilities, and railroads first as a unit, and the unit value is then divided among the various taxing jurisdictions.

The Commissioner first attacked Enbridge’s 2012 appeal as untimely, an argument which was rejected by the Court in Enbridge Energy, Limited Partnership v. Commissioner of Revenue (Minn. Tax Reg. Division, May 1, 2018) 2018 WL 2106421. On August 15, 2012, the Commissioner provided Enbridge with her calculation of the market value of Enbridge’s operating property allocated to Minnesota in the form of a “Summary Appraisal Report,” unaccompanied by either a transmittal letter or an explanation of Enbridge’s appeal rights. On September 24, 2012, the Commissioner provided Enbridge with a report of estimated market values, with a cover letter informing Enbridge that the Commissioner’s market values had already become “final” and had been certified to the counties “on or before August 1.” Enbridge filed its appeal on April 22, 2013.

The Court held Enbridge’s appeal was not untimely. The Commissioner’s August 15, 2012, Summary Appraisal Report was not an “order” from which Enbridge was required to appeal under Minn. Stat. § 273.372, subd. 2, because it reflected the value of Enbridge’s operating property as a whole and not county-by-county. The document from which Enbridge did appeal—the Commissioner’s certification to the counties of allocated, apportioned, and equalized property values, notice of which she provided Enbridge by means of her September 24, 2012, correspondence—is specifically designated in Minn. Stat. § 273.372, subd. 2(b), as an “order” from which a taxpayer can appeal. Under Minn. Stat. § 271.06, subd. 1, and § 278.01, to which it refers, a petition challenging the assessment, value, or taxation of real property must be filed “on or before April 30 of the year in which the tax becomes payable.” The Enbridge appeal of the 2012 assessments therefore was timely.

In Enbridge Energy, Limited Partnership v. Commissioner of Revenue (Minn. Tax Reg. Division, May 15, 2018) 2018 WL 2325404, the Court found that the Commissioner overstated the system unit value of Enbridge’s pipeline operating system on all three assessment dates, using only the income approach in arriving at its determination of fair market value.

The Court held that it was not appropriate to value the subject property under a traditional sales comparison approach for any of the three years at issue, noting the “very limited amount of actual sales data to be used as an evidence of value,” nor did the Court place any weight on the stock-and-debt approach to value. The Court agreed with Enbridge’s appraiser that because the company “is not a traded entity [and] has no traded securities . . . there’s doubt that [the stock-and-debt approach] has any validity at all in the appraisal process.” Nor would it be appropriate to utilize the stock-and-debt approach to value Enbridge’s publicly traded parent as a proxy, because (1) the “stock and debt prices include a whole lot of values that are not subject to taxation”; (2) stocks are liquid assets that can be bought and sold quickly at very little cost, but property will take months to sell at significant expense; and (3) securities reflect a “different set of future expectations than does a physical property.”

The Court also rejected the parties’ use of the cost approach. Because oil pipeline companies’ earnings are exposed to competition and are essentially restricted to a fixed rate of return on the original cost less accrued depreciation and deferred income taxes, Enbridge’s appraiser argued that the assets should be valued as if Enbridge were a regulated utility and that original cost less accrued depreciation represents the most realistic indication of market value by the cost approach. The Court held that Enbridge is not rate-regulated, so original cost less depreciation is not a valid measure of market value. The Commissioner also argued that the assets should be valued at depreciated original cost, because the Commissioner is required to use that method in arriving at an initial valuation of pipeline and utility property; however, the Court held that it was not bound by that rule.

Instead, the Court held Enbridge’s property was most appropriately valued under the income approach. As a common-carrier pipeline, Enbridge transports crude oil through its pipeline system of mains, pipes, and associated equipment for a fee based on the type of crude and the distance traveled, which transactions are essentially short-term leases of capacity in Enbridge’s pipeline. Under the facts of this case, the Court concluded that the revenues generated and expenses incurred by Enbridge amount to rental income generated by its utility operating property, which, capitalized and reduced to present value, and best yields an estimate of its fair market value.

Enbridge Energy, Limited Partnership v. Commissioner of Revenue (Minn. Tax Reg. Division, May 1, 2018) 2018 WL 2106421, Enbridge Energy, Limited Partnership v. Commissioner of Revenue (Minn. Tax Reg. Division, May 15, 2018) 2018 WL 2325404

TEXAS – Taxable Situs for Dealer-Held Heavy Equipment Is Location Where Dealer Maintained Inventory, Rather Than Various Locations Where Leased Equipment Might Have Otherwise Been Physically Located

EXLP Leasing, LLC, and EES Leasing, LLC (collectively, “EXLP”), are wholly owned subsidiaries of Exterran Holdings, Inc. EXLP owns and leases out compressor stations used to deliver natural gas into pipelines. Some of these compressors are in use in Galveston County. The County traditionally taxed the compressors in its jurisdiction as business-personal property based on their full market value. But the Texas Legislature overrode that practice in 2012 when it added leased heavy equipment to a statutory formula used to appraise the value of heavy equipment held by dealers for sale. Texas law now requires appraisal based on the lease revenue the compressors generated during the previous tax year divided by twelve. See Tex. Tax Code § 23.1241(b).

EXLP contended the Legislature intended to fix a problem that arose when the same equipment was leased multiple times within one year, with each lease counting as an individual sale for tax purposes, and that the new divide-revenue-by-twelve formula simplifies the appraisal process while providing an “offsetting gain” for the tax revenue lost to the fix. The County claimed the anticipated offset never materialized because lawmakers proceeded on the erroneous assumption that counties were not already taxing leased heavy equipment at full market value. As a result, according to the County, a statutory change “intended to produce a slight gain in tax revenue or remain neutral has actually resulted in a 97% loss in [compressor-based] tax revenue” for Galveston County. According to the County, “[r]ecent litigation has determined that the valuation of leased heavy equipment under Section 23.1241 of the Texas Property Tax Code is unconstitutional.” The County argued that the Texas Constitution requires it to tax property at “fair market cash value” and that the Legislature’s chosen approach for dealer-held leased heavy equipment valued the compressors for tax purposes at “a minute fraction” of their market value.

EXLP and the County also differed over where the compressors may be taxed in light of the 2012 Tax Code amendments. After the amendments were enacted, EXLP took the position that its compressors in Galveston County are taxable only in Washington County, where EXLP maintains a business address and storage yard. Galveston County disagreed, and in a letter to all dealers with heavy equipment leased in its jurisdiction, the County announced it would appraise leased heavy equipment where it was located on January 1, in accordance with Tex. Tax Code § 22.01 covering business-personal property.

The Texas Supreme Court summarily rejected the County’s constitutional argument, holding that nothing in the Texas Constitution binds the legislature to tax only on “market value,” defined by the County as “the price at which a property would transfer for cash or its equivalent under prevailing market conditions.” The Constitution, said the Court, refers only to the legislature’s authority to set the “value” of property for taxation. The Court then rejected EXLP’s argument that Galveston County is not the taxable situs of EXLP’s compressors located there. EXLP contended that the Legislature’s 2012 Tax-Code amendments provide that taxes should be paid in the county where it conducts business—Washington County—based on the revenue generated by its inventory as a whole and regardless of the physical location of individual leased units. The Court agreed with Galveston County that the Statute on which EXLP relied nowhere mentions taxable situs. Rather, as the County argued, Chapter 21 of the Texas Tax Code determines situs. Section 21.02 provides that “tangible personal property is taxable by a taxing unit if,” among other scenarios, “it is located in the unit on January 1 for more than a temporary period.” Since EXLP’s compressors in Galveston County are semi-permanent installations that often remain in place for years, they certainly qualified under Section 21.02, and so the Court rejected EXLP’s claim that the statutory framework necessitates taxation of an entire inventory in the county where the dealer conducts business.

EXLP Leasing, LLC v. Galveston Central Appraisal District, 61 Tex. Sup. Ct. J. 453, — S.W.3d —- (March 2, 2017) 2018 WL 1122363

OREGON – Tax Court Holds Experts Providing Valuation Testimony Need Not Be Licensed Appraisers

In this dispute over the unit valuation of a telecommunications company, the Oregon Tax Court considered several evidentiary objections. The first three were objections to the valuation testimony of experts who were not licensed appraisers. In determining qualification of a witness as an expert, the Court said it must look to the nature of the opinion expressed and the basis for that opinion. With respect to the qualification of various witnesses as expert witnesses in this case, the nature of the opinions expressed all related to the unit valuation of the property subject to central assessment.

The Court admitted the expert testimony of the plaintiff’s expert, a professor of finance with a lengthy list of publications and presentations on valuation topics, many of which related directly to valuation for property tax purposes, notwithstanding his lack of licensure as an appraiser. The Court found the plaintiff’s expert qualified to testify and to submit a report on the valuation of the property at issue based on his “knowledge, skill, experience, training [and] education” as evidenced by his written resume detailing his three graduate degrees in business, economics, and finance, noting that the Oregon Supreme Court has squarely rejected a “technical training” requirement to value property subject to assessment and taxation. Over the plaintiff’s objections, the Court also admitted the valuation testimony of two of the defendant’s experts, one of whom offered a review of the plaintiff’s valuation; the other, although not licensed in Oregon, was a licensed appraiser in Utah.

The Court also considered an objection to the admission of a later transaction as evidence of value on an earlier assessment date. The Court rejected the challenged evidence, stating that the sale of a property before or after the assessment date is relevant to the value of the property on the assessment date only where there is evidence that the “conditions affecting value” are similar as a matter of law, whereas the telecommunications industry was experiencing significant change during the time period at issue.

Level 3 Communications, LLC v. Department of Revenue (Or. Tax Regular Div., May 2, 2018) 2018 WL 2230557

WISCONSIN – Income-Generating Capability of Oil Terminals Inextricably Intertwined with Land; Thus Properly Included in Assessment

Two taxpayers, Marathon Petroleum Company LP and U.S. Venture, Inc., filed separate actions alleging that the City of Milwaukee’s assessments of their oil terminal properties for property tax purposes were excessive and seeking refunds of allegedly excessive taxes paid on those properties plus statutory interest. Following consolidation and a bench trial, the Circuit Court affirmed the City’s assessments. Both taxpayers appealed.

The taxpayers claimed on appeal that the Trial Court erred as a matter of law in affirming the City’s 2008 through 2014 property tax assessments for their oil terminals because that valuation included non-assessable intangible value. They argued that sales of oil terminals involve complex corporate transactions that include intangible value which cannot be considered for tax assessment purposes. The Court of Appeals rejected that argument, holding that the income-generating capability of the oil terminals “appertains to” and is “inextricably intertwined” with the land and thus is transferable to future purchasers of the land (the “inextricably intertwined test”). Therefore, said the Court, this income may be included in the land’s assessment because it appertains to the land.

Marathon Petroleum Company LP v. City of Milwaukee, — N.W.2d —-, 2018 WI App 22 (March 20, 2018) 2018 WL 1402162

MINNESOTA – On Remand, Tax Court Did Not Improperly Apply Eurofresh Standard in Rejecting Pipeline’s Claim of External Obsolescence

Minnesota Energy Resources Corporation (“MERC”) challenged the Minnesota Commissioner of Revenue’s determination of the value of its natural gas pipeline distribution system for the years 2008 through 2012. After a four-day trial, the Tax Court found that MERC overcame the presumptive validity of the Commissioner’s valuation for each of the years at issue and determined that the value for the years 2008 through 2011 was lower than the Commissioner’s valuation and the value for 2012 was higher than the Commissioner’s valuation. In reaching this decision, the Tax Court rejected MERC’s argument that “it was entitled to receive a reduction in market value for external obsolescence.”

Both MERC and the Commissioner appealed, and the Minnesota Supreme Court concluded that the Tax Court used the wrong standard—the Eurofresh standard—to evaluate whether external obsolescence was present (See Minnesota Energy Resources Corp. v. Commissioner of Revenue, 886 N.W.2d 786, 791–92 (Minn. 2016)). External obsolescence is a loss in value caused by negative externalities that is almost always incurable. It is one of three forms of depreciation, along with functional obsolescence and physical depreciation, which may decrease the market value of a property. Under the Eurofresh standard, rather than treating external obsolescence in the same manner as the other forms of depreciation, “a taxpayer claiming external obsolescence [must] offer probative evidence of the cause of the claimed obsolescence, the quantity of such obsolescence, and that the asserted cause of the obsolescence actually affects the subject property” (see Eurofresh, Inc. v. Graham Cty., 218 Ariz. 382, 187 P.3d 530, 538 (Ariz.Ct.App.2007)). Because that erroneous legal standard played a decisive role in the Tax Court’s decision to reject MERC’s external obsolescence evidence, the Supreme Court remanded to the Tax Court to reconsider whether external obsolescence affected the pipeline distribution system’s market value.

On remand, the parties declined to submit additional evidence on the external obsolescence issue, relying instead on their respective supplemental briefs. The Tax Court reviewed the entire record and concluded that MERC failed to demonstrate, by a preponderance of the evidence, that the subject property suffered external obsolescence in any of the five years at issue. MERC appealed.

The Supreme Court affirmed the Tax Court, noting that this time it had applied the correct standard in determining the effect of negative externalities on value: direct comparison of similar properties with and without external obsolescence. On remand, the Tax Court had undertaken a detailed evaluation of the credibility, reliability, and relevance of the evidence offered by MERC in support of its external obsolescence claim, considering multiple factors: the 2008 economic crisis, the impact of changing weather conditions, government regulations and rate-making decisions, and increased conservation and energy-efficiency efforts. The Tax Court also took into account evidence that MERC’s number of customers and gas sales have, for the most part, increased slightly during each of the years at issue. The Supreme Court concluded that the Tax Court’s analysis of the weight and credibility of these factors was not a reversion to the heightened Eurofresh standard that it had rejected in the prior decision. Further, the Court concluded that the record amply supported the Tax Court’s conclusion that MERC’s evidence of external obsolescence was “not credible.” The Tax Court found that MERC’s expert failed to adequately support his conclusion of external obsolescence, and the testimony of MERC’s fact witnesses was at times “nothing more than broad generalizations” or contradictory. Based on its review of the record, the Supreme Court held that the Tax Court’s decision was “justified by the evidence and in conformity with law.”

Minnesota Energy Resources Corporation v. Commissioner of Revenue, 909 N.W.2d 569 (March 21, 2018)

CALIFORNIA – Court of Appeals Holds that Revenue from Broadband and Telephone Service May Be Included in Valuing Cable Company’s Possessory Interests, With Appropriate Deduction for Intangible Assets

On January 1, 2005, Time Warner was party to 13 franchise agreements with public entities in Los Angeles County, each of which included both a right to maintain wires and appurtenances—the distribution plant—on public rights-of-way (the possessory interest) and a right to provide cable services to subscribers. On July 31, 2006, Time Warner purchased the assets of Comcast and Adelphia, which included 77 additional franchises. Time Warner’s acquisition of Comcast’s and Adelphia’s assets triggered a Proposition 13 reassessment of the newly acquired possessory interests to determine their “base year” value, i.e., the value upon which current and future tax assessments would be based. At the same time, Time Warner sought to reduce the property tax assessment of its legacy interests, contending they declined below the roll value. Time Warner thus initiated proceedings before the Los Angeles County Assessment Appeals Board to dispute the value of the legacy interests.

Eleven days before the commencement of proceedings before the Assessment Appeals Board, the Assessor sent notice of his intent to augment the values of the possessory interests. Time Warner paid the resulting taxes, then instituted refund proceedings before the Board to contest the Assessor’s valuation. The Board found against Time Warner on all grounds. Time Warner then appealed to the Superior Court. Time Warner argued that the Assessor erred in valuing the possessory interests based on all three income streams (television, broadband, and telephone) and, because the possessory interests are available in inexhaustible supply to any prospective cable operator at five percent of television revenue, the only way to calculate the fair market value of the possessory interests was by capitalizing a portion of the franchise fee. The Trial Court agreed with Time Warner, reasoning that no prospective cable operator would pay more than five percent of television revenue to Time Warner for any possessory interest because the exact same interest could be purchased from the County at that price.

The County appealed, contending that the Trial Court overlooked the fact that there is no actual, working market for cable possessory interests. According to the County, prospective cable operators do not go to the franchising authority, obtain a franchise, and then build cable systems from the ground up. Instead, prospective cable operators buy existing systems because the capital costs are excessive relative to the riskiness of the potential return. The County argued that the value of the possessory interests is not accurately captured by capitalizing the franchise fee; instead, their value is based on the economic rent the possessory interests would command in a rational market.

The Court of Appeals agreed with the County, observing that the possessory interests at issue generated a considerable amount of revenue for Time Warner beyond what they received from providing television services. The Court held that the added value that Time Warner enjoyed by using the possessory interests to provide telephone and broadband services was not beyond the reach of property tax assessment. The absence of an actual market for a particular type of property does not mean that it has no value or that it may escape from the constitutional mandate that “all property . . . shall be taxed in proportion to its value.” Given that there was no evidence of an open and competitive market for Time Warner’s possessory interests during the assessment period, the Court held that the Assessor’s valuation of the possessory interests as a percentage of gross revenue from the telephone and broadband income streams was valid, and that the Assessor was not limited to valuing the possessory interests by capitalizing the franchise fee. However, the Court of Appeals also held that no substantial evidence supported the finding that five percent of gross revenue from broadband and telephone represented the fair market value of the possessory interests in providing those services, and that the entire five percent of revenue constituted the measure of taxable value, with no allocation of any portion of the economic rent to the intangible assets of the cable systems. The Court remanded to the Board on those issues.

Time Warner Cable Inc. v. County of Los Angeles, — Cal.Rptr.3d —- 18 Cal. Daily Op. Serv. 7224, (Ct. App. 2nd Dist., July 19, 2018)