October 2024 Newsletter

ARIZONA – Income generated from a Power Purchase Agreement may be considered under the income approach in valuing an electric generating plant

Mesquite Power, LLC owns and operates an electric generation facility in Arizona.  Through a “Power Purchase Agreement” between Mesquite and a group of buyers, Mesquite guarantees them a specific amount of electrical capacity during a particular period in exchange for fixed payments to Mesquite. The payments to Mesquite are mandatory and remain the same whether the buyers actually take delivery of any power. The Power Purchase Agreement does not require that the Mesquite produce the electricity that fulfills Mesquite’s obligations to the buyers. Mesquite may purchase power on the open market or from another source to cover the capacity guarantee to the buyers. The Power Purchase Agreement provides that, with the buyers’ prior approval, the agreement may be severed from the Mesquite Power Plant and transferred separately. The original Power Purchase Agreement was entered into on 2011, and subsequently amended several times. Currently the guaranteed payments total approximately $48,000,000 per year.

Mesquite challenged the Department of Revenue’s statutory valuation of its electric generation plant for tax year 2019 by appealing to the Tax Court. Although both parties used the income approach to value the plant, they disputed whether the income approach permits consideration of income from the Power Purchase Agreement. Mesquite’s expert valuation did not include income from the Power Purchase Agreement. Instead, Mesquite’s valuation was based on income from what it considered the taxable property, a hypothetical income model that valued the Mesquite Power Plant as a merchant base load plant competing in the market by selling energy at wholesale prices. In contrast, the Department’s expert valuation under the income approach included income from the Power Purchase Agreement and did not deduct the value of the Power Purchase Agreement. The Tax Court entered partial summary judgment for Mesquite, ruling that the Power Purchase Agreement “is a ‘non-taxable, intangible asset’ that is separate and severable from the tangible property and the valuation of Mesquite’s tangible property for property tax purposes cannot include the value of the [Agreement.]”

The Department of Revenue appealed, and the Court of Appeals reversed the Tax Court, holding that where intangible assets enhance the real and tangible property’s value, a competent appraisal must consider the effect such intangible assets have on the taxable property’s value, and that any valuation approach must appraise the operating unit by its current usage to be competent. The Court of Appeals found Mesquite’s appraisal to be inappropriate under the circumstances because, by assuming the Power Purchase Agreement did not exist, it did not reflect the property as it currently operates. Mesquite appealed.

The Arizona Supreme Court concluded that income from the Power Purchase Agreement is not automatically and entirely irrelevant to the Mesquite Power Plant’s valuation under the income approach, and that income from the Agreement may be considered in the valuation if it is relevant to the calculation of income derivable from the property itself in its continued use as a power plant. The Court explained that income generated from an existing Agreement may evidence a facility’s expected income, which the income approach capitalizes to value the facility. However, the Court cautioned that the Tax Court should consider other factors bearing on the strength of that evidence for property valuation purposes, such as whether the Agreement is severable from the subject property, how many other like facilities have similar agreements, and the facility’s historical role in generating the product under the Agreement. And, said the Court, the taxpayer may demonstrate that the Agreement has independent value that should be subtracted from the final expected income figure.

The Court further concluded that A.R.S. § 42-11054(C)(1)—which provides that the property’s “[c]urrent usage shall be included” in the valuation—does not require consideration of the Power Purchase Agreement, reversing the Court of Appeals on this point. Here, the Court said, the Mesquite Power Plant’s “current usage” is as a base load power plant. By its terms, the Power Purchase Agreement requires Mesquite to provide a certain amount of electrical capacity to the buyers, but the Agreement does not alter or restrict the way the Mesquite Power Plant property is used or what activity occurs on the property. The Power Purchase Agreement does not implicate how the property is used—as a base load power plant—at the time of valuation. Because the Power Purchase Agreement does not implicate “current usage,” the statute does not mandate consideration of the Power Purchase Agreement.

Mesquite Power, LLC v. Arizona Department of Revenue, 127 Arizona Cases Digest 120, 552 P.3d 502 (July 22, 2024)

ARIZONA – Accumulated depreciation cannot reduce the full cash value of public utility property to a negative number nor decrease the full cash value of unrelated property

SDG&E owns an interstate electric transmission line that runs from western Maricopa County through Yuma County and into California. In its 2020 annual valuation filing, SDG&E reported an original plant in service cost of $48,817,396, accumulated depreciation of $51,446,397 and construction work in progress of $3,648,000. These amounts yielded a net plant in service full cash valuation of negative $2,629,001 and a net property full cash valuation of approximately $1,020,000. As part of its accumulated depreciation calculation, SDG&E included the future cost of removal for its electric transmission and distribution property. The Department of Revenue rejected SDG&E’s inclusion of future removal costs in its accumulated depreciation calculation. Accordingly, the Department valued SDG&E’s property at $12,302,121, representing $48,817,396 original plant in service cost, less $40,163,750 in accumulated depreciation, for a plant in service full cash value of $8,653,646 plus a construction work in progress amount of $3,648,475. In response, SDG&E appealed, challenging the Department’s full cash valuation as excessive and filed a motion for summary judgment, seeking a net property full cash valuation of $1,019,474, which used a negative plant in service full cash value (after depreciation) as an offset against construction work in progress on an unrelated asset. The Tax Court granted summary judgment in favor of SDG&E, and the Department appealed.

On appeal, the Department challenged the Tax Court’s ruling that accumulated depreciation under Arizona’s statutory full cash valuation formula includes the future cost of removing electric transmission and distribution property, and, alternatively, that if accumulated depreciation encompasses the cost of removal, such accumulated depreciation may not reduce the full cash value of a plant in service to a negative number or offset the valuation of unrelated construction work in progress.

The Court of Appeals rejected the Department’s first claim. A.R.S. § 42-14154 applies to the valuation of electric transmission and distribution property, and requires the Department to calculate the full cash value of a plant in service by determining the “original plant in service cost” and then subtracting “[t]he related accumulated provision for depreciation.” Although the latter phrase is not defined in the statute, all of the statute’s terms and applications are to be interpreted in accordance with the FERC accounting rules under § 42-14154(F). Under those rules the “accumulated provision for depreciation” expressly includes the “cost of removal.” 18 C.F.R. § 367.1080. The Court concluded that accumulated depreciation includes the cost of removal under A.R.S. § 42-14154.

However, the Court agreed with the Department on its other two claims The Court found nothing in the plain language of the valuation statutes addressing the issues but said that allowing accumulated depreciation to reduce the full cash value of a plant in service to a negative number would lead to an “absurd result.” Further, said the Court, accumulated depreciation may reduce only the “related” original plant in service cost. The “related” accumulated depreciation that A.R.S. § 42-14154(B) expressly states shall reduce the original plant in service cost may not reduce the value of construction work in progress, which is separately calculated under subsection (C) as “fifty per cent of the amount spent and entered on the taxpayer’s accounting records as of December 31 of the preceding calendar year.” Accordingly, the Court held that accumulated depreciation under A.R.S. § 42-14154 encompasses the future costs of removing electric transmission and distribution property, but that such accumulated depreciation cannot reduce the full cash value of a plant in service to a negative number or offset the value of unrelated property.

San Diego Gas & Electric Company v. Arizona Department of Revenue, 256 Ariz. 344, 539 P.3d 136 (2023)

WEST VIRGINIA – Ownership not required in order to appeal a property tax assessment if appellant is otherwise aggrieved

EQT Production Company appealed the 2021 property tax appraisal and assessment of twenty-seven producing horizontal natural gas wells in Marshall County by the West Virginia Department of Revenue to the County Board of Assessment Appeals. EQT alleged that Chevron USA, Inc., from whom EQT had acquired the wells in 2020, had erroneously reported gross receipts from natural gas liquids on its 2021 property tax returns, thereby causing the Tax Department to grossly overvalue the wells. The Board upheld the assessment and EQT appealed its decision to the Circuit Court.

The Tax Department and the Board challenged EQT’s appeal for lack of subject matter jurisdiction and the Circuit Court dismissed the appeal. The basis for the dismissal was that EQT did not have standing because Chevron owned the wells when the 2021 property tax appraisal and assessment were completed, and although EQT apparently contracted with Chevron to pay any property taxes associated with the wells for tax year 2021, EQT could not challenge the taxes assessed to Chevron. The Circuit Court found that by challenging the assessment, EQT effectively sought to amend Chevron’s 2021 tax returns to remove income attributed to the sale of natural gas liquids. The Circuit Court concluded that only a taxpayer can challenge the taxes it owes, not a third party, and a third party does not become a party liable to the taxing authorities by virtue of a private contract.

The Court of Appeals reversed. West Virginia Code § 11-3-25(a), permits “any person claiming to be aggrieved” by any property assessment who has appeared to contest that valuation before the Board to “apply for relief to the circuit court of the county in which the property books are made out.” Although the statute does not contain any statutory definitions for the phrase “any person claiming to be aggrieved,” the plain language permits EQT to apply for relief. The statute does not limit the class of appellants to owners of the property which is the subject of the appeal, but rather allows any person who is aggrieved by any assessment to appeal that assessment if they have appeared and contested the valuation before the Board.

EQT Production Company v. Irby, 2023 WL 8663543 (W. Va. Inter Ct. of App., Dec. 15, 2023)

NEW YORK –  In order for fiber-optic installations to qualify as nontaxable because used in the “transmission of news or entertainment radio, television or cable television signals,” evidence must show they are “primarily or exclusively used” for one of those purposes

SLIC Network Solutions, Inc. provides internet, telephone and cable television services via fiber-optic cables and conduits to its private customers around the State of New York. Under the Real Property Tax Law, such equipment falls within the ambit of “local public utility mass real property” and is therefore generally taxable real property when owned by other than a telephone company. The Real Property Tax Law excludes from the definition of “local public utility mass real property” equipment such as that at issue here when it is “used in the transmission of news or entertainment radio, television or cable television signals.” SLIC challenged the 2020 assessment ceilings for the jurisdictions in which it owns property arguing that its fiber-optic cables are non-taxable because excluded from the definition of public utility mass real property in that they are used in the “transmission of … cable television signals.” The hearing officer rejected SLIC’s argument and SLIC appealed to the Supreme Court.

On appeal, SLIC asserted that virtually 100 percent of its fiber-optic cables are utilized to transmit television signals and that approximately 85 percent of the total percentage of its fiber-optic plant is required for that transmission. SLIC also contended that it holds numerous franchise and content agreements obligating it to provide cable television services and that it continues to invest significantly in television infrastructure and expand its service. The Supreme Court found this evidence unconvincing and affirmed the administration determination. None of these claims, or the evidence proffered in support thereof addressed the extent to which the fiber-optic cables are used for the transmission of cable television signals in comparison to the other documented uses of those same lines. Similarly, evidence that other government entities license or recognize SLIC as an operator of a cable television system was unconvincing in the absence of any proof regarding the criteria used for such licensure or designation. Further, SLIC proffered no evidence concerning the allegedly ancillary nature of the internet and telephone signals it transmitted.

SLIC appealed to the Appellate Division, which agreed with the Supreme Court. The Appellate Division noted that the exclusion for equipment used in the “transmission of news or entertainment radio, television or cable television signals” has been narrowly construed, and applied to fiber-optic installations only if they are “primarily or exclusively used” for one of the excluded purposes. Although the Court recognized that the transmission of cable television signals is among SLIC’s uses of its fiber-optic cables, it found lacking the type of proof of use contemplated by the Real Property Tax Law and case law needed to demonstrate entitlement to the exclusion and affirmed the Supreme Court’s decision.

SLIC Network Solutions, Inc. v. New York State Department of Taxation and Finance, 223 A.D.3d 1126, 204 N.Y.S.3d 301, 2024 N.Y. Slip Op. 00342 (2024)

ALABAMA – Circuit Court not limited to “mass appraisal” cost approach method of valuation in property tax appeal, and properly considered the recent voluntary sale of a petrochemical production plant as a measure of fair market value

Indorama Ventures Xylenes & PTA, LLC purchased a petrochemical production plant from British Petroleum in 2016 for $322 million. After acquiring the plant, Indorama hired an appraiser to a prepare a purchase price allocation report using the cost, market, and income approaches to determine the fair value of the plant’s assets as of the date of acquisition for financial-reporting purposes. He estimated the fair value of the personal property at the plant to be $346 million, a figure that included nontaxable personal property. Indorama then hired a CPA to prepare its tax return for the 2017 tax year, and he estimated the plant’s value at $297,527,700. The CPA relied on the $346 million appraisal to calculate the total value of Indorama’s personal property and then adjusted down for nontaxable pollution-control equipment and depreciation.

 Indorama filed its tax return with the Morgan County Revenue Commissioner’s Office, but the Commissioner rejected the valuation and assessed the property at $449,682,078. The Commissioner arrived at that figure using the “mass appraisal” method of valuation, which took BP’s original acquisition cost of the plant in 2000 — $1,706,210,252 — and adjusted that number down using a standardized depreciation schedule. Indorama filed an objection to the Commissioner’s valuation with the Board of Equalization. After a hearing, the Board upheld the value set by the Commissioner, and Indorama appealed to the Circuit Court. The next year, Indorama filed its 2018 tax return with the Commissioner’s Office, reporting a total personal-property value of $280,470,266. The Commissioner rejected that return as well and assessed the total value of personal property at $442,302,752. Indorama filed an objection with the Board, which upheld the Commissioner’s valuation. Indorama appealed that valuation as well, and the appeals were consolidated.

At the trial, the Board explained how it had valued Indorama’s personal property by relying on guidance from the Alabama Department of Revenue for appraising property for tax purposes, which provides that “[f]air and reasonable market value is the basis for valuation of properties for ad valorem taxation in the State of Alabama” and calculates “fair and reasonable market value” as “ ‘the price that property would bring at a fair voluntary sale.’ ” The Department of Revenue materials describe three different approaches to valuation — cost, market, and income — but express a preference for the “mass appraisal method,” a standard cost approach to valuation that considers the historical cost of the property and applies a deduction using straight-line depreciation. The Board explained that tax assessors are required to follow the Department of Revenue materials.

 Indorama responded to the appraisers’ testimony by offering evidence about its valuation methods. For each valuation, its appraiser considered the three standard approaches to appraisal: a sales-comparison or market approach, an income approach, and a cost approach. He explained that the sales-comparison approach was not useful in determining fair market value because of the uniqueness of the property, but utilized the other two methods. After considering all the evidence, the Circuit Court issued a detailed, carefully reasoned judgment that found that Indorama had met its burden of overcoming the presumption of accuracy afforded to the Board’s assessment.

The Board appealed to the Supreme Court, arguing that the only valid method of appraisal is the mass-appraisal cost approach. The Court rejected that argument, holding that by statute, the Circuit Court was entitled to consider all the evidence presented and was not restricted to any particular method of valuation and affirmed the Circuit Court decision. Contrary to the Board’s assertions, said the Court, Alabama law does not prohibit appraisers from using other methods of valuation, such as the income approach. Indeed, the Department of Revenue materials do not mandate the use of a particular approach, and while they express a preference for the mass-appraisal cost method, they expressly permit three types of valuation methods: cost, market, and income.

The Court also rejected the Board’s contention that the Circuit Court erred by considering the sale price of the plant between BP and Indorama in determining the fair market value of Indorama’s personal property, rather than relying solely on the “original” or “historic” cost to BP when it first acquired the plant because original cost has been “the primary cost basis used for valuing property in a wide variety of contexts.” The Circuit Court had correctly noted that BP’s acquisition cost might have been “arrived at in error” because it was not verified by a certification of accuracy, which the Department of Revenue materials require. Further using the historic cost would require Indorama to pay the personal-property tax on BP’s acquisition cost, which was nearly 1.5 times higher than Indorama’s acquisition cost. Finally, the sale-price approach to valuation was more consistent with the Department of Revenue materials because they define “market value” as “the highest price for which a property would sell, if the sale occurred under satisfactory conditions for all parties to the transaction.” The Court held that Circuit Court correctly considered the “recent voluntary sale” as a measure of fair market value.

Morgan County Board of Equalization v. Indorama Ventures Xylenes & PTA, LLC, — So.3d —- (2024)        

ARIZONA – The “value” of an investment tax credit under A.R.S. § 42-14155 for purposes of determining the taxable original cost of renewable energy equipment is the full amount of the credit, set when the applicable equipment is placed in service and the credit is claimed.

The Arizona Department of Revenue values renewable energy equipment. Under a statutory formula, the Department calculates the “taxable original cost” of the equipment by subtracting “the value of any investment tax credits … applicable to the taxable renewable energy and storage equipment” from the equipment’s “original cost,” where “original cost” is defined as actual construction and acquisition costs. The Department then deducts any applicable depreciation from the taxable original cost and multiplies the remaining, depreciated cost by twenty percent, yielding the equipment’s full cash value for property tax purposes. A.R.S. § 42-14155(B).

Agua Caliente Solar, LLC operates a solar-electricity power-generation facility that uses renewable energy equipment which was placed into service in 2012. Agua Caliente received investment tax credits in the amount of $465,454,649 from the federal government for building its facility, some of which were carried forward as a deferred corporate tax asset for federal tax purposes.  The Department initially valued Agua Caliente’s renewable energy equipment without including any of the investment tax credits. Agua Caliente challenged that valuation, arguing the Department should have included the tax credits. The Department then revised its valuation to include the investment tax credits which had been used to reduce income tax liability but refused to include the credits carried forward as a deferred corporate tax asset. The Department maintained that the formula used in the applicable statute, A.R.S. § 42-14155, does not recognize investment tax credits until they are used to reduce income tax liability. Agua Caliente appealed the Department of Revenue’s valuation of its equipment for tax years 2016 through 2020, arguing that investment tax credits are to be recognized as soon as they are claimed. The Tax Court granted summary judgment in favor of the Department, and Agua Caliente appealed.

On appeal, the Court of Appeals said that to determine whether the statutory formula compels the Department to recognize deferred investment tax credits when calculating renewable energy equipment’s taxable original cost, it must interpret the statutory phrase “reduced by the value of any investment tax credits … applicable to the … equipment.” Under Agua Caliente’s proposed construction, the amount of any investment tax credit is subtracted once the owner places the equipment in service and claims the credit associated with that equipment. The Department maintained that “value” equals the economic benefit that an equipment owner derives by using the credit to reduce income-tax liability. Under the Department’s interpretation, a claimed investment tax credit is not factored into the valuation of renewable energy equipment until the credit is used to offset a federal tax liability. The Department argued that because the credits are not transferrable and cannot be sold, they have no monetary worth apart from their specific use.

The Court rejected the Department’s interpretation—that investment tax credits have no value for purposes of valuing renewable energy property until the credit is used to offset a federal tax liability—on the basis that it is not supported by the plain meaning of the statute, it flies against the context of the statute, and runs contrary to general property law principles. According to the Court, a plain reading of the text A.R.S. § 42-14155, the applicable statute, supports Agua Caliente’s interpretation: an investment tax credit’s monetary worth, and thus its value, is the full amount of the credit claimed, even before its use.

Agua Caliente Solar, LLC v. Arizona Department of Revenue, 122 Arizona Cases Digest 11, — P.3d —- (2024)