MINNESOTA – Tax Court holds that Commissioner of Revenue had understated system and allocated valuations of crude oil pipeline based on cost and income approach analyses.

Enbridge Energy, LP, owns and operates an interstate petroleum pipeline system, a portion of which is located in Minnesota. Pipeline property in Minnesota is required to be assessed at fair market value using the unit method by the Commissioner of Revenue. A return or assessment of tax made by the Commissioner of Revenue is prima facie correct and valid. The Commissioner valued Enbridge’s system-wide pipeline operating property, as a unit, at $7,129,548,100 as of January 2, 2015, and $7,950,754,500 as of January 2, 2016. Enbridge overcame the prima facie validity of the Commissioner’s assessments by introducing fee appraisals for its property as of the assessment dates, each of which arrived at a different system unit-value than the Commissioner’s system unit-value. Enbridge’s appraisers valued the pipeline system at $5,300,000,000 as of January 2, 2015, and $5,500,000,000 as of January 2, 2016.

The Court first considered the stock-and-debt approach to value, which is based on the premise that the value of assets is equal to total liabilities plus equity. The Commissioner’s 2015 and 2016 valuations using the stock-and-debt approach were approximately $1.5 billion higher than the valuations using the other two approaches to value. Because at trial the Commissioner did not ask the Court to reach a determination of value using the stock-and-debt approach, and because Enbridge’s appraisers did not use the sales comparison approach due to the very limited amount of actual sales data available, the Court did not determine the market value of EELP’s operating property under either the sales comparison or stock-and-debt approach.

In its consideration of the cost approach, the Court noted that both the Commissioner’s and Enbridge’s experts relied on some variation of the original cost of the pipeline. After discussing and resolving the differences in original cost between the two appraisals, the Court examined Enbridge’s claims of external obsolescence: 1) competition from other pipelines and from rail, which the Court rejected because evidence indicates that there is actually a shortage of pipeline capacity and that shippers turn to rail only when unable to ship by pipeline; 2) lingering effects of recent crude oil spills near Marshall, Michigan, and Romeoville, Illinois, which the Court rejected for lack of evidence; 3) “the dramatic [decrease] in oil prices,” which the Court rejected because it found that lower oil prices themselves have no effect on the profitability of a pipeline system as interstate oil pipelines do not usually take title to hydrocarbons and, thus, are not generally directly exposed to commodity price risk; and 4) the effect of governmental regulations, which the Court rejected after noting that regardless of the ceiling on rates imposed by FERC, a pipeline can charge any rate to which each of its current customers has agreed.

Finally, the Court turned to the income approach analyses offered by the two appraisers. Although the approach requires the specification of only two components—a cash-flow stream and a discount rate—the Court observed that experts use a multitude of methods to determine each component, some of them quite complex. The Court said it was obligated to “descend into complex—even onerous—methodological discussions” in order to choose the most reliable versions of the components available to value the pipeline and discharge its duty to evaluate and weigh the parties’ evidence.

Enbridge’s appraiser used the band-of-investment technique, while the Commissioner’s appraiser used the direct capitalization approach. The Court’s findings with respect to future net operating income were lower than those of either appraiser. This was because Enbridge’s appraiser inappropriately incorporated income projected to be earned in the future from assets that were not part of the pipeline on either valuation date, and the Commissioner’s appraiser did not reduce the estimates for income taxes or consider the effect on depreciation of the acquisition and disposition of portions of the pipeline during the years in question. The Court then considered capitalization rates. The Court began by determining the capital structure that a hypothetical buyer would likely use to finance the purchase of the pipeline assets. It then determined the expected cost of debt and the expected cost of equity to a hypothetical buyer of the assets. From those three figures, the Court then calculated the weighted average cost of capital to a hypothetical buyer of the pipeline assets. Having determined net operating income, expected costs of both debt and equity capital as of each valuation date, and the expected capital structure a prospective buyer of the subject property would adopt, it arrived at system unit-values under the income approach.

The Court then reconciled its cost and income approach valuations of the pipeline system and applied allocation factors agreed upon by the parties to arrive at apportioned valuations for both 2015 and 2016 which exceeded the Commissioner’s system and apportioned valuations for both years. The Court valued the pipeline system at $7,347,862,000 as of January 2, 2015, and $8,144,171,700 as of January 2, 2016.

Enbridge Energy, Limited Partnership v. Commissioner of Revenue, 2019 WL 2853133 (Minn. Tax Reg. Div., June 25, 2019).

WEST VIRGINIA – Regulation authorizing use of annual average “Steam Coal Price Per Ton” and coal seam thickness averages for ad valorem tax valuation does not violate statutory requirement that natural resources property be assessed at its “true and actual value.”

Murray Energy Corporation and Consolidation Coal Company are owners of coal interests in Marshall County, West Virginia. In the appraisal of these coal interests for ad valorem tax purposes, the State Tax Department utilizes a “statewide mass appraisal system” for valuation of active and reserve coal properties, as described in West Virginia Code of State Rules § 110-1I-1 et seq. (2006). This case involved the Tax Department’s use of certain averages for purposes of valuing Murray’s and Consolidation’s coal interests through the mass appraisal system.

The mass appraisal system utilized by the Tax Department for valuation of coal property values the coal inside the mine, rather than the mine itself, and uses the income approach to value, which assumes that property is worth its future income, discounted to present value. The methodology for valuation of coal interests, as outlined in the Code of State Rules, was developed through the legislative rule-making process.

The appraisal system uses averages for certain values necessary to calculate the value of the minerals, rather than individualized data. Murray and Consolidation challenged two such averages—the statewide “Steam Coal Price Per Ton” average (“SCPPT”) and the seam thickness average—which are calculated by using the sources and formulas prescribed by regulation. These averages are then filed with the West Virginia Secretary of State as “natural resource valuation variables” and made available for public comment annually.

The SCPPT average for any particular year is calculated by using 1) confidential data concerning purchases of coal obtained from the West Virginia Public Service Commission and reports of fuel purchases from the Federal Energy Regulatory Commission and the U. S. Energy Information Administration, 2) published information from major coal companies, 3) royalty information derived from county courthouse records, and 4) industry publications. Only West Virginia–sourced coal information is utilized from these sources. The SCPPT average for any particular tax year is derived by averaging the price per ton for the three years preceding the tax year, and so it is a “three-year rolling average.”

With respect to the coal seam thickness average, seams of coal vary in thickness and density, which determines the amount of coal at any particular location. The West Virginia Legislature determined that use of an average to estimate the seam thickness at any given location based on acreage was appropriate; the formula provided by legislative rule calculated the average seam thickness to be approximately 1,800 tons per acre-foot, based on United States Geologic Survey data. This coal seam thickness average is expressly set forth in the regulation and does not vary from year to year.

Murray and Consolidation appealed their property tax assessments to the Board of Equalization and Review. They offered expert testimony on the average price per ton of their coal reserves for the years in question and argued that the regulatory methodologies and averages did not reflect the “true and actual” value of their coal properties, causing them to be over-valued for ad valorem taxation purposes.

A mineral appraisal expert who helped design the State’s mass appraisal system during its legislative development testified on behalf of the Tax Department that the coal property mass appraisal system was designed to eliminate “peaks and valleys” in the price of coal and allow for greater predictability of tax burdens and revenues by the taxpayer and the State, respectively. He explained that use of a mass appraisal system is necessary because the State “can’t, on an annual basis, have assessors go out and reassess every individual property as though you were hiring a real estate agent[.]”He further testified that the average seam thickness figure is a “published piece of information … [and] [t]here was no sense in reinventing the wheel there.” He testified that taxpayers may supply specific data regarding their seam thicknesses and mineability for inclusion in the State database, but that Murray and Consolidation had historically failed to do so. Further, he noted that taxpayers are also permitted to provide an appendix with their return which states how much coal they sold and at what price, but Murray and Consolidation had not historically provided this information either.

The Board denied the protest. Murray and Consolidation appealed to the Circuit Court, which likewise denied their appeal. Adopting the Tax Department’s position wholesale, the Circuit Court concluded that because the Constitution provides that “value” is “to be ascertained as directed by law,” the legislative rules are the Legislature’s manner of directing the determination of value. It found that Murray and Consolidation failed to establish that the Tax Department’s calculations were inaccurate, and had instead proposed new methodologies to replace the one prescribed by legislative rule. The Circuit Court also rejected their equal protection argument, concluding that they had failed to prove that the methodology was misapplied or that they were being treated differently than other taxpayers. The Supreme Court affirmed.

Murray Energy Corporation v. Steager, 827 S.E.2d 417 (W. Va., April 29, 2019).

ARIZONA – Supreme Court holds that Department of Revenue lacks statutory authority to value leased solar panels but remands on issue of whether they may be valued by county assessor and, if so, whether A.R.S. § 42–11054(C)(2)’s zero-value provision applies.

SolarCity Corporation and other solar power companies (“SolarCity”) lease solar panels to homeowners and commercial property owners. The panels are installed on or near a building to capture solar energy, convert it to electricity in a self-contained “inverter,” and use it to power the property. Although the panels operate independently of a utility company’s power grid, they transfer any excess energy to the utility company through the grid for use by others. The utility company gives the lessee property owner credit for the retail value of the excess energy.

Prior to 2015, these leased solar panels were neither valued nor taxed. In 2015, the Arizona Department of Revenue issued a “notice of value,” which notified taxpayers that their panels had been assigned full cash values and property taxes would be assessed. In response, SolarCity sued, seeking a declaratory judgment that 1) the panels are “considered to have no value” pursuant to A.R.S. § 42-11054(C)(2) and therefore are not subject to property tax, and 2) the panels are not subject to valuation under §§ 42-14151 and -14155, which authorize the Department to value “renewable energy equipment” used by SolarCity in the operation of an “electric generation facility.” The Department responded that it properly valued the panels under those statutes and alternately asserted that applying § 42-11054(C)(2)’s “zero value” provision to the panels would violate the Exemptions Clause and the Uniformity Clause of the Arizona Constitution.

On cross-motions for summary judgment, the Tax Court agreed with SolarCity that §§ 42-14151 and -14155 do not authorize the Department to value leased solar panels, holding that the panels are “general property” that must be valued by county assessors pursuant to § 42-13051(A), which concerns real property valuation. The Tax Court agreed with the Department that the zero-value provision of § 42-11054(C)(2) violates both the Exemptions Clause and the Uniformity Clause of the Arizona Constitution, and held that county assessors must value SolarCity’s leased solar panels and, in doing so, cannot assign a zero value. The Court of Appeals affirmed in part and reversed in part. It agreed with the Tax Court that §§ 42-14151 and -14155 do not authorize the Department to value SolarCity’s panels, but it held that § 42-11054(A)’s directive that the Department prescribe appraisal guidelines, together with § 42-11054(C)(2)’s zero-value provision, authorizes Department, not the counties, to value the solar panels. The Court of Appeals also concluded that § 42-11054(C)(2) violates neither the Exemptions Clause nor the Uniformity Clause. The Supreme Court granted review.

The Supreme Court first held that the solar energy panels were not taxable as “renewable energy equipment” under § 42-14151(A), the renewable energy equipment valuation statute. The statute applies to businesses that operate an electric generation facility, and SolarCity is in the business of leasing solar panels, not operation of a facility that converts solar energy into electricity. Nor does it deliver electricity to its customers “through a transmission and distribution system.” Instead, SolarCity leases panels to customers to enable those customers to generate electricity for self-use. Although utilities take excess electricity to transmit it to their customers, SolarCity has no part in these transmissions and receives no benefit from them.

The Court agreed with the Department that the solar energy panels are business personal property under § 42-12001(13) but did not decide whether county assessors may value them pursuant to § 42-13051(A) or whether § 42-11054(C)(2) applies to mandate a zero-value assessment, because those issues were not addressed by the Tax Court. The Supreme Court affirmed the Tax Court’s judgment that the Department lacks statutory authority to value taxpayers’ leased solar panels, but reversed the remainder of the judgment. The Court remanded for the Tax Court to determine whether § 42-13054 authorizes county assessors to value the solar panels and, if so, whether § 42-11054(C)(2) nevertheless requires a zero valuation. If the Tax Court determines that § 42-11054(C)(2) applies, then the Tax Court must determine whether that provision violates the Arizona Constitution’s Exemptions Clause or Uniformity Clause as applied in this instance.

SolarCity Corporation v. Arizona Department of Revenue, 243 Ariz. 477, 413 P.3d 678, 786 Ariz. Adv. Rep. 34 (March 16, 2018).

TEXAS – Separate appraisal for ad valorem taxation of saltwater disposal wells and the land on which they are located does not constitute double taxation, and different appraisal methods may be utilized for each.

Bosque Disposal Systems, LLC, and other taxpayers (“Bosque”) own land in Parker County, Texas, containing four saltwater disposal wells, in which wastewater containing salt and other chemicals is injected deep underground and permanently stored in subsurface layers of rock. The manufactured components of these wells include a well bore, down-hole casing and surface pumps used to inject wastewater underground.

In 2012, 2013, and 2014, the Parker County Appraisal District appraised the wells separately from the surface land, creating distinct appraisal accounts for “saltwater disposal facilities” apart from the existing appraisal accounts for the surface land. The District estimated the four wells’ market value, based on the income generated from their commercial operation, at approximately $7 million. The District appraised the four tracts of surface land at approximately $700,000 in total. After Bosque unsuccessfully challenged the appraisals of the saltwater disposal wells with the County Appraisal Review Board, it sought review in the District Court.

Bosque moved for summary judgment, arguing that the Tax Code does not permit the County to appraise the wells separately from the land itself where both interests are owned by the same entity and have not been severed into discrete estates. The District filed a cross-motion for summary judgment, arguing that the Tax Code permitted the District to estimate the total market value of Bosque’s property by combining two separate appraisals—one for the well and one for the land. The District Court granted Bosque’s summary judgment motion and denied the District’s motion, holding that the account associated with the saltwater disposal wells “[is] declared void as illegal double taxation.” The apparent effect of the Court’s ruling was that Bosque’s property taxes for 2012, 2013, and 2014 would be based on only the value of the surface land apart from the wells. If allowed to stand, Bosque would not owe property taxes attributable to whatever additional market value might arise from the presence of the disposal wells on the land. The Court of Appeals reversed and rendered judgment in favor of the District, upholding the separate assessment of the land and the saltwater disposal wells. The Supreme Court granted Bosque’s petition for review.

The parties did not dispute that Bosque owns taxable land in the District, and that the land contains functioning saltwater disposal wells that have significant market value. Bosque did not claim that land in Parker County containing a valuable saltwater disposal well has the same market value as a comparably sized tract of land with no well. Instead, Bosque complained that the District appraised the wells as separate units of real property apart from the land. This, it contended, violated the Tax Code’s definition of “real property” and amounted to double taxation of the wells in violation of the Texas Constitution. Bosque emphasized that the wells have never been severed from the surface land and remained part of its fee simple ownership of the land, contending that the District may not divide the wells from the land for tax purposes when the wells and the land have not been divided for ownership purposes.

The District responded that it appraised the surface land in one account based on comparable sales of tracts of raw land, and it appraised the wells in another account based on the income method of appraisal. According to the District, its appraisal of the land did not take into account the value of the wells. The District’s position was that the sum of the two appraisals approximated the market value of the entire property, wells and all. In the District’s view, the Tax Code requires it to appraise property based on its market value, and splitting the property into two accounts—one for the land and one for the well—was one lawful way of estimating the properties’ overall market value.

The Court began by noting that precedent established that whether the underground facilities were viewed as an “improvement” or an “estate or interest” in property, they were a valuable part of the taxable real property that the Tax Code required the District to appraise. The Tax Code’s categories of real property “clearly overlap” and sometimes “it is difficult to draw the line between these categories,” but “property should not escape taxation entirely because it was unclear which of the Code’s appellations should apply.” Further, “[i]t has long been the case that at least some of [the Tax Code’s enumerated] aspects of real property can be taxed separately even though all are part of the same surface tract,” and “[t]his rule does not depend on whether each aspect [of real property] is separately owned, as identical properties cannot be taxed differently depending on whether, for example, a mineral interest has been legally severed.”

The Supreme Court agreed with the Court of Appeals that the question of whether the value of one aspect of the land was already contained in the appraised value of the land itself must be answered on a case-by-case basis, taking into account “the individual characteristics that affect the property’s market value.” Many aspects of real property cannot be separately assessed from the value of the surface land, and when the latter reflects the former a separate assessment would tax them twice. However, the question is not merely whether the land itself and one of its valuable aspects have been appraised separately, but rather whether the appraisal of the land itself already accounted for the value of the separately appraised aspect of the property. If so, separate appraisal of that aspect of the property would result in illegal double taxation. If not, separate appraisal may be one permissible way to achieve an overall measurement of the property’s market value.

Having concluded that the disposal wells are part of the taxpayers’ real property and contribute to its value, the Court found nothing legally improper in the District’s decision to separately assign and appraise the surface land and the disposal wells. Generally, a tract of land and its improvements are appraised together and assigned a single value. But appraisal districts are permitted to divide a tract and its improvements into separate components, each with its own tax account number, and appraise them individually. Nor does the Tax Code prohibit the use of different appraisal methods for different components of a property.

Bosque Disposal Systems, LLC v. Parker County Appraisal District, 61 Tex. Sup. Ct. J. 1196, 2018 WL 2372810 (May 25, 2018).

ARIZONA – Amendment to statute governing valuation of renewable energy equipment which allows deduction of tax incentives from cost, enacted after valuation date but prior to date of final valuation, is not retroactive.

Siete Solar, LLC, and other companies (“Siete Solar”) operate electric generation facilities that use renewable energy equipment. As part of the American Recovery and Reinvestment Act of 2009, Siete Solar received a tax incentive in the form of an investment tax credit or a cash grant in lieu of the credit for a portion of the cost to build its facilities.

In February of each year, the Arizona Department of Revenue provides a form to facility owners requesting information necessary for the valuation of their property. The Department then calculates the value of renewable energy equipment pursuant to A.R.S. § 42-14155 and A.R.S. § 42-14156, which set forth the valuation method. Before an amendment in 2014, A.R.S. § 42-14155(B) directed the Department to value renewable energy equipment at “twenty per cent of the depreciated cost of the equipment” but provided no definition of “cost.”

In 2013, Siete Solar submitted an annual report to the Department for the 2014 tax year reporting the cost of its facilities. Siete Solar calculated the cost of the energy equipment by subtracting the amount received in tax incentives from the actual cost. However, the Department disallowed the deducted tax-incentive amounts before applying the statutory valuation method to determine the properties’ full cash value, thereby increasing Siete Solar’s 2014 tax liability. Siete Solar appealed to the State Board of Equalization, which upheld the Department’s final valuation. Siete Solar then appealed the Board’s decision.

While the 2014 appeal was pending, the Legislature enacted an amendment to A.R.S. § 42-14155 specifically allowing taxpayers to deduct tax incentives from the cost of renewable energy equipment. See A.R.S. § 42-14155(C)(4) (2014). Because the 2014 Amendment did not contain an emergency provision or a retroactivity clause, it became effective on July 24, 2014, the general effective date for legislation enacted during the 2014 session. On appeal to the Court of Appeals, Siete Solar argued the 2014 Amendment should apply to its tax appeal because it became effective before the taxes in question were assessed.

In August 2014, while the dispute over the 2014 tax year valuations continued, the Department issued final valuations for the 2015 tax year. Siete Solar again reported its cost as the actual cost minus the tax incentives. The Department, applying the pre-amended version of A.R.S. § 42-14155, again disallowed the tax incentive amounts to be deducted from the actual costs. Siete Solar appealed the 2015 final determination. In a prior decision, Siete Solar, LLC v. Ariz. Dep’t of Revenue, 2015 WL 8620672 (Ariz. App. Dec. 10, 2015), the Court of Appeals concluded that the 2014 Amendment was not retroactive—nor was it a clarification of the law—and thus, it did not apply to the 2014 tax year. After that decision, the Department moved to dismiss Siete Solar’s complaint for the 2015 tax year, and the Tax Court granted the Department’s motions. Siete Solar appealed.

The issue confronting the Court of Appeals was whether the Department was required to calculate the 2015 tax year final valuations in accordance with the 2014 Amendment, which was enacted after the valuation date but prior to the date when the Department must determine the final valuation. The Court held that unless the Legislature states otherwise, the law governing the valuation method and classification of property is the law in effect on the valuation date. The Court said that the Legislature may change the law governing the valuation method after the valuation date, but for the Department to apply the new valuation method to the valuation for the corresponding tax year, the statute must be denoted as retroactive, and in this case, it was not.

Siete Solar, LLC v. Arizona Department of Revenue, , 246 Ariz. 146, 435 P.3d 1052, 809 Ariz. Adv. Rep. 25 (January 1, 2019).

CALIFORNIA – Airport terminal lessee’s exclusive duty-free concession right is intangible right not subject to property tax.

DFS Group, L.P., which engages in the business of duty-free sales at airports around the country, holds an exclusive lease and concession to sell merchandise duty-free at San Francisco International Airport in retail space within the airport’s international terminal. In reassessing the value of the possessory interests DFS obtained under a seven-year extension of its lease agreement with the airport, the San Mateo County Assessor included the value of its exclusive concession rights.

The Assessor used the income approach, which estimates the fair market value of an income-producing property by calculating the property’s expected future income stream, to value DFS’s leasehold interest.

Section 110, subdivision (d)(3) of the California Revenue and Taxation Code expressly exempts from taxation the exclusive right to operate a concession. It states: “The exclusive nature of a concession, franchise, or similar agreement, whether de jure or de facto, is an intangible asset that shall not enhance the value of taxable property, including real property.” In applying the income method, the Assessor valued DFS’s leasehold interest at the airport based upon the entire fee that DFS was required to pay the airport for its rights under their agreement during the seven-year extension period, thus treating that entire amount as rent. That fee was a minimum annual guaranteed amount, applicable when DFS’s gross revenues failed to meet targeted thresholds. DFS contended that this minimum annual payment to the airport was consideration not only for its taxable use and occupancy of space at the airport but also for the valuable but non-taxable exclusive concession rights it obtained under the agreement to sell merchandise on a duty-free basis at the airport. It argued that by capitalizing the entire payment without deducting the value of its exclusive concession rights, the County Assessor directly taxed those non-taxable intangible rights in violation of § 110, subdivision (d), and § 212, subdivision (c) of the California Revenue and Taxation Code. The trial court affirmed the Assessor’s methodology, but the Court of Appeal reversed.

The Court of Appeal rejected the County’s contention that DFS was required to establish the fair market value of its possessory interest and the value of the exclusive right to sell duty-free goods at the airport, as premised on a misunderstanding of the law. To be sure, it was the taxpayer’s burden to show the Assessor erred in its valuation by including the value of intangibles in its assessment. The taxpayer must “put forth credible evidence that the fair market value of those assets has been improperly subsumed in the valuation.” But this does not mean DFS had to satisfy the Assessment Appeals Board that its own valuations of the possessory and intangible interests were correct. “The issue that the Court must resolve is not whether the taxpayer’s calculations can be approved, or even whether its methodology is acceptable, but whether the County’s approach is valid.” DFS met its burden to prove that the exclusive duty-free concession rights it enjoyed under the agreement with the airport were valuable. The Court construed the rent provided in the agreement as including compensation for the exclusive right to sell merchandise duty-free. To avoid directly taxing DFS’s exclusive concession, said the Court, the Assessor must either value that right and separate it from the value of the possessory interest or impute a value to the possessory interest alone.

DFS Group, LLP v. County of San Mateo 31 Cal.App.5th 1059, 243 Cal.Rptr.3d 404, 19 Cal. Daily Op. Serv. 1063, 2019 Daily Journal D.A.R. 1031 (January 31, 2019).