September 2011 NewsletterSeptember 1, 2011 | Newsletter
The California Appellate Court affirmed, holding that Under §110, subdivision (e), the power plant was correctly “assessed and valued by assuming the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use,” because without the presence of the deployed ERCs, the power plant could not operate and function as intended, to make energy and money. Elk Hills Power, LLC v. Board of Equalization, 195 Cal. App. 4th 285, 123 Cal. Rptr. 3d 906 (May 10, 2011).
Nestle appealed, and hired its own appraiser. Nestle’s appraiser likewise could find no case of a powdered infant formula production facility ever being sold for continued use as such, but from this fact concluded that the “highest and best use” of the plant was not as a powdered infant formula production facility, but rather as a food processing plant. Using sales of food processing plants he found comparable to the Nestle facility, he arrived at a fair market value of $3,590,000. He also valued the facility using the cost method, concluding that the reproduction cost would be $17,196,879 and deducting $ 13,895,020 for functional obsolescence due to the fact that many FDA-required features had no value in the market for generic food-processing plants. His cost method valuation totaled $3,430,000.
On appeal, the Wisconsin Supreme Court agreed with the lower court and concluded that Nestle had failed to rebut the presumption that the DOR appraisal was correct. Specifically, the court found that the DOR appraiser’s conclusion that the “highest and best use” of the plant as a powdered infant formula production facility was supported by substantial evidence. Nestle had failed to prove absence of a market for the plant as a powdered infant formula processing facility, because by itself, the fact that such facilities are rarely bought and sold “did not per se mean that no market existed for their sale.” The court acknowledged that the applicable statute – Wis. Stat. § 70.32(1) – required that a market exist for a property’s “highest and best use” as determined by the appraiser. But the court agreed with the DOR appraiser that the strong demand for powdered infant formula and the market presence of three competitors who could be potential purchasers of the plant established that there was such a market. The fact that neither party found an instance in the United States where a powdered infant formula production facility was sold for continued use as such a facility was not determinative, because “evidence of actual sales” was not necessary to establish the “marketable” requirement of a highest and best use determination. Nestle USA, Inc. v. Wisconsin Department of Revenue, 331 Wis. 2d 256, 795 N.W.2d 46 (Feb. 2, 2011).
In an appraisal action, the court “determine[s] the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, together with interest, if any, to be paid upon the amount determined to be the fair value.” The entity is valued as a going concern based on its business plan at the time of the merger, and any synergies or other value expected from the merger giving rise to the appraisal proceeding itself is disregarded.
The court heard testimony from the parties’ respective valuation experts. Both the Global appraiser and the Golden appraiser used the same primary method of valuation—the discounted cash flow method—but Global’s expert came up with a value of $139 per share and Golden’s expert came up with a value of only $88 per share. After considering their arguments, the court held that Golden was undervalued in the merger, and found that the fair value was $125.49 per share, using a terminal growth rate of 5 percent, a tax rate of 31.6 percent, a supply side equity risk premium of 6 percent, and a beta of 1.29 in calculating Golden’s discount rate.
The court rejected Golden’s argument that the merger price itself reflected a market-tested price for several reasons. First, the Special Committee that negotiated the merger never engaged in any active market check either before or after signing the merger agreement with Vimpel. Second and more important, the passive market check required market participants to assume that Golden’s two largest stockholders, Altimo Holdings and Investments Limited and Telenor ASA, would both sell their Golden stake to another bidder, despite the fact that they had an economic interest in Vimpel that was far more substantial than their stake in Golden—an unlikely prospect made even more doubtful by Altimo’s public announcement that it did not intend to sell its 26 percent stake in Golden in another transaction. The Special Committee chairman admitted that the Committee “had focused on getting the best deal they could from Vimpel.” There was no open market check which would have provided a reliable insight into Golden’s value.
The court then turned to the valuation of Golden, using the discounted cash flow method. The discounted cash flow analysis involves discounting the expected cash flows of a business back to resent value using a discount rate – cost of capital or expected rate of return. A lower discount rate will result in a higher present value, and vice versa. Both the Global and Golden experts applied the capital asset pricing model (CAPM) in determining the discount rate and both experts agreed that a set of cash flow projections developed by Golden management were acceptable. They did not agree, however, on two critical components relevant to determining the discount rate in the CAPM – the beta (a measure of market risk) and the ERP (equity risk premium, or the premium an investor should receive for the risk associated with investing in equities versus riskless assets, such as U.S. government short-term bonds).
Golden’s expert selected an ERP of 7.1 percent from the 2008 Ibbotson SBBI Valuation Yearbook, which is based on long term valuation data from 1926 to 2007 – the historical difference of the average annual return of the S&P 500 index and the average annual income return of long-term U.S. government bonds. Global’s expert used an ERP of 6.0 percent, based on his teaching experience, the relevant academic and empirical literature, and the supply side ERP reported in the 2007 Ibbotson Yearbook. The court agreed with Global’s expert that continued use of the simple historic ERP is unjustifiable, and although the surveys he cited were “not so compelling as to be conclusive, they suggest that current academic thinking puts the ERP closer to 6.0% than to 7.1%.” The court’s acceptance of the lower supply side ERP ultimately resulted in a finding of a lower discount rate and thus significantly contributed to its higher valuation of $125.49 per share. The court’s decision raises questions about the continued viability of the use of Ibbotson’s traditional historical ERP. The case also contains an interesting discussion of whether the Bloomberg five-year weekly historical beta is the most appropriate measure of market risk or whether a so-called “predictive” beta from MSCI Barra, using either a 13-factor model of valuation-relevant factors, is better because beta estimates are not stable over long periods of time, and thus the use of an historical beta is not the best basis for predicting the future. Ultimately, the court rejected the use of a Barra beta and adopted a balanced approach giving predominant weight (2/3) to Bloomberg’s historical beta, while giving some substantial weight (1/3) to the industry beta. Global GT LP and Global GT Ltd v. Golden Telecom, Inc., 993 A.2d 497 (Del. Chancery, April 23, 2010).
In response, Qwest brought a declaratory judgment action against DPT, alleging that because some of its property is similar to that of cable service providers, the tax statutes applied to cable companies’ property should be interpreted to permit DPT to assess such Qwest property under these statutes, although Qwest is a public utility. Alternatively, Qwest claimed that denying it the tax benefits enjoyed by similarly situated cable companies, which are not public utilities, violates the state constitutional guarantees of uniform taxation and equal protection.
The Appellate Court rejected Qwest’s contention that DPT should interpret the intangible property exemption and the “cost cap” limitation on value as applying to its property. DPT reasonably interpreted the tax statutes at issue in applying them only to cable companies. The court further concluded that DPT applied these statutes constitutionally because it could have done so based on administrative convenience and affirmed the judgment of dismissal. Qwest Corp. v. Colorado Division of Property Taxation, __ P.3d __, 2011 WL 3332876, Colo. App. 2011 (August 4, 2011).
Onyx had hired several appraisers, none of whom utilized the sales-comparison approach. Onyx’s first appraiser used only the cost approach as the best method to determine fair market value. He rejected the income capitalization approach because, even assuming that one could obtain valid arms-length leases between landfill owners and operators, too many adjustments to the income stream would be required to provide a reliable value for the real estate only, and he rejected the sales comparison approach because the sale of an operating landfill is of the going concern and thus the approach necessitates significant adjustments, such as excluding elements of business value that contribute to the sale price. Onyx’s second appraiser testified that because of the numerous adjustments required, the sales-comparison approach would not reflect the market participant behavior that focuses on the income-generating capability of the landfill, and he used the income approach only. The Board of Review’s appraiser considered all three approaches to value, but did not utilize cost approach because, in his opinion, it was irrelevant because landfills are not bought and sold on a cost approach basis.
The Board of Review and the Board of Education appealed the reduction in assessment to the Court of Appeals, claiming, on the basis of Cook County Board of Review v. Property Tax Appeal Board (Omni), 384 Ill. App. 3d 472 (2008), that Onyx failed to meet its burden of going forward with evidence sufficient to challenge the assessment, because both of its appraisers had omitted the sales-comparison approach in estimating the market value of the landfill.
The court of appeals rejected their argument, explaining that although the Omni court held that the sales comparison approach must be utilized, even if “problematical” in the sense of “difficult to do,” utilization of the sales comparison approach in the valuation of the Onyx landfill was “problematic” in a different sense: the evidence showed that it would lead to an unreliable estimate of value.
The subject property was a landfill, with a defined economic life. First, the court observed that the sale of the instant landfill to Onyx in 2000 was not a reliable indicator of fair market value. Onyx had purchased the property in 2000 after the seller was ordered to divest some of its assets by the Department of Justice. Further, Onyx purchased the landfill in one transaction that included a portfolio of other northern Illinois landfills, and the consideration allocated to this landfill was based on the property tax assessment at the time of transfer. Other factors also justified the exclusion of the sales comparison approach. Most sales of landfills involve multiple assets and/or business components, not just the real estate. The sale of a landfill is a sale of a going concern, and thus extensive adjustments would have been necessary to derive a sale price for the real estate only. Additionally, sales of landfills might not yield comparable data, because analyzing each sale on a common unit of comparison, such as price per remaining cubic yard of capacity, would be a function of the profitability of the specific landfill; the profitability of a given landfill is affected by local and state landfill regulations, and each locale has different requirements. Because of the wasting nature of a landfill, unique and property-specific permit restrictions, location, and other factors, adjusting sales data would be problematic and not indicative of market participant behavior. Under these circumstances, said the court, an appraiser need not apply the sales comparison approach because it would result in an unreliable estimate of value. Board of Education of Meridian Community School District No. 223 v. Property Tax Appeal Board, 2011 WL 2578180 (Ill.App. 2 Dist.) (June 28, 2011).
The Utah Supreme Court agreed with the Counties that accounting goodwill is not exempt from property tax under the 1998 Act, but reversed the Tax Court because the Utah Constitution prohibits taxing goodwill as property. To fit within the statutory definition of “intangible property,” exempt under the 1998 Act, accounting goodwill must be “capable of private ownership separate from tangible property.” But accounting goodwill does not fit within this definition. According to the Financial Accounting Standards Board, accounting goodwill is “[t]he excess of the cost of an acquired entity over the net of the amounts of the assets acquired and liabilities assumed.” The FASB makes clear that accounting goodwill is not an exchangeable asset that is separate from other assets of the entity. Accounting goodwill is therefore subject to property taxation under the 1998 Act.
However, goodwill is not taxable under the Utah Constitution. Article XIII, section 2, clause 5 of the Utah Constitution provides that “The Legislature may by statute determine the manner and extent of taxing or exempting intangible property. . . . If any intangible property is taxed under the property tax, the income from that property may not also be taxed.” Utah Const. art. XIII, § 2, cl. 5. The Utah Legislature has chosen to exempt intangible property from taxation and instead to tax the income derived from such property. Utah Code § 59–7–101(31)(b) (2000) (“ ‘Utah taxable income’ includes income from tangible or intangible property located or having situs in this state . . . .”) Because the Legislature chose to tax the income from intangible property, it cannot also tax the intangible property itself. The meaning of “intangible property” is clear and unambiguous. As used in the law of taxation, the generally accepted definition of intangible property, is property that “ ‘has no intrinsic and marketable value, but is merely the representative or evidence of value, such as certificates of stock, bonds, promissory notes, copyrights, and franchises. Goodwill, generally defined as a “business’s reputation, patronage, and other intangible assets that are considered when appraising the business” is consistent with this definition. Indeed, goodwill has no physical aspect but represents the value associated with, for example, a business’s reputation and its relationship with its customers. The Supreme Court therefore concluded that goodwill constitutes intangible property. Because goodwill is property and because Utah’s corporate income tax imposes a tax on the income derived from all property, including both tangible and intangible property, the income derived from goodwill is already being taxed and so cannot be taxed again under the property tax. T-Mobile USA, Inc. v. Utah State Tax Commission, 254 P.3d 752 (June 3, 2011).
CORRECTION: In our squib on Jones v. Southern Natural Gas Co., 2011 WL 1405149 (La. App. 2 Cir.) April 13, 2011, printed in our last newsletter, we incorrectly stated that “Pipelines in Louisiana are assessed at 15% of fair market value.” This is only true of intrastate pipelines. Interstate pipelines are assessed at 25% of fair market value and not subject to the same valuation methodology as intrastate pipelines. CCA regrets the error.