Railroad Valuation and Equalization The 46 th Annual Wichita Program July 26, 2016

Transcription

1 Railroad Valuation and Equalization The 46 th Annual Wichita Program July 26, 2016 Stephen D. Goodwin 165 Madison Avenue Suite 2000 Memphis, TN

2 Valuation Concepts 1. All states have either statutory or constitutional provisions for the valuation of property for tax purposes. 2. Most common standard is fair market value e.g., Tennessee [ the sound, intrinsic, and immediate value for purposes of sale between a willing seller and a willing buyer without consideration of speculative values ] T.C.A (a) 3. Most states make no distinction between fair market value for railroad property and fair market value for all property. 2

3 History of Railroad Valuation Appraisal of Railroad and Other Public Utility Property for Ad Valorem Tax Purposes 2. The Gray Ghost 3. The first comprehensive analysis of the valuation of railroad property 4. Discussed Central assessment Unit appraisals vs. summation appraisals Income to be capitalized Cap rates Stock and debt Cost approach Weighting the different approaches 3

4 Challenging Valuations 1. State remedies Administrative appeals State court judicial review 2. Railroads often faced stringent burdens of proof 3. State judicial review of administrative determination was often limited 4. Relief in federal court was barred by the Tax Injunction Act, 28 U.S.C

5 Congress Acts 1. The landscape changed in 1976 with the passage of the Railroad Revitalization and Regulatory Reform Act of 1976 ( the 4-R Act ) 2. Section 306 of the 4-R Act generally forbids the states and local governments to discriminate against railroads in matters of taxation 3. Section 306 was enacted after 15 years of study by Congress of state taxation of railroads 5

6 Federal Court Jurisdiction 1. Section 306 is exempted from the Tax Injunction Act 2. Congress decided that a federal forum and a federal remedy was required to end the historical tax discrimination against railroads 6

7 Valuation Claims in Federal Court 1. Many of the early Section 306 cases dealt with equalization claims 2. Railroads could challenge de jure discrimination. [e.g., Tennessee s state constitutional provision assessing railroads at 55% of value while assessing other commercial property at 40/30%] 3. Railroads could challenge de facto discrimination resulting from assessment practices [to be discussed later] 7

8 Valuation Claims in Federal Court (continued) 4. But federal judges were reluctant to disturb a state s determination of the fair market value of railroad property 5. Several courts dismissed claims by railroads that the state s determination of value exceeded the actual fair market value of railroad property 8

9 Burlington Northern v. Oklahoma 1. First Section 306 case to reach the U.S. Supreme Court in Lower courts had dismissed the railroad s claim that its property had been over-valued 3. Justice Thurgood Marshall for a unanimous court held that railroads must be able to challenge valuations in order for Section 306 to be effective 9

10 CSXT v. Georgia 1. Despite BN v. Oklahoma, federal courts remained reluctant to entertain railroad valuation claims 2. Courts begin to read BN v. Oklahoma to allow only a challenge to the application of a state s preferred method of valuation, but not the method itself 3. In 2007, again in an unanimous decision, the Supreme Court made clear that Congress made true market value a question to be litigated in federal court 10

11 Union Pacific Railroad Co. v. Affected Counties v. Utah State Tax Commission 1. Case No , in the Second Judicial District Court of Davis County, Farmington Department, State of Utah, May 1, Most important recent railroad valuation case 3. A textbook on valuation issues, whether you agree with the results or not 4. Not a Section 306 case, but the same issues would arise in a Section 306 valuation case 5. Rule 62 11

12 Cost Approach UP s expert did not perform one Counties expert used HCLD Both experts and court agreed that the cost approach was not reliable 12

13 Comparable Sales 1. Often used in residential and commercial real estate valuations 2. But both experts and court agreed that there were no sales of comparable properties that would allow for accurate valuation estimates 13

14 Income Approach 1. Preferred indicator of both experts 2. Neither expert used direct cap 3. Both experts calculated a yield capitalization and a DCF 4. Value = CF k g k = nominal, risk adjusted discount or yield rate g = expected growth rate of the cash flow 14

15 Income Approach Net Cash Flows Adjustments to operating income must be made for items that either increase or decrease the availability of cash to the business UP s expert used a five-year average and a growth factor ( g ) Less tax depreciation Plus tax expense Less capital expenditures (reinvestment) Less disposed property Less working capital increase Court agree with UP s expert that no DIT (deferred income tax) adjustment was necessary Court rejected reliance on aggressive and speculative cash flow assumptions from a draft long range plan 15

16 Income Approach Discount Rate k Use of CAPM formula Court discussed estimates for risk free rate, beta, cost of equity, and discount rate 16

17 Leased Property Railroads lease a significant portion of their rolling stock Generally recognized method for capturing that value of leased operating property is to treat such property as if owned (1) disallow rent expense; (2) allow a depreciation expense; (3) recalculation of tax consequences; and (4) make an appropriate allowance for the capital expenditures that would be required to maintain and replace the property 17

18 Stock and Debt Approach Based on the basic balance sheet formula that assets equals liabilities plus stockholders equity UP did not present a stock and debt number Court accepted testimony that this approach typically understates or does not reliably capture that value of intangible property This method does not offer useful valuation estimates for railroad properties 18

19 Correlated System Value 1. Court relied on DCF income indicator 2. Court rejected reliance on yield cap indicator and stock and debt indicator 19

20 Intangible Assets Computer Software Utah has been the site of several significant cases concerning intangible property Intangible property is exempt in Utah Court accepted a deduction for custom computer software Court rejected the argument that no adjustment is necessary because the cost of development of software was not capitalized Court rejected argument that the valuation approach for intangibles must be the same as for the system value Court rejected argument that valuation was value in use rather than value in exchange 20

21 Intangible Assets Assembled Workforce Rejected this intangible deduction Not listed in the Utah code Not transferable Court acknowledged that there are decisions to the contrary 21

22 Locally-Assessed Vehicles Value of vehicles is captured in system value, but separately taxed Court accepted a market-to-book ratio to remove vehicles 22

23 Limitations on Valuation CSX Transportation, Inc. v. South Carolina 2006 South Carolina enacts the South Carolina Real Property Valuation Reform Act Act generally limits the permissible increase in appraised values of commercial and industrial real property to no more than 15% within a 5-year period ( the Cap ) Some exceptions e.g., sales Act excludes centrally-assessed taxpayers CSXT files Section 306 case in federal court CSXT proves that its real property valuation increased more than 50% in the applicable 5-year period 23

24 Limitations on Valuation (continued) CSX Transportation, Inc. v. South Carolina HELD: Judgment for defendant Section 306(1)(d) does not apply because the South Carolina Act does not impose a tax There was no proof of ratio disparities under Section 306(1)(a) Section 306(1)(d) not applicable to property taxes Court seems to acknowledge contrary opinions, e.g., BN v. Bair Court did not reach the various defenses raised by the State 24

25 Limitations on Valuation (continued) CSX Transportation, Inc. v. South Carolina HELD: Judgment for defendant (continued) Those defenses included the inability to break-out real property from the unit; justification ; the ACF defense CSXT has appealed to the Fourth Circuit 25

26 Equalization Do we all have a federal right to equality of taxation? The surprising answer - NO It is no violation of the federal equal protection clause of the 14th Amendment as long as there is some rational basis for the state treating one taxpayer differently than another. 26

27 So what is a reasonable basis for differentiating among taxpayers? U.S. Supreme Court has used the words palpably arbitrary or invidious to describe the kind of behavior the state must engage in to implicate the 14th Amendment. It is clear that states may classify different types of property differently and tax them either at different levels or at different rates. 27

28 So how do taxpayers become entitled to equal treatment? State Constitutions --- almost all state constitutions embody some provision for equal and uniform taxation. For example, the Texas Constitution states that taxation shall be equal and uniform. All real property and tangible personal property in this state shall be taxed in proportion to its value 28

29 How is the problem created? Local v. Central Assessment Early cases 29

30 How do we prove the level of assessment in the taxing jurisdiction? Sales assessment ratio studies are now the most widely used and accepted method of proving levels of assessment A ratio study compares appraisals to market values. Market value is taken to be the price at which a given property sells. Widely recognized by the assessing community and in their publications. 30

31 Property Appraisal and Assessment Administration edited by Joseph Eckert and published by the International Association of Assessing Officers. Standard on Ratio Studies, 2007 edition -- published by the International Association of Assessing Officers. 31

32 For an excellent description of sales ratio studies see Louisville & N.R. Co. v. Public Serv. Com n, Etc, 493 F. Supp. 162, M. D. Tennessee (1978) footnote 2 at 164 Early railroad, non-306 case Makes the point that taxpayers are entitled to some equalization even in a classification state. 32

33 How does one determine the sales price? Documentary stamps Affidavits of value Non-disclosure states 33

34 Is the sample of sales representative of the population as a whole? Basic theory Sales chasing or selective reappraisal 34

35 What does a sales ratio tell us? The average level of assessment How consistently well the assessor is valuing property The COD Is their assessment bias between low and high valued property? Price Related Differential 35

36 What is the average level of assessment? The mean The median The weighted average or the so-called ratio of the aggregates Merging data among numerous classes 36