ELK Hills Power, LLC v. Bd. of Equalization

• Decision Date: 12 August 2013
• Docket Number: S194121
• Parties: ELK HILLS POWER, LLC, Plaintiff and Appellant, v. BOARD OF EQUALIZATION et al., Defendants and Respondents.
• Court: California Supreme Court

ELK HILLS POWER, LLC, Plaintiff and Appellant, v. BOARD OF EQUALIZATION et al., Defendants and Respondents.

S194121

SUPREME COURT OF CALIFORNIA

Filed: August 12, 2013

Ct.App. 4 D056943

San Diego County

Super. Ct. No. 37-2008-

00097074-CU-MC-CTL

This case presents questions regarding how the State Board of Equalization (Board) may assess the value of an electric power plant for purposes of property taxation. The issue is complicated by the circumstance that, with exceptions not relevant here, assessors may not include the value of intangible assets and rights in the value of taxable property. (Cal. Const., art. XIII, § 2; Rev. & Tax. Code, §§ 110, 212; Roehm v. County of Orange (1948) 32 Cal.2d 280 (Roehm).) In this case, the power company purchased "emission reduction credits" (ERCs) — credits the company had to purchase to obtain authorization to construct the plant and to operate it at certain air-pollutant emission levels. All parties agree these ERCs constitute intangible rights for property taxation purposes. However, they dispute whether the Board improperly taxed the ERCs when it assessed the power plant. This dispute turns on our construction of Revenue and Taxation Codesection 110, subdivisions (d) and (e), and section 212, subdivision (c) (hereinafter sometimes sections 110(d), 110(e), and 212(c)).¹

Sections 212(c) and 110(d) prohibit the direct taxation of certain intangible assets and rights, including the ERCs in this case. However, in assessing taxable property under section 110(e), the Board may "assum[e] the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use." The key issue is whether section 110, subdivisions (d) and (e) are mutually exclusive provisions, as the Court of Appeal held, or whether they can be applied together. We conclude that subdivisions (d) and (e) can be applied together. Resolution of this issue determines the validity of the Board's assessment of the power plant.

In this case, the Board used two methods of assessing the power plant, a replacement cost method and an income approach. With the replacement cost method, the Board estimated the cost of replacing the assets of the power plant. (Cal. Code Regs., tit. 18, § 6.) Because ERCs are necessary to put the power plant to beneficial use, the Board included the estimated cost of replacing the ERCs when it valued the plant. The issue is whether the Board may include the estimated cost of replacing the ERCs in using the replacement cost method. We conclude that the Board directly and improperly taxed the power company's ERCs when it added their replacement cost to the power plant's taxable value.

With the income approach, the Board estimated the amount of income the property is expected to yield over its life and determined the present value of that amount. (Cal. Code Regs., tit. 18, § 8.) The issue is whether the Board was required to attribute a portion of the plant's income stream to the ERCs and deductthat value from the overall income estimate prior to taxation. We conclude that the Board was not required to deduct a value attributable to the ERCs under an income approach. There was no credible showing that there is a separate stream of income related to enterprise activity or even a separate stream of income at all that is attributable to the ERCs in this case.

I. FACTS AND PROCEDURAL HISTORY

Elk Hills Power, LLC (Elk Hills), is a Delaware limited liability company that owns and operates an independent electric power plant in Kern County. Elk Hills brought this action under section 5148, subdivision (a), to recover property taxes paid to the County of Kern (County) during the five-year period from 2004 and 2008. Elk Hills alleged that the County improperly added an increment of value to Elk Hills's tax assessment that directly and impermissibly taxed its ERCs. Elk Hills had purchased these ERCs to gain authorization to construct the power plant and to operate it at specified emission levels.

In 1999, Elk Hills had applied for a permit to construct and operate a power plant in Tupman, California. Tupman is in the jurisdiction of the San Joaquin Valley Unified Air Pollution Control District (District), which ensures that proposed pollution sources comply with state air quality regulations. The California Clean Air Act of 1988 (Stats. 1988, ch. 1568, p. 5634) (California Clean Air Act) requires local air quality districts "to achieve and maintain the state and federal ambient air quality standards . . . and . . . enforce all applicable provisions of state and federal law." (Health & Saf. Code, § 40001, subd. (a).) In the San Joaquin Valley, the District's air quality rules forbid "net increases in emissions above specified thresholds from new and modified Stationary Sourcesof all nonattainment pollutants." (Rules & Regs. of the San Joaquin Valley Unified Air Pollution Control Dist., rule 2201, § 1.2.)²

The District has also implemented an emission offset system to allow for the development of new pollution sources in compliance with local and federal mandates. (Health & Saf. Code, § 40709; Rule 2301.) Under the emission offset system, preexisting pollution sources that voluntarily reduce their emissions below the levels required by law are eligible to receive ERCs. Once ERCs are certified by the District, they can be sold to other emission sources for profit or banked for future use. (Health & Saf. Code, § 40709; Rule 2301.) The District requires new pollution sources to purchase ERCs to offset future emissions before it will issue an "authority to construct" document. (Pub. Resources Code, § 25523, subd. (d)(2); Rule 2201, § 4.5.) The use of surplus emission reductions, or credits, ensures the accommodation of economic growth without further increasing air emissions above the authorized levels of pollution (i.e., the "baseline" or "cap") for the air quality region. (See Health & Saf. Code, § 40709, subd. (b), added by Stats. 1979, ch. 1111, § 1, pp. 4044-4045; State Air Resources Bd., Enrolled Bill Rep. on Sen. Bill No. 847 (1979-1980 Reg. Sess.) Sept. 25, 1979, p. 2.)

Here, the District required Elk Hills to purchase five ERCs at an approximate cost of $11 million to offset the plant's projected emissions of nitrogen oxides, sulfur oxides, and volatile organic compounds. The purchased ERCs authorized Elk Hills to produce electricity at a continuous capacity of 500 megawatts of power. Elk Hills "surrendered" its ERCs to the District in 2003 and began producing electricity at specified levels.

The Board used two different methods of unit valuation, the replacement cost approach and the income capitalization approach, to calculate the unitary value of the plant. Power plants are valued using a system called unit taxation. (ITT World Communications, Inc. v. City and County of San Francisco (1985) 37 Cal.3d 859, 863-864.) The purpose of unit taxation is to capture the entire real value of the property when all of its component parts are considered together (i.e., as a unit), as opposed to valuing the component parts in isolation or at scrap value. (Id. at p. 863.) "It has long been recognized that 'public utility property cannot be regarded as merely land, buildings, and other assets. Rather, its value depends on the interrelation and operation of the entire utility as a unit.' " (Ibid.) "Unit taxation prevents real but intangible value from escaping assessment and taxation by treating public utility property as a whole." (Ibid.)

For the taxable years from 2004 to 2008, the Board used the replacement cost approach to assess the unit value of the plant. Under the replacement cost approach, the tax assessor values the property "by applying current prices to the labor and material components of a substitute property capable of yielding the same services and amenities" and then applying a depreciation factor to arrive at a taxable base value. (Cal. Code Regs., tit. 18, § 6.) For all five years in question, the Board added a site-specific adjustment to account for the average replacement cost of the plant's ERCs. Elk Hills claimed that these annual additions directly and improperly assessed its ERCs.

For the taxable years from 2006 to 2008, the Board also used the income capitalization approach to assess the unit value of the plant.³ Using the incomeapproach, an appraiser "estimates the future income stream a prospective purchaser could expect to receive from the enterprise and then discounts that amount to a present value by use of a capitalization rate." (GTE Sprint Communications Corp. v. County of Alameda (1994) 26 Cal.App.4th 992, 996 (GTE Sprint); see also Cal. Code Regs., tit. 18, § 8.) In other words, the fair market value of an income producing property is estimated as the present value of the property's expected future income stream. (See Union Pacific R.R. Co. v. State Bd. of Equalization (1989) 49 Cal.3d 138, 148.) " 'The income approach may be called the capitalization method because capitalizing is the process of converting an income stream into a capital sum.' " (Ibid.) Elk Hills claimed that the Board improperly taxed its ERCs because it failed to attribute a portion of the plant's income stream to the ERCs and deduct that value from the plant's projected income stream prior to taxation.

During the property tax refund litigation, the parties filed cross-motions for summary judgment. Finding no triable issues of fact, the trial court denied Elk Hills's motion for summary judgment and granted summary judgment for the Board and the County. The trial court found, in accordance with the parties' stipulation, that ERCs are intangible rights. It then determined that because ERCs are "intangible attributes of real property," they are subject to assessment under section 110, subdivision (f) (section 110(f)).

The Court of Appeal affirmed the trial court's rulings on a different ground. It held that section 110, subdivisions (d) and (e) are mutually exclusive...