Fall River County v. S. DAK. DEPT. OF REV., 20883.

• Citation: 1999 SD 139,601 N.W.2d 816
• Decision Date: 27 October 1999
• Docket Number: No. 20883.,20883.
• Parties: FALL RIVER COUNTY, a political subdivision of the State of South Dakota, Plaintiff and Appellant, v. SOUTH DAKOTA DEPARTMENT OF REVENUE and Burlington Northern Santa Fe Railroad Company, Defendants and Appellees, and the Counties of Beadle, Brown, Clark, Codington, Corson, Custer, Day, Edmunds, Grant, Hamlin, Kingsbury, Lake, Marshall, Minnehaha, Perkins, Roberts, and Walworth, political subdivisions, for themselves and on behalf of all municipalities, school districts, townships and any and all other public taxing districts and governmental subdivisions located therein, Defendants.
• Court: Supreme Court of South Dakota

601 N.W.2d 816

1999 SD 139

FALL RIVER COUNTY, a political subdivision of the State of South Dakota, Plaintiff and Appellant, v. SOUTH DAKOTA DEPARTMENT OF REVENUE and Burlington Northern Santa Fe Railroad Company, Defendants and Appellees, and the Counties of Beadle, Brown, Clark, Codington, Corson, Custer, Day, Edmunds, Grant, Hamlin, Kingsbury, Lake, Marshall, Minnehaha, Perkins, Roberts, and Walworth, political subdivisions, for themselves and on behalf of all municipalities, school districts, townships and any and all other public taxing districts and governmental subdivisions located therein, Defendants.

No. 20883.

Supreme Court of South Dakota.

Argued September 14, 1999.

Decided October 27, 1999.

James Sword, Fall River County State's Attorney, Hot Springs, South Dakota, for plaintiff and appellant Fall River County.

Mark Barnett, Attorney General, David D. Wiest, Assistant Attorney General, Pierre, South Dakota, for defendant and appellee South Dakota Department of Revenue.

Mark F. Marshall, Johnson, Heidepriem, Miner, Marlow & Janklow, Sioux Falls, South Dakota, Richard A. Malm, Dickinson, Mackaman, Tyler & Hagen, Des Moines, Iowa, for defendant and appellee Burlington Northern Santa Fe Railroad Company.

SABERS, J.

[¶ 1.] Fall River County (County) appeals the 1997 tax assessment of Burlington Northern & Santa Fe Railway Company (BNSF) by the South Dakota Department of Revenue (DOR). We affirm.

FACTS

[¶ 2.] BNSF is an interstate railroad company which is the entity being evaluated for tax purposes herein. BNSF was created on December 31, 1996 by merging Burlington Northern Railroad Company (BNRR) and Atchison, Topeka and Santa Fe Railway Company (ATSF). See Fall River County v. SD Dept. of Rev. & BNRR, # 20886, a similar case relating to the valuation of predecessor, BNRR, for the 1996 tax year, which is being affirmed and expedited simultaneously. For the County's appeal of the 1993 assessment, see Fall River County v. SD Dept. of Rev., 1996 S.D. 106, 552 N.W.2d 620.

[¶ 3.] The parent companies of BNRR and ATSF were Burlington Northern, Incorporated (BNI) and Santa Fe Pacific Corporation (SFPC), respectively. BNI and SFPC agreed to merge in 1994 knowing it would take two years to complete. On September 22, 1995, BNI and SFPC formed a separate corporation, the Burlington Northern Santa Fe Corporation. The merger was accomplished through a stock swap where the BNI stock was traded one share for one share in the new entity, while SFPC stock was traded approximately four-tenths of a share for one share in the new entity. On February 1, 1996, this new holding company, Burlington Northern Santa Fe Corporation, was the owner of BNI and SFPC. In turn, BNI owned BNRR, while SFPC owned ATSF.

[¶ 4.] On December 30, 1996, BNI merged with SFPC. On December 31, 1996, ATSF merged with BNRR creating a new railroad named Burlington Northern Santa Fe Railway Company (BNSF).¹ On January 1, 1997, BNSF was owned by SFPC. SFPC was owned by Burlington Northern Santa Fe Corporation. As indicated, BNSF is the entity being evaluated for tax purposes herein.

[¶ 5.] On January 1, 1997, BNSF owned railroad operating property in 18 counties in South Dakota. Pursuant to SDCL 10-28-1, all railroad operating property within the state is subject to tax assessment. The assessment process requires valuing the railroad operating property as a total unit, allocating a proportionate value to the state, and then distributing the taxable value among local taxing jurisdictions. SDCL 10-28-9, -12, -16. Thus, the railroad property is assessed centrally by DOR, but is taxed by local jurisdictions. SDCL 10-28-21.

[¶ 6.] Brad Blinsmon is a property tax specialist employed by DOR to determine the value of centrally assessed properties located within South Dakota on assessment date, January 1 of each year. He has been performing central assessments since September of 1990 and completes approximately fifty central assessments per year. The trial court found that "he is an expert in the area of the central assessment of property."² Furthermore, the trial court specifically stated:

The Court considers Mr. Blinsmon to be well qualified as an expert by reason of his education, experience, and training to perform appraisals of railroads and utilities. This Court finds him to be a particularly conscientious, credible, and unbiased witness on unit valuation. Considering each expert's demeanor and motivation in this case, the Court finds Mr. Blinsmon's opinion of value much more persuasive and credible than that of Dr. Ifflander.

[¶ 7.] The 1997 assessment of BNSF was difficult due to the fact that it was a new railroad without historical financial information of its own. Pursuant to SDCL 10-28-3, Blinsmon requested information from BNSF to assist him in his assessment. He prepared a preliminary valuation, which reflected a correlated value of $10 billion. Blinsmon then had a meeting, authorized by SDCL 10-28-15, with BNSF's tax representative, Alan Annis, on July 15, 1997. Annis provided additional information to Blinsmon to consider in his valuation. Annis also offered his opinion as to BNSF's value: $7,186,000,000.

[¶ 8.] Pursuant to statute, Blinsmon considered three approaches in his assessment process: the income approach, the cost approach, and the market approach.

[¶ 9.] Under the income approach, a single year's normal net railway operating income (NROI) is capitalized by the cost of capital (capitalization rate). First, the cost of capital is calculated by using a comparison of equity to debt. Initially, Blinsmon found the equity component to be 62% and the debt component to be 38%, which reflects a capitalization rate of 11.37%. On April 21, 1997, Blinsmon altered the equity to debt comparison to 70/30, making the final capitalization rate 11.94%. Second, BNSF's normal income is determined. Traditionally, DOR uses five years of net railway operating income (NROI) to determine this. However, BNSF was a new entity and the NROI information for the previous five years was not available. Therefore, Blinsmon used the NROI of BNRR and ATSF, the predecessor railroads to BNSF. Special charges, accruals made in advance of the expenditure of money, were incurred by both BNRR and ATSF in those five years. These special charges, which lowered the net income, made it difficult to forecast the normal income of BNSF. BNSF provided "normalized" income information for both BNRR and ATSF; the special charges were added back in and the actual cash expenditures were deducted in the year the expenditures were actually made. Blinsmon calculated a three-year average NROI of $806,466,000, a five-year average of $655,454,600, and a weighted three-year average of $847,471,333. Blinsmon exercised "appraiser's judgment" and found the normal income of BNSF to be $850 million. This normal income, $850 million, was capitalized at 11.94% to yield an income indicator of value of $7,118,927,973.20.

[¶ 10.] In the cost approach, the value of the property is the replacement cost. The assessor determines the book value of all operating property from the balance sheet and deducts physical, functional and economic depreciation. Blinsmon found that the purchase accounting method was used in the merger. Purchase accounting is an accounting procedure used when property is acquired at a price higher than the book value of the property. Here, BNI, the holding company of BNRR, acquired SFPC, the holding company of ATSF, in a complicated merger that was completed, in large part, through a swap of stock. The merger required the accountants of ATSF to inflate the book value of some of ATSF assets to match the merger "price." This inflated price was carried over to BNSF's books. It also appeared that some of ATSF's assets were deflated in value. The book value of BNRR's assets, however, were neither inflated nor deflated. This method of purchase accounting resulted in a book value of the ATSF assets above the book value of the BNRR assets, even though BNRR was the larger railroad before the merger.

[¶ 11.] The transaction "price" of the merger was approximately $4.5 billion, but the ATSF assets were written up to $9 billion. Purchase accounting had a substantial effect on the book values of BNSF. Blinsmon excluded the purchase accounting impact and determined the net book value of BNSF's plant to be $12,739,034,534. Materials, supplies and non-capitalized leases³ were added and book depreciation was subtracted to arrive at a net book value of all BNSF's operating property, either owned or leased, of $14,828,142,803. After physical, functional and economic obsolescence was calculated and subtracted, Blinsmon determined BNSF's cost indicator of value to be $6,880,059,559.⁴

[¶ 12.] The market approach compares the selling price of property for cash with the subject property to determine the fair market value. Because comparable sales of railroad properties rarely occur, this approach is not used. Alternatively, the stock and debt approach is used which is based on the accounting principle of "assets equal debt plus owner's equity." The first step is to determine the value of the stock of the company being appraised. On the legal assessment date, BNSF's stock was not publicly traded. Therefore, Blinsmon had to determine the value of the stock of the holding company, Burlington Northern Santa Fe Corporation. As of January 1, 1996, the market value of Burlington Northern Santa Fe Corporation's equity was $12,762,142,922. The next step required Blinsmon to determine the value of long and short-term debt of the holding company. Long term debt was $4,546,000,000 and short term debt was $2,311,000,000. These three figures were added to determine the holding company's total value of $19,619,142,922. Then Blinsmon allocated a percentage of this total to BNSF by using the asset method of allocation. Blinsmon concluded that the allocated total stock and debt value for BNSF was...