Mesquite Power, LLC v. Ariz. Dep't of Revenue

• Decision Date: 20 December 2022
• Docket Number: 1 CA-TX 22-0002
• Citation: 86 Arizona Cases Digest 4,523 P.3d 960
• Parties: MESQUITE POWER, LLC, Plaintiff/Appellee, v. ARIZONA DEPARTMENT OF REVENUE, Defendant/Appellant.
• Court: Arizona Court of Appeals

86 Arizona Cases Digest 4

523 P.3d 960

MESQUITE POWER, LLC, Plaintiff/Appellee,

v.ARIZONA DEPARTMENT OF REVENUE, Defendant/Appellant.

No. 1 CA-TX 22-0002

Court of Appeals of Arizona, Division 1.

Filed December 20, 2022

Mooney, Wright, Moore & Wilhoit, PLLC, Mesa, By Paul J. Mooney (argued) and Bart S. Wilhoit, Counsel for Appellee

Arizona Attorney General's Office, Phoenix, By Lisa Neuville (argued) and Kimberly Cygan, Counsel for Appellant

Judge Paul J. McMurdie delivered the Court's opinion, in which Presiding Judge Brian Y. Furuya and Judge Jennifer B. Campbell joined.

McMURDIE, Judge:

¶1 The Arizona Department of Revenue ("Department") appeals from the tax court's judgment reducing the full cash value of property held by Mesquite Power, LLC ("Mesquite") for the 2019 tax year. The Department argues the tax court erred by (1) discounting the impact of an established power purchase agreement on the property's value and (2) considering incompetent expert testimony.

¶2 We hold that where intangible assets enhance the real and tangible property's value, a competent appraisal must consider the effect such intangible assets have on the taxable property's value. Thus, we vacate the judgment, vacate the award of attorney's fees, costs, and expenses, and remand for the court to affirm the statutory value found by the Department.

FACTS AND PROCEDURAL BACKGROUND

¶3 The heart of this dispute is Mesquite's power plant's full cash value assessment for the 2019 tax year. At issue is whether the existence of an intangible agreement enhances the value of the real and tangible personal property subject to the tax assessment.

1. Mesquite's Power Plant.

¶4 Mesquite's power plant is one-half of a two-block, combined-cycle, natural gas-fired electric generation facility in western Maricopa County. It operates as a "base load plant," meaning it runs continuously. The plant sells the electricity it generates on the open market as a "merchant plant."

¶5 A power plant's capacity is measured in megawatts. The plant has a nameplate capacity of 691.6 megawatts and a net operating capacity of 625 megawatts. Another metric, called "heat rate," confirms how efficiently a plant converts fuel into energy. The plant's historical heat rates are superior to the average for comparable facilities in the region and across the United States.

2. Transaction History.

¶6 Sempra U.S. Gas & Power ("Sempra") built the plant in 2003. Sempra structured the plant and its accompanying business as Mesquite. In 2015, Sempra sold Mesquite to ArcLight Capital Partners, LLC ("ArcLight") for nearly $357 million.

¶7 ArcLight spent over $27 million in capital improvements for the plant. In December 2017, less than a month before the January 1 valuation date¹ for the 2019 tax year, ArcLight solicited offers for the sale of Mesquite. Southwest Generation Operating Company ("Southwest") first offered $518 million, and the deal closed in July 2018 for around $556 million. Southwest currently owns Mesquite.

3. The Purchase Agreement.

¶8 Southwest's purchase of Mesquite from ArcLight included transferring a contract for power generation ("Purchase Agreement"). Under the Purchase Agreement, Mesquite guaranteed the Southwest Public Power Resources Group ("SPPR") access to 271 megawatts of electrical capacity until May 2021, when the capacity increased to 475 megawatts. In return, SPPR promised to pay Mesquite $34 million per year, rising to $48 million per year in 2022, as well as certain operation and maintenance costs for the plant. SPPR's payments are fixed whether SPPR draws upon any guaranteed electrical capacity. The terms of the Purchase Agreement run through 2046. Both before and after the purchase by Southwest, Mesquite remains bound by the Purchase Agreement.

¶9 The Purchase Agreement does not require that Mesquite provide electricity to SPPR from the Mesquite plant. If it chooses, Mesquite may purchase power on the open market to cover the capacity guarantee to SPPR. Although technically the Purchase Agreement and the plant are severable, any such severance would require approval by SPPR. According to Southwest's vice president, the presence of the Purchase Agreement was a deciding factor in purchasing the property.

4. Litigation History.

¶10 This is not the first time Mesquite has appeared before the tax court. While still under the ownership of ArcLight, Mesquite challenged the Department's valuation of the property for the 2016 and 2017 tax years. The tax court issued a consolidated judgment in Mesquite's favor, establishing reduced property values for those years and finding that the Purchase Agreement was a "non-taxable, intangible asset." The Department did not appeal that judgment.

¶11 In this case, the Department valued the property for the 2019 tax year at $196 million ("statutory value"). Mesquite appealed that assessment to the tax court, claiming that the statutory value exceeded the property's market value in violation of A.R.S. § 42-11001(6). Mesquite argued that the property's full cash value should be reduced to $105 million.

¶12 Before the tax court, Mesquite moved for partial summary judgment on whether the Purchase Agreement could be considered in the property's valuation. Mesquite asserted that the 2016–17 rulings estopped the Department from considering the Purchase Agreement. The Department, in turn, argued that while the Purchase Agreement was not taxable, its existence enhanced the value of the taxable property and should be considered in determining value. The tax court entered partial summary judgment for Mesquite, ruling that the Purchase Agreement is a "non-taxable, intangible asset that is separate and severable from the tangible property." The court partially denied the motion about "whether cash flows attributable to the Purchase Agreement can be considered as part of the valuation of Mesquite's property." The court did not address the cash flow issue in its final judgment.

¶13 At trial, Mesquite offered expert testimony supporting its $105 million evaluation claim. The Department offered expert testimony valuing the property at $432 million. Each expert considered the three standard appraisal methods (market,² income, and cost), although Mesquite's expert gave no weight to the cost or market approaches. Only the Department's evaluation included the "cash flows attributable" to the Purchase Agreement. Mesquite's expert, instead, constructed a hypothetical income model that excluded the Purchase Agreement income.

¶14 After a five-day bench trial, the tax court ruled for Mesquite, valuing the property at $105 million for the 2019 tax year. The Department appealed, and we have jurisdiction under A.R.S. §§ 12-2101(A)(1) and 42-1254(D)(4).

DISCUSSION

¶15 "We view the facts in the light most favorable to sustaining the trial court's judgment." Cimarron Foothills Cmty. Ass'n v. Kippen , 206 Ariz. 455, 457, ¶ 2, 79 P.3d 1214, 1216 (App. 2003) (quoting Sw. Soil Remediation, Inc. v. City of Tucson , 201 Ariz. 438, 440, ¶ 2, 36 P.3d 1208, 1230 (App. 2001) ). We will "defer to the trial court's factual findings as long as the record supports them."

In re the Gen. Adjudication of All Rts. to Use Water in the Gila River Sys. & Source , 198 Ariz. 330, 337, ¶ 15, 9 P.3d 1069, 1076 (2000). We review pure questions of law and mixed questions of law and fact de novo. See Robson Ranch Mountains, LLC v. Pinal County , 203 Ariz. 120, 125, ¶ 13, 51 P.3d 342, 347 (App. 2002).

¶16 When challenging the statutory value, the taxpayer must rebut the statutory presumption and show that a lower valuation is correct. See Graham County v. Graham County Elec. Coop., Inc. , 109 Ariz. 468, 469–70, 512 P.2d 11, 12-13 (1973).

¶17 Arizona values property at its "full cash value" for tax purposes. Bus. Realty of Ariz., Inc. v. Maricopa County , 181 Ariz. 551, 553, 892 P.2d 1340, 1342 (1995). "Full cash value" generally means "fair market value," defined as "that amount at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts." Id. Fair market value can be derived by using "standard appraisal methods and techniques." A.R.S. § 42-11001(6).

¶18 "Current usage shall be included in the formula for reaching a determination of full cash value." A.R.S. § 42-11054(C)(1). "The valuation of electric generation facilities," like the property here, is determined by looking at, among other things, "[t]he value of land, .... [t]he valuation of real property improvements used in operating the facility, .... [and the] valuation of personal property used in operating the facility." A.R.S. § 42-14156(A)(1)–(3). " ‘Personal property’ means all tangible property except for land and real property improvements." A.R.S. § 42-14156(B)(2).

A. Mesquite Misattributes Value to the Purchase Agreement.

¶19 The parties agree that Southwest bought Mesquite—including real and personal property and the Purchase Agreement—for about $556 million. Mesquite's expert appraised the tangible property at $105 million. Though there was no appraisal for Mesquite's intangible property, it follows from the sale price that, as of the time of Southwest's purchase, Southwest valued Mesquite's intangible property (which includes the Purchase Agreement) at more than $400 million.

¶20 Although Mesquite did not separately appraise the value of the Purchase Agreement, the Department argues that the Purchase Agreement has little to no independent value. The Department also contends, however, that the Purchase Agreement's presence enhances the value of the real and tangible property of the plant.

¶21 The Purchase Agreement is a contract to provide electricity to SPPR in exchange for SPPR paying Mesquite a fixed annual rate and operational costs. But the Purchase Agreement itself does not represent or evidence the value of these transactions. If the Purchase Agreement no longer existed, it would change nothing about...