Watson Cogeneration v. County

• Decision Date: 05 June 2002
• Docket Number: No. B147752.,B147752.
• Parties: WATSON COGENERATION COMPANY, Plaintiff and Appellant, v. COUNTY OF LOS ANGELES, Defendant and Respondent.
• Court: California Court of Appeals Court of Appeals

120 Cal.Rptr.2d 421

98 Cal.App.4th 1066

WATSON COGENERATION COMPANY, Plaintiff and Appellant, v. COUNTY OF LOS ANGELES, Defendant and Respondent.

No. B147752.

Court of Appeal, Second District, Division 4.

June 5, 2002.

Morrison & Foerster, Thomas H. Steele, Peter B. Kanter, San Francisco, and Pilar M. Sansone for Plaintiff and Appellant.

Rodi, Pollock, Pettker, Galbraith & Cahill, C. Stephen Davis and Cris K. O'Neall, Los Angeles, for Independent Energy Producers Association as Amicus Curiae on behalf of Plaintiff and Appellant.

Lloyd W. Pellman, County Counsel and Albert Ramseyer, Principal Deputy County Counsel for Defendant and Respondent.

EPSTEIN, Acting P.J.

In this case, we conclude it was proper for the Los Angeles County Assessor to consider the actual income stream resulting from an above-market price, government-facilitated power purchase agreement in the property tax valuation of an independent power plant developed and operating under that agreement. For this reason, we affirm the judgment in favor of the County of Los Angeles (County).

FACTUAL AND PROCEDURAL SUMMARY

Appellant is Watson Cogeneration Company, an independent power producer which owns and operates a cogeneration power facility located within Atlantic Richfield Company's Los Angeles Refinery in Carson. The facility was developed as a "qualifying facility" in accordance with the Public Utility Regulatory Policies Act of 1978 (16 U.S.C. § 796 et seq.), a federal legislative scheme intended to encourage the development of cogeneration and small power production facilities. The rules promulgated by the Federal Energy Regulatory Commission as part of this program required utilities to purchase electric energy from a qualifying facility at the utility's avoided cost. This is the cost the utility would have incurred had it generated the electricity itself—the construction cost plus the operating costs.

To assist in the implementation of this federal legislation, the California Public Utilities Commission (PUC) approved a series of "standard offer contracts" which contained standardized terms for the utilities' purchase of power from qualifying facilities. The standard offer contracts were intended to overcome the disparities in bargaining power between the utilities and the qualifying facilities by approving standardized terms for the sales. A qualifying facility which met the terms of a standard offer contract would be assured of selling its output to a public utility, and the utility would be assured that the PUC would approve passing along the cost of the purchased energy to its ratepayers.

Most of the standard offer contracts were long term. The energy prices in these contracts were based on forecasts of future market prices for fuel. Because some assumptions underlying the avoided cost structure were not borne out by subsequent events, the pricing of certain standard offer contracts exceeded the market price eventually established for electricity.

In 1984, before appellant Watson built its qualifying facility, it entered into a modified version of a Standard Offer 2 contract with Southern California Edison. This was a long-term contract, running from April 1988 to April 2008, providing for fixed capacity payment, capacity bonus payments, and avoided-cost energy pricing. It is undisputed that as of the lien date for tax year 1997, this power purchase agreement provided Watson with above-market prices for its output.

Watson's cogeneration facility was assessed by the Los Angeles County Tax Assessor for tax year 1997. Watson paid the tax, then filed an application with the Los Angeles County Assessment Appeals Board (Board) for refund of $2,491,343.30, claiming the tax assessment should not have included the full value of its power purchase agreement because that favorable contract is an intangible asset exempt from property taxation. The Board denied Watson's application, and the Los Angeles County Board of Supervisors denied Watson's subsequent claim for refund.

Watson then brought this action against the County for tax refund. The parties filed cross-motions for summary judgment. After oral argument and additional briefing, the trial court granted the County's motion for summary judgment. Watson appeals from the judgment.

DISCUSSION

Watson argues that its contract is an intangible asset exempt from property tax, and claims the County improperly included it as taxable property in its assessment. Under the California Constitution, "All property is taxable and shall be assessed at the same percentage of fair market value." (Cal. Const., art. XIII, § 1.) For purposes of property taxation, fair market value is "the amount of cash or its equivalent that property would bring if exposed for sale in the open market under conditions in which neither buyer nor seller could take advantage of the exigencies of the other and both the buyer and the seller have knowledge of all of the uses and purposes to which the property is adapted and for which it is capable of being used and of the enforceable restrictions upon those uses and purposes." (Rev. and Tax.Code, former § 110, subd. (a).)¹

Article XIII, section 2 of the Constitution gives the Legislature authority to exempt certain property from taxation. Accordingly, section 212, subdivision (c) provides that "the value of intangible assets and rights shall not enhance or be reflected in the value of taxable property." But subdivision (c) also provides that "[T]axable property may be assessed and valued by assuming the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use." (See also § 110, subds. (d) & (e).)

In accordance with this exemption, California decisions have held that assets such as copyrights, liquor licenses, airport car rental concessions, ballpark food concessions, and cable television franchises are intangible rights which cannot be directly subjected to property tax assessment. (See, e.g., Michael Todd Co. v. County of Los Angeles (1962) 57 Cal.2d 684, 693, 21 Cal.Rptr. 604, 371 P.2d 340; Roehm v. County of Orange (1948) 32 Cal.2d 280, 290, 196 P.2d 550; Shubat v. Sutter County Assessment Appeals Bd. (1993) 13 Cal. App.4th 794, 803-505, 17 Cal.Rptr.2d 1; Comity of Los Angeles v. County of Los Angeles Assessment Appeals Bd. (1993) 13 Cal.App.4th 102, 112-113, 16 Cal.Rptr.2d 479; County of Stanislaus v. Assessment Appeals Bd. (1989) 213 Cal.App.3d 1445, 1453-1454, 262 Cal.Rptr. 439.) But while "intangible property is exempted from direct property taxation, the courts in this state have repeatedly held that the value of such intangible property may be included in the valuation of otherwise taxable tangible property." (GTE Sprint Communications Corp. v. County of Alameda (1994) 26 Cal.App.4th 992, 1002, 32 Cal. Rptr.2d 882; Shubat v. Sutter County Assessment Appeals Bd., supra, 13 Cal. App.4th at p. 804, 17 Cal.Rptr.2d 1; County of Stanislaus v. Assessment Appeals Bd., supra, 213 Cal.App.3d at pp. 1454-1455, 262 Cal.Rptr. 439; see also County of Orange v. Orange County Assessment Appeals Bd. (1993) 13 Cal.App.4th 524, 534, 16 Cal.Rptr.2d 695.) That is what was done in this case.

The California State Board of Equalization Assessors Handbook² explains the interaction of these two concepts: "Even though intangible assets and rights are not subject to taxation, the second fundamental principle states that tangible property should nonetheless be assessed and valued by assuming the presence of those intangible assets and rights that are necessary to put the tangible property to beneficial or productive use. Under this principle, an appraiser valuing tangible property must assume the presence of any intangible assets or rights necessary to the beneficial or productive use of the property being valued. The `beneficial or productive use' is equivalent to the highest and best use of the property." (State Bd. of Equalization, Assessors' Handbook—Treatment of Intangible Assets and Rights (1998) p. 150; see also Pacific Mutual Life Ins. Co. v. County of Orange (1985) 187 Cal.App.3d 1141, 1148, 232 Cal.Rptr. 233 [The "highest and best use of property" is a factor in determining market value.]; CAT Partnership v. County of Santa Cruz, supra, 63 Cal.App.4th 1071, 1085, 74 Cal.Rptr.2d 652 [land should "be valued at its highest and best use subject to the condition that the use be one which is legally permissible."].)

The choice of valuation method resides in the assessor, subject to review by the Board and the courts. (Kaiser Center, Inc. v. County of Alameda (1987) 189 Cal. App.3d 978, 984, fn. 4, 234 Cal.Rptr. 603.) In this case, the assessor used the income approach for determining fair market value.³ The income approach is defined as "[t]he amount that investors would be willing to pay for the right to receive the income that the property would be expected to yield, with the risks attendant upon its receipt." (Cal.Code Regs., tit. 18, § 3, subd. (e).) "Using the income approach, an appraiser values an income property by computing the present worth of a future income stream. This present worth depends upon the size, shape, and duration of the estimated stream and upon the capitalization rate at which future income is discounted to its present worth." (Cal.Code Regs., tit. 18, § 8, subd. (b).) The net earnings to be capitalized are not those of the current owner, but those that a prospective purchaser would anticipate. (De Luz Homes, Inc. v. County of San Diego (1955) 45 Cal.2d 546, 566, 290 P.2d 544.)

Watson does not claim that it was improper to use the income approach. It argues the income approach was improperly applied, because the assessor did not remove the value of the power purchase agreement, an intangible asset, from the assessment. According to Watson: "The issue in this case is whether the Assessor can tax Watson's property based not upon the fair market value of that property, but upon income Watson receives by...