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Elk Hills Power, LLC v. Board of Equalization et al

May 10, 2011


APPEAL from a judgment of the Superior Court of San Diego County, Ronald L. Styn, Judge. (Super. Ct. No. 37-2008-00097074- CU-MC-CTL)

The opinion of the court was delivered by: Huffman, Acting P. J.



This action for refund of property taxes and for declaratory relief was brought by an owner-operator of an independent electric power plant, plaintiff and appellant Elk Hills Power, LLC (Elk Hills), against defendant California State Board of Equalization (the Board), and the County of Kern (the County, where the plant is located), for taxes paid from 2004 to 2008. As a state assessee, Elk Hills sued the defendants under California Revenue and Taxation Code section 5148, subdivision (a).*fn1 Elk Hills's major claim of entitlement to refunds relates to the application of section 110, which provides definitions and guidelines for determining the "full cash value" or "fair market value" of assessed property, including, as relevant here, the treatment of intangible rights relating to "the uses and purposes to which the property is adapted and for which it is capable of being used," and relating to "the enforceable restrictions upon those uses and purposes." (§ 110, subd. (a).)

Specifically, in order to construct and operate its independent electric power plant (the power plant), Elk Hills purchased and applied certain emission reduction credits (ERCs), pursuant to Health and Safety Code section 40709, with the approval of regulatory authorities. Such credits are part of a statutory scheme allowing the issuing, applying, deploying, trading, banking, and/or refunding of interchangeable air pollution ERCs, among regulatory authorities and power plant operators (also known as "emissions sources"), to enable a plant owner to suitably operate its power plant, in terms of its selection of the available technology and compliance with regulatory limits on pollution. (Health & Saf. Code, §§ 40709-40913; for regulations implementing § 40709, see Cal. Code Regs., tit. 17, § 91500 et seq.)

According to Health and Safety Code section 40709, subdivision (b), this ERC system "is not intended to recognize any pre-existing right to emit air contaminants, but to provide a mechanism for [regulatory] districts to recognize the existence of reductions of air contaminants that can be used as offsets, and to provide greater certainty that the offsets shall be available for emitting industries." (Ibid.) Once this power plant went into operation, it began to utilize Elk Hills's deployed ERCs, and it will continue to do so while it operates at its current level, to continue its compliance with state emissions requirements. (Pub. Resources Code, § 25000 et seq., the Warren-Alquist State Energy Resources Conservation and Development Act.)

Beginning in 2004, when the Board assessed Elk Hills's power plant on a unitary basis, it utilized two valuation approaches, a replacement cost approach and an income analysis. (ITT World Communications, Inc. v. City and County of San Francisco (1985) 37 Cal.3d 859 (ITT).) With respect to each approach, it considered the value added to the power plant by the ERCs, in their nature as intangible rights that contributed to the productivity and value of the power plant property. (§ 110, subd. (e) ["Taxable 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."].)

On appeal, Elk Hills contends the trial court misinterpreted section 110, when granting the Board's motion for summary judgment and denying the cross-motion of Elk Hills. In applying section 110, the trial court drew certain conclusions from the undisputed facts to determine that (1) when Elk Hills purchased and applied the ERCs for construction and operation of its power plant, the ERCs represented intangible rights that relate directly to the power plant real property, and therefore section 110, subdivision (f) applied;*fn2 (2) since those ERCs are not transferable while the plant is operating in accordance with the way it was built, the ERCs were necessary to lawfully operate the power plant in accordance with state emissions requirements (§ 110, subd. (e)). Using those conclusions, the trial court relied on section 110, subdivisions (e) and (f), to rule in favor of the Board: "The ERC's rights apply directly to the power plant's real property because they were necessary to construct the power plant"; thus, the Board "properly included these rights in its replacement cost approach and was not required to subtract such rights from its income analysis."

On appeal, Elk Hills points out that this is a matter of first impression with respect to the character of ERCs as intangible rights. It renews the arguments made to the trial court, that under the parties' stipulated facts and a proper construction of section 110, when all its subdivisions are read together and harmonized, the Board should be found to have illegally imposed extra annual taxes directly upon the valuable intangible ERC assets (worth around $10 million), or alternatively, failed to deduct their value as required, thereby imposing on Elk Hills an extra tax burden of around $300,000 in all, for the subject five years. (§ 110, subd. (d)(2).)

To support its claims, Elk Hills relies on basic canons of statutory construction and on the authorities interpreting the character of intangible rights, and argues the ERCs were impermissibly separately assessed under the terms of section 110, subdivision (d): "Except as provided in subdivision (e), for purposes of determining the 'full cash value' or 'fair market value' of any taxable property, all of the following shall apply: [¶] (1) The value of intangible assets and rights relating to the going concern value of a business using taxable property shall not enhance or be reflected in the value of the taxable property. [¶] (2) If the principle of unit valuation is used to value properties that are operated as a unit and the unit includes intangible assets and rights, then the fair market value of the taxable property contained within the unit shall be determined by removing from the value of the unit the fair market value of the intangible assets and rights contained within the unit . . . ." (Italics added.)

In response, the Board, joined by the County (together the Board), contends that a proper determination of the statutorily defined character of ERCs as intangible rights leads to a conclusion that the governing provision is section 110, subdivision (e) (an express exception to § 110, subd. (d)), such that under section 110, subdivision (e), this power plant must be "assessed and valued by assuming the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use." (Ibid.) According to the Board, these ERCs are intangible assets "that cannot be separately taxed as property," but that may be reflected in the valuation of taxable property, because assessing authorities may take into consideration those earnings derived from the unit that "depend upon the possession of intangible rights and privileges that are not themselves regarded as a separate class of taxable property." (Roehm v. Orange County (1948) 32 Cal.2d 280, 285-286 (Roehm).)

The Board is correct. Its unitary taxation determinations properly assessed the power plant "as a going concern." (ITT, supra, 37 Cal.3d 859, 864; original italics.) The Board's worksheets in the record that contained site-specific adjustments for the ERCs, as relied on by Elk Hills, do not demonstrate the Board impermissibly assessed and taxed the value of the ERCs as a single asset, even though the tax forms filed by Elk Hills listed a value for the asset. Instead, the Board legitimately took into account the value added by the ERCs, as contributing to the value and earnings of the property as a whole. Based on the undisputed facts presented here, we limit our decision to an interpretation of section 110, subdivision (e), and need not reach issues concerning subdivision (f) of that section. Under section 110, subdivision (e), the power plant was correctly "assessed and valued by assuming the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use," because without the presence of the deployed ERCs, the power plant cannot operate and function as intended, to make energy and money. We affirm.


A. Emission Reduction Credits; Assessments; Complaint

In the early 2000's, Elk Hills, as the owner-operator of an independent wholesale electric power company, built the plant in Kern County, California.*fn3 In compliance with emission regulations of the San Joaquin Air Pollution Control District (the District), Elk Hills purchased about $10 million worth of ERCs, and used them to obtain the necessary permits and certifications for the power plant, completed in 2003, to commence operations. Beginning in 2004, Elk Hills filed tax returns that included the Board Form BOE-529-I (Form 529-I), reporting the cost of the ERCs as $10,701,575.

In 2004 and continuing into 2005, the Board utilized one of the three general methods of valuation for property assessment of the plant. This was the replacement cost approach for analyzing valuation, in light of the cost of replacing the property with a substitute property, less accrued depreciation (the replacement cost approach). (See Watson Cogeneration Co. v. County of Los Angeles (2002) 98 Cal.App.4th 1066, 1071 (Watson).)

From 2006 to 2008, the Board continued to use the replacement cost approach (in part, as next explained), and it also added an alternative valuation method, an income approach utilizing a "capitalized earning ability" or CEA factor (the income approach).*fn4 The Board gave this income approach less weight than the replacement cost approach (i.e., the income approach represented 20 percent of the analysis in 2006, and 30 percent in 2007-2008).

In reaching its valuation conclusions, the Board's assessor's worksheets listed a "site-specific adjustment" for each year that referred to the ERCs as part of the calculation of replacement cost estimates. The parties do not dispute that the site-specific adjustment was applied per megawatt to reach the value of the ERCs, as part of the Board's analysis of statewide information from regulatory authorities, to factor in a replacement amount for the ERCs. The power plant generates at least 500 megawatts, and the assessor's notes also take into account figures on depreciation and remaining economic life, among other relevant considerations.*fn5

After amendments, in February 2009, Elk Hills's operative complaint for tax refunds under section 5148, subdivision (a), was filed in San Diego as the proper venue, due to the location of an office of the Attorney General here. Elk Hills set forth the lien date unitary assessed values for each of the five years' assessments that were challenged, ranging from around $293 million through $335 million, and alleged that these were excessive because the Board had assessed the intangible ERCs in an illegal manner. The Board and County answered the complaint and case management proceedings followed.

B. Cross-Motions for Summary Judgment

The parties prepared cross-motions for summary judgment, arguing questions of law for interpretation of the definitions provided in section 110 and section 212. In Elk Hills's motion, it argued the ERCs qualify as intangible assets that are exempt from taxation, under section 110 and section 212, subdivision (c), providing: "Intangible assets and rights are exempt from taxation and, except as otherwise provided in the following sentence, the value of intangible assets and rights shall not enhance or be reflected in the value of taxable property. Taxable 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." (Italics added.)

In support of its motion, Elk Hills provided an original and supplemental declarations by James Asay, its tax manager. Also in support, Elk Hills provided a declaration by its vice president, Joseph Rowley, who described the process through which Elk Hills obtained governmental approvals for the plant, by purchasing and deploying the ERCs for almost $11 million. The surrendered ERC certificates do not have a face value. Elk Hills did not dispute that it could not operate the plant as designed without applying the ERCs, under applicable regulation.

In general, each declaration from Elk Hills describes the assessment process and the respective understandings of how the ERCs were treated as intangible assets, as supported by documents prepared during the process and newly prepared interpretive analyses. The declarations incorporate numerous exhibits, including annual tax forms reporting the cost of acquiring the ERCs (over $10 million), excerpts from the Board's manuals and guidelines, and a supporting legal memorandum on behalf of a Board member. According to Elk Hills, in preparing the unitary valuation of the plant, using the two different valuation methods, the Board failed to recognize that the value of all relevant governmental permits were already bundled in, and it impermissibly treated the ERCs' value separately. The refunds sought amounted to somewhere between $226,000 to $300,000.

In the Board's motion for summary judgment, it sought to defend its assessments as appropriate under well accepted unitary valuation methods and principles. In support of its motion, the Board provided original and supplemental declarations by its principal property appraiser Donald Jackson, who described the valuation methods and considerations his staff used in calculating the unitary value of the plant. They included in the valuation the typical costs associated with possessing many types of permits necessary to the facilities' construction and operation, including not only ERCs but also building permits and waste discharge permits. Other costs were capitalized to such permits, including filing fees, engineering fees, environmental fees, attorney fees, and so forth (soft costs). The staff did not expressly consider actual or booked ERC costs, as those were reported on Elk Hills's tax forms (to be further described in the discussion portion of this opinion). Normally, ERCs are issued to sources of emissions, and they can be banked to offset an operator's future emission overloads, or a power plant operator can sell the ERCs to other sources. (Health & Saf. Code, § 40709 et seq.)

The Board provided a declaration from David Warner, director of the permit services department for the District, about the necessity for District-issued ERCs, if a power plant operator cannot otherwise comply with emission control regulations. To construct the plant, Elk Hills supplied the "best available control technology" (BACT) to reduce emissions, but it nevertheless was also required to purchase ERCs at market rates, to allow it to use its technology at 500 megawatt production levels and to offset future emissions.

Elk Hills was therefore required to surrender (or "deploy") five of the certificates for ERCs it had purchased, from other emission sources, to enable its technology to produce power at the permitted levels. These covered excess pollutants such as nitrogen oxides, volatile organic compounds, and sulfur oxides.

Judicial notice was sought and granted of legislative history materials for section 110 and section 212, subdivision (c), to support the Board's position that ERCs must be considered in determining the fair market value of power plants, through assuming the presence of the ERCs as intangible assets or rights that are necessary to put the taxable property to beneficial or productive use, and allowing them to be reflected in the fair market value determination.

An extensive opposition and reply process then took place, in which each party filed supplemental and responsive separate statements, containing more documentation of the plant approval process and the five years of assessments. The County joined in the position taken by the Board.

C. Oral Argument and Rulings

At the outset, the trial court observed that there appeared to be some remaining factual dispute about how the assessments were actually carried out, i.e., whether the ERCs were separately assessed, or whether their presence was assumed as part of the replacement value calculation, and later in the income approach. In response, Elk Hills argued that the "Site Specific Adjustments: ERC" displayed on Board worksheets showed how separate valuation and separate taxes must have been imposed on the ERCs. Elk Hills also contended that its tax forms, Form 529-I, provided evidence that the ERCs cost over $10 million, which was value that could be removed, but a portion of that value was apparently impermissibly taxed, when the Board's worksheets referred to the "site-specific adjustments" for the ERCs, of amounts ranging from $5,400-$20,000.

The Board's position, on the other hand, was that under either valuation method, the ERCs were necessary to the beneficial and productive use of the plant, requiring that the unit valuation assumed there was value they contributed or added, such that no separate assessments of the intangibles were made. The ERCs amounted to costs necessary for the use of the property that could not be removed from the assessment. The ERCs were related to the particular property involved, which the regulatory authorities had evaluated in terms of its weather conditions, inversion layers, and other factors that affected how much pollution could be tolerated there.

At oral argument, the parties did not address section 110, subdivision (f) until the latter part of the hearing. Ultimately, the trial court ruled there were no triable issues of material fact and summary judgment must be granted for the Board, while the cross-motion by Elk Hills was denied. The order made the following key findings:

"1. The Emission Reduction Credits (ERCs) purchased and applied by [Elk Hills/EHP] for its power plant provide[s] intangible rights that relate directly to the power plant real property. The closest case is Mitsui Fudosan v. County of [Los Angeles] (1990) 219 ...

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