Opinion
No. 1 CA-TX 14-0002
02-24-2015
SULPHUR SPRINGS VALLEY ELECTRIC COOPERATIVE, INC., an Arizona corporation, Plaintiff/Appellant, v. ARIZONA DEPARTMENT OF REVENUE, an executive administrative agency of the State of Arizona; PIMA COUNTY; COCHISE COUNTY; GRAHAM COUNTY; and SANTA CRUZ COUNTY, all political subdivisions of the State of Arizona, Defendants/Appellees.
COUNSEL Gallagher & Kennedy, P.A., Phoenix By Michael G. Galloway, Hannah H. Porter Co-counsel for Plaintiff/Appellant Frazer, Ryan, Goldberg & Arnold, L.L.P., Phoenix By Douglas S. John, Giselle C. Alexander Co-counsel for Plaintiff/Appellant Arizona Attorney General's Office, Phoenix By Kenneth J. Love, Macaen F. Mahoney Counsel for Defendants/Appellees
NOTICE: NOT FOR OFFICIAL PUBLICATION. UNDER ARIZONA RULE OF THE SUPREME COURT 111(c), THIS DECISION IS NOT PRECEDENTIAL AND MAY BE CITED ONLY AS AUTHORIZED BY RULE. Appeal from the Superior Court in Maricopa County
Nos. TX2010-000398, TX2011-000002, TX2011-000592, TX2012-000446 (Consolidated)
The Honorable Dean M. Fink, Judge
AFFIRMED
COUNSEL Gallagher & Kennedy, P.A., Phoenix
By Michael G. Galloway, Hannah H. Porter
Co-counsel for Plaintiff/Appellant
Frazer, Ryan, Goldberg & Arnold, L.L.P., Phoenix
By Douglas S. John, Giselle C. Alexander
Co-counsel for Plaintiff/Appellant
Arizona Attorney General's Office, Phoenix
By Kenneth J. Love, Macaen F. Mahoney
Counsel for Defendants/Appellees
MEMORANDUM DECISION
Judge Lawrence F. Winthrop delivered the decision of the Court, in which Presiding Judge Kent E. Cattani and Judge Peter B. Swann joined. WINTHROP, Judge:
¶1 Plaintiff/Appellant, Sulphur Springs Valley Electric Cooperative, Inc. ("Sulphur Springs"), appeals the tax court's grant of summary judgment in favor of Defendants/Appellees, Arizona Department of Revenue ("the Department"), Pima County, Cochise County, Graham County, and Santa Cruz County (collectively, "the Counties"). For the following reasons, we affirm.
We refer to the Department and the Counties collectively as "Defendants."
FACTUAL AND PROCEDURAL BACKGROUND
¶2 Sulphur Springs is a nonprofit electric utility cooperative that distributes electric power to approximately 51,000 customers in rural areas of southern Arizona. It has taxable property consisting of overhead lines, transmission lines, power poles, substations, and miscellaneous tools and equipment (collectively, "the Property"). For tax years 2010 through 2013, Sulphur Springs challenged the Department's valuation of the Property for property tax purposes.
¶3 After the State Board of Equalization affirmed the Department's valuation of the Property for tax years 2010 through 2012, Sulphur Springs appealed to the tax court, and for tax year 2013, Sulphur Springs appealed directly to the tax court. Thereafter, the court consolidated the four cases.
¶4 Sulphur Springs filed a motion for summary judgment, asking the tax court to declare the Department's method of valuing the Property invalid. The court denied Sulphur Springs' motion as well as Defendants' cross-motion. Thereafter, Defendants moved for summary judgment on the basis that Sulphur Springs' expert appraiser, Michael E. Green, had improperly relied on an income approach to valuation in formulating his opinion of value, that such evidence was incompetent as a matter of law, and therefore, Sulphur Springs was unable to rebut the statutory presumption of correctness established by Arizona Revised Statutes ("A.R.S.") section 42-16212(B) (West 2015). The tax court granted Defendants' motion and dismissed Sulphur Springs' appeals for all four years, reasoning that our supreme court's holding in Graham County v. Graham County Electric Cooperative, Inc., 109 Ariz. 468, 512 P.2d 11 (1973), prohibits the use of an income approach in valuing the property of a nonprofit electric distribution cooperative.
As designated by the American Society of Appraisers, Mr. Green is an Accredited Senior Appraiser (ASA), who specializes in public utilities.
Absent material revisions after the relevant dates, we cite the current version of a statute unless otherwise indicated.
¶5 Sulphur Springs timely appealed the tax court's judgment in favor of Defendants, and we have jurisdiction pursuant to A.R.S. § 12-2101(A)(1).
ANALYSIS
¶6 Arizona law requires the Department to value electric transmission and distribution property owned by for-profit corporations according to a statutory formula, which is based on original plant in service cost, less depreciation, with some exceptions. See A.R.S. § 42-14154(A)-(B). The Arizona Legislature, however, has excluded property owned by member-owned nonprofit electric distribution cooperatives from that statutory valuation formula, see A.R.S. § 42-14154(A)(1), and, for the tax years at issue in this appeal, no statutory formula existed. In the absence of a statutory formula, the Department is required to value the property of a nonprofit electric distribution cooperative by applying "standard appraisal methods and techniques." A.R.S. § 42-11001(6) ("If no statutory method is prescribed, full cash value is synonymous with market value which means the estimate of value that is derived annually by using standard appraisal methods and techniques." (emphasis added)).
For valuation years beginning from and after December 31, 2013, the legislature has mandated that the valuation of distribution cooperatives be computed using a statutory formula, which includes a standard market value factor. See A.R.S. § 42-14159; 2013 Ariz. Sess. Laws, ch. 226, §§ 3-4 (1st Reg. Sess.). As affirmed by the parties at oral argument, the 2013 legislation does not affect our analysis for the tax years at issue.
¶7 This appeal involves the question of what constitutes "standard appraisal methods and techniques" as applied to the valuation of a nonprofit electric distribution cooperative. Sulphur Springs raises two issues on appeal: (1) Did Sulphur Springs' expert use standard appraisal methods and techniques in forming his opinion of value? (2) Did the Department utilize standard appraisal methods and techniques in valuing the Property and/or was the methodology the Department applied invalid under Arizona's Administrative Procedure Act ("the APA")? See A.R.S. §§ 41-1001 to -1092.12.
Our supreme court has acknowledged the complexity involved in valuing electric transmission and distribution property, especially when such property is owned by a nonprofit cooperative. See Graham Cnty., 109 Ariz. at 470-71, 512 P.2d at 13-14.
¶8 We will affirm a grant of summary judgment if there are no genuine issues as to any material fact and the moving party is entitled to judgment as a matter of law. Ariz. R. Civ. P. 56(a); Orme Sch. v. Reeves, 166 Ariz. 301, 305, 802 P.2d 1000, 1004 (1990). We review de novo a grant of summary judgment, see Wilderness World, Inc. v. Dep't of Revenue, 182 Ariz. 196, 198, 895 P.2d 108, 110 (1995), and view all facts in the light most favorable to the party against whom judgment was entered. Nat'l Bank of Ariz. v. Thruston, 218 Ariz. 112, 116, ¶ 17, 180 P.3d 977, 981 (App. 2008).
I. Sulphur Springs' Valuation of the Property
¶9 We begin by acknowledging that Arizona law establishes a presumption that the state or county's valuation of property is lawful and correct. A.R.S. § 42-16212(B) ("The valuation or classification as approved by the appropriate state or county authority is presumed to be correct and lawful."). A taxpayer challenging the valuation of his or her property has the burden of proving, by competent evidence, that the state or county's valuation is excessive. See Pima Cnty. v. Trico Elec. Coop. ("Trico I"), 15 Ariz. App. 517, 519, 489 P.2d 1219, 1221 (1971). In the absence of competent evidence rebutting the statutory presumption, the taxing authority's valuation will stand as lawful and correct. See id. Accordingly, Sulphur Springs has the burden of proving the Department's valuation of the Property is excessive.
A. Mr. Green's Appraisal Reports
¶10 As we have noted, Sulphur Springs retained an expert appraiser, Mr. Green, to formulate an opinion of the market value of the Property for each tax year at issue. Sulphur Springs argues Mr. Green's appraisal report utilized standard appraisal methods and techniques, and therefore is competent evidence which rebuts the statutory presumption of correctness under A.R.S. § 42-16212(B). Defendants argue the report does not constitute competent evidence sufficient to overcome the statutory presumption because Mr. Green relied on an income approach in valuing the Property, which Arizona law prohibits.
¶11 There are three generally accepted approaches to valuing real property in Arizona: the market data approach, the cost approach, and the income approach. Dep't of Revenue v. Transamerica Title Ins. Co., 117 Ariz. 26, 29, 570 P.2d 797, 800 (App. 1977). Mr. Green arrived at his opinion of value by using both the income approach and the cost approach.
¶12 In his report, Mr. Green generally described the income approach as follows:
The income approach to value is predicated upon the assumption that the market value of an income producing property is the present worth of future benefits (income) to be derived from owning the property. . . . Typically, this approach involves projecting potential income (e.g. earning capacity) and deducting all operating expenses and capital expenditures to arrive at an estimate of free cash flow.He further explained his application of the income approach to this specific Property by stating: "The income approach has been utilized in this appraisal due to the fact that the subject is income producing and its earning capacity is the primary basis for value."
¶13 Mr. Green also applied an alternative cost approach in valuing the Property; however, this approach also utilized income data because he estimated external obsolescence by applying an "income shortfall method," which he described as follows:
Mr. Green's report defines "external obsolescence" as "the loss in value due to factors outside the property such as excess supply, competition or regulation."
External obsolescence is estimated by the income shortfall method where projected net utility operating income is compared to target net utility operating income (rate base times the cooperative market rate of return). The income shortfall is capitalized at the market rate of return as a measure of external obsolescence.Thus, Mr. Green's alternative cost approach relied in part upon "projected net utility operating income."
¶14 Mr. Green reconciled the income and cost opinions of value to arrive at an estimated market value of the Property for each tax year. In calculating his final opinions of value, Mr. Green gave greater weight to the income approach.
B. Arizona Supreme Court Precedent
¶15 Our supreme court has issued three opinions addressing the valuation of nonprofit electric cooperatives: Graham County; Department of Property Valuation v. Trico Electric Cooperative, Inc. ("Trico II"), 113 Ariz. 68, 546 P.2d 804 (1976); and Arizona Department of Revenue v. Trico Electric Cooperative, Inc. ("Trico III"), 151 Ariz. 544, 729 P.2d 898 (1986). In the first of these three opinions, Graham County, the court concluded it is "fundamentally wrong" to rely upon the capitalization-of-income method in valuing the property of a nonprofit corporation:
We are bound by the decisions of our supreme court. See McKay v. Indus. Comm'n, 103 Ariz. 191, 193, 438 P.2d 757, 759 (1968) ("Whether prior decisions of the highest court in a state are to be disaffirmed is a question for the court which makes the decisions. Any other rule would lead to chaos in our judicial system." (citation omitted)).
The utility's expert used the capitalization-of-income method which is an approved appraisal method. He reasoned that the balance of income over operating costs for the taxpayer utility was in fact a profit, and he proceeded to capitalize the figure for the years in question to arrive at his
valuation. The method used is fundamentally wrong in that the taxpayer is a non-profit corporation, and it sets its rates with the deliberate intention of not making a profit.109 Ariz. at 471, 512 P.2d at 14 (emphasis added). After determining reliance on the capitalization-of-income method was "fundamentally wrong," the court concluded the taxpayer had failed to meet its burden of presenting competent evidence to rebut the statutory presumption of correctness. See id.; see also Recreation Ctrs. of Sun City, Inc. v. Maricopa Cnty., 162 Ariz. 281, 288, 782 P.2d 1174, 1181 (1989) (reiterating Graham County's holding that "the appraiser's use of the income approach was improper because the taxpayer was a nonprofit corporation that set its rate with the deliberate intention of not making a profit").
¶16 Three years after Graham County, the supreme court again addressed the valuation of a nonprofit electric cooperative. In Trico II, the taxpayer's expert utilized both the cost and income approaches to value, and he testified at trial regarding those methods. 113 Ariz. at 70-71, 546 P.2d at 806-07. In addition, the trial court admitted into evidence an exhibit containing a summary of the expert's computations. See id. On appeal, the Department argued the expert's "income approach was essentially based on the capitalization of income method which is not a proper valuation technique in the context of the valuation of a nonprofit corporation." Id. (citing Graham County). Relying on its earlier decision in Graham County, the court reversed and remanded for a new trial, concluding the trial court had erred in admitting the expert's testimony and corresponding exhibit. Id. at 71, 546 P.2d at 807.
¶17 Ten years later, the supreme court again addressed the valuation of Trico's property in Trico III. By that time, the legislature had enacted legislation providing for the statutory valuation of electric transmission and distribution property, including property owned by nonprofit electric cooperatives. See Trico III, 151 Ariz. at 546-47, 729 P.2d at 900-01 (explaining the enactment of A.R.S. § 42-124.01). In Trico III, the taxpayer challenged the legislature's decision to utilize cost, less depreciation, in the statutory formula for valuing electric transmission and distribution property. See id. at 549, 729 P.2d at 903. The supreme court upheld the legislature's selection of the cost approach to value and, in so doing, reiterated its holding from Graham County as follows:
This statutory formula was originally applied to the property of nonprofit electric distribution cooperatives; however, in 1986, the legislature exempted such property from the statutory formula. See 1986 Ariz. Sess. Laws, ch. 133, § 1 (2nd Reg. Sess.).
Arizona has recognized three generally-accepted approaches to estimating real property valuations: the income approach, the market data approach, and the cost-less-depreciation approach. Department of Revenue v. Transamerica Title Insurance Co., 117 Ariz. 26, 570 P.2d 797 (App. 1977).Trico III, 151 Ariz. at 549, 729 P.2d at 903 (emphasis added).
We have held that using the income approach to calculate full cash value of property owned by a cooperative utility is "fundamentally wrong" because such an entity "is a non-profit corporation, and it sets its rates with the deliberate intention of not making a profit." Graham County v. Graham County Electric Cooperative, Inc., 109 Ariz. 468, 471, 512 P.2d 11, 14 (1973). Left with selecting either the market data approach or the cost-less-depreciation approach, we decline to find the legislature's selection of the latter approach arbitrary or capricious. . . . We conclude that the legislature's 1980 decision to require full cash value of certain utility property to be calculated by the generally-recognized cost-less-depreciation method was rational.
In its briefs and at argument, Sulphur Springs relied upon an older decision from this court also involving Trico. See Trico I, 15 Ariz. App. at 519-20, 489 P.2d at 1221-22. In that case, this court stated: "Assuming arguendo that an income approach was appropriate in the case at bench, it is the capacity for earning income rather than the income actually derived which reflects full cash value for taxation purposes." Id. It is clear from our supreme court's subsequent decision in Graham County, however, that an income approach is not appropriate in valuing the property of a nonprofit electric distribution cooperative under Arizona law. See 109 Ariz. at 471, 512 P.2d at 14.
¶18 In this case, Mr. Green utilized both the capitalization-of-income approach and the cost approach to value. His cost approach, however, was predicated on income because he utilized an "income shortfall method" to calculate external obsolescence. Accordingly, both of his approaches relied upon income to establish market value. Under Graham County, Mr. Green's approach to valuing the Property is "fundamentally wrong" because the Property is owned by a nonprofit electric distribution cooperative.
¶19 In arguing that Mr. Green utilized standard appraisal methods and techniques, Sulphur Springs claims the discounted cash flow ("DCF") form of income capitalization approach is the primary valuation method currently used by market participants and lenders to value nonprofit electric distribution cooperatives. For the purpose of our review, we accept Sulphur Springs' statement as true. See Thruston, 218 Ariz. at 116, ¶ 17, 180 P.3d at 981. Nevertheless, under Graham County, the DCF form of income capitalization approach is not a permissible method of valuing the property of a nonprofit electric distribution cooperative for Arizona property tax purposes. See 109 Ariz. at 471, 512 P.2d at 14.
"Discounted cash flow (DCF) analysis is a procedure in which a yield rate is applied to a set of income streams and a reversion to determine whether the investment property will produce a required yield given a known acquisition price." Appraisal Institute, The Appraisal of Real Estate ch. 24, at 540 (13th ed. 2008). We acknowledge that a DCF analysis is a standard appraisal method and technique for valuing other types of property. See id. at 539 ("In many markets and for many property types, DCF analysis is the technique investors prefer.").
¶20 Sulphur Springs also argues the DCF approach employed by Mr. Green is different than the direct income capitalization approach applied by the utility's expert in Graham County. This may be true; nevertheless, the DCF approach is still a type of income capitalization, and the supreme court found such an approach "fundamentally wrong" as applied to the property of a nonprofit electric distribution cooperative. Applying the holding from Graham County, as we must, see McKay, 103 Ariz. at 193, 438 P.2d at 759, we affirm the tax court's grant of summary judgment determining that Sulphur Springs failed to overcome the statutory presumption of correctness because its expert's opinion of value was based on the income capitalization approach.
As explained in The Appraisal of Real Estate's thirteenth edition at chapter 20, page 465:
The two methods of income capitalization are direct capitalization, in which a single year's income is divided by an income rate or multiplied by an income factor to reach an indication of value, and yield capitalization, in which future benefits are converted into a value indication by discounting them at an appropriate yield rate (DCF analysis) or applying an overall rate that reflects the investment's income pattern, value change, and yield rate.
II. The Department's Valuation of the Property
¶21 Sulphur Springs alternatively argues the methodology utilized by the Department in valuing the Property is, in effect, a de facto and invalid rule under the APA, and that, accordingly, the statutory presumption established in § 42-16212(B) does not apply. In response, Defendants argue that no formal rule is required, and that the Department's method is based upon standard appraisal methods and techniques.
¶22 The legislature has granted the Department express statutory authority to value all electric distribution property in the state. See A.R.S. §§ 42-14001(A), -14151(A)(5). As previously noted, if such property is owned by a nonprofit electric distribution cooperative, the statutory formula does not apply and the Department is required to use standard appraisal methods and techniques. See A.R.S. §§ 42-14154(A)(1), -11001(6). Generally, in applying standard appraisal methods and techniques, the Department may choose among commonly accepted valuation methods. See generally London Bridge Resort, Inc. v. Mohave Cnty., 200 Ariz. 462, 467, ¶ 24, 27 P.3d 819, 824 (App. 2001). In addition, the Department may apply a combination of these approaches. See Recreation Ctrs. of Sun City, 162 Ariz. at 291, 782 P.2d at 1184 (concluding that a taxing authority may value property by utilizing a "hybrid method of appraisal").
¶23 From the late 1980s through the tax years in question, the Department valued the property of nonprofit electric distribution cooperatives by applying a combination of the cost and market approaches to value. Specifically, the Department utilized both a "trended calculation of original cost" approach and a "surrogate market approach," and then reconciled the two approaches. Although the parties dispute whether Sulphur Springs agreed to this methodology, the record reflects taxpayer acquiescence for a considerable period of time. Moreover, there is evidence in the record that the Department's approach yielded valuations that were at times advantageous to the electric distribution cooperatives.
It appears that, for a period of years, the Department and the taxpayer, along with other industry representatives, attempted to craft a rule or guidelines for the valuation of nonprofit electrical cooperatives. Those efforts stalled, but the parties agree the methodology applied to the valuations at issue in this appeal is essentially the same methodology proposed during the stalled rule-making process.
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¶24 Notably, Sulphur Springs has admitted the Department applied "some type of" standard appraisal method and technique in valuing the Property. In responding to the Department's cross-motion for summary judgment, Sulphur Springs stated:
There is no dispute in this case that the Department is using some type of SAMT [standard appraisal methods and techniques] which, as the Department admits, is a "surrogate" valuation of Co-op property of which income cannot be used by way of the Trico decision and a market approach is used even though there are no sales of Co-op properties.(Emphasis added; underscore in original.) Likewise, during the administrative appeal, Sulphur Springs' representative explained to the State Board of Equalization that "we don't have a problem with the methodologies that are used, the correlation of a cost and a market approach."
¶25 "The legislature is capable of requiring the Department to adopt rules when it so desires." Duke Energy Arlington Valley, LLC v. Ariz. Dep't of Revenue, 219 Ariz. 76, 78-79, ¶ 11, 193 P.3d 330, 332-33 (App. 2008) (citing statutes); see also A.R.S. § 42-3304(B) ("The department shall adopt rules prescribing the procedures for claiming and verifying sales that are exempt under this section."); A.R.S. § 42-5009(F) ("Under rules the department may prescribe, the department may also require additional information for the seller to be entitled to the deduction."); A.R.S. § 42-5106(A) ("The department shall adopt rules defining food consistent with § 42-5101 and this section."). For the tax years in question, the legislature did not require the Department to promulgate rules and regulations for valuing the property of nonprofit electric distribution cooperatives. Rather, the legislature mandated that the Department apply "standard appraisal methods and techniques." A.R.S. § 42-11001(6). The approach the Department has taken to valuing this Property is within the scope of the authority granted it by the legislature. See Facilitec, Inc. v. Hibbs, 206 Ariz. 486, 488, ¶ 10, 80 P.3d 765, 767 (2003) (holding that the degree to which an agency can exercise power "depends upon the legislature's grant of authority to the agency").
¶26 Our role is not to determine the preferred method for valuing this Property. See Navajo Cnty. v. Four Corners Pipe Line Co., 106 Ariz. 511, 522, 479 P.2d 174, 185 (1970) ("[I]t is not the function of the judiciary to promulgate tax assessment regulations in the form of judicial opinions."). If a taxpayer is unhappy with the appraisal methods and techniques utilized in valuing its property, the taxpayer must present competent evidence to the court to rebut the statutory presumption of correctness. See Trico I, 15 Ariz. App. at 519, 489 P.2d at 1221. Because Sulphur Springs presented evidence predicated on the capitalization-of-income method, which is not permitted under Arizona law, it failed to rebut the statutory presumption of correctness. Thus, the tax court's ruling was proper.
CONCLUSION
¶27 For the foregoing reasons, we affirm the tax court's grant of summary judgment in favor of Defendants.