Sky River v. Kern County















Filed
2/21/13 Sky River v. Kern County CA5









NOT
TO BE PUBLISHED IN THE OFFICIAL REPORTS







California Rules of Court, rule 8.1115(a), prohibits
courts and parties from citing or relying on opinions not certified for publication
or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for
publication or ordered published for purposes of rule 8.1115.





>

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

FIFTH APPELLATE DISTRICT




>

SKY RIVER LLC et al., Plaintiffs and Respondents, v. KERN COUNTY, Defendant and Appellant.

F063766 (Super. Ct. Nos. CV-269555 & CV-268774) >OPINION

APPEAL from
a judgment of the Superior Court of href="http://www.adrservices.org/neutrals/frederick-mandabach.php">Kern County. Sidney P. Chapin, Judge.

Theresa A.
Goldner, Kern County Counsel and Jerri S. Bradley, Deputy County Counsel, for
Defendant and Appellant.

Rethink,
Gordon & Polland, Paul M. Gordon and Jonathan Polland, attorneys for
Plaintiffs and Respondents.

-ooOoo-

This is an
appeal by Kern County from the trial court’s judgment, which rejected the
decision of the Kern County Assessment Appeals Board (board) upholding the
county tax assessor’s increased valuation of plaintiffs’ business property and
the resulting increased property tax.
The county contends the trial court applied the wrong standard in
reviewing the administrative decision; it contends application of the correct
standard would have resulted in a judgment upholding the administrative
decision because it was supported by substantial evidence. The county further asserts that the trial
court erred when it admitted new evidence that was not presented to the board
and when it determined the tax assessor used incorrect revenue figures in
calculating the income stream on which the property value was based in one of
the appraisals. We conclude the trial
court applied the correct standard of review, properly admitted evidence at trial,
and correctly rejected the county’s revenue figures. Contrary to the trial court’s judgment,
however, the matter must be remanded to the board for further proceedings
because factual questions remain.

>FACTUAL AND PROCEDURAL BACKGROUND

Plaintiffs
in these consolidated actions, Sky River LLC (Sky River) and Mojave 16/17/18
LLC (Mojave), are two related limited liability companieshref="#_ftn1" name="_ftnref1" title="">^[1] that own and operate wind farm electricity
generation facilities in Kern County.
They challenged the tax assessments of the Kern County tax assessor for
plaintiffs’ business propertyhref="#_ftn2"
name="_ftnref2" title="">^[2] for 2006 and 2007. The property consisted of wind turbine
generators and related equipment, used to generate and transmit
electricity. Both plaintiffs paid the
taxes and initiated administrative proceedings before the board to challenge
the valuations of their property. The
board held two hearings; it reviewed the complex calculations the tax assessor
used in computing the tax and the alternative calculations proposed by
plaintiffs, and found in favor of the county.
The board approved the tax assessor’s increased valuation of the
property. Plaintiffs then filed actions
in the superior court for a refund of a portion of the property taxes paid,
again asserting that the tax assessor overvalued the property. The trial court found in favor of plaintiffs,
concluding the tax assessor used a flawed methodology in calculating the value
of the property, resulting in an inflated value and an overstated tax. It adopted the method of computation plaintiffs
advocated and accepted the corrected figures they submitted. The trial court entered judgment setting out
the corrected values for each plaintiff’s property and ordering a refund of any
excess tax paid. The county appeals from
the judgment of the trial court.

>DISCUSSION

>I. Standard of Review

The initial
issue presented by this appeal concerns the appropriate standard of review in
the trial court. The county contends the
board’s decision was based on factual determinations; accordingly, the trial
court should have deferred to the board’s findings of fact and should have
reviewed the decision only to ascertain whether it was supported by substantial
evidence. Plaintiffs contend the
material facts were undisputed and the issue was whether the tax assessor
applied the proper methodology in calculating the value of the property, in
accordance with applicable statutes and regulations. Plaintiffs assert this was an issue of law,
which the trial court properly reviewed de novo. The correct standard of review depends upon
the nature of the dispute before the trial court.

Property
subject to taxation must be assessed at its full value, which is defined as its
full cash value or fair market value.
(Rev. & Tax. Code, §§ 110.5, 401.) “‘[F]ull cash value’ or ‘fair market value’
means 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. & Tax. Code, § 110, subd. (a).) There are three basic methods for calculating
fair market value: (1) the comparative
sales or market data method; (2) the reproduction or replacement cost method;
and (3) the income method. (Cal. Code Regs., tit. 18, §§ 3, 4, 6,
8; Pacific Mutual Life Ins. Co. v. County
of Orange (1985) 187 Cal.App.3d 1141, 1147.) In this case, the parties agree the value of
the property should be calculated by using the income method, which is
described in California Code of Regulations, title 18, section 8 (Rule 8).href="#_ftn3" name="_ftnref3" title="">^[3]

The income approach seeks to
determine “[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.”
(Rule 8, subd. (b).) “‘The
income method rests upon the assumption that in an open market a willing buyer
of the property would pay a willing seller an amount approximately equal to the
present value of the future income to be derived from the property.’ [Citation.] …
‘“The income approach may be called the capitalization method
because capitalizing is the process of converting an income stream into a
capital sum, i.e., value.”
[Citations.]’” (>Freeport-McMoran
Resource Partners v. County of Lake (1993) 12 Cal.App.4th 634, 642 (>Freeport).)

“‘The
assessor capitalizes “the sum of anticipated future installments of net income
from the property, less an allowance for interest and the risk of partial or no
receipt.” [Citation.]’ [Citations.]”
(Freeport, supra, 12
Cal.App.4th at p. 642.) “The
discount factor or capitalization rate which is applied reflects interest, the
risk of no return or a lesser return of income, liquidity, investment
management, taxes, and depreciation, where appropriate. [Citation.]
Thus, a high-risk investment carries a proportionately higher
capitalization rate.” (>Texaco
Producing v. County of Kern (1998) 66 Cal.App.4th 1029, 1037 (Texaco).) “Since a property’s ‘full value’ must be
determined by reference to the price it would bring on an open market, ‘[t]he
net earnings to be capitalized … are not those of the present owner of the
property, but those that would be anticipated by a prospective
purchaser.’” (Freeport, at p. 642.)

There are two means by which a capitalization rate may be developed. (Rule 8, subd. (g).) “The
preferred method is to derive the rate from the market by ‘comparing the net
incomes that could reasonably have been anticipated from recently sold
comparable properties with their sales prices adjusted, if necessary, to cash
equivalents .…’ [Citation.]” (Texaco,
supra, 66 Cal.App.4th at
p. 1037.) Alternatively, when there
is a lack of comparable property sales, a “band-of-investment method” may be
used: a discount rate is developed by “deriving
a weighted average of the capitalization rates for debt and for equity capital
appropriate to the California money markets.”
(Rule 8, subd. (g)(2).) Using
this method, also known as the weighted average cost of capital (WACC) method,
the appraiser must “weight the rates for debt and equity capital by the
respective amounts of such capital he deems most likely to be employed by
prospective purchasers.” (>Ibid.)
“This method is based on the premise that the yield rate is the weighted
average of the return on the different portions of the investment, i.e., debt
and equity. [Citation.]” (Texaco,
at p. 1038.)

The income stream to be capitalized
pursuant to Rule 8 is “the net return which a reasonably well informed owner
and reasonably well informed buyers may anticipate on the valuation date that
the taxable property … will yield.”
(Rule 8, subd. (c).) Net return
is the difference between gross return and gross outgo; gross outgo does not
include amortization, depreciation, property taxes, or income taxes. (Ibid.) Because taxes are not excluded from net
return, the income stream to be capitalized is before-tax. Accordingly, the discount rate used must also
be before-tax. The discount rate
computed pursuant to the WACC method, however, is an after-tax rate, which must
be adjusted to a before-tax rate in order to apply it to the income
stream. (SBE Assessors’ Handbook (Dec.
1998) § 502, Advanced Appraisal, p. 98 & appen. A, p. 180
[as of Feb. 14, 2013].) This adjustment is made “by dividing the
after-tax WACC by 1 minus the combined state and federal corporate income tax
rate.” (SBE Assessors’ Handbook,> supra, § 502, appen. A, at
p. 180.) The income tax rate to be
used is “the combined federal and state marginal corporate income tax rate
(i.e., the tax rate paid on each incremental dollar of income).” (Id.,
at p. 98 & appen. A, at p. 178.) The
higher the income tax rate used, the higher the discount rate and the lower the
value of the property.

The parties agree the income approach is the appropriate method of
valuation and, due to a lack of sales of comparable property; the
band-of-investment approach should be used to calculate the discount rate. Although the parties disagreed in the
administrative proceeding about how this band-of-investment, or WACC, method
would apply in calculating the discount rate, in the trial court plaintiffs
accepted the method proposed by the assessor, with the exception of the income
tax rate to be used to adjust the discount rate to a before-tax rate.

In this appeal, the parties again
agree that the income method should be used to calculate the value of the
property in issue. They also agree that
the band-of-investment method should be used to develop the discount rate to be
used to establish the present value of the future income stream. They disagree, however, on the income tax
rate to be used in converting from an after-tax discount rate to a before-tax
discount rate. The assessor calculated
an average rate of corporate income tax he believed a potential purchaser of
the property would anticipate.
Plaintiffs contend the maximum combined federal and state marginal rate
should be used.

Because of the parties’ agreement on certain aspects of the methodology
to be used, the county contends the parties agree on the methodology and
disagree only on the factual data to “plug in” to make the calculations. Because it contends only factual matters are
in issue, the county argues that the substantial evidence standard of review
applies. Plaintiffs, however, argue that
the dispute relates to one element of the methodology―the appropriate
income tax rate to apply to the conversion―rather than to factual
matters, so the de novo standard of review applies. We review case authority for guidance.

In Maples v. Kern County Assessment Appeals Bd. (2002) 96 Cal.App.4th
1007 (Maples), the owner of a
low-income housing development challenged the assessor’s valuation of the
property; under the federal program pursuant to which the housing development
was operated, the owner paid market interest on its mortgage, but received a
tax credit for the interest, which reduced the effective mortgage rate to 1
percent. The tax assessor valued the
property using a cost approach; it bolstered its argument for that value by
showing that an income approach to valuation, calculated using the 1 percent
effective mortgage rate in the debt component of the band-of-investment
capitalization rate calculation, reached a similar result. (Id.
at pp. 1011-1012.) The owner contended
an income approach should have been used, and the value should have been
calculated using a market interest rate.
(Id. at p. 1011.) The county appeals board agreed with the
owner that the income approach should have been applied, using a market
interest rate. (Id. at p. 1012.) The
assessor sought a writ of mandate in the trial court; the trial court treated
the issue as one of law and concluded the income method was the proper
valuation method, but the 1 percent effective mortgage interest rate should
have been used for the debt component of the band-of-investment capitalization
rate calculation. (Ibid.)

On appeal, the parties disagreed on
the standard of review: whether the
appellate court was to defer to the board’s findings of fact and apply a
substantial evidence standard or determine the issue de novo. (Maples,
supra, 96 Cal.App.4th at pp. 1012-1013.)
The court summarized the applicable standards of review: “Where the taxpayer claims a valid valuation
method was improperly applied, the trial court is limited to reviewing the
administrative record.
[Citation.] The court may
overturn the assessment appeals board’s decision only if there is no
substantial evidence in the administrative record to support it. [Citation.]
However, where the taxpayer challenges the validity of the valuation
method itself, the court is faced with a question of law. In such a case, the court does not evaluate
whether substantial evidence supports the board’s decision, but rather must
inquire into whether the challenged valuation method is arbitrary, in excess of
discretion, or in violation of the standards prescribed by law. [Citation.]”
(Id. at p. 1013.) The court noted: “Whether a taxpayer is challenging
‘method’ or ‘application’ is not always easy to ascertain. [Citation.]
If none of the facts are in dispute, what might otherwise appear to be a
factual challenge, and therefore subject to substantial evidence review, is
actually a legal challenge.
[Citation.] ‘“The issue is not
whether the assessor misunderstood or distorted the available data, but whether
he or she chose an appraisal method which by its nature was incapable of
correctly estimating market value.”’
[Citation.]” (>Id. at pp. 1013-1014.) Determining that the only issue presented was
whether to use the subsidized interest rate or a general market interest rate,
the court concluded the question was one of law, reviewable by the trial court
and the appellate court de novo. (>Id. at p. 1014.)

In Bret Harte Inn, Inc. v. City and County of San Francisco (1976) 16
Cal.3d 14 (Bret Harte), plaintiff,
owner of a hotel, challenged the amount of its personal property tax
assessment. The assessor had determined
the value of plaintiff’s personal property by taking the original cost and
deducting 50 percent for depreciation, regardless of the age or condition of
the particular items of property. (Id.
at p. 18.) Undisputed evidence presented
by plaintiff at trial indicated its property had a lower value than that
ascribed to it by the assessment. (>Id. at p. 19.) The trial court entered judgment for
plaintiff, after concluding the valuation method was invalid, and defendant
appealed.

The court concluded that, when a
taxpayer challenges the validity of a valuation method, it presents a question
of law: whether the challenged method of
valuation is arbitrary, in excess of discretion, or in violation of the
standards prescribed by law. (>Bret Harte, supra, 16 Cal.3d at p.
23.) The court treated the question
before it as a question of law. It
determined the cost method of valuation could be used, but only if it was
“designed so that cost factors, which by their nature can have no >direct relationship to present value,
are modulated by depreciation factors in a manner reasonably calculated to
achieve an approximation of such value with respect to the individual
taxpayer.” (Id. at p. 25.) The method
used by the assessor failed to do this; it discounted the original cost by a
uniform 50 percent, regardless of age or condition of the property, without
attempting to distinguish among individual properties and establish their
current individual values. (>Ibid.)
This method was arbitrary, in excess of the assessor’s discretion, and
in violation of the constitutional and statutory requirements that all property
be assessed at its full value. (>Ibid.)


Similarly, in ITT World Communications, Inc. v. County of Santa Clara (1980) 101
Cal.App.3d 246 (ITT World), the SBE,
which had operated under a rule that valuation of state-assessed utility
property could not exceed its reproduction cost new less depreciation (RCNLD),
rescinded that rule and subsequently assessed plaintiff’s property at an amount
in excess of the RCNLD. The court
concluded the issue raised by plaintiff―whether the method used by the
board to assess its property was itself illegal because it did not retain the
use of RCNLD as a ceiling on value―presented a question of law. Thus, the court was required to determine
whether the board’s abandonment of the RCNLD as a ceiling “was arbitrary, in
excess of discretion, or in violation of the standards prescribed by law.” (Id.
at pp. 252-253.)

In Bontrager v. Siskiyou County Assessment Appeals Bd. (2002) 97
Cal.App.4th 325 (Bontrager),
plaintiff owned rental housing subsidized by a federal government program; in
exchange for plaintiff charging lower rent to eligible tenants, the government
subsidized the interest rate on financing for the property, so plaintiff paid
only one percent. Plaintiff challenged
the tax assessor’s assessment of the value of the property. The parties agreed that the income approach
and the band-of-investment method should be used to determine the property
value. (Id. at p. 331.) Plaintiff
argued, and the board agreed, that the market rate of interest should be used
in determining the debt component of the WACC calculation. (Id.
at p. 329.) The trial court
disagreed. On appeal, the court held the
correct interest rate to use was the actual rate paid by plaintiff, i.e., one
percent; use of the market rate would not produce an accurate estimate of the
fair market value of the property. (>Id. at p. 333.) The court rejected plaintiff’s contention
that the question was one of fact, subject to substantial evidence review. “[T]he determination of whether the face rate
of interest charged by a lender or the actual amount of interest paid by the
borrower should be used in calculating the capitalization rate is a question of
law, both before the trial court and on appeal.… The factual issue, the amount of that rate,
is undisputed.” (Id. at p. 334.)

Like the taxpayers in >Maples, Bret Harte, ITT World,
and Bontrager, plaintiffs in this
case contend the assessor used an improper method to calculate the value of
their property and the amount of their tax.
Plaintiffs contend that, although the assessor correctly chose the
income approach to determine value, and the band-of-investment method to
calculate the capitalization rate, he improperly used an estimated average
income tax rate, rather than the marginal rate prescribed by the assessor’s
handbook, when converting the discount rate from an after-tax rate to a
before-tax rate. We conclude that
plaintiffs are correct, and the issue presented constitutes a question of law
as to an element of the chosen method to be used in calculating the market
value of the property. Which income tax
rate should be used―the marginal rate or an average rate―is a
question about the method of calculating the appropriate conversion rate. The exact percentage to be used for that rate
would be a question of fact to be determined by the board based on the evidence
presented. Determining which rate should
be used does not present a question about the facts specific to plaintiffs’
case or the data to insert when calculating the value of the property. Rather, it presents a question about the
methodology prescribed by SBE rules for calculation of the property value.

>II. Proceedings
before the Board and at Trial

Because it is presumed that the
assessor has properly performed his duties, the burden is on the taxpayer
challenging an assessment to prove that the value on the assessment roll is not
correct. (Cal. Code Regs., tit. 18, §
321, subd. (a).) This presumption,
however, disappears when the assessor seeks to increase the valuation of the
taxpayer’s property; in that event, the burden is on the tax assessor to prove
the higher value of the property. (>Id., § 313, subd. (f).) In this case, the assessor sought to raise
the enrolled value of the properties, so the county bore the burden of proof of
the increased value.

To determine the value of
plaintiffs’ property using the income method, the assessor must compute the
present worth of a future income stream.
(Rule 8, subd. (b).) The future
income stream is a forecast of the income expected to be generated by the
property being appraised; it is the income that a typical, prudent buyer would
expect the property to yield over the income projection period. (SBE Assessors’ Handbook, >supra, § 502, at p. 56.) In his appraisals for 2006 and 2007, the
assessor calculated an expected future income stream for Mojave’s property
until 2028 and for Sky River’s property until 2020. The assessor also estimated expenses for the
same periods, based on plaintiffs’ operating histories. He subtracted the expenses from the income to
arrive at annual net income figures for the projection period. He then calculated the rate to use to
discount that net income to present value by using the band-of-investment
method.

The parties agree the appropriate method for developing a discount rate
is the band-of-investment method. (Rule
8, subd. (g)(2); Maples, supra, 96
Cal.App.4th at p. 1011.) In this
method, the capitalization rates attributable to components of a capital
investment (debt and equity) are weighted and combined to derive a
weighted-average rate attributable to the total investment. (SBE Assessors’ Handbook, >supra, § 502, at p. 78.) “The first step in performing a
band-of-investment analysis is to determine the percentage of debt that would
be appropriate for the specific property.
The percentage remaining after subtracting this debt from 100 is the
equity. The debt percentage is then
multiplied by the cost of the debt, i.e., the mortgage rate, and the equity
percentage is multiplied by the expected rate of return for this investment. Adding these two figures together provides an
overall indication of the discount rate.”
(Texaco, supra, 66 Cal.App.4th
at p. 1038.)

A variation of this WACC technique, called the pure play or comparable
company method, uses data from the capital market relating to publicly traded
companies engaged in a line of business similar to that of the property being
valued to estimate a discount rate for the cash flow of an entity that is not
publicly traded. (SBE Assessors’
Handbook, supra, § 502, appen.
A, at p. 166.) Using the pure play
method, the assessor identifies publicly traded companies that compete in the
same line of business as the property being valued, estimates “the typical
capital structure (proportions of debt and equity),” for companies in that line
of business, estimates the appropriate cost of debt and equity, and calculates
the WACC from this information. (>Ibid.)


The assessor attempted to use the
pure play method to calculate the WACC for plaintiffs’ properties. John Matthews, a certified property tax
appraiser testifying on behalf of the county, explained that he identified
eight publicly traded companies in the business of generating electricity, and
based his calculations of the WACC on their data. “The best candidates for comparable companies
are nonintegrated, single-product companies in a line of business closely
related to the asset or property being appraised.” (SBE Assessors’ Handbook, >supra, § 502, appen. A, at p.
166.) Plaintiffs are stand-alone wind
energy companies. The county’s witnesses
readily admitted that the eight companies identified in their appraisal were
not single-product companies in a closely related line of business, nor were
they selected because they were similar to the property being appraised. The companies in the assessor’s study are
major energy companies that derive income from all types of electricity
generation; the witnesses presented by the assessor did not know which of them
derived income from wind energy.

The WACC is calculated by taking the estimated cost of debt and the
estimated cost of equity and combining them, weighting them according to their
proportions in the capital structure.
(SBE Assessors’ Handbook, supra,
§ 502, at p. 98 & appen. A, at p. 178.) The calculation uses
after-corporate-income-tax figures. (>Ibid.)
Because interest on debt is tax deductible, the estimated cost of debt
(i.e., the interest rate on debt) must be converted to an after-tax rate. (Ibid.) “The after-tax cost of debt equals the
before-tax interest rate multiplied by the combined federal and state marginal
corporate income tax rate (i.e., the tax rate paid on each incremental dollar
of income).” (Id., appen. A, at p. 178.)
In his calculations, Matthews determined the after-tax cost of debt by
multiplying the before-tax interest rate by the maximum combined federal and
state marginal corporate income tax rate:
41 percent.href="#_ftn4"
name="_ftnref4" title="">^[4]

John Louden, an auditor appraiser with the assessor’s office, testified
that he took the after-tax capitalization rate calculated by Matthews using the
WACC method and converted it into a before-tax rate to be applied to the
before-tax income stream being valued.
In doing so, he did not use the maximum combined federal and state
marginal rate; instead, he calculated an “effective tax rate” for each company. Louden began with the same eight companies
used by Matthews, which he believed represented potential buyers of the
property being appraised. Using data
gleaned from the companies’ 10k reports filed with the Securities and Exchange
Commission, Louden calculated for each company a “net income adjusted to DCF
[discounted cash flow] analysis income”; apparently, he adjusted the income or
loss reflected in the companies’ 10k reports to reach a figure approximating
the “net return” prescribed by Rule 8, subdivision (c).

Louden arrived at an “effective tax rate” for each company based on the
actual income taxes the companies paid.
He then excluded some of the companies for various reasons; he took the
rates for the three remaining companies and calculated a weighted average,
added a property tax component, and used the resulting rate to convert
Matthews’ after-tax discount rate to a before-tax discount rate. The result was a before-tax discount rate
(“present value factor”) of 11.5 percent for 2006 and 14.75 percent for 2007.href="#_ftn5" name="_ftnref5" title="">^[5]

At the May 12, 2009, hearing, plaintiffs presented their calculations of
the before- and after-tax discount rates, which followed a process similar to
that followed by the assessor, but used an SBE capitalization rate study as the
basis for the after-tax discount rate.
Plaintiffs noted that their cash flows differed only slightly from the
assessor’s and they agreed with most of the components, with the exception of
certain items in Sky River’s 2007 appraisal.
Plaintiffs argued for before-tax discount rates of 20.44 percent for
2006 and 21.32 percent for 2007. At the
end of the May 12, 2009, hearing, the parties stipulated to the assessor’s cash
flow figures, but reserved for argument the issue of the proper capitalization
rate and the final property values; they excepted from the stipulation the 2007
assessment for Sky River, which the board set for a further hearing on
September 15, 2009.

At the September 15, 2009, hearing, the assessor presented the same
method of calculating the before-tax discount rate as he had presented at the
earlier hearing, and used it to discount Sky River’s anticipated income stream
to present value. Plaintiffs challenged
some of the income figures in the assessor’s cash flow data, offered expert testimony
to show the assessor’s discount and valuation figures were incorrect, and
presented their own before-tax discount rate and final valuation figures.

After the hearings were complete, the board issued its findings of fact,
in which it accepted the assessor’s discount rates, finding that the assessor’s
methodology for conversion of the after-tax discount rate to a before-tax
discount rate, which relied on “expected” or “effective” corporate income tax
rates, complied with Rule 8. Plaintiffs
filed complaints in superior court, challenging the rulings of the board. The court tried the issues presented by the
complaints: whether the board erred by
permitting the assessor to use, in the conversion from an after-tax discount
rate to a before-tax discount rate, an “effective” income tax rate that was, in
reality, an average rate, rather than a marginal rate; and whether the board
erroneously permitted the assessor to use incorrect figures for the capacity
payments in his revenue figures for Sky River’s 2007 appraisal. The trial court issued a statement of
decision, in which it concluded its standard of review of the board’s action
was de novo, the methodology used by the assessor and accepted by the board was
legally erroneous, and the use of the wrong figures for the capacity payment
was arbitrary and improper. The trial
court also concluded that remand to the board was not necessary; the errors
could be corrected by recalculation, and the properly calculated figures were
those presented by plaintiffs in their appraisals at trial.

In this appeal, the county challenges the trial court decision. It contends the proper standard of review was
substantial evidence, so the trial court was bound by the findings of the board
and could review its decision based only on the administrative record; it was
not permitted to take new evidence or make its own factual findings. The county contends the trial court erred in
admitting in evidence plaintiffs’ appraisals, which were new evidence, not
presented to the board. The appraisals
presented by plaintiffs at trial began with the figures from the assessor’s
appraisals, but where the assessor used an “effective” tax rate to convert the
discount rate from an after-tax rate to a before-tax rate, plaintiffs
substituted the maximum marginal combined federal and state income tax rate of
41 percent. The result was a higher
before-tax discount rate and a lower property value than those proposed by the
assessor. The county contends substantial
evidence supported the board’s decision to accept the assessor’s use of an
effective or average tax rate and the use of figures for the capacity payment
that were based on historical rates superseded by newer contractual rates.

>III. Proper
Corporate Income Tax Rate to be Used

In the trial court, plaintiffs did not dispute the county’s cash flow
data or its calculation of the after-tax discount rate, with the exception of
Sky River’s 2007 assessment, where plaintiffs challenged the figures for income
from capacity payments. The primary issue
was the income tax rate to be used in converting from an after-tax to a
before-tax discount rate. The assessor’s
handbook provides that the relevant income tax rate is the expected combined
federal and state marginal rate. (SBE
Assessors’ Handbook, supra,
§ 502, appen. A, at pp. 179-180, fn. 175.) The handbook “is used as a basic guide by tax
assessors.” (Exxon Mobil Corp. v. County of Santa Barbara (2001) 92 Cal.App.4th
1347, 1353 (Exxon), fn.
omitted.) Although assessors’ handbooks
are not regulations and do not possess the force of law, they serve as a
primary reference and basic guide for assessors, and have been relied upon and
accorded great weight in interpreting valuation questions. (Prudential
Ins. Co. v. City and County of San Francisco (1987) 191 Cal.App.3d 1142,
1155.) “The interpretations and opinions
of an agency administrator, while not controlling upon the courts, constitute a
body of experience and informed judgment to which courts and litigants may
properly resort for guidance.
[Citation.] ‘Because the agency
will often be interpreting a statute within its administrative jurisdiction, it
may possess special familiarity with satellite legal and regulatory
issues. It is this “expertise,”
expressed as an interpretation (whether in a regulation or less formally …),
that is the source of the presumptive value of the agency’s views.’ [Citation.]”
(Exxon, supra, at p. 1357.)

A marginal income tax rate is the tax rate applicable to the taxpayer’s
last dollar of net income. The federal
corporate income tax rate increases as taxable income increases (26 U.S.C.
§ 11), so the rate payable on the highest increment of income is higher
than the rate applicable to lower increments; it is also higher than the
average rate the taxpayer pays on its entire taxable income. The marginal rate is the rate at which any
new income of the taxpayer will be taxed.
Consequently, the assessor’s handbook recognizes that, in determining
the value of property by using the income approach, the appropriate income tax
rate to consider would be the rate at which new income would be taxed, which is
the potential purchaser’s combined marginal federal and California income tax
rate. href="#_ftn6" name="_ftnref6"
title="">^[6] (SBE
Assessors’ Handbook, supra,
§ 502, appen. A, at pp. 179-180, fn. 175.)

The California corporate income tax rate is a flat 8.84 percent, subject
to a minimum payment (Rev. & Tax. Code, § 23151); thus, this is the
marginal California rate. The federal
marginal rate to be used in the income approach depends on the taxable income
of the potential purchaser. The county
did not attempt to calculate the companies’ taxable income for federal tax
purposes, from which their federal marginal rates could have been determined.href="#_ftn7" name="_ftnref7" title="">^[7]
Instead, Louden took the income or loss reported by the companies in
their publicly available financial statements, deducted capital expenditures,
and added depreciation and amortization in order to convert it to a before-tax
net return figure as defined in Rule 8, subdivision (c).href="#_ftn8" name="_ftnref8" title="">^[8] He
took the total taxes paid by the company―federal tax, state tax to any
state, and foreign tax―and adjusted for tax credits. He then divided the adjusted taxes by his
Rule 8, subdivision (c) net return figure, to arrive at his effective income
tax rate. Thus, he began with an income
figure that may or may not approximate taxable income. Then he lumped together all income taxes
paid, to any taxing authority and at any rate, and used the income and tax
figures to arrive at some kind of an average rate, which he called the
“effective tax rate.” He used this rate
in lieu of the potential purchaser’s combined federal and California marginal
rate in converting the discount rate from an after-tax rate to a before-tax
rate.

This average rate did not represent a relevant rate a potential purchaser
of the property would take into consideration in determining the price it was
willing to pay for the property. It did
not represent an estimate of the marginal rate at which the income stream from
the subject property would be taxed, since an average rate will always be lower
than the marginal rate. Consequently,
the county’s attempt to use an average of the potential buyers’ tax rates as an
“expected” or “effective” tax rate, in lieu of using the potential buyers’
marginal tax rates was arbitrary and not consistent with the method set out in
the assessor’s handbook.

In the administrative proceedings,
the board rejected use of the maximum marginal rate, based on a footnote in the
assessor’s handbook, which states:
“Using the top statutory combined federal and state marginal income tax
rate may incorrectly estimate the expected marginal combined rate, which is the
relevant rate for the analysis. Because
of various tax factors, the expected marginal rate may differ from the top
statutory combined marginal rate.” (SBE
Assessors’ Handbook, supra,
§ 502, appen. A, at p. 179, fn. 175.)
The board chose to apply the assessor’s average or “expected” tax rate
rather than the “maximum tax rate” in the conversion, omitting from its
discussion any mention of the “expected marginal combined rate,” which the
handbook indicated was “the relevant rate for the analysis.” We do not interpret the handbook’s footnote
as a basis for rejecting use of the marginal rate. Rather, we interpret it to mean that the >maximum marginal rate may not be the
correct marginal rate to use, if the typical potential buyer would not have a
taxable income that would be taxed at the highest marginal rate. In that event, the potential buyer’s
“expected marginal combined rate,” that is, the marginal rate applicable to the
last increment of that potential buyer’s taxable income, would be the
appropriate rate to use in the conversion.
(Ibid.) It is the potential purchaser’s >marginal rate, not some average rate
that is prescribed by the handbook.

We agree with the trial court that the methodology the assessor used and
the board approved was legally incorrect.
Pursuant to the assessor’s handbook, the appropriate tax rate for the
conversion from an after-tax to a before-tax discount rate is the typical
potential purchaser’s expected combined California and federal marginal income
tax rate. The tax assessor and the board
erroneously used an average rate that included taxes paid to other states; the
trial court correctly concluded the county’s valuation method was arbitrary and
inconsistent with the standards set out in the assessor’s handbook. The trial court did not err in rejecting the
county’s methodology.

>IV. Additional Evidence>

Before the
board, plaintiffs presented their own calculations to support the discount rate
they contended should apply to reach present value of the property under the
income approach. In the trial court,
however, plaintiffs abandoned their calculations of the cash flow (revenue and
expenses) and the after-tax discount rate and accepted the county’s, because
their own were not significantly different from the calculations of the
assessor. The issue in the trial court
was the income tax rate to use in converting from an after-tax discount rate to
a before-tax rate. In their presentation
to the trial court, plaintiffs submitted appraisals in which they set out the
county’s cash flow figures and after-tax discount rate, applied plaintiffs’
proposed conversion rate to the assessor’s after-tax discount rate, then used
the resulting before-tax discount rate to calculate the present value of the
property. The county contends the trial
court’s review of the board’s decision was limited to the administrative
record, the trial court was not permitted to admit additional evidence, and
plaintiffs’ new appraisals constituted additional evidence that should not have
been admitted.

In this
matter, plaintiffs are challenging the validity of the method used by the
assessor to arrive at the present value of the property of the wind farms. In the trial court, when the taxpayer
challenges the method of valuation used by the tax assessor, the issue is a
legal one and the trial court “is not restricted to the transcript of the
proceedings before the board, but may receive additional evidence bearing on
the legal question.” (>Norby
Lumber Co. v. County of Madera (1988) 202 Cal.App.3d 1352, 1363 (Norby).) The trial court
“may take evidence on the validity of the method, and may overturn the
assessment if the challenged method of valuation is arbitrary, in excess of
discretion, or in violation of standards prescribed by law.” (Dominguez Energy v. County of Los Angeles (1997) 56 Cal.App.4th 839, 852.) Consequently, the appraisals submitted by
plaintiffs were admissible in the trial court to show that the assessor’s
method of calculating the discount rate and the resulting property value was
arbitrary, in excess of discretion, or in violation of the applicable legal
standards. The appraisals demonstrated
the method of converting the after-tax discount rate to a before-tax discount
rate that plaintiffs contended was legally correct. Plaintiffs used them both to show that their
method was legally correct and to show that the result using the county’s method
was a significantly different property value.
To the extent they were admitted to demonstrate the invalidity of the
assessor’s methodology, we find no error in the trial court’s admission into
evidence of plaintiffs’ appraisals.

>V. Remand

The county
contends that, if the trial court was correct in rejecting the board’s
decision, this matter must be remanded to the board for a redetermination of
the property values and the tax. The
trial court concluded the matter did not need to be remanded to the board for
further action because the errors could be corrected by recalculation, and the
correct calculations of the property values and the property taxes could be
found in the numbers provided by plaintiffs’ appraisals. The judgment set out the values to be
enrolled for plaintiffs’ property for 2006 and 2007, and ordered the county to
calculate and refund the excess tax payments to plaintiffs.

“[W]hen
reviewing an equalization determination properly before it in a refund action,
a court may correct an assessment and grant a tax refund if value is calculable as a matter of law without remanding to the
county board of equalization.
[Citations.] [¶] However, where a
judgment must still be exercised as to value, a remand to the local board of
equalization is required.
[Citations.]” (>Plaza Hollister Ltd. Partnership v. County
of San Benito (1999) 72
Cal.App.4th 1, 24, italics added, fn. omitted.)
“If the board has used an improper method of value or has failed to use
proper criteria in valuing the property and there is no evidence or there is a
conflict in the evidence from which a proper value can or should be made, the
trial court must remand the matter to the board for further proceedings.” (Norby,
supra, 202 Cal.App.3d at p.
1366.) Remand “is generally required if
the refund determination depends upon an exercise of valuation functions and
does not simply involve mathematical computations. [Citation.]
The ‘cases establish that the key question concerning remand is whether
there remain factual determinations to be made in establishing market
value.’” (CAT Partnership v. County of Santa Cruz (1998) 63 Cal.App.4th 1071,
1088.)

Plaintiffs
contend the property values and taxes are calculable from the appraisals
presented at trial by plaintiffs, and therefore remand is not required. However, their argument assumes that, as a
matter of law, the correct income tax rate to be used in the conversion from an
after-tax discount rate to a before-tax discount rate is the maximum combined federal and state marginal
income tax rate. That assumption is not
correct. The correct rate is the
expected combined marginal federal and state income tax rate of a typical
potential purchaser of the property in issue.
In the administrative proceedings, the county presented evidence of an
average income tax rate for the companies it contended were potential
purchasers. It presented no evidence of
the companies’ expected marginal tax rates.
Plaintiffs argued that the maximum marginal rate applied, but presented
no evidence that a typical potential purchaser would be taxed at the maximum
rate. Plaintiffs argue in this appeal
that the county’s appraisal documents demonstrate that potential buyers would
be in the highest tax bracket. While the
county’s appraisals presented some revenue, expense, and tax figures for the
eight companies it presented as potential buyers, as plaintiffs themselves
recognized in documents filed in the administrative proceeding and the trial
court, the county did not present evidence of the companies’ taxable incomes,
from which the appropriate marginal rate could be determined. Consequently, there was insufficient evidence
to support the assumption that potential purchasers would be taxed at the
maximum rate.

Factual issues remain regarding the
correct expected combined federal and state marginal income tax rate applicable
to a typical potential purchaser of the property in issue. Accordingly, the matter must be remanded to
the board so that it can take further evidence and redetermine the appropriate
income tax rate to be used in the conversion of the after-tax discount rate to
a before-tax discount rate, and thereafter recompute the value to be enrolled
and the applicable property tax.

>VI. Capacity Payments

The county
contends the trial court erred in concluding that substantial evidence did not
support the board’s finding that the capacity payment reflected as a revenue
item in the assessor’s calculation of the discount rate for the 2007 appraisal
of Sky River was an appropriate figure to use in that calculation. A capacity payment is a payment Southern
California Edison (Edison), the electric company to which plaintiffs sell the
electricity they generate, pays to plaintiffs as an incentive to keep their
capacity up at times when the demand is high.
The board found the capacity payments reflected in the assessor’s 2007
Sky River appraisal were properly based on historical information known on the
appraisal date. The trial court found
the assessor “arbitrarily used old historic superseded rates” for the capacity
payments reflected for Sky River for 2007, and the rates did not bear any
relationship to contract rates in place since 2003, although the correct rates
were used for the 2006 appraisal.

On appeal,
“‘[t]he burden of affirmatively demonstrating error is on the appellant. This is a general principle of appellate
practice as well as an ingredient of the constitutional doctrine of reversible
error.’ [Citation.] The order of the lower court is ‘“presumed to
be correct on appeal, and all intendments and presumptions are indulged in favor
of its correctness.”’ [Citation.]” (State Farm Fire & Casualty Co. v. Pietak (2001) 90 Cal.App.4th 600, 610.) “‘It is the duty of a
party to support the arguments in its briefs by appropriate reference to the
record, which includes providing exact page citations.’ [Citations.]
If a party fails to support an argument with the necessary citations to
the record, that portion of the brief may be stricken and the argument deemed
to have been waived. [Citation.]” (Duarte v. Chino Community Hospital (1999)
72 Cal.App.4th 849, 856.)

Although the county argues in its
brief that the trial court erred in finding that the capacity payments
reflected in the 2007 Sky River appraisal were not supported by substantial
evidence, it fails to cite evidence in the record supporting its
assertions. Any reference in an
appellate brief to matter in the record must be supported by a citation to the
volume and page number of the record where that matter may be found. (Cal. Rules of Court, rule
8.204(a)(1)(C).) This rule applies to
matter referenced at any point in the brief, not just in the statement of
facts. (Lona v. Citibank, N.A. (2011) 202 Cal.App.4th 89, 96, fn.
2.)

At the administrative hearings,
there was evidence that the capacity rates are set by a schedule in the
contract with Edison; the rates are higher during peak season (June through
September) and at certain times of the day.
Matthews testified the capacity payments used by the assessor in the
2006 appraisals were calculated “based on the prior three years’ averages for
that revenue component.” The county has
not pointed to any similar testimony about the 2007 appraisal. There was evidence plaintiffs and Edison
entered into a revised capacity agreement in December 2003, and the capacity
price was changed for the remainder of the life of the contract. Although this information was provided to the
assessor, he used older rates, from the late 1990s and 2000 to 2003, when the
capacity revenue was much higher, in his calculations for 2007; he used the
current rates in his 2006 calculations.
The county has cited no evidence in the record indicating the capacity
payment in the 2007 Sky River appraisal was based on current rates or the prior
three years’ information; it has cited no evidence that there was any
reasonable basis for using superseded data from some earlier period for that
appraisal. Consequently, the county
failed to meet its burden of demonstrating that the trial court erred in
finding that substantial evidence did not support the board’s finding in favor
of the county on the capacity payment for the 2007 Sky River appraisal.

>DISPOSITION

The
judgment of the trial court is reversed, and the trial court is directed to
enter a new and different judgment in favor of plaintiffs and against the
county, determining that the method used by the board and the tax assessor to
calculate the value of the property, and specifically the method used to
convert the discount rate from an after-tax rate to a before-tax rate, was
arbitrary and invalid. The trial court
shall remand the matter to the Assessment Appeals Board for further proceedings
to take evidence as needed and recalculate the value of the property in
accordance with the views expressed in this opinion. The parties shall bear their own costs on
appeal.





_____________________

HILL, P. J.

WE CONCUR:





_____________________

CORNELL, J.





_____________________

GOMES, J.