IN THE SUPREME COURT OF THE STATE OF KANSAS
No. 89,578
IN THE MATTER OF THE APPEAL OF
ANR PIPELINE COMPANY
FROM A DECISION OF THE DIRECTOR OF PROPERTY VALUATION
OF THE STATE OF KANSAS.
SYLLABUS BY THE COURT
1. It is the duty of the Board of Tax Appeals (BOTA), in reviewing a valuation by the Department of Revenue Property Valuation Division (PVD), to exercise its judgment anew based on the evidence presented to it at the hearing and without giving deference to the PVD's valuation.
2. BOTA is the paramount taxing authority in this state. BOTA is a specialized agency that exists to decide taxation issues. Its decisions are given great weight and deference when it is acting in its area of expertise. The party challenging BOTA's decisions has the burden to prove that the action taken was erroneous. However, if BOTA's interpretation of law is erroneous as a matter of law, appellate courts will take corrective steps.
3. Orders of BOTA are subject to judicial review under the Act for Judicial Review and Civil Enforcement of Agency Actions. In reviewing BOTA decisions, this court determines whether relief is warranted under the provisions of K.S.A. 77-621(c), which requires the court, in part, to determine whether BOTA has erroneously interpreted the law, has made a determination of fact that is not supported by substantial competent evidence, or has acted in an unreasonable, arbitrary, or capricious manner.
4. K.S.A. 79-5a04 requires the PVD to determine the fair market value of public utility property. In doing so, the PVD may allocate the unit value to Kansas if practicable. However, the method used must reflect the fair market value of the public utility's property in Kansas.
5. When a decision of BOTA is challenged for insufficiency of evidence or as being contrary to the evidence, it is not the function of the appellate court to weigh the evidence or pass on the credibility of the witnesses. If the evidence, with all reasonable inferences to be drawn therefrom, when considered in the light most favorable to the prevailing party, supports the decision, it will not be disturbed on appeal.
6. A determination of the unit value of a public utility property utilizing an income approach to value depends to a large extent on a forecasting of future earnings to the best of the appraiser's judgment. Admission of actual earned income subsequent to the evaluation date is generally not permitted since its admission undermines a forecasting of future income. However, in rare circumstances where no data exists from which a forecast can be made, and the post evaluation data is within close proximity to the evaluation date, actual income earned after the evaluation may be admitted. The Uniform Standards of Professional Appraisal Practice, Appraisal Standard No. 3, adopted by the Kansas Legislature is subject to the above limitations.
7. Based upon the record before this court, the capitalization rates used by BOTA to determine the unit value of a public utility's property for 1994 and 1995 are supported by substantial competent evidence and are not unreasonable, arbitrary, or capricious.
8. It is fundamental that the Kansas Constitution limits rather than confers powers. Where the constitutionality of a statute is involved, the question presented is not whether the act is authorized by the constitution but whether it is prohibited thereby. Nothing in the Kansas Constitution prohibits the taxation of public utility intangibles. The provisions of K.S.A. 79-5a04 are presumed constitutional and are consistent with the provisions of the Kansas Constitution.
9. An intangible that constitutes an essential portion of a tangible asset without which the tangible asset could not function is taxable as tangible property. Moreover, intangible property even though nontaxable may be included in valuing the business of a public utility to the extent it is used to enhance the value of tangible personal property. Thus, where the cost of installation, overhead, and other related expenses are an integral part of the unit value of a public utility, the failure to include such costs would frustrate any attempt to determine the fair market value of the unit.
Appeal from the Kansas Board of Tax Appeals. Opinion filed November 7, 2003. Affirmed.
Richard D. Greene, of Morris, Laing, Evans, Brock & Kennedy, Chartered, of Wichita, argued the cause, and Karen L. Pauley, of El Paso Corporation, of Houston, Texas, was with him on the briefs for appellant.
William E. Waters, of the Kansas Department of Revenue, argued the cause and was on the brief for appellee.
The opinion of the court was delivered by
DAVIS, J.: ANR Pipeline Company (ANR) appeals from a Board of Tax Appeals' (BOTA) decision regarding the value of its interstate company or its unit value for the years 1994 and 1995. ANR claims its unit value was overvalued because (1) sufficient consideration was not given to the Federal Energy Regulatory Commission (FERC) Order 636 in forecasting ANR's future income, (2) intangible assets not subject to tax in Kansas were included in the unit values, and (3) BOTA's adoption of overall capitalization rates were not supported by the weight of evidence. ANR also claims that BOTA applied an erroneous standard of review by giving deference to the Department of Revenue Property Valuation Division (PVD). For the reasons stated in this opinion, we affirm BOTA's decision.
This appeal deals with BOTA's determination of the value of ANR's entire operation or unit value. That value was determined primarily through an income approach. The cost approach was also used as well as the market approach. However, less weight was given to the market approach since ANR had no publically traded stock. The income approach utilizes a formula to arrive at value where value equals income, divided by a capitalization rate. The dispute in this case involves both the income and the capitalization rate components of the formula. BOTA correctly identified the issues:
"A. [What was] [t]he appropriate unit valuation of the Taxpayer's property for 1994 and 1995 tax years, including:
a. The use of income forecasts in the income approach.
b. The appropriate capitalization rate, including the appropriate cost of equity[?]
"B. Were the values of nontaxable intangibles included in the unit valuation for the tax years 1993, 1994, and 1995[?]"
Before considering the merits of ANR's claims as to BOTA's determination of unit values, we must determine a threshold issue of whether BOTA applied the correct standard of review in its decision. We also must determine our standard of review.
BOTA'S STANDARD OF REVIEW
It is the duty of BOTA, in reviewing a valuation by the PVD, to exercise its judgment anew based on the evidence presented to it at the hearing and without giving deference to the PVD's valuation. In re Appeal of Colorado Interstate Gas Co., 270 Kan. 303, 14 P.3d 1099 (2000). In a prior appeal of this same case, we reversed and remanded to BOTA based upon our conclusion that BOTA may have given the PVD deference and based upon our decision in Colorado Interstate Gas, we rejected the standard adopted by BOTA that a public utility must demonstrate that the PVD intentionally and grossly disregarded the standards prescribed by K.S.A. 79-5a04 in order to prevail. While BOTA did not articulate such a standard in this case, we held that it was not possible to conclude that BOTA disregarded the erroneous standard of review adopted in Colorado Interstate Gas. We, therefore, reversed and remanded to BOTA for further proceedings. After a review of the law in Kansas regarding the appropriate standard BOTA must use in its determination of value in a public utility's appeal from a PVD determination of value, we said in Colorado Interstate Gas:
"Based upon the expert testimony presented by the PVD before BOTA that the unit valuation method used need not represent the fair market value of CIG's property in Kansas, and considering that BOTA applied an incorrect standard of review for that evidence by giving deference to the PVD's determination of value, there is a real possibility that BOTA's final determination of value for the years in question was not based on fair market value as required by K.S.A. 79-5a04." 270 Kan. at 321.
In the present appeal, ANR again challenges the standard of review applied by BOTA, claiming that BOTA paid lip service to the standard of review set forth in Colorado Interstate Gas but effectively applied a similarly erroneous standard by again giving deference to the valuation determined by the PVD. In support of its claim, ANR points to the following language in the BOTA decision:
"38. The Taxpayer has the burden of proof to show by a preponderance of the evidence that the Director has not appropriately valued the Taxpayer's property pursuant to K.S.A. 79-5a04. Id.
. . . .
"41. The Board finds that PVD used appropriate methodologies and came to rational conclusions concerning depreciation and obsolescence in the cost approaches to value.
. . . .
"47. PVD's overall capitalization rate for tax years 1994 and 1995 are similar to the overall capitalization rates recommended by the Natural Gas Pipeline Property Tax Forum. Finally, PVD's capital structure determination is similar to the capital structure determination of the Natural Gas Pipeline Property Tax Forum.
. . . .
"53. The Board finds that the Taxpayer has not shown by a preponderance of the evidence that PVD's unit valuation of the Taxpayer's property is in error. After considering the standards prescribed by K.S.A. 79-5a04, the Board concludes that PVD's unit valuation of the Taxpayers property for tax year 1993 of $1,640,000,000, for 1994 of $1,590,000,000 and for tax year 1995 of $1,560,000,000 are appropriate estimates of the fair market value of the Taxpayer's property and should be sustained."
ANR argues that the above language makes clear that BOTA once again gave deference to the PVD and required ANR to shoulder the burden of proving that the PVD erred. ANR notes that it should have no burden to show that the PVD erred or to negate the contentions of the PVD, but argues that its burden is limited to showing by a preponderance of evidence that its proposed values are correct. We agree that ANR's burden before BOTA was to establish by a preponderance of evidence that its proposed values are correct. We, however, disagree that BOTA actually deferred to the PVD in its decision on the unit value of ANR's property and the fair market value of its property in Kansas.
Following remand, the proceeding continued with an agreement by the parties to consider the matter based upon the existing record. At that point, the record contained the PVD's determinations as to ANR's value together with all supporting evidence in addition to ANR's determination of its value together with its supporting evidence. In order to prevail before BOTA, the burden fell upon ANR to establish by a preponderance of the evidence the accuracy of its valuation. BOTA recognized its role when it said that ANR "has the burden of proof to show by a preponderance of the evidence that the [PVD] has not appropriately valued the Taxpayer's [ANR] property pursuant to K.S.A. 79-5a04." In other words, ANR's burden was to show that the PVD was wrong and the value ANR asserted was supported by substantial competent evidence. Thus, BOTA was giving no deference to the PVD except to say that when the PVD established evidence supporting its valuation, ANR must necessarily attack and undermine the PVD's valuation. It is up to BOTA--by paying neither side deference--to determine which side presents the most compelling case.
ANR argues that Paragraph 38, quoted above, shows how BOTA deferred to the PVD's judgment. Within this context, BOTA's statement that the taxpayer has the burden of proof to show by a preponderance of the evidence that the director has not appropriately valued and allocated the valuation, as prescribed by K.S.A. 79-5a04, is another way of saying that the burden lies with ANR. In order for ANR to prove its valuation, it would be reasonably required to prove that the PVD valuation was incorrect.
ANR also complains that evidence of BOTA deference is found in Paragraph 41, where BOTA said that the PVD came to rational conclusions. However, BOTA also said in the same sentence that the PVD's methodologies were appropriate. Consistent with exercising judgment anew, it would be logical for BOTA to adopt conclusions that were rational and reached by appropriate methodologies.
ANR argued that because the PVD's overall capitalization rates and capital structure determinations in Paragraph 47 above are similar to that recommended by the Natural Gas Pipeline Property Tax Forum (Property Tax Forum), BOTA deferred to the PVD. However, it must be noted that ANR was a member of the Property Tax Forum and a member of the subcommittee recommending overall capitalization rates for the years 1994 and 1995 as more fully discussed below. Far from indicating a deference to the PVD, it demonstrates that BOTA, like the PVD, considered the Property Tax Forum a valuable resource for determining overall capitalization rates, especially since the capitalization rates determined by a subcommittee of the Property Tax Forum were recommended to all members including ANR.
In Paragraph 53, when BOTA said in its original order on remand that ANR has not showed "by a preponderance of the evidence that the PVD's unit valuation of Taxpayer's property is in error," BOTA was also saying that the PVD had shown by a preponderance of evidence that its valuation was correct. Unlike the previous appeal, there is no indication that BOTA relied on an intentional and gross disregard standard of review or otherwise deferred to the PVD in determining the unit value of ANR's property. See Colorado Interstate Gas, 270 Kan. at 315.
BOTA understood the mandate of this court in Colorado Interstate Gas and applied a correct standard of review as demonstrated in its order denying ANR's motion for reconsideration:
"4. The Taxpayer asserts that the Board did not exercise its judgment anew, but instead, found that the Taxpayer did not meet its burden to show that the Director has not appropriately valued the subject property. The Taxpayer further argues that the Board's standard of review inherently gives deference to the Director's valuation in direct contravention of the Supreme Court's remand. The Board believes the Taxpayer has misinterpreted the Board's findings and conclusions.
"5. The Board is well aware that the standard of review requires that the Board exercise its judgment anew based on the evidence presented and without giving deference to the Director's valuation. The Taxpayer's argument in these matters is basically that the Director has excessively valued and allocated the valuation of the Taxpayer's property. The Taxpayer must provide evidence to show that the Director's valuation is in error and the Director must provide evidence in support of his valuation. The Board must review the evidence provided and by applying the factors enumerated in K.S.A. 79-5a04 determine the appropriate valuation of the Taxpayer's property. In these matters, the Board gave no deference to the Director's valuations, but rather reviewed the evidence presented and concluded by the weight of the evidence that the appropriate unit valuation for 1993 is $1,640,000,000 for 1994 is $1,590,000,000, and for 1955 is $1,560,000,000, which are the same as determined by the Director."
Nevertheless, ANR argues that a decision on whether BOTA applied the correct standard of review should be determined by considering the record as a whole, not by considering what BOTA said in its order denying reconsideration. Further, ANR argues that BOTA's order denying reconsideration does not negate the admissions of deference in BOTA's original order since BOTA's figures matched those of the PVD's despite the subjective nature of the judgment exercised by the PVD.
The fact that BOTA's figures matched those of the PVD's provides little if any evidence that BOTA applied a deferential standard of review. ANR is right that this determination must be made from the record as a whole. If BOTA is to be believed, it gave no deference to the PVD in its determination of value. However, we must point out that initially it was the responsibility of the PVD to value ANR's property for ad valorem taxation in Kansas. It did so based upon the judgment of its experts and all of the factors which are now before this court. The proceeding before BOTA started with the PVD's determination of value and its contention before BOTA that the unit value as well as the fair market value in Kansas was established. The assessment had been made by the PVD. Before BOTA, both the PVD and ANR presented their cases regarding the testimony of unit value as well as the fair market value of ANR's property in Kansas. BOTA decided this case based upon all the evidence without giving deference to the PVD.
ANR had the burden to establish that its unit value was correct, thereby establishing that the determination by the PVD was invalid based upon the record as a whole. BOTA concluded that ANR failed to meet its burden, thus providing a basis for concluding based upon all evidence presented that the valuation determined by the PVD was correct. Instead of giving deference to the PVD by adopting its valuation, BOTA determined that the record supported the determination made by the PVD. To say that BOTA adopted the PVD's values without any consideration of the evidence ignores the record as a whole as well as BOTA's expressed conclusion that its determination was made anew based upon all the evidence presented.
STANDARD OF REVIEW OF BOTA DECISIONS
In reviewing a BOTA decision, several well-established principles govern. BOTA is a specialized agency and is considered to be the paramount taxing authority in this state. Wirt v. Esrey, 233 Kan. 300, 314, 662 P.2d 1238 (1983). BOTA is a specialized agency that exists to decide taxation issues. Hixon v. Lario Enterprises, Inc., 257 Kan. 377, 378-79, 892 P.2d 507 (1995). Its decisions are given great weight and deference when it is acting in its area of expertise. In re Tax Appeal of Boeing Co., 261 Kan. 508, 515, 930 P.2d 1366 (1997). The party challenging BOTA's decisions has the burden to prove that the action taken was erroneous. Board of Ness County Comm'rs v. Bankoff Oil Co., 265 Kan. 525, 537, 960 P.2d 1297 (1998). However, if BOTA's interpretation of law is erroneous as a matter of law, appellate courts will take corrective steps. In re Tax Appeal of Family of Eagles, LTD, 275 Kan. 479 Syl. ¶ 1, 66 P.3d 858 (2003).
Orders of BOTA are subject to judicial review under the Act for Judicial Review and Civil Enforcement of Agency Actions. See K.S.A. 77-601 et seq.; K.S.A. 74-2426(c); In re Appeal of Topeka SMSA Ltd. Partnership, 260 Kan. 154, 162, 917 P.2d 827 (1996). In reviewing BOTA decisions, this court determines whether relief is warranted under the provisions of K.S.A. 77-621(c), which provides:
"(1) The agency action, or the statute or rule and regulation on which the agency action is based, is unconstitutional on its face or as applied;
"(2) the agency has acted beyond the jurisdiction conferred by any provision of law;
"(3) the agency has not decided an issue requiring resolution;
"(4) the agency has erroneously interpreted or applied the law;
"(5) the agency has engaged in an unlawful procedure or has failed to follow prescribed procedure;
"(6) the persons taking the agency action were improperly constituted as a decision-making body or subject to disqualification;
"(7) the agency action is based on a determination of fact, made or implied by the agency, that is not supported by evidence that is substantial when viewed in light of the record as a whole, which includes the agency record for judicial review, supplemented by any additional evidence received by the court under this act; or
"(8) the agency action is otherwise unreasonable, arbitrary or capricious."
"Arbitrary or capricious" may be established under K.S.A. 77-621(c)(8) where an administrative order is not supported by substantial evidence. Kansas Racing Management, Inc. v. Kansas Racing Comm'n, 244 Kan. 343, 365, 770 P.2d 423 (1989). "Substantial evidence is evidence which possesses both relevance and substance so as to form a basis of fact from which the issues can be reasonably resolved. [Citation omitted.]" Dalmasso v. Dalmasso, 269 Kan. 752, 758, 9 P.3d 551 (2000).
FACTS
There is little agreement between the parties as to the material facts of this case. Since we are called upon to review the BOTA decision, we begin with BOTA's statement of facts, leaving the factual arguments of the parties to the analysis portion of this opinion.
The BOTA order on remand sets forth the following factual findings:
"4. On remand, the parties have agreed that additional evidence is not necessary and that the Board should review the evidence previously presented and issue a decision utilizing the standards set forth by the Supreme Court in remanding these matters and in remanding the Colorado Interstate Gas cases. The following issues are before the Board:
. . . .
"4. [Paragraph misnumbered.] At the January 1997 hearing of these matters the following individuals testified:
Called as witnesses by the Taxpayer:
John C. Goodman ASA, PE, Appraiser with AUS Consultants
Kenneth Williams Vice-Chairman, Brown, Williams, Scarbrough
& Quinn, Inc., Consulting
Prof. J. Peter Williamson The Laurence F. Whittemor Professor of
Finance, Amos Tuck School of Business,
Dartmouth College
Dr. John H. Davis, II PhD, MAI, SRPA, ASA, Business Valuation
Floyd Rumsey Supervisor, Utility Section, State Appraised
Properties, Division of Property Valuation
Kansas Dept. of Revenue
Called as witnesses by the Division of Property Valuation:
Michael W. Goodwin CAE, ASA, Michael W. Goodwin & Associates
Dr. A. James Ifflander PhD, CFA, Private Consultant
John Hughes Tax Examiner 4, Division of Property Valuation,
Kansas Dept. of Revenue
Floyd Rumsey Supervisor, Utility Section, State Appraised
Properties, Division of Property Valuation,
Kansas Dept. of Revenue.
"5. At the outset of the January 1997 hearing, Taxpayer withdrew all issues regarding unit valuation of the Taxpayer's operating properties for tax year 1993 and accepted the Director's unit valuation with the exception of an issue regarding deduction of intangibles. Therefore, the only issue before the Board for the 1993 tax year involves the Director's treatment of intangibles.
"6. The primary issue before the Board for the 1994 and 1995 tax years is that fair market value (unit valuation) of the Taxpayer's operating properties. The Taxpayer is not raising any issues concerning the Director's allocation of the unit valuation to Kansas pursuant to K.S.A. 79-5a04, nor the Director's apportionment pursuant to K.S.A. 79-5a25 of the assessed valuation to the taxing units in Kansas where the Taxpayer has property located.
"7. The Taxpayer has also raised a number of constitutional issues. The Board does not have the authority to determine whether these arguments have merit. The Board is to presume that the Kansas Constitution does not violate the federal constitution and that the Kansas statues do not violate the U.S. Constitution or Kansas Constitution. The Board has no authority to determine constitutional questions. Zarda v. State, 250 Kan. 364, 826 P.2d 1365, cert denied, 504 U.S. 973, 119 L. Ed. 2d 566, 112 S. Ct. 2941 (1992). Therefore, the Taxpayer's constitutional arguments will not be addressed.
"FINDINGS OF FACT
"8. The Taxpayer's common equity is owned 100% by American Natural Resources Company, which in turn is owned 100% by Coastal Natural Gas Company, which is owned 100% by The Coastal Corporation. Coastal is a diversified energy company that derives approximately 30% of its revenues from natural gas transmissions investments, which include the Taxpayer and several other pipeline properties or interests.
"9. The Taxpayer owns and operates an interstate natural gas pipeline system consisting of more than 12,000 miles of pipeline which provides storage, transportation, and balancing of natural gas for customers through its facilities in 18 states, including Kansas. Taxpayer Exhibits 20, 21, 30, pp. 2, 8, & 113, pp. 2-3. The Taxpayer transports gas from sources in the West and Southeast to markets in the upper Midwest area including portions of Wisconsin, Michigan, Illinois, Indiana and Ohio.
"10. The Taxpayer is a natural gas company as defined by the Natural Gas Act. 15 U.S.C. § 717(c). The Taxpayer is regulated by the Federal Energy Regulatory Commission ('FERC'), which exercises preemptive jurisdiction over nearly all of Taxpayer's interstate natural gas transmission, storage and gathering business activities.
"11. FERC establishes 'just and reasonable' rates for the Taxpayer's services based upon the costs and expenses associated with operating and maintaining the pipeline with allowance of a reasonable return on the Taxpayer's investment.
"12. 'Rate Base' is the measure for establishing the investment upon which the Taxpayer can earn a return. Rate base consists of the original cost of facilities, less accumulated depreciation, less deferred taxes, plus working capital allowance.
"13. In May of 1992, FERC issued Order 636, which required a dramatic restructuring of the entire natural gas industry. Transcript at 82. Effective in November of 1993, FERC Order 636 changed the business environment for the Taxpayer by unbundling the several functional operations of the Taxpayer, providing for capacity release and implementation of straight-fixed variable price contracting and providing for increased competition. While FERC Order 636 provided opportunities for competition, it also provided other business opportunities for the Taxpayer.
"14. Prior to full implementations of FERC Order 636, the Taxpayer consistently earned more than its allowed rate of return.
"15. The restructured environment and increased risks had a tendency to drive downward the rates that pipelines were able to charge for the remaining unbundled services. The opportunity for pipelines to earn anything over and above allowed return was capped. The result was to move pipelines, like the Taxpayer, who had been earning more than the allowed rate of return, down to an earnings ceiling of rate base times allowed rate of return.
"16. The effects of FERC Order 636 have been more severe on the Taxpayer due to its previous performance, and its highly competitive market position in the upper Midwest.
"17. The effects of FERC Order 636, and specifically how the Order would negatively impact the future earnings of the Taxpayer, was generally known on January 1, 1994, and January 1, 1995. A willing buyer on such dates would have taken into consideration the anticipated effects.
"18. As of the assessment date for tax year 1994, the Division of Property Valuation (hereinafter referred to as 'PVD') had been studying the impact of FERC Order 636 for at least 18 months. PVD was generally aware at this time that the Order had dramatically changed the natural gas industry, had introduced increased competition in each segment of the business, had forced discounting and rate structures that would mean loss of revenues, and had given rise to significant regulatory uncertainty.
"19. In meetings between the Taxpayer and PVD in 1994 and in 1995, the Taxpayer reiterated the negative impact of FERC Order 636 on its business. Specifically, he Taxpayer told PVD that its business was changing, that net book cost had become a ceiling on its value, and that earning would be driven to rate base times rate of return.
"20. However, the Taxpayer was unable to define when the full effect of FERC Order 636 would be felt by the Taxpayer, and what its financial impact would be as a whole.
"21. The experts generally agreed that the three indicators of the unit value of a utility's operating properties to be considered are the cost approach, the income approach, and the stock and debt approach.
"22. The correlated unit values assessed by PVD for the year at issue were higher than any of the value indicators relied upon by PVD. Specifically,
1994 (See Exhibit PV 4a)
Book O.C. Less Depreciation (net book cost) $1,244,964,466
Reproduction Cost Less Depreciation $1,587,428,288
Stock & Debt $1,141,600,578
Income Approach $1,581,352,709
Correlated Unit Value $1,590,000,000
1995 (See Exhibit PV 5a)
Book O.C. Less Depreciation (net book cost) $1,237,050,141
Reproduction Cost Less Depreciation $1,471,630,589
Stock & Debt $1,553,369,978
Income Approach $1,555,120,383
Correlated Unit Value $1,560,000,000
"COST APPROACH
"23. The cost approach is considered reliable because it is the principal determinant of a regulated pipeline's earnings capability and is not contaminated by the vagaries of the more simplistic direct capitalization model or the likelihood of including intangibles unrelated to the operating properties.
"24. The net book cost indicators developed by the experts herein are as follows:
For tax year 1994:
PVD $1,244,964,466
Goodman $1,184,100,000
Davis $1,073,411,000
Goodwin/Ifflander (Goodman critique) $1,243,