OREGON APPLICATION OF INTANGIBLE PROPERTY

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1 GARVEY SCHUBERT BARER OREGON APPLICATION OF INTANGIBLE PROPERTY A. GENERAL CYNTHIA M. FRASER 1 In general, only real property and tangible personal property within the state of Oregon is subject to assessment and taxation. ORS The exception is the property of railroads and utilities, all of which, whether tangible or intangible, is assessable. ORS Real property is defined to "include the land itself, above or under water; all buildings, structures, improvements, machinery, equipment or fixtures erected upon, above or affixed to the land; all mines, minerals, quarries and trees in, under, or upon the land; all water rights, and water powers and all other rights and privileges in any way appertaining to the land; or any estate, right, title or interest whatever in the land or real property, less than the fee simple." ORS (1). The statute defines the rights to be included in the value of the land, not the types of interest subject to taxation. Tangible personal property is defined to include "all chattels and movables, such as boats and vessels, merchandise and stock in trade, furniture and personal effects, goods, livestock, vehicles, farming implements, movable machinery, movable tools and movable equipment." ORS (1). The definition of intangibles was originally defined in Oregon through case law and was codified by statute in 1993 with lobbying efforts on behalf of industry when the Department of Revenue attempted to use appraisal methods to capture the value of intangible assets rather than the historical use of a depreciated cost approach. See ORS (1). 1 Cynthia M. Fraser is an Owner with the Portland office of Garvey Schubert Barer. Cynthia s tax practice focuses on property tax appeal litigation, specializing in industrial property valuation disputes and centrally-assessed properties before the Oregon Tax Court. She has also litigated property tax appeals in California and Tennessee. She is the Oregon representative for the American Property Tax Council, the national affiliation of property tax attorneys. Cynthia is recognized as a preeminent eminent domain lawyer and dispute resolution attorney, having been recognized by her peers as a Super Lawyer in 2011, 2012 and 2014 and Best Lawyers in America, This document is for discussion purposes for Garvey Schubert Barer s 2014 Washington Tax Strategies Seminar and is an information document only. It shall not be reproduced without the permission of the author, Cynthia M. Fraser of Garvey Schubert Barer, 121 SW Morrison Street, Portland, Oregon

2 Page Page 2 There are three recognized approaches to the appraisal of any property: the Cost Approach; the Income Capitalization Approach; and the Sales Comparison Approach. In the Cost Approach, value is estimated as the current cost of reproducing or replacing the improvements (including an appropriate "entrepreneurial incentive or profit"), minus the loss in value from depreciation, plus land value. In the Income Capitalization Approach, value is indicated by a property's earning power, based upon the capitalization of income. In the Sales Comparison Approach, value is indicated by recent sales of comparable properties in the market. Appraisal Institute, The Appraisal of Real Estate 36 (14th ed. 2014). Oregon courts have historically condemned the practice of valuing industrial property by use of an Income Approach that attempts to capitalize the income stream of the business enterprise, as opposed to the real property: As the authorities cited by the taxpayer point out, the general rule is that the capitalization of the income of a going concern is not a proper method of assessing its real and personal property for ad valorem tax purposes. It is very difficult if not impossible to segregate income attributable to the real property and personal property being assessed, to say nothing of trying to make a proper allowance for income resulting from intangibles such as good will and management. Oregon Portland Cement Co. v. Mack, 230 Or. 389, 393, 369 P.2d 765, 768 (1962). See also Truitt Bros, Inc. v. Dep t of Revenue, 10 Or. Tax 111 (1985); aff d 302 Or. 603, 610, 732 P.2d 497, 502 (1987) ( The income approach cannot be applied in this case due to the difficulty of distinguishing income attributable to nontaxable and intangible assets. ). B. CASE LAW DISCUSSION 1. Jones Intercable, Inc. v. Department of Revenue, 12 Or. Tax 436 (1993). a. Franchise and Other Non-Possessory Agreements In Jones Intercable, plaintiff Jones Intercable owned and operated cable television systems (CATV) in Douglas County. It appealed the assessment of its property when the County elected to treat the cable television systems as centrally assessed property. The court rejected outright that the CATV systems were public utilities under the central assessment statutes allowing the taxation of intangibles. Jones Intercable, 12 Or. Tax at 439 (citing ORS ). Because cable television was not identified in the statute as a business subject to taxation as a central assessment property, and because a proposal before the 1991 legislature adding cable -2-

3 Page Page 3 television had been rejected by the legislature, the court determined that the CATV systems are not a regulated public utility under ORS Id. The court then addressed what property was subject to taxation and what would qualify as business intangibles. The first issue was whether or not the franchise agreement, which the cable operator must obtain for authority to operate within the public street and right-of-ways and to sell the television signals, was an intangible. Secondly, CATV operators enter into pole attachment agreements allowing them to place their lines on existing utility poles. Under such agreements, the CATV operator pays the utility a fee for using its pole. Finally, the television signals received by the CATV system are protected by copyright laws, which require the CATV operator to pay a negotiated fee per subscriber and allows it to sell subscriptions for its services. In analyzing these business agreements, the court addressed the possessory interest rights of the plaintiff to the franchise and pole agreements. The court, determining that the franchise agreements are expressly a nonexclusive possessory interest because they provide the CATV operator the right to use the public right-of-way but do not dictate which streets, which side of the street or whether the cables should be located above ground or below ground, found that the plaintiff's interests are not taxable possessory interests. While the plaintiff does not need a franchise agreement to turn its system on and process television signals, it needs a franchise agreement to install its cable within the public right-of-way. The franchise therefore does not add value to the installed equipment because the right to install the equipment on public property is separate from the equipment itself. In addressing that property tax should be limited to property value and ownership of property carries certain rights and responsibilities, the court held: A tax upon tangible property requires a valuation of rights in that property, rather than a valuation of business or franchise rights in connection with which such property is used. Id. at 444 (quoting Joan M. Youngman, The Role of Valuation in Determining Ownership for Tax Purposes, 43 Tax Law. 65, 81 (1989). Because the right to install cable television equipment in the city streets is granted in the abstract without regard to any particular property, any value associated with the franchise agreement, pole agreement, subscriber list or other nonpossessory agreements are intangible property and not subject to taxation. b. Appropriate Valuation Method The court then went on to discuss the appropriate valuation method in light of the business intangibles. The court found that the Sales Comparison Approach cannot be used because the sale price would include the value of the franchises or other non-possessory -3-

4 Page Page 4 agreements. The Income Approach, likewise, was inappropriate because the income information pertained to the income of the operating business. In this case, neither party submitted information which reflected or measured the income attributed only to the taxable property. The court did not foreclose the sales comparison method if the sale excluded franchises and other business agreements and if all business intangibles could be reasonably segregated. This leaves the Cost Approach, which the court concluded was the most appropriate valuation of the property. 2. Boise Cascade Corporation v. Department of Revenue, 12 Or. Tax 263 (1991). In Boise Cascade, the Oregon Department of Revenue valued Boise Cascade s veneer mill in Independence, Oregon utilizing a discounted cash flow income approach modeled after the income approach utilized for valuing railroad and utility property. To assist them in preparing for trial, the parties requested the Tax Court enter a preliminary ruling on the legal issue presented: Id. at 264. The issue presented is whether the intangibles, goodwill, going concern, management, and work force in place, are includable in the assessed value of real property for property tax purposes. a. Goodwill The Oregon Tax Court held that goodwill, as defined by the appraisal authorities, is an intangible asset that is not subject to taxation because "it arises not from the property but from the business operation of the property." Id. at 267. Goodwill and going concerns had long been recognized in Oregon as not taxable. Id. The court concluded/found that [t]he concept of market value, or value in exchange, is a synthesis of conflicting economic theories." Id. at 266 (quoting American Institute of Real Estate Appraisers, The Appraisal of Real Estate (9th ed. 1987). The court provided: To utilize that concept, the appraiser attempts to replicate the positions of a hypothetical buyer and a hypothetical seller. To do this, the appraiser must ignore the specific circumstances or peculiarities associated with specific owners of property. Id. at 266 (citing Joseph Hydro Associates, Ltd. v. Dep t of Revenue, 10 Or. Tax 277 (1986)). The court went on to clarify that facts or circumstances not directly connected with the property, such as who owns the property, should not affect its assessed value. Id. (citing First -4-

5 Page Page 5 Interstate Bank v. Dep t of Revenue, 10 Or. Tax 452 (1987) aff d 306 Or. 450, 760 P.2d 880 (1988) (holding that an appraisal rule attempting to value property on the basis of who owns it is unconstitutional). The court defined goodwill as [a] salable business asset based on reputation, not physical assets. Id. at 267 (quoting American Institute of Real Estate Appraisers, The Dictionary of Real Estate Appraisal 141 (1984). Goodwill is not taxable property and, [i]f goodwill exists in connection with tangible, real or personal property, it arises not from the property but from the business operation of the property. Consequently, goodwill is an intangible asset that is not subject to taxation. Id. (citing Buck v. Mueller, 221 Or. 271, 285, 351 P.2d 61 (1960). b. Going Concern Going concern value, as traditionally defined, is different value from market value. In Boise Cascade, the court considered the following definition: Going-concern value is the value created by a proven property operation; it is considered a separate entity to be valued with an established business. This value is distinct from the value of the real estate only. Going-concern value includes an intangible enhancement of the value of an operating business enterprise which is associated with the process of assembling the land, building, labor, equipment and marketing operation. This process leads to an economically viable business that is expected to continue. Id. at (quoting American Institute of Real Estate Appraisers, The Appraisal of Real Estate 22 (9th ed. 1987)). The court then went on to refer to the Oregon Department of Revenue's administrative rule OAR (D)(1)(c) which states that when property is an operating plant or an operating complex it should be considered to be a going concern. Id. at 268. The court interprets this rule not to allow the valuation of a going concern in the broader sense as that term is defined by the American Institute of Real Estate Appraisers, but in a more narrow sense. The court went on to state: The court interprets this rule to include two elements of value: (1) Value created by assembling separate parts into an integrated hole. The process of assembly includes engineering or design, manual labor to install the parts and their connecting ties, and materials such as concrete, pipes and wiring used to create the integrated whole....(2) Value created by the -5-

6 Page Page 6 demonstrated ability of the property to perform as an integrated unit. This is a risk-averted value. It exists only if the capabilities and functions of the parts are so aligned and arranged as to perform to a demonstrable level. This value may also reflect the start up expenses incurred in bringing the assemblage to the point where it operates as an integrated unit. Id at This narrowed definition of going concern value as found in the Department of Revenue s rule is to be distinguished from going concern value in the broader sense. The broad sense includes value attributable to product quality, marketing and other attributes associated with the business operation. To avoid confusion, the court labeled the more restricted meaning as assembled value. Assemblage value is part of the market value at the taxable property. Going concern in the broad sense is not part of the market value of the property. Rather it is the value of a business which includes property. Id. c. Workforce and Management The court declined to include workforce and management as an intangible. However, the 1993 legislature included assembled labor force in the list of intangible personal property not subject to taxation. See ORS (1)(H). ORS defines personal property: (1) As used in the property tax laws of this state, unless otherwise specifically provided: (a) Intangible personal property or intangibles includes but is not limited to: (A) (B) Money at interest, bonds, notes, claims, demands and all other evidences of indebtedness, secured or unsecured, including notes, bonds or certificates secured by mortgages. All shares of stock in corporations, joint stock companies or associations. 2 Legislative Counsel Committee, CHAPTER 307 Property Subject to Taxation; Exemptions, oregonlegislature.gov/bills_laws/lawsstatutes/2013ors307.html (2013) (last accessed Sep. 24, 2014). -6-

7 Page Page 7 (C) (D) (E) (F) (G) (H) (I) Media constituting business records, computer software, files, records of accounts, title records, surveys, designs, credit references, and data contained therein. Media includes, but is not limited to, paper, film, punch cards, magnetic tape and disk storage. Goodwill. Customer lists. Contracts and contract rights. Patents, trademarks and copyrights. Assembled labor force. Trade secrets. While the Oregon statute defines specific intangibles not subject to taxation, the definition is not exclusive or limiting and allows by its term but is not limited to consideration of additional personal property within the statutory definition of intangible property. * * * -7-