BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Michael Machado, Chair
AB 964 - J. Horton
Amended: July 14, 2005
Hearing: August 17, 2005 Fiscal: YES
SUBJECT: Property tax: Assessment of airline property
EXISTING LAW (Proposition 13) imposes property tax on
all taxable real and personal property. The Constitution
provides that taxation of "real" property (structures
affixed to the ground, etc.) is limited to the 1975
valuation adjusted for new construction plus an annual
inflation factor of no more than 2%. When a change in
ownership takes place, real property is valued at full
market value as of the year the transaction takes place.
"Personal" property (generally, property other than
"real" property) is subject to property tax, based on the
current market value of the property (i.e., personal
property is not protected by the Proposition 13
"acquisition value" standard).
Generally, the valuation of business personal property
is based on the acquisition cost of the property. The
acquisition cost is multiplied by a price index - an
inflation trending factor based on the year of acquisition,
to provide an estimate of its "reproduction cost new." The
reproduction cost new is then multiplied by a "percent good
factor" (a depreciation factor) to provide an estimate of
the depreciated reproduction cost of the property. The
"reproduction cost new less depreciation" value becomes the
taxable value of the property for the fiscal year.
Under existing law, commercial air carriers file
"property statements" for each location in each county in
which they own or use personal property, detailing their
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property holdings, acquisition costs, and flight and ground
data. These statements are the basis for determining the
property tax assessment for the upcoming year.
Certificated aircraft are valued for purposes of
property taxation under a "fleet" concept. This means that
the basis of the assessed value is not the value of any
single aircraft owned by an air carrier, but rather the
value of ALL aircraft of each particular fleet type (i.e.,
all aircraft owned of an identical make and model (Boeing
737-300, Airbus A300-F4-300S, etc) regardless of age) that
is flown into a particular airport. Under the "fleet"
concept, the types of aircraft of an air carrier that have
gained status in California by their entry into revenue
service are valued as a fleet and then only an allocated
portion of the entire value of the airline's fleet is
ultimately taxed to reflect actual presence in California.
Under existing law, certificated aircraft must be
valued each year at current fair market value. Existing law
is silent as to the method to be used in determining value
of any particular aircraft. However, for assessment years
1998 through 2003, the law detailed a valuation methodology
for certificated aircraft which was presumed to equal the
fair market value of the aircraft for those years. In prior
years the law did not provide any specific assessment
methodology for valuing certificated aircraft. But in
1997-98 a group of counties and airline industry
representatives met to resolve issues related to the
property taxation of property owned and used by airlines
which would be embodied in a settlement agreement to
dispose of outstanding litigation and appeals. That
settlement, and the legislation enacted pursuant thereunto,
expired at the end of 2003.
In 2003, SB 593 (Ackerman) proposed transferring the
assessment jurisdiction of airliners' property to the Board
of Equalization. That bill died in the Senate
Appropriations committee.
Existing law also provides an allocation formula to
determine the frequency and the amount of time that an air
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carrier's aircraft makes contact and maintains status
within a particular county. An allocation ratio is made up
of two components: a ground and flight time factor, which
accounts for 75% of the ratio, and an
arrivals-and-departures factor, which accounts for 25% of
the ratio. The sum of these two factors yields the
allocation ratio, which is applied to the full cash value
of a fleet of a particular type of aircraft operated by an
air carrier and, thus, the calculation of the assessed
value for that type of aircraft. The sum of the assessed
allocated values for each make and model used by an air
carrier results in the total assessed value of the aircraft
for that air carrier for a particular county.
THIS BILL would provide for a form of "centralized"
assessment of commercial aircraft. The bill would allow
commercial air carriers to file a single, consolidated
property statement with a designated "lead" county. The
bill would provide a process for selecting the "lead"
county for each airline, notifying the airline of the
responsible lead county to which it would file its
information, and detailing the duties of the lead county
(i.e., accepting property statements, determining fleet
value, transmitting values to other counties, and lead the
mandatory audit process, whereby the "mandatory" (once
every four years) audit for each air carrier would be
performed by a team comprising staff from one to three
counties, rather than all counties in which the airline
holds property).
The bill would outline a methodology for determining
the value of certificated aircraft for property tax
purposes, based on the lesser of (1) historical cost basis,
as specific in statute, or (2) prices listed in the
"Airliner Price Guide," a commercially-prepared value guide
for aircraft, and adjusted as specified.
FISCAL EFFECT:
Board of Equalization estimates that "there is no
revenue impact from this bill, as the proposed valuation
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methodology is a reasonable method to determine fair market
value of certificated aircraft."
BOE states that "while it is true that the revenue
realized under the proposed valuation method might be
different from the revenue derived from the methodology in
the original [law,] the change in value is due to the
actual change in value of certificated aircraft as
determined by market forces. The proposed methodology takes
these changes in the industry into consideration."
COMMENTS:
A. Purpose of the bill
The bill is intended to increase efficiency and reduce
administrative costs for both the airlines and the state.
The bill contains findings and declarations: "A
difficult and contentious property tax assessment issue
concerns the assessment of certificated aircraft following
the incident of September 11, 2001. The difficulty of
measuring the economic obsolescence resulting from the
incident, pertaining to a variety of aircraft types, many
with tax situs in several counties, justifies a
standardized approach to the appraisal of these aircraft.
This bill would codify a valuation methodology jointly
developed and agreed to by the airline industry and a
county assessor working group. This bill reflects the
legislative portion of the settlement agreement which once
signed would also dispose of many pending appeals and
future potential lawsuits related to airlines. The
difficulty of appraising certificated aircraft following
the 9/11 has given rise to much litigation and many tax
appeals. The uncertainty created by pending litigation and
appeals over the assessment of airline property is
disruptive to both airline industry tax planning and local
government and school finance.
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"It is the intent of the Legislature in enacting this
act to establish a unique methodology for the assessment of
certificated aircraft in light of the special circumstances
that befell this property and the airline industry
following the September 11, 2001, incident."
B Centralized assessment of aircraft
The assessment methodology for certificated aircraft
codified in 1998 via a settlement agreement between
counties and airlines expired after the 2003 assessment
year. Commencing with the 2004 assessment year no
assessment methodology has been specified in statute for
certificated aircraft.
Property appraisal is subjective and opinions of value
differ. This bill will provide certainty and predictability
in the valuation of aircraft for both assessors and
airlines. Absent a codified methodology, there is no
guarantee that the values determined by each individual
county assessor would be the same, higher, or lower than
they would be without this bill. It is generally agreed
that a uniform standard, uniformly administered, would be
best for both the airline industry and the counties.
C. The 2005 settlement agreement refines prior valuation
methodology
This bill essentially builds upon the prior
methodology. It recognizes the need to distinguish between
different types of aircraft - passenger vs. freighter
aircraft. In addition, it recognizes the need to detail the
specific calculation of the variable components that were
previously lacking. With respect to calculating a
reproduction cost new less depreciation value indicator
(i.e., the historical cost basis), each variable component
is specified: (1) acquisition cost, (2) price index, (3)
percent good factor, and (4) economic obsolescence. With
respect to using the "Airliner Price Guide," a "blue book"
value guide for aircraft, the use of values referenced in
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that guide is specifically delineated and recognizes that
airlines generally receive a fleet discount that is not
reflected in prices listed in the guide. Assessors indicate
that based on a sample of large and small airlines the new
methodology, in comparison to the prior methodology,
produces values that range from 5% to 15% less. It is
believed that this methodological change will properly
reflect the post-9/11 economic and operational environment
that airliners now face.
D. Software issue
The proposed valuation methodology addresses certain
software that is installed in a commercial aircraft. An
emerging issue in the assessment of aircraft is a deduction
for "embedded software." According to counties, some
airlines have sought a 2% to 10% reduction in aircraft
values to account for non-taxable software (i.e., a
computer program that is not a "basic operational program,"
as defined in statute), which, to date, has not been
granted. There is some disagreement over whether the
software installed in the manufacture and outfitting of
commercial aircraft is "basic operational software" that is
fully taxable, or whether it should be exempt as nontaxable
software. Currently, there is no law or regulation that
directly addresses this issue as it applies to aircraft.
Some airlines have filed appeals to reduce their assessment
by the value of the software in question, but to date have
not successfully won an appeal at the local level. This
bill specifically addresses the taxation of this type of
software, by clarifying that "embedded software" ("software
installed in the manufacture and outfitting of commercial
aircraft that is reasonably related to its ordinary, safe
and effective operation") is included in "acquisition cost"
of commercial aircraft.
E. September 11
The change in the airline industry given the
unanticipated events of September 11 proved the need to
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modify the assessment methodology to reflect "economic
obsolescence." This bill includes legislative intent
language explaining the difficult of measuring economic
obsolescence when a major incident such as September 11
occurs. The bill would establish detailed procedures in
determining adjustment for economic obsolescence that would
better capture significant changes in market values in
response to severe changes in the industry's economic
condition. This would be accomplished by measuring the
difference between the average of certain airline industry
indicators in the assessment year, as compared with the
past-10-year average of those indicators.
F. Centralized assessment would ensure consistency of
valuation
Centralized calculation of the fleet value by the
"lead county" would ensure statewide consistency in the
bale valuation of the fleet. Airlines have claimed that
even though all the counties were using the same assessment
methodology during the first settlement agreement period,
the fleet value calculated by various counties differed,
sometimes substantially. Counties countered that the value
discrepancies could be traced to differences in the
information reported by the airlines to the counties or
differences that have been discovered via an audit of the
company. This bill will ensure a uniform statewide
assessment by designating a lead county to calculate the
fleet value and ensuring that airlines report the same
information to every county. Therefore, the bill should
eliminate any discrepancies with aircraft assessment from
one county to another and achieve the goal of uniform
assess values for aircraft for any one particular company
in each county.
Support and Opposition
Support:California Assessors Association.
United Airlines
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Oppose:California Taxpayers Association
Southwest Airlines
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Consultant: Martin Helmke