BILL ANALYSIS Ó SENATE COMMITTEE ON GOVERNANCE AND FINANCE Senator Robert M. Hertzberg, Chair 2015 - 2016 Regular ------------------------------------------------------------------ |Bill No: |SB 661 |Hearing |4/22/15 | | | |Date: | | |----------+---------------------------------+-----------+---------| |Author: |Hill |Tax Levy: |No | |----------+---------------------------------+-----------+---------| |Version: |4/13/15 |Fiscal: |Yes | ------------------------------------------------------------------ ----------------------------------------------------------------- |Consultant|Grinnell | |: | | ----------------------------------------------------------------- PROPERTY TAXATION: STATE ASSESSMENT: COMERCIAL AIR CARRIER PERSONAL PROPERTY Transfers assessment of airline personal property from local assessors to BOE. Background and Existing Law Section 1 of Article XIII of the California Constitution provides that all property is taxable unless explicitly exempted by the Constitution or federal law. While the Constitution limits the maximum amount of any ad valorem tax on real property at 1% of full cash value, and precludes reassessment unless the property is newly constructed or changes ownership, assessors value personal property each year. I. Assessors and BOE. In 1850, the Legislature first directed county assessors to tax property; however, assessors in different counties often applied different tax rates and methods of assessment. The California Constitution of 1879 created BOE to equalize rates and assessment practices among counties. In 1910, voters amended the Constitution to direct BOE to value property owned by railways, companies selling gas and electricity, or telephone companies. The Constitution additionally allows the Legislature to authorize BOE assessment of property owned or used as "public utilities". SB 661 (Hill) 4/13/15 Page 2 of ? II. Valuing certificated aircraft. Generally, assessors value business personal property, such as aircraft, by multiplying the taxpayer's cost of acquiring it by a price index that measures inflation to estimate its "reproduction cost new," an approximation of the cost to replace the property at current market prices. This "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, which becomes the taxable value of the property for the fiscal year. Assessors may only value certificated aircraft with "situs" in California on a fleet basis, which is all aircraft owned by the taxpayer by make and model. Assessors must value an airlines' entire A380 fleet if only one enters the state, but doesn't include any of its 747's if none of them do, regardless of the total number or value of A380s or 747s an airline owns. Once assessors calculate value, they must apportion it among counties based on a weighted average of the fleet's ground and flight time (75%) and arrivals and departures (25%) measured only during the "representative period," currently designated by BOE as the second full in week in January. This apportioned fleet value is then multiplied by the appropriate rate for the tax rate area in that county. Until 1998, state law did not prescribe a specific method for assessors to determine the value of aircraft, resulting in years of disagreements and litigation between assessors and airlines. In 1998, the Legislature detailed a valuation methodology for certificated aircraft which was presumed to equal the fair market value of the aircraft for those years, enacting three bills to codify a settlement agreement between several counties and airline industry representatives (AB 1807, Takasugi; AB 2318, Knox; and SB 30, Kopp). In 2003, the agreement expired, and assessors again locally valued aircraft without specific guidance from the Revenue and Taxation Code. In 2006, assessors and the airlines again agreed on a new valuation methodology, and directed a "lead assessor" to value each airline's fleet that sunset after the 2010-11 fiscal year (AB 964, Horton). Instead of filing property statements with each county, airlines file a single consolidated statement with a single assessor designated by the Aircraft Advisory Subcommittee of the California Assessors' Association. The SB 661 (Hill) 4/13/15 Page 3 of ? measure established categories for mainline jets, regional aircraft, production freighters, and converted freighters, and set forth a valuation methodology for each. The bill also directed the lead assessor to audit the airline every four years. The new methodology provided that the aircraft value was the lesser of: A historical cost basis, including transportation and improvement costs, as well as capitalized interest, with specific provisions for leased aircraft, aircraft in a sale/leaseback or assignment of purchase rights, or aircraft acquired in bankruptcy, with specified adjustments, or 10 per cent off (for a fleet adjustment) on the wholesale prices listed in the "Airliner Pricing Guide," If the APG ceases to exist, the Board of Equalization (BOE) shall determine the guide or adjustment. AB 964 also directed assessors to analyze the cost to see if an economic obsolescence allowance should apply. To determine economic obsolescence for mainline jets and regional aircraft, the assessor calculates three factors for both the previous calendar year and the past ten years: average net revenue per seat mile, net load factor, and yield. The assessor then compares each factor's previous calendar year value with its value for the past ten years to determine the amount of difference. The assessor then applies a weighted average of the indicated percentage adjustments: net revenue per available seat mile (35%), net load (35%), and yield (30%). The assessor must reduce the original cost by the percentage, but only if the final economic obsolescence exceeds 10%. AB 964 applied a different economic obsolescence formula similar to the above for freighters, except it uses net revenue per available ton mile (50%) and ton load (50%) factors instead. After Governor Schwarzenegger vetoed the first bill that extended the sunset (AB 311, Ma, 2009), he signed a similar bill the next year (AB 384, Ma, 2010). AB 384 extended the lead assessor model and the valuation methodology until the 2015-16 fiscal year, but differed from AB 311 by: SB 661 (Hill) 4/13/15 Page 4 of ? Replacing language specifying value with a rebuttable presumption, Allowing the taxpayer to rebut the presumption with appraisals, invoices, and expert testimony, and Capping an aircraft's value at its original cost. With AB 384's sunset approaching, certificated aircraft will revert to local assessment without a lead assessor on January 1, 2016, requiring each assessor where a plane lands to independently value aircraft. Instead of extending the lead assessor model, the commercial airline industry wants BOE to assess its personal property instead, including certificated aircraft, due to the burden of complying with the lead assessor model, and disagreements with assessors over the application of the economic obsolescence factor. Proposed Law Senate Bill 661 transfers assessment of personal property owned by commercial air carriers to BOE, including certificated aircraft, commencing in 2017-18 fiscal year. The bill extends the current lead assessor model one year to 2016-17. BOE must use the same methodology to establish value currently used by assessors. BOE allocates revenue from assessing this property by situs. BOE must audit commercial air liners that have assessable personal property with a value of four hundred thousand dollars or more. The measure codifies the representative period as the second full week in January, which was previously designated by BOE in consultation with assessors. The bill also makes conforming changes striking out sections necessary to change from the lead assessor model to BOE assessment. State Revenue Impact According to BOE, SB 661's revenue effect is unknown. SB 661 (Hill) 4/13/15 Page 5 of ? Comments 1. Purpose of the bill . According to the author, "SB 661 creates a centralized process that will bring efficiencies and uniformity compared to the current decentralized county assessment process. The goal of SB 661 is to be revenue neutral to counties from a tax assessment perspective, since the Board of Equalization will use the same airline taxation formula in current law that is utilized by county assessors. Article XIII, Section 19 of the California Constitution requires the BOE to assess property owned or used by regulated railroad companies. It also requires the BOE to assess the property owned by certain public utilities. These properties are commonly referred to as "state assessed" properties because the BOE, rather than the local county assessor, is responsible for determining the value of the property for property tax purposes. However, counties are responsible for billing, collecting, and apportioning the resulting taxes. These functions are the responsibility of the county auditor and the county tax collector. A state assesses property holdings are valued as a single unit and the total value is subsequently allocated among the counties. Generally, state assessed properties operate as an integrated unit and often cross county boundaries. Property owned or used by a state assesse that is used in the company's primary operations as part of the company's integrated system is assessed as "unitary property" and the company is valued as a single unit under the principal of unit valuation. A "unit valuation" of a public utility company or a railroad company captures the value of the company's property as a system of interrelated assets, rather than a valuation of individual components of land, buildings, and other assets. For these companies, value depends on the interrelation and operation of the entire public utility or entire railroad. For example, there would be little worth to one section of railroad track or one section of an electrical transmission line; rather their value depends on being a part of an integrated system. There are currently 450 state assesses and over the last three years about 35-40 appeals have been filed with the BOE. Only two of these appeals have gone before the board over the last three years and in both cases the BOE ruled against the taxpayer." 2. Who assesses ? SB 661 asks legislators to decide whether locally-elected county assessors or the State Board of Equalization is better suited to establishing the correct value, SB 661 (Hill) 4/13/15 Page 6 of ? especially because the bill maintains the same assessment methodology that's been in place since 2006. Placing the duty with either assessors or BOE will have tradeoffs, as each will have distinct advantages over the other. Assessors argue that they are better suited to value aircraft because they're professional property appraisers who aren't subject to political influence, have experience to establish correct values based on their long experience doing so BOE lacks, and are subject to rigorous BOE oversight. It's also easier for assessors to be physically present at airports within their counties to track takeoffs and landings. BOE argues that it has extensive experience valuing utility properties, and as a result, only rarely must consider appeals over values with taxpayers it currently assesses. BOE additionally notes that SB 661 would result in less litigation, conform to other states' practices, achieve efficiencies, and increase uniformity. 3. Burden . The burden on the taxpayers to comply with the current lead assessor model, not to mention local assessment, would be reduced significantly under SB 661, as taxpayers would only have to supply BOE with information they currently send to the assessor in each county in which they do business. Additionally, taxpayers would only have to appeal to BOE if they disagreed with its appraisers' value, as opposed to county assessment appeals boards, whose decisions aren't binding on other counties. Taxpayers would only be subject to BOE audits, as opposed to a mandatory audit from a lead county every four years as required by current law, as well as more limited audits from other counties. However, the measure would create a significant precedent because BOE would solely assess airline personal property, while assessors would value airline real property, creating a unique treatment which could invite other proposals to shift responsibility for assessment from the local level to BOE. Another potential concern for SB 661 is that the same body that administers the tax would also consider appeals; when the Legislature first imposed the personal income tax, it also created the Franchise Tax Board to administer the tax, but assigned appeals to BOE due to this concern. 4. How to assess ? Assessment of personal property, especially certificated aircraft, is inherently difficult. Not only are planes valuable, which leads to a larger range of disagreement, but the economic condition of the airline industry can change rapidly due to terrorist attacks, economic recessions, and SB 661 (Hill) 4/13/15 Page 7 of ? mergers, all of which have occurred in recent years. The Legislature initially codified an assessment methodology after years of litigation resulted in settlement agreements. AB 964's methods of assessment were supposed to establish a very detailed methodology based on either an easily knowable cost basis or a well-known price index. However, that bill also created a kind of safety valve that would reduce values due to obsolescence whenever a weighted average of three metrics fell 10% below its average for the past ten years. Some airlines appealed assessors' valuations over different issues, including arguing that assessors erred by using an incorrect period to calculate the ten year average, incorrect comparison information, and applied the incorrect base year. Assessors disagreed, and assessment appeals boards subsequently upheld the assessor's valuations. However, airlines subsequently filed suit in several counties challenging that determination, and to preserve legal standing. 5. One of a kind . BOE is the nation's only elected tax appeals board. As such, it has been criticized for its tax appeal decisions being politicized and favorable to affluent taxpayers. BOE allows taxpayers and their representatives to directly lobby its members, which is generally barred in judicial or quasi-judicial settings, creating the impression that effective lobbying and political strategy is more influential than applying the facts to the law in tax cases, and creating an administrative record that could help guide taxpayers and tax enforcement agencies. In a recent case, the Second District Court of Appeals faulted BOE "for rendering a decision without due regard for the statutory and constitutional laws that govern its decision-making" City of Palmdale v. State Board of Equalization, Case B232833. The Court held that, "To vacate the judgment and reinstate [BOE's] decision would not only imply the agency acted properly, it would also undermine the effectiveness of the judgment in exposing [BOE's] deficiencies in handling the administrative appeal." Due to a reduction in the number of published decisions, the Legislature recently required publication of BOE decisions in significant cases (AB 2323, Perea, 2012). However, AB 2323 doesn't seem to have resulted in further clarity. A December, 2014, BNA Bloomberg news article that concluded the bill "had been a disappointment to some practitioners and tax professionals hungry for more insight into why the board makes the decisions it does." SB 661 proponents counter that local assessment appeals boards can be biased SB 661 (Hill) 4/13/15 Page 8 of ? towards counties that rely on property tax revenues from assessing aircraft, and point to the lack of current disputes between BOE and taxpayers it currently assesses. 6. Appeals . Either BOE or local assessment will each have strengths and weakness, however, one important issue to consider is standing for appeals. Under current law, taxpayers can only appeal local assessment appeals board decisions to superior court if they believe assessment are illegal; issues of pure valuation must be resolved administratively. Additionally, even if taxpayers win art one county assessment appeals board, its decisions aren't binding on other counties. On the other hand, under SB 661, taxpayers could challenge BOE valuations in Superior Court, and name counties as defendants. Local agencies would lack standing to challenge BOE aircraft assessments. 7. Constitutional ? Assessors argue that the Legislature can't assign the duty to assess commercial airline personal property because they aren't "public utilities." The author counters with a Legislative Counsel opinion that disagrees, relying mostly on Independent Energy Producers Association, Inc. v. Board of Equalization (2004) 125 Cal.App.4th 425. In that case, the Court ruled against energy generators who argued that the Legislature's enactment of AB 81 (Migden) which was preceded by BOE Rule 905, unconstitutionally required BOE to assess electricity generation, as they weren't "public utilities." Assessors had valued these power plants after investor-owned utilities had sold them as a result of California's attempt to deregulate them (AB 1890, Brulte, 1996.) 8. Embedded. In addition to BOE assessment, another point of contention between assessors and airlines is whether to value embedded software. Assessors may value storage media and basic operational programs, defined as those fundamental and necessary to a computer functioning; however, "computer programs" are expressly exempt (the statute, crafted in 1972, refers to punched cards, tapes, discs, or drums). In 1996, BOE implemented Property Tax Rule 152, which interprets statute to include only the ROM-based kernel software contained in a computer, and allowed operating system software to be exempt from the property tax. However, the grand bargains represented in AB 964 and AB 384 was to maintain local assessment of certificated aircraft, but not to include embedded software in valuation. SB 611 transfers assessment to BOE, while remaining SB 661 (Hill) 4/13/15 Page 9 of ? silent on embedded software. 9. Another way ? The Constitution does allow the Legislature to authorize counties to create multi-county assessment appeals boards. The Legislature could elect to do so to find a middle ground between this bill and AB 1157 (Nazarian), which extends the current lead assessor method. That measure is currently in the Assembly Revenue and Taxation Committee. Support and Opposition 4/17/15 Support : Alaska Airlines, American Airlines, California Chamber of Commerce, California Taxpayers Association, Delta Airlines, State Board of Equalization, Southwest Airlines, United Airlines. Opposition : California State Association of Counties, California Tax Reform Association, County of Santa Clara, Santa Clara County Assessor Larry Stone, California Assessor's Association -- END --