California Supreme Court Draws Bright-Line On Taxation of Intangibles

Recently, the California Supreme Court issued an important decision regarding the property tax treatment of intangible rights and assets. In Elk Hills Power, LLC v. Board of Equalization,1 the court held that the value of intangibles cannot be included when assessing taxable property. Although the decision specifically addressed the proper treatment of emissions reduction credits ("ERCs"), the holding is generally applicable to all types of intangible property. Reed Smith filed an amicus brief supporting the taxpayer in the Elk Hills case on behalf of the Institute for Professionals in Taxation.

Background

The taxpayer, the owner and operator of an electric power plant, was required to purchase ERCs in order to operate in the local county.2 Under California law, power plants are assessed using a system called unit valuation, where the value of the power plant is captured by considering all of its component parts together, as one unit.3 The State Board of Equalization ("SBE") used two methods of unit valuation to value the power plant - the replacement cost approach and the income capitalization approach. Under the replacement cost approach, the value of the power plant was determined by estimating the cost of replacing all of the component parts of the power plant.4 Under the income capitalization approach, the value of the power plant was determined based on the present value of the income the plant was estimated to yield over its life.5

At issue in the case was whether the SBE improperly included the value of the ERCs in its assessment of the power plant. California Revenue & Taxation Code §§ 110(d) and 212(c) prohibit the direct taxation of intangible property. However, Revenue & Taxation Code § 110(e) permits an assessor to assume the presence of intangibles when valuing taxable property. Despite precedent from appellate courts6 prohibiting the inclusion of the value of intangibles when assessing taxable property, the SBE auditors argued that they were permitted to include the value of the intangibles, if those intangibles were necessary for running the business. The SBE took the position that the portion of the statute allowing the assumption of the presence of intangibles when valuing taxable property superseded the section disallowing the direct taxation of intangible property.

The California Supreme Court Decision

The California Supreme Court disagreed with the SBE's argument. Thus, it ruled that an assessor cannot include the value...