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Minnesota Energy Resources Corp. v. Commissioner of Revenue

Supreme Court of Minnesota

November 9, 2016

Minnesota Energy Resources Corporation, Relator,
v.
Commissioner of Revenue, Respondent. Commissioner of Revenue, Relator,
v.
Minnesota Energy Resources Corporation, Respondent.

         Tax Court Office of Appellate Courts

          Michael A. Scodro, Gail H. Morse, Jenner & Block LLP, Chicago, Illinois; Jeffery J. McNaught, Minneapolis, Minnesota; and Ann E. Kennedy, Minneapolis, Minnesota, for Minnesota Energy Resources Corporation.

          Lori Swanson, Attorney General, Michael Goodwin, Assistant Attorney General, Saint Paul, Minnesota, for Commissioner of Revenue.

          Took no part, Chutich, McKeig, JJ.

         SYLLABUS

         1. The evidence in the record supported the tax court's decision not to include an additional company-specific risk factor in its calculation of the taxpayer's cost of equity.

         2. The tax court clearly erred when it failed to explain its determination of the beta factors used in calculating the taxpayer's cost of equity.

         3. The evidence in the record supported the tax court's decision to reject the build-up method of calculating the taxpayer's cost of equity.

         4. The tax court erred when it applied the standard from Eurofresh, Inc. v. Graham County, 187 P.3d 530 (Ariz.Ct.App. 2007), rather than general evidentiary principles, to determine whether a taxpayer's property suffered from external obsolescence.

         5. The tax court did not clearly err when it made a deduction from the income indicator of value to account for the taxpayer's nontaxable intangible assets and working capital.

         6. The tax court did not clearly err when it declined to consider a prior sale when estimating the market value of the taxpayer's tangible personal property in Minnesota.

         Affirmed in part, reversed in part, and remanded.

          OPINION

          STRAS, Justice.

         In a proceeding before the Minnesota Tax Court, Minnesota Energy Resources Corporation (MERC) challenged the Commissioner of Revenue's valuation of its natural-gas pipeline distribution system for the years 2008 through 2012. With the exception of 2012, the lone year in which it increased the assessed value of the pipeline distribution system, the tax court reduced the Commissioner's valuation and ordered the Commissioner to recalculate MERC's tax liability. Both parties appeal from the tax court's order and raise a variety of challenges to the tax court's findings and conclusions. For the reasons that follow, we affirm the tax court's decision in part, reverse it in part, and remand to the tax court for further explanation of the beta factors it used to calculate MERC's cost of equity and to reconsider whether external obsolescence impacted the pipeline distribution system's market value.

         I.

         MERC, a wholly owned subsidiary of Integrys Energy Group, Inc. (Integrys), owns a natural-gas pipeline distribution system in Minnesota. During the tax years at issue, 2008 through 2012, MERC delivered natural gas over 3, 600 miles of pipeline to approximately 205, 000 customers in 50 Minnesota counties. As a regulated utility, MERC's pipeline distribution system is taxable personal property under Minn. Stat. § 273.33 (2014).

         MERC's pipeline distribution system stretches south from Canada across several states, including Minnesota. Each year, the Commissioner of Revenue determines a market value for MERC's pipeline distribution system, which includes distribution pipes, gas mains, gate stations, gas meters, distribution-regulation stations, gas valves, and odorizing equipment. See Minn. Stat. § 273.33, subd. 2. The Commissioner uses information provided by MERC to make her calculations. See Minn. Stat. § 273.371, subd. 1 (2014). After calculating the total market value of MERC's pipeline distribution system within Minnesota, the Commissioner apportions the value among the taxing districts through which it passes. See Minn. Stat. § 273.33, subd. 2; see also Minn. R. 8100.0200 (2015) ("[B]y the process of apportionment, the portion allocated to Minnesota is distributed to the various taxing districts within the state."). Each district then assesses MERC's personal property based on the share allocated to it by the Commissioner. See Minn. Stat. § 273.062 (2014). MERC's real property, by contrast, is assessed separately by the county or taxing district in which each parcel is located. See Minn. Stat. § 273.17, subd. 1 (2014).

         Before the tax court, MERC challenged the Commissioner's 2008 to 2012 valuation of the pipeline distribution system. In support of its position that the Commissioner's valuation was excessive, MERC presented an expert report and testimony from Kevin Reilly of American Appraisal Associates, Inc. The Commissioner relied on the expert opinion of Brent Eyre, an independent accredited senior appraiser with a background in property-tax valuation, to support an even higher valuation of MERC's pipeline distribution system than the amount originally calculated by the Commissioner.

         Following a 4-day trial, the tax court issued findings of fact and conclusions of law, in which it found that Reilly's report and testimony were sufficient to overcome the presumptive validity of the Commissioner's valuation. See Minn. Stat. 272.06 (2014). It then conducted its own valuation of MERC's property, based on the relevant law and its consideration of the testimony of both experts. For each of the years from 2008 to 2011, the court determined that the market value of MERC's property was lower than the Commissioner's valuation. For 2012, it reached the contrary conclusion, deciding that the Commissioner had undervalued MERC's pipeline distribution system by approximately $13 million. In valuing MERC's property, the court used a combination of two of the three approaches to valuing property, the cost and income approaches, and rejected the third approach, the market approach, after determining that it would not lead to an accurate assessment of market value. The court also deducted the value of nontaxable intangible assets and working capital on the basis that neither is taxable under Minnesota law, a point on which the parties disagree. The following table summarizes the Commissioner's original valuation, the valuations proposed by both experts, and the market-value determination of the tax court, for each taxable year:

Taxable Year

Commissioner's Apportionable Value

Eyre's Apportionable Value

Reilly's Apportionable Value

Tax Court's Apportionable Value

2008

$118, 247, 871

$199, 951, 677

$51, 461, 168

$94, 732, 200

2009

$112, 627, 661

$231, 954, 372

$65, 250, 150

$102, 981, 800

2010

$144, 628, 839

$258, 799, 869

$99, 360, 276

$131, 233, 100

2011

$155, 934, 300

$271, 870, 280

$106, 518, 546

$144, 747, 800

2012

$161, 525, 900

$273, 892, 276

$120, 510, 785

$174, 125, 500

         Both MERC and the Commissioner appeal from the tax court's decision. MERC challenges four decisions made by the tax court: its failure to adopt a company-specific risk factor, its rejection of the build-up method, its lack of explanation of the beta factors it applied, and its adoption of the Eurofresh standard for proving external obsolescence. Eurofresh, Inc. v. Graham Cty., 187 P.3d 530, 535, 538 (Ariz.Ct.App. 2007). We will explain the background principles underlying each of these challenges in more detail below.

         The Commissioner, by contrast, challenges only two aspects of the tax court's decision. She objects to the deductions for intangible assets and working capital and asserts that the tax court clearly erred by rejecting the market approach in its entirety without at least considering the price paid by Integrys when it purchased MERC in a 2006 arms-length sale. We consolidated the two appeals, designating MERC as the appellant for briefing and oral argument. We now address the challenges to the tax court's decision, beginning with those raised by MERC and then turning to the Commissioner's arguments.

         II.

         Our review of the tax court's decision is limited and deferential. Cont'l Retail, LLC v. Cty. of Hennepin, 801 N.W.2d 395, 398 (Minn. 2011). Specifically, "[w]e review tax court decisions to determine whether the tax court lacked subject matter jurisdiction, whether the tax court's decision is supported by the evidence in the record, and whether the tax court made an error of law." Hohmann v. Comm'r of Revenue, 781 N.W.2d 156, 157 (Minn. 2010). More generally, we review the tax court's legal determinations de novo and its factual findings for clear error. Cont'l Retail, 801 N.W.2d at 398. With respect to the tax court's valuation of the property, we defer to the tax court's determination unless it clearly misvalued the property or failed to explain its reasoning. Id. at 399.

         A.

         MERC's first challenge is to the tax court's decision to reject the application of a company-specific risk factor to MERC's cost of equity. The cost of equity is one of the components each expert used to calculate the value of MERC's pipeline distribution system under the income approach. The court, as well as both experts, estimated value using direct capitalization, one of two methods of determining value under the income approach. The direct-capitalization approach "convert[s] a single year's income expectancy into" an indication of market value by dividing the estimate of a single year's net operating income by a capitalization rate. Appraisal Institute, The Appraisal of Real Estate 491 (14th ed. 2013); see also Eden Prairie Mall, LLC v. Cty. of Hennepin, 797 N.W.2d 186, 195 (Minn. 2011) (explaining the direct-capitalization approach).

         The parties' disagreement in this case focuses on the capitalization rates applied by the tax court, and in particular, the cost of equity it used to determine each year's rate. The tax court calculated the capitalization rates by estimating both the cost of debt and the cost of equity for each taxable year, based on the straightforward principle that most businesses, including utilities, finance the purchase of property through a combination of debt and equity. See In re Minn. Power & Light Co., 435 N.W.2d 550, 559 (Minn. 1989). Applying this principle, the tax court multiplied the percentage of equity by the cost of equity and the percentage of debt by the cost of debt using the figures submitted by Eyre, the Commissioner's expert. It then added those two figures together to generate a capitalization rate, which the court then used in combination with the yearly estimates of MERC's net operating income to calculate the value of MERC's pipeline distribution system. Several of ...


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