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.
Swanson, Attorney General, Michael Goodwin, Assistant
Attorney General, Saint Paul, Minnesota, for Commissioner of
no part, Chutich, McKeig, JJ.
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.
tax court clearly erred when it failed to explain its
determination of the beta factors used in calculating the
taxpayer's cost of equity.
evidence in the record supported the tax court's decision
to reject the build-up method of calculating the
taxpayer's cost of equity.
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.
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
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.
in part, reversed in part, and remanded.
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.
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).
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).
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.
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:
Commissioner's Apportionable Value
Eyre's Apportionable Value
Reilly's Apportionable Value
Tax Court's Apportionable Value
$118, 247, 871
$199, 951, 677
$51, 461, 168
$94, 732, 200
$112, 627, 661
$231, 954, 372
$65, 250, 150
$102, 981, 800
$144, 628, 839
$258, 799, 869
$99, 360, 276
$131, 233, 100
$155, 934, 300
$271, 870, 280
$106, 518, 546
$144, 747, 800
$161, 525, 900
$273, 892, 276
$120, 510, 785
$174, 125, 500
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.
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
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.
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).
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 ...