Opinion ID: 2516415
Heading Depth: 2
Heading Rank: 4

Heading: Kenneth WilliamsConsultant for CIG

Text: Kenneth Williams, a pipeline consultant, testified with regard to valuation and allocation. On the argument that rate base and net book should not be used because they allow an asset to be depreciated to zero, even though that asset is still a part of the system and still contributing, Williams stated that it would not be to the advantage of a pipeline company to fully depreciate an asset because the company could then not earn a rate based on that asset. He testified that rate base would be a good allocation factor because it is tied closely to the value of the company in that net depreciated original cost would be what a willing buyer or seller would pay for the company. There is not, however, the same connection between gross original cost and the value of the company; therefore, original cost would not make a good allocation factor. E. John H. Davis IIIExpert Appraiser for CIG Appraiser John H. Davis III, a specialist in the field of public utility valuation, testified on behalf of CIG with regard to the valuation and allocation process. Davis testified that CIG asked him to come up with a system value and an allocation factor which would fairly allocate the system value to Kansas in a manner that would show the fair market value of the property in Kansas. Davis testified that in the valuation process, the traditional method of valuing the system is through the income approach, although an appraiser should also consider the cost approach and direct sales approach and reconcile and weigh the values. With regard to the use of an allocation factor, Davis stated that an allocation factor should be used that will best result in the proper fair market value of the properties in the state. He testified that achieving fair market value through the use of the unit method is not impossible but, instead, fairly simple as long as there is a connection between the allocation factor and the method used in valuing the business as a whole. He opined that rate base should be used as an allocation factor because rate base is used to find net income which is then used to value the business in the income method. In the alternative, according to Davis, net book could also be used as an allocation factor and would still supply a link to fair market value. Davis testified that no one uses original cost to develop a system value and, therefore, original cost should not be used as an allocation factor because there is no link between original cost and the value of the property. Davis stated that it was impossible to achieve fair market value with an original cost allocation factor because it fails to take into account the age and condition of the plant and equipment. Davis calculated allocation factors for the years in question using rate base as an allocator. He came up with an allocation factor of 5.11% in 1993, 4.78% for 1994, and 4.85% for 1995 (compared to the PVD's allocation factors of approximately 9.9%, 10.3%, and 10.3%). Davis also used a summation approach which is used in some other states and does not use a unit method. In this approach, Davis valued CIG's actual property in Kansas using its net book value and also valued the property using its rate base value. These summation values compared favorably with the result obtained under the unit method using rate base as an allocation factor. Davis testified that the PVD's values using original cost as an allocation factor were grossly out of line with the other indicators of value. Davis also testified that the other states in which CIG operated use mostly net book as an allocation factor which takes into account depreciation and, therefore, Kansas' use of original cost will cause Kansas properties to be overvalued. Addressing concerns that rate base would not be a good allocation factor because it allows some assets to be depreciated to zero, Davis testified that FERC controls depreciation rates and would act to prevent a certain asset group from being depreciated to zero. Under cross-examination, Davis admitted that rate base is not a generally accepted appraisal method of allocating unit value. According to Davis, this is because most companies do not keep the records needed to determine such a factor. However, Davis testified that the next best allocation method would be to use net book as an allocation factor which is a generally accepted appraisal method. F. John Hughes IITax Examiner for the PVD John Hughes II, tax examiner for the PVD, testified regarding the valuation process and allocation factors. Hughes testified that he attempts, through the valuation process, to achieve a fair market value of the companies as a whole rather than the fair market value of their property in Kansas. He admitted that the use of an allocation factor which is unrelated to value could result in a unit value allocated to Kansas which is not related to the value of the property in Kansas. Hughes testified that neither the cost approach nor the stock and debt approach to value are particularly suited to valuing an income producing property and that the income approach is the preferred method. Hughes stated that to get the best fit, he would prefer to use an income component that would work as an allocation factor. However, rate base, in Hughes' opinion, would not work as an allocation factor because the depreciation in the rate base of equipment is spread throughout the system rather than applied to individual assets. He further testified that net book is not a good allocation factor because it allows for depreciation and does not bear a relationship to what the property is earning. Further, according to Hughes, net book would give the taxpayer a double benefit because the original cost starting point would be lower for an older asset, and then depreciation would lower the value even more. G. Floyd RumseyAppraiser for the PVD Floyd Rumsey, an appraiser for the PVD, testified regarding the valuation process. Rumsey stated that in using the unit method, the PVD is trying to determine, as fairly as possible, what proportion of the entire system's value exists within Kansas. The PVD is not trying to achieve the fair market value of the operating property in Kansas. Rumsey testified that in his opinion, rate base is not a generally accepted allocation factor and net book would not be a good allocation factor because it would not reflect the contribution of the assets to the production of income. Rumsey also testified that net book would be burdensome on the companies that might not keep as detailed depreciation information as CIG. Rumsey was of the opinion that net book does not necessarily equate to income and original cost was just as valid an allocation factor. H. Dr. A. James IfflanderValuation Consultant for the PVD Dr. A. James Ifflander, a valuation consultant retained by the PVD, admitted that states should use an allocation process methodology that provides the best judgment of fair market value in the state.
Michael W. Goodwin, an expert appraiser, testified on behalf of the PVD. Goodwin stated that it is not the task in unitary valuation to arrive at fair market value of specific assets within a geographical area but rather to apportion a reasonable amount of the unitary value to the area. Goodwin admitted that it would be preferable to use multiple allocation factors to do so in that more allocation factors would offset deficiencies in the others. He testified that there is no universally applicable allocation factor. Rather, the bottom line is that the results should make sense. Goodwin opined that original cost is a usable factor because it reflects the amount of investment made throughout the system and the Kansas allocation method based on original cost is reasonable. He testified that the Kansas allocation, if used by all states, would fully apportion CIG's value. According to Goodwin, some states use original cost exclusively and others use it with other factors as a basis for allocation of value. The PVD has in the past and continues to use original cost for all pipelines. Moreover, original cost is used by FERC to allocate expenses. He testified that there are other allocation factors which would give Kansas a higher percentage of value. However, under cross-examination, he admitted that original cost is not a reliable indicator of value for a large gas transmission taxpayer and noted that most states that use original cost as an allocation factor blend it with other factors. BOTA DECISION Two of the five members of BOTA recused themselves for this hearing. BOTA's final decision consisted of a majority opinion by two members and a concurring opinion by another member. The majority determined that BOTA's review was de novo but also found that it was required to defer to the judgment of the PVD unless the standards prescribed by K.S.A. 79-5a04 had been intentionally and grossly disregarded. Using this standard, the BOTA majority found that the capitalization rate used by the PVD was appropriate. The BOTA majority further found that CIG had not shown that the PVD incorrectly taxed exempt intangible property. The BOTA majority also determined that the PVD's use of original cost was reasonable and further held that the allocation in Kansas did not have to be representative of the fair market value of CIG's property in Kansas. According to the BOTA majority, this would require abandonment of the unit value methodology. The BOTA majority found no evidence that the allocation factor used imported value to Kansas grossly out of proportion to CIG's presence in the state. Accordingly, the BOTA majority affirmed the allocation factors used by the PVD. The concurring opinion disagreed with the BOTA majority's determination that allocation in Kansas did not have to be representative of fair market value in Kansas. The concurring opinion would hold that fair market value must be the benchmark and that if the allocation factor used or the unit valuation system did not reasonably relate to fair market value, different factors and methods must be used under the statute. However, the concurring opinion concluded that the results reached by the majority were correct and that the appellate courts would be able to sort out the requirements and reach a just result. CIG filed a motion for reconsideration which was granted. On reconsideration, the three members of BOTA modified their opinion, acknowledging that the allocation must have a rational relationship on its face and in its application to the property of the taxpayer in the state. BOTA affirmed its original order. CIG appealed directly to the Court of Appeals pursuant to K.S.A. 74-2426(c)(3) (granting the Court of Appeals jurisdiction over action for review of property appraised and assessed by the PVD). The matter was then transferred to this court on its own motion pursuant to K.S.A. 20-3018(c). APPELLATE COURT STANDARD OF REVIEW This is an appeal from an order of BOTA and this court's scope of review is dictated by K.S.A. 77-621. See K.S.A. 74-2426(a) (stating that actions by BOTA are subject to review in accordance with the act for judicial review and civil enforcement of agency actions). Under K.S.A. 77-621(c), this court may grant relief if it determines: (1) The agency action, or the statute or rule and regulation on which the agency action is based, is unconstitutional on its face or applied; (2) the agency has acted beyond the jurisdiction conferred by any provision of law; (3) the agency has not decided an issue requiring resolution; (4) the agency has erroneously interpreted or applied the law; (5) the agency has engaged in an unlawful procedure or has failed to follow prescribed procedure; (6) the persons taking the agency action were improperly constituted as a decision-making body or subject to disqualification; (7) the agency action is based on a determination of fact, made or implied by the agency, that is not supported by evidence that is substantial when viewed in light of the record as a whole, which includes the agency record for judicial review, supplemented by any additional evidence received by the court under this act; or (8) the agency action is otherwise unreasonable, arbitrary or capricious. We have stated that BOTA is a specialized agency that exists to decide taxation issues, and its decision should be given great weight and deference when it is acting in its area of expertise. However, if we find that BOTA's interpretation is erroneous as a matter of law, we will take corrective steps. In re Tax Appeal of Univ. of Kan. School of Medicine, 266 Kan. 737, 749, 973 P.2d 176 (1999).