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Tax Review Commission

MINUTES OF THE

TAX REVIEW COMMISSION

September 12, 1997 - 1:00 p.m. -- Room 405 State Capitol



Members Present:    
    Mr. Gary Cornia, Chair
    Mr. James B. Lee, Vice-chair
    Mr. Mark Buchi
    Rep. Judy Ann Buffmire
    Mr. Robert M. Graham
    Sen. Lyle W. Hillyard
    Ms. Carol McCormick
    Judge Jon Memmott
    Ms. Bonnie Miller
    Mr. W. Val Oveson    
    Mr. Ray Wood


    
Members Excused:
    Ms. Dorothy Owen    
    
Members Absent:
    Rep. John Valentine
    Sen. E. George Mantes

Staff Present:
    Mr. Bill Asplund
     Executive Director
    Ms. Rebecca L. Rockwell
     Associate General Counsel
    Ms. L. Kaye Clark
     Secretary

Note:    A list of others present and a copy of materials distributed in the meeting are on file in the Office of Legislative Research and General Counsel.
    
1.     Call to Order and Approval of Minutes -- Vice-chair Lee called the meeting of the Tax Review Commission ("TRC") to order at 1:15 p.m.

    MOTION: Mr. Wood moved to approve the minutes of the August 15, 1997 meeting. The motion passed unanimously. Mr. Buchi was absent for the vote.

2.     Continuation of Presentations on Property Tax Methodology
    
    a. Robert Strong, Property Tax Manager, PacifiCorp, referred to a chart "PacifiCorp/Utah Power" showing the total state and local tax burden by state for the ten states in which PacifiCorp operates. He said that 35.5 percent of PacifiCorp's investment is spent in Utah, but 47.6 percent of total taxes are paid to Utah. He said it is important to consider the total tax package when comparing states.

    Mr. Strong reviewed the handout "PacifiCorp - Capitalization Rate Analysis, Comparability Factors" including reports from the Property Tax Division ("the Division") showing which companies are used as comparisons. He said these companies are not comparable in terms of financial or physical characteristics. He said this illustrates one of the problems of using direct capitalization.

    Mr. Strong distributed a handout titled "Tax Review Commission, State of Utah, Submissions by Robert G. Strong" in response to the request at the August 15, 1997 meeting that he outline suggestions as to how intangibles should be defined. This material includes his suggestions for changes to the Utah Code and in the Utah State Tax Commission's ("Tax Commission's") rules and regulations . He said that the model used by the Division creates intangibles because it uses direct capitalization and stock prices to arrive at value. He suggested the TRC study the examples of language included in the handout that have been used successfully in other states' rules, codes and case law regarding intangibles.

    b. Andrew Ottinger, Senior Tax Counsel, U S West Communications Inc., presented information regarding the inclusion of intangibles in the valuation of centrally assessed properties from the handout "State of Utah, Tax Review Commission, Centrally Assessed Property Tax Information Hearing, September 12, 1997." He said the Tax Commission gives undue weight to the value of U S West Communications' stock in valuing their taxable property. The value of the common stock not only reflects the value of the real property and tangible personal property held by the company to provide local exchange telephone service, and also reflects anticipation of value from future services that is unrelated to the assets held by the company. He feels that the cost approach is the best valuation indicator for the telecommunications industry.

    Mr. Ottinger reviewed graphs showing comparisons between the valuation of U S West Communications' taxable property in Utah to the same property in other states where U S West does business. These charts do not include Ohio, Oregon or Minnesota. He said that Utah has the highest correlated system value in U S West's fourteen state operating region. He attributed this disparity to the fact that the Tax Commission gives undue weight to the value of common stock. He said that because the stock and debt approach and the income approach include the company's intangible assets, the resulting valuation is inappropriately high.

    Mr. Ottinger stated that the role of the Tax Commission is to ensure that its valuation process does not include intangibles in the valuation of a company's taxable property. He said that the Tax Commission cannot continue to rely on the stock and debt approach to valuation at its current high weighting without specifically identifying and removing from the computation the value of the intangible assets.

    Mr. Ottinger commented that the income approach as utilized by the Tax Commission is not an income approach but rather a stock and debt approach. He said the Tax Commission uses a direct capitalization methodology which lumps intangible assets with real property in reaching a correlated system value. He said the correlated system valuation using the yield model is also overstated.

    Mr. Ottinger suggested that the cost approach is the most appropriate method of valuation for the telecommunications industry because it places centrally assessed telecommunications providers in the same position as other competitive businesses. He said the cost approach is accurate, easy to administer, equitable, and does not include the value of intangible assets. Mr. Ottinger concluded his presentation by urging the TRC to give serious consideration to abandoning valuation methodologies that inherently capture intangible values.

    Vice-chair Lee asked if Mr. Ottinger would recommend changing the statute to require the use of the cost approach methodology for the telecommunications industry valuation. Mr. Ottinger said he would prefer the methodology to be prescribed by rule.

    Chair Cornia asked how a value is placed on licences. Mr. Ottinger said that with reasonable assumptions about the growth of the industry, it would be possible to value licenses.
Chair Cornia then asked if some of the intangible issues will be resolved when price competition on the local level increases. Mr. Ottinger said that when prices for long distance decreased the market exploded and the revenues expanded. He said that competition will come in the form of resale. He predicted that future telecommunication services will be bundled and appear on one bill. He said this will create increased name recognition and therefore more intangible value.     
    Mr. Graham asked Mr. Ottinger to discuss U S West stock prices over the last four years. Mr. Ottinger replied that the stock price is difficult to identify because in 1995 U S West went to a targeted stock environment. There are now two stocks: U S West Inc. and U S West Media Group.

    c. Gerald A. Hendrikson, Assistant Tax Director, AT&T, presented the material in the handout "Outline, September 12, 1997." He said that AT&T Communications is assessed on a unitary basis in more than 30 states. Of those states, the unitary values determined by the Tax Commission are typically more than twice the national average of the values determined for the same unit. He said that the problem with unitary appraisal is that the units being compared are not necessarily comparable nor is the accounting data used comparable. He said the companies being assessed do not have enough similarities to use a direct capitalization methodology. Of further concern is that comparisons will become more difficult as the telecommunications industry evolves. AT&T's position is that the direct capitalization method is flawed and should not be used to value long distance companies. Mr. Hendrikson also said that both the income approach and the stock and debt approach arrive at a business value which contains intangibles that must be removed.

    Mr. Hendrikson said AT&T recommends the use of the cost approach as well as working out a methodology that is administratively simple and arrives at a fair valuation. He stated that competitive telecommunications companies should be treated equally not only among themselves, but also with other commercial and industrial companies .

    Vice-chair Lee asked if Mr. Hendrikson would recommend prescribing by rule the use of the cost approach. Mr. Hendrikson said he would prefer a rule by the Tax Commission because that would allow for changes as circumstances require. Mr. Oveson said that the cost approach still relies on decisions based on judgments and asked Mr. Hendrikson to identify those judgments. Mr. Hendrikson said the appraisals must determine replacement costs, loss of value, and functional and economic obsolescence.

    Chair Cornia asked Mr. Hendrikson to explain the changes in the regulatory climate for AT&T. Mr. Hendrikson said that AT&T is now classified as a non-dominant carrier. Chair Cornia asked why intangibles are more of an issue after a reduction in rate regulation. Mr. Hendrikson said that as the long distance industry becomes more competitive, a company's intangibles (especially their trade name) become more valuable. He said that it is vital that companies not be placed at a competitive disadvantage due to property tax or any other cost element.

    d. Peter J. Emanuel, Director, Property Taxes, Union Pacific Corporation, distributed a handout titled "Utah Tax Review Commission, September 12, 1997" which addressed the issues raised at the last TRC meeting. First, he reviewed information showing Union Pacific's unit values in Utah compared to the valuations in other states for 1995-1997 commenting that there has been an overvaluation in Utah. Second, he addressed the differences in value calculated by the Division, the counties, and the taxpayers. He stated that the principal difference in values claimed by Union Pacific and values determined by the Division and the counties is reliance on stock market-derived evidence of value. He said this reliance overstates the value of property.

    Mr. Emanuel stated that the valuation methodology needs to fit the property. He said that although the cost approach is appropriate for rate based industries, cost has no relationship to value with regard to railroads. He said that the main concern in choosing a methodology is that it arrives at fair market value under the laws of the state. He recommended the use of a discounted cash flow method or a yield capitalization method based on the standard cost of capital.

    Third, Mr. Emanuel addressed the WilTel decision which states that the taxpayers should identify their intangibles for removal. He feels the better solution is to adopt methodologies that do not include intangibles. Mr. Emanuel concluded that the current system does not need to be replaced, but that it needs to be administered fairly.

    Mr. Oveson asked about the historical cost of Union Pacific. Mr. Emanuel said it is $19 billion. He said that one of the problems for railroads with the cost indicator is that the replacement costs are prohibitive for the amount of income from that investment. He said the term for this is obsolescence.

    Chair Cornia asked if the replacement cost could be adjusted appropriately by measures of depreciation and obsolescence to arrive at fair market value. Mr. Emanuel said that fair market value could be calculated through income deficiency.

    Chair Cornia requested that all the presenters provide the TRC with a capitalization rate analysis showing comparisons being used by the Division for their companies. He then asked why Union Pacific opposes the use of stock prices. Mr. Emanuel said there has been a general run up in the stock market and that a recent report indicates the value of the liquidity associated with securities is 50 percent. He said railroad assets cannot be converted. Chair Cornia requested a copy of that report.

    e. Glen Stevens, Supervisor, Property Tax, Questar Pipeline Co., distributed a handout titled "Tax Review Commission, State of Utah, Comments by Glen Stevens, September 12, 1997" in response to a request for further information at the last TRC meeting. Mr. Stevens discussed the following topics: (1) how centrally assessed taxes are calculated and the problems with those calculations that have resulted in appeals; (2) how the indicators of value used by the Division differ from other states; (3) how intangible value is imputed into the property tax valuations; (4) how the indicators used for centrally assessed taxpayers differ from locally assessed taxpayers and why that is unfair; and (5) recommendations.

     Mr. Stevens reviewed data showing comparisons of property tax system values by state for the states in which Questar Pipeline does business. He stated that over the last nine years, Utah's values have averaged 138.25 percent over the average of the other states.

    Mr. Buchi asked about the relevancy of deferred federal income tax. Mr. Stevens explained that deferred federal income taxes are derived from taking accelerated depreciation for tax purposes. He said that FERC removes the deferred federal income tax from the rate base and does not allow the company to earn on that balance sheet item. Mr. Buchi stated that this passes on the accelerated benefit to the rate payer.

    Mr. Stevens said that a properly calculated yield capitalization adjusts for the risks of a particular industry compared to the market as a whole. Vice-chair Lee stated that the Division would still be required to make judgments regarding the allowable range. Mr. Stevens said the Division would have to justify the decision based on data.

    Mr. Buchi asked if the yield capitalization method produces some taxation of intangible property. Mr. Stevens said that for rate regulated businesses any intangibles would be included in the rate base. Judge Memmott asked how the weighting in yield capitalization is determined. Mr. Stevens said it is based on an industry average of comparable companies. Judge Memmott asked how the decision is made regarding which methodology is used to calculate value. Mr. Oveson replied that it is an administrative decision.

    Chair Cornia responded that the TRC's position is to study all approaches and make an independent decision as to which approach is the most appropriate. Mr. Wood asked about the possibility of amending the constitution to allow taxation on intangibles. Chair Cornia said that is an option the TRC may consider. Mr. Buchi expressed concern about the impact of taxing intangibles.

    Vice-chair Lee requested that Mr. Stevens continue his presentation at the October TRC meeting. Chair Cornia said the airline and wireless industries would like to make a presentation to the TRC at the October meeting.

    Mr. Wood expressed concern about finding a suitable solution to the intangible issue. Mr. Buchi said that the difference between Utah and other states is the use of direct capitalization. He recommended that Utah forbid the use of direct capitalization as Idaho has done by rule. Mr. Lee said the decision as to the capitalization rate will create a problem. Judge Memmott said there are both legal and political considerations. He said the uniform and equal rate creates a dramatic shift in the tax burden, especially in rural counties. Chair Cornia said that adjustments in methodology can be phased in over time.

    Mr. Buchi said the presentations have shown that there are more appeals in Utah than in states that do not use the direct capitalization method. Rep. Buffmire stated that the information consistently shows that Utah's property tax is higher than most other states. Mr. Oveson said the TRC is trying to determine the reasons that Utah is high.

     3.     Federal Tax Reform and Its Impact on Utah _ This item was not discussed.
        

     4.    Other Business - The next meeting of the TRC will be held October 17, 1997, at 1:00 p.m. in room 405.
            
     5.    Adjournment

     MOTION: Chair Cornia moved to adjourn the meeting at 4:40 p.m. The motion passed unanimously.
    



    

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