BEFORE THE UTAH STATE TAX COMMISSION
Petitioner, : FINDINGS OF FACT,
: CONCLUSIONS OF LAW,
v. : AND FINAL DECISION
PROPERTY TAX DIVISION : Appeal No. 88-1334
OF THE UTAH STATE :
TAX COMMISSION, :
Respondent. : Tax Type: Centrally Assessed
STATEMENT OF CASE
This matter came before the Utah State Tax Commission for a formal hearing on XXXXX through XXXXX. Commission Chairman W. Val Oveson presided during the hearing. Commissioner Alice Shearer, Commissioner Roger O. Tew, Commissioner Joe B. Pacheco and Administrative Law Judge G. Blaine Davis also heard the matter for the Commission. Present and representing Petitioner were XXXXX, XXXXX, and XXXXX from the law firm XXXXX. Present and representing Respondent were XXXXX and XXXXX, Assistant Attorneys General. Present and representing the affected Counties were XXXXX, and XXXXX from the law firm XXXXX.
Based upon the evidence and testimony presented at the hearing, the Tax Commission hereby makes its:
FINDINGS OF FACT
1. This is a property tax valuation appeal.
2. The year in question is XXXXX, with a lien date of XXXXX.
3. In its original assessment, the Property Tax Division of the Utah State Tax Commission, (the Division) set the system value of XXXXX at $$$$$ and set the value of the portion of XXXXX operating property allocated to Utah at $$$$$, which was XXXXX% of the system value.
4. Petitioner, XXXXX is a telecommunications company with its principal offices in XXXXX, XXXXX. XXXXX is a subsidiary of XXXXX, a telecommunications holding company whose other principal subsidiaries are the XXXXX and XXXXX. XXXXX is a wholly owned subsidiary of XXXXX.
5. Until XXXXX, XXXXX was a wholly owned subsidiary of XXXXX and one of XXXXX XXXXX companies. As a result of anti-trust litigation brought by the United States Department of Justice, XXXXX and the Department of Justice entered into a consent decree entitled the Modification of Final Judgement (MFJ), pursuant to which XXXXX divested itself of ownership of portions of operating telephone companies that related to exchange telecommunications services, exchange access functions, XXXXX service, printed directory advertising, as well as XXXXX cellular advanced mobile communications service business. Ownership of these operations was transferred to XXXXX newly formed XXXXX, one of which was XXXXX.
6. XXXXX furnishes telecommunications services in XXXXX, XXXXX, XXXXX, XXXXX, XXXXX, XXXXX, and XXXXX. It provides XXXXX data transmission, transmission of radio and television programs, and private line voice and tele-typewriter services in those areas. Since XXXXX, telephone directories for the company’s service have been published by XXXXX, an affiliate of XXXXX, pursuant to a contract with the company.
7. For the year ending XXXXX, the principal sources of revenue for XXXXX were local service (XXXXX%), access charges (XXXXX%), and toll service (XXXXX%). There were XXXXX network access lines in service on XXXXX.
8. The company has made and expects to continue to make, large construction expenditures to meet the demand for telecommunications services and further improve such services. Total investment in telephone plant increased to $$$$$ on XXXXX, from $$$$$ on XXXXX, after giving effect to retirements but before deducting accumulated depreciation on such dates. Annual construction expenditures for XXXXX were $$$$$.
9. The FCC’s Notice of Proposed Rulemakingof XXXXX, proposed a dramatic change in the method of regulating the interstate rates of dominant telecommunications common carriers. In XXXXX, citing the growth of competition in the market for various interstate services and alleging a number of deficiencies in the traditional regulatory approach, the FCC suggested replacing it with a “price cap model” of regulation.
10. There is increased recognition of competitive market forces at the federal level and also growing awareness of the structural changes in the local and state telecommunications market. Increasing consumer sophistication, larger numbers of choices, the availability of user-friendly technology, and more and better integrated systems are primary motivators in the movement towards greater competition among suppliers of both traditional telecommunications service and newer information products. The company remains a major participant in both the traditional and newly emerging markets.
11. Following the mailing of the valuation notice, on or about XXXXX XXXXX filed a timely Petition for Redetermination with the Commission in which it alleged that the Original Assessment was erroneous and excessive. XXXXX further alleged that its Utah operating property should be assessed at XXXXX% of its fair market value in the same manner as property assessed by county assessors pursuant to what was then Utah Code Ann. §59-2-304(1).
12. A portion of the claim of XXXXX was based upon a closely related issue (the “Amax Issue”) which was then pending before this Commission in the matter of Amax Magnesium Corp.v. Tax Comm’n,796 P.2d 1256 (Utah 1990), appeal after remand, 874 P.2d 840 (Utah 1994). Pursuant to a Joint Stipulation of the parties, dated XXXXX, this Commission entered an order on XXXXX, staying the proceedings in this appeal until the related issue in the Amax case was fully resolved. Following the legislative amendments to Utah Code Ann. §59-2-304(1), which became fully effective XXXXX, XXXXX voluntarily withdrew the Amax issue. The formal hearing in this matter was then set to begin on XXXXX.
13. Because XXXXX Utah property is operated as part of an integrated, XXXXX telecommunications system, the fair market value of the Utah property of XXXXX is best determined under the unit approach to value. Under the unit approach, the value of the entire system of XXXXX is first determined as a going concern. A portion of the system value determined under the unit approach is then allocated to the state of Utah. The unit approach does not mean that nontaxable or intangible property is subject to property taxation.
14. All parties agreed that the allocation methodology recommended by the XXXXX may properly be applied to the determined system value of XXXXX. The allocation factor to allocate a portion of the total value to the State of Utah, agreed upon by the parties and accepted by this Commission, for the XXXXX tax year is XXXXX%.
15. In determining the value of XXXXX entire operating system, the standard to be applied is “fair market value,” which is the price “at which [the] property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the facts.” Utah Code Ann. §59-2-102(2).
16. XXXXX is a telecommunications utility subject to traditional rate base/rate of return regulation at the federal and state levels.
17. The interstate telephone operations of XXXXX are regulated by the Federal Communications Commission (“FCC”). The intrastate telephone operations of XXXXX are regulated by the Utah Public Service Commission (“PSC”) and its counterparts in the other XXXXX in which XXXXX operates (collectively with the FCC, the “Regulatory Commissions”).
18. The Regulatory Commissions all require XXXXX to maintain its financial records in accordance with the FCC’s Uniform System of Accounts. These standardized accounts are used by the Regulatory Commissions both for reporting purposes, e.g., as the basis for XXXXX annual report to the FCC on Form M, and for purposes of establishing the authorized rate base and overall allowed rates of return on rate base for XXXXX.
19. The accounting procedures followed by XXXXX under the Uniform System of Accounts in preparing its Form M reports can differ from the accounting procedures followed by XXXXX under Generally Accepted Accounting principles in preparing its annual Form 10-K report filed with the Securities and Exchange Commission.
20. The objectives of traditional rate base/rate of return regulation are to provide universal access to service at reasonable rates, while affording the utility the opportunity to earn a reasonable rate of return on its investment.
21. The investment base on which the utility is afforded the opportunity to earn a return is typically referred to as its “rate base.” The calculation of the amount of the utility’s authorized rate base begins with the original or historical cost of its operating property on the date it was first placed in service, sometimes referred to as the date the property was first devoted to public service. Regulatory Commissions limit the amount and type of costs that may be included in the utility’s authorized rate base to those costs deemed reasonable and necessary to provide utility service and those costs that the Regulatory Commissions determine as a matter of policy should be borne by the customers or ratepayers of the utility.
22. From the original or historical costs allowed in the rate base, the Regulatory Commissions then deduct amounts attributable to accumulated depreciation. For regulatory purposes depreciation is calculated on a “straight-line” basis over the useful life of the asset, again as determined by the regulatory authorities. As a result, regulatory depreciation rates can and typically do vary substantially from depreciation rates allowed for income tax or general accounting purposes.
23. At the formal hearing, three expert appraisals were presented: one by XXXXX for XXXXX, one by XXXXX for the Division and one by XXXXX for the Division.
24. XXXXX prepared his appraisal using five separate indicators of value: Historical Cost Less Depreciation (HCLD) cost approach indicator adjusted for obsolescence; a rate base cost approach indicator; two income approach indicators, one utilizing a projected income based on authorized rates of return on rate base, and one projecting expected income from historical earnings patterns; and a business segments stock and debt approach.
25. XXXXX appraisal calculated six valuation approaches: an adjusted HCLD cost approach; direct capitalization of both net operating income (NOI) and net cash flows based upon market multiples; a discounted cash flow approach based upon projections from the historical earnings of XXXXX; a stock and debt approach which calculated the value of the equity of XXXXX through the application of various ratios; and a stock and debt approach adding an estimated “mergers and acquisitions” premium to the traded stock price.
26. XXXXX prepared his appraisal using four valuation approaches: an historical cost less depreciation (HCLD) cost approach adjusted by a market to book ratio derived from the seven RBOC’S; a direct capitalization income indicator; a discounted cash flow approach based upon a range of estimated percentage increases in the historical earnings of XXXXX; and a stock and debt approach based upon a direct estimation of the value of the equity of XXXXX using market multiples derived from the RBOC’S.
27. XXXXX prepared his appraisal using five separate indicators of value as has been set forth above.
28. While preparing his appraisal, XXXXX reviewed two analyst reports for the stock and debt indicator. No other market analyst reports were reviewed or considered.
29. XXXXX rate base cost indicator of value was calculated on Appendix A, Table 4a of Exhibit 30. In that estimate of value, XXXXX began with the Gross investment in telephone property from the books of the company of $$$$$, and deducted depreciation and amortization of $$$$$, accumulated deferred federal income taxes (DFIT) of $$$$$, and land development and construction deposits of $$$$$, then added materials and supplies of $$$$$ to arrive at a system valuation, which was equal to rate base, of $$$$$.
30. In XXXXX adjusted rate base indicator of value for the cost approach, he makes two additional reductions from his original rate base indicator of value calculated above which are set forth on Appendix A, Table 4 of Exhibit 30. First, XXXXX deducted an amount of $$$$$ for “inadequate earnings power.” XXXXX asserts that this adjustment is necessary to reflect the “economic obsolescence caused by regulatory treatment of licensing revenues and certain operating expenses that imposes a limitation on earnings from the cost-regulated utility property so that the realizable rate of return is less than the average rate of return allowed by regulatory authorities.” (Footnote 10, Appendix A, Table 4 to Exhibit 30). The position of Respondent is that ninety percent (90%) of this adjustment is caused by XXXXX deduction of advertising revenues, and the remaining ten percent (10%) of the adjustment is caused by XXXXX deduction of operating expenses, such as charitable and community contributions which are not allowed by regulators in calculating rate base or in the calculation of the revenue requirements of the utility. The second adjustment to the rate base was for “inadequate allowed rate of return on fixed income securities.” The adjustment was in an amount of $$$$$, and represented the difference between the imbedded debt rates and the market debt rates. After the deduction of those two items, XXXXX determined the rate base, or adjusted system value based on the cost approach to be $$$$$. Due to a small calculation error, the deduction for inadequate allowed rate of return on fixed income securities was reduced by approximately $$$$$, thereby increasing the indicator to $$$$$. (Appendix A, Table 4, Exhibit 31).
31. In XXXXX estimate of value based upon the income approach and utilizing the expected earnings model, he made an estimate of the projected earnings of XXXXX. That estimate was based, not upon the past earnings of the company, but instead upon the rate base which he had calculated in the cost approach (XXXXX) multiplied by XXXXX% which he said was the expected earnings rate on net investment. The expected earnings rate of XXXXX% was the average of the rates of return allowed by all regulatory jurisdictions. (Appendix A, Table 3 of Exhibit 30). From the expected earnings of $$$$$, XXXXX deducted the net licensing revenues after taxes of $$$$$ because he claims that when regulatory authorities include those licensing revenues in net income for rate making purposes, it imposes a limit on the actual revenues to be derived from telecommunications properties. He also deducted an amount of $$$$$ from those expected earnings for additional operating expenses which he says were “certain prudent operating expenses which are not chargeable to customers for rate making purposes.” (Footnote 13, Appendix A, Table 3 of Exhibit 30). Thus, the expected income to be capitalized was reduced from $$$$$ to $$$$$. That income was capitalized by XXXXX at a rate of twelve percent (12%) to arrive at an estimated system valuation based upon the capitalization of expected earnings of $$$$$. (Appendix A, table 2 of Exhibit 30). XXXXX also testified that if the same method had been used but the directory revenues and additional operating expenses had not been deducted from the projected revenues, then the capitalization of the projected revenues of $$$$$ at 12.0% would produce a value of $$$$$.
32. In XXXXX estimate of value based upon the income approach and utilizing the historical earnings model, he used the net operating income for Petitioner for XXXXX from the annual Form M filed with the Federal Communications Commission (F.C.C.) in an amount of $$$$$. From that amount, XXXXX deducted the same licensing revenues and additional operating expenses as discussed above, but added $$$$$ for income from telephone property under construction, to arrive at income to be capitalized of $$$$$. (Appendix A, Table 3a, Exhibit 30). That income was capitalized at 12.0% (Appendix A, Table 2a, Exhibit 30) to arrive at an estimated value of $$$$$. If that same approach was used without the deduction for directory revenues or additional operating expenses, then the value would calculate to $$$$$.
33. XXXXX also made an estimate of value based upon the stock and debt approach, which he entitled “Stock and Debt Market Price Approach” (Appendix A, Table 5, Exhibit 30). XXXXX took the gross value of all of the debts, obligations, and securities of XXXXX, primarily as of the end of XXXXX, although some matters, such as the bond prices, were averages for the year. In addition, for other liabilities, he only included 50% of the amount of other liabilities as of the end of the year. XXXXX apparently attributes approximately 50% of the total consolidated net income of XXXXX to the activities of XXXXX, and has therefore apparently allocated the other liabilities on the basis of the contribution of XXXXX to the net income. (Exhibit 507 (A).) XXXXX determined a gross value for all securities and other obligations of $$$$$. XXXXX then deducted the non-operating property in a total amount of $$$$$ to arrive at the total system value based upon the stock and debt approach of $$$$$.
34. In arriving at the estimate of value based upon the stock and debt approach, XXXXX only included the value of the common stock of XXXXX after deducting from the value of XXXXX the values of all other subsidiaries. To determine the amount which XXXXX would include in common stock for the stock and debt approach to value, he began with the total value of the common stock of XXXXX as of XXXXX of $$$$$ (No. Of Shares times the average selling price for XXXXX), and then reduced the aggregate stock price by the following items in the following amounts:
A) $$$$$ for XXXXX (determined by placing the value of $$$$$ per share on the stock of XXXXX set forth in the XXXXX prospectus).
B) $$$$$ for the “loss subsidiaries” (based on the book value of subsidiaries with losses during XXXXX).
C) $$$$$ for XXXXX (based on a price/earnings multiple developed by using XXXXX as a comparable).
D) $$$$$ for XXXXX, which was based upon book value.
E) $$$$$ for the remaining “profitable subsidiaries” (based on the book value of profitable subsidiaries). (Exhibit 507 (A)).
35. The remaining XXXXX (XXXXX) was allocated among the XXXXX telephone companies (XXXXX, XXXXX, XXXXX) based on net income, of which XXXXX% or $$$$$ was allocated to XXXXX. To this common stock value was added the market price of the funded debt, current liabilities, and other liabilities, yielding a gross stock and debt value of $$$$$. This amount was reduced by current assets of $$$$$, an imputed value for directory advertising revenues of $$$$$, other assets of $$$$$, investments and funds of $$$$$, and approximately $$$$$ in miscellaneous physical property, resulting in a system value of $$$$$. XXXXX did not give any weight to the stock and debt approach.
36. By calculating the estimated stock and debt value of XXXXX in the manner which XXXXX did (i.e., by starting with the total values for XXXXX and then deducting the estimated values of several other companies and functions to show the value of XXXXX at whatever is left after those deductions) any and all errors made in calculating the values of any of the other subsidiaries would flow through to cause an error in the value of the property of XXXXX. Therefore, the Commission finds that the stock and debt values determined by XXXXX for the stock and debt approach is of questionable reliability. However, since XXXXX did not give any weight to the value determined by this approach, such a finding would not modify the final values recommended by XXXXX.
37. The overall correlated system value determined by XXXXX was determined by giving one-third of the weight to the adjusted rate base indicator, and two-thirds of the weight to the expected earnings model adjusted for the small calculation error. The final estimate of value of XXXXX was $$$$$. Based upon the allocation percentage of 12.63% agreed to by all parties, XXXXX allocated $$$$$ of the total value to the state of Utah.
38. XXXXX, a registered state appraiser developed six (6) indicators of value. He prepared a traditional historical cost less depreciation (HCLD) cost indicator, two income indicators based on direct capitalization, and three market indicators including a traditional stock and debt approach, a mergers and acquisition approach, and a financial forecast approach. Unlike XXXXX and XXXXX who used the FCC Form M, XXXXX took his numbers from the SEC Form 10K. There was testimony that the differences between the FCC’s Form M and Form 10K, are approximately 2-3%. In preparing his appraisal, XXXXX reviewed and considered numerous analyst reports.
39. XXXXX cost approach was a historical cost less depreciation (HCLD) or net book cost indicator with the present value of construction work in progress (CWIP) added pursuant to Tax Commission RuleR884-24P-20. He arrived at a value based upon the cost approach of $$$$$.
40. In his two income indicators, XXXXX utilized the direct capitalization model. This model is used extensively by the Division in assessing properties each year. The model is based on a conversion of income into value in one step through the use of market derived ratios. The algebraic formula to determine value as used by XXXXX is:
Value = NOI
NOI = Normalized Forecast Net Operating Income
Rate = Blended direct cap rate of debt and forecast
41. XXXXX developed his direct capitalization rate of XXXXX% analyzing industry capital structures and determined a market structure of XXXXX% debt and XXXXX% equity. His debt rate of XXXXX% was based upon yields for XXXXX publicly traded debt maturing after XXXXX. The earnings to price (E/P) rate was developed through a three (3) tiered analysis of comparable companies. XXXXX based his analysis largely upon Value Line for companies in the telecommunications industry. Twenty-two companies were chosen, nearly all of which had SIC codes of XXXXX, meaning they were telephone companies. XXXXX then estimated the degree of similarity to XXXXX based upon revenues, size, foreign domicile, and degree of regulation. This second analysis narrowed the list to fourteen. Finally, XXXXX compared the financial characteristics of these fourteen companies with XXXXX, and included historical growth trends, profitability, bond ratings and common financial ratios. These fourteen companies were narrowed to six. Five of the six companies selected by XXXXX wereXXXXX, nearly identical to those selected and used by XXXXX, and XXXXX. Also included in his analysis with the XXXXX was XXXXX.
42. Having selected his guideline companies, XXXXX compared earnings to price (E/P) and cash flow to price (CF/P) ratios. These ratios were based upon forecast earnings and forecast cash flows. Based on this comparison, XXXXX selected an E/P rate of XXXXX% and a CF/P rate of XXXXX%, both of which were higher and more conservative than those of the selected guideline companies. Applying the debt and equity rates to his selected capital structure, XXXXX derived a direct capitalization rate based on NOI of XXXXX% and a direct capitalization rate for NOI plus depreciation (cash flow) atXXXXX%. (Schedule I/1 and I/2 of Exhibit 531).
43. In developing a yield or discount rate for discounting construction work in progress, (CWIP), XXXXX developed his equity rate by considering the capital asset pricing model (CAPM), the dividend growth Model (DCF Model), and a risk premium model. Based on this analysis, XXXXX selected XXXXX%. Blending that rate with the cost of debt of XXXXX%, XXXXX developed a yield rate of XXXXX%.
44. XXXXX developed a forecast normalized NOI by analyzing historical trends from the company since XXXXX coupled with analyzing future forecasts made by analysts. He selected $$$$$ as the forecasted NOI. That forecast income was then capitalized at the direct capitalization rate of XXXXX% indicating a value based upon one of his income approaches of $$$$$. (Schedule I/1 of Exhibit 531).
45. XXXXX also developed an income approach based upon a forecast normalized NOI plus depreciation, (cash flow) by analyzing historical trends of the company since XXXXX, coupled with future forecasts, and adding depreciation. He concluded that there would be $$$$$ of normalized NOI plus depreciation. This number was capitalized at the direct capitalization rate of XXXXX% leading XXXXX to conclude a value based upon his normalized NOI income approach of $$$$$. (Schedule I/2 of Exhibit 531).
46. In XXXXX traditional stock and debt approach, he determined the stock value (equity value) allocated to XXXXX by first calculating the stock value of XXXXX. XXXXX analyzed stock price movements toward the end of the year and selected $$$$$ per share. The equity value of XXXXX was allocated to XXXXX based upon XXXXX contribution of net income to the total company resulting in an imputed value allocated to XXXXX of $$$$$. (Schedule 5/1 of Exhibit 531). XXXXX added long-term debt and other liabilities to this stock value resulting in a gross stock and debt value of $$$$$. Non-operating property was then removed by applying a ratio of XXXXX% resulting in a final estimate of value based upon the stock and debt approach of $$$$$. (Schedule 5/1 of Exhibit 531).
47. In his mergers and acquisition market approach, XXXXX analyzed the common stock in light of an assumed control premium. XXXXX studied typical mergers and acquisitions and concluded that when the assets of a company have been sold, a control premium has typically been paid during the sale. In analyzing this premium, XXXXX selected a control premium of XXXXX%, which was based upon the median premium paid in XXXXX and XXXXX for companies whose stock was originally selling for XXXXX to XXXXX times earnings. Applying this control premium to the stock value allocated to XXXXX resulted in a stock value of approximately $$$$$. This amount was added to long-term debt and other liabilities and adjusted for non-operating property, which resulted in a value based upon the mergers and acquisitions market approach of $$$$$. (Schedule M&A/1 of Exhibit 531).
48. In his financial forecast model, XXXXX analyzed the common stock value based upon a five-year forecast of dividends and a terminal value which used the E/P rate he had developed for his income indicators. These future estimated cash flows to equity holders were discounted to a present value. That present value of the estimated cash flows was added to long-term debt and other liabilities and adjusted for operating property indicating a value based upon the financial forecast model of $$$$$. (Schedule DCF/1 and DCF/2 of Exhibit 531).
49. In reconciling the indicators, XXXXX placed no weight on the cost approach, some but little weight on the mergers and acquisition market approach, some weight on the financial forecast model, some weight but more than the financial forecast model was placed on the income indicator of NOI plus depreciation, and significant weight was placed on the NOI direct capitalization indicator and the stock and debt approach. Based upon the values indicated by his analysis, XXXXX concluded that the fair market value of the assets of XXXXX was $$$$$, with XXXXX% or $$$$$ being allocated to Utah.
50. XXXXX, prepared four indicators of value. He prepared a cost indicator, a direct capitalization income indicator, a yield or DCF income indicator, and a stock and debt indicator. In preparing his appraisal, XXXXX reviewed a number of analyst reports.
51. XXXXX cost approach was based upon historical cost less depreciation (HCLD), adjusted by a market to book (M/B) ratio of XXXXX. That market to book ratio was developed as a composite weighted market to book ratio from the market to book ratio for common stock of XXXXX and the market to book ratio for debt of XXXXX as calculated by XXXXX. (Table 2 of Exhibit 539). The market to book ratio of XXXXX% for common stock was developed by analyzing the equity market to book ratios of the seven comparable XXXXX. Each market to book ratio was adjusted to account for the effects of deferred federal income taxes (DFIT) as a source of zero cost capital. A market to book ratio at the low end of the range was selected because XXXXX market to book ratio was the lowest of the comparable companies. The market to book ratio for long term debt of XXXXX% was calculated by dividing the market prices by related book values of XXXXX securities. The composite or blended market to book ratio for debt and equity was based on the company’s market capital structure of XXXXX% debt and XXXXX% equity, and was determined to be XXXXX%. Applying this ratio to HCLD resulted in a value based upon the cost approach of $$$$$. (Table 3 of Exhibit 539).
52. For his income indicators, XXXXX used both a direct capitalization and a yield capitalization model. XXXXX developed his direct capitalization rate by selecting the company’s market capital structure of XXXXX% debt and XXXXX% equity. The debt rate of XXXXX% was calculated by dividing the proforma interest expense ($$$$$) by the market price of XXXXX long term debt securities ($$$$$). (Table 4 of Exhibit 539). The direct capitalization rate for common stock was derived by comparing the E/P rates of the XXXXX.
53. In analyzing the XXXXX, XXXXX was aware of their cellular subsidiaries. Some of the analyst reports he reviewed believed that cellular values were not reflected in the stock prices of the XXXXX. However, other analysts concluded there could be some cellular influence that ranged from XXXXX% to XXXXX% during the fourth quarter of high and low average common stock prices on average for the XXXXX. He concluded that the average cellular price as a percent of the fourth quarter average stock price was about 13%. XXXXX potential cellular value was among the lowest at 10%. XXXXX adjusted the stock prices for cellular influence and calculated an E/P rate of 11%. By applying his debt and equity rates to the capital structure, he developed a direct cap rate of XXXXX%.
54. XXXXX forecasted NOI by applying several expected growth rates to XXXXX XXXXX NOI. Some of the analysts expected only a small increase in income for the local exchange companies, including XXXXX. Accordingly, XXXXX projected modest growth rates ranging from XXXXX% to XXXXX%. Using this range of growth rates, the direct capitalization model indicated a range in value from $$$$$ to $$$$$. (Table 5 of Exhibit 539).
55. In his discounted cash flow (DCF) model, XXXXX estimated future cash flows for the company and discounted them to present value using two models; one based on company plans, and one based on more modest growth estimates. The discount rate was developed by weighing the equity discount rate with the debt discount rate based upon a typical industry capital structure of XXXXX% debt and XXXXX% equity. An imbedded debt rate of XXXXX% was used, which corresponded to the average yield to maturity of XXXXX long term debt securities. The equity discount rate of XXXXX% was developed using the traditional equity models including the dividend growth model(DCF) and the capital asset pricing model (CAPM). The equity rates were adjusted for cellular influence, resulting in a discount rate ranging from XXXXX% based on earnings growth to XXXXX% based on dividend growth. The equity rate was selected after considering that many analysts believed that cellular values were not reflected in the stock prices. The resulting weighted average cost of capital or discount rate was XXXXX%.
56. XXXXX considered financial forecasts by XXXXX in its business planning for the first five years of the projection period in estimating future cash flows. He also estimated cash flows based on XXXXX forecast, but with a more modest growth expectation (XXXXX%). XXXXX placed greater reliance on this latter estimate of cash flows because it was less aggressive and appeared to him to be more realistic than the business planning documents suggested. XXXXX analyzed investment reports and developed the opinion that local exchange telephone company revenue growth would approximately track general economic and population growths in the XXXXX% to XXXXX% range. Each of the discounted cash flow models contained a value matrix based on a range of terminal growth rates, and a range of discount rates from XXXXX% to XXXXX%. Applying these matrices to the range of growth, and adding the terminal growth rate indicated a range of values based upon the discounted cash flow model of between $$$$$ and $$$$$. (Page 30 of Exhibit 539).
57. In his stock and debt indicator, XXXXX averaged various ratios applied to the common stock value of XXXXX to determine the stock value of XXXXX. He used a price to revenue (P/R) multiple of XXXXX, a price to cash flow multiple (P/CF) of XXXXX and a price to equity book value multiple (P/B) of XXXXX resulting in an equity value of $$$$$. This number was added to long-term debt and adjusted for non-operating property resulting in a value based upon the stock and debt indicator of value of $$$$$.
58. In correlating a final opinion of value, XXXXX placed little weight on the cost indicator of value, but significant weight was placed on both the income indicator of value and the stock and debt indicator of value. XXXXX concluded that the fair market system value of these assets was $$$$$. That value would result in an allocation to the State of Utah of $$$$$.
59. Fair market value (FMV) is the amount at which property will change hands between a willing and knowledgeable buyer and seller. It is the most probable price at which the property would change hands. See The Appraisal Institute, The Appraisal of Real Estate, Edition, 1993.
60. In preparing a fair market value appraisal, the Division and Counties argue that it is necessary to analyze reports from market analysts. Both XXXXX and XXXXX relied heavily on their review of analyst reports, especially for understanding market trends, growth rates, expected cash flows and the cellular influence. The Division and Counties contend that these reports influence the actions of market participants (including large institutional investors) who buy and sell the securities of these companies, which in turn directly influences the value of the underlying assets. These reports provide meaningful information to an appraiser.
61. XXXXX, through XXXXX, on the other hand, considered only two reports. [Tr. Pp. 873-874} These two reports were from XXXXX, and were of a general industry type.
62. Based upon the evidence, the Commission finds that where the assets of a company are publicly traded through their securities, the study and analysis of market analyst reports are an important element of the appraisal process to properly value the underlying assets of a company. These reports provide meaningful information about financial forecasts, growth trends, etc. for the companies which influence the prices paid by market participants who buy and sell the securities of these companies.
63. Although the study and analysis of market analyst reports are an important element in the appraisal process, it is not the only element in that process and is likely not the most important element in that process. Numerous external forces which are not related to the expectations of investors for a particular company will have an influence on the selling prices of the securities of that company. Also, different analysts may ascribe different reasons for changes in the selling prices of the securities of a particular company, and they likely do not all agree on whether various aspects of the business of a particular company are all being considered in determining the price at which the securities of a particular company should be bought or sold. In this case, there was not unanimity among the analysts as to whether the “cellular influence” of XXXXX was fully reflected in stock prices of the parent company, XXXXX. Further, even among those analysts who agreed that there was some “cellular influence” in the stock prices, there was not unanimity among the analysts as to the amount of that influence, in terms of dollars, on the securities prices for the parent company.
64. Accordingly, an appraisal may be a valid appraisal even if it is not focused upon analysts reports. These analyst reports may have an important part to play in the appraisal process, but they do not necessarily control the total appraisal process.
ROLE OF REGULATION
65. XXXXX contends that in determining the fair market value of the assets of a regulated company such as XXXXX, that regulation plays a predominant role and that the rate-making process determines value. [Tr. p.498] XXXXX argues that rate base is the beginning focal point for determining value.
66. XXXXX prepared two cost indicators of value which were both related to rate base. Both income indicators of value relied heavily on XXXXX view of the actions of regulators. For example, the cash flows which XXXXX determined and utilized in his estimates of value based upon the income approach were essentially a function of rate base. Further, the yield capitalization rate which was developed by utilizing the average of the allowed returns on equity for all regulatory jurisdictions which regulate the business of XXXXX, in essence, lets the regulatory agencies determine the capitalization rates.
67. The Division and Counties agree that regulation influences value. However, the Division and Counties contend that the effects of regulation on value are directly recognized and accounted for in the financial performance of the company and the market prices of securities. They assert that regulation and its impact on value is directly accounted for in the activity of market participants and is reflected in market prices paid by market participants after analyzing the financial performance of the company.
68. The Division and Counties argue that it is not necessary to review rate design proceedings or tariff filings or calculate rate base in order to value a regulated utility. XXXXX testified that there is no basis for assuming that investors will always expect a firm’s income to equal the allowed return multiplied by the estimated rate base. It may be lower or it may be higher (XXXXX Report, Exhibit 513, pp. 22-23.) Rate base and authorized rates of return are not tightly sealed constraints that absolutely limit the income of XXXXX.
69. The Division and Counties contend that XXXXX takes an overly restrictive and narrow position when they argue that regulation creates value rather than influences value. The Division and Counties have argued that as a matter of law the value for ad valorem tax purposes and value for rate-making purposes are not the same and that Rate base is not a surrogate for fair market value.
70. This debate over the role of regulation in the valuation process is a fundamental distinction between the appraisal presented by XXXXX and the two appraisals presented by the Division and Counties.
71. The position of Petitioner is set forth in the appraisal prepared by XXXXX, which clearly focuses on the effects of regulation and the performance of the regulators. The starting point and total focus of the appraisal of XXXXX is upon the rate base and the regulatory process. XXXXX did state that “rate base does not equal value,” but his entire appraisal is premised upon rate base and the rates of return authorized by regulatory agencies constituting the foundation, starting place and focal point for all value determinations.
72. The position of Respondent is that the market place and market information form the foundation, starting place and focal point to ascertain the fair market value of the property, and that the effects of regulation are reflected in that market information. The two appraisals prepared by XXXXX and XXXXX both used the market place and market information as the foundation, starting place and focal point for their appraisals.
73. In theory, if both valuation approaches are properly analyzed, they should yield essentially the same value. The critical question centers on the nature and the degree of the necessary adjustments. However, since the Commission is being asked to determine the fair market value of the property of XXXXX as measured by the open market, the Commission is more comfortable starting from a market point of view rather than a regulatory point of view. That does not mean that regulation is not an important consideration. It is. Nevertheless, in principle, the general affects of regulation should be recognized by the market place and reflected in the corresponding stock prices. The nature and effectiveness of regulators may argue for adjustments to stock prices or they may impact the confidence which appraisers may have in a particular appraisal methodology. However, if reasonably comparable stock market information can be obtained, and the necessary adjustments can be calculated, then the fact that the property being valued is for a regulated entity does not mandate a “regulation-based” starting point.
74. The Commission finds that the rate base function is not a market function. To the degree that market information has been properly interpreted, adjusted and employed, market information would be a more appropriate foundation, starting place and focal point for determining the fair market value of the property than would be the rate base and regulatory treatment of the company.
75. Regulation influences and impacts value, but regulation does not determine the fair market value of property for ad valorem tax purposes. The regulatory environment is also shifting to one of less regulation, so it is likely that regulation will have less influence and impact on value in the future than it does for the year at issue in this proceeding.
76. Rate base as determined by regulators is not necessarily equal to or determinative of the fair market value of property for ad valorem tax purposes.
77. Direct capitalization is one of the most common methods of estimating the value of an income producing property, it assumes that the value of a property is determined by the income which it will produce. That anticipated income is then capitalized at a rate which is reasonably expected to satisfy the expectations of investors for a reasonable return on their investment. Under this method, the value of the property is determined by dividing the income by the capitalization rate, and it is algebraically expressed as:
Value = Income or V = I
78. Direct Capitalization is a simple income method to use and is normally a reliable indicator of value if it is based upon an accurate determination of income, and a capitalization rate that has been calculated from comparable properties that are nearly identical to the property which is being valued. To the extent that the comparables may not be identical to the property being valued, there may be distortions in the value determined by using those comparables. Small distortions in the capitalization rate can cause substantial distortions in the total value.
79. Yield capitalization is also a very common method of estimating the value of an income producing property by attempting to estimate the present worth of the future benefits of the property, i.e., the anticipated income stream of the property. The formula for estimating value based upon the yield capitalization approach is expressed as:
V = I1 + I2 + IN
1+y (1+y)2 (1+y)N
where V is the present value, I is income (or cash flow), Y is the appropriate discount (or yield) rate, and N is the number of periods.
80. In the calculation of yield capitalization rates, there are many factors, such as the degree of risk and the nature and estimated length of the income stream, that affect the overall capitalization rates. In the calculation of direct capitalization rates, there are also many factors that affect the overall capitalization rates. However, in direct capitalization there is the added problem of trying to ascertain whether each of the those factors has had the same impact and influence on the comparables as it has had on the property being valued.
81. For appraisals made using the direct capitalization method, if capitalization rates have been calculated from an analysis of the performance of the securities of comparable companies, the Commission has always been concerned with whether the comparable companies are truly comparable to the company being valued. That concern is not just with whether the comparables are the “most comparable” companies available, but with whether they are truly comparable in all respects. That decision must include an analysis of the factors that may cause the comparable companies to be different than the company being valued, and to therefore cause investors to treat differently the securities of those companies.
82. In this case, each of the appraisers utilized certain information from the XXXXX in making their appraisals, especially in their use of the direct capitalization method. The Commission finds that the utilization of the XXXXX provides the best comparables to XXXXX that are available, but there are still concerns about the comparability of those companies. Those concerns relate to the comparability of the business operations, subdivisions and subsidiaries of the comparable companies that are not directly related to the telephone operations of the company, and whether those non telephone operations may distort the comparability of those companies with XXXXX. However, the existence of the seven XXXXX which had recently come into existence prior to the lien date in this case, and the common fact that the overwhelming preponderance of the activities of each of the companies was associated with telephone company operations, is sufficient to validate the use of the XXXXX as comparables to XXXXX in this case.
83. The Commission, consistent with general appraisal theory, has taken the position that if values are made using both the direct capitalization method and the yield capitalization method, and if the market information for comparable companies is properly selected, adjusted and interpreted, then the values calculated under each method should be close in terms of total value. The Commission continues to maintain that position. However, in this case, the Commission does not have complete confidence that the selected market information is for sufficiently comparable companies, or that it has been property adjusted or interpreted. The Commission is fully aware that it may not be possible to properly adjust and interpret the market information for the selected companies.
84. The Direct Capitalization method has some limitations, primarily related to the difficulty in making the needed adjustments from the comparable companies to the company being valued. The adjustments to be made to the comparables are to a high degree subjective adjustments which rely upon the judgment of the appraiser. Therefore, as the number of required adjustments increases, the Commission’s confidence in the reliability of the determined values decreases.
85. The direct capitalization income approach has been relied upon by the Commission and has been given moderate weight in its final reconciliation of values. However, because of the concern of the Commission regarding the complete comparability of the XXXXX, and because the Commission has greater confidence in the values determined by the yield capitalization income approach, greater weight will be given to the yield capitalization values.
CONSTRUCTION WORK IN PROGRESS (CWIP)
86. The parties have raised as an issue the proper treatment of Construction Work in Progress (CWIP) in the determination of the value of Petitioner’s property. The primary issue is whether all CWIP should be added to the value otherwise determined, or only the “growth” portion of the CWIP, thereby eliminating the “replacement” portion of the CWIP. Utah Administrative RuleR884-24P-20.E, requires CWIP to be added to HCLD in the cost and income approaches, but does not mention a delineation between “growth” and “replacement.” Prior orders of the Commission, in A T & T, et al. V. Property Tax Division of the Utah State Tax Commission, Appeal No. 90-1322, and Union Pacific Railroad vs. The Property Tax Division of the Utah State Tax Commission, Appeal No. 89-0967, have defined the delineation of “growth” and “replacement.” However, the composition of the Commission has changed since the issuance of those decisions.
87. Consistent with their prior positions, Commissioners Tew and Pacheco are of the opinion that only the “growth” portion of CWIP should be added to the income and HCLD cost indicators of value. In their opinion, the CWIP that will replace existing plant and equipment should not be added to the value because part of the existing plant in service or equipment will be removed or written off at the time the CWIP is completed and placed into service.
88. Commissioners Oveson and Shearer are of the opinion that all CWIP should be added to the income and HCLD cost indicators of value because it is part of the total investment in property made by Petitioner.
89. Because of the lack of a majority position on this issue, the position of the Commission in its prior decisions, that only “growth” CWIP will be added to the value, will remain the governing principle for CWIP.
90. The amount of replacement CWIP must therefore be removed from the income and HCLD cost indicators of value as utilized hereafter. The amount of that deduction will be calculated substantially from Exhibit 68 presented by XXXXX. Pursuant to that Exhibit, the amount of all CWIP is $$$$$, and the growth CWIP is $$$$$, leaving a difference for replacement CWIP of $$$$$. XXXXX would then have reduced that amount by a market to book ratio of XXXXX to arrive at a replacement CWIP of $$$$$.
DEFERRED FEDERAL INCOME TAXES
91. Deferred Federal Income Taxes (DFIT) are created by differences in the period a tax liability is recognized by the utility using the straight-line depreciation rates allowed for rate making purposes by the Regulatory Commissions and the period when the tax liability is recognized by the utility using accelerated depreciation rates allowed for income tax purposes by the Internal Revenue Service (the “IRS”). These book/tax timing differences produce the deferred income tax liabilities that are recorded and tracked in the DFIT account.
92. During the initial years of an asset’s useful life, use of the accelerated IRS depreciation rates results in less income tax being due than would be payable if the straight-line, regulatory depreciation rates were used. During the later years of the asset’s life after all accelerated depreciation has been taken, this process reverses with more income tax becoming due than would have been payable under the regulatory, straight-line depreciation rates. This DFIT account appears on the same (right hand) side of XXXXX balance sheet as XXXXX liabilities. It is similar to an accrued liability that may be canceled because the tax benefit will reverse after a few years.
93. Regulatory agencies do not allow XXXXX to include DFIT in its rate base and DFIT must be deducted from its assets. Therefore XXXXX is not allowed to earn a rate of return on funds represented by DFIT.
94. Because the ratepayers who would receive the benefit of the reduced taxes in the early years of the asset’s life in the form of lower rates may not be the same ratepayers who will be required to pay the increased taxes in the later years of the asset’s life in the form of higher rates, each of the Regulatory Commissions requires XXXXX to “normalize” the amount of income taxes paid by the ratepayers of XXXXX. Normalization means that during the early part of an asset’s life when accelerated depreciation is available, the ratepayers pay the utility company rates that include taxes that will not be due until some future period. When the process reverses in the later years, ratepayers are not then required to pay rates which include the increased amount of taxes actually paid by the utility. The deferred taxes paid by the ratepayers to the utility because of these timing differences creates the source of funds known as DFIT. Because XXXXX is constantly replacing its operating property, DFIT always exists.
95. Similarly, under the applicable regulations of the Internal Revenue Service, XXXXX is not allowed to claim accelerated depreciation for federal income tax purposes unless the Regulatory Commissions either deduct the full amount of this DFIT from rate base of XXXXX or treat it as interest-free or “zero cost,” capital in arriving at the total cost of capital used to determine XXXXX authorized rate of return on rate base.
96. As of XXXXX, the Utah Public Service Commission assigned a zero cost of capital to DFIT reserves. This treatment had essentially the same financial impact on XXXXX as the alternative then being followed by each of the other Regulatory Commissions of deducting the full amount of DFIT from the authorized rate base of XXXXX.
97. For purposes of simplifying their presentations, all of the witnesses at the hearing presented their calculations of the authorized rate base/rate of return for XXXXX as if the Utah Public Service Commission deducted DFIT from rate base in the same manner as the other Regulatory Commissions. The calculations presented in these Findings follow this same convention. We note that the Utah Public Service Commission has now changed its practices to conform with those of the other Regulatory Commissions and currently requires the deduction of DFIT from rate base for all regulated utilities.
98. The treatment of DFIT required by the Regulatory Commissions is designed to ensure that all cash flow benefits attributable to DFIT timing differences benefit the ratepayers in the form of lower rates and that there is no net cash flow benefit to the investors of XXXXX.
99. In the Original Assessment for XXXXX, the Division deducted the full amount of DFIT from the net book value of XXXXX in its HCLD cost approach.
100. For tax year XXXXX, it was represented by Petitioner, and uncontroverted by Respondent, that the Division allowed similar deductions for the full amount of DFIT in its HCLD cost approach for every other rate base/rate of return regulated utility operating in the state of Utah. However, in this case, the Division gave zero to little weight to the HCLD cost approach in making its reconciliation of the three approaches to value to arrive at a final opinion of value. Therefore, even though for XXXXX the full amount of DFIT was deducted from the net book value to determine the HCLD cost approach value for the other rate base/rate of return regulated utilities, the impact on the final value of all other rate base/rate of return regulated utilities would not have been substantial, and was likely only of minimal impact in arriving at the final values for those companies for that year. Nevertheless, the Commission finds that such a deduction should be allowed to XXXXX for XXXXX to equalize XXXXX and place them in a uniform position with other similar companies for that year. Further, if the Commission were to accept the position of XXXXX that the cost indicator of value is to be given substantial weight, then the deduction of DFIT for that year would become much more important.
101. If XXXXX is not allowed a deduction under the HCLD cost approach for the full amount of its DFIT, it will be the only rate base/rate of return regulated utility in the state of Utah assessed by the Division not allowed this deduction for the XXXXX tax year.
102. The additional revenues for taxes paid to the utility by the ratepayers in the early years through “normalized” tax rates provide a source of additional capital for the utility. These funds become part of the common “pool of funds” available to the utility for its general purposes.
103. Because the utility’s investors did not provide the additional source of capital represented by the DFIT reserves created through normalized rates for the utility’s future tax liability, the Regulatory Commissions do not allow the utility to earn a return on these amounts for its investors. Instead, any value associated with the temporary use of this additional source of capital is required to be passed back to the utility’s customers in the form of lower rates. Even though this treatment is designed to ensure that there is no net cash flow benefit to the utility’s investors from DFIT, the Regulatory Commissions would find it imprudent for the utility not to take advantage of accelerated depreciation to lower the rates charged to its ratepayers.
104. In the case of Northwest Pipeline Corp. V. Property Tax Division of the Utah State Tax Commission, Appeal Nos. 85-0074 and 86-0255, the Commission approved the position advocated by Petitioner in this proceeding, i.e., that DFIT should be deducted from the HCLD cost approach indicator of value. In that case, the Commission stated that, “an informed investor would not be willing to pay full cost as measured by net book for Petitioner’s operating system because that amount exceeds the value of the rate base upon which the investor would be allowed to earn.” The Commission therefore ruled that, “the net book value should be reduced by the amount of DFIT.” That decision has also likely been implemented in other decisions of the Commission.
105. Since the time of the Northwest Pipeline decision, two of the Commissioners who signed that decision are no longer members of the Commission, and the Commission is now equally divided as to whether DFIT should be deducted from the HCLD cost indicator of value.
106. The position of Commissioners Tew and Pacheco is that the reduction in utility rates which results when regulatory agencies require the deduction of DFIT from rate base has effectively dedicated the DFIT portion of the property of XXXXX to the public sector. Therefore, in the opinion of Commissioners Tew and Pacheco, if XXXXX cannot earn a return on that (DFIT) portion of its property, then XXXXX should not be required to pay taxes on that (DFIT) portion of its property.
107. Because of the regulatory restrictions on earnings associated with DFIT, Commissioners Tew and Pacheco would require a deduction for DFIT to the extent that it reflects impaired earnings associated with regulation beyond its value as zero-cost capital, although they acknowledge that the exact amount of DFIT attributable to impaired earnings is not ascertainable from the information presented in this case.
108. Commissioners Tew and Pacheco believe that DFIT is similar to government imposed rent controls where a governmental agency has limited the earning potential of a property. These limited earnings by way of governmental mandate have effectively taken a portion of the bundle of rights of the property and assigned that portion of the rights to the public. Therefore, Commissioners Tew and Pacheco believe that Petitioner should not be required to pay taxes on property that is owned by the Public and is not owned by the company.
109. Commissioners Tew and Pacheco are further of the opinion that the regulatory earnings limitations imposed by regulatory agencies because of DFIT are a legitimate form of economic obsolescence, they therefore believe that it may be preferable for the impact of DFIT and other regulatory limitations to be reflected in an economic obsolescence adjustment to the HCLD cost approach indicator of value.
110. Commissioners Tew and Pacheco base their opinion on the fact that virtually all appraisal texts and theory recognize the concept of adjusting for economic obsolescence, and they therefore believe that such an economic obsolescence adjustment is required. This view is applicable to this area of DFIT as well as later discussion relating to the economic obsolescence views of Commissioners Tew and Pacheco.
111. Because of the absence of any studies by the Property Tax Division to account for any economic obsolescence, including regulatory impacts, Commissioners Tew and Pacheco feel that they are left with the only position available to them to account for the economic obsolescence caused by DFIT being to support the deduction for DFIT in the HCLD cost approach indicator of value.
112. The position of Commissioners Oveson and Shearer is that the “value” which is associated with the funds which are booked by the utility as DFIT have been effectively transferred to the utility’s ratepayers in the form of lower utility rates. If the value of income producing property is determined by the future income to be produced by the property, then a portion of the value of the property of XXXXX resides with the utility and will be returned to the utility in the form of future income, but another portion of the value of the property resides with the ratepayers and will be returned to the ratepayers in the form of lower utility rates to those ratepayers. Commissioners Oveson and Shearer further believe that to determine the total value of the fee simple interest of the property, the portion of the total value belonging to XXXXX must be added to the portion of the total value belonging to the ratepayers. The Utah Constitution and the statutes of the state require that “All tangible taxable property shall be assessed and taxed at a uniform and equal rate on the basis of its fair market value....” (Utah Code Ann. §59-2-103(1).) If DFIT is deducted from the HCLD cost approach value, then in the opinion of Commissioners Oveson and Shearer, the property is being taxed at less than its fair market value. Commissioners Oveson and Shearer would determine that DFIT should not be deducted from the HCLD cost approach indicator of value.
113. XXXXX cost approach adjusted net book (HCLD) value by subtracting the full amount of DFIT in the same manner ordered by the Commission in Northwest Pipeline and followed by the Division in its original assessments of XXXXX and all other rate base regulated utility companies in Utah for tax year XXXXX. If the Commission did not allow the deduction of DFIT to XXXXX for XXXXX, it would be faced with an equalization issue. Since all other rate base/rate of return regulated utilities had their HCLD cost approach values determined by deduction of DFIT from the net book value for the taxable year XXXXX, then XXXXX would be treated discriminatorily if it were not allowed the same deduction for DFIT. Utah Code Ann. §59-2-103(1), supra, which requires that property be assessed at its fair market value, also requires that property must be assessed “at a uniform and equal rate.” Therefore, the Commission determines that for XXXXX, and any other years for which DFIT, was deducted in determining the HCLD cost approach value for other rate base/rate of return regulated utilities, the uniform and equal provision must supersede the requirement to value the property at its fair market value. Accordingly, for any such years, DFIT should continue to be deducted from the HCLD cost approach value of the property of XXXXX.
114. In view of the equal division of the Commission on the issue of the deductibility of DFIT, however, the equalization issue for this case becomes moot. The lack of a majority position on the deductibility of DFIT will leave intact the prior decision of the Commission as set forth in Northwest Pipeline Corp. V. Property Tax Division that DFIT should be deducted from the HCLD cost approach indicator of value.
115. XXXXX and XXXXX maintain that the HCLD cost approach value of the property of XXXXX should be reduced for items of economic obsolescence which they maintain have occurred. They maintain that economic obsolescence has occurred anytime the utility is precluded from earning a market rate of return, and they have identified several factors which they maintain reduce the income stream to investors, and thereby result in economic obsolescence. Although the Commission does not necessarily agree that all of these factors are appropriately denominated as economic obsolescence issues, they will be dealt with herein only because that is the way these issues were framed by Petitioner. The factors which were identified by Petitioner as economic obsolescence issues are:
A. Telephone Directory revenues derived from non- operating or intangible property.
B. Charitable and Community contribution.
C. The limitation to the earnings of XXXXX to the level required to pay the embedded interest costs or its debt rather than the higher current market costs.
D. Construction and land deposits for future construction.
E. Amortization of abandoned construction projects not allowed in rate base and required to be borne by investors.
These factors are each discussed and explained in more detail below.
Telephone Directory Revenues Derived from Non- Operating or Intangible
116. XXXXX entered into an agreement with XXXXX whereby XXXXX agreed to publish telephone directories for XXXXX. XXXXX also agreed to pay XXXXX a subsidy. XXXXX contends that these net revenues should be excluded for one of two reasons. First, he argues that it is not the function of the telephone operating system to produce this income because there is no physical relationship between this income and the property and equipment of the utility. XXXXX cites a XXXXX Court decision, Matter of Mountain States Tel. and Tel., 745 P.2d 563 (Wyo. 1987) to support this argument. Secondly, XXXXX claims that income from directory revenues is derived from an intangible of the company and is thus exempt.
117. The Division and Counties contend that income from directory revenues is directly attributable to the local network of XXXXX and is part of the economic benefits associated with that network. It is so closely associated with the company through name recognition, publishing of the white pages, common billings, related network management functions (i.e., the timing of changes in subscriber numbers affecting value and usefulness of both white and yellow pages), and historical association as to be considered “de facto” part of the operating network. (XXXXX Report, Exhibit 513.) The position of the Division and Counties is that regulators classify directory advertising and sales revenues as “operating revenues”. (Exhibit 80.)
118. The Division and Counties further contend that as a subsidy to XXXXX, directory revenues keep telephone rates down. Without this subsidy (for example if the assets of XXXXX were sold separate from this subsidy), XXXXX would still be allowed a fair return, meaning telephone rates would have to go up to compensate for this lost subsidy. Hence, with or without these revenues the company will maintain its revenue requirements.
119. Regarding the alternative claim by XXXXX that the income from directory revenues is derived from intangibles, the position of the Division and Counties is that XXXXX has not met its burden of proof. The Division and Counties claim that XXXXX has not shown that the assets relating to these directory revenues can be sold or marketed separate and apart from the remaining property of XXXXX. Petitioner did not meet its burden of proof on this issue and did not persuade the Commission that these revenues are from intangibles or that the value represented by such revenues should be exempt from ad valorem taxes.
120. It is clear from the publishing agreement that one of the service functions of XXXXX is to make available to its telephone subscribers an alphabetical listing of names, addresses and telephone numbers of telephone company subscribers. Indeed, providing a listing of telephone numbers is “part and parcel of the ‘service to or for the public’”. Matter of Mountain States Tel. And Tel., 745 P.2d at 570. However, unlike the Wyoming court in Matter of Mountain States Tel. and Tel., which dealt with regulation of these revenues, this Commission is not concerned with whether the yellow pages portion of a telephone directory constitutes a monopoly requiring regulatory oversight. Instead, it is concerned with determining the fair market value of taxable assets.
121. We find that directory revenues are closely associated with XXXXX network and should be considered part of the operating network. We are further persuaded by the subsidy argument stated above, i.e., that with or without directory revenues, the cash flows of the company will remain unchanged. Thus, even if directory revenues they were not deemed to be part of the operating network and removed in a subsequent fair market sale, the revenue requirements (and thus cash flows) of the company would remain unchanged. The Commission determines that an adjustment for directory advertising revenues is not appropriate.
B. Charitable and Community Contributions.
122. XXXXX made an additional adjustment to his adjusted rate base in the form of operating expenses which he maintains are made by prudent management but are not allowed by regulators for purposes of calculating revenue requirements to determine utility rates. These operating expenses included such items as charitable and community contributions.
123. The Division and Counties argue that the deduction of such contributions and expenses from value is inappropriate for purposes of determining the value of the property. Such expenditures are discretionary or “below the line” expenses, which are paid from the net operating income (NOI) of the company. Those items are not deducted to determine or arrive at the NOI of the company. They are not allowed as operating expenses for rate making purposes because the regulatory agencies have determined that ratepayers should not be required to bear such costs. The Division and Counties argue that in negotiating the price of a sale, a prudent seller would not permit a discretionary expense to reduce the value of his or her property by the reduction in cash flow.
124. The Commission determines that this deduction is not appropriate in determining value and finds that although such expenses and contributions may be common, they are discretionary, and should not have the effect of reducing the value of property for ad valorem tax purposes. These items do not constitute economic obsolescence to be deducted from the HCLD cost indicator of value.
C. The Limitation To The Earnings of XXXXX To The Level Required to Pay the Embedded Interest Costs on Its Debt Rather Than The Higher Current Market Costs.
125. XXXXX also suggested an adjustment to his adjusted rate base indicator (HCLD cost approach) for what he describes as the inadequate allowed rate of return on fixed income securities. XXXXX claims that because the coupon rates of XXXXX bonds (embedded debt) were less than current market rates, an adjustment for this inadequate return must be made to the HCLD cost indicator.
126. The Division and Counties assert that this adjustment is nothing more than an income shortfall adjustment or obsolescence adjustment which makes the cost indicator circular with the income indicator and which has been rejected by the courts. Pacific Power & Light v. Dept. Of Revenue, (Oregon Court); Northwest Pipeline Company, (1987 Commission Decision); Investigative Report in the Matter of the Review of the Property of Wyoming Rural Electric Cooperative Utilities. Exhibit 513, p.21. The Division and Counties assert that the value of a company’s assets is neither reduced (obsolescence) or enhanced (appreciation) when the embedded debt rate differs from the market debt rate because debt rates are simply passed on to the ratepayers by the regulators.
127. The Commission is unpersuaded that such an adjustment is necessary or appropriate, and therefore, finds that the adjustment for economic obsolescence for the limitation to the earnings of XXXXX to the level required to pay the embedded interest costs on its debt rather than to allow the higher current market costs is not an appropriate adjustment.
128. We also find that such an adjustment is improper because debt rates are simply passed on to the ratepayers of a utility. The change in debt rates does not affect the value of the property of XXXXX.
D. Construction And Land Development Deposits for Future Construction.
129. XXXXX deducted land development and construction deposits from the HCLD cost approach value. His reason for this deduction was because regulatory agencies will not allow the utility to earn a return on these deposits because it constitutes deposits, or free capital, which has already been provided by the utility ratepayers. The reasoning of regulatory agencies is that the ratepayers should not be required to pay a return on funds which they have provided.
130. In the opinion of Commissioners Tew and Pacheco, if a rate base regulated utility is not allowed to earn a return on a portion of its investment, then there has certainly been some economic obsolescence. The very meaning of economic obsolescence is that the property is not able to earn a reasonable rate of return. Since the construction deposits are prohibited by regulatory agencies from earning any return, then in the opinion of Commissioners Tew and Pacheco, there is economic obsolescence. Although there are reservations about the method of calculating the correct amount of economic obsolescence, the only testimony from which the Commission can calculate a deductible amount is the testimony of XXXXX. He testified that the amount of such obsolescence is $$$$$. (Appendix A, Table 3, Exhibit 30).
131. Commissioners Oveson and Shearer believe that even though the utility is not allowed to earn a return on those construction deposits, the property purchased with those deposits, still constitutes property on which ad valorem taxes should be paid. In their view, to allow a deduction for economic obsolescence is to tax only a portion of the bundle of rights and to violate the Constitutional and statutory mandate to tax the full fair market value of the property.
132. Rule R861-1A-5.E, Utah Administrative Code will prevail. That rule provides in part:
If the Commission vote
results in a tie vote on any matter, the position of the petitioning taxpayer,
will be deemed to have prevailed, and the Commission will publish the
133. Again, because of the lack of a majority position on this issue, the position of the taxpayer will prevail and an amount of $$$$$ will be deducted from the HCLD cost approach indicator of value.
D. Amortization of Abandoned Construction Projects Not Allowed in Rate Base and Required to be Borne By Investors.
134. Regulatory Commission policies have not allowed XXXXX to include in the costs of service, which are passed through to its ratepayers, the unamortized acquisition costs of certain properties or construction projects acquired for future expansion, but ultimately not used because of changes in the demographics of its customer base or technological advances. Therefore, even though Petitioner still owns these properties, they are not allowed by the regulatory agencies to include those properties in the rate base, and they cannot earn a return on those investments.
135. The position of Commissioners Tew and Pacheco with respect to these items is identical to their position on construction deposits; i.e., that there is economic obsolescence if a return cannot be earned on that investment, and it should therefore, be deducted from the HCLD cost indicator of value.
136. The position of Commissioners Oveson and Shearer is that if and when the property is disposed of by XXXXX, then it would be removed from the value of XXXXX property for ad valorem tax purposes. Until that time, the value should be included for ad valorem tax purposes.
137. It is also the position of Commissioners Oveson and Shearer that there was no evidence presented as to whether the property alleged to have been abandoned was ever taken out of service and locally assessed. It is their position that if the property has not been taken out of service and become locally assessed property, then it should continue to be included as property of the utility and its value should not be deducted from the values otherwise determined.
138. Again, because of the absence of a majority position on this issue, the position of the taxpayer will prevail and an amount of $$$$$ (Tr. 548) will be deducted from the HCLD cost indicator of value.
CONCLUSIONS OF LAW
1. “All tangible property in the state, not exempt under the laws of the United States, or under this Constitution, shall be taxed at a uniform and equal rate in proportion to its value, to be ascertained as provided by law.” Utah Const. Art. XIII, §2(1).
2. “[E]very person and corporation shall pay a tax in proportion to the value of his, her or its tangible personal property.” Utah Const. Art. XIII, §3(1).
3. “All tangible taxable property shall be assessed and taxed at a uniform and equal rate on the basis of its fair market value, as valued on XXXXX, unless otherwise provided by law.” Utah Code Ann. §59-2-103(1).
4. “By May 1 of each year,” all taxable property of public utilities “shall be assessed by the commission at 100% of fair market value, as valued on XXXXX,” Utah Code Ann. §59-2-201(1).
5. “Fair market value” “means the amount at which [the] property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the facts.” Utah Code Ann. §59-2-102(7).
6. Because the Division elected not to present or defend its Original Appraisal, and based upon the pre-hearing stipulation of the Parties and the order of this Commission, XXXXX, has the burden of providing “a sound evidentiary basis for reducing the original valuation”. Utah Power & Light Co. v. Utah State Tax Comm’n, 590 P.2d 332,335 (Utah 1979) and Hercules Inc. v. Utah Tax Comm’n, 877 P.2d 169,172 (Utah Ct. App. 1994).
7. None of the appraisals presented by either the Division or by the Petitioner is entitled to any “presumption of correctness.” The Commission will review all evidence presented under a simple “preponderance of evidence” standard. Hercules, 877 P.2d at 172.
DISCUSSIONS AND ANALYSIS
The Commission has carefully reviewed each of the appraisals together with many additional documents which were submitted by the parties. In performing that review, it is very evident that XXXXX, XXXXX, and XXXXX each approached their appraisal from a very different perspective and point of view. The Commission has attempted to take each of the different approaches to value used by each of the appraisers, and make a reconciliation of those appraisals by adding or subtracting amounts where the Commission has determined that adjustments or factors considered by particular appraisers were not, in the opinion of the Commission, appropriate. However, because the basic approach for each of the appraisers was so significantly different, such a reconciliation was not possible. Therefore, the Commission must try to determine which portions of the three appraisals are most acceptable to the Commission, and which appraisal, in the opinion of the Commission, is the most reliable indicator of the fair market value of the property of XXXXX.
The appraisal of XXXXX was to a very substantial degree based upon the assumption that the fair market value of the property of XXXXX is tied directly to the rate base and rate of return determined for XXXXX by the regulatory agencies. As has been stated above, this Commission does not accept the premise that rate base is equal to the value of the property. Further, the Commission does not feel that because a regulated utility is being valued requires a “regulation based” valuation methodology.
Notwithstanding this view, the Commission lacks a majority position on the issue of the deductibility of DFIT from the HCLD cost approach indicator of value. This leaves intact the prior position of the Commission that DFIT should be so deducted. Also, the Commission has determined that for the year in question Deferred Federal Income Taxes (DFIT) should be allowed to this taxpayer because it was allowed for all other similarly situated taxpayers, so DFIT will be deducted from the HCLD cost approach indicator of value.
The assumptions of XXXXX relating to rate base also forms a substantial basis for at least one of his income approaches to value, by including in income only that income which would generally be allowed on the rate base by the regulatory agencies. Further, in XXXXX stock and debt approach, by including only the value of the common stock of XXXXX, after deducting from the total value of common stock all of the other subsidiaries of XXXXX, it leaves any errors in the valuations of any of those companies in the value of the company being valued herein. Therefore, the Commission does not have substantial confidence in the stock and debt approach utilized by XXXXX. Accordingly, the Commission has determined that in its opinion, in this case, the appraisal of XXXXX does not accurately determine the fair market value of the property of XXXXX, and the Commission finds that it is not a reliable indicator of value for this case.
The appraisal of XXXXX was made by placing heavy reliance upon stock market information. In the cost approach, the division of the assets between the various companies and subsidiaries of XXXXX was made by XXXXX utilizing stock market information, and in the income approach the capitalization rate was calculated strictly from companies which XXXXX felt were comparable. Further, in the stock and debt indicator of value utilized by XXXXX, most of the divisions of the liabilities and the securities between the various companies and subsidiaries of XXXXX were made based upon stock market information. XXXXX mergers and acquisition approach is more aggressive than the Commission is willing to accept as a reliable indicator of the fair market value of the property.
While there is no question that the stock market information utilized by XXXXX is very important and is frequently a reliable indicator of value, it is not always the complete or best determinant of value, and in some cases it may not be the most reliable indicator of value. The primary issue is one of comparability of the companies used as comparables. In this case, XXXXX utilized primarily the RBOC’s as the comparables. Even though it is likely that those companies are the most comparable companies which are available to be utilized for XXXXX, it is a fact that each of the XXXXX has a different mix of subsidiaries and business operations, including real estate companies, directory advertising, cellular companies, telephone manufacturing companies, and numerous other diverse holdings and operations. Therefore, it is extremely difficult to determine whether the factors which are gleaned from a comparison of those companies is or is not applicable to the operations of XXXXX. Accordingly, the appraisal of XXXXX, made by XXXXX, appears to be a reasonable appraisal, but the Commission does have some reservations about the reliability and the comparability of the data utilized in that appraisal in comparison to XXXXX.
In the opinion of the Commission, the most reliable appraisal received in this proceeding was that which was prepared by XXXXX. Although XXXXX appraisal also places substantial reliance upon stock market information, the overall appraisal and the rationale of XXXXX provides better support for the conclusions. The data used by XXXXX tends to be conservative but very reasonable.
The cost approach estimate of value made by XXXXX was $$$$$. However, as has been indicated earlier in this decision, the Commission determined that it must deduct the Deferred Federal Income Taxes, replacement CWIP, Land Development and Construction Deposits, and Abandoned Construction Projects from the cost approach to arrive at the net cost approach to be used in this decision. The DFIT adjustment testified to by XXXXX for the XXXXX appraisal, on Exhibit 69, was $$$$$. That adjustment leaves an estimated value based upon the cost approach of $$$$$. The replacement CWIP adjustment is $$$$$. The Land Development and Construction Deposits adjustment is $$$$$, and the Abandoned Construction Projects adjustment is $$$$$.
XXXXX utilized three different income approaches to value. The first income approach was his direct capitalization approach. In that method, he arrived at four different values depending upon the expected growth from XXXXX to XXXXX. In the opinion of the Commission, a 2% growth rate is reasonable, but still very conservative. Based upon that growth rate, the value determined by XXXXX under that approach was $$$$$.
XXXXX calculated two separate yield capitalization estimates of value, and under each method, he included numerous alternatives depending upon the terminal growth rate which was assumed and the discount rate which was assumed. The first discounted cash flow utilized by XXXXX was based upon XXXXX forecast of future income. However, XXXXX testified that the forecast of XXXXX was very aggressive, and he believed that a more realistic estimate of growth was XXXXX which he utilized in Table 8 of his appraisal. XXXXX testified that the actual discount rate for the company which he calculated was XXXXX%, and based upon that assumption with a terminal growth rate of XXXXX%, the value of the company based upon a discounted cash flow would be $$$$$. Replacement CWIP in an amount of $$$$$ must also be deducted from the income approach values.
For the market approach, or stock and debt approach, XXXXX prepared an estimate of value and determined that the stock and debt indicator of value would be $$$$$. The Commission has determined that each of those values is a reasonable estimate of value, and that they should all be utilized in arriving at the fair market value for the property of XXXXX for the year XXXXX.
The Commission has further determined to correlate the different values by assigning very little weight to the cost approach, ( XXXXX in his appraisal did not give any weight to the cost approach), so the Commission believes that 10% weight is adequate for the cost approach. The Commission has further determined to assign 25% of the weight to the value determined by XXXXX under the direct capitalization approach, 40% to the value determined under the yield capitalization approach, and 25% of the value is to be based upon the market or stock and debt approach. Based upon the assignment of those weights, and the calculation of the respective value determined thereby, the Commission has determined that the fair market value of the property of XXXXX for XXXXX is $$$$$. Based upon an allocation of that value to the State of Utah, the value of XXXXX for XXXXX allocated to the State of Utah is $$$$$.
It is so ORDERED.
DATED this 22nd day of November, 1995.
BY ORDER OF THE UTAH STATE TAX COMMISSION.
W. Val Oveson Roger O. Tew
Joe B. Pacheco Alice Shearer