Document Number
04-16
Tax Type
Local Taxes
Description
Machinery and Tools Tax
Topic
Accounting Periods and Methods
Appropriateness of Audit Methodology
Date Issued
05-14-2004

May 14, 2004


Re: Appeal of Assessment: Final Local Determination
Taxpayer: *****
Locality Assessing Tax: *****
Machinery and Tools (M&T) Tax

Dear ****************:

This final state determination is issued upon the application for correction filed by you on behalf of ************** (the "Taxpayer") with the Department of Taxation. You appeal the ********* (the "City") valuation of certain machinery and tools for purposes of the M&T tax in tax year 2003.

The M&T tax is imposed and administered by local officials. Virginia Code § 58.1-3983.1 (D) authorizes the Department to issue determinations on taxpayer appeals of M&T tax assessments. On appeal, a M&T tax assessment is deemed prima facie correct. In other words, the local assessment will stand unless the taxpayer proves that it is incorrect.

The following determination is based on the facts presented to the Department as summarized below. This determination addresses the question of whether the cost basis utilized by the City for the valuation of the property in question for tax year 2003 is appropriate.

The Code of Virginia sections and public documents cited are available on-line in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.state.va.us.
FACTS

The Taxpayer is a manufacturing business. For purposes of the M&T tax, the City computed the assessed value of the Taxpayer's machinery and tools using a valuation method of 25 percent of original cost. The City applied a rate of ***** per $100 to the assessed value in determining the M&T tax due. The City utilizes this methodology for all M&T tax assessments.

The Taxpayer appeals the assessment, asserting that the City's method of valuation ignores the constitutional principle of fair market value. In an amended return filed with the City, the Taxpayer utilized the "fair value" it reported in accordance with the Statement of Financial Accounting Standard (SFAS), as required by the New York Stock Exchange (NYSE) for purposes of annual reports and filings of 10K forms with the Securities and Exchange Commission (SEC). Using this method, the Taxpayer concluded that the "fair value" of its machinery and tools in 2003 was *****. The City valued the property in question at *****, using its valuation method of taking 25 percent of original cost as the basis for M&T taxation. The Taxpayer asks that the commissioner of the revenue be required to assess its machinery and tools at 25 percent of their fair market value, rather than at 25 percent of original cost.
ANALYSIS

Taxation of Property

All tangible personal property, unless declared intangible under the provisions of Va. Code § 58.1-1100 et seq., is reserved for local taxation by Article X, § 4 of the Constitution of Virginia. Article X, §§ 1 and 2 of the Constitution of Virginia provide that all property, unless specifically exempted within the provisions of the Constitution of Virginia, shall be taxed at a uniform rate among classes, and that taxes and "all assessments of real estate and tangible personal property shall be at their fair market value to be ascertained as prescribed by general law." [Emphasis added.] Fair market value is defined as the price a property will bring when offered by one who desires, but is under no obligation, to sell it, and the buyer has no immediate necessity to purchase it. See Tuckahoe Women's Club v. City of Richmond 119 Va. 734 (1958).

Valuation for Purposes of Property Taxation

The local taxation of machinery and tools of manufacturers is separate from the general classification of tangible personal property. The method of valuation used to ascertain the fair market value of machinery and tools is set forth by general law in Va. Code § 58.1-3507(B).
    • Machinery and tools segregated for local taxation . . . other than energy conservation equipment of manufacturers, shall be valued by means of depreciated cost or a percentage or percentages of original total capitalized cost excluding capitalized interest. [Emphasis added.]

In the present case, the City uses an assessment ratio of a straight 25 percent of original cost to determine the value of property for purposes of the M&T tax. In other words, machinery purchased in 1980 is assessed at 25 percent of its original cost in 1980 and in subsequent years.

At issue in the present case is the method of valuation used by the City in calculating the M&T tax due. In Southern Railway v. Commonwealth, 211 Va. 210 (1970), the Virginia Supreme Court addressed the question of the powers of the state to classify property, establish rates, methods of assessment, valuation and collection of taxes:
    • The power of a state to make reasonable and natural classifications for purposes of taxation, it has been said, is clear and not questioned. Such classifications may be made with respect to the subjects of taxation generally, the kinds of property to be taxed, the rates to be levied or the amounts to be raised, or the methods of assessment, valuation, and collection. Granting the power of a state to make classifications in tax matters, it has been said, we must then grant the right to select the differences upon which the classification shall be based. (The general rule with respect to the classification of subjects of taxation from 51 Am. Jur., Taxation, Section 173, pp. 230-231, cited with approval in City of Richmond v. Commonwealth, 188 Va. 600. Italics were supplied by the Court.)

Virginia has elected to create a separate classification of tangible personal property for machinery and tools used in manufacturing. In so doing, it has also prescribed the valuation method localities may elect to use in assessing such property for taxation. Localities have much more latitude in electing the valuation methods they use in assessing the general classification of tangible personal property as defined in Va. Code § 58.13503(B). Under this section:
    • Methods of valuing property may differ among the separate categories, so long as each method used is uniform within each category, is consistent with requirements of this section and may reasonably be expected to determine actual fair market value as determined by the commissioner of revenue or other assessing official . . . A commissioner of revenue shall upon request take into account the condition of the property. The term "condition of the property" includes, but is not limited to, technological obsolescence of property where technological obsolescence is an appropriate factor for valuing such property.

The Taxpayer would have the principles of Va. Code § 58.1-3503(B) apply to machinery and tools used in manufacturing. Virginia Code § 58.1-3507 provides for a separate classification for machinery and tools used in manufacturing, however, and the methods of valuation for such property are strictly prescribed in that section.

Uniformity and Fair Market Value

Article X, § 1 of the Constitution of Virginia provides that "All taxes shall be levied and collected under general laws and shall be uniform upon the same class of subjects within the territorial limits of the authority levying the tax . . . ." The Virginia Supreme Court has consistently held that the constitutional requirements of uniformity and fair market value should be construed together, with the preference given to uniformity. See Skyline Swannanoa v. Nelson County 186 Va. 878 (1947), quoted with approval, R. Cross Inc. v. City of Newport News 217 Va. 202 (1976).

This does not diminish the importance of fair market value, however. In Tuckahoe Women's Club v. City of Richmond, the Virginia Supreme Court held that while the uniformity provision is preferred, when the uniformity and fair market value clauses are in conflict
    • that does not mean that property in any taxing jurisdiction may be assessed in excess of and without relation to its fair market value as required by the Constitution. It means only that a taxpayer whose property is assessed at its true market value has a right to have the assessment reduced to the percentage of that value at which others are taxed so as to meet the uniformity required by § 168 of the Virginia Constitution as well as by the Equal Protection Clause of the Fourteenth Amendment. Lehigh, etc., Co. v. Commonwealth, 146 Va. 146 (1926). [Emphasis added.]

In other words, if an assessment is based on a valuation that is significantly greater than fair market value, the method of valuation resulting in the significant deviation must be revised so as to more reasonably approximate fair market value. If, however, the assessment at fair market value results in a lack of uniformity of taxation among similar properties, the assessment must be reduced to the percentage of the value at which similar properties are taxed so as to meet the constitutional requirements of uniformity. In this case, the City has adopted a uniform method of assessing machinery and tools at a percentage of original cost.

Historically, the Court has recognized that property is often assessed at less than fair market value and has not objected to such assessments so long as they are applied uniformly. See Norfolk and Western Railway Company v. Commonwealth of Virginia, et al. 211 Va. 692 (1971).

The Taxpayer contends that the original cost of its machinery and tools far exceeds its present fair market value, and using it for purposes of valuation violates the constitutional mandate for the use of fair market value. The Taxpayer states that for purposes of the SFAS, its depreciated cost of its machinery and tools in 2003 was *****, or 37.5 percent of the original capitalized cost of *****. The Taxpayer contends that the depreciated cost, rather than original cost, should be the basis for computing the machinery and tools tax. Its proposed formula would be:

Depreciated cost x 0.25 (assessment ratio) x tax rate

The method the City uses is:

Original capitalized cost x 0.25 (assessment ratio) x tax rate

In accordance with the provisions of Article X, § 2 of the Constitution of Virginia, and Va. Code § 58.1-3507(B), for purposes of the M&T tax, the City has the option of using as its method of valuation: (1) depreciated cost, or (2) a percentage of original total capitalized cost excluding capitalized interest, or (3) percentages of original total capitalized cost excluding capitalized interest. The option proposed by the Taxpayer, that of using a percentage of depreciated cost (representing fair market value) in assessing machinery and tools used in manufacturing, is not lawfully permitted. In its annual study Tax Rates 2002, the Weldon Cooper Center for Public Service surveyed all 39 Virginia cities, 95 counties and 149 of Virginia's 189 incorporated towns to ascertain the methods of valuation employed by localities for purposes of local taxation. Thirty-seven cities and 84 counties reported using original cost multiplied by some assessment ratio as the basis for the machinery and tools tax. Those localities that used depreciated cost used a 100 percent assessment ratio. Many localities use a declining assessment ratio as a multiplier of original cost. If a locality elects to use a depreciated basis, the assessment ratio must be 100% to accurately approximate fair market value.


In this case, the City has adopted a percentage of original capitalized cost as its method of valuing machinery and tools used in manufacturing. This has resulted in a valuation of the Taxpayer's property of *****. If the City elected to use a depreciated cost basis for valuation, the Taxpayer would be assessed at 100 percent of its fair market value, or depreciated cost in tax year 2003. Under this method, the basis for the Taxpayer's M&T assessment would be ***** more than it is under the valuation methodology currently utilized by the City.

In its appeal, the Taxpayer cites Board of Supervisors of Fairfax County et al, v. Telecommunications Inc., 246 Va. 472 (1993), in which the Court reiterates that "the preference for uniformity must stop short of assessment at greater than fair market value." In fact, as has been demonstrated, the City's assessment was less than fair market value. The only valuation methodology available to the City would be depreciated cost. A percentage of depreciated cost or percentage of fair value is not contemplated in the statute for purposes of the M&T tax.

The Taxpayer also cites J.L. Fray v. County of Culpeper, 212 Va. 148 (1971) to support its position. I do not find this case to be persuasive. In J.L. Fray, the Court addressed the valuation of real property. As discussed previously, Va. Code § 58.13507(B) provides the valuation methods available for machinery and tools for M&T tax purposes. These methods were not an issue before the Court in J.L. Fray, and I do not agree that the decision by the Court extends to the valuation of machinery and tools, particularly when the General Assembly has specifically set forth the valuation methods to be used for local tax purposes.

Federal Regulations and the M&T tax

The Taxpayer suggests that the regulations promulgated by the SEC determine the methodology utilized by localities in determining valuation of machinery and tools of manufacturers in determining M&T tax assessments. I cannot agree. There is nothing in either the Constitution of Virginia or in the Code of Virginia that would link the SFAS requirements for SEC purposes to local tax treatment of machinery and tools.
DETERMINATION

The City's valuation methodology meets the uniformity requirements imposed by the Constitution of Virginia and does not violate its fair market value requirements. The formula for assessing machinery and tools used in manufacturing proposed by the Taxpayer is not provided for in either the Constitution or in the Code of Virginia. Finally, there is no direct relationship between the reporting requirement imposed by the SEC and the valuation methodology required by both the Constitution and Va. Code 3507(B) for purposes of the M&T tax. I find, therefore, that the valuation method used by the City is proper, and the M&T tax assessment for tax year 2003 is correct.

If you have any questions about this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.

                • Sincerely,


                • Kenneth W. Thorson
                  Tax Commissioner



AR/49738H




Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46