October 23, 2018
Re: Appeal of Final Local Determination
Taxpayer: *****
Locality Assessing Tax: *****
Business Tangible Personal Property 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 an assessment of business tangible personal property (BTPP) tax issued to the Taxpayer by the ***** (the “County”) for the 2016 tax year.
The BTPP 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 BTPP tax assessments. On appeal, a BTPP tax assessment is deemed prima facie correct, i.e., 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 summarized below. The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site.
FACTS
The Taxpayer operated a food products distribution facility in the County. The Taxpayer installed an automated racking system, but the system was not fully operational because of performance issues. As a result, the facility did not operate at full capacity.
The County issued an assessment of BTPP tax to the Taxpayer for the 2016 tax year. The Taxpayer appealed to the County, contending that the value of the system should be reduced because it was not fully utilized. The County denied the Taxpayer’s appeal, concluding that the Code of Virginia did not provide for the requested reduction to the system’s valuation. The Taxpayer appealed to the Department, contending that the fair market value of the system must be reduced by such “economic obsolescence.”
In Public Document (P.D.) 17-177 (9/25/2017), the Department determined that the Taxpayer had not provided sufficient evidence to demonstrate that the County’s valuation method was invalid. The Department, however, remanded the case to the County to consider any bona fide independent appraisal the Taxpayer might obtain.
The Taxpayer obtained an appraisal, but the County issued another determination upholding the assessment. The Taxpayer appealed to the Department again, contending that the appraisal established the fair market value of the system.
ANALYSIS
All tangible personal property, unless declared intangible under the provisions of Virginia 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, shall be taxed at a uniform rate among classes, and that “all assessments of real estate and tangible personal property shall be at their fair market value to be ascertained as prescribed by general law.” This provision of the Constitution contains the presumption that the General Assembly’s prescribed valuation method will both standardize valuation practices across all the local governments in the Commonwealth and result in something approximating fair market value. Virginia Code § 58.1-3103 specifically charges local commissioners with the responsibility of assessing property at fair market value.
As part of his duties each commissioner of the revenue shall ascertain and assess, at fair market value, all subjects of taxation in his county or city on the first day of January in each year, except as otherwise provided by law. [Emphasis added.]
Fair market value is generally 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. County of Richmond, 119 Va. 734, 101 S.E.2d 571 (1958). If the valuation methodology employed by a locality results in an assessment well above fair market value, the locality may use another methodology prescribed in Virginia Code § 58.1-3507 B. See P.D. 05-129 (8/3/2005).
Virginia Code § 58.1-3503 A 17 specifies that for most items of tangible personal property, fair market value is to be ascertained either by a percentage or percentages of original cost, or in the case of trucks and cars and certain other vehicles, by means of recognized pricing guides. Further, this statute stipulates:
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 . . .
Whenever a locality is considering the valuation of property for purposes of either the machinery and tools (M&T) tax or the BTPP tax, the Department’s policy has been that the locality must consider a bona fide independent appraisal offered by the taxpayer. See P.D. 05-129 and P.D. 12-145 (8/30/2012). The Department has also upheld a locality’s assessment where it performed due diligence in hiring an outside appraiser to value the property in dispute. See P.D. 07-103 (7/27/2007).
The Taxpayer’s appraisal discounts the value of the system because of inutility from economic obsolescence. The Department cast doubt on the Taxpayer’s theory of economic obsolescence in P.D. 17-177, observing that problems with the system were still being addressed and that normally “obsolescence” implies a permanent impact to the property’s use. The appraisal defines “economic obsolescence” as:
A form of depreciation where the loss in value of a property is caused by factors external to the property. These may include such things as the economics of the industry; availability of financing; loss of material and/or labor sources; passage of new legislation; changes in ordinance; increased cost of raw materials, labor, or utilities (without an offsetting increase in product price); reduced demand for the product; increased competition; inflation or high interest rates; or similar factors.
The appraisal details inefficiencies specific to the system and how it was being used by the Taxpayer. Citing the system’s economic obsolescence, the appraisal applied an inutility formula that adjusted the system’s value based on how efficient it was operating compared to its maximum capacity. System-specific inefficiencies, however, were not factors external to the property. Therefore, as the Department first observed in P.D. 17-177, it appears that economic obsolescence was not a proper basis for depreciation.
In addition, as stated above, Virginia law defines fair market value 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. County of Richmond, 119 Va. 734, 101 S.E.2d 571 (1958). It appears in this case, however, that the appraisal depreciates the value of the system according to how useful it was to this particular taxpayer. The appraisal indicates, for example, that the system’s capacity was “not realistic” for the Taxpayer because the Taxpayer did not receive the perfect mix of product sizes to fit into the system’s different storage size containers. The appraisal describes another issue caused by the fact that the Taxpayer accepted perishable goods that had to be processed on a first-in, first-out basis. The appraisal explains that the Taxpayer enabled an inventory control feature on the system to limit product loss but as a result, the system’s efficiency decreased. In addition, the appraisal describes an issue that sometimes occurred with the outbound conveyor that was apparently caused by changes in the weather such as higher humidity. Further, the appraisal explains that the Taxpayer could not adjust its working hours to mitigate the system’s inefficiencies because of the timing of delivery trucks.
These observations raise questions about how much more useful the system might be for other businesses, and thus potentially more valuable on the market. Notably, the appraisal indicates that a sales comparison approach to valuation was considered but that sufficient identifiers were not available to perform a complete sales comparison. As a result, the appraisal relied only on the cost approach in which the inutility adjustment was applied in arriving at a depreciated value. The adjustment was specific to this Taxpayer, but it is doubtful that the adjustment would be the same for all taxpayers.
Not only was just one appraisal approach considered but, in the Department’s opinion, accepting the Taxpayer’s methodology under such circumstances risks adding unreasonable administrative complexity and uncertainty to the valuation process. In future tax years, the County, for example, would have to rely on the Taxpayer to report efficiency changes accurately or else subject the Taxpayer to ongoing audits of the system’s performance. In addition, questions could arise concerning what is the appropriate percentage capacity to use in the inutility formula for any given tax year because those capacities have changed over time, and they could also fluctuate during the year.
DETERMINATION
Because the system was not functioning properly because of efficiency issues with the system itself and not external factors, economic obsolescence was not an appropriate basis for depreciation. In addition, it appears that the appraisal values the system based on its worth to the Taxpayer, not its fair market value based on the legal standard in Virginia. Accordingly, it is the Department’s determination that the Taxpayer has failed to carry its burden of proving that the County’s assessment was incorrect. Therefore, the County’s assessment is upheld.
If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1709.M