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Texas Supreme Court upholds heavy equipment appraisal formula

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On March 2, 2018, the Texas Supreme Court held that a statutory formula used to appraise the value of heavy equipment held by dealers for sale is constitutional.1 Instead of basing the property tax on the actual market value a willing buyer would pay to a willing seller, the statute permissibly values the property based on the lease revenue the equipment generated during the previous year divided by 12. The Court further held that the proper taxable situs for dealer-held heavy equipment is the location where the dealer maintains its inventory, rather than at the various locations where the equipment might otherwise be physically located.

Background
EXLP Leasing, LLC and EES Leasing, LLC (“EXLP”) are wholly owned by Exterran Holdings, Inc. EXLP owns and leases out compressor stations used to deliver natural gas into pipelines. Some of these compressors are used in Galveston County, but EXLP conducts business and maintains its inventory in Washington County.

Galveston County traditionally taxed the compressors in its jurisdiction as business-personal property based on their full market value. However, the legislature overrode this practice beginning with the 2012 property tax year when it added leased heavy equipment to a statutory formula used to appraise the value of heavy equipment held by dealers for sale.2 Accordingly, state law currently requires an appraisal based on the lease revenue of heavy equipment generated during the previous tax year divided by 12.3 Galveston County claimed that this statutory change resulted in a 97% loss in compressor-based county tax revenue from EXLP.

Following the statutory amendments that changed the method for appraising leased heavy equipment, EXLP took the position that its compressors in Galveston County were taxable only in Washington County, where EXLP maintained a business address and a storage yard. Galveston County disagreed and contended that it could tax the compressors that were located in the county. In a letter to all dealers with heavy equipment leased in its jurisdiction, the county announced it would appraise leased heavy equipment under the statute generally covering business-personal property, declaring that “[r]ecent litigation has determined that the valuation of leased heavy equipment . . . is unconstitutional.”

After EXLP sued for judicial review, EXLP and Galveston County both moved for summary judgment. The trial court granted the county’s motion in part, declaring that EXLP’s compressors were heavy equipment under the statute, but the amendments that changed the method for valuing leased heavy equipment were unconstitutional as applied to those compressors. The trial court also declared Galveston County as the compressors’ taxable situs.

EXLP subsequently appealed the trial court’s decision. The Court of Appeals reversed in part, holding that “[n]either side produced summary judgment evidence demonstrating, as a matter of law, that the method of appraising compression unit rentals inventories . . . is either a reasonable or unreasonable method of calculating their reasonable market value.” The case was remanded for further proceedings on the constitutionality of the appraisal statute. The Court of Appeals affirmed the trial court’s decision that Galveston County was the taxable situs of EXLP’s compressors. Both parties sought review by the Texas Supreme Court.

Valuation based on lease revenue is constitutional
The Texas Supreme Court first determined that the statute appraising the value of leased heavy equipment held by dealers based on income, rather than the traditional concept of actual market value, is constitutional.

The Texas Constitution requires that taxation “shall be equal and uniform” and that real property “shall be taxed in proportion to its value, which shall be ascertained as may be provided by law.”4 The party challenging the statute’s constitutionality bears the burden of demonstrating that the enactment fails to meet constitutional requirements.5

Galveston County argued that the statutory formula determining the taxable value of leased natural-gas compressors located in its jurisdiction violated these constitutional provisions because this formula values the compressors at a “minute fraction” of their market value. The county argued that for constitutional purposes, “value” under Texas Constitution, article VIII, section 1(b) means the actual market value a willing buyer would pay a willing seller for the compressors at issue.

The Texas Supreme Court found that the legislature has the constitutional power to decide how property should be valued for taxation. The Court noted that the constitution sets no requirement that “value” must approximate “market value,” and that the constitution assigns to the legislature the task of determining “value,” providing that it “shall be ascertained as may be provided by law.”6 This provision “would seem to leave the Legislature free to adopt the mode of ascertaining the value of any class of property by such method as it might deem best.”7

In reaching its decision, the Court reviewed the Texas property tax valuation statutes. Texas law provides that taxation generally should be on “market value,” but clarifies that “market value” may have different meanings depending on the “accepted appraisal method.”8 The standard valuation methods are supplemented by a variety of “special appraisal provisions” that establish different valuation rules for discrete categories of property.9 The statute that is challenged in this case is one of seven statutes that value certain categories of property based on a portion of income. Specifically, four of the statutes calculate “market value” by dividing annual revenue by 12.10 Each of the statutes refers to “market value” when describing the number produced by the formula. The Court determined that viewing the appraisal statutes as a whole, “the legislature clearly chose a single label—‘market value’—as a catch-all reference to the taxable value produced through application of the code’s rules.” As explained by the Court, “[t]he tax code has not ‘codified’ a single understanding of market value as the price a willing buyer would pay a willing seller,” but “the term encompasses a variety of ways to determine taxable value.”

To support its argument, Galveston County cited cases in which the Texas Supreme Court referred to “reasonable market value” when considering the constitution’s value provision. However, none of these cases addressed whether “value” as used in the constitution means “market value.”

The Court upheld the statute, finding that the county did not satisfy its burden of demonstrating that the enactment failed to meet constitutional grounds. The Court reasoned that “[t]he entirety of the county’s argument against [the appraisal statute] is that it impermissibly ignores the compressors’ actual market value; the county offers no additional arguments for why the scheme is otherwise unreasonable, arbitrary, or capricious.” Furthermore, the Court explained that “no one argues the legislature attempted to approximate market value, and we hold it is not constitutionally bound to do so.”

The county briefly argued that the appraisal statute violates the constitution’s “equal and uniform” provisions because compressors that are owned rather than leased are still taxed based on their market value.11 However, the legislature is allowed to draw distinctions provided the classifications are not unreasonable, arbitrary, or capricious. The Court explained that companies that own compressors for their own use and those who own them to lease out to other companies are both compressor owners, but they are in different tax classes. However, the county failed to make an argument why this classification was not permissible, and due to the lack of analysis on this constitutional issue, the county’s argument failed.

The Texas Supreme Court concluded that the trial court erred by holding that the valuation statutes were unconstitutional. Also, the Court of Appeals erred by not reversing the trial court and holding that the county failed to rebut the presumption that the valuation statutes were constitutional.

Tax situs is location where dealer maintains its inventory The Texas Supreme Court held that the taxable situs of EXLP’s compressors was Washington County, the county where EXLP conducted business, rather than Galveston County, the compressors’ physical location.

EXLP argued that the legislature’s tax code amendments that were effective for the 2012 tax year provide that taxes should be paid in the county where it conducts business based on the revenue generated by its inventory as a whole and regardless of the physical location of individual leased units.

The Texas Supreme Court agreed with EXLP, holding that although the statute concerning heavy equipment inventory does not mention taxable situs, it reflects “the legislature’s intent to fix the situs of dealer-held heavy equipment at the location where the dealer maintains its inventory, rather than at the various locations where the equipment might otherwise be physically located through application of the default situs rules.”

The value of a dealer’s heavy equipment inventory is statutorily determined by the annual income generated by the inventory as a whole, rather than the income from each individual unit of equipment.12 It necessarily follows that the dealer’s ultimate tax liability can be made and incurred in only one county. Otherwise, the Court noted, dealers would face multiple levels of taxation when paying taxes on an entire inventory in every county where a unit of property is located.

Commentary The valuation of leased heavy equipment in Texas following the statutory amendment that applies to tax years after 2011 is controversial and has resulted in considerable litigation. The Texas Supreme Court unambiguously rejected Galveston County’s constitutional argument. In doing so, Galveston County and all other appraisal districts in Texas, will have to accept property tax filings conforming to the “heavy equipment inventory” statutes. Based on this decision, dealers that lease heavy equipment should ensure that their equipment is valued under the statutory formula based on income and taxed by the county in which the dealer maintains its inventory. The application of the statute has significantly reduced the property tax liability of certain dealers of leased heavy equipment and correspondingly reduced tax revenue in many counties. On April 2, 2018, Galveston County filed a motion for rehearing with the Texas Supreme Court.

The Court left the door open to another constitutional challenge by referencing, but not analyzing the “equal and uniform” provision of the constitution.13 The Court acknowledged that the legislature has, for tax purposes, classified heavy equipment owned by dealers differently from heavy equipment owned by its ultimate users. Galveston County summarily declared that the legislature’s method for assigning market value was unreasonable, arbitrary, and capricious without making an argument for why the classification was impermissible. The Court did not explicitly rule on the “equal and uniform” constitutionality issue, but rather stated that the county’s argument provided nothing to analyze, so it failed. Based on the controversy surrounding the taxation of leased heavy equipment, there undoubtedly will be further developments concerning this issue.


 
1 EXLP Leasing, LLC v. Galveston Central Appraisal Dist., Texas Supreme Court, No. 15-0683, March 2, 2018.
2 Ch. 322 (H.B. 2476), Laws 2011.
3 TEX. TAX CODE ANN. § 23.1241(b). Heavy equipment is defined as “self-propelled, self-powered, or pull-type equipment, including farm equipment or a diesel engine, that weighs at least 1,500 pounds and is intended to be used for agricultural, construction, industrial, maritime, mining, or forestry uses.” The term does not include a motor vehicle that is required to be registered. TEX. TAX CODE ANN. § 23.1241(a)(6).
4 TEX. CONST. art. VIII, § 1(b).
5 Spring Branch Indep. Sch. Dist. v. Stamos, 695 S.W.2d 556, 558 (Tex. 1985).
6 TEX. CONST. art. VIII, § 1(b).
7 Quoting Mo., K. & T. Ry. Co. of Tex. v. Shannon, 100 S.W. 138, 144 (Tex. 1907).
8 TEX. TAX CODE ANN. § 23.01(a), (b).
9 TEX. TAX CODE ANN. §§ 23.11–23.16.
10 TEX. TAX CODE ANN. §§ 23.121, 23.124, 23.1241, 23.127.
11 See TEX. CONST. art. VIII, § 1(a).
12 See TEX. TAX CODE ANN. § 23.1241(b).
13 See TEX. CONST. art. VIII, § 1(a).




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