SOUTHWEST v. ADOR/STATE

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NOTICE: THIS DECISION DOES NOT CREATE LEGAL PRECEDENT AND MAY NOT BE CITED EXCEPT AS AUTHORIZED BY APPLICABLE RULES. See Ariz. R. Supreme Court 111(c); ARCAP 28(c); Ariz. R. Crim. P. 31.24 IN THE COURT OF APPEALS STATE OF ARIZONA DIVISION ONE SOUTHWEST AIRLINES CO., a Texas ) corporation, ) ) Plaintiff/Appellant, ) ) ) v. ) ARIZONA DEPARTMENT OF REVENUE, ) an agency of the State of ) Arizona; STATE OF ARIZONA, ) ) ) Defendants/Appellees. ) No. DIVISION ONE FILED: 07/26/2012 RUTH A. WILLINGHAM, CLERK BY: sls 1 CA-TX 11-0007 DEPARTMENT T MEMORANDUM DECISION (Not for Publication Rule 28, Arizona Rules of Civil Appellate Procedure Appeal from the Arizona Tax Court Cause No. TX2007-000621 The Honorable Dean M. Fink, Judge AFFIRMED Mooney Wright & Moore PLLC By Paul J. Mooney Bart S. Wilhoit Attorneys for Plaintiff/Appellant Mesa Thomas C. Horne, Attorney General Phoenix By Kenneth J. Love, Assistant Attorney General Attorneys for Defendants/Appellees ________________________________________________________________ J O H N S E N, Judge ¶1 This appeal arises out of the valuation for property tax purposes of the aircraft fleet owned by Southwest Airlines Co. Southwest contends the Arizona Department of Revenue erroneously failed to allow for obsolescence in determining the full cash value of the aircraft for tax years 2008, 2009 and 2010. After a six-day bench trial, the Arizona Tax Court issued findings of Department s fact and conclusions valuations. For the of law reasons upholding that the follow, we affirm. FACTS AND PROCEDURAL BACKGROUND ¶2 Southwest s annual property-tax reporting forms identify each of its airplanes and its original cost, along with its manufacturing and acquisition dates. tax valuation formula in Arizona Applying the property Revised Statutes ( A.R.S. ) section 42-14254 (West 2012) to that information, the Department determined the full cash values of the company s aircraft to be $211,343,700 in tax year 2008, $212,727,000 in 2009 and $211,002,000 in 2010. 1 ¶3 Southwest obsolescence Airliner 1 for Price timely the Guide 2008 asked the Department tax year. After ( APG ), Department to consider consulting representative the Kirk Absent material revision after the date of the events at issue, we cite a statute s current version. 2 McElhaney exceeded determined the APG s that the wholesale Southwest s airplanes. Department s values for full fewer cash than values five of Accordingly, the Department refused to reduce the valuation based upon obsolescence. Southwest and the Department repeated the process with respect to the 2009 and 2010 tax years. ¶4 Southwest appealed the assessments for all three tax years pursuant to A.R.S. §§ 42-14005 and 42-16204 (West 2012). After trial, the tax court found that the Department s valuation of the aircraft was correct 16213(B)(2) (West 2012). for purposes of A.R.S. This timely appeal followed. § 42- We have jurisdiction pursuant to A.R.S. § 12-2101(A)(1) (West 2012). DISCUSSION A. ¶5 Legal Principles. We defer to the tax court s factual findings so long as they are not clearly erroneous. Kocher v. Dep t of Revenue, 206 Ariz. 480, 482, ¶ 9, 80 P.3d 287, 289 (App. 2003). review mixed questions of law and fact de novo. We Eurofresh, Inc. v. Graham County, 218 Ariz. 382, 385, ¶ 14, 187 P.3d 530, 533 (App. 2007). ¶6 Arizona taxes property based upon its full cash value as provided in A.R.S. § 42-11001(6) (West 2012): Full cash value for property tax purposes means the value determined as prescribed by 3 statute. If no statutory method is prescribed, full cash value is synonymous with market value which means the estimate of value that is derived annually by using standard appraisal methods and techniques. Full cash value is the basis for assessing, fixing, determining and levying secondary property taxes. Full cash value shall not be greater than market value regardless of the method prescribed to determine value for property tax purposes. ¶7 The method for valuing flight property such as Southwest s aircraft is prescribed by A.R.S. § 42-14254(B)(2), which directs the Department to determine the valuation of each fleet type [a]llow by the original additional cost obsolescence less if depreciation, supported by then market evidence. B. Trial Proceedings. ¶8 Both sides called expert witnesses who had determined the full cash value of the aircraft as a percentage of the total company (unitary Arizona. 2 value) with an allocation for the state of Each of the two experts considered three standard appraisal methods -- income, cost and market (sales). 3 ¶9 Southwest s expert, Thomas K. Tegarden, employed the cost and income approaches to support his opinion that the full 2 The parties agree on the percentage of value allocated to Arizona. 3 See Maricopa County v. Sperry Rand Corp., 112 Ariz. 579, 581, 544 P.2d 1094, 1096 (1976). 4 cash values of the aircraft were lower than those set by the Department. Tegarden used the yield capitalization method to employ income the approach and rejected the Department s expert s use of the sales-comparison approach. ¶10 The Department s expert, D. Brent Eyre, declined to employ the cost approach. (using a direct Instead, he used the income approach capitalization method) and approach (using the stock and debt method). sales-comparison According to Eyre, the Department s valuations fell below fair market values. ¶11 The tax court found Southwest had rebutted the statutory presumption that the Department s valuations of the aircraft were correct. be qualified, based The court found both expert witnesses to on their education and experience. The court stated, however, Having had the special opportunity of listening to each witness as he gave live testimony and was subjected to rigorous cross-examination, the Court was especially impressed by Mr. Eyre and found his testimony and opinions to be more credible, more reliable, more persuasive, and entitled to greater weight than the testimony and opinion of Mr. Tegarden. ¶12 The tax court concluded: The Court has weighed the evidence and testimony of the expert witnesses, both of whom it has found competent, and finds that the weight of the evidence, in particular 5 the opinion of Mr. Eyre, in the light of all the evidence, preponderates in support of the value urged by the Department as against either the value urged by [Southwest] or any intermediate figure. * In accordance Court finds [Southwest s] 2008, 2009, $211,343,700, as noticed by C. * * with all of the foregoing, the that the full cash value of flight property for tax years and 2010 shall remain at $212,727,000, and $211,002,00, the Department. A.R.S. § 42-16212(B) and the Burden of Proof. ¶13 Southwest first argues the tax court erred by failing to adopt Tegarden s analysis after the court concluded Southwest had rebutted Department s the presumption analysis. We of correctness disagree: The afforded court to the was not obligated to overturn the Department s valuation simply because it concluded Tegarden s opinions were sufficient to rebut the presumption accorded the Department s valuation. ¶14 The valuation . . . as approved by the appropriate state or county authority is presumed to be correct and lawful. A.R.S. § 42-16212(B) (West 2012). Once the presumption is rebutted, the tax court is bound to follow the usual rules of evidence in reaching the ultimate conclusion of fact. Dep t of Revenue v. Transamerica Title Ins. Co., 117 Ariz. 26, 28, 570 P.2d 797, 799 (App. 1977). taxing authority s valuation Even when the party attacking the submits 6 sufficient evidence to rebut the statutory presumption, that party retains the burden to show that the authority s valuation is incorrect. Graham County v. Graham County Elec. Coop., Inc., 109 Ariz. 468, 470, 512 P.2d 11, 13 (1973); Honeywell Info. Sys., Inc. v. Maricopa County, 118 Ariz. 171, 174, 575 P.2d 801, 804 (App. 1977); see Inspiration Consol. Copper Co. v. Ariz. Dep t of Revenue, 147 Ariz. 216, 231, 709 P.2d 573, 588 (App. 1985), superseded by statute on other grounds, 1990 Ariz. Sess. Laws, ch. 360, § 1 (2d Reg. Sess.). 4 ¶15 was Southwest further argues, however, that the tax court obligated opinions aircraft. were At to accept not oral Tegarden s competent evidence argument, opinions of Southwest the because values acknowledged Eyre s of the that a properly calculated fair market value necessarily will reflect obsolescence of the sort the tax statutes reference. 4 It argues Southwest cites Department of Property Valuation v. Salt River Project Agricultural Improvement & Power District, 27 Ariz. App. 110, 551 P.2d 559 (App. 1976), rev d, 113 Ariz. 472, 556 P.2d 1134 (1976), but that case does not teach a different rule. The court there found that the Department s affidavits overcame the presumption of correctness of valuations earlier set by the State Board of Property Tax Appeals. Id. at 114, 551 P.2d at 563. The court explained that this statutory presumption merely gives rise to a burden of proof requirement and as pointed out in [Dep t of Prop. Valuation v. Trico Elect. Coop., Inc., 113 Ariz. 68, 546 P.2d 804 (1976)] that the Department must bear the burden of proving that the assessment is insufficient when it appeals from the decision of the Board. Id. (emphasis added). 7 that Eyre s opinions of the fair market values of the aircraft were not competent because they were not derived from standard appraisal methods and techniques pursuant to A.R.S. § 42- 11001(6). 5 ¶16 More methodology valuation income by has specifically, which been approach, capitalization Eyre Southwest applied expressly Eyre method the income rejected. used that contends a uses In variation that the approach to performing of price/earnings the direct ratios than comparable sales to derive a capitalization rate. his rather Although the capitalization rate normally is determined from sales of comparable properties, both experts comparable properties to Southwest. agreed there are no Southwest argues that the authorities teach that while the use of price/earnings ratios to calculate capitalization rates might be appropriate in valuing stock, it property. is not appropriate in valuing real or personal But as the Department points out, in PacifiCorp v. State, 253 P.3d 847, 851-52, ¶¶ 26-28 (Mont. 2011), the Montana supreme court endorsed Eyre s use of price/earnings ratios to 5 Southwest argues that by referring to the APG to determine the obsolescence of the aircraft, the Department failed to use standard appraisal techniques. The tax court, however, did not endorse the Department s use of the APG to set the full cash value of the aircraft. In affirming the decision of the tax court, we do not need to consider whether the Department correctly used the APG. 8 calculate capitalization rates in a case involving the value of a utility company. Southwest argues PacifiCorp does not support Eyre s approach in this case because in Montana, the assessing agent is required to begin the valuation process by calculating the value of all of a company s assets, including intangible assets that are not at issue here. This argument lacks merit, however, given that the starting point in this case for both sides consideration of the existence of obsolescence was to estimate a unitary value of the company. ¶17 Southwest also attacks Eyre s use of the stock and debt approach as a surrogate for the sales approach. See Delta Air Lines, Inc. v. Dep t of Revenue, 984 P.2d 836, 842-43 (Or. 1999). Southwest argues this method is inappropriate as a means of appraising tangible assets because it uses the value of a company s debt and equity securities, which by fungible and more liquid than its tangible assets. nature are Further, Southwest argues that because Eyre could not identify any other airlines comparable to Southwest, he used Southwest s own reported stock price and the value of its publicly traded debt securities. Southwest argues, That may tell someone what the value of the company is as a whole, but it does nothing to determine the value of Southwest s flight property (i.e., its 9 airplanes), which is the only taxation under A.R.S. § 42-14254. ¶18 Eyre, however, property that is subject to (emphasis in original). testified that the stock and debt approach was appropriate to evaluate the going concern value of a publicly traded company with 85 percent of its capital in operating property. After using the stock and debt approach to derive an estimate of the value of the company, Eyre deducted a portion attributable to intangible property using a balance sheet analysis, and then made further refinements to determine the value allocable to Southwest s aircraft. And at trial, Tegarden conceded that he had used the same approach in valuing Southwest in 2003 in a tax proceeding in another state. ¶19 In sum, we do not agree with Southwest that Eyre s opinions must be rejected as incompetent. The tax court found Eyre s opinions were more reliable, more persuasive, and for that reason, entitled to greater weight than Tegarden s opinions, and we are unwilling to upset those findings of fact. 10 D. Southwest Failed to Demonstrate Valuations Were Excessive. 1. that the Department s Obsolescense in general. ¶20 At following trial, estimates McElhaney, of the Eyre full and Tegarden cash value of offered the Southwest s aircraft: Tax Year 2008 2009 2010 Department $211,343,700 $212,727,000 $211,002,000 ¶21 Eyre $413,500,000 $351,000,000 $269,000,000 Tegarden $184,776,000 $178,118,750 $164,082,000 In applying the cost method, Tegarden determined that additional deductions from the statutory formula were needed to account for obsolescence. Tegarden derived obsolescence percentages ranging from 50.21 to 51.11 for the three relevant tax years. ¶22 defined Obsolescence, as a loss of functional or economic. which value is a and form is of depreciation, classified as is either Ariz. Dep t of Revenue v. Questar S. Trails Pipeline Co., 215 Ariz. 577, 580, ¶ 12, 161 P.3d 620, 623 (App. 2007) (quotations omitted). Economic obsolescence, the type at issue in this case, is a loss in value caused by forces external to the property and outside the control of the property owner. Magna Inv. & Dev. Corp. v. Pima County, 128 Ariz. 291, 293, 625 P.2d 354, 356 (App. 1981). 11 ¶23 Eyre argued Tegarden failed to test his obsolescence opinion against market evidence. Eyre recommended comparing weighted market values to book values; if the resulting ratio exceeds one, the investment community is valuing the taxpayer s assets in excess of their book value. Eyre overall market-to-book ratio for 2008 as 1.64. calculated the For the 2009 and 2010 tax years, Eyre s values were 1.26 and 1.22, respectively. From this, Eyre argued the market-based evidence fails to support any adjustment for obsolescence. 2. Tegarden s calculation of obsolescence. ¶24 In its specific criticisms of Tegarden s opinions, the Department argues his reliance upon the income-shortfall approach to perform a cost valuation was erroneous. It argues Tegarden s analysis was flawed because, inter alia, rather than compare Southwest s Tegarden created entirely income a subjective to the comparison figure income market for what of by other airlines, hypothesizing he thought an that [Southwest s] earnings should be and compared the hypothetical earnings to its actual earnings. The tax court accepted Eyre s criticism of this method as circular. 6 6 See, e.g., Delta Air Lines, 984 P.2d at 849 (characterizing the income-deficiency approach as illogical at best and stating that at worst the method strips the cost approach of its use as an independent determiner of value, because it always will track the result under the income approach ). 12 ¶25 Moreover, the Department argues that the income- shortfall approach that Tegarden used has been rejected by the Western States PacifiCorp, Association 253 P.3d at of Tax 854-55 Administrators. (rejecting use See of income- shortfall approach); Transcon. Gas Pipe Line Corp. v. Bernards Twp., 545 A.2d 746, 754 (N.J. 1988) (noting circularity of the approach). ¶26 At capitalization trial, Eyre income also approach criticized to Tegarden s valuation. This yieldapproach forecasts future net cash flows, and uses a discount figure to calculate value from those anticipated cash flows. Eyre argued Tegarden used dissimilar companies to select the average cost of capital, improperly chose and inflated the risk premium for the capital asset pricing model, used incorrect long-term growth rates, and used non-airline companies to compute cost of equity. ¶27 The record confirms these deficiencies. Rather than using other domestic airlines as comparables, Tegarden compared Southwest to profitable companies such as FedEx and UPS. Indeed, Eyre found that Tegarden s cost of capital calculations exceeded Southwest s during similar periods. ¶28 In assumption of addition, no Eyre growth, strongly which would criticized mean that Tegarden s depreciation would tend to approximate capital expenditures in perpetuity. 13 As noted, this conclusion flies in the face of the investment community s valuation of Southwest s assets, which reflects an expectation of growth. ¶29 Another problem with Tegarden s calculation was his admitted failure to specifically account for the value of leased property. 302(1), According flight aircraft. to property Arizona Administrative includes both Code R15-4- and leased owned When Tegarden calculated Southwest s net operating income, he did not include the income stream generated through use of leased airplanes, which resulted in a lower rate of return. ¶30 tax Based on the record presented, we cannot conclude the court erred by accepting these criticisms of Tegarden s analysis. E. The Tax Court Was Not Required to Find the Market Value of the Aircraft. ¶31 Finally, Southwest argues without citation to legal authority that the tax court erred by failing to determine the aircraft s market values during the relevant years. We disagree. Under A.R.S. § 42-14254, the Department must value the aircraft using original cost less depreciation, then must [a]llow evidence. additional obsolescence if supported by market Southwest urged the tax court to reject the values the Department established because, according to Southwest, they 14 exceeded the argument, aircraft s the tax market court was values. not In required evaluating to make that express findings of the aircraft s market values during the tax years in question. values It only had to find that the Department s full-cash did not exceed market values. When the tax court concluded that the Department s full-cash values were correct, it impliedly concluded that the fair market values aircraft exceeded the Department s valuations. which the fair market values of the of the The extent to aircraft exceeded the Department s valuations, however, is irrelevant. CONCLUSION ¶32 to Substantial evidence supports the tax court s decision reject Southwest s appeal of the Department s valuations. The tax court was in the best position to judge the testimony of the two sides expert witnesses. Both Eyre and Tegarden bear impressive credentials and produced detailed reports, but the tax court persuasive. found The Eyre s weight testimony to be to be accorded more reliable expert testimony and is within the sole province of the trial court, and since competent evidence supports its conclusion, we decline Magna, 128 Ariz. at 294, 625 P.2d at 357. to intervene. We affirm the tax court s judgment with respect to all three tax years, and award the Department its costs on appeal, subject to its compliance 15 with Rule 21(a) of the Arizona Rules of Civil Procedure. /s/ DIANE M. JOHNSEN, Judge CONCURRING: /s/ MAURICE PORTLEY, Presiding Judge /s/ PHILIP HALL, Judge 16 Appellate

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