On appeal from the Superior Court, Appellate Division.
For reversal and remandment -- Chief Justice Wilentz and Justices Clifford, Pollock, Handler, O'Hern, Garibaldi, and Stein. Opposed -- None. The opinion of the Court was delivered by Handler, J.
This case presents the complex issue of determining the proper method for valuing the property of a regulated industry for purposes of local property taxation.
We are asked to review the municipal tax assessments of segments of pipeline that are used by the taxpayers for the interstate transmission of natural gas, an operation that that is subject to comprehensive federal regulation. We determine that the method of valuation proposed by the taxpayers, which is based essentially on the book value of the property that is
used and approved for ratemaking purposes, does not reflect the proper worth or fair market value of their pipelines for property tax purposes, and that such property should be valued according to its depreciated replacement cost. Further, because the methodology used by the municipal assessor to determine value for tax assessment purposes was so patently deficient and the resultant assessment amount so unreliable, the assessment cannot be affirmed. Accordingly, we remand the matter to the Tax Court for an independent determination of the value of the property for tax purposes.
Transcontinental Gas Pipe Line Corporation (Transco) and Algonquin Gas Transmission Company (Algonquin) both operate interstate natural gas pipelines that run through Bernards Township. Prior to the 1983 property tax assessment, the pipelines had been valued according to an interim or provisional method established in Transcontinental Gas Pipeline v. Township of Bernards, 115 N.J. Super. 593 (App.Div.1970) (Transcontinental I), aff'd o.b. 58 N.J. 585 (1971), and Texas Eastern Trans. Corp. v. Borough of Carteret, 116 N.J. Super. 9 (App.Div.1970), aff'd o.b. 58 N.J. 585 (1971). Under this method, interstate natural gas pipelines were valued at their original cost less depreciation, without any recognition of any increase in value over time, up to an upper limit of 48% depreciation. Following this methodology, the Transco pipeline's assessed value, including its fifty-foot easement, was $675,000, resulting in a property tax of $32,718.60. The Algonquin pipeline was valued at $569,700, resulting in a property tax of $28,371.06.
For the 1983 tax year, as part of an overall reassessment of the Township's property, Bernards Township abandoned the Transcontinental I methodology and assessed the property at its replacement cost less depreciation. As of the October 1, 1982, assessment date, Transco's pipeline was valued at $1,959,200, resulting in a tax of $34,677.84 and Algonquin's pipeline
was valued at $1,678,900, resulting in a tax of $30,068.76. The similarity between the 1982 and 1983 tax figures for the two pipelines is not coincidental; in his deposition, the assessor who performed the original assessment candidly admitted that while he did consult some external sources to determine replacement cost, his primary consideration was to establish a value that would yield substantially the same tax dollars at the Township's new tax rate as had been yielded in the previous year under the old tax rate. Since other property in the Township had been assessed, on average, at approximately three times its 1982 value due to the 1983 revaluation, the assessor essentially tripled the pipelines' 1982 assessment and worked backwards to determine replacement cost and depreciation figures.
The pipeline companies challenged these assessments in the Tax Court, alleging that the assessment methodology was incorrect. In addition, they challenged the 48% cap on depreciation established by the Transcontinental I court's interim methodology, arguing that, as a regulated utility their income was limited by the value of property that is included in their rate base by the Federal Energy Regulatory Commission (FERC). Since the FERC-mandated depreciation of their property had long ago exceeded 48%, the pipeline companies argued that it was unfair to value their property for ad valorem property tax purposes at a value higher than the FERC-determined value at which it earned income as part of the utility's rate base. The two cases were tried together by the Tax Court, with evidence of each proceeding applying to both cases.
At trial, the pipeline companies used the unit-valuation method, determining the value of each pipeline company as a whole, then allocating a percentage of this overall figure to the company's assets within the Township. The rationale for this approach is that a pipeline must operate as an entire unit to produce earnings, and an isolated section of pipeline would have little or no value standing alone. The pipeline company experts presented evidence of comparable sales as well as income and cost figures based on the income, rate of return, and cost
figures utilized in FERC ratemaking proceedings. The resulting values were all very close to the book value of the property: Transco's expert testified to a valuation of $216,000, in contrast to a depreciated original cost of $213,376, and Algonquin's expert computed a value of $252,318, compared to a depreciated original cost of $208,392.
The Township, on the other hand, presented evidence that the original assessment, if anything, was too low. In light of the useful lifetime of the property, which the taxpayers' own experts testified was indefinite if properly maintained, and the Township's expert estimated to be at least 100 years, the Township argued that the 45% lump sum depreciation used in the original assessment was too high, and that a 1% annual straight line depreciation for each pipeline would be more appropriate. The Township expert thus opined that the proper replacement cost new less depreciation of the Transco property was $3,428,923, and the proper value of the Algonquin pipeline was $3,440,000. The Township's expert also testified that he found no reason to reduce the value of the property to reflect functional or economic obsolescence.
The Tax Court upheld the original assessment, rejecting both pipeline companies' proposed market sales and capitalized income valuations, and in addition rejecting Algonquin's proffered stock and debt valuation as well as its depreciated replacement cost method, which in essence equated FERC depreciation with economic obsolescence. In Transcontinental Gas Pipeline Corp. v. Bernards Township, (Transcontinental II), 7 N.J. Tax 508 (Tax Ct.1985), aff'd 9 N.J. Tax 636 (App.Div.1987) (per curiam), the Tax Court rejected Transco's*fn1 contention that the pipeline should be valued for property tax purposes in the same manner as it is valued in FERC ratemaking proceedings, and concluded that replacement cost new less
depreciation is the proper method of valuing such special purpose property. The Appellate Division consolidated the Transco and Algonquin appeals, and the majority below affirmed the Tax Court decisions in each case. The dissent, however, argued that the Tax Court approach failed to consider the impact of this manner of property taxation on the pipeline as a whole. The case thus comes to us as an appeal as of right pursuant to Rule 2:2-1(a)(2).
Taxpayers, in challenging the municipality's original assessment, bear the burden of rebutting the validity of the quantum of this assessment. Riverview Gardens v. Borough of North Arlington, 9 N.J. 167, 175 (1952). As we observed in Pantasote Co. v. City of Passaic, 100 N.J. 408 (1985), this presumption is not simply an evidentiary mechanism allocating the burden of proof, but "a construct that expresses the view that in tax matters it is to be presumed that governmental authority has been exercised correctly and in accordance with law." Id. at 413. In Aetna Life Ins. Co. v. City of Newark, 10 N.J. 99 (1952), the Court announced what has come to be accepted as the definitive verbal formulation of the burden imposed on a taxpayer challenging an ad valorem property tax assessment: "it is not sufficient for the taxpayer merely to introduce evidence: the presumption stands until sufficient competent evidence is adduced to provide a true valuation different from the assessment. Such evidence must be definite, positive, and certain in quality and quantity to overcome the presumption." Id. at 105. In Pantasote we interpreted this to mean that the presumption remained in place even if the municipality utilized a flawed valuation methodology, so long as the quantum of the assessment is not so far removed from the true value of the property or the method of assessment itself is so patently defective as to justify removal of the presumption of validity. Pantasote, supra, 100 N.J. at 415.
In attempting to meet this burden, taxpayers presented evidence of market value,*fn2 income capitalization, original cost less depreciation, and replacement cost less depreciation including a significant reduction based on FERC regulation as a form of economic obsolescence. We agree with the Appellate Division that the Tax Court was correct in ruling that taxpayers failed to overcome the presumption of correctness that attaches to the municipality's assessment.
The Tax Court correctly rejected taxpayers' market valuation on the grounds that the pipelines are speciality property so uniquely adapted to its current purpose of transporting natural gas that no ready market for such property exists. See, e.g. Hackensack Water Co. v. Borough of Old Tappan, 77 N.J. 208, 223 n. 1 (1978) (Handler, J., dissenting), Tenneco, Inc. v. Town of Cazenovia, 104 A.D. 2d 511, 512-13, 479 N.Y.S. 2d 587, 589 (1984) (defining special purpose property), appeal after remand, 134 A.D. 2d 772, 522 N.Y.S. 2d 250 (1987). Taxpayers' own experts conceded that no market exists for the isolated sections of pipe standing alone, and that sales of entire pipeline systems were sufficiently separate in time, place, and characteristics of the property in question as to make the comparative sales approach virtually meaningless. It has long been the rule in this State that for special purpose property the test of its selling price on the open market is an inappropriate measure of value, and expert testimony with respect to this value is not probative of value. Royal Mfg. Co. v. Bd. of Equal. of Taxes, 76 N.J.L. 402 (Sup.Ct.1908), aff'd 78 N.J.L. 337 (E. & A.1909), see also Dworman v. Borough of Tinton Falls, 1 N.J. Tax. 445 (Tax Ct.1980), aff'd, 180 N.J. Super. 336, 3 N.J. Tax. 1 (App.Div.), certif. denied, 88 N.J. 495 (1981) (noting that the cost approach is utilized to value special purpose property). For this reason, both our
courts, see Texas Eastern, supra, 116 N.J. Super. at 16, Transcontinental I, supra, 115 N.J. Super. at 597, and the courts of other states, see, e.g., Tenneco, supra, 104 A.D. 2d at 512-13, 479 N.Y.S. 2d at 589, have rejected the market approach to valuing interstate natural gas pipelines for the purposes of ad valorem property taxation.
Taxpayers, however, argue that this market information is relevant in a secondary sense, since the evidence presented shows that most pipelines sell at or near book value, which is essentially the figure reached by their capitalization of income and cost valuation approaches. Although some courts have found this corroborating evidence relevant to the valuation of utility property, see Montaup Electric Co. v. Board of Assessors of Whitman, 390 Mass. 847, 852-53, 460 N.E. 2d 583, 587 (1984) (rejecting any valuation figure significantly above book value (depreciated original cost) in the absence of evidence that a willing buyer would pay more than that amount for the property), we are not persuaded by this approach. It would be contradictory to reject the market approach on the grounds that it is an unreliable and inappropriate measure of an asset's worth, due to the fact that the asset was constructed for a particular purpose by the owner without any consideration of resale, see CPC International, Inc. v. Borough of Englewood Cliffs, 193 N.J. Super. 261, 269-70 (App.Div.1984), but then give credence to the result of such an approach as support for the correctness of another valuation approach.
In addition, it does not appear that such transactions reflect all of the interests in the property of a regulated utility. Almost all such sales are from one natural gas pipeline company to another, and are subject to the approval of FERC, which prevents the new purchaser from including in the purchasing utility's rate base any value for the pipeline in excess of the purchased pipeline's book value. The reason for this is that the cost of an asset owned by a utility is eventually charged to the ratepayers as a cost through depreciation, and to allow a
purchaser to increase its rate base to reflect the purchase price would force the ratepayers to pay twice for the same asset.*fn3 See, e.g., Texas Eastern Transmission Corp. v. Sealy Ind. Sch. Dist., 580 S.W. 2d 596, 601 (Tex.Civ.App.1979). Due to the fact that FERC allows such property to be depreciated over a time period considerably shorter than its functional life, however, this totally depreciated property in fact has a significant value to the consumers that would not be reflected in the purchase price paid by an investor for the undepreciated assets of the utility. For these reasons, we find that taxpayers' evidence of comparable sales had no probative weight either as direct evidence of value or corroborative evidence of the validity of the results of other valuation methods.
The Tax Court was also justified in not relying on taxpayers' attempt to establish the value of their property through the capitalization of income approach. Under this assessment methodology, the value of a property purchased for investment purposes is equated with the present value of the projected net income stream that will be earned by the property over its useful life. American Institute of Real Estate Appraisers, The Appraisal of Real Estate, 71, 315 (7th ed. 1978). To use this valuation approach it is necessary to obtain a reliable determination of the property's earning potential, as well as an appropriate capitalization rate that reflects the return investors would require on similar investments. In the absence of such information, the capitalization of income approach must be rejected, and another valuation methodology utilized. See, e.g., Pantasote, supra, 100 N.J. at 412 (rejecting income approach for special purpose property).
The income approach is problematic in this case. Unlike an apartment building or a shopping mall, the properties at issue here are sections of pipeline in Bernards Township that produce no income in and of themselves. They have value only as links in the interstate systems that transport and sell gas to local utility companies. To circumvent this problem, both taxpayers urge this Court to adopt the unit valuation method, which values the entire pipeline system as an operating business and then allocates or attributes a portion of the total net income to the particular property in question. In this case, taxpayers suggested as an allocation factor the ratio of the book value of the pipelines in Bernards Township to the total book value of all of the assets in the utility's rate base.
We reject this method of valuation, which has been urged, in some form, by the dissent below. Although the approach is attractive in its simplicity, its application as a method of property tax valuation is inappropriate for several reasons. On a theoretical level, for example, it defeats the purpose of the income approach of property taxation, which attempts to capitalize the income of the real property separate from the value of the business using the property, see, e.g., Transcontinental II, supra, 7 N.J. Tax. at 521. Furthermore, it is contrary to the approach taken by the Tax Court with respect to other locally valued utility property, see, e.g., Hackensack Water Co. v. Haworth, 178 N.J. Super. 251, 261, 2 N.J. Tax. 303, 313 (App.Div.), certif. denied, 87 N.J. 378 (1981) (court rejected a valuation process that sought to recognize the cost of improvements located outside the taxing district in the assessment of the utility's reservoir).
More importantly, however, there appear to be insurmountable practical problems with the unit valuation approach. In particular, the taxpayers' methodology for allocating a percentage of this income to a particular asset of the utility is problematic. Taxpayers performed this allocation by comparing the book value of the utility's rate base property as a whole to the
book value of the property in question. This allocation factor, however, is based on several questionable assumptions. First, in determining the percentage of the total value of the utility property represented by the property in Bernards Township, the allocation factor proposed by taxpayers assumes that book value is an accurate measure of even the comparative worth of the various components of the utility's property. However, due to the fact that such property is added to the rate base over a span of decades, the book value of the utility as a whole will include property with greatly disparate costs of construction. As long as construction costs increase over time, book value will tend to overvalue newer property in relation to older property. To the extent that FERC allows depreciation of utility property over a period of time much shorter than its useful life, this undervaluation of older property is magnified. Thus, within a regulatory scheme similar to FERC's, substantially similar assets can have dramatically different book values. See, e.g., Public Service Co. v. New ...