deluxe rentacar's fraud king and special interest's poster child for abuse

Special Interest at Work - $21 Billion Debt but ...

THE PEOPLE OF

THE STATE OF CALIFORNIA We want our money to run a 9.865 E/T …?

$2-8,000,000 taxpayer’s money in John Hennessay’s pocket

Teacher, police, firemen laid off/cutbacks… 19% unemployment

Government agencies are aware but do nothing, and have their hands tied....

Here where your school teacher’s money is going to undereducated your kid…..

http://www.youtube.com/watch?v=Foz2ZGGpz3s

California Economic Terrorist Teachers, Firemen and Police will be laid off and take pay cuts Officials won’t stop it…. You will pay the $21 Billion in debt

He will buy new race cars and going on vacations

400+ victims every day… $2-4 million in fraud annually and no charges

John Hennessey, Rental Car Bandit & Poster Child of Special Interest Abuse

The continuing raping of the American economy has help empower the wealthy pirates to a point of

arrogance upon where the feel untouchable. This sector of “The Wealthy” work to become even

further distanced from the working class from theft and fraud rather than invention and innovation.

Much like parents tell their children about “Santa Clause” so children behave appropriately and have

something to look forward to, the “Wealthy” use “The Trickle-Down Effect - Fairy Tale” for the

working class. This is cloaked in deceptive legislation and adaptation and interpretation of laws to

bypass the wisdom of the founders of the US. These same founders that escaped the very privileged

class oriented structure to come and start this country free of such abuse would turn in their graves to

see how the “Privileged” have abused the system to create the enormous debt of the nation and

enriched themselves to well beyond conspicuous consumption. While I am definitely not referring to

all of this class, there is surprisingly large number of them. John is a real person but is only

representative of the abuse that happens across the nation when political agenda dwarf personal

constitutional protection guaranteed by the government.

The U.S. economy has been attacked and damaged far worse than the terrorist of 911. This has

started the domino effect that has reached the far corners of the world and made the most powerful

country in the world look like low FICO paupers with bad debt to the rest of the world. The real

terrorists are the leaches that suckle the financial resources of the people through fraud. These are

“Domestic Terrorist” and not the mentally disturbed ones like Timothy McVeigh, these are the bright,

educated, well spoken, politically connected, lawyer protected ones that everyone knows runs a

successful business and are looked up to as a success story to tell your kids about the American

dream and rewards of working hard.

This story is a lie as the truth is they are common gypsies, and con artist and they are worse than the

crack-head in the projects. You see able to see the crack-head is a dirty addict that will rob and steal

whatever he can to get high to escape the pain he feels in his life. The economic terrorist is

“Timmy’s” dad in Beverly Hills that owns multiple businesses and exacts his “terror” on the pockets

of consumers, and conspires to defrauds the state of tax revenue to buy second and third homes, go on

vacations and build race cars

The crack-head can’t steal from 400-1000 people per day… The owner of a Rental Car Agency

can… and John Hennessy thru Deluxe Rent A Car did…for nearly two years, and even continued to

do so for 3mo. after his Beverly Hills attorney’s were notified about the fraud. In fact during this

fraud he was so blatantly, arrogantly, unconcerned he just changed the name of and continued the

fraud. Being part of the “Rental Car Cartel” provides some protection because their records are

protected by the Board that governs them…and run by them!

For example, this particular terrorist is part of a protected special interest group created and

controlled by members of the car rental industry. They even initiated adding them as a new segment

to the travel industry and also given a certain level of immunity and impunity providing they deliver

the “voluntary contribution” needed pay the interest as a minimum return on the bond to fund the

Rental Car Facility. This is a politically created cartel specifically created to bypass the need to have

the people actually vote to fund the project. This is done for the perceived economic good of the

population. The problem is in order to do this there are sweetheart deals with arrangements creating

both insinuated and actual legal protections.

Imagine the farmer allowing the “Foxes” to create a commission to see over “the Henhouse” with

the promise to give them some eggs every month under the condition that they won’t abuse the

chickens. You tell us how many eggs you collect and give us 10% and as long as we get enough to

cover the interest you can cover the henhouse and we won’t ask you how many chickens there are

Well the farmer will likely never know nor do much when hearing the screams of the chickens as

long as the “Foxes” continue to deliver the eggs. Overtime they will make alliances with other

“Foxes” all around the US and teach them to make the same arrangement and eventually those that

play the game and keep it low-key will be part of the Fox-n-Egg Industry segment and have enough

power to not worry anymore about the farmer and monopolize a whole industry. Now I’m not saying

that all the “Foxes” are bad but that’s a lot of power to put in the hands of those that love to eat

chicken. Now what if one “Fox” really liked screwing the unlucky birds that came his way… and

would screw 400 a day and told the chickens that complained “F-you, sue me then… that’s what I

pay my lawyers for”. Eventually one of the chickens who really hated being screwed might get loose

and go screaming to let the whole world know about the “Chicken F-er” until the farmer or someone

else took action to remedy the situation.

This is the Rental Car Industry created just so the LAWA could fund the RAC facility. The problem

is these officials created the possibility of these monsters to exist and empowered them through the

use of sovern powers, property rights and lease assignments and an unsupervised deregulated

industry. John Hennessey… he’s just like the “Chicken F-er” and somebody from some agency needs

to properly deal with this abuse before more people get “F-ed”.

Meanwhile in States without $21 Billion in debt……

Brevard County Sues Web Sites and Online Merchants over Tax Money

11/3/2009

Brevard County has sued online travel sites Priceline.com Inc., Orbitz, Inc. and Expedia Inc. for what

it claims are millions of dollars in unpaid tourist taxes. The web sites buy rooms at discounted

wholesale rates from Space Coast hotels and motels, then sell them to customers at higher retail

prices, keeping the difference as profit. Local hotel and motel owners pay Tourist Development Tax

on their wholesale transactions. But the Web sites have not paid taxes on the difference charged to

customers -- although they do factor the value of the tax into their prices. Brevard's lawsuit also

names several other online merchants including Travelocity.com LP, Hotwire, Inc., Hotels.com and

Travelweb Ltda. as 'unjustly enriching' themselves by not paying the 5% tourist development tax

from their sales. Online companies have said they shouldn't have to pay hotel-room taxes, because

they don't own any hotels. The county also seeks penalties and attorneys fees.

Jury Awards $20 Million in Texas Hotel Tax Dispute Against Orbitz Inc., Priceline.com Inc.,

Hotels.com LP, Hotwire Inc., Travelocity and Expedia Inc

11/3/2009

A group of online travel services companies plans to appeal a $20 million verdict awarded to more

than 170 Texas cities in a dispute over hotel occupancy taxes. The 2006 class-action lawsuit was

brought by cities wanting to collect tourism tax revenue they alleged was underpaid by Internet hotel

room wholesalers. San Antonio and other Texas cities alleged the online companies booked blocks of

rooms at, for example, $75 a night, resold them for $100, then paid taxes on the lower rate. Jurors

found the companies controlled hotels under the cities' ordinances and should have paid hotel

occupancy taxes on the amounts they charged. The verdict was returned Friday in San Antonio,

where the suit was originally filed. The 11 companies sued included Expedia Inc., Travelocity,

Hotwire Inc., Hotels.com LP, Priceline.com Inc. and Orbitz Inc.. They contended they do not control

the hotels because they don't control the actual building and that they paid all the taxes due to the

cities.

The Pine Bluff Advertising and Promotion Commission Files Lawsuit Against a Dozen Online

Travel Companies Claiming Not Paying All of the Hotel Taxes

09/26/2009

The Pine Bluff Advertising and Promotion Commission filed a lawsuit against a dozen online travel

companies, claiming they are not paying all of the hotel taxes they collect from their online

customers. The lawsuit, filed in Jefferson County Circuit Court, seeks to include other Arkansas

advertising commissions, cities and counties that collect hotel taxes throughout Arkansas. The

complaint alleges the defendants contract with Pine Bluff hotels at discounted rates, then mark the

prices up on their Web sites. The online companies, the lawsuit alleges, then remit taxes on the

discounted rate, not the higher rate paid by the customer. Defendants are Hotels.com LP, Hotwire

Inc., Trip Network Inc., Travelport Limited, Expedia Inc., Internetwork Publishing Corporation,

Maupintour Holding, LLC, Orbitz, LLC, Priceline.com Inc., Travelocity.com LP, Travelweb, LLC

and Site59.com, LLC.

I guess they actually want the tax that was collected in their name …..

[

13800 Coppermine Rd, Herndon, VA 20171 Office: 703.234.5425 - Fax: 703.234.5740 - www.ipsaintl.com

National Security, the Financial Crisis and Bernie Madoff

On February 12, 2009, Director of National Security (DNI), Dennis C. Blair, testified before

the Senate Select Committee on Intelligence. DNI Blair provided the Committee with the

Annual Threat Assessment of the Intelligence Community. The first sentence of the

assessment states:

“The primary near-term security concern of the United States (U.S.) is the global economic

crisis and its geopolitical implications.”

This was the first time in six years that terrorism was not listed as the primary threat to the

country. Fraud and other criminal activity resulting in the laundering of illicit funds have

always been considered a threat to our national economy. The current financial crisis was

primarily driven by the frightful combination of fraud, greed and arrogance. The magnitude

of that fraud, greed and arrogance has clearly shaken not only our national economy but the

global economy as well. In so doing, as noted by DNI Blair, the resulting international

instability created by the financial crisis has become the most significant threat to our

national security.

Bernard Madoff appeared in U.S. District Court in the Southern District of New York on

March 12, 2009. He pleaded guilty to 11 felony counts, including securities fraud, mail fraud

and money laundering. The fraud and Ponzi scheme involved a reported $65 billion.

Madoff has clearly become the poster child for the fraud, greed and arrogance that

symbolize the financial crisis.

As a former FBI Agent, with extensive investigative experience in sophisticated fraud and

financial crime schemes, I was intrigued by a statement Madoff made to the court during his

pleading. He said “… and as the years went by, I realized my arrest and this day would

inevitably come.” Someone needs to ask Madoff the question “at what point in time did

you realize that your scheme would be detected?” How many years ago did Madoff reach

his conclusion? In my experience, at that point in time, Madoff began planning his exit

strategy.

Big time fraudsters usually theorize that their schemes have a certain shelf life, and at some

point, their fraud will be detected. Therefore, many of these fraudsters make contingency

plans and devise exit strategies. In many cases, that would mean fleeing the U.S. and

relocating to a safe haven such as Robert Vesco and Marc Rich did. Interestingly, Madoff did

not. So what was his exit strategy? Could he have been laundering funds for an extended

period of time, in an attempt to separate them from his fraud and give such funds an air of

legitimacy for his family or other designees to benefit from at the expense of his victims?

Kevin

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Kevin

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[

13800 Coppermine Rd, Herndon, VA 20171 Office: 703.234.5425 - Fax: 703.234.5740 - www.ipsaintl.com

Could he have been insulating co-conspirators by focusing guilt solely on himself and

confessing at a preordained time to protect them?

Hopefully, prosecutors, investigators and government appointed Trustee Irving Picard will

ask these questions and assess Madoff’s exit strategy. As a result, they should be able to

recover or account for missing funds and identify other individuals who wittingly

participated in the fraud.

Congress should take into account that the questionable activities of Madoff, and many

other prominent business executives have contributed to our financial meltdown, thereby

undermining the economy and threatening our national security. In this context, Madoff,

and other despicable business executives and fraudsters should be considered economic

terrorists. As such, Congress should strongly consider legislating more stringent criminal

and civil penalties. Current penalties for white collar criminals are not as harsh as they

should be considering the state of our current economy. Madoff, for example, should be

sentenced to life in a maximum security facility and subject to forfeiture of all assets owned

by him and his wife, and perhaps the assets of his immediate family as well. That is unlikely

to occur. He will more likely be sentenced to a minimum security facility and have many

millions of dollars in assets protected and in safe keeping for his wife and others.

It’s bad enough to be consumed by greed and arrogance, but when prominent business

executives cross the line and allow greed and arrogance to result in millions or billions of

dollars in fraud, they should be considered economic terrorists. As economic terrorists,

when they are convicted, they should face the same criminal and civil penalties as other

domestic or international terrorists.

By Dennis M. Lormel 3/13/2009

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Members of the Board of Airport Commissioners of the City of Los Angeles, California

INDEPENDENT AUDITOR’S REPORT ON COMPLIANCE WITH REQUIREMENTS APPLICABLE TO THE PASSENGER FACILITY CHARGE PROGRAM

AND ON INTERNAL CONTROL OVER COMPLIANCE Compliance We have audited the compliance of Los Angeles World Airports (Department of Airports of the City of Los Angeles, California) (LAWA) with the compliance requirements described in the Passenger Facility Charge Audit Guide for Public Agencies (the Guide), issued by the Federal Aviation Administration, for its passenger facility charge program for the year ended June 30, 2007. Compliance with the requirements of laws and regulations applicable to its passenger facility charge program is the responsibility of LAWA’s management. Our responsibility is to express an opinion on LAWA’s compliance based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States; and the Guide. Those standards and the Guide require that we plan and perform the audit to obtain reasonable assurance about whether noncompliance with the compliance requirements referred to above that could have a direct and material effect on the passenger facility charge program occurred. An audit includes examining, on a test basis, evidence about LAWA’s compliance with those requirements and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Our audit does not provide a legal determination of LAWA’s compliance with those requirements. In our opinion, LAWA complied, in all material respects, with the requirements referred to above that are applicable to its passenger facility charge program for the year ended June 30, 2007. Internal Control over Financial Reporting The management of LAWA is responsible for establishing and maintaining effective internal control over compliance with requirements of laws and regulations applicable to the passenger facility charge program. In planning and performing our audit, we considered LAWA’s internal control over compliance with requirements that could have a direct and material effect on the passenger facility charge program in order to determine our auditing procedures for the purpose of expressing our opinion on compliance, but not for the purpose of expressing an opinion on the effectiveness of internal control over compliance. Accordingly, we do not express an opinion on the effectiveness of LAWA’s internal control over compliance.

5

A control deficiency in LAWA’s internal control over compliance exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect noncompliance with a type of compliance requirement of the passenger facility charge program on a timely basis. A significant deficiency is a control deficiency, or a combination of control deficiencies, that adversely affects the LAWA’s ability to administer the passenger facility charge program such that there is more than a remote likelihood that noncompliance with a type of compliance requirement of the passenger facility charge program that is more than inconsequential will not be prevented or detected by LAWA’s internal control. A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that material noncompliance with a type of compliance requirement of the passenger facility charge program will not be prevented or detected by the Authority’s internal control. Our consideration of the internal control over compliance was for the limited purpose described in the first paragraph of this section and would not necessarily disclose all matters in the internal control that might be significant deficiencies or material weaknesses. We did not identify any deficiencies in internal control over compliance that we consider to be material weaknesses, as defined above. This report is intended solely for the information and use of the members of the board of commissioners and management of LAWA, and the Federal Aviation Administration, U.S. Department of Transportation, and is not intended to be and should not be used by anyone other than these specified parties.

Certified Public Accountants Los Angeles, California January 28, 2008

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Home > LAX

Rental Cars

Approximately 40 rental car companies operate out of LAX, with vehicle rental sites located off the airport. Many of these rental car companies provide phone links inside or near the baggage claim areas on the Lower/Arrival Level of the terminals so travelers can request a free shuttle pick up to reach the rental car sites.

Ten rental car companies are permitted to pick-up and drop-off their customers directly from the airline terminals using courtesy shuttles. These are the following companies:

Advantage www.advantage.com

Alamo www.alamo.com

Avis www.avis.com

Budget www.budget.com

Dollar www.dollar.com

Enterprise www.enterprise.com

Hertz www.hertz.com

Fox www.foxrentacar.com

Payless www.paylesscarrental.com

National www.nationalcar.com

Thrifty www.thrifty.com

These are allowed to meet arriving customers under the purple sign "Rental Car Shuttles" on the Lower/Arrival level islands outside baggage claim.

Customers of other rental car should contact their rental car of choice using the Ground Transportation Telephone Boards in baggage claim areas of each terminal to arrange for pick-up.

These customers will use the free LAX Shuttle Bus to reach the Off-Airport Rental Car Terminal to meet their rental car courtesy shuttle. Customers should meet the LAX Shuttle Bus "Lot C" on the Lower/Arrivals level island under the sign for LAX Shuttle to travel to the rental car terminal.

Click on the following for a list of rental car companies serving LAX. [Rental car serving LAX]

Click the image above for Waiting Area Map

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Page 1 of 1Rental Cars

6/19/2009http://www.lawa.org/welcome_lax.aspx?id=1294

“Legalfigher” is Deluxe Rent A Car – This is his Written Assault on me

Kevin

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So.... After lying, stealing, forgery and verbal abuse... John Hennessey wants to see "Me" in court and call me names

RICHELLE L. KEMLER [email protected]

In Reply Refer To: D191-1

August 4,2008

VIA E-MAIL AND U.S. MAIL

Kevin Powell 22320 Harbor Ridge Lane #2 Torrance, CA 90602

Re: Deluxe Rent a Car

Dear Mr. Powell:

This firm represents Deluxe Rent-a-Car and its president, John Hennessay. Mr. Hennessay learned just last Wednesday, July 30,2008, of your extreme dissatisfaction with the vehicle you rented from Deluxe on or about June 5,2007 through June 26,2007. On behalf of Mr. Hennessay, we extend our sincere apologies for your unfortunate experience and wish to try to make amends for the problems you encountered.

Because the rental took place more than one year ago now, we have no way at this time to verify your complaints and compensate you for that vehicle rental. We can tell you that the condition of the car you have described is below Deluxe's accepted standards, it was a mistake to have issued you a car in that condition, and for that our client extends his sincere apology. On the other hand, one complaint that we must take issue with is your accusation of fraud. That is a very serious accusation, and we are confident that none of our employees would have forged your signature, especially when your signature was not required on the form you allege was forged.

Nevertheless, we wish to rectify this situation. As such, please let us know what we can do to settle this unfortunate matter.

Sincerely,

GLASSMAN, BROWNING, SALTSMAN & JACOBS, INC. >-

By: & k c ~ / & RICHELLE L. KEMLER

w

Kevin

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Kevin

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Deluxe & Carrentals.com Fraud Analysis

Hertz www.hertz.com • Hertz (28.0% market share) Enterprise www.enterprise.com • Enterprise Avis www.avis.com • Avis (21.4% market share) Thrifty www.thrifty.com • Thrifty (3.7Budget www.budget.com • Budget (10.5% market share) • Others ‐ (1.6% market share)Alamo www.alamo.com • Alamo (10.5% market share) Advantage www.advantage.com National www.nationalcar.com • National (12.1% market share) Fox www.foxrentacar.com Dollar www.dollar.com • Dollar (8.5% market share) Payless www.paylesscarrental.com

Carrentals.com ‐ Web ClientsLAWA Approved

Daily Rate 1 Wk Rate W/Taxes Tax & Fee CA Tax Tour TaxNo $190.40 $248.53 $56.13 $21.66 $4.76

$362.69 $441.92 $79.23 $38.45 $9.07

Airport Van Rentals N/A Does not rent Automobiles

Economy Yes $243.70 $311.88 $68.18 $22.54 $6.09Luxury $425.40 $536.98 $111.58 $39.35 $10.64






Economy Yes $72.86 $509.99 $641.82 $131.83 $47.17 $12.75Luxury $80.28 $561.99 $706.24 $144.25 $51.98 $14.05


Economy Yes $76.00 $531.99 $669.07 $137.08 $49.21 $13.30Luxury $581.99 $731.02 $149.03 $53.83 $14.55


*** All Companies listed on carrentals.com are on the list of LAWA's approved agencies ‐ therefore, we can conclude that all of the business from cThis means a) The "State of California's" direct loss of tax revenue due to this fraud is between $117,573 and $223,964 annualy b c) The LAWA's direct loss of ACRF funds amounts to between $1,077,000 and $2,051,577 d) Th

*Carrentals.com currently has figures that don’t match invoices … incorrect tax calculation and fees for other co. See O/F

* U/P Tax = Unpaid tax based on corrected rental price adjusted with fraudulent ACRF fee

Weekly Analysis /

National

Deluxe

Avis

Hertz

Payless

Fox

Enterprise

Thrifty

Budget

Dollar

Alamo

(3.7% market share) Low High CA Tax 9.25%% market share) 13.10% 27.00% Tour Tax 2.50%

1‐Time LAWA $10.00 Vehicle Licensing FeeFleet ‐Size 1,400 Economy Car CostRental % 70.00% Luxury Car CostActive Rentals 980

LAWA $10 ACRF‐11.1% O/Fees

Low ACRF High ACRF U/P Tax LOW

U/P Tax HIGH

U/P CFC FEE ACRF

Unpaid CA. Tax

$0.00 * $21.13 * $0.00 $24.94 $51.41 $2.31 $4.76 $10.00 $24,443.55 $2,261.03$0.00 * $40.26 * $0.00 $47.51 $97.93 $4.39 $9.06 $10.00 $46,562.14 $4,307.00

LAWA‐ACRF Tax Dif

$10.00 27.05 $2.50 $0.88 $26,509.00 $864.60$10.00 47.22 $4.38 $0.90 $46,275.60 $881.51

$10.00 27.61 $2.55 $1.34 $27,057.80 $1,317.86$10.00 47.77 $4.43 $1.36 $46,814.60 $1,334.76

$10.00 47.48 $8.66 $17.87 $46,530.40 $17,516.10$10.00 52.64 $9.60 $5.37 $51,587.20 $5,267.16

$10.00 48.15 $4.45 $18.43 $47,187.00 $18,061.82$10.00 56.88 $5.26 $8.91 $55,742.40 $8,730.89

$10.00 48.15 $4.45 $18.43 $47,187.00 $18,061.82$10.00 56.88 $5.26 $8.91 $55,742.40 $8,730.89

$10.00 54.05 $7.82 $25.50 $52,969.00 $24,994.73$10.00 56.88 $11.30 $13.52 $55,742.40 $13,254.33

$10.00 56.61 $5.30 $25.51 $55,476.71 $25,003.79$10.00 62.38 $5.84 $13.53 $61,133.27 $13,263.39

$10.00 55.32 $8.01 $26.61 $54,213.60 $26,082.53$10.00 60.58 $8.77 $14.41 $59,368.40 $14,125.48

$10.00 48.15 $16.42 $27.55 $47,187.00 $26,998.09$10.00 56.88 $13.77 $15.38 $55,742.40 $15,076.39

$10.00 59.11 $5.47 $27.60 $57,927.80 $27,043.42$10.00 64.66 $5.98 $15.43 $63,366.80 $15,121.72

carrentals.com (90%‐95% of Deluxe's business) would have gone to one of those 10 companies b) The "State of California's" indirect loss could be between $162,533 and $1,523,831 he LAWA's indirect loss is between $1,378,468 and $3,295,074 that would have been paid by "Approved Agencies" Fees column for discrepancies

Assumptions

/ Car Weekly Fraud Results

ACRF FRAUD

$1,378,468 #####

Car Cost LF Total/ VLF U/B / Day$19,000.00 ##### $0.26$30,000.00 ##### $0.41

Unpaid Tax due California

Direct LAWA Loss Total Fraud Loss

$117,573 1,077,009.02 $1,194,582.51 Actual Fraud Committed By Deluxe Rent‐A‐Car$223,964 2,051,577.75 $2,275,541.65

+ Tax Loss + LAWA Cost ACRF Fraud Cost Net Effect of the Fraud Commmited By Deluxe Rent‐A‐Car

$162,533 1,378,468.00 $1,541,000.95 *** Low End ‐ Estimate ***$163,412 2,406,331.20 $2,569,743.21

$186,102 1,407,005.60 $1,593,107.55$186,981 2,434,359.20 $2,621,340.21

$1,028,411 2,419,580.80 $3,447,991.67$391,466 2,682,534.40 $3,074,000.05

$1,056,788 2,453,724.00 $3,510,511.94$571,580 2,898,604.80 $3,470,184.75

$1,056,788 2,453,724.00 $3,510,511.94$571,580 2,898,604.80 $3,470,184.75

$1,417,299 2,754,388.00 $4,171,687.37$806,799 2,898,604.80 $3,705,403.37

$1,417,771 2,884,789.03 $4,302,559.78$807,270 3,178,930.15 $3,986,200.10

$1,473,865 2,819,107.20 $4,292,972.17$852,098 3,087,156.80 $3,939,254.99

$1,521,474 2,453,724.00 $3,975,198.35$901,546 2,898,604.80 $3,800,150.75

$1,523,831 3,012,245.60 $4,536,076.85 *** High End ‐ Estimate ***$903,903 3,295,073.60 $4,198,976.45

Annual Results ‐Fleet

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Hello Kevin, Yes, The Judge can call me at anytime (310-444-1574) for facts regarding Deluxe. The District Attorney's final reveals the follow "Former employee of Deluxe Rent A Car is being framed by her employer. No evidence to indicate that defendant forged a customer's signature." As previously mentioned, this information is available for court but the actually report / notes can only be presented in court as they have not yet been charged with a crime! Have a wonderful weekend. Detective T. Gipson >>> <[email protected]> 6/12/2009 11:06 AM >>> Hi Tim I talked to Deluxe's attorney and she was supposed to be working on a continuance in the case and I was expecting Deluxe's attorney to respond before today, but unfortunately my daughters graduation was yesterday and my nephew graduates from High School today and Deluxe has yet to respond. This means I haven't had or have the time to file the "ex parte" request as planned. I am putting together a request to ask to have it removed from calender pending retention of council and to allow for me to finish gathering the info on the "newest" fraud they are commiting. I haven't been able to catch up with you on the notes or whatever you can document on the steps they took to avoid producing the documents they forged and how it mysteriously disappeared. I want to ask the judge to make an order preventing them from destroying documents and I believe that your input on this company will be helpful. I am actively investigating the option of refiling this case under "California False Claims" statues. The DA won't pursue the fraud on this case because they destroyed the document they forged but if I can file under this the Attorney General is mandated to do so within 60 days. I have given the LAWA this information, the city attorney, written the Mayor, and even the Governor and nobody wants to do anything about it or sees in terms of nickles and dimes. These whistle blower statues or the simular tax ones appear to be viable options but as the re have been less than ten thousand of the cases filed finding an attorney has harder than I expected. As this is a specialty the attorneys so far know less than I do about it and I have to explain to them why they are wrong and quote the case law, or they are so large that the $2-4million in fraud isn't worth their time as they go after the $Billion frauds. Although the law requires that the person who commits the offence is chaged "treble" the damage and the agency get a third, the prosecuter gets 1/3, the "original source" gets 1/3. As the original source of both the ACRF fraud and the new info on their newest fraud I sent to you the other day, perhaps I may be able to actually recover something for the 100's of hrs this case has taken from me and get justice served at the same time. It's been a eye opening experience to me. I cant believe I can document a fraud, provide proof to multiple government agencies that the fraud exists and demonstrate using plausible numbers a fraud that indicate the following ... “The "rentals" subject to the tax include any payments required by the lease…. ”

From: TIM GIPSON <[email protected]>To: [email protected]

Subject: Re: DeluxeDate: Fri, Jun 12, 2009 1:54 pm

Page 1 of 3Re: Deluxe

6/15/2009http://webmail.aol.com/43471/aol/en-us/mail/PrintMessage.aspx

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Local Policy Information Print This Page

YOU ALWAYS SAVE MORE BECAUSE DELUXE DOES NOT CHARGE ANY EXTRA AIRPORT FEES LIKE OTHERS........YOU WILL ALWAYS RECIEVE A TOTAL PRICE WITH NO SUPRISES. AFTER YOU COLLECT YOUR LUGGAGE, EXIT THE TERMINAL AND GO TO THE OUTSIDE ISLAND UNDER THE RED SIGN THAT READS HOTELS AND COURTESY SHUTTLES. BOARD THE WHITE JOHNNYPARK SHUTTLE at C THAT WILL BRING YOU TO OUR FACILITY.....WE ARE OPEN 24 / 7 Minimum age for renters and drivers is 21. Renters and drivers under the age of 25 are subject to an underage charge of $20.00 per day. .........NO LOCAL RENTERS...........................YOU may be asked to HAVE A RETURN AIRLINE TICKET TO RENT WITH US............DELUXE IS AN AIRPORT CAR RENTAL COMPANY. only access is from LAX . No walk ins allowed. RENTALS........................................................................Renters must have a valid return Airline ticket in their name departing from LAX. Debit cards: Debit card only accepted at time of rental when presented with the return flight segment of a round trip airline ticket in the renters name. .... Debit card must have available funds of $400.00 plus total estimated rental charges. Unused funds will be returned through the credit card processor after vehicle return. Due to bank processing it can take up to 14 days to appear back on your account when using this form of payment, additional fees and restrictions may apply....................................................................... State of California requires that all renters have Liability insurance. Deluxe requires all renters to have insurance to cover damage to our rental car. Residents living in the U.S.A or Canada please bring with you your insurance card issued by your auto insurance company. If you did not bring this proof with you, you will be required to fill out a statement of insurance form that Deluxe will provide. .Deluxe Rent A Car is an Airport Only Car Rental Company.. NO LOCAL RENTALS. Renters must have a valid return Airline ticket in their name departing from LAX. Our company is not insured or set up to service the local customers.. Any violations of the rental contract will cause your rate to change. Rate changes will be determined by the management. MPG information is highway miles from Manufactures web site. International Drivers, other restrictions or fees may apply. .......... Additional drivers must have a valid drivers license and the additional proof of insurance required by renter. Major credit cards: Valid drivers license and credit card must be in the same name. Credit card must have available funds of $300.00 plus estimated amount of rental charges. Unused funds will be returned through the credit card processor after vehicle return. Due to bank processing it can take between 2 to 5 days to appear back on your account when using this form of payment. Cash payments also accepted at end of rental. .............................................................................. Reservations will be honored for a period of four hours after the confirmed pick up date and time. Vehicles must be returned with the same amount of fuel as at the start of the rental to avoid refueling charges. All renters must have a return airline ticket in their name departing out of LAX no latter than 28 days from the rental pick up date. Renters are only allowed to drive in the state of California, Nevada and Arizona.

Page 1 of 1CarRentals.com - Local Policy Information

8/11/2008http://www.carrentals.com/localPolicy.jsp?vendor=21&pickupCode=19737_LAX

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Note the bold print showing their attempt to "Spin Control" and their new policies.... This happened within 7 days of their exposure

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An Airport Only Rental company... without airport access and not paying the ACRF fee. This creates a unfair competitive advantage against everyone who follows the rules That's a direct violation to the intent of what the legislators put into place to raise funds for the expansion of the airport. By-passing the law and then defrauding thousands of people to the tune of a few hundred thousands of dollars per year is egregious and is not only stealing from the innocent consumer... It's stealing from the State of California

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Join the Deluxe Rent A Car Revolution and say NO to additional Airport taxes and fees. Through special contracts with the Los Angeles Airport, Deluxe Rent A Car at LAX no longer needs to charge our valued car rental customers ANY additional Airport fees or taxes that other car rental companys charge. You will only pay sales tax and the standard California 2 ½ % Tourism fee, this is a savings of over 30% off your total rental bill in most cases when compaired to others. Shop around and compare our TOTAL COST with other car rental companies at LAX, then return to our site, pick out one of our 16 discount coupons found on our site under DEALS and book on line and save.

We are still located at our LAX location and adding even more of the cars you like to rent, like the new Hondas and Toyotas. Our new 2,500 sq ft state of the art customer service lobby should be ready soon to serve our ever growing customer base. NEWS FLASH !!!! Deluxe Rent A Car voted the Best Deal and Fastest Growing car rental company at the Los Angeles Airport for 2008. “Book Now” says Jonathon Drake EVP," I have never seen rate increases like this in my 34 years in the business". Mr. Drake goes on saying, “ in the coming months there will be a large imbalance of supply vs. demand at most airports world wide. The big 3 car companies have cut production over 50% and the major car rental companies will have a very hard time finding cars to replace their older fleet. The major car rental companies will be running older cars with much higher miles, and with most of the them not having their own maintenance departments, will find managing their fleets to be a difficult task. Deluxe is in a great position to take advantage of this as our fleet needs are not as great as

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2/10/2009http://campaign-archive.com/?u=f4c9c2127e84103f76f524f33&id=71a5fb87e6&e=21686...

the large car rental companies and as we always have done in the past, we go directly to the retail dealers and buy new cars right off the lots". Also, says Mr. Drake," Deluxe has its own in-house, full service maintenance facility, staffed with factory trained and certified technicians. With the combined synergy from our sister company "johnnypark" (our airport parking company) and our new lower cost “no airport fees total pricing”, Deluxe Rent A Car is your ticket to great savings at the Los Angeles Airport".

You are receiving this one time email because you are a customer of Deluxe Rent a Car at LAX Unsubscribe [email protected] from this list. Our mailing address is: Deluxe Rent a Car 11101 hindry ave los angeles, ca 90045 Our telephone: 310-338-3370 Add us to your address book Copyright (C) 2009 Deluxe Rent a Car All rights reserved. Forward this email to a friend Update your profile

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no buddy the owner is so freakin greedy , he wont give u nothing, he give commission cuz as rental agent we sell insurances which i doubt he got any , but all the rental company pays commission , anyway lets meet up somewhere buddy n talk? i can see u in person and from the impression i will get the idea about u, and if u were honest person as u seem like it then i will stand with the truth. but there is no commission on ACRF , that money is straight in his pocket , its suppose to be for LAX but Mr. John loves to steal and that's why he has team of lawyers and that's one of the reason i don't wanna work for him. later In a message dated 5/23/2009 1:19:30 P.M. Pacific Daylight Time, ThePlatinumLife writes:

I am very curious as to how did the commission structure worked at Deluxe and if it was tied into the ACRF fee.

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From: [email protected]: [email protected]

Subject: Re: Commission structureDate: Sat, May 23, 2009 6:44 pm

Page 1 of 1Re: Commission structure


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No they have nothing against me, I didn't work with any of their stuff, they know that , and they never made me sign any paper, i just got my check even after 1 week of termination, legally it should be within 24 hours but I don't mind those little stuff, Plus I don't wanna fight for myself, i rather fight for other people. In my life i always fight for others and try to forgive people who did wrong to me. The reason i am with u on deluxe cuz they ripped off 100s of customer and the greedy owner will never stop, so that's y i wanna stop him to rip off other people in the future. About that employee froged the paper n lost it is all bollshit, employees has nothing to deal with paper and contracts. its all there with managers and goes to corporate office. later In a message dated 5/31/2009 9:24:05 P.M. Pacific Daylight Time, ThePlatinumLife writes:

Do you have copies of your e-mails ? With this and the termination without cause you have a wrongful termination case with federal protection... he will be screwed. And better believe they will have a ton of negative shit to say about you. When the investigating detective demanded they provide the "disappearing" original document that they "didn't forge" they lost it and blamed it on a employee they fired at that worked there when it happened. When did you start and When did they fire you ? Did they make you sign paperwork about your termination ? there are steps that mudt be taken or they have failed to follow rules and they are exposed to litigation. This could be great !!! http://www.deluxerentacar.info/index2_frame.htm This communication and any files or attachments transmitted with it may contain information that is confidential, privileged and exempt from disclosure under applicable law. This communication is intended solely for the use of the individual or entity to which it is addressed. If you are the intended recipient of this information, please treat it as confidential information and take all necessary action to keep it secure. If you are not the intended recipient, you are hereby notified that any use, dissemination, forwarding, or copying of this communication is strictly prohibited. If you have received this communication in error, please notify the sender at once so that appropriate action may be taken to protect the information from further disclosure. Kevin Powell -----Original Message----- From: [email protected] To: [email protected] Sent: Sun, 31 May 2009 7:56 pm Subject: Re: Deluxe I got terminated with no reason, I think the main reason was that I never like ACRF or other charges such as International Driver license Fee , and Local policy that they were discriminating local renters cuz Deluxe owner said that they steal a lot of cars, and when he will have so many cars standing n no one renting then he will welcome local again. I dont like to quit cuz i am a challenger and never give up on anything. I was fired cuz they manager likes those who listens to his stories of previous jobs n experiences rather then hard working and dedicated employees. I was the top performer in deluxe and there best salesman ever. In those 11 months i never ripped off a single customer nor did i steal any money from company. Deluxe knows about my honesty. but in California they can let u go anytime for no reason. I personally avoid confrontation with my job place and always leave with good will. I left the company with respect and i am sure the owner and manager will not say anything bad cuz i never give them a chance. Anyway u r fighting a just cause and i will do my best i can to help u. Take that Carrentals.com seriously and do ur best the first thing to take deluxe out of that site. Once they r out from there then they will be finished. later


Subject: Re: DeluxeDate: Sun, May 31, 2009 9:38 pm



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that's great work, the way he was scamming customers he deserves that and this is one of the reason i am no longer in that company, i am honest and straight forward guy and i think working in deluxe for 11 months was stilla lot. The ACRF i removed that on him, i sent him email and told him that when we sell insurance the ACRF goes high and on some contracts the ACRF was over 200$ and those poor international customer who came to Deluxe to get a cheaper and better deal the others which carrentals.com advertises would get ripped off in ACRF . I told the managers a few times about ACRF but even the general manager didn't do anything, and finally i have to put my job online and send email to owner to remove it or lower it. If u really want to go after this Scammer John then the best thing will be to do something to remove him from Carrentals.com web site and once he is out of there, he will have to shut down his business. Carrentals got a lot of complains from customers but they r still there, u should put the power from Attorney side or any other way to take Deluxe rent a car out of Carrentals.com then they wont get no customer , they will have to shut down this scammer company. thx for the email later

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Subject: Re: DeluxeDate: Sun, May 31, 2009 3:20 pm



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Fraud, Forgery False Advertisement & Deceptive Trade Practices

Here is was my “guaranteed clean, comfortable and affordable vehicle”

This was a “Guaranteed 2007-2008” Vehicle – But was 2006 – With false Registration

Dear Mr. Powell, Your request for information was forwarded to our City Attorney's office for a response, since it involves pending litigation and because their office is the designated point of contact for all such requests. Speaking personally but not for LAWA, I can say however that LAWA has no contractual relationship with Deluxe rent a car, "special" or otherwise. This means that 1) Deluxe may not operate its own courtesy shuttle vehicles in the LAX central terminal area to pick up its customers; and 2) that they may not charge customers a "airport concession fee" which on-airport rental car concessionaires (e.g. Hertz, Avis, Dollar) are entitled to do. Note that Deluxe utilizes the services of its sister company - Johnny Park - as a means of picking up its customers at the terminals. We view this as somewhat of a loophole in Johnny Park's permit which we hope to soon close. Also note that the "airport concession fee" is defined in Section 1936.1 of the California Civil Code; it allows, but does not require rental car companies to charge such a fee if they hold a concession contract with an airport wherein they pay the airport a concession fee. Charging such a fee without holding a valid rental car concession contract would be considered a violation of the statute, which is why we have forwarded information on companies who have done this to our City Attorney's Consumer Fraud unit for investigation and possible prosecution. I cannot say however whether the City Attorney, District Attorney or Attorney General would be the appropriate entity to charge violators of this state statute. I am available to speak with you if I can be of immediate assistance. However, a letter from our City Attorney's office would be much more useful to you in any litigation against Deluxe. Personally I would view the ad below as deceptive, but technically it doesn't appear to be illegal. However, as a non-lawyer, that's just my personal opinion - not speaking for LAWA. -Mark Miodovski LAWA Concession Services Division (310) 646-3987

From: [email protected] [mailto:[email protected]] Sent: Thu 2/26/2009 6:56 PM To: MIODOVSKI, MARK R.; LANGLOIS, MEIGHAN J.; STROUSE, MICHAEL Subject: Fwd: Summer Specials at Deluxe Rent a Car (LAX) To: LAWA Michael Strouse, et al Fr: Kevin Powell I have recieved this e-mail today and would like you to please review it. Deluxe is advertising that they have reached a special agreement with the LAWA and "no longer has to charge any airport fee or taxes". As they never had to or were even allowed to charge or collect this tax I am confused about this ad. I would like to know officially if they have truly reached an agreement with the LAWA. Also, I sent a request for information regarding Deluxe Rent A Car a week ago and I have not recieved a response or even an acknowlegement of reciept. Please let me know if there is an official channel to request the information I have requested, and the process to do so. Thanks

From: MIODOVSKI, MARK R. <[email protected]>To: [email protected]

Subject: RE: Summer Specials at Deluxe Rent a Car (LAX)Date: Thu, 26 Feb 2009 7:38 pm


Page 1 of 3RE: Summer Specials at Deluxe Rent a Car (LAX)


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They were going to rip off Ashley with the ACRF - Airport Cost Recovery Fee. - April 2008 - I expect that they have charged this to every customer since the unbundling occured

To: Los Angeles World Airport LANGLOIS, MEIGHAN J. <[email protected]> MIODOVSKI, MARK R. <[email protected]> Michael Strouse, et al Re: Deluxe Rent A Car – ACRF Fee. Fr: Kevin Powell 310-259-2240 This is an official request for a statement of facts in regards to “Deluxe Rent a Car”. Background I rented a car from Deluxe Rent-a-Car on 6-05-07. I was rented a car with expired tags that led to me and my children being stopped by the police. I refused to pay the rental as no manager or owner to this date has ever responded to a single call to address my issue. This dispute through my credit card resulted in “Deluxe” forging my signature and my bank declining my dispute. I have since filed a complaint with the LAPD in which Deluxe is trying to push off on an employee that can’t be found and would have gained nothing from doing so. In review of the forged documents I noticed a $43 13% ACRF tax I had never paid attention to and called them. They informed me that it was a Airport Concession Recovery Fee the tax that the airport charges to everyone. As a Torrance resident I was surprised as I had not used the airport facility On or about August 4th 2008 I contacted the LAWA and spoke to Michael Strouse for more information on how this worked. I was informed in no uncertain terms that “Deluxe” not charged this tax. As they were using Johnny Park’s shuttles to pick up customers they are charged $1.50 per person on a “Honor System”. After what I have found out about this company that in itself is a joke, as this company has no ethics. Although the LAWA was aware of the loophole they were exploiting they were not aware that they were charging this tax. The LAWA turned this over to the LA City Attorneys office and the criminal aspect is being handled by James Santistaban. [email protected] Other People After having this issue with “Deluxe” I researched them and found many complaint as to the unethical nature of this company and many allegations regarding paying more than they agree through gas scams, additional damage claims, midnight dim lit inspections and subsequent damage claims. I put up my site to inform people and to find others in the same position. I have been contacted by multiple persons including Ashley from Texas who came to Los Angeles to attend a 3 day concert. Ashley like me was also rented an expired tag vehicle and charged a 13.3% ACRF fee. Her guaranteed 2007-8 car was a 2006 with tags that expired 1yr previously and false documents in the window. This led to her being pulled over, the car being impounded and missing most of her 1st day at the concert and one of her favorite bands. This vacation long planned and saved for was ruined. If that wasn’t enough, Deluxe then promised to take care of the ticket and lied. As it was their car and she had no way to cure the expired tag issue and she

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lived 2000 it was fair to believe they would do so. They didn’t and it became a $900 ticket and a collection notice issued and a threat to suspend her license. This never was corrected by Deluxe. I have since been contacted by a few people who have also been charged this fee and have attached their receipts for your review. This shows a pattern that leads me to believe that they fully intended to use the tax to enhance the profit margin on their unfairly marketed low prices. Dani a regular renter of deluxe was charged fees that ranged from 13.3% to 27%. They have created an unfair advantaged that has taken business away from legitimate car rentals and worse yet the LAWA. With 450 cars @ $40/day x 13.3% = $2394/day or $873,810 per year “Bilked” from not only the consumer but also from the LAWA’s fund. With a revenue of $50,000,000 this still is a large chunk of money that could be allocated elsewhere. Legal Issues My original intent was to file a class action suit and request the Judge to enjoin them from these practices, order a independent agent to audit and refund the money to all that could be located and the rest be given to the LAWA and punitive award to be equal to what the defrauded the public and the LAWA for and give it to the LAWA. I learned that a class action is difficult to get done and as a private citizen I don’t have the right for that award. I have since filed a suit in conjunction with Ashley. Timeline July 28th 2008 My site went up. http://www.deluxerentacar.info July 31th 2008 Deluxe became aware of my activities August 1st 2008 Deluxe threatens to sue me on http://www.youtube.com/deluxerentacar and

call me “a scum bag” and to “have Micky D deliver another big mac to your fat ass.” August 4th 2008 I am contacted by their Attorney and I inform them about the additional

ACRF violation I discovered and Ashley’s problem. I ask them to make a fair offer and set up a program that returns the money bilked.

August 8th 2008 I end all communication and continue what I was doing. August 9th 2008 I videotape their activities and talk to their clients. They are now beginning

to give unexplained ACRF refunds to people returning the vehicles August11th 2008 Deluxe and Car rentals change the site and remove the ACRF fee. August 13th 2008 Deluxe reinstates the fee but renames it to an Airport fee in a attempt to hide

the offence and continue to commit consumer fraud

November 26,2008. My attorney gave notice of our intent to sue and to seek an injunction to prohibit their behavior.

December 15th2008 In a letter in regards to my case they claim “Although in the past Deluxe

did charge an ACRF tax. it has long since changed its policies and no longer does.”

Here is the really interesting part, in January this year I am contacted by Dani a long time renter of Deluxe who is upset over her treatment by “Deluxe” She sent me her receipts and the review was very informative as to the nature of their conduct and ethics. I have included this for your review. But this is of note :

1) Between 3/10/2008 and 12/17/2008 Dani rented from Deluxe 8 times with these taxes ranging from 13.3% to 27.62%.

2) Although Deluxe claims to have cease these behavior “a long time ago” they had

manipulated the fee, hidden it renamed it and even increased it to 27.62%.They continued to do so until 12/11/2008 two weeks after receiving notice of this suit.

I was contacted last month by a person who is a friend who had also rented from “Deluxe” and was charged an ACRF fee. She also was sent an interesting advertisement which states “

“ Join the Deluxe Rent A Car Revolution and say NO to additional Airport taxes and fees.”

“ Through special contracts with the Los Angeles Airport, Deluxe Rent A Car at LAX

no longer needs to charge our valued car rental customers ANY additional Airport fees or taxes that other car rental companys charge.”

“ You will only pay sales tax and the standard California 2 ½ % Tourism fee, this is a savings of over 30% off your total rental bill in most cases when compaired to others.”

Conclusion As Deluxe never had the right to charge people I am concerned about this ad. Through a concentrated effort and a unfair advantage they have position themselves to be the lowest price on carrentals.com and with a review section that has no access to add to complain and show only positive reviews this company has scammed many people. They now solely rent to travelers eliminating many issues for them. A traveler who must take a flight out of the state or country is unlikely to fight a charge and less likely to file suit or go through all the steps I have had to endure. Even with everything I have documented and presented it has taken this massive undertaking to get here. The horror stories on the internet show a company who has a pattern of abuse similar to ones you hear about in “Mexico”.

MySpace

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My boyfriend and I decided last minute to attend the Coachella 3 day music festival in Indio, CA. so we flew into LAX back on April 25th and flew out 4 days later. We were rushed for time since we missed our original flight on the 24th and we had to pay the airline an additional $50 each to guarantee us on a flight for Friday and one of the main bands we wanted to see was Fri. night around 6pm.

We got into LAX around 1pm and immediately went to get the rental car...long story short..after a long wait to get the car and receiving the car, we drove only 16 miles (hour and a half in LA traffic) when we got pulled over by CA highway patrol and were told the car had registration tags that were a year expired. Even after we explained to the cop that it was a rental and he could see this on the papers he did not care and was overall not friendly. The car got impounded, I was given a citation and we had to wait over an hour for another car to be brought to us. We ended up getting to the festival super late and missed all the bands we wanted to see that 1st day of the festival. This incident pretty much ruined our vacation and caused stress between my boyfriend and I the rest of the time. When we went to return the vehicle I told the manager I did not want to pay for the car and that they needed to pay for the citation. The manager was actually friendly and comped the bill. I brought the car back on empty and didn't pay that either. A lady from another dept. came out and took all the info. from the citation and said it would be taken care of.

Three months later I get a notice in the mail for the Superior Court in LA for a bail amount of $808.00 for failure to show in court or pay the fines and that a hold was on my drivers license with the DMV and possible suspension if it was not paid. I called someone in the legal dept. at Deluxe and left a long detailed message and no one called me back. My mom has worked for many lawyers so she called and spoke to the office manager earlier today about the situation for me. The manager claims she will take care of the ticket but my mom is helping me draft a letter to the court to explain that this needs to be redirected to Deluxe since it is there car. I am also going to try and get compensated for our concert tickets and a few other things on my own, but if that doesn't work I'm going to try and find a lawyer.

That would be great if somehow there could be a class action lawsuit but I'm not sure how those work. I honestly don't know how that place stays in business with all the complaints and negative feedback I have come across online. If I had the money I would hire an attorney right now to sue them but I live in Texas and cannot afford an attorney :(

I can't believe they forged your name - that is ruthless.

----------------- Original Message -----------------From: KevinDate: Aug 6, 2008 5:31 PM

Tell me what happened and when I'd love to hear. I recieved a letter from their attorney on monday. Today the detective told me that they have failed to produce the original reciept that they forged. The more info I have the more I can do. I have the attention from the LAPD and the LAWA right now.

Kevin

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http://www.msplinks.com/MDFodHRwOi8vcHJvZmlsZS5teXNwYWNlLmNvbS9pbmRleC5jZm0/ZnVzZWFjdGlvbj11c2VyLnZpZXdwcm9maWxlJmZyaWVuZGlkPTM5ODc4NzYyMCZNeVRva2VuPTg2NmUwZmVkLWNlMDMtNGZmOC04MzBkLTYzMWVhNzFkMzg2Mw==

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She now has a $808 FTA on her record, a hold on her license and a potential suspension, and a potential collection mark on her credit.

I formally request a statement of facts from the LAWA which clarifies the following information and records which should be available to the public. 1) The date in which the unbundling began 2) Deluxe’s legal ability to have charged ACRF tax in the past 3) Deluxe’s past and current standing as being authorized to pick up from the airport 4) All information as to the agreement to which they make claims including date of

resolution 5) The terms, conditions and number of passengers Johnny Park claims per year for

themselves and for Deluxe and the total amount contributed to the LAWA each of the years post unbundling.

Thank You Kevin Powell [email protected] 310-259-2240

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since they removed the ACRF fee look at the 17.62% fee they charged

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Car Rentals FAQCustomer CareCar Rentals Home

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(LAX) Intermediate (2008 Civic,Advenger (36 Mpg) Or

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(LAX) Special (2008 Honda, Pt Cruiser (36 Mpg)

Or Similar)





(LAX) Economy (Hyundai Accent Or Similar)

Automatic Air Conditioning Unlimited Mileage

$28.95/day Total With Taxes $116.62

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(LAX) Compact

(Ford Focus Or Similar)



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(LAX) Intermediate

(Dodge Caliber [hwy 29 Mpg] Or Similar)



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(LAX) Standard (2008 Accord, Charger ( 31 Mpg)

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Automatic Air Conditioning

Special 10% Discount$43.81/day

Search 100% completed. Found 140 rates

Page 1 of 14CarRentals.com - Rental Search

8/10/2008http://www.carrentals.com/rentalrates.jsp?r=1218408840192

Kevin

Note

After Exposing them they removed the fee they have been charging 10's of thousands of innocent victims.

Car Rentals FAQ Customer Care

Car Rentals Home

Pick-Up

Sunday, August 17 10:00 AM LOS ANGELES INTERNATIONAL AIRPORT (LAX)

11101 S HINDRY AVENUE LOS ANGELES, CA 90045

Drop-Off Wednesday, August 20 10:00 AM

LOS ANGELES INTERNATIONAL AIRPORT (LAX) 11101 S HINDRY AVENUE LOS ANGELES, CA 90045

Car Type Full Size Special

2008 Charger/advenger (30 Mpg) Or Similar

* image represents sample car - actual may differ

Features Automatic

Air Conditioning Unlimited Mileage GUARANTEED

MODEL 2007 Or 2008!

Rate Information 3 Days @ $43.81/day

$131.43 Special 10% Discount Rate

3 Days @ $39.43/day $118.29

Estimated Taxes and Fees $9.76

Total Price= $128.05

Deluxe only services clients who are flying into LAX Airport. Renters must have a valid return Airline ticket in their name departing from LAX. No local renters. After you collect your luggage, please exit the terminal and go to the middle island. Look for the red sign that reads "Hotels and Courtesy Shuttle." Please wait there for a white shuttle-

van that reads (Johnnypark). The shuttle circles the airport every 15 minutes, and will bring you directly to the facility. If you have any questions, call 1-800-831-5556 from any phone for information.

Local Policy Information General Rental Rules

VendorDeluxe Rent A Car

Page 1 of 2CarRentals.com - Make Reservation

8/10/2008http://www.carrentals.com/order.jsp;jsessionid=BNMGDNBOKJCE?id=50&psid=BNMG...

Kevin

Note

Notice How they bypass the system...

Kevin

Highlight


Join the Deluxe Rent A Car Revolution and say NO to additional Airport taxes and fees. Through special contracts with the Los Angeles Airport, Deluxe Rent A Car at LAX no longer needs to charge our valued car rental customers ANY additional Airport fees or taxes that other car rental companys charge. You will only pay sales tax and the standard California 2 ½ % Tourism fee, this is a savings of over 30% off your total rental bill in most cases when compaired to others. Shop around and compare our TOTAL COST with other car rental companies at LAX, then return to our site, pick out one of our 16 discount coupons found on our site under DEALS and book on line and save.

We are still located at our LAX location and adding even more of the cars you like to rent, like the new Hondas and Toyotas. Our new 2,500 sq ft state of the art customer service lobby should be ready soon to serve our ever growing customer base. NEWS FLASH !!!! Deluxe Rent A Car voted the Best Deal and Fastest Growing car rental company at the Los Angeles Airport for 2008. “Book Now” says Jonathon Drake EVP," I have never seen rate increases like this in my 34 years in the business". Mr. Drake goes on saying, “ in the coming months there will be a large imbalance of supply vs. demand at most airports world wide. The big 3 car companies have cut production over 50% and the major car rental companies will have a very hard time finding cars to replace their older fleet. The major car rental companies will be running older cars with much higher miles, and with most of the them not having their own maintenance departments, will find managing their fleets to be a difficult task. Deluxe is in a great position to take advantage of this as our fleet needs are not as great as

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the large car rental companies and as we always have done in the past, we go directly to the retail dealers and buy new cars right off the lots". Also, says Mr. Drake," Deluxe has its own in-house, full service maintenance facility, staffed with factory trained and certified technicians. With the combined synergy from our sister company "johnnypark" (our airport parking company) and our new lower cost “no airport fees total pricing”, Deluxe Rent A Car is your ticket to great savings at the Los Angeles Airport".

You are receiving this one time email because you are a customer of Deluxe Rent a Car at LAX Unsubscribe [email protected] from this list. Our mailing address is: Deluxe Rent a Car 11101 hindry ave los angeles, ca 90045 Our telephone: 310-338-3370 Add us to your address book Copyright (C) 2009 Deluxe Rent a Car All rights reserved. Forward this email to a friend Update your profile

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08/04/08 Fr: Kevin Powell To: Richelle L. Kemler, et al John Hennessay Re: Deluxe Rent A Car aka Netstar Dear Richelle: Thank you for your letter. However for us to move further we need to eliminate the untruths, as that in fact is how we got to this place. I have attached files for you to review carefully. Take into consideration the following

1) Jonah your operations manager knew since the event occurred and the person I left multiple calls for, ignored my calls and to this day has never contacted me.

2) The person I spoke to on the phone refused to leave his name and accused me of causing

the flat tire that left me stranded.

3) I was given a car in that condition… and expired tags undisclosed to me. Leading to an encounter with the police and my 3&5 yr old children leaving them asking if were going to jail.

4) Jonah is the one who contested my formal dispute…. He was of aware of this and it is my

contention that he or one of his underlings committed the forgery not John. However it’s irrelevant corporate liability and accountability still stand.

5) Mr. Hennessay is being less than truthful to council when he says he just found out about

this on or about July 30th 2008. BBB Complaint - Company's Initial Response - Posted 06/26/2008 We apologize for the condtion of the car that was rented to Mr Powell. Sometimes we run very low on cars and we have to rent out cars waiting to be registreded. Mr. Powell was a local renter so he should have asked to swap out the car when another car was available. Our Business license is posted in our office. If Mr Powell refused to sign the rental agreement, they should not have given him a car. We are sorry for any incovenience that he was caused. We have never forged his name to anything we sent to his credit card. We answer all chargebacks to the best of our ability.

6) Are you aware of the numerous complaints there are online and at the BBB about your

client.

7) Today I contacted the LAWA regarding the $42 in airport tax charged n my receipt only to find out that Deluxe is not allowed to pick up from the airport and thereby are not charged an access fee. I WAS CHARGED 13.1% or $42 in airport fees and I live in Los Angeles. Deluxe and Johnney Park both owned by Netstar has the clients board the Johnney Park Bus when they land at the airport. There is in fact a $1.60 charge each way for this trip

totaling $3.20. Imagine the effect of his 450 cars rented to people who were “fraudulently charged” on average of $25@ 13.1% or $1462.50 per day. That adds up to about $553,812 per year. Please review your case law and statutes when taking issue to my serious allegations

8) While I can’t prove it, but I’m sure through IP tracing somebody can. Take note to the

response I received for my video by a person who joined within 2hrs and went to my site and my myspace.com/deluxerentacar page. This person had two video views – that day and attacked me http://www.youtube.com/watch?v=TK3bFGx_Ajo This was on the same day your client may have 1st became aware of my decision not to let my self be abused but definitely “Not of My Issue “

9) I have invested at least 100+ hours in this campaign to expose them, much gas, phone calls,

frustration and aggravation. You client is still claiming that the signature wasn’t forged… I wont get into details but you can see the obvious on the site as well as the attached file as would a jury.

10) I agree it was “shear stupidity” that caused someone to forge my signature, however it was

truly done. upon the police receipt of the original as I’m sure you still have in possession, the handwriting analysis under microscopic analysis will show that it wasn’t me. It simply doesn’t make sense that I would complain as I have and done and to document what I have done and then be stupid enough to sign the document. I’m obviously very confident what the results of the investigation will be. I am glad you are confident in your employees; I hope you are as confident as to the views of the jury. They will see the reprint that was submitted by fax violating “wire fraud act” that is missing the coupons as they were reprinted at another time when I was not there. – the accidental loss of this original would call into question the validity of you clients claim to innocence. Lets meet at the LAPD station with the original and turn it in together if you client is so sure. Then we can drop that issue in its entirety

With that said please re-review the information and if you were me…. How would you feel about the events as I see them and the work and money invested to get to this point and what it would take for you to sleep well and at peace at night ? Then you can make me an offer… Sincerely Kevin Powell

This is a rough draft of what I was thinking... I hope it helps to see where I am at . Attorney Kemler I have been giving thought to your letter. I understand that your client may or not have been aware of what was going on at his corporation. Obviously he is a busy man and may not be involved in the day to day operations of such. This is the reason he hires "Operations Managers" such as Jonah to run his companies. However this bad choice in of this "Operation Manager" has led to this situation. I would be hard pressed to believe Mr. Hennassey himself had any direct knowledge of what happened initially and of course would believe the person he trusted to run his operation over a stranger. However, I have read multiple complaints regarding Jonah and the way he chooses to operate Deluxe Rent A Car. I personally have been ignored by him and would bet he is the one who refused to give his name when I called. I was denied returned calls and it was him who addressed the Better Business Bureau. He was obviously either the one or the one who had somebody forge my signature. I would suggest that if they intend to stay in business at all that they start by removing the cancer that exist within the company and then appoint somebody who has the charm, personality and moral credibility to turn things around. Should I find myself without cause to continue my campaign, I would allow my existing site be changed but left up for 1 year and it would express the company's regret for any persons who have had a problem with your client's company and the contact person they can call directly to address the situation and make amends. This would have to be a real commitment and I will retain ownership of the site for the year and while they can control it and maintain it, I will maintain the right to approve or disapprove what goes on the site. This would give all injured parties time to find out and for matters to be settled. There will also be a link from company's main site to this one for people seeking customer resolution. Deluxe will assign a person responsible for all customer complaints who reports only to John and is independent from all actions of other employees. This provides transparency between the complaints and Mr. Hennassey. He will no longer be able to claim lack of knowledge. I will have free access to those files to guarantee that there is follow through for same 1 year the site is up. I also want a written and signed apology letter on company letterhead from him, obviously without admitting to issues creating liability. Also a written letter signed by managementfor any ligitimate claim processed by the new person In exchange I will agree to remove all video's, blogs, comments, links, post that are available for me to do so. Those that aren't I will repost and amend something to the effect of.... "After being contacted by John Hennassey directly and fully explaining the problems I encountered he has offered me a sincere apology and has corrected my matter. I believe him to be truthful in his commitment. Further he has stated "Netstar as the parent company of Deluxe takes responsibility for any and all actions of their employees, whether known or unknown as a result we have restructured our company to include a complaints department and changed operations management. We take your complaints seriously. If you have an issue with billing or any employee conduct please contact this department and we will do a thorough investigation of this complaint and make ammends". I will stop and drop all complaints including the impending airport tax issue. I will deny interviews and have no comment or an agreed


Subject: Deluxe Rent A CarDate: Wed, 6 Aug 2008 4:50 pm

Page 1 of 3Deluxe Rent A Car

8/15/2008http://webmail.aol.com/38265/aol/en-us/Mail/PrintMessage.aspx

script for any of the news organizations, and media I have previously contacted. I would of course sign a limited confidentality agreement of which we can negotiate. On my site I promised that this company would do business right or it would not do business at all. I stand by that commitment. You ask your client to make an offer of what he believes is fair compensation for emotional damage to my children, my efforts, time, lack of sleep,ect. to finally get his attention and make Mr Hennassey aware of these shortcomings within his company. I believe this is fair and will help Mr Hennassey protect his interest in the long run. Showing good faith I will stop all planned courses of action I have developed and stop all commenting on any sites as long as we are in negotiation. Also to show good faith from your client .... I was just contacted by a young lady named Ashley from Texas.

ASH myspace.com/baby_doll_ash Date: Aug 6, 2008 3:35 PM RE: Deluxe Rent A Car.... Body: I read your story on of those forums and I couldn't believe how many other negative responses were out thereby other people. I will tell you the whole story but I'm actually walking out the door right now to run a quick errand so when I return I will write back. Ashley ----------------- Original Message ----------------- From: Kevin Date: Aug 6, 2008 5:31 PM Tell me what happened and when I'd love to hear. I recieved a e-mail from their attorney on Monday. Today the detective told me that they have failed to produce the original reciept that they forged. The more info I have the more I can do. I have the attention from the LAPD and the LAWA right now. Kevin If you approve I will give her your number and have her contact you. Your commitment to make sure her complaint gets thouroghly investigated and resolved will go a long way in expiditing our negotiation. Kevin Powell 310-259-2240

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Attorney Kemler Re:Deluxe Rent A Car Per our conversation this afternoon and your company's stance to refuse to present an offer to me I have contacted council regarding the situation. I had hoped to see a good faith effort from your client to make amends and had offered an opportunity for client and council to offer a figure fair for this 16 mo. ordeal. Instead of the originally planned course of action and on the advice of un-retained council I have been advised to request the sum of $100,000 along with the previous rough draft demands as needed to modified based on already enacted changes. The information you seek in regards to the Airport Use Tax, Deluxe's licensing to access airport property, and Johnny Park's $1.60/ per person fee can be addressed by contacting Michael Strouse of the Los Angeles World Airport. Michael Strouse 310.646.2250 Office 310.646.5024 Fax Los Angeles World Airports-Landside Operations 7301 World Way West Los Angeles, CA 90045-5828 This is who verified my information regarding the fees and use of Johnny Park's shuttles to bypass Deluxe's inability to have airport access. And as such their subsequent inability to charge the 13.1% airport tax they charged me and the 13.3% they charged the person who contacted me yesterday Ashley. This is a separate issue from the criminal complaint previously filed for the forgery of my name and it has yet to be formally addressed. As the booking agent I have as of this time not addressed the relationship with CarRentals.com and the use of this company to book my rental and what their potential liability for their participation in this and other similar bookings. I am giving your client until close of business Friday to at least respond with contact stating his intensions. If I receive no response I will take it as a denial without counter a pursue my original plans and explore my other options starting this weekend as to not undue the momentum begun last week. Sincerely, Kevin Powell

It's time to go back to school! Get the latest trends and gadgets that make the grade on AOL Shopping.


Subject: Deluxe - Conversation Aug 7th 2008Date: Thu, 7 Aug 2008 6:29 pm

Page 1 of 1Deluxe - Conversation Aug 7th 2008


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64 • ARN NOVEMBER 2OO7

Recently, the Miami-Dade County Boardof Supervisors prevailed in a lawsuitchallenging an access fee for limousinesdropping off passengers at MiamiInternational Airport. That fee was $2.50per trip and did not apply to taxis operatingat the airport. A federal district court ruledthat the differential treatment was justifiedby the increased congestion caused bylimousines and their need for specialparking areas. The court also concludedthat the fee was not an unreasonableburden on interstate commerce.

This decision is one of the latestadditions to a long line of casesaddressing the legality of access fees foroff-airport companies. Access fees havebeen contested, on constitutional andstatutory grounds, in federal and statecourts throughout the country. This articleexplains basic principles that are nowsettled and offers suggestions for airportoperators who seek to generate revenuefrom access fees.

THE EVANSVILLE TEST

Modern access fee law largely hasdeveloped from a 1972 U.S. Supreme Courtcase involving two government charges on

commercial airline passengers and airlines.One of them, levied by the Evansville-Vanderburgh Airport Authority District,was a “use and service charge” in theamount of $1 per passenger enplaning acommercial aircraft operated from DressMemorial Airport. The airlines had tocollect and remit the charge, less 6%allowed for their administrative costs. Theairport authority devoted the revenue fromthe charge to construction, improvement,equipment and maintenance of the airportand its facilities.

The other charge at issue was a“service charge” imposed by the State ofNew Hampshire. That charge was leviedon airlines, but they were allowed to passit on to passengers. The charge was in theamount of $1 or $.50 per passengerenplaning an aircraft at any of the state’spublic airports, depending on the grossweight of the aircraft. Half of the revenuewent to the state’s aeronautical fund andthe other half went to the airportoperators in the form of unrestrictedgeneral revenues.

The U.S. Supreme Court upheld bothcharges against constitutional challengesfiled by several airlines. Those challengesinvolved claims that the charges violatedthe right to travel, that they intruded intoCongress’ regulatory jurisdiction overinterstate commerce, and that theydenied equal protection of the law. Thecourt characterized the two charges as afee for the use of airport facilities, and itsanalysis focused primarily on the airlines’interstate commerce argument. In thekey passage from its decision, the courtruled that a user fee is valid if it satisfiesthree criteria (commonly referred to asthe “Evansville test”):

• The fee is based on some fair approximation of use or privilege for use.

• The fee is not discriminatory against interstate commerce.

• The fee is not excessive in comparison with the government benefit conferred.

Unhappy with the result in this case,Congress enacted the Anti-Head Tax Actthe following year. Subject to a variety ofexceptions, that statute prohibits stateand political subdivisions from levying orcollecting a “tax, fee, head charge, orother charge” on any of the following:individuals traveling in air commerce; thetransportation of such individuals; the saleof air transportation; or the gross receiptsfrom that air commerce or transportation.As explained below, the statute has beeninvoked unsuccessfully in preemptionchallenges to access fees for off-airportrental car companies.

SETTING THE FEES

The Evansville test is highly deferentialto the business judgment exercised byairport operators in the establishment ofaccess fees. If a fee passes the test, it isirrelevant that some other formula mightreflect more exactly the relative use ofairport facilities by individual users.

Two federal court cases illustrate thisprinciple. In one, the Eleventh Circuit Courtof Appeals applied the Evansville test to theSarasota-Manatee Airport Authority’soff-airport rental car “user fee” forSarasota-Bradenton Airport (SRQ). Thatfee was 10% of gross receipts derived fromautomobile rentals to airport passengers.By contrast, hotels and motels werecharged a “courtesy vehicle fee” of $50 or$100 (depending on vehicle size) or $800per vehicle for an annual fee. The courtcharacterized the gross receipts formula as“imperfect.” It upheld the user fee,

The ABCs of Access Fees

BY TERENCE R. BOGA

consultant’s corner

ARN NOVEMBER 2OO7 • 65

however, on the basis that the formula wasnot an unfair approximation of the usebeing made of the airport facility.

More recently, a federal district court inVirginia applied the Evansville test to theNorfolk Airport Authority’s off-airportparking operator “privilege fee” forNorfolk International. That fee was 8%of gross revenues derived fromtransporting customers to or from theairport. Limousines, taxis and hotelvehicles were subject to a different fee.The court concluded that it was rationalfor the airport authority to impose apercentage-based fee on companies thatoperated almost exclusively tosupplement the airport’s existing services.

The Evansville test is not the onlystandard that must be satisfied for accessfees to survive constitutional challenge. Ifsuch fees are not rationally related to alegitimate government interest, they willbe invalidated for violating equalprotection rights or for resulting in adeprivation of property without dueprocess of law. This “rational basis review”also is highly deferential.

Airport operators thus enjoyconsiderable discretion with respect tothe amount and applicability of accessfees. Appropriate factors to consider inthe setting of the fees include:

• Fee amounts can be based on an approximation of the overall commercial benefit derived from the exploitation of the airport’s presence.

• Fee amounts can reflect the airport’sdebt service, equipment, maintenance and planned future development costs.

• Formulas can be flat rate, per trip or a percentage of gross receipts attributable to airport customers.

• Formulas can vary according to business type and vehicle size.

Neither the Evansville test nor rationalbasis review requires airport operators tomake formal findings when access fees areestablished. Still, airport operators shouldhave an articulable and credible justificationready in case a challenge is filed.

THE PREEMPTION MYTH

The most common statutory challengeto access fees is that they are preemptedby federal law. Virtually all suchchallenges have failed.

Most preemption claims to date have

been based on the Anti-Head Tax Act. Inone case, for example, a rental carcompany invoked that statute in an effortto invalidate the City of Palm Springs’access fee for the Palm Springs RegionalAirport (PSP). The Ninth Circuit Court ofAppeals concluded that neither the textnor the legislative history of the statutesuggests that it was intended to apply tofees on ground transportation service.Federal district courts in Louisiana andNew York have made similardeterminations.

Recently, two preemption claims havebeen asserted based on the InterstateCommerce Commission Termination Act of1995 (ICCTA). With various exceptions, aprovision in that statute prohibits state andpolitical subdivisions from levying orcollecting a “tax, fee, head charge, or othercharge” on any of the following: individualstraveling in interstate commerce by motorcarrier; the transportation of suchindividuals; the sale of passengertransportation in interstate commerce bymotor carrier; or the gross receipts fromthat transportation. This provision is similarto the Anti-Head Tax in more than justlanguage. Congress enacted this provisionin response to a U.S. Supreme Courtdecision upholding an Oklahoma sales taxon purchases of interstate bus tickets.

Neither ICCTA preemption claimsucceeded. In a state court case, theAppellate Court of Illinois determined thatneither the text, structure or history of thestatute indicates a congressional intent topreempt taxes on motor carrierdepartures from airports to nearby or out-of-state homes, hotels and businesses.The First Circuit Court of Appeals laterreached the same conclusion in a federalcourt case concerning an access fee onground transportation providers operatingat Boston’s Logan Airport.

ANTI-TRUST DEFENSES

Another, albeit less frequent, statutorychallenge to access fees is that theycontravene federal antitrust laws. Onedefense available to airport operators is theLocal Government Antitrust Act of 1984.That federal statute precludes claims formonetary damages for antitrust violations.

State statutes also can provide adefense. U.S. Supreme Court precedentmakes local government agenciesexempt from federal antitrust laws whenthey implement a clearly expressed state

policy. This exemption applies ifsuppression of competition is explicitlyauthorized by, or is the foreseeable resultof, the enabling legislation. The statelegislature’s intent is critical if the enablinglegislation lacks explicit authorization.

A comparison of two federal courtdecisions is instructive. One case involvedthe City and County of Denver’s access feeand operating regulations for off-airportparking companies that provided shuttlebus service at the former StapletonInternational Airport. The Tenth CircuitCourt of Appeals determined that Denverwas immune from an antitrust challengebecause Colorado law expressed a statepolicy of displacing competition in theoperation of airports and related activities,including off-airport shuttle bus parking. Amore recent case involved theSusquehanna Area Regional AirportAuthority’s award of an exclusivecontract for taxi pick up of passengers atHarrisburg International (MDT). Afederal district court ruled that the airportauthority was not immune from anantitrust claim because the enablingPennsylvania statute did not explicitly orimpliedly authorize competition-displacingcontracts. Ironically, the court stilldismissed the antitrust claim because onlymonetary damages were sought.

Airport operators thus should identifyany provisions in their state statutes thatauthorize displacement of competition.In California, for example, the StateAeronautics Act actually requires publicairport operators to limit or prohibit“destructive” business competitionwhen managing their facilities andgranting concessions.

CONCLUSION

Courts nationwide repeatedly haveupheld access fees against constitutionaland statutory challenges. These decisionsconfirm that access fees are a valuablemeans for airport operators to generaterevenue for operating, maintenance andcapital improvement expenses.

Terence R. Boga is a shareholder of thelaw firm Richards, Watson & Gershon inthe Los Angeles office. He is a member ofthe firm’s Transportation Practice Groupand provides general counsel services forthe Burbank-Glendale-Pasadena AirportAuthority. He can be reached at213.626.8484 or [email protected].

i .

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION m SESSMENT STANDARDS DIVISION m N STREET, MIC: 64, SACRAMENTO, CALIFORNIA IP.0. BOX 942879. SACRAMENTO , CALIFORNIA 94279-0001)

Telephone: (9161 445.4982

December 16, 1993

MEMBER Ftnt Dlsrrlct

BRAD SHERMAN second Dlarrlct. Los AmJercs

ERNEST J. DRONENBURG. JR Thtrd Dmrrct. San Oqo

MAl7iP.V K. FONG Fourth Dmrct. Los Arwda

GRAY DAVIS conmllw. s¶clamanm

BURTON W. OLIVER Erecuvvs Dlmctw

No. 93/75

TO COUNTY ASSESSORS:

RECENT COURT DECISIONS RELATING TO INTANGIBLES

Here are four recent court decisions that relate to the issue of intangibles. Three of the cases dealt with the assessment of possessory interests. The fourth case involved the valuation of a geothermal power plant.

For your information, copies of the following decisions are enclosed:

Countv of Oranqe v. Oranqe Countv Assessment Aopeals Board No. 1 (American :elevision and Communications Corporation) (13 Cal.App.4th 524)

2. Emil Shubat v. Sutter Countv Assessment Appeals Board No. 1 (Nor Cal Cablevision. Inc.) (13 Cal.App.4th 794, as modified February 24, 1993)

3. Countv of Los Anqeles v. Countv of Los Anqeles Assessment Aopeals Board No. 1 (Dollar Rent A Car Svstems. Inc.) (13 Cal.App.4th 102)

Freeoort-McMoran Resource Partners v. Countv of Lake (12 Cal.App.4th 634; iodified 13 Cal.App.4th 1066a)

If you have any questions concerning these decisions, please contact our Real Property Technical Services Unit at (916) 445-4982.

Sincerely,

2LPk Verne Walton, Chief Assessment Standards Division

VW: kmc Enclosures

524 COUNTY OF OlthGE v. ’ ORMUGECOUNTYASSESMENTAPPEUS BD.

13 [email protected] 524; - CaLRpdd - [Jan. 1993]

[No. G012151. Fourth Dist., Div. Thre-e. Jan. 28, 1993.1 x . .:$

COUNTY OF ORANGE, Plaintiff and Appellant, v. ORANGE COUNTY ASSESSMENT APPEALS BOARD NO. 1, Defendant and Respondent; AMERICAN TELEVlSION AND COMMUNICATIONS CORPORATION, Real Party in Interest and Respondent.

- ,

SUMMARY ,

The trial court denied a county’s petition for a writ of mandamus seeking to set aside a decision of a county assessment appeals board adopting the position of a communications company concerning the property tax on its

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Jonathan H. Cannon, Judge.)

The Court of Appeal affirmed. It held that, for purposes of determining the value of the cable television system, the trial court did not err in separating the company’s property into land and land improvements, fixtures, and personal property, rather than considering all of the company’s property as one appraisal unit for valuation purposes, since applicable law suggests there is no wrong in rationally dividing property into component parts for valuation purposes Further, the court held, the trial court did not err as a matter of law in rejecting the comparable sales and income approaches in establishing the property’s value. The court held that the selection of a particular method rests in the hoard’s discretion and is constrained only by fairness and uniformity. The board determined that the income capitalization method using the annual franchise rent was appropriate for the company’s possessory inter- it used the cost rephtcement approach to value the remainder of the property. The board found that neither the comparable sales approach nor the income approach was a reliable method for this property, and that the cost method was. When that is so, the court held, the cost method becomes preferable (Cal. Code Regs., tit. 18, 0 6, subd. (a)). (Opinion by Wallin, J., with Moore, Acting P. J., and Sonenshine, J., concurring.)

,

. ,._ _-.__--..-. _ -_._ --.- _---. ^*UI--rl.C s-a c rr-YCr- Y -- - ___ -em ----

COUNTY OF ORANGB v. 525 &UNGE COUNTY A!isalw APPEALS BD. 13 CaiAp~.4tb 524; - Cal.Rptr.2d - [Jan. 19931

\

HBXDNOTES

Classified to CMifor~G Digest of Official Reports

(la, lb) Property Taxes 8 42.~Assessment-Valuation-Cable Tele- vision System-Separation of Property Into Components.-A county assessment appeals board, for purposes of determining the value of a cable television system owned by a communications company, did not err in separating the company’s property into land and land improvements, fixtures, and personal property, rather than considering all of the company’s property as one appraisal unit for valuation purposes. Taken as a whole, neither Rev. & Tax. Code, 0 51 (taxable value of real property), in general, nor Rev. & Tax. Code, 9 51, subd. (e) (“real property” means that appraisal unit that persons in marketplace commonly buy and sell as unit, or which is normally valued separately), in particular, mandated appraisal of the property as a single unit. Appli- cable law suggests that there is no wrong in rationally dividing property into component parts for valuation purposes.

vision System-Valuation Approach-Appeal-Standard of Re- view.-On appeal from a judgment denying a county’s petition for a writ of mandate seeking to set aside the decision of a county assessment appeals board adopting the position of a communications company regarding the property tax on its cable television system, the appropriate standard of review was whether, as a matter of law, the board’s valuation method was arbitrary, in excess of discretion, or in violation of the standards prescribed by law, where the county’s attack was directed at the validity of that method. The Court of Appeal was required to look not to whether another approach might also have been valid or yielded a more precise reflection of the property’s value, but whether the method chosen was contrary to law.

(3) Property Taxes $42--Assessment-Valuation-Standard of Re- view.-If a party challenging a property tax assessment claims only that the assessment board erroneously applied a valid method of determining full cash value, the decision of the board is equivalent to the determination of a trial court, and the trial court in turn may review only the record presented to the board. The trial court may overturn the board’s decision only when no substantial evidence supports it, in which case the actions of the board are deemed so arbitrary as to constitute a deprivation of property without due process. On the other hand, when the party challenges the validity of the valuation method

526 COUNTY ORANGE COUNTY ASSESSMENT APPEAS BD.

13 Cal.Apjutth 524; - Cal.&mti - [Jan. 19931

itself, the trial judge is faced with a question of law. The question is whether the challenged method of valuation is arbitrary, in excess of discretion, or in violation of the standards prescribed by law.

(4) Property Taxes 0 42.2-Assessment-Valuation-Cable Television System--Valuation Approach .-A county assessment appeals board, for purposes of determining the value of a cable television system owned by a communications company, did not err as a matter of law in rejecting the comparable sales and income approaches in establishing the property’s value. The three basic methods of valuation are the reproduction cost or cost replacement method, the market data or comparable sales method, and the income capitalization method. The selection of a particular method rests in the board’s discretion and is constrained only by fairness and uniformity. The board determined that the income capitalization method using the annual franchise rent was appropriate for the company’s possessory interest; it used the cost replacement approach to value the remainder of the property. The board found that neither the comparable sales approach nor the income

that the cost method was. When that is so, ----------- -.-- -- -._-. --.- .--_ ---. - - ~~~.-CZS.~~,.g@T&-X&~~

(a)). The board’s cost approach yielded a lower value than the other two approaches, but that was because the assessor’s method had captured intangibles that were not subject to taxation.

[See C&Jur3d, Property Taxes, $77; 9 Witkin, Summary of Cal. Law (9th ed. 1989) Taxation, !$ 178 et seq.]

COUNSEL

Terry C. Andrus, County Counsel, and Thomas C. Agin. Deputy County Counsel, for Plaintiff and Appellant. .

No appearance for Defendant and Respondent.

Shartsis, Friese & Ginsburg, Douglas MO and Paul M. Gordon for Real Party in Interest and Respondent.

OPINION

WALLIN, J.-The County of Orange (County) appeals the judgment denying its petition for writ of mandamus seeking to set aside a decision of the

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&uN-rY OFLOS ANGELES V. : COUNTY OF Los ANGELES ASSESSMENT APPEALS BD. 13 Cal.App.rith 102; - CaLRptr.Zd - [Feb. 19931

103

issue in the present case. Although that determination could not extend to the similar question now posed for the first time with respect to the other two airports, which were not the subject of the prior action, the court further held that taxable possessory interests in public property are grounded on physical possession or use of it, and that the further rights granted the firms by the concession agreements were not possessory interests. AccordingIy, the trial court properly refused to reinstate the county’s theory of valuation and its resulting assessments. (Opinion by Fukuto, J., with Boren, P. J., and Nott, J., concurring.)

EIEADN~~S

Classified to California Digest of Official Reports

(I) Judgments 0 81-Res Judicata-Collateral Estopped-Doctrine, Collateral estoppel forecloses relitigation of an issue that is identical to one decided in a prior case involving the same party or parties or those in privity with them and which resulted in a fina jud,ment on the merits.

[See Cal.Jur.3d, Judgments, $236 et seq.] . .

(2a, 2b) Judgments 0 97-Res Judicata-Collateral Estoppel-Matters

I

(3)

Concluded-Interest in Real Property-Taxation of pbssessory In- terest.-In denying a writ of mandate sought by a cbunty challenging a decision of its assessment appeals board as to the extent of the taxable possessory interests of several car rental firms at three airports in the county, the superior court properly invoked its prior judgment against the county in an earlier case involving the same parties at one of the airports. The judgment had become final and the primary issue was identical, even though the present case concerned later assessments and different agreements, since the terms that generated the possessory interests in question were the same, as were the facilities, and hence so were the interests themselves. There had also been no change in the content or character of the law subsequent to the fast judgment. However, similar questions posed for the first time with respect to the other two airports were not precluded.

Judgments $96--Res Judicata-Collateral Estopped--IMatters Concluded-Interest in Real Property-Questions of Law.- Whether an arguably precluded issue is one of law or more properly a mixed question of law and fact is ultimately inconsequential; coIIatemI

D 1 1 I I I I I / I I I

.‘I. - * a, .p-,-(& . . CO7JNrYOFOB&BV. 'I- ' . - , ORANGE COUNTY A.vassmm APPEALS BD.

-527

13 Cal.App.4th 524; - CaLRptr.2d - [Jan. 19931

Orange County Assessment Appeals Board No. 1 (Board), which adopted the position of taxpayer American Television and Communications Corpo- ration (American) concerning the property tax on American’s cable television system. The County contends the Board erred as a matter of law by: (1) failing to consider the appropriate appraisal unit as a whole for valuation purposes: and (2) rejecting the comparable sales and income approaches in establishing the property’s value. We affirm.

The Board heard several days of testimony and made certain findings. The trial court relied on that testimony in ruling on the petition for writ of mandamus. We summarize the Board’s findings:

American owns and operates a cable television system which provides services for a fee to subscribers in the City of Orange and an abutting unincorporated area. To do so, it obtained requisite licenses, permits and approval to operate in that geographical area. It receives television signals and transmits them to the subscribers through a network of trunk and feeder cables, some of which are above and some of which are below ground.

-.-. - --- -.- -__- _.._ - r~.*.“.“.e-“...~.~.z4.-. 37 -.-- -,&m&cm ~\?ms and uses taxable tan@l_e_pEjerty to carry on its business, ..;~-~-L;--~~-~L~.-~;;;;r;;-, - -------_.-.- - ,:- ..c-- - -=*;. -..- =-~------

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antennas, local origination television equipmknt, furniture and fixtures, converters, and surplus and test equipment. American owned some of its taxable tangible property when it began operations in 1980 and acquired more later. E

As Dart of the aDDrova1 urocess, American entered into a franchise agree- - ment bith the City and C&mty of Orange which included the right ti use public property for its cable distribution network. That right constitutes a taxable possessory interest in public property. (Rev. & Tax. Code, 3 107.7.)

For the lien dates in 1987, 1988, and 1989, the assessor calculated the full cash value of American’s property at $30 million, $35 million, and $38 million, respectively,* and American challenged those values before the Board. To obtain the values the assessor used a “unitary approach,” determining all of American’s property should be valued as a single appraisal unit, applying a valuation approach, and allocating the total value among the various component parts of the appraisal unit.

To support his use of the “unity approach,” the assessor presented evidence of two other methods. First, he presented a comparable sales approach, which involved taking purchase prices for other cable television

‘Although the assessor determined those values, the amounts actually enrolled were considerably less due to the constraints of the California Constitution, article XIII A. popularly known as Proposition 13. The enrolled amounts were approximately $16 million, $18 million, and $19, million respectively.

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. 52.8 Corn OF ORANGE V. .

hANGI t%JNTY ASSESSMBNTAPPEALSBD. a 13 Cal.App.clth 524; - CaLRptr2d - [Jan. 19931

.$

systems in southern California, determinin g the price per subscriber, and ‘48 P multiplying that figure by the number of American’s subscribers. The Board found that approach unreliable because it included the value of nontaxable

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intangible assets such as existing franchises or licenses to construct, a * subscriber base, marketing and programming contracts, management and ..+ operating systems, an in-place work force, going concern value, and goodwill.

The assessor also presented the income approach, which involved multiplying American’s net income by a capitalization rate. The Board rejected this approach for the same reason it rejected the comparable sales approach, it did not factor out the value of nontaxable intangible assets. The assessor did not present evidence as to how the property would be valued using a third accepted method of valuation, the replacement cost approach.

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The Board accepted the testimony of American’s three expert appraisers who identified American’s taxable tangible property and opined as to its value. For all items except American’s possessory interest, the property was

I I I I I I I

personal property.2

As to the fixtures and personal property, the board considered all three methods of valuation and determined the replacement cost approach was the most reliable. It would not include nontaxable intangible value, and it best equalized assessments since the assessor had traditionally used that approach in valuing fixtures and personal property of similar businesses. The Board used the testimony and data from American’s witnesses to calculate the appropriate replacement cost for these items. 3 it calculated the value for the undergrounding, which was categorized as land and land improvements, by taking its cost and assigning it an infinite life with no trending for the years in question.4

For the possessory interest in public property, the Board used the income capitalization method, which is presumptively correct under Revenue and Taxation Code section 107.7. It found American’s franchise fees were the market rent which paid for the possessory interest and capitalized them at a

The land and land improvements were comprised of the leasehold improvements and the undergrounding (the joint trench and back build); the fixtures were comprised of the cable distribution plant (except for the undergrounding), headend. tower. antenna. and earth station: and the personal property was comprised of the office furmture, computers. tools, csblecast- ing equipment. radios and test equipment. electronic ad equipment, converters, and supphes.

3These items totaled $6,695,366 in 1987, $6,404,988 in 1988, and $6,172.436 in 1989. ‘The values were $2,401,080 for !987, $2,671,931 for 1988, and .S2,SO5,000 for 1989.

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COUNTYOFthANGEV. ORANGBCOUNTYASSESSMENTAPPEALSBD. 13 Cal.App.4th 524; - CaI.Rptr.Zd - [Jan. 19931

10 percent rate; yielding a $5 million value for each of the three years in question. The Board determined that American’s total value for the years in 0 question was greater than that &rolled, due to the effect of Reposition 13, and that the enrolled value should remain unchanged.5 The assessor was ordered to change the assessed values for the years in question to those e found by the Bo&d.

I

(la) The County argues the Board erred as a matter of law by failing to consider all of American’s property as one appraisal unit for valuation purposes. In other words, the County claims the Board should not have separated the property into land and land improvements, fixtures, and personal property in determining the value of American’s property. We conclude the Board acted properly, but first we must consider the applicable standard of review.

(2a) American asserts the Board’s determination, and that of the trial

Cal.Rptr. 154, 544 P.2d 13541, set out the proper standard. (3) “If the [petitioner] claims only that the [board] erroneously applied a valid method of determining full ce .‘: value, the decision of the board is equivalent to the determination of a trial court, and the trial court in turn may review only the record presented to the board. [Citations.] The trial court may overturn the board’s decision only when no substantial evidence supports it, in which case the actions of the board are deemed so arbitrary as to constitute a deprivation of property without due process. [Citations.] On the other hand, when the [petitioner] challenges the validity of the valuation method itself, the trial judge is faced with a auestion of law. [Citations.] That question . . . is whether the challenged method of vaiuatlon is arbitrary, in excess ot discretion, or in violation of the standards prescribed by law.” (Id. at p. 23; see also County of Stanislaus v. Assessment Appeals Bd. (1989) 213 Cal.App.3d 1445, 1450 [262 Cal.Rptr. 4391.) I

(2b) The County’s attack is directed at the Board’s method of valuation, so we and the trial court look to see whether, as a matter of law, the method was arbitrary, in excess of discretion, or in violation of the standards I prescribed by law. (Bret Harte Inn, Inc. v. City and County of San Francisco,

The totals were $14.096.446 in 1987, $14,076,919 in 1988, and 13,977,436 in 1989. These amounts are less than amounts actually enrolled. At oral argument the County conceded the Board’s ruling would actually lower the enrolled amounts to these levels. I

530 Courm OF OIUNGE v. ORN~GE CotMTy ASSESSMENT APPEALS BD.

13 Cal.App.dtb 524: --cahRptr.2d - [Jan. 19931

supra, 16 Cal.Sd at p. 23.)6 In this regard we look not to whether another approach might also have been valid or yielded a more precise reflection of the property’s value, but whether the method chosen was contrary to law. (Trailer Train Co. v. State Bd. of Equalization, sup-a, 180 Cal.App.3d at p. 585 [selection of a particular method of valuation from among valid methods rests in the board’s discretion]; see also, Union Pacific Railroad Co. V. State Bd. of Equalization (1991) 231 Cal.App.Sd 983, 992 [282 Cal.Rptr. 7451 [inappropriate application of an otherwise valid valuation method could be considered a factual question].) “The law requires only that an assessor adopt and use a reasonable method-neither a trial court, nor this court, can reject a method found by the board to be reasonable merely because, in [its] nonexpert opinion, another method might have been better.” (Texaco, Inc. v. County of Los Angeles (1982) 136 Cal.App.Sd 60, 63 [ 186 CaLRptr. 161, fn. omitted.)

(lb) Relying on Revenue and Taxation Code section 51, subdivision (e), the County says the Board erred as a matter of law by failing to value American as one unit, “the whole system itself.” That subdivision is of no *

and sell as a unit, or which are normally valued separately.”

Subdivisions (a) and (b) deal with the determination of a property’s value as the lesser of its full cash value and its base year value (1975) enhanced by an inflation factor. Those subdivisions, say nothing about the propriety of dividing the appraisal unit into components to determine its value. Further, subdivision (e) states, albeit ungrammatically, that an “appraisal unit” can be that “which are [sic] normally valued separately.” Taken as a whole, neither section 51 in general, or subdivision (e) in particular, mandates appraisal of the property as a single unit.

Rule 22(b) of the Orange County Assessment Appeals Board and Assess- ment Hearing Officer Rules is similarly of no avail. That rule provides that

We reach this conclusion recognizing there is often a fine line between a challenge to an application of a valuation method and a challenge to the method itself. (Trailer Train Cu. v. State Bd. of Equalizarion (1986) 180 Cal.App.3d 565,582 [225 Cal.Rptr. 7171; see also People v. Louis (1986) 42 Cal3d 969, 984-988 [232 Ca1.Rpt.r. 110, 728 P.2d 1801 [discussing mixed questions of law and fact].) Here, the Board opted to value American’s property in separate sub-units and to apply the cost method of valuation, after determining the ssessor’s approach to valuation improperly captured intangibIe asset value. That determmation involved at least a mixed question of law and fact and, based upon the Board’s expertise. should be adopted by the courts in reviewing the propriety of the method selected. (See Shell Wesrern E & P. Inc. v. Counfy of Luke (1990) 224 Cal.App.3d 974, 979 1272 Gl.Rptr. 3131 [assessment appeals boards have special expertise in property valuation and their factual determinations are entitled to deference].)

--

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I COUNTY OF ORANGE v. 531 l I ORANGE COUNTY ASSESSMENT APPEALS BD. 13 Cal.App.4th 524: - Cal.Rptr.2d - [Jan. 19931

- I

in considering a reduction in assessed value, the Board must “make a determination, of the’ full value of the whole property.” Nothing in the rule

‘says how the Board must make that determination, let alone that it may not I value components separately. It does provide the Board may “adjust the value of the parts,” a task seemingly impossible unless the parts have been separately valued. And, contrary to the County’s assertion that “the most appropriate unit for valuation is the whole system itself,” the testimony I before the Board established that the cable distribution plant of cable television companies is valued separately, usually using the cost approach.

Further support exists for the concept that the components df taxable I

property may be separated for valuation purposes. Revenue and Taxation Code section 107.7 deals with valuation of cable television possessory interests and provides the preferred method of valuing that portion of a cable television company’s property shall be capitalizing the annual rent. (Rev. & I

Tax. Code, 0 107.7, subd. (b)(l).) It says nothing about changing the preferable methods for valuing other types of taxable property. (Cal. Code Regs., I tit. 18 _-.- --_A.- .L

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other asp% of the property when the preferred methods differed would require separating the two facets of the property for valuation purposes, as was done here.’ I

Title 18, section 461, subdivision (d) of the California Code of Regula- tions states that where there are declines in value (here, the fixture portion of the cable distribution plant), “Land and improvements constitute an appraisal @I

_

unit . . . [and] fixtures and other machinery and equipment classified as

I ‘The Legislature’s observation in enactmg Revenue and Taxanon Code sectlon 107.7 that

“[p]ossessory interests of cable television systems do not sell by themselves” does not alter the analysis. (Stats. 1988, ch. 1630. $ l(d).) The section codified the holding in Cox Cable San Diego, Inc. v. County ofSun Diego (1986) 185 Cal.App.3d 368 I229 CaLRptr. 8391 that possessory interests of cable television companies constitute taxable property. (Cowry of I Sranislaus v. Assesstnenr Appeals Bd., supra. 213 CaLApp3d at p. 1452, fn. 3.) The Legisla- ture’s observation in the enabling legislation merely justifies use of the income capitalization method so the value of such property can be captured and assessed. (See id. at p. 1455.)

The County reasoned at oral argument that because the possessory interest is worth nothing without cable in place along the right-of-way, the value of the cable was wedded to the possessory interest and should not have been valued separately. But the preferred method of capitalizing that portion of the franchise fee attributable to the possessory Interest takes the County’s reasoning into account. A cable television company would not “rent” the nght-of- way unless it intended to use it. Thus, capitalizing that portion of the franchise fee reflects the value to the cable company of having the right-of-way with cable in place. I

. a

To summarize, applicable law suggests there is no wrong in rationally dividing property into component parts for valuation purposes. (Compare .

’ McDonnell Douglas Corp. v. County of Los Angeles (1990) 219 Cal.App.3d _

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economiGiiii~i~&~ssessor was not GGGiGiX EFE -3 ceE~=,T&f$&j-*m-

its individual &Xrictions].) The Counb has provided no -authority to the contrary. The Board was within its discretion to separate the property as it

532 Corn OF OIUNGE r;. ORANGE CO- -

13 C~I.A~~AUI 524; - GdPpu.2d - [Jan. +31

improvements constitute a separate appraisal uniL” The rule contemplates a ” division in the appraisal unit for valuation ~urposes.~ 1

Other sources rebut the County’s claim that a taxpayer’s property cannot be separated for valuation purposes. Title 18, se&m 3 of the California Code of Regulations provides than an assessor “shall consider one OT more” of the three acceptable valuation approaches. (Italics added.) Similarly, title 18, section 324 provides the board “shall determine whether the method(s) ’ used was (were) properly applied,‘* and “[t]he findings shall also include a statement of the method or merhodr of valuation used . . . .” (Cal. Code Regs., tit. 18, 0 324, subds. (a) and (e), italics added.) One way to use ; multiple methods would be when value is best calculated by breaking down :- the property into component parts.

II

(4) The County urges the Board erred as a matter of law by rejecting the comparable sales and income approaches in establishing the property’s value. Using the same review standards discussed above, we conclude it did not.

:

The three basic methods of valuation are the reproduction cost or Cost replacement method, the market data or comparable sales method, and the income capitalization method. (Pacific Mutual Life Ins. Co. v. County of Orange (1985) 187 Cal.App.3d 1141, 1147 [232 Cal.Rptr. 2331.) The selection of a particular method of valuation from among the valid methods rests in the Board’s discretion. (Trailer Train Co. v. State Bd. of Equalization, supra, 180 Cal.App.3d at p. 585.) It is constrained only by fairness and uniformity. (ZTT World Communications, Inc. v. County of Santa Clara (1980) 101 Cal.App.3d 246, 252 [I62 Cal.Rptr. 1861.)

*By engaging in this reasoning, we do not hold fixtures must always be valued apart from the land and land improvements. We merely provide an example which helps refute the County’s assertion that the converse is true.

Here, the Board determined the income capitalization method using the annual franchise rent was appropriate for American’s possessory interest. It was tbe’preferred method (Rev. & Tax. Code, 3 107.7, s&d. (b)(l)), and the County does not contend it was improper.

The County does attack tbe Board’s use of the cost replacement approach to value the remainder of the property, contending we held in Pacific Mutual Life Ins. Co. v. County of Orange, supra, 187 Cal.App.3d 1141 that the income capitalization approach was “a preferred method for valuing all income producing real property . . . .” Not so. All we held there was that the cost reproduction approach was not appropriate where it was “designed solely to capture the specific utility of property to a particular owner. . . .” (Id. at p. 1149.)

Several cases have upheld the validity of the cost replacement approach for tangible taxable property. (Bret Harte inn, Inc. v. Cit> and County of San Francisco, supru, 16 Cal.3d at pp. 21-23,25 [cost approach is not inherently’ arbitrary although it was in that instance]; May Depurtment Stores Co. v.

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COUNTY OF O~UNGE v. ORANGE COUNTY ASSESSMENT AFFEALS BD. 13 Cal.App.4th 524; - Cal.Rprr.2d - [Jan. 19931 *

533

5835; Midstate fheatres, I&. I. Co&y of Staklaus (1976) 55 Cal.Apg3d 864, 882 [ 128 Ca1.Rpt.r. 541; Guild Wineries & Distilleries v. County of Fresno (1975) 51 Cal.App.3d 182, 188-189 [ 124 CaLRptr. 961 [single open market sale does not bar use of replacement cost approach]; Western Title Guarunry Co. v. County of StanisZaus (1974) 41 Cal.App.Sd 733, 739-741 [116 Cal.Rptr. 3511.) The County argues the other two methods were preferable. The comparable sales method is preferable “when reliable market data are available.” (Cal. Code Regs., tit. 18, $j 4.) The income method is preferable “when reliable sales data are not available and the cost approaches are unreliable.” (Cal. Code Regs., tit. 18, 0 8, subd. (a).)

Here, the Board found that neither the comparable sales approach nor the income approach was reliable and that the cost method was. When that is so, the cost method becomes preferable. (Cal. Code Regs., tit. 18, $ 6, subd. (a).)

The County seems to reason that because the cost approach yielded a lower value than the other two approaches, it did not yield an assessment at full value as required by law. (Rev. & Tax. Code, fi 110.) But the Board correctly reasoned why the values differed. The assessor’s method captured intangibles which are not subject to taxation such as existing franchises or licenses to construct, a subscriber base, marketing and programming contracts, management and operating systems, an in-place work force, going concern value, and goodwill.

rpnlnrfimt2nt snnrnach --

534 COUNTY OF ORANGE v. ORANGE COUNTY ASSBSSMENT AFFEALS BD. 13 Cal.AppAtb 524; - CaJ.Rptr.2d - [Jan 19931

The assessor and board may apply a method of assessment which reflects the value enhancement of tangible taxable property due to the presence of intangible property. (County of Stanislaus v. Assessment Appeals Bd., supra, _ 213 CaLApp13d at pp. 1454-1455.) The Board did so here when it applied the income capitalization method prescribed by Revenue and Taxation Code section 107.7 to value the possessory interest. (Zbid.) Any additional value must have been attributable to intangibles which enhanced the value of the business, not the propert>: e.g., m-place work force, going concern value, .! and goodwilL 4 .:

-.*

The Board’s choice of the cost replacement method for fixtures and personal property was not arbitrary, an abuse of discretion, or contrary to law. (Bret Harte Inn, Inc. v. Ciry and County of San Francisco, supra, 16 Cal.3d at p. 23.) The Board considered all three methods and selected the cost replacement method because it best expressed the value of American’s property and was necessary to achieve fairness and uniformity by equalizing assessments. (ITT World Communications, Inc. v. County of Santa Clara,

The judgment is affied.

Moore, Acting P. J., and Sonenshine, J., concurred.

9At oral argument, the County conceded there would be a problem if the assessor bad enrolled the entire $38 million value he had calculated because it might have included impermissible business value intangibles such as good will. The County asserted this potential problem was avoided because the assessor only enrolled a value of $19 million, and reasoned that figure eliminated any business value intangibles.

But the $19 million figure was arrived at by taking the 1975 base value pursuant to Proposition 13 and adding new property acquisitions and the permissible inflation enhancement. It did not purport to have anything to do with scientifically eliminating business value intangibles from the total properry value. Conversely, American presented expert testimony, which the Board accepted, affiatively showing the value of the property apart from business value intangibles. Thus, the Board only had one analytically and procedurally proper valuation before it. The County admitted as much in oral argument when it reasoned that if the assessor erred, it was in assuming (as opposed to proving) that the $19 million reduction in the enrolled value accounted for all business value intangtbles.

.

794 SHUBATV. SUTTERCOUNTYASSESSMENTAPPEALSBD. 1

[No. C011938. Third Dist. Jan. 28, 1993.1

[As modified Feb. 24,1993.]

EMIL G. SHUBAT, as Assessor, etc., Plaintiff and Appellant, v. SUTTER COUNTY ASSESSMENT APPEALS BOARD NO. 1, Defendant; NOR CAL CABLEWSION, INC., et al., Real Parties in Interest and Respondents.

After a corporation purchased the outstanding shares of entities involved in the cable television business, a county assessor reassessed the value of the local cable television service. The assessor allocated a portion of the total calculated value to tangible assets and the remainder to an intangible asset identified as the service’s taxable possessory interest in the public rights-of- way. The service objected to the reassessment and filed an application for reduction. The assessment appeals board generally agreed with the assessor on the total value, but also determined that the value included certain nontaxable intangibles. The assessor filed a petition for a writ of administrative mandamus challenging the board’s allocation of value to nontaxable intangibles. The trial court concluded the record supported the allocation and denied relief. (Superior Court of Sutter County, No. 40970, Terence J. Keeley, Judge.)

The Court of Appeal affirmed. Initially, the court held that an assessment appeals board’s factual determinations are entitled to the same deference and respect due a judicial decision. The court also held that the record supported the board’s determination that the cable television service’s right to do business, as well as the “enterprise value” of it as a going concern, had a separate value. Thus, the court held that the board’s method of allocating one-third of the residual value, after assigning amounts to the tangible assets, to the possessory interest and the remainder to other nontaxable intangibles was reasonable under the circumstances. (Opinion by Puglia, P. J., with Blease and Sparks, JJ., concurring.)

(1) Property Taxes 0 33-Assessment-Validity of Assessment-Coun- ty Tax Assessment Appeals Board-Judicial Review.-The factual 1:

determinations of a county assessment appeals board, as an agency of 1

,. u constitutional origin, are entitled to the same deference and respect due II a judicial decision. Where it is claimed the board applied an improper method of valuing a taxpayer’s assets, a question of law is presented,

; , l!

and a court may determine whether the challenged method of valuation 1)

is arbitrary, in excess of discretion, or in violation of the standards prescribed by law. Where it is claimed the board erroneously applied a /(/ I proper method of valuation, the decision may be overturned only when no substantial evidence supports it, in which case the actions of the ’ i 1 lr II board are deemed so arbitrary as to constitute a deprivation of property without due process.

%I!

_

ii I (2) Property Taxes 0 U-Subjects of Taxation--Real Property-Pos-

sessory Rights-Cable Television Service: Radio and Television 0 6-Cable Television-Franchises-Components.-A cable television service’s possessory interest in the public rights-of-way for transmission of its service, although intangible, is taxable. However, the right profitably to use public easements is not the only intangible asset such a service possesses by virtue of its franchise rights. Cable television franchises consist of two primary components, the right to use the public streets to lay the cables and the right to charge a fee to

-.---------- ----. _- _.__ ‘f-l’“--~:~-~-y~.~--. y-T-;‘ 2 .

SHUBAT v SUTTER COUNTY ASSESSMENT APPEALS BD. 13 Cal App.4th 794; - Cal.Rptr.Zd - [Jan. 19931

795 .;

HEADNOTES 'ill

Classified to California Digest of Official Reports

(3) Property Taxes 8 U-Subjects of Taxation-Intangible Assets- Right to Conduct Business .-In an action challenging a county assessment appeals board’s allocation of value to a cable television service’s tangible and intangible assets, the board properly concluded that the cable television service’s right to do business had a separate value. The right to do business is an intangible asset exempt from property taxation. Moreover, the board’s conclusion that favorable franchise terms, which made the cable television service more economical than was typical, had no value separate from the right to do business, was effectively a conclusion that the favorable terms were subsumed within, and enhanced the value of, the cable television service’s right to do business.

(4) Property Taxes 9 42.2-Assessment-Valuation-Cable Television Service-Intangible Assets-Enterprise Value.-In an action challenging a county assessment appeals board’s allocation of value to a

796 SHUBAT v. SUTTER COUNTY A~~IXSMENT APPEAU BD. 13 CaLAp~.ti 794; - Cal.RptrsZd - [Jim 19931

I 11:: !, :

I’ /[,I

IN ij I 3 I 1 I

I ) ! / I I

lrlh i,

II .

(9

cable television service’s tangible and intangible assets, the record contained substantial evidence that the service had value apart from the franchise and tangible assets. Whether labeled as a subscriber list, going concern value, or enterprise value, the record supported the existence of value attributable to the operational nature of the service. These intangibles relate to-the business and relate to real property only in their connection with the business using it. Thus, although intangible values may be reflected in the value of a possessory interest, they are not necessarily subsumed as a matter of law.

Property Taxes 0 33-Assessment-Validity of Assessment-Coun- ty Tax Assessment Appeals Board-AllocaCion of Value.-In au action challenging a county assessment appeals board’s allocation of value to a cable television service’s tangible and intangible assets,

ceedings before an assessment board, the officers are presumed to have properly performed their duties, and the taxpayer has the burden of showing that the assessments were not fair and equitable. A State Board of Equalization rule enumerating the permissible modes of assessing possessory interests does not purport to be exclusive, and when no sound or practicable basis appears for apportionment of income as between enterprise activity and the property itself, then a method may be employed which imputes an appropriate income to the property. After assigning amounts to the tangible assets, the board reasonably allocated one-third of the residual value to the possessory interest and the remainder to other intangibles. None of these intangibles had value to the service independent of the others; there was no basis for attributing a higher value to any one of the intangibles, and no basis for attributing a higher value to the possessory interest.

[See Cal.Jur.3d, Property Taxes, $78; 9 Witkin, Summary of Cal. Law (9th ed. 1989) Taxation, 0 180.1

Darrell W. Larsen, County Counsel, and Ronald S. Erickson, Assistant County Counsel, for Plaintiff and Appellant.

No appearance for Defendant.

Douglas MO, Shartsis, Friese & Ginsburg and Paul M. Gordon for Real Parties in Interest and Respondents.

SHUBAT v SUTTER COUNTY ASSESSMENT APPEALS BD. 13 Cal.App.4th 794; - Cal.Rptr.Zd - [Jm 19931

OPINION

PUGLIA, P. J.-Plaintiff Emil G. Shubat, the Sutter County Assessor (Assessor), appeals from the judgment of the trial court denying his petition for writ of administrative mandamus. The Assessor challenges the determination by defendant Sutter County Assessment Appeals Board No. 1 (Board) of the taxable value of real party in interest Nor Cal Cablevision, Inc. (Nor Cal). The Board found a portion of Nor Cal’s overall value attributable to non-taxable intangible assets. The Assessor contends this determination is (1) contrary to law and (2) not supported by substantial evidence. We disagree and shall affirm.

I

Effective October 1, 1986, respondent and real party in interest Continen- tal Cablevision, Inc. (Continental) purchased the outstanding shares of several subsidiaries of McClatchy Newspapers involved in the cable television business, including Nor Cal. Nor Cal provides cable television service to residents in both Sutter and Yuba Counties. After certain postsale adjustments, the total purcjase price paid by Continental was $127.648.647.

In order to fulfill his statutory obligation to assess property at its full value (Rev. & Tax. Code, 0 401), the Assessor reassessed the value of Nor Cal at the time of transfer. The computation of property value normally i&olves one or more of three general methods of valuation. The “market’* approach looks at recent sales of ComDarable oroDertv. including that beine valued.

of-the property. This present value depends-upon not only-the magnitude and duration of the projected income stream but the discount rate used. The higher the discount rate the lower the present value of the property. (Cal. Code Regs., tit. 18, 0 8, subd. (d).) The third method of valuation, the “cost” approach, looks at the cost of replacing the property less accrued deprecia- tion. (Cal. Code Regs., tit. 18, 0 25, subd. (c).)

In computing a total value for Nor Cal, the Assessor used a market approach based on the price paid by Continental. Beginning with the amount reported by Continental as attributable to the purchase of Nor Cal, and making certain adjustments not relevant to this dispute, the Assessor arrived at a total value of $37,872,000.’ Of this amount, $16,226,260 was allocated to tangible assets, such as land, buildings, equipment and other personal

‘The total assessment was apportioned between Sutter and Yuba Counties to arrive at a taxable value in Sutter County of $19,887,206. There is no dis

I, ; Ill : i I, I. i 798 SHUBAT Y.

111 ! 1 i

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property: the remainder was allocated to intangibles. The only intangible identified by the Assessor was Nor Cal’s taxable possessory interest in the public rights-of-way for delivery of cable signals, to which the entire residual amount was allocated.

I Nor Cal objected to the reassessment and filed an application for reduc-

tion.2 The Board was convened to hear Nor Cal’s application. At the hearing before the Board, Nor Cal presented the report and testimony of its expert John E. Kane, Kane used both a market and income approach to arrive at a total value for Nor Cal of $28 million. For the income portion of his analysis, to which Kane assigned the greatest weight, a discount rate of 16 percent was used based on the risk associated with the business and the corresponding cost of capital.3

-~~~~~,~~~sa~~~~~-~~~~-~ of - - 1 ~---..--.-~---.=.T~r~ I

“excess earnings” method to allocate value to the intangibles. This metho& required computation of the projected income attributable to the tangible assets by multiplying the total value of such assets by a discount rate of 13 percent, which Kane determined to be an appropriate rate of return based on the lower risk associated with tangibles. This income amount was then subtracted from the total projected income to come up with an income amount attributable to the intangibles.

Kane identified six intangible assets of Nor Cal, to wit: (1) sub&iber list, (2) franchise operating rights, (3) a lease (not pertinent to this dispute), (4) assembled work force, (5) noncompete agreement, and (6) going concern. The second of these, the franchise rights, Kane further subdivided into (1) the right to conduct business, (2) favorable franchise terms, and (3) the possessory interest in the public rights-of-way.

The subscriber list referred to by Kane was actually the subscriber base, i.e., Nor Cal’s customers. Using an income approach, Kane determined an income amount appropriate to this asset and applied a discount rate of 16 percent to compute a present value. After subtracting this amount from the

value between the two counties. Although, this appeal involves only the assessment for Sutter County, for the sake of convenience, we shall refer throughout this opinion to the combined value of the vanous assets of Nor Cal.

2The original application was actually filed on behalf of Continental. However, the matter was thereafter prosecuted in the name of Nor Cal.

‘As explained by Kane, the discount rate fluctuates with the level of risk associated with the property or business. It represents the expected return on investment. The greater the rusk associated with the property or business, the greater the return demanded by mvestors and hence the greater the discount rate. The greater the discount rate, the lower the present value of the asset.

SHUBAT v. SUTTER COUNTY ASSESSMENT APPEALS BD. 13 CaI.App.4th 794, - Cal.Rptr.Zd - [Jan. 19931

total attributable to intangibles, Kane applied the remaining income to the three franchise rights in equal proportions. Kane then computed a present value for these intangibles using a higher discount rate than that applied to the tangible assets because of the higher risk involved. Nineteen percent was used for the right to conduct business and favorable franchise terms, while twenty percent was used for the possessory interest in public rights of way because of the added need to compensate for property taxation of this asset. Through this income valuation method, Kane arrived at values for these intangibles as follows:

Subscriber list $5,202,124 Right to conduct business $4,272,884 Favorable franchise terms $4,272,884 Possessory interest in public

rights of way $4,059,929

Of th&e amounts, Kane independently computed values for the favorable franchise terms and possessory interest using other methods. The amounts computed cqr-roborated his one-third allocation. The remaining value of Nor Cal was divided among the other intangible assets by various methods, with going concern allocated the residual of $518,155.

The Board generally agreed with the Assessor on total value of Nor Cal. However, the Board agreed with Kane this figure includes certain non-

,taxable intangibles. After subtracting the value of tangible assets and the subscriber list, the Board arrived at a residual value of $18.242.130. The

do business and the going concern value, to which the Board allocated the residual equally in accordance with the methodology used by Kane. In order to determine final taxable value, the Board added one-half of the present value of future franchise fees to the possessory interest.”

The Assessor initiated this proceeding challenging the Board’s failure to allocate all residual value to the taxable possessory interest. The trial court

4Futur.e franchise fees are estimated from projected revenue. These are considered another cost paid for the right to operate Nor Cal. The present value of such future payments is thus computed and added to total value of the system. The Board concluded only half of this amount is attributable to the possessory interest, with the other half attributable to the right to do business.

We note a possible discrepancy in the Board’s computation. The Board purported to divide the residual of $18.242.130 by three to arrive at an allocation to the three intangibles. Before addition of one-half the value of future franchise fees to the possessory interest, the Board assigned a value to the three intangibles of $6.072.212. However, one-third of $18.242.130 is

800 SHUBAT~V. SUTTER COUNTY ASSESSMENT APPEALS BD. 13 Cal.AppAth 794; - Cal.Rptr.2d - [Jan. 19931

concluded the record substantiated allocation of value to the nontaxable right-to-do-business and going concern. The court further concluded the record adequately supported the specific amounts allocated. However, the court remanded to the Board to answer four questions: “(1) in valuing the ‘possessory interest’ held by Nor Cal did the Board consider the extent to which the naked ‘possessory interest’ is enhanced by nontaxable [sic] ‘intangibles’? (2) what income does the Board ascribe to the ‘possessory interest’? (3) in determining the income stream to be ascribed to the ‘possessory interest’ does the Board impute to the ‘possessory interest’ any income directly related to nontaxable [sic] ‘intangibles,’ and, if so, to what extent? and, (4) what capitalization rate did the Board rely upon in determining the value of the ‘possessory interest,’ together with the basis for the utilization of said rate?”

!l!zkL On remand, the Board responded that it had considered the extent to

t ----==-~~tiT”,,1,,

1 particular, the Board noted all the income allocated tothe$&&ory &ter%st---‘--

;!I was related to the nontaxable intangibles “because none of it could be earned

rl

I, absent Nor Cal’s franchise, subscriber base, and other intangible assets that

81 ( I make Nor Cal a going concern.” However, the Board further noted the extent

‘8 of such contribution by the nontaxable intangibles “is not ascertainable.”

1 i/l : Regarding income stream attributable to the possessory interest, the Board

A , indicated it “did not and could not rely on an income approach” for such valuation because of the unavailability of a suitable capitalization rate. Thus, the remaining questions posed by the court could not be answered although the Board noted that use of an income stream of $531,008 (one-third the residual income) and a capitalization rate of 8.744 percent (the overall system rate) results in a possessory interest value substantially equivalent to

l!i’\

11

I)! / 1,: I

that arrived at by the Board.

Upon review of this supplemental decision. the court concluded the Board’s findings were supported by substantial evidence and denied writ relief. Judgment was entered accordingly.

(1) As an agency of constitutional origin (Cal. Const., art. XIII, 5 16; Kaiser Center, inc. v. County of Alameda (1987) 189 Cal.App.3d 978, 982 [234 CaLRptr. 6031). the Board’s factual determinations are entitled to the same deference and respect due a judicial decision. (Strumsky v. San Diego Count Employees Retirement Assn. (1974) 11 Cal.3d 28, 36 [ 112 CaLRptr.

actually $6.080.710. The parties raise no contentlons regarding this apparent computational error. We shall therefore accept the Board’s computations for purposes of this appeal.

SHUBAT LJ SUTTER COUNTY ASSESSMENT APPEALS BD 13 Cal App 4th 794, - Cal.Rptr.Zd - [Jan 19933

801 ’ I ‘1 E

805, 520 P.2d 291.) Review of a board determination may therefore involve two distinct standards. Where it is claimed the Board applied an improper method of valuing a taxpayer’s assets, this presents a question of law. We determine “whether the challenged method of valuation IS arbitrary, In excess of discretion, or in violation of the standards prescribed by law.” (Brer Hurte Inn, Inc. v. City and County San Francisco (1976) 16 Cal.3d 14, 23 [ 127 CaLRptr. 154, 544 P.2d 13541.) Where it is claimed instead the Board erroneously applied a proper method of valuation, the decision may be overturned “only when no substantial evidence supports it, in which case the actions of the board are deemed so arbitrary as to constitute a deprivation of property without due process.” (Ibid.)

The Assessor challenges the Board’s allocation of value to nontaxable intangibles on two grounds. He contends all of the intangibles are taxable either in their own right or as they add value to the possessory interest. He further contends the Board’s allocation to intangibles other than the taxable possessory interest was arbitrary and not supported by substantial evidence. These challenges implicate both standards of review.

III

We first consider the Assessor’s claim all intangibles identified by the

‘II / ’ iill 1 II

- hil I

m: 1 II II !I

Board are taxable. Unless exempt under federal or state law, all property in California is subject to taxation according to its value. (Cal. Const., art. XIII,

I; Rev. & Tax. Code, 0 201; County of Stanislaus v. Assessment Appeals

ownership.” (Rev. & Tax. Code, Q 103.) Real property inclubes any posses- ----.- . .._._.

-t. sory interest in real property which is defined as any right to possession of land, except where coupled with actual ownership of the land, or taxable improvements on tax-exempt land. (Rev. & Tax. Code, $0 104, 107.)

i/j/

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id

The Board acknowledged and allocated value to four intangibles: right to do business, possessory interest, going concern, and subscriber list. (2) It is undisputed Nor Cal’s possessory interest in the public rights-of-way for transmission of its service is taxable. (Cox Cable San Diego, Inc. v. County of San Diego (1986) 185 Cal.App.3d 368, 378 [229 Cal.Rptr. 8391.) However, the right profitably to use public easements is not the only intangible asset obtained by Nor Cal by virtue of its franchise rights. Franchises such as at issue here consist of two primary components: “the right to use the public strbets to lay the cables and the right to charge a fee to subscribers for their use of the cable facilities.” (County of Stanislaus v. Assessment Appeals Bd., supru, 213 Cal.App.3d at p. 1452.)

I ii

802 S~BATY. S~~~RC~~NTYASSEFSMENT APPEALS BD. 13 Cal.App.clth 794; - CaLRptr.Zd - [Jan. 19931

(3) The right to do business has been recognized as an intangible asset exempt from property taxation. (County of Stanislaus v. Assessment Appeals Bd., supra, 213 Cal.App.3d at p. 1454.) The Assessor nevertheless contends Nor Cal’s right to engage in a cable television business has no value because this is a right available to anyone and only has meaning when coupled with a right to use the public easements. This argument is frivolous. If it is open to anyone to conduct a cable television business, it is also open to anyone to use the public easements for this purpose. The two rights are concomitant and follow from the acquisition of a franchise. (Id. at p. 1452.) Obviously the Assessor would not argue the right to use public easements has no value merely because this right is open to everyone.

Cable operators “pay local entity franchise fees up to 5 percent of their

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gross receipts for the privilege of operating their businesses. They also are subject to income tax on their corporate franchise earnings under the Bank and Corporation Tax Law (pursuant to Cal. Const., art. XIII, $ 27). Thus, it p.&z&---L~,~& - ----- __.- ~~~~~&~he-ca~~lerrision, -. - _ . -----.-v-w-_ --,,.-‘. I

‘I business under the property tax laws.“(Id. e-m 3- E. I----Y-*-

at p. la54.) -------me

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Nor Cal’s general right to do business is further enhanced by favorable franchise terms identified by Kane. These Kane defined as terms of the franchises making them more economical than typical cable franchises. For example, Nor Cal is not required to fund a local public access corporation or provide service to low density areas. By concluding these favorable terms have no value separate from the right to do business, the Board effectively concluded they were subsumed within, and enhanced the value of, Nor Cal’s right to do business. Thus, the Assessor’s contention the right to do business had no separate value is unavailing.

(4) The Assessor also disputes separate valuation for the subscriber list and going concern. According to the Assessor, neither item exists separate from the possessory interest. However, regardless of the label used, the record contains substantial evidence Nor Cal had value apart from the franchise and tangible assets. According to Kane, Nor Cal had value by virtue of the integration of the various elements of the business. These elements he described as including “business and technical procedures, accounting and billing systems, programming contracts, FCC licenses (5) and relationships with local advertisers.” Nor Cal also had a trained work- force in place and procedures for operating its business.

At the time of purchase by Continental, Nor Cal had a customer base of 26,075 basic subscribers out of 34,162 homes passed, or a 76 percent saturation rate. There were also 10,675 total pay channel units. Kane indicated this saturation rate was higher than average. The Assessor cannot

SHUBAT v SUTTER COUNTY ASSESSMENT APPEALS BD. 13 Cal.App 4th 794, - Cal.Rptr.Zd - [Jan 19931

reasonably argue this customer base had no value to Nor Cal separate from use of the possessory interest. Were this true, a cable system with no customers would be as valuable as a comparably sized system with many customers, Admittedly, the customers are of no value without the possessory interest. However, the converse is also true. Thus, whether labeled a subscriber list, going concern value, or enterprise value, the record amply supports the existence of value attributable to the operational nature of Nor Cal. The question to be resolved therefore is not whether these assets have value, for clearly they do. We must decide, instead, whether value was properly allocated.s

IV

Despite separate existence, the Assessor contends the franchise rights and going concern value of Nor Cal must be subsumed within the possessory interest. According to the Assessor, these assets are no different from other intangible attributes of real property such as location, zoning, view, archi- tecture, etc. which would not be separated from the real property for valuation purposes.

This argument too is frivolous. There is a fundamental distinction between the attributes identified by the Assessor and the intangibles involved in this dispute. Zoning, location and other such attributes relate directly to the real property involved. They are an integral part of and effectively define it. By contrast, intangibles such as going concern or franchise rights relate to the . .D& -Me.coti&d, on. the reabroperty. They relate to the real -..-.-.- ___ _ .-- -.-_ .d- _ _ -.+yaw-.-~&,~~-~ y-. -.- - -__ __ property only m their connect~an-wiitrt~~~~~~~-~~~.~== -- --------- .____ b.

SAlthough arguably not applicable to this dispute because its effective date came after the date of purchase, Revenue and Taxation Code section 107.7 provides further support for the separate existence and property tax exemption of the Intangible assets recognized by the Board. Subdivision (d) provides: “Intangible assets or rights of a cable television system are not subject to ad valorem property taxation. These intangible assets or rights, include. but are not limited to: franchises or licenses to construct, operate, and maintain a cable television system for a specified franchise term (excepting therefrom that portion of the franchise or license which grants the possessory interest), subscribers, marketing, and programming contracts, nonreal property lease agreements, management and operating systems, a work force in place, going concern value. deferred, startup, or prematurity costs, covenants not to compete, and goodwill. However, a cable television possessory interest may be assessed and valued by assuming the presence of intangible assets or rights necessary to put the cable television possessory interest to beneficial or productive use in an operating cable television system.”

This legislation was intended “to clarify the application of existing law and provide uniformity and certainty in the assessment of cable television possessory interests.” (Stats. 1988, ch. 1630, 8 3, p. 5940.) In County of Smanislaus v. Assessmenr Appeals Bd., supra, 213 Cat.AppJd 1445, 1452, footnote 3, the court indicated this section “is not considered a change in the law.**

804 SHUBAT Y. SLMTER Cornrry ASSESSMENT APPEAU BD. 13 Cal.App.4th 794; - CaLRptr.Zd - [Jan. 19931

The Assessor nevertheless contends many cases have held intangibles such as involved here do not exist separate from the possessory interest and must therefore be assessed as part of it. In Scott-Free River Expeditions, Inc. v. County of El Dorado (1988) 203 Cal.App.3d 896 [250 Cal.Rptr. 5041, this court held the right of a commercial rafting outfitter to exclusive commercial use of the flow of water in a river is a possessory interest subject to property taxation. The Assessor contends Scott-Free stands for the proposition the right to take a profit from the use of public property cannot be separated from the possessor-y interest in the property. However, in Scott-Free no issue was raised regarding the value to be placed on the possessory interest or whether the commercial rafting outfitter had value distinct from its tangible assets and the possessory interest. The sole issue raised was whether the taxing authority had the power to tax the possessory interest, an issue not disputed here. “ ‘[Cl ases are not authority for propositions not considered therein.’ ” (Worthley v. Worthfey (1955) 44 Cal.2d 465, 472 [283 P.2d 191.)

- .-_. __ _.--. -- _ -.._ ____ _ -icJ~z.ig~~ -...m - _ - 1 - -c28sms~%~~ the court indicated: “Intangible values . . . that cannot be separately taxed as property may be reflected in the valuation of taxable property. Thus, in determining the value of property, assessing authorities may take into consideration earnings derived therefrom, which may depend upon the possession of intangible rights and privileges that are not themselves regarded as a separate class of taxable property. [Citations.]‘* (Accord, Michael Todd Co. v. County of Los Angeles (1962) 57 Ca!.2d 684, 693 [21 Cal.Rptr. 604, 371 P.2d 3401; IIT World Communications, Inc. v. County of Santa Clara (1980) 101 Cal.App.3d 246, 257 [162 Cal.Rptr. 1861.)

While we agree intangible values may be reflected in the value of a possessory interest, it does not follow such values are subsumed as a matter of law. In County of Stanislaus v. Assessment Appeals Bd., supra, 213 Cal.App.3d 1445, the assessor apphed to the board to increase the value of the taxpayer cable television system to $18,350,000. It was argued this value was justified by the effect of nontaxable intangibles on the other assets of the business. The board concluded the intangibles could not be taxed and reduced the assessed value to $5,455,599. The trial court denied relief. (At pp. 1448-1449.)

The appellate court concluded the value of taxable assets may be enhanced by the nontaxable intangible assets. The court explained: “Without the right to put its possessory interest to beneficial or productive use by soliciting subscribers and charging them a fee for transmitting a signal, i.e., the right to engage in business, [the taxpayer’s] possessory interest would have little or no market value.” (At p. 1456.) The court concluded: “In

SHUBAT v. SUTTER COUNTY ASSESSMENT APPEALS BD. 13 Cal.App.4rh 794: - Cal.Rptr.2d - [Jan. 19931

805

valuing [the taxpayer’s] possessory interest on remand, the assessor shall consider the intangible right to do business as required by the above authorities. In so doing, the assessor may impute to the possessory interest an ‘appropriate’ income from the right to engage in business. [Citation.]” (Ibid.)

Significant to this ruling was the appellate court’s failure to direct valuation at the full value of the cable system despite a stipulation that such value was $19.4 million. In effect, the court concluded the full value of the intangible right to do business need not be imputed to the possessory interest. Instead, the court remanded to permit the assessor to decide whether and to what extent the value of the possessory interest should be enhanced by the right to do business.

The trial court here did likewise. From the record before it, the court apparently could not determine if and to what extent the Board took into consideration the nontaxable intangibles in computing a value for the possessory interest. The court posed four questions to the Board primarily to clarify this point. In response to the question whether nontaxables were taken into consideration in valuing the possessory interest, the Board indicated: “Nor Cal’s possessory interest would be of little or no value if Nor Cal did not also possess non-taxable intangibles such as its subscriber list, the right to operate a cable television business, and going concern value. The Board’s $6,072,211 possessory interest value represents the ‘in use’ value of the possessory interest when put to beneficial and productive use along with and enchanced [sic] by Nor Cal’s non-taxable intangibles.‘* The Board

zz~~inzz~e-fs a-g_uestion about the income attributed to II .-w-e. .-A‘- -____ -‘Lr-,-zLy-=‘- the. possessq mterest:mge in~.*~~~~~~~~~~~~~~~~~~~~-~

interest is $53 1,008. All of this income is directly related to Nor Cal’s - ,i non-taxable intangibles because none of it could be earned absent Nor Cal’s /\ franchise, subscriber base, and other intangible assets that make Nor Cal a ‘I going concern. The converse is also true. The intangible assets enhance the I, value of each other and none of them standing alone have [sic J any substan- ;:i’

tial value. All of the income of the possessory interest is directly related to and dependent upon the non-taxable intangibles and the taxable tangibles and intangibles. To what extent the income attributable to the possessory interest is directly related to the non-taxable intangibles is not ascertainable.” In our view, the record sufficiently establishes the Board considered the effect of intangibles on the value of the possessory interest. It was required to do no more.

(5) The Assessor contends the Board’s allocation of value to the right to 11’1 I;:, do business, possessory interest and going concern is not supported by

substantial evidence. According to the Assessor, II I ]j /

divide the residual into equal proportions was arbitrary and not within the permissible valuation methods. Instead, the Board should have adopted the

!/ i Assessor’s allocation of all residual to the taxable possessor-y interest. tj ; ‘i, ! ,’ ! In proceedings before an assessment board, “the assessing officers are I presumed to have properly performed their duties: the taxpayer has the

burden of showing that the assessments were not fair and equitable.” (IIT World Communications, Inc. v. County of Santa Clara, supra, 101

I Cal.App.3d at p. 252; Cal. Code Regs., tit. 18, 0 321, subd. (a).) “Revenue

II

1 ,,/I

and Taxation Code section 1610.8 requires the applicant for a reduction in an assessment to establish the full value of property by independent evidence.” (County of San Diego v. Assessment Appeals Bd. No. 2 (1983) 148

I

1

Cal.App.3d 548, 559 [195 CaLRptr. 8951, italics in original.)

Of the three intangibles assigned a portion of the residual by the Board, -----_..-__._ ._ __ :-- -!~?k-

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~.~-Tk~~r’~~t~-..-..--- -----e----.-;- .--------.-- -SW-.-,.?M .-_ with the Board’s allocation of only one-thud of the residual to-tGosses- ---

sory interest. How the Board allocated the other two-thirds is irrelevant.

State Board of Equalization rule 25 enumerates permissible modes of assessing possessory interests. Included are the three methods described earlier, the comparable sales approach, the income approach, and the cost approach. (Cal. Code Regs., tit. 18, $25.) None of these methods was used by the Board. However, this rule does not purport to be exclusive. It indicates possessor-y interests “may” be measured by one or more of the enumerated methods.

The Assessor himself acknowledges a cable television possessory interest, “[b]y its nature,” may not be measured by one of the approved methods. However, this does not mean, as the Assessor concludes, the full residual value must be apportioned to the possessory interest. As the court in California Portland Cement Co. v. State Bd. of Equalization (1967) 67 Cal.2d 578 [63 Cal.Rptr. 5, 432 P.2d 7001, indicated: “When no sound or practicable basis appears for apportionment of income as between enterprise activity and the property itself, then a method may be employed which imputes an appropriate income to the property.” (Id. at p. 584, italics added and citations omitted; accord, County of Stanislaus v. Assessment Appeals Bd.. supra, 213 Cal.App.3d at p. 1455, and cases cited therein.)

Nor Cal relied almost exclusively on the testimony of its expert Kane. Kane determined the intangibles could be separated into six general catego- ries: subscriber list, right to do business, favorable franchise terms, possessory interest, work force and noncompete agreement. Using an income

SHUBAT Y. SLITTER COUNTY ASSESSMENT APPEALS BD. 13 Cal.App.4th 794; - Cal.Rptr.2d - [Jan 19931

807

approach, Kane allocated an amount to the tangible assets and subscriber list. The remaining income was allocated In equal proportlons to the right to do business, favorable franchise terms and possessory interest. After computing a present value for these and the other assets and including an allocation for the noncompete agreement, the residual value of Nor Cal was assigned to going concern.

The Board adopted Kane’s approach to valuing intangibles with certain modifications. First, the Board rejected a separate allocation for favorable franchise terms, treating them instead as part of Nor Cal’s right to do business. The Board also rejected Kane’s allocation of the residual value to the going concern. According to the Board, going concern should have been assessed equally with the right to do business and possessory interest. Thus, after assigning appropriate amounts to the other assets, the Board allocated the residual one-third to the possessory interest and two-thirds to the remaining intangibles. The Board also allocated one-half of the present value of future franchise fees to the possessory interest and the other half to the right to do business.

In our view this methodology is reasonable and appropriate under the circumstances presented. As previously indicated, the Assessor himself acknowledged none of the traditional methods of valuation was possible. Nevertheless, Kane indicated the possessory interest, right to do business and going concern operated together to impart value to Nor Cal. None had

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Kane opined the possessory interest contributed approximately one-third of Nor Cal’s residual income after deducting that attributable to tangible assets and the customer base. Applying a discount rate of 20 percent, this resulted in an allocation of $4,059,929, which Kane corroborated with an independent valuation based on franchise fees paid.6 Although Kane attributed the other two-thirds of the residual income to a different mix of intangibles than did the Board, this is of no concern to our analysis. None of these intangibles is taxable. The difference in value attributed to the possessory interest, $4,059,929 by Kane moment. This discrepancy reflects merely a different total valuation of the business and different residual value, neither of which is challenged here.

The record also supports the Board’s allocation of the present value of future franchise fees. Kane opined the two parts of the franchise, the

Wsing a SO percent profit margin, which Kane identified as typical in the industry, income attributable to the S percent franchise fee was determined. From this, a present value of $4,335,24S was computed.

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808 SHUBAT v. SUTTER COUNTY ASSESSMENT APPEALS BD. 13 Cal.AppAth 794; - CaLRpnld - [Jan 19931

possessory interest and right to do business, contribute equally to Nor Cal’s income stream. Thus, the Board’s allocation of value to the possessor-y interest, and corresponding exclusion from total taxable value for other intangibles, is supported by substantial evidence.

None of the intangible assets identified by Kane and the Board has value to Nor Cal independent of the others. Each contributes to the total business. On the present record, there is no basis for attributing a higher value to any one of these intangibles and certainly no basis for attributing all value to the possessor-y interest. On the contrary, the opinions of Nor Cal’s expert provide substantial evidence to support the allocation arrived at by the

,.Y Board. In our view, the Board used an acceptable method of valuation and imputed an “appropriate” value to the possessor-y interest. . ----.--._e_. _-._-___--l~-_-_--_l-_-l _.-__--_-__I . _-.e--- *.*T.Tl-\*-. -e- -e-i-- .% rZI--YC-*ma.?.- -.------lv---*m-- ----e -- -----I_ w-_-m---.

1 ne Juagmenc is arrirmea.

Blease, J., and Sparks, J., concurred.

the state and carmot be modified by the parties without governmental approval. In light of this regulation, capitalization of the income to be generated under the contract properly measures the value of appellant’s property because it is the income a prospective purchaser of the property not only could anticipate but would be guaranteed. It would appear obvious that if the situation were reversed and the SO4 contracts prescribed a below- market rate of income, appellant would be advancing precisely the position taken by the county here-and, in that situation, would be entitled to the benefit of the decrease in property value.”

This modification does not effect a change in the judgment. - . . -- _,-.._-

102 COUNlYOF~SkVGELE5 v. COUNNOFL~SANGELESASSESSS~EHTAWEALSBD.

I3 Cal.App.4th 102; - cal.RpuZU -fib.19931

[No. B06512S Second Disk. Div. Two. Feb. 10, 1993.1

COIINTY OF LOS ANGELES, Plaintiff, Cross-defendant and Appellant,

&JNTY OF LOS ANGELES ASSESSMENT APPEALS BOARD NO. 1, Defendant and Respondent; DOLLAR RENT A CAR SYSTEMS, ENC., Real Party in Interest and Respondent; GRAND RENT A CAR CORPORATION et al., R& Parties in Interest, Cross-complainants and Respondents.

The trial court denied a writ of mandate sought by a county challenging a decision of its assessment appeals board as to the extent of the taxable possessory interests of several car rental firms at three airports in the county. The firms, operating under concession agreements with the airports, maintained counters in the terminals and, at two of the airports, spaces in “ready/return” parkin, Q lots. They agreed to pay, subject to guaranteed minimums, a percentage of gross receipts from all car rentals delivered in the airports’ areas. The county began assessing the firms’ airport possessory interests by capitalizing their guaranteed or prpjected payments to the airports, on the premise that these payments constituted rent for possessory interests in the airports as business premises. This greatly multiplied the appraised value of the interests. The firms obtained a favorable decision from the superior court rejecting this method of assessment at one airport, which decision was not appealed and became final. The county nonetheless continued assessing the firms’ posWsory interests using the rejected concepts and formulae for subsequent years, and the furns obtained a ruling from the assessment appeals board that the piior judgment controlled and preclusively determined by collateral estoppd the extent of the&interests and the invalidity of the assessments. The county then petitioned for a tit of mandate. (Superior Coti of Los Angeles County, No, C 708538, William W. Huss, Judge.)

,

The Court of Appeal affirmed. It held-that the trial court properly invoked its prior judgment to resolve adversely to the county the issue of the extent of the firms’ possessory interests at the airport concerned for the tax years aI

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104 ckKNl”f OF @S &GEL?3 v. Corn OF Los ANGELES Asmmm AppEhLs BD.

13 cal.App.4LtI 102; - (;zI.R;tl.2d - [Feb. 19931

COUXSEL

estoppel yet applies to “legal” issues, albeit with more qualifications than in cases of factual issues.

(See 7 Witkin, Cal. Procedure (3d ed. 1985) Judgment, 5 274 et seq.1

Property Ta,,es $ IGSubjects of Taxatio&Real Property-Pos- sessory Rights-Requirement of Physical Possession.-Just as private possessory interests in public property are a species of taxable property, the possession or use grounding these interests means and requires not just some benefit from the public property, but physical possession or use of it. Hence, in a mandamus action brought by a county challenging a decision of its assessment appeak board as to the extent of the taxable possessory interests of several car rental fums at airports in the county, the trial court properly rejected the county’s assessment, which was based on the firms’ “use” of the airports as a whoie, valued by capitalizing the firms’ concession fees (a percentage of gross receipts), rather than on their possession and exclusive use of their counters and reserved pa&kg lots. Further rights granted by the firms’ agreements with the airports, to do business at the airports and their environs, were not possessory interests; they were intangibles, not subject to prooerty tax. Moreover, the firms’ income stemmed largely from commer&al endeavors other than their physical facilities there.

De Witt W. Clinton, County Counsel, Albert Ramseyer and Paul I. Yoshinaga, Deputy County Counsel, for Plaintiff, Cross-defendant and Ap- pellant.

Kelvin H. Booty, Jr., County Counsil (Alameda), James F. May, Assistant County Counsel, Thomas F. Casey RI, County Counsel (San Mateo), Mary K. Rafter-y, Deputy County Counsel, Steven Woodside, County Counsel (Santa Clara), and Karen Heggie, Deputy County Counsel, as Amici Curiae . on behalf of Plaintiff, Crossdefendant and Appellant,

NO appearance for IL +ndant and Respondent.

Rintala, Smoot, Jaexicke e(. Brunswick, Peter C. Smoot and Robert W. ’ Hodges for Real Party in Interest and Respondent.

Mr,mger, Tolles & Olson, Gregory P. Stone, Latham & Watkins, Robert D, Crockett, Jayne Fan, O’Melveny & bieyers, Thomas M. McCoy and Marcy Jo Mandel for Real Phes in Interest, Cross-complainants and Respondents. c

Courim 0FLOS AuGELEs v. 105 COUNTY OFL~SAUGELESASSESSMENTAPPEALS BD: 13 Cal.App.4th 102; - Cal.Rptr.‘Ld - [Feb. 19931

OPINION

FUKUTO, J.-The County of Los Angeles (County) seeks reversal of a judgment which denied its petition for writ of mandate against the County’s assessment appeals board (Board) and awarded possessory interest tax refunds to car rental companies that operate at the three major airports within the County. The Board and the trial court rejected the County’s contention that the rent-a-cars’ possessory interests extend to the use of each airport generally, not simply the areas the companies occupy (principally service counters}, and also disapproved the County’s method of valuing the interests, by capitalizin, 0 concession fees which were based on and included enterprise income. We conclude that the trial court correctly resolved these issues, which to some extent had already been conclusively determined by another superior court judgment in 1986. The judgment consequently will be affirmed.

FACTS

This case concerns ad valorem .property tax assessments of possessory interests of four car rental companies (Dollar Rent A Car Systems, Inc. (Dollar), Grand Rent A Car Corporation (Avis), The Hertz Corporation (Hertz), and National Car Rental System, Inc. (National), hereafter collectively the rent-a-cars) at Los Angeles International Airport (LAX), Burbank- Glendale-Pasadena Airport (Burbank), and Long Beach Municipal Airport (Long Beach), for tax years 1985-1987 with respect to LAX and 1983-1987 with respect to Burbank and Long Beach. Except for Dollar with respect to Long Beach, each of the rent-a-cars has operated under “concession agreements” or (in the case of Burbank) “leases and concession agreements” (hereafter collectively the agreements) with the airports’ respective owners, the City of Los Angeles, the Burbank-Glendale-Pasadena Airport Authority,

~ and the City of Long Beach.

The agreements grant both the right to conduct a car rental business at the particular airport and the right to occupy and use certain limited portions of it, namely designated counters or booths, and, in the case of Burbank and more recently Long Beach, spaces in a “ready/return” parking lot. The _ _

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I Burbank agreements also grant a nonexclusive right to use common areas to be designated, as weil as terminal public areas such as restrooms and waiting areas; the Long Beach agreements authorize joint use of walkways surround- 1 ing the rental booths, as well as “the use o . . on [sic] the Airport” to . conduct the car rental concession. In exchange for these rights, the rent-a- cars have agreed to pay the airport authorities, subject to guaranteed &i- : mums, 10 percent of gross receipts from all car rentals deIivered jn the i

1

106 COLNTY OFLOSANGELES v. COUNTY OFLOS ANGELES ASSESSMENT APPEALS BD.

13 Cd.App.kh 102; - CdRptrJd -(Feb. 19931

airports’ areas, whether or not arranged through the booths. Burbank separately charges specified “rent” for the booths and lot spaces.

1. The Prior Litigation.

The present case is the second to review the propriety of the County’s assessments of the rent-a-cars’ airport possessory interests. In 1982 the County Assessor began assessing these interests by capitalizing the rent-a- cars’ guaranteed or projected payments to the airports under the agreements, , on the premise that these payments constituted “rent” for possessory interests in the airports as business premises. This change, from previous assess-

; ti

ment of the rent-a-cars’ possessory interests as comprising only their exclusive counter spaces, increased the appraised value of the interests, in the case of LAX, by rbughly 5,000 to 10.000 percent.

The rent-a-cars sought redetermination of the 1982 LAX assessments before one of the County’s assessment appeals boards. That board rejected the County’s assertion that the taxable possessory interests extended further than the airport counters (and related telephone reservation boards), and reduced the appraisals, although not as much as the rent-a-cars had requested.

The parties then commenced a series of actions and proceedings in Los Angeles Superior Court, to review the administrative decision. The cases : were ordered consolidated and tried before a single judge. (Hertz Corpora- . :

, tion v. County of Los Angeles (Super. Ct. L. A. C&n;y, 640. C537445).j The court rendered a statement of decision and judgment in favor of the rent-a- cars, embracing the following principal determinations.

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(1) The rent-a-cars’ possessory interests at LAX included only their counters, telephone boards, and signs, the latter two nor having significant value. ’

(2) The taxable value of these interests was fair market rent, which wouid be no greater than the assessed value of airline counter space at the airport, then $15 per square foot. However, the rent-a-cars having sought reduction only to $45 per foot, they would receive that measure.

(3) The County’s conw method of valuation, based on capitalized concession fees, was invalid for two further reasons. First, it produced valuations of similarly situated, like-kind-and-character properties that widely differed between the rent-a-m, in violation of constitutional requirements of uniform, equal taxation. Second, it improperly included income and value derived not from the property but from the rent-a-cars’

*. I.. 5.:’ :: ,.*

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Coux~Y OF Los ANGELES Y. 10; --_ COUNTY OF Los AXGELES ASSESSMENT APPEALS BD. 13 Cal.App.4th 102: - Cal.Rptr.Zd - [Feb. 19931

overall enterprises -i.e., business produced not by the airport counters but through advertising, goodwill, national reservation systems, and the like.1

The judgment, rendered August 27, 1986, ordered reduction of the LAX assessments accordingly, together with refunds.

2. The Present Case.

The County did not appeal from the 1986 judgment, and it became fma]. Nevertheless, the County continued to assess the rent-a-cars’ possessory interests, at all three airports, usin g the same concepts and formulas he superior court had rejected. The County did so under the premise, as stated by its counsel at administrative hearings, that ‘The superior court decision is not binding authority. . . . And the assessor does not have to follow a superior court decision . . . .”

The rent-a-cars again sought reduction of their assessments, this time at all three airports, for various years including and following 1983. After an extended hearing, the Board ruled that the prior judgment controlled and preclusively determined, by collateral estoppel, the extent of the possessory interests, as well as the invalidity of the assessments because they attributed unequal values and included enterprise value. After resolving adversely to the rent-a-cars a separate issue concerning the projected duration of their interests, the Board reassessed the various values at levels amounting to only a few percent of those the County had advanced.

The County then commenced this litigation, by petition for writ of mandate (Cod= Civ. Proc., 5 1094.5) against the Board. As real parties m interest, the rent-a-cars answered, alleging collateral estoppel by the prior judgment as a defense. All but Dollar also filed cross-complaints seeking tax refunds.

At the hearing on its motion for peremptory writ, the County argued, “[A]t Some point . . . the County of Los Angeles has to be able to go to court and get review of what we consider a patently erroneous decision; . ~ . We’re appealing the 1986 decision here today, your Honor.” The court denied the County’s petition, holding that the prior jud,gment controlled the case, and rejecting the County’s contention that there had been a subsequent change in the law of possessory interests, justifying a different result.

The County moved for reconsideration, based on a new appellate decision, announced two weeks after the court’s tentative decision. (United Air Lines, Inc. v. county of Sun Diego (1991) 1 Cal.App.4th 418 [2 CaLRptr.2d 2121

Tke court furtker found that the Board’s reduced valuations-roughly onequarter of the assessor’s-were unsupported by evidence.

108 cOUl4l-Y OF IAS iLVGEUts v. Cotnrry OF Los ANGELES ASSESSMEXT APPEALS &I.

13 CaLApp.4th 102; - Ca1.Rptr.U - [Feb. 19931

[hereafter United Air Lines].) The court granted reconsideration, but adhered to its ruling denyin, * the petition. The subsequent judgment also awarded Hertz, Avis, and National refunds, as sought by their cross-complaints, but denied, without prejudice to other tax years, their further claims that the Board had improperly judged their remaining terms of possession.*

DISCUSSIONS

As reflected above, the primary basis for both the judgment below and the Board’s determinations which it affied was the superior court’s prior,

1986 jud,grnent, in proceedings between the same parties, rejecting the County’s method of assessing the possessory interests at LAX. We therefore turn first to the question af collateral estoppel, prompted also by consider- ations of judicial economy’that in part animate that doctrine.

(1) Collateral estoppel forecloses relitigation of an issue that (l)‘is identical to one decided in a prior case (2) involving the same party or parties or those in privity with them and (3) which resulted in a final judgment on the merits. (E.,., 0 bdud V. Bank of America (1942) 19 CaI.2d 807, 813 [ 122 P.2d 8921.) @a) In the present case the second and third criteria plainly appear: the County and the rent-a-cars all were parties to the prior litigation, which ended in a final judgment on the merits that the County chose not to appeal. The remaining inquiry concerns the identity of issues between the two cases.

(3)(sec In. 4~) The primary issue determined in the prior litigation was that the rent-a-cars’ possessory interests at LAX extended to no more than their counters (and insignificant boards).4 (2b) With respect to LAX, this issue is identical to the threshold one in the present case. Although the two

ZAt the conclusion of the hearing on the writ petition, tit cow directed those rent-a-cnrs with cross-complaints pending to file a motion for summary judgment on that phase of the case. The record on appeal does not reflect any such proceedings, but the County as appellant does not complain of any such procedural omission.

ane County has requested judicial notice of certain congressional hearings that were conducted and published well before the hearings in the trial court:, but were not offered there. We deny this untimely request to expand the record. (See Code Civ. Proc., 3 1094.5. subd- (e).) The rent-a-cars’ request for judicial notice of portions of the administrative record in the prior cxse also is denied. (See Evid. Code, 5 352.)

Whether this issue is one of law, as the parties assert, or more properly a mixed question of law and fact, is ultimately inconsequential. The partics cite a series of cases that chamc- te&e khether or not a taxpayer has any possessory interest as a question of law, indcpcn- dently reviewable regade’ss of its treatment at the administrative level. (E.g., fczcifi Grove-Adomar Operating COT. v. Counry of Monterey (1974) 43 Cal.App.3d 675, 680-683 [117 CaLRptr. 8741.) Collatenl estopped yet applies to “legal” issues, albeit with more qualifications than in cases of factual issues. (See 7 Witkim. CaI. Procedure (3d ed. I9851

ciit.in~ OF Los ANGELES v. co-UYTY OF Los ANGELES ASSESSMENT APPEAU BD. 13 Cd.App.4~h 102; - Cal.Rptr.2d - [Feb. 19931

109

ases involve different tax years and, for some of them, different agreements, the agreements with respect to LAX are materially identical, as is the physical situation to which they apply. The prior judgment’s determination of the extent of the rent-a-cars’ possessory interests at LAX therefore appears to preclude the County’s present effort to claim and assess broader possessory interests there.

Apparently having abandoned the untenable position that a superior court jud,oment cannot be “binding” beyond its immediate case, the County pro- pounds two principal objections to application of Collateral estopped in this context and fashion. The first is that the present case concerns later assessments, of interests for the most part created by different agreements than those at issue in the prior case. As already stated, this is not decisive. The terms of the several LAX agreements that generated the po$sessory interests in question are the same, as are the faciiities in question, and hence so are the interests themselves. That this case involves later tax years does not seuarate the issues or render them nonidentical. (Cf. Months v. United S&es (1979) 440 U.S. 147, 158-162 [59 L.Ed.2d 210, 219-222, 99 S.Ct. 9701 [determination that tax was constitutional applied by collateral estoppel to subsequent suit involving different contracts].)

Second, the County seeks to invoke the doctrine that collateral estoppel as Second, the County seeks to invoke the doctrine that collateral estoppel as to legal issues should not apply where the content or character of the l%w has changed since the frost judgment, so that application of it would produce obsolete, inequitable administration of the laws. (See Montana v. United S;ares, supra, 440 U.S. at pp. 161-162 [59 L.Ed.2d at pp. 221-2221; Com- missioner v. Sunnen (1948) 333 U.S. 591, 599-601 [92 L.Ed. 898.906-908, 68 S.Ct. 7151; Rest.2d Judgments, 0 28(2)(b).) In this regard, the County contends that, following the prior judgment, the law governing the issue of the extent of the rent-a-cars’ possessory interests changed, favorably to the County’s “airport as a whole” theory. To this alleged effect, the County relies on a Court of Appeal decision recognizing a possessory interest in Commercial river-rafters’ rights to use a river (Scott-Fve River Expeditions, Inc. v. County of El Dorado (1988) 203 Cal.App.3d 896 12.50 CaLRptr. 5041 [hereafter Scott-Free]), another such decision concerning aircraft landing rights (United Air Lines, supra), a federal Court of Appeals case involving a

$& - possessory interest in an experimental fusion device (US. V. County of San possessory interest in an experimental fusion device (US. V. County of San :+$!. Diego (9th Cir. 1992) 965 F.2d 691), and finally, the Supreme Court’s Diego (9th Cb. 1992) 965 F.2d 691), and finally, the Supreme Court’s 5%;’ depublication of a decision by the Fourth District Court of Appeal that had depubl&tion of a decision by the Fourth District Court of Appeal that had *W’z: ’ rejected contentions similar to the County’s with respect to car rental rejected contentions similar to the County’s with respect to car rental -3%. _ ~$2: Judgment, $8 274276, pp. 714-717.) As discussed, the County’s efforts to invoke some of Judgment, $8 274276, pp. 714-717.) As discussed, the County’s efforts to invoke some of I&%$, these restrictions are unavailing. these restrictions are unavailing. =y$. . .: #- . p&; ’ -a- *

110 COIJXl-YOF~ShG~~Y. CO~~~YOFLOS~GELESASS~APPEZLLSBD.

13 CaLAFpAth 102; - CaLRprr2d - [Fci 15931

possessory interests at San Diego’s Lindbergh Field (Hertz Corporutian v. County ofSun Diego (NOV. 28, 1990) D010144).

The County’s attempted use of the last-noted depublication is baseless. (Cal. Rules of Court, rule 979(e).) And, as we shall explain shortly, none of the substantive decisions on which the County relies altered or upset the law the prior judgment followed. Accordingly, there is no impediment to appIy- ing collateral estoppel by that judgment to its full reach in this litigation. The superior court properly invoked its prior judgment to resolve adversely to the County the issue of the extent of the rent-a-cars’ possessory interests at LAX for the tax years here in issue.

That determination cannot, however, extend to the similar question now posed for the first time with respect to Burbank and Long Beach, which were not the subject of the prior action. The prior action determined the extent of the rent-a-cars’ possessory interests at LAX. Although the agreements between the rent-a-cars and the authorities at Burbank and Long Beach are similar to those with respect to LAX, they are not identical. Nor are the physical situations coterminous. Most prominently, the limited possessory interests which the rent-a-cars admitted at the other two airports include not only different counters at different facilities but also “ready/return” parking spaces, not implicated or .addressed in the prior case. In light of these differences,. the prior judgment cannot be deemed to have decided the issue of extent of possessory interests at Burbank and Long Beach.

Similarly, we do not perceive collateral estoppel to obtain with respect to the prior judgment’s conclusions that the County’s method of valuation case was improper. Those determinations related to the particular facts of that case, involving the 1982 LAX assessments. Although the County employed the same valuation techniques in the present case, the holding of unlawfully unequal taxation involved, and requires, comparison of particular assessments; and the fading that enterprise value was improperIy included for LAX in 1982 cannot be transposed to later tax years, and operations in other locations, without evidence of the nature and source of the income and v&e appraised in those years.

Accordingly, the correctness of the judgment below cannot be fu!Iy decided by invocation of the prior jud,gment. (4) However, we are con- vinced that the trial judge here, like his predecessor in the prior case, correctly resolved the dispositive issues on the merits. We begin wirh the question of the extent of possessory interests at Burbti and Long Beach.

Possessory interest law and taxation implicate T;rivate interests in-public property, which is not itselfsubject to property tax. The statutory derrmdon

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Coum~ OFLQS ANGELES v. Cotir~ OF Los ANGELES ASSESSMENT APPEALS BD. 13 Cal.App.4th 102; - CaLRph2d - [Feb. 19931

111

of a possessory interest is “Possession of, claim to, or right to the possession of land or improvements, except when coupled with ownership of the land or improvements in the same person.” (Rev. & Tax. Code, $ 107, subd. (a).) Other definitions add “exclusive use” to “possession.” (Cal. Code Regs., tit. 1 S, 3 21, subd. (a), (e).) In recent years there has been much litigation concerning the nature and degree of “exclusivity” of use necessary to create a possessory interest. The consistent trend of decisions has been to favor assessors’ claims, by holding that possessory interests may arise from lim- ired or concurrent exclusive uses, so long as they involve a grant of rights not shared by the general public. (See, e.g., Freeman v. County of Fresno (198 1) 126 Cal.App.3d 459 [ 178 Cal.Rptr. 7641.) But none of these holdings impairs or retreats from the basic principle that, just as possessory interests are a species of taxable property, the possession or use which grounds them means and requires not just some benefit from the pubhc property, but physical possession or use of it.

This is the fundamental flaw in the County’s claim that the rent-a-cars own or hold possessory interests “in the airport as a whole,” or in their “full bundle of rights in the airport locations.” Under the agreements and evidence concerning Burbank and Long Beach, as at LAX, there is no dispute that the rent-a-cars enjoy possession and exclusive use of their counters (booths) and ready/return spaces. But that is the full extent of the rent-a-cars’ rights of possession or use of airport property, except in common with, and coequal to, everyone else. And this means that the County’s concept of a broader possessor-y interest cannot be sustained.

The cases the County principally relies upon illustrate and confirm the foregoing. In Scott-Free, supra, 203 Cal.App.3d 896, numerous commercial river-rafters challenged the assessor’s determination that their use permits, authorizing exclusive commercial use of the river, created possessor-y inter- &s in it. Rejecting the challenge, the court confiied that although the river was not taxable property, the plaintiffs* use of it was. Further, the court held, these rights of use were exclusive even though multiple, because plaintiffs, but not the public, had “a special right of access for profit.” (rd. at p. 910.) Both of these holdings were based on the facts that the plaintiffs physically used--i.e., rafted upon-the river.

S~ilruly instructive is United Air Lines, supra, 1 Cal.App.4th 418. There, a divided court sustained a claim of possessory interests in several airlines’ use of airport landing areas and related facilities (runways, wash racks, etc.), finding that the airlines were a distinct category of exclusive users (regularly scheduled passenger carriers). But both the claim of interest and the holding

112 COUNIY OF Los AXGELES Y. COUNTY OFLOS~IGELES Amsnm-r APPEALS BD.

13 ‘2aLXppAtb 102; - CalJlptr.Zd - (Feb. 19931

concerned physical occupancy and use of specific facilities. There was no suggestion that the airlines, primary and pervasive users of the airport, held a general possessory interest in “the airport as a whole.” ,

Thus, even apart from the issue of enterprise, the mere fact that the rent-a-cars derive customers and revenues through the gates of an airport terminus or “system” does not define the existence and extent of their possessory interest in the airport property. The County’s colloquial concept of airport “use” does not account for possession or occupancy, and thus misconceives the elements and requisites of a possessory interests

In a further attempt to expand the meaning of poss&ory interest, the County cites US. v. Count of San Diego, szqra, 965 F.2d 691,694, for the proposition that “[A] license or permit is a taxable possessory interest in property.” This contention too is exaggerated. The quoted statement-made in a case approving taxation of a possessor-y interest in a fixture subject to taxpayer use-inaccurately paraphrased the California authority on which it relied, Stadium Concessions, Inc. V. Ctiy of Los AngeIes (1976) 60 Cal.App.3d 215 [ 131 Cal.Rptr. 4423. Stadium Concessions recognized possessory interests in food concession stands located in sports arenas. Holding that the underlying agreement and facts satisfied the possessory interest test, including exclusive use, the court stated, “[A] concession agreement may, in a particular case, prodzce a possessory interest in pubIic premises by the concessionaire.” (Id. at p. 225, italics added.)6

That indeed has occurred under the rent-a-cars’ concession agreements with Burbank and Long Beach (and LAX)-but only with respect to the property exclusively possessed and used. The further. rights granted by the agreements, to do business at the airports and their environs, are not possessor-y interests. They are intangibles, not subject to property (possessory interest) tax. (Accord, Coltnfy of Sfanislaus V. Assessment Appeals Bd. (1989) 213 Cal.App.3d 1445, 1452-1454 [262 CaLRptr. 4391.)

For related reasons, the Board and the trial court also properly disapproved the County’s method of valuation, which involved capitalizing the rent-a-cars’ concession fees, which are measured as a percentage of their income from their airport area operations. The County seeks to justify this approach by characterizing these payments as “rents” and asserting they

This misconception also pemdes the arguments of amici curiae in support of the County. Vimilarly, the portion of Stcdi~n Conces~ims cited by the Ninth &wit was a treatise’s

sntement t&t a possessory icterest may be held by ” ‘a mere permitter or Lkenset.“’ (Id. at p. 222, original ialics.) (But see Kaiser Co. v. Reid (1947) 30 Cal.2d 610,619 [I84 P.2d 8791, cited by both Sradirun Comessiom and US. v. County of San Diead [a “right to use [which is] no more than a permit cr lic:nse” could not give rise to a p~~ssessary interest or ‘be responsible for a ‘proFe*?’ tax”].)

COUrJTY OFLOS ANGELES Y. COUNTY OF Los ANGELES ASSESSMENT APPEALS! BD. 13 Cal.App.4tb 102; - Cal.Rptr.Zd - [Feb. 19931

113

were arrived at through a market process by which the rent-a-cars evaluated and agreed to pay reasonable value for their possessory interests. But this analysis again fails to differentiate between the possessor-y interests in question and the valuable but intangible business opportunities for which the agreements provide and the concession fees also pay.

*.

Furthermore, the County’s argument cannot overcome the evidence and determination below that the income the rent-a-cars earn at their airport locations stems largely from commercial endeavors other than their physical facilities there, i.e., enterprise. There was substantial evidence that most of the income upon which the concession fees and hence the County’s v&a- tions were based derived not from the rent-a-cars’ limited physical presence - at the airport but from remote and extensive business techniques to draw customers and reservations. But that is neither an accurate nor a proper basis to determine the value of taxable property, even if the property is a possessory interest lease providing for percentage rentals. (California Portland Cement Co. v. State Bd. of Equalization (1967) 67 Cal2d 578, 584 [63 CaLRptr. 5,432 P.2d 7001; Counry of Riverside v. Palm-Ramon Development Co. (1965) 63 CaL2d 534, 538 [47 CaLRptr. 377, 407 P.2d 289J.)

“4

Accordingly, the trial court properly refused to reinstate the County’s theory of valuation and its resultin, 0 assessments.’ This does not mean that valuation of the rent-a-cars’ possessory interests may not consider their airport locations, as contributing to and enhancing their independent value as business properties. (Cf. County of Stanislaus V. Assessment Appeals Bd., supra, 213 Cal.App.3d at pp. 14551456.) That factor, which the rent-a-cars have represented their own appraisals took into account, remains appropriate for consideration in any reassessment. However, as between the possessory interest concepts and valuation methods adduced below, the Board and the trial court properly disapproved the County’s.

I hS?OSITION

‘7 -.: ’ -4

The judgment is affmed.

Boren, P. J., and Nott, J., concurred. :. c

it ;;:,

Le. i.’ I- L.. 5 $> . If ‘h $f is;, :

wc: find it unnecessary to consider the ConStitUtiOnal qUeStiOn of unequal taxation.

FREEPORT-MCMORAN RESOURCE PARTNERS v. COUNn OF LAKE

12 Cal.App.4th 634; - Cal.Rp!dd - [Jan. 19931

llll CNo. A055683. Fust Dist., Div. Two. Jan. 19. 1993.1

FREEPORT-McMORAN RESOURCE PARTNERS, Plaintiff and Appellant, v. COUNTY OF LAKE, Defendant and Respondent.

SUMMARY

Z~anxtim in .which _I --- _._- --- a Peothetmal newer &+.nt owner challenged the county’sasses-g~~-~~~~~~~~~~l. ..--L

county summary judgment. The owner had acquired long-term contracts to sell electricity to a power company for a fixed price. This particular type of contract was subsequently disapproved by the California Public Utilities Commission, but existing contracts remained in force. In assessing the value of the owner’s plants, the county assessor calculated the income stream for the years of the contract by reference to the fixed energy price in the contract. The owner challenged the assessment, asserting that the valuation should have been based on the market price for energy, an amount lower than the contract price. The county board of equalization upheld the assessor’s method of forecasting income. The owner brought its action in superior court for refund of taxes and declaratory relief. The trial court found that the income approach was the appropriate method by which to determine the fair market value of the property, that the assessor’s and the board’s valuation method was valid, and that substantial evidence supported the board.5 determination concerning the proper application of the income approach to valuation. (Superior Court of Lake County, No. 26135, Robert L. Crone, Jr., Judge.)

The Court of Appeal affirmed. It held that the full value of the property included projected income at the contract rates, rather than market rates, since a prospective purchaser would be willing to pay more for the plant with the existing contracts. The court also held that the contracts were the

. . :t

means by which the property was put to beneficial use for purposes oi assessing the property’s full value. It preliminarily held that the question presented was one of law, and thus it reviewed the trial court’s decision de novo. (Opinion by Kline, P. J., with Smith and Benson, JJ., concurring.)

FREEPORT-MCMORAN RESOURCE PARTNERS v. 635 COUNTY OF LAKE 12 Cal.App.4th 634; - CaLRprr 7d - [Jan. 1993)

HEADNOTES

Classified to Califorma Digest of Offhal Reports

(la, lb) Property Taxes $ 33-Assessment-Validity-Standard of Re- view-Challenge to Method of Assessment Used.-On appeal of a summary judgment, by which the trial court ruled that a county assessor’s method of valuation of certain property was valid, the issue was one of law, and thus a de novo standard of review was applicable. The property owner, who operated geothermal plants, had acquired contracts to sell eleccriclty to a power company at a fixed price. This particular type of contract was disapproved by the California Public Utilities Commission, but existing .cootracts remained in force. The county assessor calculated the income stream for the years of the contract by reference to the fixed energy price in the contract. The owner asserted that the valuation should have been based on the market price. The parties disputed which method of determining the income stream was the more appropriate, but there were no disputed issues of fact. The parties agreed even on the amount of the valuation under either approach. Thus, the question presented was one of law.

(2) Property Taxes 9 33-Assessment-Validity-Standard of Review. -Where a taxpayer challenges the validity of the valuation method used by an assessor, the trial court must determine as a matter of law

l%lgemEe*- -- -‘-....-....

violation of the standards pre&ibed bj; law. Thb -- appellate court’s review of such a question is de novo. By contrast, where the taxpayer challenges the application of a valid valuation method, the trial court must review the record presented to the board of equalization to determine whether the board’s findings are supported by substantial evidence but may not independently weigh the evidence. The appellate court also reviews a challenge to application of a valuation method under the substantial evidence rule.

(3)

(4)

Property Taxes 0 42-Assessment-Valuation-Full Value or Fair Market Value: Words, Phrases, and Maxims-Full Value-Fair Market Value.-For purposes of Rev. & Tax. Code, 0 401 (all property subject to general property taxation must be assessed at its full value), full value, or fair market value, is a measure of desirability translated into money amounts, and might be called the market value of property for use in its present condition.

Property Taxes 6 42-Assessment-Valuation-Methods-Income Method.-In assessing property for tax purposes, the income method is

636 FREEWRT-MCMORAN F&SOURCE PARTNERS v. COUNTY OF LAKE

12 Cal.App.4tb 634; - Cal.Rptr.2d - [Jan. 19931

one of three basic methods for determining full cash value, the others being the comparative sales approach and the reproduction and replacement cost approach. The income method rests upon the assumption that in an open market a willing buyer of the property would pay a willing seller an amount approximately equal to the present value of the future income to be derived from the property. Under this approach, an appraiser values an income-producing property by estimating the present worth of a future income stream. The income approach may be called the capitalization method because capitalizing is the process of converting an income stream into a capital sum, i.e., value. The assessor capitalizes the sum of anticipated future installments of net income from the property, less an allowance for interest and the risk of partial or no receipt. Since a property’s full value must be determined by reference to the price it would bring on an open market, the net earnings to be capitalized are not those of the present owner of the property, but those that would be anticipated by a prospective

- -. purchaser. .- _.-- _-- .-. . . . .*.A=% ,.-.,-,,,,.,,------~----“----- d.IL_..______I_ __4-a--- .--... - -r_ .--t--.-t. - e-- uI-r.Mcc- U,..C .,,UZi. -- --.----. - __-_- -.-A-~-.--.-w--- __e-___ I_ me.-. - A

@a-Sc) Property Taxes 9 42.2-Assessment-Valuation-Capitaliza- tion of Geothermal Plant’s Income.-In valuing geothermal power plants for property tax purposes, the county assessor properly capitalized the plant’s income from fixed-priced contracts under which the plant sold electricity to a power company at rates above market price.

, The plant’s owner had acquired the long-term contracts to sell electricity for a fixed price. Although this particular type of contract was subsequently disapproved by the California Public Utilities Commis- sion, existing contracts remained in force and could be transferred to subsequent purchasers. Even though the contracts were no longer

jn available, the full value of the property included projected income at :/ .I the contract rates, rather than market rates, since a prospective pur-

chaser would be willing to pay more for the plant with the existing i

contracts. Also, the contracts were the means by which the propert! was put to beneficial use for purposes of assessing the property’s full

I I value. Moreover, the higher price received under the contracts was not the result of successful operation of the plants but of the regulatory scheme that allowed the owner the benefit of a long-term fixed contract

I price.

#” LL

J. [See Cal.JurJd, Property Taxes, Q 78; 9 Witkin, Summary of Cd.

Law (9th ed. 1989) Taxation, 8 ISS.]

(6) Property Taxes § 12-Subjects of Taxation-Personal Property- Intangible Values .-Although only tangible personal property is subject to taxation under Cal. Const., art. XIII, p 2, intangible values that

FREEPORT-MCMORAN RESOURCE PARTNERS w. 637 COUNTY OF LAKE 12 CaLApp.4th 634. - Cal.Rptr.2d - IJan 1993)

cannot be separately taxed as property may be reflected in the valuation of taxable property. Thus, in detertinlng the value of taxable property, assessing authorities may take into consideration earnings derived therefrom, which may depend upon the possession of intangible rights and privileges that are not themselves regarded as a separate class of taxable property.

(7) Property Taxes 0 42-Assessment-Valuation-Methods-Income Method-Earnings From Enterprise Activity.-Under the income approach to valuation of taxable property, only earnings from the property itself or the beneficial use thereof are to be considered. Income derived in large part from enterprise activity may not be ascribed to the property. When no sound or practicable basis appears for apportionment of income as between enterprise activity and the property itself, then a method may be employed which imputes an appropriate income to the property. c

COUNSEL .

Crosby, Heafey, Roach & May, Peter W. Davis, John E. Carne and Peter L. Shaw for Plaintiff and Appellant.

Cameron L. Reeves, County Counsel, and Anita L. Grant, Deputy County Counsel, for Defendant and Respondent. -.-- ; -0 I a..- __- _^ --I---“-.-“-I----“- __ ____ _.r-_y-- ‘--‘-- ---- --- -- -p----=““q- e-.-.-z- UP%-. &:a. *#p=b~++G-=z=--nv- ~sax.w.~-w.z<M~~ _--. . . . .^--_- m.I.-.-.,^*.--. ___- .- --. ----. ---..---- .__-- -.-w--.--c Endman, Lincoln, Turek & Heater; Donald R. Lincoln, Henry E. Heater, Thomas M. Fries and Allen Lenefsky as Amici Curiae on behalf of Defend- ant and Respondent.

OPINION

KLINE, P. J.-This case arises from a dispute regarding the property tax assessment of geothermal power plants owned by appellant Freeport-McMo- ran Resource Partners (Freeport). Appellant contends the county overvalued the property by basing its assessment on capitalization of the income stream of fixed price contracts under which appellant sells electricity to Pacific Gas and Electric Company (PG&E) at rates well above present market rates.

STATEMENT OF THE CASE AND FACTS :i .” I,

Under the Public Utility Regulatory Policies Act of 1978 (PURPA), 16 United States Code section 796 et seq., and Federal Energy Regulatory

Commission (FERC) rules, utilities are required to purchase electricity from “qualifying facilities” (facilities that meet FERC requirements) at a price no greater than the utility’s “avoided cost” (the cost the utility would have incurred by generating the electricity itself). (16 U.S.C. $ 824a-3 (1985); 18 C.F.R. 9 292.1Ol(b)(6)(1990).) As a result of PURPA, the California Public Utilities Commission (CPUC) approved “standard offer” contracts to en- courage qualifying facilities to sell energy to public utilities on standardized terms. The energy prices in these contracts were developed by public utilities and approved by the CPUC in 1983 based on then current forecasts of future market prices for fuel. Four types of standard offer contracts were devel-

\ oped, of which two are relevant here. Standard Offer 1 agreements (Sol) provided for payments to be adjusted throughout the contract term to reflect changes in the utility’s short-run avoided costs; Standard Offer 4 agreements (SO4) were long-term energy supply contracts that contained various payment options including a fixed price option.

PURPA (West Ford Flat and Bear Canyon Creek). Appellant had previously acquired from third parties SO4 contracts with 20-year terms and the plant-s began supplying energy to PG&E under the terms of these contracts in 1989.’ The contracts provided for a fixed price for the first 10 years based upon 1983 projections of PG&E’s avoided costs over the contract term, the principal component of these long-run avoided costs being the market price of natural gas purchased by PG&E to generate electricity. Payment during the subsequent 10 years was to be based cn PG&E’s short-run avoided operating costs, which are adjusted from time to time to reflect changes in the market price of natural gas.

In 1985, the CPUC suspended approval of new SO4 agreements with fixed energy prices, after determining that the fixed prices did not reflect market prices for energy because they were based on overestimates of the utilities’ long-run avoided operating costs due to incorrect assumptions that market prices for natural gas would continue to rise. As of March 1, 1989, the only new standard offer contracts available to geothermal plants from PG&E were the adjustable SO1 agreements. Existing SO4 contracts remained in force.

The county’s witnesses testified before the Lake County Board of Super- visors, acting as the Board of Equalization (Board) that the terms of the SO4

‘Appellant ongmally aqulred SO4 contracts for supply of energy from as yet unbullt facilities m Sonoma and Lake counties; PG&E consented to transfer of the contracts to appellant’s propertles.

~REEPORT-MCMORAN RESOURCE PARTNERS v. 639 &UNIT OF LAKE 12 Cal App 4th 634. - Cal Rptr.Zd - [Jan 1993)

contracts could not be changed during the contract term: that the contractc were abslgnable; that appellant’s properties would be offered for sale only in conjunction with the SO4 contracts that provided the terms for sale of electricity and so were necessary to make the projects economically viable; that a project with an SO4 agreement would sell at a higher price than one with an SO1 agreement because the former guarantees a higher income; and that an SO4 contract in and of itself (not attached to a project) would not have value in the marketplace. Appellant’s witness testified that geothermal plants and SO4 contracts are distinct assets that can be sold separately and have separate values, but acknowledged that as a general rule purchasers of I tic pro]ccts Si-muflaneous~y purchase the Contracts.

In determining the assessed value of appellant’s plants, the assessor calculated the income stream for the years 1989-1998 by reference to the fixed energy prices in the SO4 agreements, The West Ford Flat plant was valued at $166,163,000, and the Bear Canyon Creek plant was valued at c !j $100,630,000. Appellant applied for changed assessment, contending the ‘I

assessor should have based his valuation on the market prices for energy in effect in 1989, which were much lower than the prices in the SO4 contracts. According to appellant, the two plants should have been valued at $55,412,000 and $22,908,700 respectively. The Board held a hearing on appellant’s applications on November 29 and 30, 1989, and issued findings ; of fact on May 22, 1990, upholding the assessor’s method of forecasting I income. The Board determined that the taxable values of the plants were I

_.---- ------ qgg&&&~~~~~~=~

- -- -&y=-q&Tp= .---- .NI.. ,.J....e..~s-~~ _- _- _I c______.__ ..-_ --...----.---.----~- __..c----

On November 13, 1990, appellant filed a complaint in superior court for refund of taxes and declaratory relief. The parties stipulated to the relevant

1

facts and submitted the matter on cross-motions for summary judgment. The parties agreed that the capitalized income approach was the proper one to use in determining the value of geothermal properties but disagreed as to the proper method for determining the income stream to be utilized under this /

approach. The parties further agreed that if appellant’s method of determining the income stream was accepted the correct values of the two properties would be $55,412,000 and $22,908,700, while if the Board’s method was accepted the correct values would be $157,108,287 and $93,801,278.

On August 28, 1991, the court granted the county’s motion for summary judgment, ruling that the income approach was the appropriate method by which to determine the fair market value of the properties, that the assessor’s and Board’s valuation method was valid and that substantial evidence supported the Board’s determination concerning the proper application of the income approach to valuation.

440 FREEPORT-MCMORAN RESOURCE PARTNERS v. bJNTY OF LAKE

12 Cal.App.4th 634; - CaLRpcr.2d - [Jan. 19931

A timely notice of aooeal was filed on November 15, 1991.

(la) The patties dispute whether this court should employ a de nova or a substantial evidence standard of review in this case. (2) Where a taxpayer challenges the validity of the valuation method used by an assessor, the trial court must determine as a matter of law “whether the challenged method of valuation is arbitrary, in excess of discretion, or in violation of the standards prescribed by law.” (Bret Harte Inn, Inc. v. City and County of San Francisco (1976) 16 Cal.3d 14,23 [127 Cal.Rptr. 154,544 P.2d 13541.) Our review of such a question is de novo. (Dennis v. County of Santa Clara

the trial coc must review-the record presented to the Board to determine whether the Board’s findings are supported by substantial evidence but may not independently weigh the evidence. (Bret Harte Inn, Inc. v. City and County of San Francisco, supra, 16 Cal.3d at p. 23; Dennis v. County of Santa Clara, supra, 215 Cal.App.3d at p. 1026.) This court, too, reviews a challenge to application of a valuation method under the substantial evidence rule. (Dennis v. County of Santa Clara, supra, 215 Cal.App.3d at p. 1026.)

(lb) In the present case, the assessor employed the income approach to valuation, which “estimates current fair market value of a property by attempting to determine the amount that an investor would be willing to pay for the right to receive the future income the property is projected to produce.” (Union Pacific Railroad Co. v. State Bd. of Equalization (1991)

983, 989-990 [282 CaLRpu. 7451.) The parties stipulated that they “%&ree that the ‘income approach to value,’ referred to in Rule 8, 18. CCR $ 8, is the proper approach for assessing properties of this kind” and that the only dispute in the case is “about the proper method for determining the income stream for these properties under an income approach to valuation.” Appellant views this as a case for de novo review, characterizing the issue as whether the valuation method used by the county and Board was proper; the county views the disputed issue of which income stream to utilize as a question of “application” of the income method of valuation.

The determination whether a challenge is to “method” or “application” is not always easy. In Union Pacific Railroad Co. v. State Bd. of Equalizatron, supra, 231 Cal.App.3d 983, 989, railroad operating assets had been assessed

FREEPORT-MCMORAN KESOURCE PARTNERS v. 641 COUNTY OF LAKE I? Cal App 4th 634. - Cal.Rptr.Zd - [Jan. 19931

by means of the “ ‘income’ or ‘capitalized earnings ability’ approach.” The parties agreed this wac; the hest general approach for valuing the assets in question but disputed issues regarding the size of the income stream- whether certain costs should be deducted as expenses and whether the income stream should be projected as a perpetuity or a limited lifetime. (id., at pp. 989-990.) With respect to the standard of review, the court stated: “A valuation method may be recognized as theoretically coherent and logical, yet be so inappropriate to the type of property being assessed as to ensure, for all properties of that general kind, that the results reached will not approximate fair market value. A claim of this kind could be termed a challenge to the ‘application’ of the method, presenting a factual question. But where the claim is that, due to the basic undisputed characteristics shared by an entire class of properties, the challenged method will produce systematic errors if applied to properties in that class, the issue is not factual but legal. The issue is not whether the assessor misunderstood or distorted the available data, but whether he or she chose an appraisal method which by its nature was incapable of correctly estimating market value.” (231 Cal.App.3d at p. 992; see Southern Pac[fk Transportation Co. v. State Bd. of Equalization (1987) 191 Cal.App.3d 938, 956 [237 Cal.Rptr. 1911.)

Similarly, here, the parties dispute which of two possible methods of determining the income stream to be used in an assessment under the income approach to valuation is the more appropriate given the nature of the properties and industry in question. There are no disputed issues of fact; the

parties a~re-~e_n~JMunomu JlfAhewtia& - .-- Bz?fson -presented%7@s&Bffaw a.iWiiE~~r~~.the cow-

..-.,;;n-,-c~.~.-rrr.;-~ -- -L--.4--. =-- ‘Z;. _ .‘;. _____- 2 ru. _cc__..__e

II.

(3) Revenue and Taxation Code section 4012 requires that all property subject to general property taxation be assessed at its “full value.” “ ‘[FJull cash value’ ” or “ ‘fair market value’ ” is defined as “the amount of cash or its equivalent which property would bring if exposed for sale in the open market under conditions in which neither buyer nor seller could take advantage of the exigencies of the other and both with knowledge of all of the uses and purposes to which the property is adapted and for which it is capable of being used and of the enforceable restrictions upon those uses and purposes.” (3 110, subd. (a); see De Luz Homes, Inc. v. County of San Diego (1955) 45 CaL2d 546, 563 [290 P.2d 5441; Cal. Code Regs., tit. 18, p 2.) Fair market value “‘is a measure of desirability translated into money amounts

2All statutory references will be to the Revenue and Taxation Code unless otherwise specified.

642 FREEPORT-MCMORAN RESOURCE PARTNERS v. I

II “V”‘.. . Y.

12 Cal.App.4th 634; - Cal.Rptr.2d - {Jan. 19931 I

[citation], and might be called the market value of property for use in ifs present condition.’ ” (Union Pacific R.R. Co. v. State Bd of Equalization (1989) 49 CaL3d 138, 148 [260 CaLRptr. 565, 776 P.2d 2671, quoting De Luz Homes, Inc. v. County of San Diego, supra, 45 Cal2d at p. 562, italics added in Union Pacific.)

The income method is one of three basic methods for determining full cash value, the others being the comparative sales approach and the reproduction and replacement cost approach. (Cal. Code Regs., tit. 18, $ 3; Bret Harte inn, Inc. v. City and County of San Frncisco, supra, 16 Cal.3d 14, 24.) “The income method rests upon the assumption that in an open market a willing buyer of the property would pay a willing seller an amount approximately equal to the present value of the future income to be derived from the oroDertv.‘* (Bret Harte Inn. Inc. v. City und County of San Francisco,

income stream. “Ihe ‘income- approach may called the capitalization method because capitalizing is the process of converting an income stream into a capital sum, i.e., value.’ [Citations.] The assessorcapitalizes ‘the sum of anticipated future installments of net income from the property, less an allowance for interest and the risk of partial or no receipt.’ [Citation.]” (Union Pacific R.R. Co. v. State Bd. of Equalization, supra, 49 Cal .3d at p. 148; see Cal. Code Regs., tit. 18,s 3, subd. (e) (defining income approach as “[tlhe amount that investors would be willing to pay for the right to receive the income that the property would be expected to yield, with the risks attendant upon its receipt”].) Since a property’s “full value” must be determined by reference to the price it would bring on an open market, “[tlhe net earnings to be capitalized . . . are not those of the present owner of the property, but those that would be anticipated by a prospective purchaser.” (De LK Homes, inc. v. County of San Diego, supru, 45 Cal.2d at p. 566.)

(5a) Appellant contends that assessment of the value of its properties based upon the income to be generated under the SO4 contracts violated the requirement that an objective, market based standard be used to determine the income to be capitalized. According to appellant, because SO4 contracts wcrc no longer available as of the lien date, the value of the properties must be determined by reference to the market price for electricity reflected in an SO 1 contract.

Appellant relies upon cases holding that the value of properties subject to below-market rate leases must be determined by reference to the income the properties could generate on the open market rather than the income generated under the actual contracts. (Clayton v. County of Los Angeles (1972) 26

;~ -.---I.. -- _-

FREEPORT-M&IoR 1~: KEWI RCI- PAR: ::iR, COUNTY OF LAM. 12 CaLhpp 4th 63-l - Cal Kptr 7d - [ian lYY3\

643

Cal.App.3d 390 [ 103 Cal.Rptr. 6X7]; Dentus v. County of Santa Clara, supra, 215 Cal.App.3d 1019.) These cases rest upon the premise that property owners cannot deflate the value of their properties for tax purposes by entering “had” leases. (Cluyton v. County oj Los Angeles, supra, 26 Cai.App.3d at pp. 392-393; Denrlis v. County of Santa Clara, supra, 215 Cal.App.3d at pp. 1029-1031; see Carlson v. Assessment Appeals Rd. I (1985) 167 Cal.App.3d 1004 [213 Cal.Rptr. 555) [improper to consider privately imposed restrictions on use of property in determining value].) As explained in De Luz Homes, Inc. v. County of San Diego, supra: “The present owner may have invested well or poorly, may have contracted to pay very high or very low rent, and may have built expensive improvements or none at all. To value property by capitalizing his anticipated net earnings would make the value of property equal to the present value of his profits; since, however, the lcgislatrve standard of value is ‘full cash value,’ it is clear that whatever may be the rationale of the property tax, it is not the profitableness of property to its present owner.” (45 Cal.2d at p. 566.)

The cases do not, however, require that valuation be based on market rather than actual income forecasts in all circumstances. In De Luz Homes, Inc., the court determined that the value of a housing project located on a military installation should be determined by capitalizing expected future actual income, noting that future income could be expected to remain stable because rents were controlled by the government and occupancy was assured by the fact that the project was located on a permanent military installation. (45 Cal.2d at pp. 571-572.3 Host International, Inc. v. County of San Mate0 (1973) 35 Cal.App.3d 286 [llO CaLRptr. 6521, involved valuation of the possessory interest under a lease of space for food concessions at San

valuation -based on its actuai rental Faymeni was improper because these payments exceeded the income that could have been obtained if the leasehold was sold on the open market. The court held it proper to use Host’s experience as a guide to market value, as there were no sales of comparable leases and no evidence other ooerators would not assume the existing lease. (35 Ca.l.App.3d at p. 289.)

In the present case, appellant owns a geothermal plant and a contract guaranteeing for 10 years an income that exceeds the income obtainable

3De Luz Homes, Inc. did not mvolve a question of market versus above- or below-market rents; the alternatIve means of determinmg future income considered by the court was to impute an amount of mcome equal to a mmimum reasonable return on estimated market value. (45 CaL2d at p. 565.) The court indicated that the imputed income method should be used where future income could not be estimated with reasonable accuracy or could not be ascrlbed entirely to the property, as when actual income is derived largely from enterprise . . ._. -_- ---.

absent the contract. Appellant’s argument that its future income must be determined based on current market prices because SO4 contracts are no longer available ignores the obvious fact that appellant’s income for the ten year period in question is fixed by the SO4 contract at a level above the current market price. The evidence in this case showed that appellant’s plant would only be offered for sale in conjunction with the SO4 contract because the contract is integral to the economic viability of the plant and that a prospective purchaser would be willing to pay more for a plant with an SO4 contract than for a plant without one because the SO4 contract guarantees a higher income. As stated in Host fntemational, Inc., “De Luz permits reference to appellant’s operation in determining what another lessee would pay for the same space upon like terms. It recognizes also, as a factor in market value of the possessory interest, governmental control of the project and stability of income . . . .” (35 Cal.App.3d at p. 290.) Since the “full value” of appellant’s property must be taxed (0 401), and “full cash value” must be

italizing the net earnings -----

a-==@=@- .--A- supra, 45 Cal.2d at p. 566), to ignore the SO4 contracts would be to artificially deflate the value of appellant’s properties.4

Indeed, appellant’s characterization of the “market” to which reference must be made in determining the value of its properties is misguided. While appellant stresses that only SO1 contracts are currently available from PG&E, this simply means that a purchaser negotiating with PG&E for a new power purchase agreement would only be able to obtain an SO1 contract. The evidence showed that a purchaser could obtain an SO4 contract in a transaction for an existing power project with an SO4 contract, and that no SO1 contract projects were in operation in PG&E territory. Since some 60 to 70 percent of the 1,300 to 1,500 qualifying facilities in California operate

I 4Appellant’s reliance on the board of equalnatlon’s property tax rule 8. suhdlvlslnn rd) I\ unavailing. Rule 8, subdivisIon (d), provrdes: “ln valumg property encumbered by a lease. Lhc

I net income to be capltabzed IS the amount the property would yield were tt noI so encum- !I bered, whether this amounts exceeds or falls short of the contract rent and whether tbe lessor

or the lessee has agreed to pay the property tax.” (Cal. Code Regs., tit 18. 5 8. subd. (d) ) Appellant extrapolates from this a rule rhat property must be valued without conslderatlon of any type of contract pertammg to income to be denved from property. We are unwilimp to accept appellant’s broad defimtlon of rule 8. subdivlslon (d). Tbe rule is by its terms addressed specifically to leases: It serves the purpose of precludmg potential manlpulatlon by

II

property owners of tbe taxable value of their property (See Clayton v County of Los Angdrs. supra, 26 Cal.App.3d 390; Denms v. County of Sanfa Clara, supra, 215 Cal.App 3d 1019 )

f

r The present case presents no posslblllty of such mampulatlon. smce the Income to be

. ii generated by the property IL I’LXL~ by CUIIKLLC~ terms tha cannot tw altered CdpltJlzattclll clt the Income to be generated under the contract properly measures the value of appellant’s

I!‘+ property because it 1s the mcome a prospective purchaser of the property not only could . .

-

FREEPORT-MC-MORAN RESOURCE PARTNERS 1’. COCNTY oF LAKE 12 Cal App.4th 634. - Cal.Rptr.Zd - [Jan. 19933

w1t.h SO4 contracts, the assessor determined that the market for SO4 projects constituted a market for prospective purchasers. The evidence thus shows that the proper market against which to judge the value of appellant’s plants was that consishng of existing facilities with SO4 contracts.

We are not persuaded by appellant’s ‘argument that consideration of the SO4 contract income impermissibly taxes nontaxable intangible property. (6) Only tangible personal property is subject to taxation. (Cal. Const., art. XIII, $ 2; ITT World Communications, inc. v. County of Santa Clara (1980) 101 Cal.App.3d 246, 251 [I62 Cal.Rptr. 1861.) But “‘[i]ntangible values . . . that cannot be separately taxed as property may be reflected in the vufuarion of taxable property. Thus, in determining the value of [taxable] property, assessing authorities may take into consideration earnings derived therefrom, which may depend upon the possession of intangible rights and privileges that are not themselves regarded as a separate class of taxable property.’ ” (County of Stanislaus v. Assessment Appeals Bd. (1989) 2 13 Cal.App.3d 1445, 1455 [262 Cal.Rptr. 4391, quoting Roehm v. County of Orange (1948) 32 Cal.2d 280,285 [ 196 P.2d 5501, italics added in County of Sfanislaus.) “ ‘[MJarket value for assessment purposes is the value of property when put to beneficial or productive use.’ ” (County of Stanislaus v. Assessment Appeals Bd., supra, 213 Cal.App.3d at p. 1455, italics in original.) For example, County of Stanisfaus, supru, involved taxation of a cable television franchise. The franchise was viewed as consisting of two components, the right to use public streets for cables and the right to charge fees to subscribers for use of the cable facilities. The former component, the

----W=snrr-~~~~~~.:~~~~~~ ~.R.. .-. ,~s‘k..n-z - . ..-_.-v r- ~~sliie~~~_~~-iii;cTt:~‘C~~less~~e court concluded that the value of the intangible right-without which the possessory interest could not be put to beneficial or productive use-should be considered in valuing the possessory interest. (213 Cal.App.3d at pp. 1451-1456.) (Sb) In this case the SO4 contracts are the means by which appellant’s properties are put to beneficial use and must be considered in assessing the properties’ “‘full value.”

We are similarly unpersuaded by appellant’s argument that valuation on the basis of the SO4 contract improperly taxes appellant’s enterprise activity or business skill. (7) Under the income approach to valuation, only “‘earnings from the property itself or the beneficial use thereof’ are to be considered: income derived in large part from enterprise activity may not be ascribed to the property. (California Portland Cement Co. v. State Bd. of Equalization (1967) 67 Cal.2d 578, 584 [63 Ca1.Rpt.r. 5, 432 P.2d 7001; United Air tines, Inc. v. County of San Diego (1991) 1 Cal.App.4th 418,438 [2 Cal.Rptr.‘Ld 2121.) “When no sound or practicable basis appears for

apportionment of income as between enterprise activity and the property itself, then a method may be employed which imputes an appropriate income to the property.” (California Portland Cement Co. v. State Bd of Equaiiza- tion, supra, 67 Cal.2d at p. 584; United Air Lines, Inc. v. County of San Diego, supm, 1 Cal.App.4t.h at p. 438.) In California Porthd Cement Co., the owner of a quarry and adjacent cement factory contended that profitability of its manufacturing business could not be considered in valuing the property. The court rejected the owner’s argument that its business profits were not relevant to determining the “full cash value” of the cement mill as “a play on words which lacks persuasion,” noting that the quarry and cement mill were “operated as a unit, with each contributing to the economy and profitability of the other.” (67 Cal.2d at p. 585) (SC) In the present case, because the SO4 contract is the means by which appellant can sell the electricity it produces, the income generated by the SO4 contract is inextri-

Moreover, there is no evidence the increased value of the SO4 contract over an SO1 contract’s market rate is due to appellant’s enterprise activity: The higher price received under the SO4 contract is not the result of appellant’s successful operation of its plants but of the regulatory scheme that allowed appellant the benefit of a long-term fixed contract price.

‘Ihe judgment is affirmed.

Smith, J., and Benson, J., concurred,

____ -_- -..,-- - __- -.. _ _ --.-- . . . I____ ---.- FREEPORT-MCMOIUN RESOURCE PARTNERS Y. 1066a

[No. A055683. First Disc, Div. Two. Feb. 18, 1993.1

FREEPORT-McMORAN RESOURCE PARTNERS, Plaintiff and Appellant, v. COUNTY OF LAKE, Defendant and Respondent.

[Modification* of opinion (12 CaLApp.4th 634; 16 Cal.Rptr.2d 428) on denial of petition for rehearing.]

KLINE, P. J.-The opinion filed on January 19, 1993, is hereby modified as follows:

At puge I3 [ 12 Cal.App.4th 644, advance report]: Footnote 4 is deleted. The following is inserted at the end of the page [12 Cal.App.4th 644, advance report, foll. line 191 as a new paragraph

“Appellant’s reliance on the board of equalization’s property tax rule 8, bdivision (d), is unavailing. Rule 8, subdivision (d), provides: “In valuing

e operty encumbered by a lease, the net income to be capitalized is the amount the property would yield were it not so encumbered, whether this amounts exceeds or falls short of the contract rent and whether the lessor or the lessee has agreed to pay the property tax.” (Cal. Code Regs., tit. 18,s 8, subd. (d).) Appellant extrapolates from this a rule that property must be _-- ;

-m_&&&*F”“~~~~-~y- 7,* z?%?%&i %%ii-p%~~~%&?&e unwilling‘ to accept appellant’s broad 1 I i

interpret&on. Rule 8, subdivision (d), is by its terms addressed specifically to leases; it serves the purpose of precluding potential manipulation by property owners of the taxable value of their property. (See Ctayton v. County of Los Angeles, supra, 26 Cal.App.3d 390; Dennis v. County of Santa Clara, supra, 215 Cal.App.3d 1019.) The present case presents no possibility of such manipulation, since the income to be generated by the property is fixed by contract terms that cannot be altered. Unlike leases (Chytok v. County of Los Angeles, supra, 26 Cal.App.3d 390; Dennis v. County of Santa Chzra, supru, 215 Cal.App.3d 1019) or deed restrictions (Curlson v. Assess- meti Appuh Bd. I, supra, 167 Cal.App.3d 1004), the contracts that determine the income to be produced by appellant’s properties are regulated by

yThis rnoditication require movement of text affecting pages 637-646 of the bound -.- -.- -___A

Taxation Silos: Embedded Intangibles andEmbedded Services Under U.S. Law

by Richard L. Doernberg

The U.S. Treasury has gotten the internationaltax community’s attention by promulgating a

proposed transfer pricing regulation containing aspecial rule for services transactions that effect atransfer of intangible property.1 The proposed regu-lation provides that a transaction structured as aservices transaction may ‘‘result in a transfer, inwhole or in part, of intangible property, or may havean effect similar to the transfer of intangible prop-erty, or may include an element that constitutes thetransfer of intangible property.’’ In that situation,the intangible element would be analyzed under theapplicable transfer pricing rule for intangibles.2

The following example illustrates the proposedrule. A U.S. taxpayer enters into a contract with a

foreign related party for the U.S. taxpayer to per-form research and development for the foreign re-lated party. The R&D services lead to the develop-ment of know-how, which is memorialized intechnical documentation provided to the taxpayer.3The example concludes that the arm’s-length pricingof the know-how element must be determined underthe rules governing intangibles.4

Treasury has received comments on why this‘‘embedded intangible’’ rule should be changed.5Those who work in transfer pricing are concernedabout the transfer pricing implications, but thereare also significant implications in other areas of anapproach that disaggregates services and intan-gibles. Before looking at those implications, consideranother recent development.

The American Jobs Creation Act of 2004 estab-lished a new deduction for some domestic productionactivities. Internal Revenue Code section 199 allowsa deduction for qualified production activities in-come. Qualified production activities income in-cludes gross receipts from a ‘‘lease, rental, license,sale, exchange, or other disposition’’ of computer

1Prop. reg. section 1.482-9(m)(2).2Prop. reg. section 1.482-4.

3Prop. reg. section 1.482-9(m)(6), Ex. 4.4The result may be more income allocated to the U.S.

taxpayer for U.S. tax purposes.5See, e.g., ‘‘Deloitte Criticizes Proposed U.S. Services

Transfer Pricing Regs,’’ 2004 WTD 61-17 or Doc 2004-6535(Mar. 30, 2004).

Richard L. Doernberg is the K.H. Gyr Pro-fessor of Law at Emory University School ofLaw in Atlanta. This article was prepared forthe 2005 George Washington University/IRS18th Annual Institute on Current Issues inInternational Taxation.

Copyright © 2005, Richard L. Doernberg.

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Software payments may be made under mixedcontracts. Examples of such contractsinclude . . . concessions of the right to use soft-ware combined with the provision ofservices. . . . Where necessary the total amountof the consideration payable under a contractshould be broken down on the basis of theinformation contained in the contract or bymeans of a reasonable apportionment withappropriate tax treatment being applied toeach apportioned part.34

But that same OECD Commentary appears torestrict disaggregation when possible in favor of aunified single characterization by referring to thatportion of the commentaries dealing with distin-guishing know-how from services.35

In business practice contracts are encounteredwhich cover both know-how and the provisionof technical assistance. . . . The appropriatecourse to take with a mixed contract is, inprinciple, to break down, on the basis of infor-mation contained in the contract, and then toapply to each part of it so determined thetaxation treatment property thereto. If, how-ever, one part of what is being provided consti-tutes by far the principal purpose of the contractand the other parts stipulated therein are onlyan ancillary and largely unimportant charac-ter, then the treatment applicable to the princi-pal part should generally be applied to thewhole amount of the consideration.36 [Empha-sis added.]

Unfortunately, the OECD Commentaries provideno guidance as to when a part of a contract is ‘‘anancillary and largely unimportant character.’’ Forexample, if in a contract the provision of servicesaccounts for 90 percent of the contract value and theprovision of an intangible (for example, sale, license,or lease of copyrighted property) accounts for 10percent of the contract, should the payment in itsentirety be treated as a payment for services? Whatif the split were 75/25 or 60/40? The resolution ofthat issue is really a function of tax administrationrather than tax policy.

As the tax system struggles with characterizationand disaggregation issues involving services andintangibles in the international tax context, weshould recognize that those issues have also arisenin other areas in the U.S. tax system.

A. Employment Taxes

For example, in IRS CCA 200305007, the IRSruled that when a taxpayer tried to disaggregate atransaction into a service and a royalty component,the entire transaction would be treated as a pay-ment for services. In that ruling, the taxpayer wasan accountant who provided both services and hisown customer list to related entities that employedhim. To the extent that payments for the customerlist were considered royalties, no employment taxesor income taxes would be withheld. The rulingdetermined that the economic substance of thetransaction revealed that all payments received bythe taxpayer were for services rendered and weresubject to withholding. Stated differently, in this factpattern the taxpayer was claiming that there was anembedded intangible being provided to his employer— a customer list — but the IRS was unwilling todisaggregate the transaction:

Taxpayer was performing accounting servicesfor ABC PC under an employment contract.The ABC PC tax return listed him as spending90% of his time performing services for ABCPC. Whether as an employee, shareholder andPresident of ABC PC, or as a limited partner toABC LP he was performing accounting duties.The flow of funds from the accounting clientsthrough ABC PC and ABC LP and finally toTaxpayer was generated by accounting servicespersonally performed by Taxpayer as an em-ployee of ABC PC. Applying the economic sub-stance test, we are satisfied that there was noeconomic substance to the purported sale ofaccounting client lists and subsequent royaltypayments to the Taxpayer. Given the signifi-cant amounts reported as royalty payments bythe Taxpayer, both individually and by ABC PCand ABC LP, it is apparent that the classifica-tion of these amounts as royalty payments wasmerely a recharacterization of wages in orderto avoid employment taxes.

The ruling does not foreclose disaggregation in allcases, suggesting instead that the taxpayer mayhave overclaimed. Nevertheless, the ruling doesevidence a reluctance to divide what is inherently aservices contract into a services contract and aroyalty contract.

B. Tax-Exempt Entities

The ruling in the employment tax area reliesheavily on a well-developed series of cases andrulings involving similar issues (services versusrents/royalties) with tax-exempt entities. IRC sec-tion 511 imposes a tax on the unrelated businesstaxable income of exempt organizations. IRC section512(a)(1) defines the term ‘‘unrelated business tax-able income’’ as the gross income derived by anyorganization from any unrelated trade or business

34OECD Commentaries, art. 12, para. 17.35OECD Commentaries, art. 12, para. 11.36OECD Commentaries, art. 12, para. 11.6.

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CFC1 may be subpart F income. To illustrate, sup-pose that the IRS were to conclude that some or allof the payment was really either a royalty for the useof a copyright right (for example, the right to use andmanipulate the software) or was a rental paymentfor the use of a copyrighted article (for example, useof the software for a limited period of time). Then thefees received by CFC1 would most definitely besubpart F income.11 Both rental payments and roy-alty payments fall into the foreign personal holdingcompany category of subpart F income. Even ifCFC1 were actively producing the software or mar-keting the software, no exception would be availablefor rents or royalties received from related parties.12

A variation of this first example might be asituation in which CFC1 provides contract R&Dservices for CFC2. If, under the reasoning of theproposed transfer pricing regulations, the IRS wereto find that part of the payment to CFC1 was for theacquisition of know-how, then subpart F income mayresult.13 Because subpart F income would probablybe includable in USP’s tax return,14 the effects ofwhat may go on inside the section 482 or the section199 silos may be pronounced.

Consider a second example not involving a sub-part F determination. Suppose that USCO, a U.S.corporation, pays a fee to Forco, an unrelated foreigncorporation, for the same back-office functionalitydescribed in the previous example. If the fee paid istreated as a payment for the provision of servicesand the services are considered performed where theserver is located, then USCO has no withholdingobligation and Forco has not generated income tax-able in the United States.15 However, if the income isconsidered in whole or in part to be either rental or

royalty income, then USCO might have a withhold-ing obligation and Forco might have U.S. tax liabil-ity.16

If Forco were providing contract R&D services toUSCO, a determination that part of the paymentwas a payment for know-how may well impose awithholding obligation on USCO and a U.S. taxobligation for Forco if the know-how were consideredlicensed to USCO.17

Both of those examples (that is, turning non-subpart F into subpart F income and turning nowithholding obligation into a withholding obliga-tion) involve situations in which the IRS might findan embedded intangible in what is intended to be aservices contract. To be sure, there are many othersituations when changing services income to royaltyor rental income may present an unpleasant sur-prise for taxpayers. But the reverse is also true.There are many times when a taxpayer may thinkthat the income generated is royalty or rental in-come when the potential for an embedded servicemay have unintended consequences.

In the third example, suppose that USCO li-censes, leases, or sells software to non-U.S. custom-ers. USCo takes the position that the income gener-ated is foreign-source income.18 That position allowsUSCO to maximize the use of its foreign tax credits.As part of the license, lease, or sales agreement,USCO and its customers enter into a separatesoftware maintenance contract under which USCO

11For this example, there is no need to distinguish betweenwhether the payment is a rental payment or a royaltypayment, because either category would constitute foreignpersonal holding company income.

12IRC section 954(c)(2)(A).13Prop. reg. section 1.482-9(m)(2). If the know-how were

deemed to be licensed, then IRC section 954(c)(1)(A) wouldresult in subpart F income. There would be no active trade orbusiness income exception for royalty income from a relatedparty.

14Assuming that high tax exception or de minimis rules donot apply. IRC section 954(b)(4) (high tax exception) andsection 954(b)(3)(A) (de minimis rule).

15Presumably, Forco would not be engaged in a U.S. tradeor business from this particular activity; even if Forco wereengaged in a U.S. trade or business, the services incomewould be foreign-source income, which would not be effec-tively connected. See IRC section 864(c)(4). No gross basetaxation would arise under IRC section 881 because theservices would generate foreign-source income.

16Both rental and royalty income would be subject to 30percent U.S. withholding under IRC sections 881 and 1442 ifpayments were deemed to be U.S.-source income. However, nowithholding would be required if USP received a FormW-8ECI from Forco. Then Forco would file a Form 1120F andreport the income as income effectively connected with theconduct of a U.S. trade or business. See IRC section 864(b). IfUSP does not receive the Form W-8ECI, then there will be 30percent withholding unless USP receives a Form W-8BENindicating that a reduced rate of withholding under anapplicable treaty applies. Here, it may be important todetermine whether the payment is rent or royalty, becausetreaties typically reduce the withholding rate for royalties,but not for rental payments.

17If the know-how were deemed sold to USCO for anoncontingent amount, withholding should not be required.

18For purposes of this article, it is not necessary to decideamong license, lease, or sales characterization. Assume thatunder all three characterizations, foreign-source incomewould result. IRC section 861(a)(4) (for license or leasepayments, the place where the property is used determinessource); IRC section 861(a)(6) (for purchased inventory, wheretitle passes); IRC section 863(b) (for manufactured inventory,50 percent of income sourced where title passes). Under IRCsections 904(d)(2)(A) and 954(c), for this discussion assumethat any rental or royalty income generated would meet theactive rents and royalties exception in reg. section 1.954-2(b)(6).

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promises to provide users with upgrades or updatesto the software and to provide technical support.19

Typically, industry practice is to provide updatesand technical support under a single agreementwith a single price.20

The proposed regulations put taxpayers on noticethat under IRC section 199, a software maintenancecontract between USCO and a foreign customer maycontain an embedded service.21 If so, then the tech-nical support aspect may be treated as a serviceprovided in the United States (for example, a U.S.help desk) rather than a foreign-source payment forsoftware acquisition.22 While that embedded servicerule is aimed at IRC section 199, there should beconcern about the effect of that disaggregation inother areas (for example, foreign tax credit use).

The three examples illustrate three different con-cerns apart from transfer pricing under section 482and apart from the section 199 domestic productionactivities. The embedded intangible (or service) is-sue may affect subpart F inclusion, withholding taxliability, and foreign tax credit use. In the first twoexamples, purported services income may in part orin whole be treated as income generated by anintangible. In the third example, income generatedpurportedly by an intangible may be recharacterizedin whole or in part as income from services. Differ-entiating between services and property transac-tions (whether intangible or otherwise) is not newand is not a uniquely international tax issue. Areview of how the issue arises and how it has beenapproached in other areas may shed light on currentthinking.

I. To Disaggregate or Not toDisaggregate

Every transaction can be divided into parts.When a customer acquires the use of a tangibleproduct (for example, by rental or purchase agree-

ment), the customer, in one sense, acquires theservices that went into making the product, thecomponent parts that make up the product, thefinancing that made production possible, the intan-gibles used in the production process, and the trade-mark stamped on the product. In general, the U.S.tax system recognizes that it is not desirable tobreak up every transaction into many parts.

In Rev. Rul. 75-254,23 the IRS ruled that incomefrom a trademarked product should not be disaggre-gated for sourcing the income on a sale to a distribu-tor. The IRS reasoned that the sale of a trademarkedproduct carries with it the right to use the trade-mark on resale.24 Because there was no specificgrant of trademark rights by the seller to the dis-tributor, no imputed (that is, embedded) royalty wasappropriate. The logic of the ruling is present in thesection 482 regulations.25 Those provide that trans-fer of tangible property is not considered a transferof a related intangible ‘‘if the controlled purchaserdoes not acquire any rights to exploit the intangibleproperty other than rights relating to the resale ofthe tangible property under normal commercialpractices.’’

Similarly, when a customer acquires an intan-gible product (for example, by license or purchaseagreement), the customer, in one sense, acquires theservices that went into making the intangible, butgenerally the U.S. tax system does not, for example,require a licensee to disaggregate the license intocomponent parts to evaluate the source and charac-ter of any payment. That approach is captured in theregulations dealing with the characterization andsourcing of income in connection with software.

The determination of whether a transactioninvolving a newly developed or modified com-puter program is treated as either the provi-sion of services or another transaction . . . isbased on the facts and circumstances of thetransaction including, as appropriate, the in-tent of the parties (as evidenced by their agree-ment and conduct) as to which party is to ownthe copyright rights in the computer programand how the risks of loss are allocated betweenthe parties.26

That is not to suggest that disaggregation is neverappropriate. Indeed, the software regulations doprovide for disaggregating a transaction when thetransaction consists of more than one category of

19The upgrades consist of new software that supplementsthe original program, often providing new features thatimprove the functionality of the program. The technicalsupport aspect provides customers with assistance requiredto use the software. The support may be offered by e-mail orphone or through online databases. Typically, technical sup-port does not include user training, which might be providedby separate contract.

20See, e.g., ‘‘Attorneys Address Treatment of SoftwareUnder U.S. Domestic Production Activities Provision,’’ 2005WTD 73-14 or Doc 2005-7517 (Mar. 31, 2005). Users do notdistinguish between the software acquired and maintainingits functionality. Sellers find value in having users enjoy thefull functionality of the product.

21Prop. reg. section 1.199-3(h)(4).22IRC section 861(a)(3) (services performed at place of

performance).

231975-1 C.B. 243.24Sunbeam Corp. v. Payless Drug Stores, 113 F. Supp. 31

(ND Cal. 1953).25Reg. section 1.482-3(f).26Reg. section 1.861-18(d).

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regularly carried on by it, less the allowable deduc-tions that are directly connected with the carryingon of that trade or business, both computed with themodifications provided in section 512(b). IRC section512(b)(2) excludes royalties from the computation ofunrelated business taxable income, whether mea-sured by production or by gross or taxable incomefrom the property, and all deductions directly con-nected with that income.

In Sierra Club, Inc. v. Commissioner,37 the courtstated that income derived from the Sierra Club’srental of its mailing list was royalty income underIRC section 512(b)(2) and not payment for services.For income derived from the Sierra Club’s affinitycredit card program, the court remanded for find-ings of fact on whether the amounts constituteroyalties under section 512(b)(2). The Tax Courtsubsequently concluded that those amounts wereroyalties and therefore not taxable under section511.38

In Oregon State University Alumni Association,Inc. v. Commissioner and Alumni Association of theUniversity of Oregon, Inc. v. Commissioner,39 thecourt held that payments made by a bank to thealumni associations were not payments for promo-tional and management services associated withtheir mailing lists, but were royalty payments ex-cluded from unrelated business taxable income un-der IRC section 512(b)(2).

In Common Cause v. Commissioner,40 the courtfound that list rental transaction activities wereroyalty-related and that each rental payment there-fore constituted a royalty excluded from unrelatedbusiness taxable income under IRC section 512(b)(2)even though there were some list maintenance ac-tivities in connection with the lists. The court foundthat the parties involved in the transaction engagedin activities to exploit and protect the mailing list;thus, the activities were royalty-related. The courtappeared reluctant to disaggregate the paymentreceived even when services may be rendered inconnection with the transfer of the intangible.

In the instant case, we must decide whetherany part of the mailing list rental paymentsconstitutes compensation to petitioner forgoods or services. In each mailing list rental

transaction, the mailer’s rental payment com-pensates petitioner for the mailer’s use of peti-tioner’s list and, also, compensates Names,Triplex, and the list brokers for their partici-pation in the transaction. Certain of theseactivities exploit and protect the intangible(i.e., the list). We have held that the owner ofan intangible may engage in certain activitiesto exploit and protect the intangible which donot change the nature of the payment received.See Wm. J. Lemp Brewing Co. v. Commis-sioner, 18 T.C. 586, 596 (1952) (payment to theowner of the intangible was a royalty eventhough the owner reserved the right to super-vise the advertising, marketing, and quality ofthe product which was to bear the trademarkedname); see also Mississippi State Univ. Alumni,Inc. v. Commissioner, T.C. Memo 1997-397 (re-view of marketing material and endorsementof an affinity credit card program bearing thename of an exempt organization were not ser-vices provided to the card issuing company). Tohold otherwise, it seems to us, ‘‘would requireus to hold that any activity on the part of theowner of intangible property to obtain a roy-alty, renders the payment for the use of thatright UBTI and not a royalty.’’ Sierra Club, Inc.v. Commissioner, 86 F.3d at 1536. Accordingly,in the instant case, we carefully scrutinize theactivities of each of the parties compensated inthe list rental transaction to ascertain whetherthey are undertaken to exploit or protect peti-tioner’s list.

The characterization and disaggregation issuesinvolving intangibles and services have grown in im-portance with the growth in the role of intangibles inthe U.S. economy. However, an intangible is simplyone type of property. Conceptually, the disaggrega-tion analysis involving intangibles could benefit fromsimilar issues involving services and tangible prop-erty. Three areas in which characterization (disag-gregation) issues have arisen involve inventory ac-counting, the investment tax credit, and FSCbenefits.

C. Inventory Accounting

The following cases typify the struggle to distin-guish transfers of property (in these cases, sales)from the provision of services. In Wilkinson-Beane,Inc. v. Commissioner,41 the IRS argued that thetaxpayer should separate services from property for

3786 F.3d 1526 (9th Cir. 1996), aff’g T.C. Memo. 1993-199and rev’g 103 T.C. 307 (1994).

38See T.C. Memo. 1999-86.39193 F.3d 1098 (9th Cir. 1999).40112 T.C. 332 (1999). See also Planned Parenthood Fed-

eration of America, Inc. v. Commissioner, T.C. Memo. 1999-206 and Rev. Rul. 81-178, 1981-2 CB 135. For private letterrulings dealing with the same issue, see LTR 200303062 andLTR 200149043.

41Wilkinson-Beane, Inc. v. Commissioner, 420 F.2d 352 (1stCir. 1970).

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income.27 Of course, the recognition in the regula-tions that some transactions should not be disaggre-gated, but others should, raises the question of howto distinguish between them.

As noted above, the disaggregation issue is reallya subset of the characterization issue. A transactionthat purports to involve a services (intangibles)contract may contain an imbedded intangible (ser-vice). If so, it may be appropriate to disaggregate thetransaction and treat each aspect separately. If thatembedded intangible (service) constitutes 100 per-cent of the contract, then the disaggregation isessentially 100 percent to the embedded aspect and0 percent to the purported characterization.

Well before the software regulations were promul-gated,28 the IRS and courts were confronted bycharacterization issues (for example, distinguishingbetween services and some type of transfer involvingan intangible). For example, in Ingram v. Bowers,29

the court held that Enrico Caruso’s contract torecord master discs at Victor Talking Machine Co.’sNew York studios resulted in income from the ren-dition of personal services in the United States.Because Caruso never obtained an interest in therecord matrices that were distributed worldwide forcopying, the court found irrelevant the contractualrequirement that he be paid a portion of the royal-ties received from the license of that property. Fortax purposes, the source of Caruso’s income was theplace his voice was recorded and not the place wherethe records were sold.

Boulez v. Commissioner30 presented a similar casein which the Tax Court again held that the paymentsreceived by the taxpayer were compensation for per-sonal services rather than royalty income. Boulez, amusical conductor who resided in Germany, maderecordings under a contract with CBS Records inwhich his compensation was tied directly to the pro-ceeds received by CBS Records from sales of the re-cordings. The court found that the parties intendeda personal services contract and that the taxpayerhad no property right in the recordings that he couldlicense.

A third case raising the same issue is Karrer v.U.S.31 A Swiss scientist contracted with a Swissemployer to provide basic research in return for aportion of the patent royalties generated from thatresearch. Although the patents were applied for inthe taxpayer’s name for legal reasons, the applica-tions were assigned to a U.S. company. The licenseemade royalty payments to both the scientist and hisSwiss employer. The royalties paid by the U.S.company to the Swiss scientist were held to benontaxable compensation for services provided byhim outside the United States.

The embedded intangible (orembedded service) issue can haveprofound implications for moregeneralized international taxissues.

In those cases, the taxpayers contractually agreedto perform services leading to the creation of an intel-lectual property right owned from its inception by theothercontractingparty.Supposethecontract fromthebeginning isacontract involvingpropertyrather thanservices. If a nonresident creates an intellectual prop-erty right and then sells or licenses it, the resultingincome should be gain from a sale or royalty income.Even if the nonresident transfers ownership rights inproperty before creating it, so that the creator is neverthe owner of the property, the income might be treatedasgainfromasaleorroyalty incomeif thenonresidentis not obligated to perform. For example, a fee paid toan author for the exclusive right to publish in theUnited States all books and stories written by theauthor was held to be royalty income rather thanservice income.32 Becausethecustomerhadnocontrolover the subject matter of the author’s product or theschedule of production, the source of the income wasdetermined by the end product rather than by thecreative process.33

The OECD Model Income Tax Convention, likeU.S. domestic tax law, has wrestled with character-ization issues involving intangibles and services.The OECD Commentary on article 12 provides:

27Reg. section 1.861-18(b)(2). The subpart F regulationsparallel the software regulations by first recognizing that itmay be necessary to determine the character of a transactionby looking at more than the label in the contract. Reg. section1.954-1(e)(1). But at the same time, when a single transactionconsists of separable parts, disaggregation may be appropri-ate. Reg. section 1.954-1(e)(2).

28Reg. section 1.861-18.2957 F.2d 65 (2d Cir. 1932).3083 T.C. 584 (1984), cert. denied, 484 U.S. 896 (1987).

31152 F. Supp. 66 (Ct. Cl. 1957).32Rev. Rul. 74-555, 1974-2 C.B. 202, modified, Rev. Rul.

76-283, 1976-2 C.B. 222.33See also Rev. Rul. 84-78, 1984-1 C.B. 173 (payments

received by a domestic corporation — which owned rights tobroadcast and record a prizefight — for another corporation’sright to broadcast the fight in a particular foreign countrywas royalty income and not service income because the fightwas not exclusively performed for the foreign corporation’sbenefit and the foreign corporation did not obtain the benefitof the domestic corporation’s labor).

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applying the appropriate accounting method to re-flect income.42 The taxpayer provided a completefuneral service, including the casket, which couldnot be purchased separately. Related services in-cluded the use of the funeral home, hearse, motorvehicles, funeral personnel, and management. Asingle unitemized price was charged for the com-plete service. The commissioner recomputed thetaxpayer’s income using the accrual method ratherthan the cash method for the caskets. The Tax Courtruled against the taxpayer, and the First Circuitaffirmed the decision on the basis that the casketswere plainly both merchandise and a substantialincome-producing factor.43

In general, the U.S. tax systemrecognizes that it is not desirableto break up every transaction intomany parts.

In Surtronics, Inc. v. Commissioner,44 the tax-payer was required to maintain inventories of met-als used in the electroplating process. The Tax Courtconcluded that metals were inventories on the basisthat the taxpayer purchased the metal from a sup-plier and sold it to the owner of the component towhich it was electroplated for approximately thecost of the metal. Although the metal was combinedwith the electronic component, the court thought thetransaction was governed by the Wilkinson-Beanecase because the cost of the metal represented asubstantial income-producing factor.

In Knight-Ridder Newspapers, Inc. v. U.S.,45 thetaxpayer was in the business of selling newspapers.The Tax Court, looking at the cost of the newsprintand ink, concluded that the commissioner waswithin his discretion to require that the taxpayermaintain inventories for the newspapers and ac-count for them using the accrual method of account-ing. As in Surtronics and Wilkinson-Beane, the courtbased its decision on the relative percentage the costrepresented of total revenues, the facts and circum-

stances of the taxpayer, and the manner and contextin which the taxpayer operated the business.

While those cases support disaggregation, othersection 471 cases reach an opposite result. In Hon-eywell, Inc. v. Commissioner,46 the taxpayer wasengaged in the business of maintaining and servic-ing computers that were either sold or leased to itscustomers. The taxpayer also entered into mainte-nance agreements with the customers to whom itleased or sold computers. Under the maintenanceagreement, the taxpayer was obligated to providelabor and materials necessary to repair the com-puters. The fee charged by the taxpayer was fixedand was the same regardless of whether the cus-tomer leased or owned its computer. The taxpayerestablished and maintained a pool of replacementparts that the field engineers used to repair thecomputers. The replacements parts pool consisted ofexpendable and rotable parts.47 The taxpayer usedthe fixed asset method of accounting for the replace-ment parts pool. The commissioner issued a notice ofdeficiency to the taxpayer based on the taxpayer’sincorrect use of the fixed asset method for therotable parts rather than the inventory method ofaccounting. The Tax Court ruled in favor of thetaxpayer, reasoning that the taxpayer and its cus-tomers viewed the transaction as involving the saleand purchase of a service and not a product. Thecustomers’ main concern was not what parts wereinside the computer, but whether the computersremained operational.

Likewise, in Hospital Corporation of America v.Commissioner, the taxpayer’s business was the own-ership, operation, and management of hospitals.48

As part of its business, the taxpayer used variousmedical and surgical supply items and pharmaceu-ticals. The commissioner argued that the taxpayerwas required to use the accrual method of account-ing for the medical supplies. The Tax Court ruledthat the hospitals engaged in service activities. Thecourt concluded that the medical supplies played anecessary and vital role in the diagnosis, prognosis,and treatment of the hospitals’ patients. Moreover,the court stated that furnishing medical supplies bythe hospitals is merely incidental to the main pur-pose of rendering healthcare services. Thus, thesupplies and the services could not be separatelyaccounted for using different accounting methods.

42Under IRC section 471 and reg. section 1.446-1(c)(2)(i),the accrual rather than the cash basis method of accountingmust be used for inventory sales.

43Moreover, the court noted that in 1963 and 1965, the costof the caskets represented 15.4 percent and 14.7 percent ofthe taxpayer’s cash basis receipts. That factor demonstratedthat the caskets were a substantial income-producing factorfor the taxpayer.

44Surtronics, Inc. v. Commissioner, T.C. Memo. 1985-277.Electroplating involves the plating of metal to switches andother component parts of electronic equipment.

45Knight-Ridder Newspapers, Inc. v. U.S., 743 F.2d 781,790 (11th Cir. 1984).

46Honeywell, Inc. v. Commissioner, T.C. Memo, 1992-453.47An expendable part was a part not repaired when it

malfunctioned, while a rotable part was a part that wasrepaired when it malfunctioned. The rotable parts were usedto service computers under the maintenance agreements.

48Hospital Corporation of America v. Commissioner, 107T.C. 116, 118 (1996).

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software.6 In the proposed regulations, Treasuryinterpreted the phrase ‘‘any lease, rental, license,sale, exchange, or other disposition’’ of computersoftware as requiring a physical transfer of a copy ofa computer program from the software vendor to thecustomer. The statement that has created concern inthe regulations is that qualifying income does notinclude ‘‘gross receipts derived from . . . provider-controlled software online access services.’’7

The proposed regulations also put taxpayers onnotice that some transactions that clearly involvethe transfer of property (for example, software) alsomight contain an embedded service.8 Income attrib-utable to that embedded service would not qualifyfor section 199 benefits, while income attributable tothe property transfer could qualify for section 199benefits.

Treasury may take income that ataxpayer may think is servicesincome and treat it as income froman intangible.

To review the bidding, in the proposed section 482regulations Treasury may take income that a tax-payer may think is services income and treat it asincome from an intangible (embedded intangible). Inthe proposed regulations for IRC section 199, theU.S. Internal Revenue Service may recharacterizeincome that a taxpayer treats as royalty or rentalincome as income from services. For online (that is,hosted) software, the recharacterization would coverall income generated. For an embedded servicewhen there is a service component to a propertytransfer, the recharacterization would affect fees forthe embedded service component. Of course, it neednot be that Treasury’s positions are inconsistent.Both could be correct or both might be incorrect.Later we will consider what factors might govern thecharacterization issue.

In both the section 199 and section 482 context,the issue is characterization, because the U.S. taxsystem does different things with different catego-ries of income. For example, in the transfer pricingarea, more income may be allocated to a transactionbetween related parties involving intangibles than atransaction involving services. For the domesticproduction activities deduction, royalty, rental, or

sales income may be deductible, while income fromservices when the service provider uses property toperform the services may not be.

As U.S. tax law grows, more complex, discretesilos — self-contained areas of tax law — arise. Formany tax practices, transfer pricing is its own sepa-rate silo — separate even from a more generalinternational tax practice. The section 199 domesticproduction activities deduction is fast becoming itsown separate silo. For example, in the preamble tothe recently proposed section 199 regulations, theIRS made clear that different standards would gov-ern the treatment of similar transactions undersection 482 and section 199.

The IRS and Treasury Department do notintend that services defined as embedded ser-vices under section 199 will be treated in thesame manner provided in [section] 1.482-2(b)(8) because such treatment would be gen-erally inconsistent with the intent and purposeof section 199.9

Yet what goes on within those silos always has thepotential to spread beyond the silo.

The embedded intangible (or embedded service)issue can have profound implications for more gen-eralized international tax issues. Consider threefairly generic examples that frame some of theissues. In the first example, suppose that USP ownsall of the shares of CFC1, a controlled foreigncorporation in a low-tax jurisdiction. CFC1 main-tains a computer server with back-office softwarethat performs a variety of financial, accounting,and/or tax functions. CFC1 makes that functionalityavailable to CFC2 and other members of the USPworldwide group in other jurisdictions. It may belikely that CFC1 is treating the payments it collectsfrom CFC2 as services income. Although foreignbase company services income is one of the catego-ries of subpart F income, services income fromservices performed inside CFC1’s country of incor-poration is not foreign base company services in-come.10

However, if the IRS were to find within thecontract between CFC1 and CFC2 an embeddedintangible, a portion or all of the fees received by

6IRC sections 199(c)(4) and (5).7Prop. reg. section 1.199-3(h)(6). See, e.g., Nebergall, ‘‘Soft-

ware Group Urges Refining Definition of Computer Softwarefor U.S. Manufacturing Deduction,’’ 2005 WTD 129-17 or Doc2005-14382 (July 7, 2005).

8Prop. reg. section 1.199-3(h)(4).

9Preamble to the proposed regulations under IRC section199.

10IRC section 954(e)(1)(B). The character and source ofincome generated by software on a server has not beendirectly addressed by the IRS. However, the source of servicesincome in general is the place where services are performed.IRC section 861(a)(3). Many tax advisers would conclude thatif software is generating a fee for the performance of services,performance takes place where the server is located. Thesource rule for that income is not the focus of this article.

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In Osteopathic Medical Oncology and Hematol-ogy, P.C. v. Commissioner, the taxpayer was a pro-fessional medical corporation with a specialty inoncology and hematology.49 The taxpayer providedindividualized chemotherapy treatment. As part ofthe treatment, the taxpayer administered chemo-therapy drugs to its patients. The taxpayer used thecash method of accounting to report income andnever maintained an inventory of the chemotherapydrugs. The commissioner determined that the tax-payer had to inventory its chemotherapy drugsusing the accrual method, while using the cashmethod for all other items. The Tax Court disagreedwith the commissioner, concluding that income gen-erated by the chemotherapy drugs was service in-come because the drugs were inseparably connectedto the performance of the medical services. Thus,dividing the drugs from the service for inventoryaccounting purposes was not permissible.

Finally, in RACMP Enterprises v. Commis-sioner,50 a concrete contractor reported businessincome using the cash basis accounting method, notaccounting for inventory. The commissioner pro-posed income tax deficiencies based on the accrualaccounting method. The court ruled that the com-missioner abused his discretion. The petitionercould use the cash method that was historically usedin the construction industry. The court found thetaxpayer to be in the business of selling services andnot merchandise. The inventory method was notrequired because the materials were sold in conjunc-tion with, were incidental to, were inseparable from,and were consumed when performing the services,and they were not merchandise held for sale tocustomers.

It is difficult to discern deep-seated principles inthose cases. Each case seems to be decided based onthe facts and circumstances, although the courtsappear to emphasize industry practice. Undoubt-edly, one of the reasons so many of these cases havebeen litigated is that widely shared governing prin-ciples are not present, allowing both parties (that is,the taxpayer and the commissioner) to reach differ-ent conclusions on what the litigated outcome wouldbe. When rules and outcomes are clear, parties tendto reach an agreement without litigation.

D. Investment Tax Credit

A second important area in which courts havewrestled with whether a payment is for services or isfor tangible property concerns the investment taxcredit. Under that regime, a taxpayer could credit

against its income particular investments in prop-erty.51 Property ‘‘used by’’ a tax-exempt organizationor governmental unit, however, did not qualify forthe credit.52 Property ‘‘used by’’ those organizationsincluded property ‘‘leased’’ to them.53

In Xerox Corp. v. United States,54 the federalgovernment obtained machines from Xerox under amaster agreement between Xerox and the GeneralServices Administration. The master contract per-mitted the federal government to cancel the ar-rangement upon proper notice to the manufacturer.Xerox also entered into similar contracts with stateand local governments, tax-exempt organizations,and commercial customers. Xerox was responsiblefor the maintenance and repair of the machines, aswell as for incorporating changes and improve-ments. Xerox generally absorbed the cost of deliver-ing the machine to the customers’ premises, but thecustomers usually paid the wiring expenses on de-livery.

After analyzing several revenue rulings and pri-vate letter rulings,55 the Court of Federal Claimsstated that ‘‘the published and private letter rulingsdiscussed above do not articulate any single testwhich one could utilize to determine whether a givenagreement is a service arrangement or a lease forinvestment credit eligibility purposes’’ and that ‘‘it isapparent that any such determination must bemade on an ad hoc basis.’’56

The court of claims then discussed two factorsfrom the IRS’s rulings to distinguish service con-tracts from leases. The first factor was the nature ofthe possessory interest in the property retained bythe taxpayer, which the IRS measured by examiningthe following criteria in its rulings: (1) retention ofproperty ownership by the taxpayer; (2) retention ofpossession and control of the property by the tax-payer; (3) retention of risk of loss by the taxpayer;and (4) reservation of the right to remove the prop-erty and replace it with comparable property. Thesecond factor was the degree to which the property ispart of an integrated operation.

The court of claims held that Xerox was providinga service, because Xerox retained ownership as wellas a possessory interest in the machines that it

49Osteopathic Medical Oncology and Hematology, P.C. v.Commissioner, 113 T.C. 376, 377 (1999).

50114 T.C. 211 (2000).

51IRC section 38.52IRC sections 48(a)(4) and (5).53Treas. reg. section 1.48-1(j), (k).54656 F.2d 659 (Ct. Cl. 1981).55The Court of Federal Claims examined Rev. Rul. 68-109,

1968-1 C.B. 10; Rev. Rul. 70-313, 1970-1 C.B. 9; Rev. Rul.71-397, 1971-2 C.B. 63; and Rev. Rul. 72-407, 1972-2 C.B. 10;as well as LTR 7829066 and LTR 7847075.

56Xerox Corp. v. United States, 656 F.2d at 674.

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placed with its customers. Xerox was responsible forrisk of machine loss or damage and was economi-cally at risk because customers could exercise a15-day cancellation provision. Further, the agree-ments provided that the customers were prohibitedfrom altering the machines and needed Xerox’spermission to move them. Xerox trained customerpersonnel to operate the machines. Xerox installednew parts, known as retrofits, to improve perfor-mance of the machines. Xerox also retained the rightto exchange machines at the customers’ offices,which illustrates the possession and control it re-tained over its machines.

One of the reasons so many ofthese cases have been litigated isthat widely shared governingprinciples are not present.

The court of claims concluded that Xerox used themachines to provide a copying service, which was anintegrated package of equipment and services de-signed to produce copies as its end result. The IRScontended that Xerox’s customers contracted onlyfor machines, which they could operate themselvesto make copies used in their work. The court heldthat Xerox’s activities of repair, maintenance, re-placement, and retrofitting indicated that it wasproviding an integrated operation, designed to pro-duce copies.

Xerox was followed by a series of similar cases.Smith v. Commissioner57 involved high-tech medicalequipment, a CT scanner, and a special diagnosticcamera, each of which had been either leased orprovided to a hospital under a service contract. Thecourt outlined the following factors to be consideredin distinguishing a lease from a service contract:

(1) which party has the use and possession orcontrol of the equipment; (2) which party oper-ates the machine; (3) whether the tax-exemptorganization pays for the use of the machine forsome duration or, instead, pays based upon thenumber of procedures executed; and (4)whether the equipment is part of a broader,integrated system of equipment and services.

The court then applied those four factors to amedical scanner and a camera. The court found thatthe taxpayer retained possession and control of thescanner by keeping it in an office adjacent to thehospital paying for its use. Thus, the taxpayer couldeffectively render services both to the hospital aswell as to patients of other hospitals and clinics. The

taxpayer’s control of the scanner was further illus-trated by its retention of a technician and a physi-cian who were responsible for the scanner’s use,operation, and maintenance. The hospital paid for aminimum number of procedures, but it was allowedto accumulate credits for unused procedures andsometimes exceeded the minimum number. Thecourt concluded that although the scanner was notpart of a broad and integrated system of services,the agreement with the hospital was a service agree-ment, not a lease.

The court reached the opposite conclusion on thecamera. It noted that the hospital was in possessionand control of the camera because the camera wason the hospital premises and was operated by thehospital. Also, the hospital paid for the cameramonthly, rather than on a per-procedure basis. Fi-nally, the camera stood by itself in the hospital andwas not connected with a broad, integrated systemdesigned to provide services.58

The judicially developed factors were used byCongress in the passage of section 31(e) of the TaxReform Act of 1984,59 which added section 7701(e)addressing the distinction between services and alease.

(e) Treatment of Certain Contracts for Pro-viding Services, Etc. — For Purposes ofChapter 1 —

(1) In General.— A contract which purports tobe a service contract shall be treated as a leaseof property if such contract is properly treatedas a lease of property, taking into account allrelevant factors including whether or not —

(A) the service recipient is in physical pos-session of the property,

(B) the service recipient controls the prop-erty,

(C) the service recipient has a significanteconomic or possessory interest in the prop-erty,

57T.C. Memo. 1989-318.

58See also Musco Sports Lighting, Inc. v. Commissioner,943 F.2d 906, 908 (8th Cir. 1991), aff’g T.C. Memo. 1990-331.The Court of Appeals for the Eighth Circuit approved thefour-factor test used in Smith. The taxpayer in Musco Sportscustom-designed and built lighting systems. The lightingsystems were installed on poles at customers’ athletic fieldsand were leased with an option to purchase. All but one of thecustomers were either governmental units or tax-exemptorganizations. The lighting systems were in possession of thecustomers and used by the customers. Although frequency ofuse was figured into the calculation, an annual fee wascharged. Based on those factors, the court determined thatthe agreements with the customers were really equipmentleases rather than service contracts.

59P.L. 98-369, 98 Stat. 518.

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(D) the service provider does not bear anyrisk of substantially diminished receipts orsubstantially increased expenditures ifthere is nonperformance under the contract,

(E) the service provider does not use theproperty concurrently to provide significantservices to entities unrelated to the servicerecipient, and

(F) the total contract price does not substan-tially exceed the rental value of the propertyfor the contract period.

IRC section 7701(e) has broad application — forall income tax provisions under the Internal Rev-enue Code. For example, in determining whether ataxpayer was entitled to foreign sales corporationbenefits, it was necessary for the IRS to classifywhether a time charter of a vessel to an unrelatedperson was a contract for the provision of services(no FSC benefits available) or a lease (FSC benefitsavailable).60 The IRS reviewed the contract, walkedthrough the section 7701(e) factors one by one, andconcluded that the arrangement was that of a ser-vices provider-customer rather than lessor-lessee.Of the seven factors, one required further factualdevelopment (rental value of property relative tototal contract price).61 One supported lease charac-terization (the time charter did not permit concur-rent use of the vessel by other parties).62 The re-maining factors supported characterization as aservices contract. Of those remaining factors, themost important seemed to be the physical possessionand the control of the property.63 In the time charteragreement, the owner’s employees, rather than thecustomer’s employees, were to operate the vessel,and the owner was responsible for a long list ofduties and responsibilities for the vessel.

II. An Embedded Approach to theEmbedded Intangible (Service) Issue?

Perhaps section 7701(e) provides an embeddedsolution, or at least an aid, to resolving an embeddedintangible (service) problem. One approach might beto first determine whether any part of the transac-tion involves the transfer of an intangible or aproduct directly resulting from an intangible (forexample, a copyrighted article) to the customer. It is

here that IRC section 7701(e) may be useful — atleast with existing property.

For property newly created under the contract,section 7701(e) may not offer much help. If newlycreated property belongs to the customer from itsinception (that is, the vendor provides services re-sulting in customer-owned property), then no prop-erty has been transferred. If newly created propertybelongs to the vendor at all times (that is, the vendorperforms services and develops know-how or someother type of intangible that it keeps), no propertyhas been transferred. It is only when newly createdproperty is deemed to be owned by the vendor underthe contract and then transferred to the customerthat tax characterization as a property transfershould result. For example, if the contract providesthat the customer pays the vendor only if the vendorproduces a specified intangible and transfers it tothe customer, a property transfer for tax purposeshas taken place.64

Second, if property has been transferred and ifservices are also involved, it should be determined ifthe services are rendered to produce the propertythat is transferred, thereby providing an indirectbenefit to the customer, or if they instead are ren-dered directly to the customer. It is the latter possi-bility that might lead to disaggregating what mayseem to be a single transaction.

Third, if disaggregation is contemplated, it mustbe determined what level of service component inthe contract renders disaggregation appropriate. Ifthe services are ancillary or subsidiary to a producttransfer, should disaggregation be mandated? If theservices are de minimis, is disaggregation required?

A. Cleaning the Carpet

Before turning to the examples introduced in thebeginning of this article dealing with intangibles,consider the following more tangible example. Sup-pose a homeowner decides it is finally time todeep-clean the carpeting throughout the house, butthe homeowner doesn’t own the necessary steamcleaner vacuum. The homeowner might make anyone of several arrangements to get the job done.

Of course, the homeowner could purchase thenecessary equipment, but the homeowner doesn’tplan to vacuum again for years. Instead, the home-owner could pay a fee to a vendor to acquire the useof the steam cleaner for a limited time — perhaps aday.65 How that limited use should be treated by the

60FSA 200228002. Under a ‘‘time charter,’’ the owner’smaster, officers, and crew continue in possession of the vessel,its management, and operation. See, e.g., Randolph v. Water-man Steamship Corp., 166 F. Supp. 732, 733 (E.D.P.A. 1958).

61IRC section 7701(e)(1)(F).62IRC section 7701(e)(1)(E).63IRC sections 7701(e)(1)(A) and (B).

64In that case, there would be no payment for services thatdid not result in a product.

65The IRS has sometimes treated short-term rental ar-rangements as the provision of services when the provision ofservices was integral to the rental — for example, the

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vendor depends on how that temporary use is ac-complished. Suppose the homeowner acquires thesteam cleaner and the homeowner cleans the car-pets. Under those circumstances, it would seem thatthe fee received by the vendor should be character-ized as a rental payment. The homeowner rents theproperty and controls its usage.66

On the other hand, suppose the vendor is hired toclean the carpets using the steam cleaner. In thatscenario, the fee received by the vendor would ap-pear to be a fee for services rendered. The vendoruses and controls the property to provide services.Resolution of this characterization issue depends oncontrol. It is who has control that IRC section7701(e) seeks to resolve.

The embedded intangible (orservice) issue may affect subpart Finclusion, withholding tax liability,and foreign tax credit use.

Consider how section 7701(e) might solve theproblem. The first factor is physical possession.67

Physical possession of property is indicative of alease. Property that is located on the premises of acustomer, or located off the premises but operated bythe customer, is viewed as in the physical possessionof the customer.68 In both scenarios, the property islocated on the premises of the homeowner, but whenthe property is used by the vendor it is not in thephysical possession of the homeowner.

The second factor is control of the property.69 Thatthe customer controls the property is indicative of alease. A customer may be viewed as controlling theproperty to the extent the customer dictates or has aright to dictate how the property is operated, main-tained, or improved. Control is not establishedmerely through contractual provisions designed toenable the customer to monitor or ensure the ven-dor’s compliance with performance, safety, or othergeneral standards.70 When the homeowner operatesthe steam cleaner, the control factor would favor a

lease; when the vendor operates the vacuum, thecontrol factor would tend to favor a services con-tract.

The third factor is whether the contract conveys asignificant possessory or economic interest to thecustomer.71 A contract that conveys a significantpossessory or economic interest to a customer re-sembles a lease. The existence of a possessory oreconomic interest in property is established by factsthat show: (1) the property’s use is likely to bededicated to the customer for a substantial portionof the useful life of the property; (2) the customershares the risk that the property will decline invalue; (3) the customer shares in any appreciation inthe value of the property; (4) the customer shares insavings in the property’s operating costs; or (5) thecustomer bears the risk of damage to or loss of theproperty.

The focus of that factor is that a lease is a form ofownership — temporal ownership in which the les-see ‘‘owns’’ the property for a period of time. Accord-ingly, the benefits and burdens of ownership for thatperiod belong to the ‘‘owner’’ (that is, the lessee).Because of the short-term nature of the steamcleaner contract, that factor may not provide muchhelp. Certainly, the property’s use is not dedicated tothe homeowner for a substantial portion of theuseful life of the property. But at least conceptually,if there is a sudden demand for steam cleanersduring the term of the contract, it is the homeownerwho would benefit through the ability to subleasethe steam cleaner. One would also look to see if thehomeowner bore the risk of damage to the propertyunder the contract. When the vendor is hired tovacuum, it would appear that damage to the cleanerwould be a risk assumed by the vendor.

The fourth factor is substantial risk of nonperfor-mance.72 Under a service contract, the vendor bearsthe risk of substantially diminished receipts or sub-stantially increased expenditures if there is nonper-formance by the vendor or the property. If the vendordoes not bear any significant risk of nonperfor-mance, that is indicative of a lease.73

Although it is not clear from the legislative his-tory of section 7701(e) what that factor targets, itappears to focus on what happens if the vendor isunable to perform after the contract is entered into.For example, assume that after the contract isentered into, the steam cleaner didn’t work becauseof a power blackout. If burden of nonperformance isborne by the homeowner, that suggests a lease. If,

short-term rental of an automobile. Rev. Rul. 88-65, 1988 C.B.32. As recognized in the preamble to the proposed section 199regulations, the short-term nature of a transaction does notalone render the transaction a service.

66There may also be an embedded service aspect. Forexample, if the contract called for the steam cleaner to bedelivered and set up at the customer’s house, disaggregationof a rental contract might be appropriate.

67IRC section 7701(e)(1)(A).68S. Rep. No. 98-169, 136-140 (1984).69IRC section 7701(e)(1)(B).70Supra note 68.

71IRC section 7701(e)(1)(C).72IRC section 7701(e)(1)(D).73Supra note 68.

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under the terms of the contract, the vendor promisedclean carpets, that would suggest a service agree-ment.

The fifth factor looks at concurrent use of theproperty.74 The concurrent use of the property toprovide significant services to other customers un-related to the customer is indicative of a servicecontract. For example, when the homeowner makesarrangements to use the steam cleaner, the steamcleaner is not available for use by others. But if thehomeowner hires a vendor to clean the carpets, itmay be that the vendor would use the steam cleanerat other houses on the street while carpets aredrying or while there is no access to some of thehomeowner’s carpets.

The sixth factor considers the rental value of theproperty relative to the total contract price.75 Thatthe total contract price (including expenses to bereimbursed by the customer) substantially exceedsthe rental value of the property for the contractperiod is indicative of a service contract. If the totalcontract price reflects substantial costs that areattributable to items other than the use of theproperty subject to the contract, the contract moreclosely resembles a service contract. Conversely,that the total contract price is based principally onrecovery of the cost of the property indicates a lease.The legislative history also observes that a contractthat states charges for services separately fromcharges for use of property is indicative of a lease.76

Presumably, in most cases a vendor would chargemore to use the steam cleaner to clean the home-owner’s carpets than the vendor would charge foruse of the same equipment by the homeowner.

The legislative history of section 7701(e) providesadditional guidance:

A contract will be treated as a lease rather thana service contract if the contract more nearlyresembles a lease. Although each of the factorsin the bill must be considered, a particularfactor or factors may be insignificant in thecontext of any given case. Similarly, becausethe test for determining whether a servicecontract should be treated as a lease is inher-ently factual, the presence or absence of anysingle factor may not be dispositive in everycase. For example, even if a tax-exempt entityor other service recipient does not have physi-cal possession of property, the arrangement

could still be treated as a lease after taking allother relevant factors into account.77

IRC section 7701(e) by its terms is intended todistinguish a lease of existing property from theprovision of services. It does not address whethernewly created property has been sold from a vendorto a customer or whether the customer has paid forservices that result in the creation of property thatthe customer owns from its inception. Nor does IRCsection 7701(e) directly apply to distinguish a li-cense from the performance of services. Yet thestandards for determining whether tangible prop-erty is leased or intangible property is licensedconceptually should be the same.

After determining that property has been trans-ferred in some manner (sale, lease, or license), itmay still be questionable whether, within the trans-action, there is an embedded service that should bedisaggregated. That determination is essentiallywhether any services rendered were rendered by thevendor for the vendor to make the property transferpossible or whether the services were rendered tothe customer. Even if the services were rendered forthe customer, if the services are de minimis orancillary to the property transfer, disaggregationmay be inappropriate.

B. Examples Redux

Revisiting the three examples described in sec-tion I above to frame the embedded intangible(services) issue, could existing IRC section 7701(e)provide some guidance? In the first example, USPowns all of the shares of CFC1, a controlled foreigncorporation in a low-tax jurisdiction. CFC1 main-tains a computer server with back-office softwarethat performs a variety of financial, accounting,and/or tax functions. CFC1 makes that functionalityavailable to CFC2 and other members of the USPworldwide group in other jurisdictions. It may belikely that CFC1 is treating the payments it collectsfrom CFC2 as services income. Although foreignbase company services income is one of the catego-ries of subpart F income, services income fromservices performed inside CFC1’s country of incor-poration would not be foreign base company servicesincome.78

74IRC section 7701(e)(1)(E).75IRC section 7701(e)(1)(F).76Supra note 68.

77Supra note 68. As discussed below, the last sentence mayhave particular relevance to intangibles.

78IRC section 954(e)(1)(B). The place where services areperformed by software on a server has not been directlyaddressed by the IRS. However, the source of services incomein general is the place where services are performed. IRCsection 861(a)(3). Many tax advisers would conclude that ifsoftware is generating a fee for the performance of services,performance takes place where the server is located. Thesource rule for that income is not the focus of this article.

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Is there a risk in that situation that the IRSwould adopt the position advocated by some regard-ing section 199 that income resulting from softwarethat is hosted on a vendor’s server rather thandownloaded could nevertheless be treated as rent orroyalty income rather than services income?79 In theproposed regulations, the IRS concludes that onlinesoftware access does not qualify for section 199benefits (that is, lease or license of computer soft-ware).80 If the same software functionality weremade available to customers through a compact discor download, section 199 benefits would be avail-able.

Generally, the international taxcommunity recognizes thatpayment for contract R&D ispayment for services.

It appears that a line has been drawn that isperhaps consistent with IRC section 7701(e). To theextent that software functionality is made availableto customers on a server that is hosted by or con-trolled by a vendor,81 apparently the IRS regards thesoftware to be used by the vendor in providingservices (that is, software functionality to the cus-tomer). In that situation, arguably the service recipi-ent is not in physical possession of the property anddoes not control the property.82 It is true that insome sense, the customer does control the propertyin that access through log-on is available, but it isthe vendor that likely: (1) has put the software onthe server; (2) makes changes to the software (thatis, updates the database); (3) provides and autho-rizes software access; and (4) is responsible forserver maintenance. Those indicia of control maysuggest that the vendor uses the property to providea service.

Advocates for the section 199 position have saidthat method of delivery should be irrelevant indetermining income characterization. That is true inan ideal world, but tax professionals are in thebusiness of arbitrary line-drawing. The softwareregulations concerning characterization and sourceclearly state:

The rules of this section shall be applied irre-spective of the physical or electronic or othermedium used to effectuate a transfer of acomputer program.83

However, examples 8 and 9 of those same regula-tions reach different characterization results inidentical transactions when the only difference isthe method of software delivery.84 Perhaps takingthe position that hosting software access is treatedas a service may provide some certainty for taxpay-ers. For the CFC providing software functionality torelated entities, knowing that access is treated as aservice would be helpful. Of course, it may be pos-sible that hosting can be treated one way undersection 199 and another way under subpart F, but ingeneral that kind of silo treatment makes for poortax policy.85

Now reconsider the variation when CFC1 pro-vides contract R&D services for CFC2. If, under thereasoning of the proposed transfer pricing regula-tions, the IRS were to find that part of the paymentto CFC1 was for the acquisition of an embeddedknow-how intangible, then subpart F income mayresult.86 The principles of IRC section 7701(e) arenot terribly helpful here when the issue is whether anewly created intangible was transferred to thecustomer. Conceptually, the payment should betreated as a payment for services under either of twocircumstances. If the contract envisions that thecustomer will own any created intangible from itsinception, then no property has been transferredfrom vendor to customer and no subpart F shouldresult. The second circumstance would be when anintangible is created by the services performed bythe vendor, but that intangible is controlled by thevendor and used by the vendor to render the ser-vices, or perhaps is not used by the vendor at all, but

79See, e.g., ‘‘Attorneys Address Treatment of SoftwareUnder Domestic Production Activities Provision,’’ 2005 WTD73-14 or Doc 2005-7517 (Apr. 15, 2005); ‘‘U.S. Software GroupSubmits Draft Reg on IRC Section 199 Treatment of SoftwareAccess,’’ 2005 WTD 155-14 or Doc 2005-16970 (Aug. 11, 2005).

80Prop. reg. section 1.199-3(h)(6).81For example, the vendor makes arrangements with a

third party to host the software.82IRC sections 7701(e)(1)(A) and (B).

83Reg. section 1.861-18(f)(2).84In Example 8, the right to make copies from a master

disk (customer does the copying) is treated as a license, whilein Example 9, when the vendor provides one disk for eachcomputer (that is, vendor does the copying), the transaction istreated as a sale of the copyrighted article.

85As noted above, the preamble to the proposed section 199regulations clarify that an embedded service treated one wayfor purposes of reg. section 1.482-2(b)(8) (‘‘ancillary andsubsidiary’’ services do not require a separate allocation) willbe treated in a different manner under IRC section 199(ancillary and subsidiary services may constitute an embed-ded service that does not qualify under section 199).

86Prop. reg. section 1.482-9(m)(2). If the know-how weredeemed to be licensed, IRC section 954(c)(1)(A) would resultin subpart F income. There would be no active trade orbusiness income exception for royalty income from a relatedparty.

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is a residual benefit of performing services that maybe useful to the vendor in the future.

The only time the services contract potentiallyshould be disaggregated would be when the know-how was created by the vendor, owned by the vendor,and transferred to the customer. It would seem thatin most contract R&D arrangements, the customeris contracting for the R&D itself rather than theknow-how that arises from performance. Typically,contracts call for payment to the vendor regardlessof whether know-how is produced.87 Generally, theinternational tax community recognizes that pay-ment for contract R&D is payment for services.88

Perhaps section 7701(e) providesan embedded solution, or at leastan aid, to resolving an embeddedintangible (service) problem.

Consider the second example. USCO pays a fee toForco, an unrelated foreign corporation, for the sameback-office functionality described in the previousexample. If the fee paid is treated as a payment forthe provision of services, and the services are con-sidered performed where the server is located, thenUSCO has no withholding obligation and Forco hasnot generated income that would be taxable in theUnited States.89 However, if the income is consideredin whole or in part to be either rental or royaltyincome, then USCO might have a withholding obli-gation and Forco would have U.S. tax liability.90

While this fact pattern involves whether there isa U.S. withholding tax rather than whether subpartF income is created, analytically it involves the same

issue discussed in the first example — whetherpayments in connection with hosted software arepayments for services or payments for propertytransfers or both. Under the principles of IRC sec-tion 7701(e), it might not be unreasonable to takethe position that the IRS has taken in the proposedregulations and treat the payment as essentially apayment for services.91

The third example focuses on source implications.Suppose USCO licenses, leases, or sells software tonon-U.S. customers. USCo takes the position thatthe income generated is foreign-source income.92

That position may allow USCO to maximize the useof its foreign tax credits. As part of the license, lease,or sales agreement, USCO and its customers enterinto a separate software maintenance contract un-der which USCO promises to provide users withupgrades or updates to the software and to providetechnical support.93 Typically, industry practice is toprovide updates and technical support under asingle agreement with a single price.94

For purposes of IRC section 199, the IRS hasindicated that there may be an embedded service

87Compare reg. section 1.861-18(h), Ex. 15 (customer con-tracted for services, not for the know-how of the serviceproviders) with Ex. 16 (customer contracted specifically forknow-how).

88Westreco v. Commissioner, 64 TCM 849 (1992). Theexample in the proposed section 482 regulations may notrepresent a departure from existing interpretation if it isnarrowly read. In the example, both the customer and thevendor were engaged in manufacturing. If the customer didcontract for know-how to be delivered to improve the cus-tomer’s manufacturing processes, disaggregation may be ap-propriate.

89Presumably, Forco would not be engaged in a U.S. tradeor business from that particular activity. Even if Forco wereengaged in a U.S. trade or business, the services incomewould be foreign-source income, which would not be effec-tively connected. See IRC section 864(c)(4).

90Both rental and royalty income would be subject to a 30percent U.S. withholding tax under IRC sections 881 and1442. Here, it might be important to determine whether thepayment is rent or royalty, because treaties typically reducethe withholding rate for royalties but not for rental payments.

91The position is based in part on administrative conve-nience. The preamble explains:

If gross receipts attributable to the use of online soft-ware were permitted to qualify as DPGR [domesticproduction gross receipts] because the same or similarsoftware also is available to customers on disk or bydownload, different items of software available onlinewould be subject to disparate treatment under section199. In addition, if online software were permitted toqualify as DPGR, it would be difficult to distinguishthis online software from software that is used tofacilitate a service.92For this article, it is not necessary to decide among the

license, lease, or sales characterizations. Assume that underall three, foreign-source income would result. IRC section861(a)(4) (for license or lease payments, the place where theproperty is used determines source); section 861(a)(6) (forpurchased inventory, where title passes); IRC section 863(b)(for manufacture inventory, 50 percent of income sourcedwhere title passes). In this example, it is likely that anyincome generated would be general limitation income. IRCsection 904(d)(1)(I).

93The upgrades consist of new software that supplementsthe original program, often providing new features thatimprove the functionality of the program. The upgrades areprovided under the contract that governs the original soft-ware transaction. The technical support aspect provides cus-tomers with assistance required to enable full functionality ofthe software. The support may be offered by e-mail or phoneor through online databases. Typically, technical support doesnot include user training, which might be provided by aseparate contract.

94Users do not distinguish between the software acquiredand maintaining its functionality. Sellers find value in havingusers enjoy the full functionality of the product.

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