The Substance of Property Tax Rule 474, Relating to the Assessment of Refineries, Was Appropriate, Valid and Consistent with Proposition 13 and Other Tax Laws... However, the Failure of the Board to Substantially Comply with the Administrative Procedures Act in its Adoption Leads to Its Invalidation

The State Board of Equalization (“Board”) enacted a rule that the valuation of petroleum refinery property should assess the land, improvements, and fixtures as a single appraisal unit because they are generally bought and sold as a unit.  An oil and gas industry trade association challenged the rule in state court, arguing that it was improper, violated Proposition 13 and other tax laws and that the procedure used in adopting the rule violated the Administrative Procedures Act (“APA”).  The trial court agreed, holding the rule invalid on both grounds.  The court of appeal upheld the trial court decision.  The California Supreme Court found that the rule was proper, consistent with Proposition 13 and other tax laws, but agreed with the lower courts that the rule should be invalidated because its adoption violated the APA.  (Western States Petroleum Assn. v. Board of Equalization (--- P.3d ----, Cal., August 5, 2013).


In 1979, the Board adopted a regulation, (Rule 461(e), related to the taxation of industrial property in which the value of fixtures, including machinery and equipment, was assessed separately from the value of land and improvements.  This rule had been applied to the assessment of petroleum refinery property.  The rule was financially favorable to property owners because it allowed them to maximize tax savings from depreciation of fixtures, by treating the same as a separate unit of appraisal for property tax assessment purposes. 

In late 2007 the Board adopted a new rule, Rule 474, which provided that land, improvements, fixtures and related components of value associated with a petroleum refinery would be assessed as a single appraisal unit.  The Board enacted Rule 474 to bring the assessment method into line with how petroleum refinery properties are treated in the marketplace, because the land, improvements, fixtures and personalty associated with a refinery are almost always bought and sold as a unit. 

The Western States Petroleum Association (“WSPA”), an oil and gas industry trade association, sued in state superior court to challenge the rule on two grounds:  First, that the rule violated tax-related laws including Proposition 13 and Proposition 8, and second that the Board did not substantially comply with the APA in adopting the rule by failing to appropriately evaluate and report on the potential adverse economic impact of the regulation in its initial determination.  The trial court held Rule 474 was invalid on both grounds, and the court of appeal upheld the trial court ruling.


Unlike the trial court and court of appeal, the California Supreme Court ruled that Rule 474 was consistent with Proposition 13, Proposition 8, and Revenue and Taxation Code section 51 (“Section 51”) and related property tax laws, effectively determining that the substance of the Rule was valid and proper.  None the less, the Supreme Court affirmed the trial court and court of appeal rulings that Rule 474 was invalid solely due to the Board's failure, in its initial determination, in connection with the adoption of Rule 474 to adequately evaluate and report on the potential adverse economic impact of the rule on businesses, as required by the APA.

The Supreme Court explained under Proposition 13, a cap is placed on the taxable value of property, by the establishment of a base-year value, such that when the fair market value of property rises its taxable value is limited by such base-year value, subject to certain adjustments.  Under Proposition 8, when a property's fair market value falls below the base-year value, the taxable value is the fair market value of the property.  In the wake of Propositions 13 and 8, the Legislature created a task force to recommend methods of implementing the changes to the property tax system.  Based on these recommendations, the Legislature amended Section 51, to define “real property” as “that appraisal unit that persons in the marketplace commonly buy and sell as a unit, or that is normally valued separately.” 

The Supreme Court rejected WSPA’s argument that the land and fixtures of industrial property have historically been appraised separately and that Section 51 was meant to codify the practice.  The Supreme Court opined that the appellate court’s reading of legislative history improperly conflated assessment and valuation.  The Supreme Court stated that instead, land and improvements that were appraised as a unit were separately listed on the assessment roll, to comply with state law.  The Court cited to several Assessors Handbooks published by the Board from 1958-1976 supporting the idea that “legal provisions do not require the separate appraisal of land and improvements but merely that the valuations of each shall be separately stated on the assessment roll.”  The Court also noted that the Handbooks presaged Section 51’s definition of real property in noting that because “the appraisal objective is to estimate market value, the proper unit to be valued is the unit that people in the market buy and sell.”  The Supreme Court stated that Rule 474 advanced this “long-standing mandate to appraise real property according to ‘actual market values’” because it brought the assessment of petroleum refinery properties into alignment with how such properties are bought and sold in the marketplace.

The Supreme Court dismissed WSPA’s contention that the rule was invalid because other types of industrial properties in which fixtures are closely integrated with the land were assessed differently, not as a unit combining fixtures with land and improvements.  The Court concluded that the Board was not required to extend Rule 474 to “all other comparable types of industrial property,” and that the Board was allowed to move one step at a time to address regulatory reforms.  The Court held that substantial evidence supported the Board’s conclusion that petroleum refinery property was different enough from other industrial property to justify single-unit appraisal of land and fixtures.

The Supreme Court also rebuffed WSPA’s assertion that Rule 474 violated the legal requirement that depreciation be taken into account in determining the “full cash value” of real property.  The Court stated that Rule 474 did in fact take depreciation into account.  The Court explained that the Revenue & Tax Code’s definition of “full cash value” was the “amount of cash or its equivalent that property would bring if exposed for sale in the open market.”  Because petroleum refinery property is typically sold as a unit, including fixtures, improvements and land, it was appropriate to treat them as a single appraisal unit.  The Court noted that to do otherwise would permit an owner to claim an “economically fictitious” drop in property value, resulting in an unjustified tax windfall.  The Court stated that neither Propositions 13,or 8 “ nor section 51 nor traditional appraisal practices require the unit of appraisal to be defined in a manner that maximizes the depreciation of fixtures in contravention of economic reality.”

Additionally, the Court dismissed WSPA’s argument that because Rule 474 would cause a rise in property taxes for some refinery owners, the rule violated the constitutional requirement that tax increases be passed by a two-thirds vote of each house of the Legislature.  The Court pointed out that the constitutional requirement applied only to a change in a state statute, not a change in an administrative rule that is “reasonably necessary to faithfully implement an existing statute.”  The Court noted that the Board merely administers and enforces property tax laws to advance uniform assessment practices and lacks any taxing power.

The Court found that Rule 474 is consistent with applicable constitutional and statutory provisions, and it is also consistent with the long-standing valuation principle that the proper appraisal unit is the collection of assets that persons in the marketplace normally buy and sell as a unit.  Accordingly, the Court found that the adoption of Rule 474 did not exceed the Board's rule-making authority.

Turning to WSPA’s technical APA challenge to Rule 474, the Court agreed that the adoption of the rule was procedurally deficient due to the Board’s inadequate consideration of the rule’s economic impact.  The Court observed that under the APA, an agency’s assessment of the economic impact of a proposed regulation entails three steps:  an initial determination whether the regulation adversely impacts business, then a public comment period during which affected parties may respond and submit information, and finally a response to public comments included in the final decision and statement of reasons for adopting the regulation.  The Court noted that the initial agency determination did not have to be extensive, but did have to provide “some factual basis” supporting the determination.  However, the Court found that the Board failed to meet this deferential standard because it failed to quantify or provide data on the amount of fixture depreciation that would be offset by appraising land, improvements and fixtures as a unit.  This failure in turn made it impossible to determine how a given refinery’s taxable value and property taxes would be impacted by adoption of the new rule.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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