In a controversial decision on May 10, 2011, the Fourth District Court of Appeal in Elk Hills Power, LLC v. State Bd. Of Equalization, No. D056943 (May 10, 2011) held that emission reduction credits (ERCs) held by a California power plant were not intangible assets once the plant surrendered them to regulatory agencies to enable the plant to operate.

Under California law, the value of intangible assets is generally excluded from property tax. Under California Revenue & Taxation Code Section 110(e), however, an assessor may assume “the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use.”

In this Fourth District Court of Appeal case, Elk Hills built a power plant and needed to comply with the emission regulations of a regulatory agency. Elk Hills, thus, purchased approximately $10 million worth of ERCs and used the ERCs to obtain the necessary certifications and permits for its plant. When assessing this plant, the State Board of Equalization used two approaches: the replacement cost approach and the income approach, but it gave more weight to the replacement cost approach. As part of its replacement cost calculation, the Board included Elk Hills’ ERCs. Elk Hills filed a complaint for refund claiming that the assessment was improper because the Board had assessed its intangible property.

Although the Court recognized that “if there is substantial evidence showing the presence and separate value of…intangible assets, the intangibles must be excluded from assessment,” the Court nonetheless upheld the Board’s determination to assess the intangible ERCs. Interpreting Section 110(e), the Court found that because Elk Hills’ ERCs were “necessary” to making “energy and money” for the power plant they should be added, and their value should be determined in the assessment. The Court reasoned that although the ERCs were purchased and tradable at one point, in this instance they were purchased in order to build the power plant, so they were not transferable while the plant was operating and were necessary to lawfully operate the plant. Thus, as argued by the Board, the plant’s replacement cost value included an estimate of the ERCs.

The Court acknowledged that California decisions have held assets such as copyrights, liquor licenses, airport car rental concessions, ballpark food concessions, and cable television franchises are intangible rights which cannot be directly subjected to property tax assessment. The Court, nonetheless, created a “necessary” standard to be used for assessment of intangible assets. This interpretation of section 110(e), and its application in this case, seems to ignore the California constitutional preclusion of taxing intangible assets. Indeed, the California Supreme Court recently granted certiorari to review this case. Taxpayers whose businesses have intangible assets that may be considered “necessary” for the beneficial or productive use of the businesses should seek the advice of a tax professional and may want to file an amicus brief with the states' Supreme Court.