OEPI’s Winter/Spring 2020 newsletter provided an overview of the issues involved in the “petition for reassessment” of the Public Utility Tangible Personal Property (PUTPP) valuations set by the Ohio Department of Taxation on the natural gas pipeline owned by the Rover Pipeline and Nexus Natural Gas Transmission companies. This article recaps the issues involved in the companies’ appeals of their pipeline’s taxable value and summarizes the main points made in the Tax Commissioner’s July 10, 2020 ruling on the appeals.
The Economics of Fracking and Natural Gas Extraction in Ohio
The combination of hydraulic fracturing (commonly known as “fracking”) with the development of horizontal (rather than vertical) drilling capability has served to make accessible the vast reserves of natural gas and other chemicals contained in the massive Marcellus and Utica shale preserves that are partially located in southeast Ohio. A second offshoot of the accessibility of this large new supply of natural gas is the need to transport the extracted resources to the marketplace. As a result, roughly 800 miles of natural gas pipeline has been constructed in Ohio over the past several years, the two largest of which are the Nexus (256 mile total length) and Rover (713 mile total length) pipelines. In addition, compression stations are required along the pipeline in order to facilitate natural gas flow through the pipeline.
Both the pipelines and the compressor stations are taxable as Public Utility Tangible Personal Property and have become part of the local property tax duplicate in the 2018 and 2019 tax years. While precise estimates of local property tax revenue are difficult to obtain due to data confidentiality restrictions, information made available publicly has suggested that property tax revenues for Ohio local governments will total to several hundred million dollars.
While fracking is not without its critics (many environmental groups have expressed concerns about the potential contamination of groundwater supplies and have expressed frustration with many drillers’ refusal to identify the chemical compounds injected into the shale out of concern for revealing “trade secrets”), the new drilling techniques have appeared to be tremendously successful in their primary goal of extracting natural gas from the previously inaccessible underground shale preserves. In fact, natural gas extraction has been so successful that there is now such a glut of natural gas that prices are at long-time lows. While this is good for consumers of natural gas who now have lower heating bills, it is not such good news for the oil and gas companies themselves. According to an article in the January 12, 2020 edition of the Columbus Dispatch, “Just last summer , seven large [oil and natural gas] producers that operate in the region spent $500 billion more on drilling than they earned in selling oil and gas.”
Why are Rover and Nexus Appealing Their Assigned Tax Valuations?
One repercussion of the financial difficulties caused by rock bottom natural gas prices has been that the natural gas pipeline companies have begun appealing the taxable values assigned to their pipelines and compressor stations by the Ohio Department of Taxation. The lower price of natural gas resulting from the oversupply has led to a reduction in the amount of gas flowing through the pipelines. This in turn reduces the revenues of the pipeline companies. If they can in turn reduce their property tax payments, they can then (at least partially) recoup the lost revenues from the sale of the natural gas they have extracted.
There are two distinct impacts of reduced pipeline values on schools and other local governments. The first is that for inside millage and fixed rate levies (i.e. traditional operating and permanent improvement levies), schools and other local government will experience a reduction in PUTPP tax revenues compared to what was expected based upon both the information initially provided by the pipeline companies and as compared to the Tax Department’s initial assessed property values. The second outcome is that in the case of fixed sum levies (i.e., bond and emergency levies), any reduction in the property taxes owed by the pipeline companies will cause an increase in the taxes owed by other local taxpayers (again compared to what was initially expected). In terms of state aid, because FY20 and FY21 state funding is essentially frozen at FY19 levels, there will be no offsetting increase in state aid should the appeal of the pipeline valuations be approved.
How Does the PUTPP Petition for Reassessment (aka “Appeals”) Process Work?
The appeals process for public utility property works as follows:
1) The taxpayer makes an appeal to the Ohio Department of Taxation (ODT) questioning the original assessed value.
2) The Tax Department is then required to send notices that the appeal has been lodged to county auditors in the counties affected by the appeal.
3) ODT holds a non-public hearing in which the taxpayer can present evidence supporting the appeal. Only the taxpayer and its representatives and ODT are present at this hearing. Other impacted parties (such as school districts and other local governments) do not have standing and are not allowed to participate.
4) The State Tax Commissioner makes a ruling on the appeal (known as a “Final Determination”), which typically takes several months.
5) After the Tax Commissioner’s ruling, either the taxpayer or the county auditor(s) can appeal to the State Board of Tax Appeals. This appeal must be made within 60 days of the appellant receiving the Tax Commissioner’s final determination of value.
Note, again, that school districts and other local government units that actually receive the property tax revenues do NOT have the legal standing to appeal a ruling they view as unfavorable. This is different from the appeals process for real property where both the property owner and the school district are allowed to challenge the assessed value assigned by the county auditor.
An additional important aspect of the appeals process is that taxpayers are required to pay only the taxes that are due based on the lower appeal value rather than on the assigned taxable value. In instances where this has occurred, school districts and other local governments have received lower tax payments than they were expecting, which can create a variety of fiscal problems at the local level. However, if the appeal is unsuccessful (or partially successful), then the taxpayer would still owe the remaining tax payment with interest.
The Tax Commissioner’s Final Determination of Value
While suggesting that it is probably never a good idea to speculate about the outcome of any case pending before the Tax Department or the Board of Tax Appeals, the initial OEPI newsletter article from earlier this year did include the paragraph below discussing how public utility tangible personal property such as gas pipelines are valued.
According to the Ohio Department of Taxation publication “A Brief Summary of Major State & Local Taxes in Ohio”, the default method of establishing the “true value” of public utility tangible personal property is cost, which is then reduced by an annual deprecation allowance. (Note that “true value” is another term for market value, and taxable value is true value times the 88% assessment percentage applicable to pipelines.) Since the cost measure referenced above is supposed to be construction cost in accordance with the company’s records, it is difficult to see how a lower than expected price for the natural gas flowing through the pipeline can lead to a reduction in the taxable value of the pipeline itself.
To make a long story short, the Tax Commissioner’s July 10th final determinations of value for both Nexus and Rover essentially agreed with the logic articulated above. In the case of Nexus, the company provided to the Tax Department on September 24, 2019 an outside appraisal which valued the Ohio portion of the pipeline at $996.4 million. This was almost exactly 30% below the Tax Department’s valuation figure of $1.426 billion. After evaluating the evidence presented for a reduction in the assessed value, the Tax Department rejected the suggested appraised value of the pipeline and chose to retain its original $1.426 billion figure. The explanation provided was, “Rather, the Department set the value based on the cost as capitalized on statutorily-prescribed valuation method, which establishes the value of public utility property based on cost as capitalized on the petitioner’s books, less composite annual allowances [aka depreciation] as set by the Commissioner” (page 1).
Nexus’ response to this was to file the Petition for Reassessment. The Tax Department’s final determination of value explains that “in order to deviate from the statutory methodology, the petitioner [Nexus] must prove that the cost-based method does not reflect the true value of the property” (page 5). In such a case “the Tax Commissioner may apply an alternate methodology to value a taxpayer’s personal property only in cases where the statutory methodology will not result in a true value of that property” (page 8).
In the Nexus Final Determination of value, the Tax Commissioner articulated 15 reasons why the proposed $996.4 million appraisal figure could not be accepted. The terms, “inaccurate,” “flawed,” “inherent circularity,” and “wild guesses” were among the more pointed terms used in the Tax Department’s ruling. In sum, the Tax Department stated, “In particular, new pipelines, such as the one in the present case are straightforward to value, as the cost to build the pipeline is known” (page 29). Further on the same page the ruling continued, “In the manner the statutory valuation method prescribed in RC 5727.11 results in an accurate and appropriate measure of the true value of the petitioner’s public utility property.”
With regard to the Rover case, the assessed value proposed by the pipeline company was $1.847 billion, which was 47% below the Tax Department’s assessed valuation of $3.505 billion. Rover offered three separate arguments for their lower valuation figure, all of which were rejected by the Tax Department for similar reasons as in the Nexus case. The pointed words “back-door,” “masquerading,” and “ignores” were all used in the Tax Department assessment of Rover’s arguments.
What Happens Now?
Both Rover and Nexus had 60 days to appeal the Tax Department’s valuation ruling to the state Board of Tax Appeals. Tax Department records show that Nexus filed an appeal on September 4th and Rover filed an appeal on September 11th.
At this juncture, despite the severity of the wording used in the Tax Commissioner’s rulings, the bottom line from the perspective of the pipeline companies appears to be the same as it was when they made their initial Petition for Reassessment – that they have little to lose (apart from some attorney fees if they employ outside counsel for such matters) and everything to gain by appealing the values to the Board of Tax Appeals.
Regardless of how the Rover and Nexus appeals of the Tax Commissioner’s ruling proceed, there are several steps that could be taken to protect school districts (and other local governments in Ohio) from actions like this in the future.
- The legislature could allow school districts and other local government units in Ohio to have the legal standing to participate in the appeals process. Currently, only the taxpayer and the county auditor have the standing to participate. As the single largest recipient of property taxes (typically around 65%), schools are by far the entity most impacted by these valuation decisions, and it would be helpful to have the opportunity to explain the impact of any valuation changes.
- The legislature should make it clear that the information regarding tax appeals is a public record and that county auditors are required to both notify schools and other local governments of such appeals and to provide to them the necessary information about the appeal (i.e. the amount of value being challenged and the tax revenue impact of the revaluation). Currently, each county auditor is free to decide whether or not to provide this information based on their understanding (or otherwise) of Ohio law.
- The legislature could authorize the Ohio Department of Taxation to update its certified property value data when a significant appeal of PUTPP valuation of the type in question in the Rover and Nexus cases results in the lowering of property valuations. Currently, it takes a specific legislative act for the Tax Department to make such a correction, which means that outdated and incorrect data is often used in the calculation of the state aid formula. In such cases, school districts will typically receive less state aid than they would if the correct valuation figures were used.
A final suggestion would be for the legislature to add an additional 3% to the interest rate owed by the taxpayer should they lose their appeal. This would create a modest disincentive for the filing of spurious appeals cases.