“A tax is a fine for doing well, a fine is a tax for doing wrong”
Editor’s note: Interested in aligning with other North Carolina job creators to shape a top-10 business legal climate here in our state? Contact NC Chamber Legal Institute President Ray Starling to learn what you stand to gain from your engagement and support.
The quote presented as the title of this piece is attributed to Mark Twain, one of the great poet laureates of the American experiment. More than a century later, Twain’s aphorism remains sharp and telling. Indeed, the quote was recently included in the prologue to N.C. Supreme Court Justice Barringer’s dissenting opinion in a case whose outcome suggests the sentiment holds as much truth today as it did all those years ago.
The case in question, In Re Harris Teeter LLC, concerned matters influencing how local taxing authorities in North Carolina conduct “true value” assessments of business personal property subject to ad valorem taxation. This is a method of taxation based on the value of property at the time a tax is levied. Since North Carolina does not levy a state property tax, these value assessments are determined by local authorities in our state: cities, counties, and – in certain cases – special tax districts. Under North Carolina statute, property value is not based on the subjective value to the owner but the objective, or true value, of the asset. “True value” is defined in statute as:
“The price estimated in terms of money at which the property would change hands between a willing and financially able buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of all the uses to which the property is adapted and for which it is capable of being used.”
Most companies own equipment or property that is used throughout – and perhaps exclusively within – their industry. And like any equipment, it must be replaced periodically. The value of that equipment typically declines over its useful life. Sometimes, however, it retains a substantial percentage of its initial value up to the point of replacement.
In the Harris Teeter matter, Mecklenburg County valued Harris Teeter’s business personal property located in six stores within the county at $21,434,313. This property included freezer and refrigerator cases, forklifts, trash compactors, computers, UPC scanners, shopping carts, shelving, and other items you might customarily find in a supermarket. Harris Teeter appealed the County’s valuation to the N.C. Property Tax Commission, estimating instead a value of $13,663,000.
Comparing the dueling assessments, the County’s valuation was 57 percent greater than the estimate put forth by Harris Teeter. The County methodology was based on “appropriate cost indices” and depreciation schedules provided in materials published by the N.C. Department of Revenue (DOR). DOR describes these schedules as a “general guide,” adding that there “may be situations where the appraiser needs to make adjustments for additional or less functional or economic obsolescence or for other factors.”
DOR recognizes three categories of depreciation: (1) physical deterioration; (2) functional depreciation; and (3) economic obsolescence. Physical deterioration is self-explanatory. Functional depreciation is a reduction in value due to outdated or flawed design; that is, an impairment of functionality inherent in the item itself. Economic obsolescence, on the other hand, is a decline in value due to external economic forces. These forces may include changes in legislation, new regulations, or prevailing market forces such as a rise in availability or a drop in demand for the item in question.
In reviewing Harris Teeter’s appeal of its property valuation, the Property Tax Commission upheld the County’s initial assessment. That decision was affirmed by the N.C. Court of Appeals, bringing the matter before the N.C. Supreme Court. The Supreme Court then affirmed in a 4-3 decision accompanied by two dissenting opinions. These dissents argue that the majority opinion appears to have affirmed a methodology for determining “true value” that is inconsistent with North Carolina statute.
Under Harris Teeter’s established protocol for updating its stores and equipment, the company often replaced equipment that was still serviceable, a strategy meant to account for the highly competitive nature of the grocery business. This high degree of competition results in frequent store closures, mergers, and bankruptcies. In this case, these factors had created an oversupply of used, serviceable grocery store equipment, consequently suppressing prices for that equipment.
The Supreme Court majority viewed this circumstance as reason to avoid using the secondary market for determining the true value of the equipment installed in Harris Teeter’s stores. In lieu of secondary market prices, the Court adopted a “cost approach.” This method estimated the current cost of the equipment being evaluated, then made deductions for the three categories of depreciation outlined above to arrive at “depreciated cost new.”
Harris Teeter argued that the competitive pressure in the grocery store sector compelled the company to periodically update its stores, including its equipment. Therefore, the company argued, even though the replaced equipment remained serviceable, it was economically obsolete because it was not compatible or consistent with the updates required to remain competitive. Therefore, a significant downward adjustment to the cost of the equipment was merited for the determination of true value. Put another way, an oversupply of equipment in the used equipment market (and fewer buyers) should have produced lower prices, indicative of a true value that was lower.
In its ruling, the Court dismissed the secondary market as unrepresentative of true value and adopted an “income approach” to adjust for economic obsolescence which assessed the rate of return on the item in question. The majority reasoned, however, that because the property being evaluated showed a rate of return to Harris Teeter that was above the industry average, that property could not be deemed obsolete. Their assessment of true value, then, remained equal to the current cost minus any physical deterioration and functional depreciation.
By definition, a showing of economic obsolescence requires identification of external forces which caused the depreciation. Justice Barringer’s dissent in this case – in which she was joined by Chief Justice Newby and Justice Berger – observes:
“Economic obsolescence is unrelated to who owns the property, and . . . the fact that a specific taxpayer’s rate of return on the subject property exceeds industry standards does not refute the existence of economic obsolescence, and certainly does not justify per se higher ‘true values.’”
Put differently, since the rate of return necessarily involves factors internal to the taxpayer, it was unlawful to use that calculation to assess economic obsolescence. To do so where the taxpayer has produced an above average rate of return unlawfully imposes a “success tax.” Justice Berger, dissenting separately, but joined by Chief Justice Newby and Justice Barringer, opined that the majority’s holding threatened any business which earned “above industry” returns. Such businesses may be, the dissent warns, the future victims of “an extra-statutory taking of the fruits of their labor.”
What learnings, then, does this case hold for the business community? For whatever reason, the County and the courts were unwilling to look at the value of Harris Teeter’s property according to the letter of the statute. Yet still, the decision stands as the law of the land in North Carolina. As there is no further appeal in the courts, it will fall to the General Assembly to remedy the issue by clarifying or rewriting the statutes in question.
Taxpayers are, of course, obligated to pay the taxes they owe. But they are also entitled to manage their tax burden to the maximum extent permitted under law. North Carolina’s continued success, moreover, depends on empowering our job creators to achieve profits and continue providing gainful employment for our citizens. Where would we be in our current economic relaunch without this crucial factor?
I started this piece with a quote from Mark Twain. I’m realizing now that perhaps the true lesson of this case comes instead from his Irish contemporary, Oscar Wilde: “No good deed goes unpunished.”
Here at the NC Chamber Legal Institute, we believe in working with aligned entities to promote a Court system that recognizes the true value our business community brings to North Carolina. You can bet the outcome of this case will heavily inform our efforts going forward.
NC Chamber Legal Institute