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    • Appellate Tax Board Update

    A periodic report for property owners, appraisers, assessors and attorneys

    February 2004
    THE YEAR 2003 IN REVIEW

    It was a quiet year at the Appellate Tax Board, at least in terms of decisions of interest to assessors. A total of 30 formal decisions were issued but only 14 involved real estate valuation and of those 10 involved houses. There was also a decision on manufacturing classification (with its personal property tax implications), a decision on the appropriate tax rate for a payment in lieu of taxes and two unsuccessful attempts for a charitable exemption. Perhaps the most significant decision involved the ongoing struggle over "telephone and telegraph" company status and that case will be the focus of this edition.

    NEWTON CALLING

    The telephone and telegraph case was RCN BECO-COM, LLC v. Commissioner of Revenue, et al (August 19) which should be looked upon less as a final decision and more as the first step in what most likely will be a journey of a thousand miles. The case is the first in what is sure to be many cases dealing with "telephone and telegraph company" status under Chapter 59, Section 39 and the resulting tax implications. At issue was RCN's personal property located in the city of Newton. The value of RCN's personal property in Newton alone was stipulated as having a value of $3,331,600. Of that amount, $3,267,788 was property that would have been treated as exempt had RCN qualified as a "telephone and telegraph" corporation. As a result of the ATB's decision, all that property was found to be taxable to the city of Newton. Project that number throughout the big cities and small hamlets of the commonwealth and the magnitude of this case is clear.

    The value of RCN's personal property located in Newton that would be taxed whether it qualified as a "telephone and telegraph" company or not was a modest $63,000 ($10,000 in wires, $23,000 in underground conduits and $30,000 in a power generator). The $3,267,788 value of the other property would not have been taxable if the ATB had made the following three rulings: 1) the company had "telephone and telegraph" status, 2) all the property should be treated as telephone and telegraph property, and 3) limited liability companies could qualify for the corporate exemption under Chapter 59, Section 5, Clause 16. The ATB did find that RCN qualified for telephone and telegraph status. It also found that the vast majority of its property, $2,833,000 worth (i.e. non-cable TV or Internet dedicated property) should be treated as telephone and telegraph property. The approximately $435,000 of value found in cable TV and Internet dedicated property was to be reported to and valued by the city of Newton. Unfortunately for RCN, the ATB found that all $2,833,000 worth of telephone and telegraph property was taxable because as a limited liability company, RCN did not qualify for the corporate exemption for telephone and telegraph companies under Chapter 59, Section 5, Clause 16. As a result, all of RCN's personal property was found to be subject to tax.

    The basic tax scheme for telephone and telegraph companies goes back to about 1915. At that time, the legislature decided to centralize the valuation of telephone company property for local property tax purposes. By placing the task of valuation in the Commissioner's hands alone, the legislature removed the administrative burden from municipalities and ensured uniform treatment of what was standard equipment for the telephone companies throughout the commonwealth. This scheme was efficient for both the companies and the municipalities when applied to "traditional" telephone companies. Once the Commissioner certified the values to the cities and towns, they would in turn apply their personal property tax rates and impose the tax.

    However, what worked when Mayberry Sheriff Andy Taylor had to go through Mabel to get Aunt Bea on the line, doesn't apply so readily in the new millenium. In Mabel's heyday, companies that provided telephone service only provided telephone service. Today, the company that provides your cable TV or Internet connection might also seek to offer your telephone service. Such was the situation in the RCN-BecoCom, LLC case. The big question presented to the ATB was how does such a multi-service provider fit under a tax scheme originally designed with pure telephone service providers in mind.

    The tension arises because modern multi-service companies want to hold onto the convenient and favorable status of "telephone and telegraph" companies (i.e. entitled to one-stop DOR valuation of all its property throughout the commonwealth and exemption for all its personal property except property such as wires-poles-generators). In looking at these cable TV or Internet access companies which expanded into the telephone service business or which started as telephone companies and then expanded into cable TV or other such telecommunication services, the DOR took the position that unless a company was exclusively engaged in providing telephone and telegraph services, it didn't merit the status of a "telephone and telegraph" company.

    RCN was the first case to go to the ATB challenging the DOR's position. RCN is a "bundled carrier" that offers telephone service along with its cable TV and Internet services. Consistent with its view, the DOR refused RCN's attempt to have all its personal property centrally valued as a telephone and telegraph company. The case brought several issues to the fore and applied new legal principles that the Supreme Judicial Court will now review. The case is scheduled for oral argument in May.

    A number of questions were addressed by the ATB (and will be reviewed by the SJC). What is a telephone and telegraph company? If a company is a telephone and telegraph company, which of its property should be centrally valued and certified by the DOR and which of its property should be valued by the municipality where it is located? Finally, and perhaps most dramatically, even if a company enjoys telephone and telegraph status, if it is not a corporation, is it nevertheless entitled to the "corporate" exemption under Chapter 59, Section 5, Clause 16.

    What is a telephone and telegraph company?

    The ATB lowered the high bar set by the DOR on this question and ruled that the test was not one of "exclusivity" but rather "substantiality." In other words was the company substantially engaged in providing telephone services or were such activities "merely trivial or incidental to the main business?" The ATB found that RCN's provision of telephone services was substantial enough for the company to be treated as a telephone and telegraph company.

    The ATB reached this conclusion by analyzing RCN from four different perspectives: revenue, subscribers, employees and equipment. It looked at these categories in terms of whether they were associated exclusively with cable TV, Internet or telephone services or were shared by those services. The ATB broke it down this way:

    PhoneCable TVInternetShared
    Revenue:58%15%26%N/A
    Subscribers:28%20%47%N/A
    Employees:12%3%N/A83%
    Equipment Value:40%20%N/A40%

    The ATB found that the lion's share of RCN's equipment was "shared property" in that it supported all three of the company's services: cable TV, Internet and telephone.

    In applying the substantiality test, the ATB decided to count not only those ingredients attributed exclusively to providing telephone services but also those which in part contributed to providing telephone services, that is those in the "shared" category. Under this analysis, the ATB found that RCN should be treated as a "telephone and telegraph company."

    Which of RCN's property is entitled to central valuation by the DOR?

    Given its determination that RCN is a telephone and telegraph company, the next task that the ATB set for itself was to determine which of RCN's property should be treated as telephone and telegraph property, thus centrally valued by the DOR. The ATB found that both the equipment used exclusively for telephone services and the "shared" equipment should be centrally valued by the DOR under Chapter 59, Section 39. Property dedicated solely to cable TV or Internet access (in Newton's case approximately $435,000 worth of property), according to the ATB, was to be returned for valuation and taxation by the individual cities and towns where the property was located pursuant to Chapter 59, Section 29.

    Regardless of who values the property, what type of entity is eligible for exemption?

    Just when RCN thought it would enjoy its hard won victory on "telephone and telegraph" company status, the ATB dealt the company a devastating blow. Yes, the ATB recognized RCN as having telephone and telegraph status. Yes, the ATB found that the vast majority of RCN's property throughout the commonwealth should be uniformly and centrally valued by the DOR, rather than by cities and towns. But No, and this is a big NO, the ATB found that RCN was not entitled to the corporate exemption for its non-pole-wire-generator property under Chapter 59, Section 5.

    RCN was a limited liability company ("LLC") for the year at issue. The ATB found that despite the prior practice of the DOR to allow the Chapter 59, section 5, Clause 16 exemption for telephone and telegraph companies organized as LLC's, the exemption was only rightfully enjoyed by businesses having the corporate form. In short, RCN won the battle, but definitely lost the war. Its taxable property in Newton shot up from approximately $63,000 to $3,331,600.

    next column

    What's Next?

    The SJC has granted the parties' request for direct review and invited "friend of the court" briefs from any interested parties. One other case now before the ATB involves whether a company, which switched its form from an LLC to a corporation, did so in time for the tax year. It is anticipated that the next wave of cases will challenge the valuation methodology of both the DOR and the individual towns and cities.

    NO CHARITY

    The first attempt for relief under Chapter 59, Section 5, Clause Third was by The Mediation Group, Inc. which owned a condominium unit in Brookline valued at $309,000. The Mediation Group, Inc. v. Brookline Assessors (February 3, 2003). The purpose of the Group was to provide mediation services to enable individuals and groups "to settle their disputes peacefully and specifically reducing the burdens on the judicial system." The Group claimed that it offered reduced-fee and free services to those unable to pay, but the ATB noted the lack of evidence showing the fee structure or criteria for reduced fees. The three founders of the Group were its only officers and directors and were its primary employees. There was testimony that about 60% of the Group's clients paid "market rates" for mediation services. The ATB found that the Group was "more akin to a commercial enterprise which operated primarily for the benefit of a limited class of persons, its officers and directors." Any benefit to the public at large, the ATB added, "was only incidental." The fee structure, as the ATB saw it, was based on criteria "which are typical of a for-profit business: to pay business expenses, to remain 'competitive', and to garner future business." Accordingly, the exemption was denied.

    The other charitable exemption case was Wing's Neck Conservation Foundation, Inc. v. Bourne Assessors (July 8). The Foundation owned three parcels of land, totaling about seven acres, on Wing's Neck, a 400-acre peninsula which extends into Buzzards Bay. The Foundation was formed in 1998 for the "acquisition and preservation of environmentally or ecologically significant land for open-space conservation purposes" with the specific goal of protecting wildlife habitat on Wing's Neck. Despite those noble goals, the ATB took note that the Foundation's lands were closed to the general public and that the acquisition of the property "was primarily for the benefit of a limited class of beneficiaries," specifically Wing's Neck residents who would prefer to have the Foundation's property left undeveloped. The ATB concluded that "the benefit to the public, if any, was merely incidental" and denied the exemption.

    FURTHER EROSION

    Although not a real estate tax evaluation case, The Sherwin-Williams Company v. Commissioner of Revenue (May 9) was another in a series of setbacks for local taxation of personal property. The case turned on whether Sherwin-Williams was a "manufacturing corporation" within the meaning of General Laws Chapter 58, Section 2. Machinery used by manufacturing corporations is not subject to local taxation.

    There was a time when Sherwin-Williams manufactured all its products, both "base" paint and colored paints, at a single centralized factory. This changed in the 1960's when the company began having its retail stores mix colorants with the base paint to create colored paints at locations closer to the end users.

    Sherwin-Williams operated 39 retail stores throughout the commonwealth and each had the equipment for mixing the paint to suit its customers' wishes. The Department of Revenue denied Sherwin-Williams' application for the manufacturing classification and the company appealed to the Appellate Tax Board. As to what constituted "manufacturing," the ATB used the concept of "change wrought through the application of forces directed by the human mind, which results in the transformation of some pre-existing substance or element into something different, with a new name, nature or use."

    Applying that almost-philosophical definition to Sherwin-Williams, the ATB found that the process of producing colored paint "effects a sufficient degree of physical change in the raw materials, base paint and colorant additives, to constitute manufacturing."

    The ATB relied on its own precedent in a case involving Mobil Oil where the ATB concluded that treating "base" gasoline with additives, thereby creating a new grade of fuel by blending together gasoline of different octanes, constituted manufacturing. Massachusetts courts have also liberally bestowed manufacturing status by holding, for example, over a half century ago, that adding chocolate to milk to make chocolate milk and blending, roasting, and grinding coffee beans to make coffee constituted manufacturing and that the same was true for "cutting, chilling, combining, and packaging vegetables."

    STRICTLY COMMERCIAL

    The Salem and Beverly Water Supply Board operates the water supply system for, you guessed it, the cities of Salem and Beverly. The legislation which established the Board allowed it to own land in other towns as part of the water supply system. The parcel at issue in Salem and Beverly Water Supply Board v. Danvers Assessors (December 5) was 454 acres in Danvers which was taken by eminent domain by the Board for a reservoir.

    Under General Laws Chapter 59, Section 5F the Board was obligated to make a payment in lieu of tax to the Town of Danvers based on the value of the land the Board owned there. Happily, the parties stipulated that the value of the 142 acres of watershed land (that is, the land around the reservoir itself) was about $5.1 Million. The parties further agreed that no value should be attributed to the 312 acres of land under the reservoir itself.

    The dispute was over the tax rate to be applied to the watershed land for purposes of calculating the PILOT. The Assessors argued that the commercial tax rate of $16.98 should be used while the Water Supply Board argued for the $12.92 residential rate. Chapter 59, Section 5F states that property owned by one municipality but located in another municipality is exempt from tax but obligates the payment of the PILOT based on the valuation of the property. Section 5F, however, is silent on how such property should be classified. The ATB concluded that the Danvers Assessors should follow the mandate of Chapter 59, Section 2A(b) that all property should be classified according to its use. The ATB quickly rejected the Water Supply's Board argument that the residential classification should not apply because, very simply, the property was not "used or held for human habitation containing one or more dwelling units." The Water Supply Board had argued that the residential classification was appropriate because it derived no profit from holding the property for use as part of the water supply system. The lack of profits was not determinative, the ATB stated, because Section 2A(b) specifically classifies as commercial any property that is held for "service," "recreational," or "governmental" functions even if those functions are for non-profit purposes which may be exempt from taxation, such income tax. In other words, the fact that the subject property was not used for a business enterprise was not sufficient to prevent its commercial classification.

    CAPITALIZATION RATE

    The only case decided during the year where the ATB clearly had to choose the appropriate capitalization rate was Three Shopping Center Assoc. v. Swansea Assessors (June 6) which dealt with a modestly-sized shopping center (170,000 square feet of leaseable space, of which 116,000 feet was in two anchor stores). For Fiscal Year 1999, the ATB chose a 12% cap rate and an 11.5% rate for 2000 and 2001. Aside from the cap rate, the decision was not particularly instructive but it is helpful to know that the ATB allowed a 5% vacancy rate for the anchor stores, a 20% to 25% vacancy rate for the smaller stores, a 6% management fee and a 3% reserve for replacements. In addition, although $8 Million was the consideration recited in the deed, the ATB concluded that this number was essentially the result of an "allocation" since the shopping center in question waspart of a "bundled sale" which included a number of properties. The bottom line was that the ATB concluded the shopping center (defined by the owner's own expert as "third rate") was overvalued by a total of about $3 Million for the three years in question.

    ON HIGHER AUTHORITY

    The Appeals Court dealt a setback to assessors in their efforts to bring more college-owned property onto the tax rolls. The case in point was Bay Path College v. Longmeadow Assessors (57 Mass. App. Ct. 807), for which the ATB decision was reported in the 2002 Update. At issue was the dwelling used as the home for Bay Path's athletic director. This house was part of what Bay Path called the "South Campus" which was separate and distinct from the "Main Campus" and about one-third of a mile away.

    The assessors denied an exemption on the grounds that the house was not "contiguous to or part of the principal location" of Bay Path as required by Chapter 59, Section 5, Clause 3(e) in order to qualify for relief. Bay Path argued that the South Campus was essential to the functioning of the college and was only a "pleasant walk" from the Main Campus, close enough to bring it within the exemption. The Appeals Court first found that providing housing to faculty was in furtherance of the charitable purpose of Bay Path and therefore met the primary qualification for a charitable exemption. As for the requirement that the athletic director's house be contiguous to the "principal location," the Appeals Court opined that the "principal location of an educational institution may consist of parcels that do not necessarily abut but are clustered in sufficient proximity so that, from a bird's-eye view, they present a coherent whole." The South Campus and the Main Campus, the Appeals Court concluded, were close enough to form a "coherent whole" from this newly-prescribed "bird's-eye view." The Appeals Court therefore upheld the ATB's decision in favor of the college. (In the interest of full disclosure, your editor and associate editor represented the Longmeadow Assessors in this losing effort.)




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