United States: California Supreme Court Draws Bright-Line On Taxation of Intangibles

Recently, the California Supreme Court issued an important decision regarding the property tax treatment of intangible rights and assets. In Elk Hills Power, LLC v. Board of Equalization,1 the court held that the value of intangibles cannot be included when assessing taxable property. Although the decision specifically addressed the proper treatment of emissions reduction credits ("ERCs"), the holding is generally applicable to all types of intangible property. Reed Smith filed an amicus brief supporting the taxpayer in the Elk Hills case on behalf of the Institute for Professionals in Taxation.


The taxpayer, the owner and operator of an electric power plant, was required to purchase ERCs in order to operate in the local county.2 Under California law, power plants are assessed using a system called unit valuation, where the value of the power plant is captured by considering all of its component parts together, as one unit.3 The State Board of Equalization ("SBE") used two methods of unit valuation to value the power plant – the replacement cost approach and the income capitalization approach. Under the replacement cost approach, the value of the power plant was determined by estimating the cost of replacing all of the component parts of the power plant.4 Under the income capitalization approach, the value of the power plant was determined based on the present value of the income the plant was estimated to yield over its life.5

At issue in the case was whether the SBE improperly included the value of the ERCs in its assessment of the power plant. California Revenue & Taxation Code §§ 110(d) and 212(c) prohibit the direct taxation of intangible property. However, Revenue & Taxation Code § 110(e) permits an assessor to assume the presence of intangibles when valuing taxable property. Despite precedent from appellate courts6 prohibiting the inclusion of the value of intangibles when assessing taxable property, the SBE auditors argued that they were permitted to include the value of the intangibles, if those intangibles were necessary for running the business. The SBE took the position that the portion of the statute allowing the assumption of the presence of intangibles when valuing taxable property superseded the section disallowing the direct taxation of intangible property.

The California Supreme Court Decision

The California Supreme Court disagreed with the SBE's argument. Thus, it ruled that an assessor cannot include the value of intangible assets and rights when assessing taxable property. The court made clear that the portion of the statute allowing the assumption of the presence of intangibles when determining the beneficial or productive use of a property7 does not mean that an assessor can include the actual value of the intangible assets in the valuation.8 Rather, assuming the presence of intangibles allows the value of taxable property to be enhanced from scrap value to fair market value when assessors assume the presence of necessary intangibles.9 Under the record before it, the court determined that the SBE improperly included the value of the ERCs under the replacement cost approach, and that the SBE did nothing more than assume the presence of the ERCs under the income capitalization approach.

The court muddied the waters a bit in its discussion of the income capitalization approach by distinguishing between intangible rights that indirectly contribute to the income stream as properly assumed when assessing taxable property, versus those that make a direct contribution to the income stream. In the case of the latter type of intangible rights, the quantifiable market value of the intangible must be deducted from the value of the capitalized income stream prior to taxation. The distinction appears to be a matter of whether the record sufficiently demonstrates that a quantifiable intangible value was used when making the assessment. In this case, the court determined that there was no indication that the SBE valued ERCs in a manner other than assuming their presence.10 The court did not make this distinction under the replacement cost method.

Implications for Other Taxpayers

The Elk Hills decision is a win for taxpayers. California's highest court drew a bright line and held that assessors cannot include the value of intangibles when assessing taxable property. Going forward, taxpayers should examine their property tax assessments and identify any intangibles associated with the property that should have been excluded from the valuation. If the SBE uses a replacement cost approach to value taxable property used in a business, taxpayers should challenge any assessment that includes the value of any intangible property used as part of the business. In contrast, if the SBE uses an income capitalization approach, taxpayers should challenge any assessment that includes income from intangibles in the income stream that is capitalized to produce the assessed value.


1.California Supreme Court, Docket No. S194121 (August 12, 2013).

2.Under the California Clean Air Act of 1988 (Stats. 1988, ch. 1568, p. 5634), local districts are required to "achieve and maintain the state and federal ambient air quality standards" (Health & Saf. Code, § 40001(a)). To enforce this mandate, the district requires new pollution sources to purchase ERCs to offset future emissions. Companies can sell or retain ERCs for future use. As such, they are intangible property rights.

3.ITT World Communications, Inc. v. City and County of San Francisco, 37 Cal. 3d 859, 863-64 (1985).

4.Cal. Code Regs., tit 18, § 6.

5.Cal. Code Regs., tit 18, § 8.

6.E.g., Roehm v. County of Orange, 32 Cal. 2d 280 (1948); Michael Todd Co. v. County of Los Angeles, 57 Cal. 2d 684 (1962); Service America Corp. v. County of San Diego, 15 Cal. App. 4th 1232 (1993); Shubat v. Cutter County Assessment Appeals Bd. No. 1, 13 Cal. App. 4th 524 (1993); County of Los Angeles v. County of Los Angeles Assessment Appeals Bd. No. 1, 13 Cal. App. 4th 102 (1993); GTE Sprint Comm. Corp. v. County of Alameda, 26 Cal. App. 4th 992 (1994).

7.Cal. Rev. & Tax. Code § 110(e).

8.Cal. Rev. & Tax. Code §§ 110(d), 212(c).

9.Opinion at p. 19.

10.Opinion at p. 27.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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