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California Court of Appeals Rules on
Valuation of Intangibles

by Scott Donald, Irvine, June 2014

 

Assessing the value of hotels for property taxes can be a complex endeavor due to the intangible assets in place, which are tax exempt. The California Court of Appeals recently ruled in favor of a hotel owner in SHC Half Moon Bay LLC v. San Mateo County who claimed the property's intangible assets were not properly backed out of the assessment.

 

It's interesting to note that a very similar case involving another hotel property (EHP Glendale LLC v. County of Los Angeles) was tried and lost at the appellate level. One of the key differences was that the legality of the methodology to assess intangible assets was tried in SCH Half Moon Bay. In EHP Glendale, the case revolved around a refund claim for over assessment, which was backed up by the methodology.

 

The Arguments in SHC Half Moon Bay

 

The owners of SHC Half Moon Bay argued that their 2004 base year value was inflated due to the inclusion of intangible assets worth $16,850,000, including:

 

1. The hotel’s workforce

2. The leasehold interest in the employee parking lot, and

3. The hotel’s agreement with the golf course operator

 

The county's position was that since management and franchise fees were deducted from the income stream, the assessment excluded the majority of value attributable to intangibles.

 

More than a Deduction

 

In ruling in favor of SHC and against the County, the judges referenced the California Assessor's Handbook, which states:

 

“The value of intangible assets and rights cannot be removed by merely deducting the related expenses from the income stream to be capitalized. Allowing a deduction for the associated expense does not allow for a return on the capital expenditure. For example, allowing the deduction of wages paid to a skilled work force does not remove the value of the work force in place from the income indicator, because the amount of the wages paid does not necessarily represent a return of and on the work force in place, and further bears no relationship to the costs associated with locating, interviewing, training and otherwise acquiring the work force. Similarly, the deduction of a management fee from the income stream of a hotel does not recognize or remove the value attributable to the business enterprise that operates the hotel.”

 

The court ruled the method used by the Assessor and approved by the Board to calculate the value of the property violated the standards prescribed by law because it failed to identify, value, and remove the value of all intangible assets from the hotel’s income stream prior to taxation.

 

Supreme Court Weighs In

 

Last year, the California Supreme Court clarified that intangible assets have “a quantifiable fair market value that must be deducted from an income stream analysis prior to taxation.”

 

As the high court explained in Elk Hills Power LLC v. Board of Equalization intangible assets like the goodwill of a business, customer base, and favorable franchise terms or operating contracts all make a direct contribution to the going concern value of the business and must be accounted for.