Home | State Tax Profiles | Tax Calendar | Locations | Client Connect Login

Capitalization of Expenses Not Assessable

by Kevin Kamfar, Irvine, September 2020

 

A ruling by the California First District Court of Appeal acknowledges that net book value and fair market value are different concepts for property tax purposes.

 

The decision serves as a warning for taxpayers with excludable costs on their balance sheets to carefully consider what they report on their business personal property tax return.

 

The Case

 

Church v. San Mateo County Assessment Appeal Board involved the assessment of manufacturing and storage equipment purchased by the biotechnology firm, Genentech, Inc. The equipment included bioreactors, fermenters, centrifuges, autoclaves, and chromatography columns, all used in the production of medicine.

 

In addition to the purchase price of its machinery and equipment (M&E), Genentech recorded in its general ledger additional equipment costs (as distinguished from production costs) that were charged as expenses over the life of the equipment including:

 

  • Capitalized interest recorded under Financial Accounting Standards Board (FASB)1, as if Genentech had financed the various acquisitions with a loan.

  • Debugging costs that were incurred after the installation of the equipment to evaluate and monitor its operation.

  • Professional and engineering costs incurred after installation to adjust and test the equipment.

Whether these additional costs should be included in determining the value of Genentech’s M&E for property tax purposes was the subject of the litigation.

 

Fair Market Value

 

Since Genentech assembled individual pieces of equipment into a larger production line, the assessor believed they should be considered “self-constructed” property and additional capitalized costs should be included in the assessed value.

 

However, the court concluded that Genentech’s equipment was purchased in a finished state so the capitalized interest, debugging costs, and capitalized labor recorded in the accounting ledger were not necessary to bring the equipment to a finished state. Therefore, the cost should be excluded in determining fair market value.

 

Consequences of the Court’s Decision

 

Because of the clarity to this case, taxpayers must take heed to look closely at all of the costs that they capitalize into their fixed assets. When booking equipment, try to break out all capitalized interest, debugging, or start-up costs, as well capitalized labor.

 

By doing so, costs can be adequately isolated so they are fully excluded in the property tax reporting process. This case allows for a clearer path to accurate reporting so that only taxable tangible personal property is assessed.