California’s Fourth Appellate District ruled that taxpayers must include the value of intangible emissions reduction credits (ERCs) when they determine the fair market value of an independent power plant’s property. Elk Hills Power, LLC v. Bd. of Equalization, No. D056943 (May 10, 2011). Elk Hills sets a disturbing precedent regarding the taxation of intangibles under California’s property tax laws, and could be applied to other industries that use emissions reduction credits. 

California subjects real and tangible personal property to property tax. The value of intangible assets related to a “going concern” value of a business generally do not enhance the value of the business’s taxable property. However, under California Revenue and Taxation Code § 110(e), assessors may assume “the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use” when assessing and valuing taxable property. The appellate court reasoned that because the ERCs are necessary to operate the power plant and “to make energy and money,” the assessor could include their value in the assessment. Interestingly, the trial court had also held that the ERCs were taxable, albeit on different grounds—the trial court found that under § 110(f), the ERCs were “intangible attributes of real property,” such as “zoning location, and other attributes that relate directly to the real property involved” that must be “reflected in the value of the property.”

Ironically, California intended § 110(d) (enacted in 1995 as SB 657) to clarify the constitutional prohibition against the taxation of intangibles. The Elk Hills decision thus seriously undermines this prohibition and could open the door to taxing energy credits—which are likely to become more common—as property in the future. For example, the California Air Resources Board is in the process of implementing the California Global Warming Solutions Act, which will rely heavily on a program that allows high-polluting industries to purchase and trade emissions offsets in lieu of directly meeting the requirements of strict climate change regulations. Including the value of such offsets in the property tax base will substantially change the manner in which such property is taxed.