A Tennessee taxpayer got a rude awakening when a state court ruled it was liable for ad valorem tax on its leasehold interest in tax exempt property despite having an agreement with local governments to make a payment in lieu of taxes. Creative Label, Inc. v. Tuck, 2011 Tenn. App. LEXIS 238 (May 11, 2011). The taxpayer, Creative Label, operated a manufacturing and warehousing facility that it leased from a local industrial development board. The lease called for annual payments of $1 for a term of 99 years. The taxpayer entered into  payment in lieu of taxes (PILOT) agreements with the county and city in which the facility is located. The court addressed whether PILOTs discharge a lessee’s total liability for ad valorem taxes on its leasehold interest or whether PILOTs only reduce the lessee’s total tax liability by an amount equal to the PILOT amounts.

The court examined the legislative history of the operative Tennessee statutes and noted that the law during the years at issue, 1993 to 1998, was ambiguous with respect to whether PILOTs completely relieve holders of leasehold interests from ad valorem taxation. Finding no clear legislative intent to provide a blanket ad valorem tax exemption for leasehold interests in property owned by industrial development corporations, and relying on the premise that courts are not to imply tax exemptions, the court held that PILOTs reduce the taxable value of a leasehold interest in tax-exempt property but do not discharge a taxpayer’s total ad valorem tax liability.

Thus, before entering into PILOT agreements, taxpayers with leasehold interests in tax-exempt property should be careful to review all relevant ad valorem tax laws and consider whether PILOTs will actually relieve all of their ad valorem tax liability.