The following blog is a bit longer than other blog entries. The reason for that is that I was heavily involved as co-counsel in the litigation described below and know this case very well.
While some judicial tax opinions can be dry, the latest opinion issued by the Supreme Court of Virginia is for a tax dispute that has been ongoing for many years and is factually fascinating. The case of International Paper Company v. County of Isle of Wight started in 2012 with the County’s valuation of International Paper’s machinery and tools. Before the County’s method of valuation is described, it is helpful to know what International Paper does in the County. Since the late 1800s, a paper mill (the Franklin Mill) has operated in Isle of Wight County. Over time, the Franklin Mill has had various owners and is presently owned by International Paper. The machinery in the mill does not date back to the 1800s, but it certainly has machines that date to the 1960s and before. The Franklin Mill has survived flooding due to hurricanes but it could not survive the change in paper demand about 10 years ago. In approximately 2010, the Franklin Mill was shuttered due to falling demand for paper. However two years later, the Franklin Mill was reopened at less than half capacity to produce fluff pulp. Fluff pulp is a paper product with a high degree of absorbency and is used in consumer products like diapers. Even at this reduced capacity, International Paper is a top economic business engine in Isle of Wight County. It is likely one of the biggest employers and likely one of the largest taxpayers in the County.
Back in 2012 (and previous and subsequent years), the County valued all machinery and tools used by manufacturers in manufacturing at 100% of its original total capitalized cost. In other words, a machine that has been in use since the 1960s was valued at its purchase price with no depreciation taken into account. A very apt analogy that most every Virginia resident can identify with is the personal property tax levied on automobiles. What the County was doing here was akin to valuing an automobile at its purchase price every year, never decreasing the value, and then assessing tax on it. The County tried to rationalize this treatment by saying the tax rate for machinery and tools was lower. Of course, the Virginia Constitution states very clearly that all property is to be valued at fair market value. The County was not doing this. Furthermore, the County’s own expert said that the machinery and tools were overvalued. The Court confirms this right in the opinion. “[T]he County had retained an expert who concluded that the County’s assessment of M&T property at 100% of its original capitalized cost resulted in valuations of M&T property in excess of fair market value…” International Paper won the initial refund action. Lest you think this was over, it was not as the County was already making plans to claw back International Paper’s tax refund.
Just before this case went to trial, the County Commissioner of Revenue lowered the valuation of machinery and tools from 100% to 60%. This reduction coincided with the County’s Board of Supervisors increasing the tax rate from $0.70 per $100 to $1.75 per $100 for the 2016 tax year. In 2016, the County issued refunds to all 2013-2015 machinery and tool tax taxpayers along with a letter warning them about a forthcoming scheme. For the 2016 tax year, the combination of the lower valuation percentage plus the increased rate created a neutral effect on all taxpayers and the County so refunds were not necessary.
We are now in 2017 and the genesis of the case that the Supreme Court of Virginia opined on. Remember the refunds issued in 2016 with the letter warning them about a forthcoming scheme? What happens next explains that. The County again raised the machinery and tools tax rate from $1.75 per $100 to $4.24 per $100. In conjunction with this rate increase, the County enacted a tax relief program dubbed “Economic Development Retention Grants.” These "grants" made it possible that all machinery and tools taxpayers would receive tax relief in the amount of the tax at the rate of $4.24 per $100 minus the tax that would have been charged at a rate of $1.75 per $100 and minus each taxpayer's 2016 refund. Said another way, every machinery and tools taxpayer would pay machinery and tools tax at the rate of $1.75 per $100 plus the amount of the 2016 refund they received. Isle of Wight County giveth and Isle of Wight County taketh away! The result of this scheme is that machinery and tools taxpayers paid varying effective tax rates in 2017 as some were not in existence in 2013-2015 or had differing tax liabilities from those years.
International Paper sued again alleging among other things that Isle of Wight County had violated the uniformity clause provision in the Virginia Constitution by subjecting machinery and tools taxpayers to varying effective tax rates. At the conclusion of International Paper’s case, the County filed a motion to strike International Paper’s evidence as the County asserted that International Paper had not proved a claim on which it could recover. The Circuit Court granted the motion and the Supreme Court of Virginia reversed in part saying that International Paper had presented a sufficient case that the County was in violation of the uniformity clause. The County argued that all it had to do to satisfy the uniformity requirement was apply the same nominal tax rate to all machinery and tools tax taxpayers and that the “Economic Development Retention Grants” were grants unrelated to taxation. The Court disagreed and saying in effect that you must look at the entire tax structure to see the end result and not just the nominal tax rate. Citing various examples in evidence both written and in testimony not the least of which was that the “grants” were never applied for by the recipients and they were given to every machinery and tools tax taxpayer as a credit on their machinery and tools tax bill, the Court said that the “Economic Development Retention Grants” were within the taxing structure and not outside as the County had argued. This case is now remanded back to the Circuit Court where presumably the case will resume with the County providing testimony and evidence.
As expressed above, the facts in this case are astounding and I have eliminated some for brevity sake. One could ask the very logical question of “Why did this case even go to trial?” Go back to the original case, Isle of Wight County was valuing property at 100% of its original total capitalized cost (i.e., purchase price). The very notion of that is offensive. Then when Isle of Wight County is told by its own expert that it had overvalued International Paper’s property, the County pressed on to court to defend its original assessment despite the fact that it knew the assessment was incorrect. Once their own expert advised them that the property was overvalued, they should have done their best to make the case go away by settling the dispute. This opinion and word of their subsequent scheme would have never been communicated to the masses. But the County made it worse by not only continuing with the losing Court case but also scheming to claw back the machinery and tools tax refunds from all recipients. Eventually, it may turn out that this scheme is unconstitutional as that has not been ruled upon.
Christian Tennant is a Virginia tax attorney and former employee of the Virginia Department of Taxation. Mr. Tennant regularly speaks and writes on Virginia taxation. In his private practice he advises and represents businesses and individuals on a range of tax matters.