Appeals from the Order of the Board of Finance and Revenue in the cases of In Re: Bessemer and Lake Erie Railroad Company, Docket Nos. R-23193, R-124, R-125, C-817, R-126, R-127, C-38500, R-941, R-3043, R-3045 and R-3047.
David McNeil Olds, with him Carl F. Chronister, Edward T. Baker and Donald J. Harrell, Reed, Smith, Shaw & McClay, for petitioner.
Eugene J. Anastasio, Deputy Attorney General, for respondent.
President Judge Crumlish and Judges Mencer, Rogers, MacPhail and Palladino. Judges Wilkinson, Jr., Blatt, Craig and Williams, Jr. did not participate. President Judge Crumlish and Judges Wilkinson, Jr., Rogers, Blatt, Craig, Williams, Jr. and Palladino. Judges Mencer and MacPhail did not participate. Opinion by Judge Craig.
[ 57 Pa. Commw. Page 342]
Bessemer and Lake Erie Railroad Company (B&LE) has appealed from orders of the Board of Finance and Revenue fixing the value of B&LE's capital stock for Pennsylvania capital stock tax purposes for each of the years 1965 through 1974. The board affirmed, and refused resettlement of, the valuations of the Department of Revenue with the exception of the year 1971, where the board reduced the departmental valuation by $5 million to $70 million. The values thus developed are listed in Table D below.
Governed by Section 1104 of The Fiscal Code*fn1 (having antedated Pa. R.A.P. 1571), our evidentiary hearings produced a stipulation of the facts in part, which the court hearby adopts as Finding No. 1, and additional evidence, from which we will make findings necessary to our decision in the course of this opinion.
1. What is the correct valuation of B&LE's capital stock for capital stock tax purposes for each of the years 1965 through 1974, in accordance with Section 21 of the Act of June 1, 1889, P.L. 420, as amended, repealed by the Act of March 4, 1971, P.L. 92, effective immediately, formerly 72 P.S. § 1871, for the years through 1970 and Section 602 of the Tax Reform Code, Act of March 4, 1971, P.L. 6, as amended, 72 P.S. § 7602, for the later years?
[ 57 Pa. Commw. Page 3432]
. Is the matter of the Commonwealth's timeliness, in accord with Section 801(b) of The Fiscal Code, 72 P.S. § 801(b), in making settlement of the 1967 capital stock tax properly before us and, if so, was that settlement untimely so that the valuation returned by B&LE must be accepted for that year?
Although two statutes govern valuation here, the enumerated criteria to be considered are identical and require this court to determine the
actual value [of the capital stock] in cash . . . ; taking into consideration, first, the average which said stock sold for during the year; and second, the price or value indicated or measured by net earnings or by the amount of profit made and either declared in dividends, expended in betterments, or carried into the surplus or sinking fund; and third, the actual value indicated or measured by consideration of the intrinsic value of its tangible property and assets, and of the value of its good will and franchises and privileges, as indicated by the material results of their exercise, taking also into consideration the amount of its indebtedness.*fn2
These factors must be analyzed by us de novo in the light of the particular situation of each case. Rest Haven-Chestnut Hill, Inc. v. Commonwealth, 35 Pa. Commonwealth Ct. 115, 385 A.2d 609 (1978); Chrysel Corp. v. Commonwealth, 6 Pa. Commonwealth Ct. 368, 295 A.2d 624 (1972). Because no trading in B&LE's stock occurred in any of the years in question, the first criterion is inapplicable here; thus the court can consider only the latter approaches.
[ 57 Pa. Commw. Page 344]
The determination of a property's value from the income it produces requires judgment as to the nature of that relationship and ultimately as to its mathematic representation.
Thus the first subordinate question to be resolved, and as to which the parties are in dispute, is what capitalization rate should be applied to B&LE's income data so that the indicated value is a legitimate measure of actual value in cash.
The Commonwealth contends that the rates it employed -- with respect to earnings, 10%; with respect to dividends, 8% -- are appropriate. However, in support of that proposition, the Commonwealth has offered virtually no evidence other than to present its tradition of using those rates, and conclusory testimony to the effect that its proffered ultimate values are "fair" and are "supported" by capitalization using those rates.
As precedents on the issue, the Commonwealth points us to Commonwealth v. Rosenbloom Finance Corporation, 91 Dauph. 359 (1969), and to O'Connor Appeal, 452 Pa. 287, 304 A.2d 694 (1973).
In Rosenbloom, the Dauphin County court, as this court's predecessor, remarked in a footnote at 91 Dauph. 362, that "[e]arnings are customarily capitalized at 10%, and dividends at 8%." We cannot read that language to bless those rates because capitalization rates were not disputed in that case; the issue there was the taxpayer's argument for more emphasis on the indicated results of capitalization and less on the intrinsic value of its assets, 98% of which were stocks and securities listed on national exchanges, making their values readily obtainable.
In O'Connor, the Supreme Court wrote, 452 Pa. at 295, 304 A.2d at 700, that "[t]he capitalization ratio [rate] used instantly was ten [10%] which we feel is within the range of reason." The footnote which accompanies
[ 57 Pa. Commw. Page 345]
that decision makes clear that the court found that rate reasonable because testimony as to the earnings/price ratio of a comparable store supported it and not because of any custom or tradition. That same footnote undermines the Commonwealth's argument that its custom has received the Supreme Court's imprimatur, in that the court refers with some reliance to a treatise on corporate financing propounding that very few businesses would be found for which a capitalization rate of 10% would be appropriate, and that the great number of older successful industrial businesses would more appropriately be valued by capitalizing earnings at 12.5%.
That the courts in those cases articulated and accepted the same rates as the Commonwealth now submits is thus not conclusive; we find those passing references to stand more clearly for the proposition that such rates are not immutable, but must be justified in a given case by economic realities if they are to be used fairly to indicate actual values.*fn3
In contrast to the Commonwealth, B&LE has offered persuasive and voluminous evidence that those rates are inappropriate. Its experts, particularly Mr. Schoenwald, explicated in detail the analyses they undertook to derive capitalization rates which are appropriate, in their judgment, in view of the realities of B&LE's position in relation to the railroad industry and the economy as a whole.
Those analyses incorporated several approaches to the question, including study of earnings/price ratios for the railroad industry (giving consideration to the comparability of different railroads to the B&LE),
[ 57 Pa. Commw. Page 346]
study of average earnings/price ratios for industrial businesses generally, and attention to the relative costs of debt financing within the railroad industry and the broader capital market. The testimony indicated that such approaches were essential to determining appropriate rates especially because of the declining attractiveness of railroads as investment opportunities and the resultant capital formation problems of B&LE and the industry as a whole. We agree that those approaches are useful because "each company must be viewed in its particular circumstances." Rosenbloom, supra, 91 Dauph. at 362.
We place little weight on the testimony of B&LE's tax officer on this question because it lacked the substantiation of the expert analyses and in some instances used capitalization rates which B&LE's experts, in similar contexts, themselves found unreasonable.
B&LE's experts, other than Mr. Schoenwald, focused their appraisals on only a few years, and derived their indicated rates from narrower data bases. Based on the comprehensive approach employed by Mr. Schoenwald and its greater attention to the myriad of factors which affect the relationship of income and value, we conclude that the ultimate rates propounded by Mr. Schoenwald, as set forth in Table A, are appropriate to use in this analysis with respect to earnings, and we adopt Table A as Finding No. 2.
[ 57 Pa. Commw. Page 347]
One point remains to be resolved on this question. Because a business is unlikely to distribute all of its earnings as dividends, dividends generally represent a relatively smaller proportion of the underlying value than earnings do. Therefore, applying the same capitalization rate to earnings and dividends would be clearly inappropriate, because the relationship the rate is to represent is not identical. The Commonwealth recognized the point, at least insofar as it employed the rates of 10% as to earnings and 8% as to dividends.
However, because B&LE and its experts have argued strenuously that B&LE's dividends are too erratic to be a valid indicator of value and should therefore be ignored, they have not addressed the question of the appropriate rates to be applied to B&LE's dividends. Nor has the Commonwealth addressed this question other than by implication from its proffered rates.
Because the statutes require us to consider dividends, and we believe their capitalization to be a legitimate consideration, we adopt for dividends a capitalization rate which recognizes that dividends usually constitute a base smaller than earnings; our approach takes heed of the only evidence on the point, namely the proportionate difference in the Commonwealth's rates. We also conclude that five-year average dividends, when available, should be used in preference to current yearly dividends, to minimize the effect of irregularities in the payment of dividends.
Accordingly, we have determined the following rates to be appropriate in our consideration of dividends as indicators of value, so that the following Table B comprises our Finding No. 3.
[ 57 Pa. Commw. Page 348]