The IntangiblesMerry-Go-Round

Ruben Miranda, ASA919 Congress Ave, Suite 1450Austin, TX, 78701ruben.miranda@duffandphelps.com512-671-5555

46th Annual Taxation ConferenceAPPRAISAL for AD VALOREM

TAXATIONof Communications, Energy and Transportation Properties

July 24 – 28, 2016

Breann Robowski, Esq. 2550 Hanover StreetPalo Alto, CA, 94304breann.robowski@pillsburylaw.com650-233-4874

Topics to be Covered

• Property Tax Treatment of Intangibles

• The Basics: Identify, Separate & Value

• Tips & Tricks from a Property Tax Attorney

• Financial Impact of Intangibles

• Examples: Energy & Airline Industry Contracts

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Property Tax Treatment of Intangibles

(using California as an example)

• Intangible assets and rights are not assessable (R&TC § 212)

• BUT, tangible property to be valued assuming presence of intangibles necessary to put tangible property to beneficial or productive use (R&TC § 110(e))

• Caveat: Intangible attributes are assessable (R&TC § 110(f))

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Overarching Approach

1. Identify

2. Separate

3. Value

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What is an Intangible?

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It is not this.

Common Examples

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CA Assessors’ Handbook § 502 at 154

When are intangibles involved?

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V.

When are intangibles involved?

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Three Approaches to ValuePros Cons Caution

Income • Availability of information

• Sensitive to inputs• Removal of

intangiblesincome/value

• Must allow for return of and on investment

Comp.Sales

• Best evidence of FMV

• Allocation upon transfer may not ≠ FMV

• Purchase price often includes intangibles

Cost • Universally applicable

• No intangibles

• Depreciation • Not often used by

investors

• FMV v. Value in use

• RCNLD ≠ Value cap

Value Separately

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How are intangibles valued?

• Cost Approach– depreciated replacement or reproduction cost,

creation or re-creation cost, one-time cost savings or avoidance

• Comparative Sales Approach – comparable sales may be limited

• Income Approach– useful for assets with an identifiable income stream

• Residual Method 10

The Big Controversy

•Rushmore Method – Theory: value of intangible assets can be

removed by deducting the related expense

– Criticism: neglects return on investment

– Party Lines:•For: California Assessors’ Association

•Against: most taxpayers & the State Board of Equalization’s Assessors’ Handbook § 502

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SHC Half Moon Bay v. County of San Mateo

(226 Cal. App. 4th471 (2014))

• Assessor’s Rushmore Method:1. Derive stabilized income stream for hotel

2. Estimate hotel’s stabilized occupancy rate

3. Reduce projected income by fixed expenses*** including franchise & management fees***

4. Deduct for reserves & taxes to arrive at net projected income

5. Apply capitalization rate to arrive at FMV

6. Allocate FMV between personal & real property

• Upheld for purposes of goodwill only 12

Tips & Tricks from a Property Tax Attorney

• Valuations and allocations made outside the property tax arena may not reflect fair market value.

• Not all intangible assets appear on the books.

• Attacking the other parties’ valuation is not sufficient.

• Keep it simple.

• Definitions are important.

• Separate valuation is also important.

• The fewer the adjustments the better.

• Don’t forget to consider the impact of contractual or legal limitations on the intangibles’ value.

• Beware of % rents.

• Reconciliation of value approaches is vital.13

Financial Impact of Intangibles

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15

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$35$35

FreeFree

How many $35

Pokémon Go Plusdevices would

Nintendo have to sell to double its stock price?

Pokémon Go Plus

Pokémon Go app

17How many blades would justify a $1B sale price?

“The company is guiding that it would hit revenues of more than $200m in 2016. Although it is not currently profitable, [CEO] Dubin told a conference in May he

expected the company could be in profit by the year-end.”https://next.ft.com/content/bd07237e-4e45-11e6-8172-e39ecd3b86fc

• Can be capitalized or off-balance sheet– Coca-Cola, Southwest brands aren’t on the books

– Just because it’s not on the books doesn’t mean it doesn’t have value

Most Common Types of Intangible Property I See

• Intellectual Property– Brands

– Trademarks

– Copyrights

– Software

– Patents

• Contracts– Customer

– Licenses & Franchises

– Many more• Supplier, Employer,

Ownership, Insurance, Real Estate, etc.

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Treatment of Intangibles for Financial Reporting

• Valuation of intangibles for financial reporting purposes governed by:– FASB Statement No. 141R ASC 805, Business Combinations – FASB Statement No. 142 ASC 350, Intangibles—Goodwill and Other – FASB Statement No. 144 ASC 360, Property, Plant, and Equipment – FASB Statement No. 157 ASC 820, Fair Value Measurement

• ASC 805 continues the guidance set forth in prior U.S. GAAP where identifiable assets are recognized if they are contractual, arise from legal rights, or if they are separable and can be separated and sold, rented, or leased (ASC 805-20-25-10, IFRS 3R Appendix A, and B31).

• An intangible asset should be separately recognized even if the asset is subject to transfer restrictions or the contract is subject to a cancellation option.

• An asset may also meet the separable criteria if it cannot be sold, licensed or exchanged individually, but could be when combined with a related contract, asset or liability (ASC 805-20-55-120 5).

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Example #1: Contracts in Energy Industry

Gathering & Transport Contracts

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Exploration & Production

(“E&P”)

Midstream

Product + Deficiency Payments

Guaranteed Throughput

Comparing OPEC Forecasts

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2010

2013

2015

2013 Forecast

2015 Forecast

$60

$80

$100

$120

$140

$160

$180

2015 2025 2035

$/b

arre

l

Pricing Forecasts:

U.S. & Canada Supply Forecasts:

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Midstream Concern

• Today? E&Ps are going bankrupt from precipitous global Gas and Oil Price Drops due to oversupplies in production

• Recently Gathering & Transport Contracts w/Midstream Providers are viewed by E&Ps as potential commitments to shed to free up cash in bankruptcy

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• Bankruptcy judge approved rejection of Nordheim contract in May 2016

• Meanwhile, Sabine expected to break even on investment in 6 months, saving $200K/month

Sabine Bankruptcy

• Sabine filed July 2015

• Existing contract with Nordheim deemed too costly

• Entered into new contract with DCP to build replacement pipeline facilities

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Sabine

Nordheim

DCP

Winners & Losers• If Gathering & Transport Contracts can be broken,

Midstream is like any other debtor in bankruptcy; recovery of pennies on dollar or less likely

• If Gathering & Transport Contracts cannot be broken, E&P bankruptcies carry heavy burden to pay the contract fees, allowing less liquidity for other debtor payments

• Shockwaves continue to reverberate– Between January 2015 and June 2016, over 70 oilfield

service providers have filed for bankruptcy in North Americahttp://www.haynesboone.com/~/media/files/attorney%20publications/2016/ofstracker.ashx

– “The Alerian MLP Index, made up of nearly 50 pipeline partnerships once favored by investors for their high payouts and dependable, long-term shipping contracts, has plunged 40% in the past year.”http://www.bloomberg.com/news/articles/2016-03-08/sabine-oil-can-break-midstream-contracts-bankruptcy-judge-says 24

Key Questions for Intangible Consideration

• Do deficiency payments constitute intangible-related revenue to the midstream provider?

• What happens in the absence of a contract? Where transactions are tied to market rent?– The present value of an asset utilized at market rates,

capitalized over its useful life, would be much smaller than the present value of the contract in place now

– The contract provides a marketplace advantage

– What’s the difference in value?

– That’s a lot of $35 Pokémon Go Plus devices...

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Example #2:Contracts in Airline Industry

•Alliance Agreements (Star Alliance, SkyTeam, oneworld)

•Marketing Agreements (Credit cards)

•Other Partner Agreements (Hotel, Rental Car, Merchandise, Tour Guide Packages, Trip Insurance)

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• CC’s purchase miles from carrier

• Enrollees receive miles from CC’s for purchases which can be redeemed for future travel on that carrier

• For financial reporting, carriers have to split the CC revenue into 2 types: a portion for “transportation fulfillment” and a portion called “marketing.”(It’s not all free money, just most of it)

• For a fee, credit card issuers (CC) receive rights to market branded airline credit cards to the airline customers (at home, online, at the airport, in the sky, etc.) and loyalty program mileage credits

Marketing Agreements

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American Airlines

• Agreement with Citi and Barclay Card announced July 12, 2016

– Citi to offer its credit cards to new customers on American Airlines’ website and mobile apps, through direct mail and in Admirals Club lounges

– Barclaycard will be permitted to reach customers in airports and during American flights

• After revenue for the transportation component is accounted for, the remaining marketing portion of the agreements are estimated to add $1.55 billion in pretax income over the next three years ($200 MM in 2016, $550 MM in 2017, and $800 MM in 2018)

28http://www.advisorperspectives.com/commentaries/20160716-u-s-global-investors-is-this-the-airlines-liftoff-investors-have-been-waiting-for

Key Questions for Intangible Consideration, Take 2

• Do marketing-related payments constitute intangible-related revenue to the carrier?

• What happens in the absence of a contract? Where transactions are tied to market rent?– The present value of an asset utilized at market rates,

capitalized over its useful life, would be much smaller than the present value of the agreements in place now

– The contract provides a marketplace advantage

– What’s the difference in value?

– How many $1 blades is that?

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Breann Robowski, Esq. 2550 Hanover StreetPalo Alto, CA, 94304breann.robowski@pillsburylaw.com650-233-4874

Ruben Miranda, ASA919 Congress Ave, Suite 1450Austin, TX, 78701ruben.miranda@duffandphelps.com512-671-5555