Freestate Elec. Coop., Inc. v. Kan. Dep't of Revenue

555 P.3d 220

FREESTATE ELECTRIC COOPERATIVE, INC. et al., Appellees,

v.KANSAS DEPARTMENT OF REVENUE, DIVISION OF PROPERTY VALUATION, Appellant.

No. 126,642

Supreme Court of Kansas.

Oral Argument Held May 10, 2024

Opinion Filed August 30, 2024

Appeal from Shawnee District Court; Teresa L. Watson, judge.

Ted E. Smith, chief counsel, Legal Services Bureau, Kansas Department of Revenue, argued the cause and was on the brief for appellant.

Greg L. Musil, of Rouse Frets White Goss Gentile Rhodes, P.C., of Leawood, argued the cause, and Chris M. Mattix and James T. Schmidt, of the same firm, were with him on the brief for appellees.

The opinion of the court was delivered by Biles, J.:

Eight rural electric cooperatives sought judicial review after the Board of Tax Appeals administratively denied their property valuation challenges for the 2019 and 2020 tax years. They elected to go to district court for a trial de novo under K.S.A. 2023 Supp. 74-2426(c)(4)(B) (review specifies "an evidentiary hearing at which issues of law and fact shall be determined anew"). The court agreed with the cooperatives, concluding the valuation methodology used by the Department of Revenue’s Property Valuation Division violated K.S.A. 79-5a04 (requiring "generally accepted appraisal procedures" when valuing public utilities). On appeal, PVD argues the district court exceeded its scope of review because the statutory compliance question was not litigated first with BOTA. See K.S.A. 77-617 (limiting judicial review of issues arising from administrative agency action). We agree with PVD and reverse the district court judgment.

[1] A trial de novo under K.S.A. 2023 Supp. 74-2426(c)(4)(B) does not enlarge a district court’s scope of judicial review beyond what is permitted by K.S.A. 77-617. This means the issue must have been raised with BOTA unless an exception applies. In re Tax Appeal of Panhandle Eastern Pipe Line Co., 272 Kan. 1211, 1235, 39 P.3d 21 (2002) ("In an appeal from an administrative agency decision, one is limited to the issues raised at the administrative hearing."). And if there is disagreement about the issues raised, the agency record controls. See Sierra Club v. Mosier, 305 Kan. 1090, 1123-24, 391 P.3d 667 (2017) ("The entire concept of judicial review contemplates that an agency must have had an adequate opportunity to consider the merits of an issue."); Kingsley v. Kansas Dept. of Revenue, 288 Kan. 390, 411-42, 204 P.3d 562 (2009) ("[A] district court may only review those issues litigated at the administrative level.").

Here, the record confirms BOTA explicitly and correctly identified the only issue before it was whether "PVD’s income approach valuation methodology violates Article 11, § 1 of the Kansas Constitution as it results in non-uniform and unequal valuations of RECs statewide." (Emphasis added.) We hold the district court exceeded its scope of review by deciding PVD’s methodology violated K.S.A. 79-5a04.

Factual and Procedural Background

Rural electric cooperatives ("RECs") are nonprofit cooperative corporations that distribute electricity within their respective service areas to retail consumers, who are their member-owners. They procure electricity from Kansas Electric Power Cooperative, Inc. ("KEPCo"), also a nonprofit cooperative corporation. KEPCo comprises 18 Kansas RECs, including the eight bringing this litigation: The Ark Valley Electric Cooperative Association, Inc., The Butler Rural Electric Cooperative Association, Inc., Heartland Rural Electric Cooperative, Inc., Sumner-Cowley Electric Cooperative, Inc., The Victory Electric Cooperative Association, Inc., The Sedgwick County Electric Cooperative Association, Inc., Twin Valley Electric Cooperative, Inc., and FreeState Electric Cooperative, Inc.

Since RECs are nonprofit entities, they do not generate profits; instead, they operate on margins (the amount of income exceeding operational expenses). KEPCo invoices each REC monthly. The REC, in turn, charges its members a rate to cover its expense for acquiring electricity and providing capital for future operations.

KEPCo’s monthly invoice to each REC includes an item called the margin stabilization adjustment ("MSA"), which lies at the heart of this property tax controversy, MSA serves as a budgeting tool allowing KEPCo to increase (through an invoice surcharge) or decrease (through an invoice credit) the amount KEPCo collects monthly from each REC based on the difference between actual and estimated power costs. Since MSA began in 2011, KEPCo has issued an MSA credit on all but one monthly invoice.

When KEPCo provides an MSA credit, each REC decides if and how to pass the credit along to its members, the retail consumers. There are three options: (1) issue a credit to a member’s monthly bill, (2) issue a single lump-sum credit annually, or (3) retain the credit by allocating it to each member’s equity account, a/k/a " ‘patronage capital’ or ‘member capital.’ " The first and second options reduce an REC’s income, but the third does not. The eight RECs here elected the third option during the 2019 and 2020 tax years—triggering this fight over the effect on their property tax bills.

During the 2019 and 2020 tax years, PVD calculated fair market value using an income approach, which translates projected future operating income for each REC into a present value estimate. See K.S.A. 79-5a04 (requiring PVD determine public utility property’s fair market value by "us[ing] generally accepted appraisal procedures"). Future operating income is projected from the RECs’ current net operating income ("NOI")—"the actual or anticipated income that remains after all operating expenses are deducted from effective gross income." In other words, the RECs’ election on MSA credits impacts its NOI, which affects valuation and therefore taxes. A higher NOI results in a higher property valuation and higher taxes. This means PVD’s chosen methodology treats our eight RECs electing the third option differently because only the first and second options reduce the RECs’ income.

Proceedings before BOTA

The eight RECs individually appealed their property valuations to BOTA complaining PVD treated the third option differently from the others. See K.S.A. 74-2438 (authorizing administrative appeals). Each filed a "Division of Property Valuation Appeal" with BOTA using a similar format as the one by Ark Valley, which identified as the "basis" for the appeal:

"All cooperatives should be valued on a uniform and equal basis. Depending on the treatment of the MSA, the NOIs of two hypothetically identical cooperatives are different depending on whether they pass through the MSA in their [equity capital account/patronage capital account] or retain it. Therefore, PVD’s income approach to value results in differing values for these identical co-ops. We believe this violates the uniform and equal standard and an adjustment should be made to the NOI to reflect the retained MSA." (Emphases added.)

BOTA conducted a two-day evidentiary hearing. In its decision favoring PVD, BOTA described the RECs’ claim:

"The RECs assert PVD’s income approach valuation methodology violates Article 11, § 1 of the Kansas Constitution as it results in non-uniform and unequal valuations of RECs statewide. PVD responds that it has used a uniform and equal basis of valuation for all Kansas RECs and, therefore, its assigned valuations should be sustained.

….

"The RECs accepted PVD’s valuation methodology, except for their claim that PVD should change its treatment of the MSA credits. The RECs contend that their independent accounting decisions to retain or not retain the MSA credits, when combined with PVD’s valuation methodology, result in non-uniform and unequal valuation determinations among RECs and arbitrarily inflates the purported value of the subject RECs for property tax purposes. The RECs request the Board remedy this inequity by ordering PVD to decrease the NOI of the subject RECs by subtracting the amount of MSA credits." (Emphases added.)

BOTA then analyzed in detail whether PVD’s valuation methodology violated article 11, section 1 of the Kansas Constitution’s mandate that "the legislature shall provide for a uniform and equal basis of valuation and rate of taxation of all property subject to taxation." BOTA noted the "RECs failed to identify any other similarly situated Kansas RECs that received different valuation treatment from PVD on essentially equivalent property" and concluded the RECs failed to satisfy their burden to demonstrate "PVD deliberately adopted a valuation system for public utilities resulting in intentional systemic unequal treatment of Kansas RECs." It eventually determined:

"Nothing in the evidence presented to the Board indicates that the subject RECs were appraised in a manner that violates the uniform and equal provisions of the Kansas Constitution. Further, the Taxpayers presented, no evidence persuading the Board that the instant RECs were not appraised at their respective fair market value." (Emphasis added.)

That single italicized sentence now becomes our focus in deciding what was litigated before BOTA. And we note neither party requested BOTA’s reconsideration of its order to better specify the issues, despite their right to do so under K.S.A. 2023 Supp. 74-2426(b).

Judicial review before the district court

The RECs petitioned for judicial review in the district court where each was located: Butler, Ford, Kingman, Neosho, and Shawnee Counties. See K.S.A. 2023 Supp. 74-2426(c)(4)(B) ("District court review of [BOTA] orders shall … be conducted by the court of the county in which the property is located."). They then jointly filed a motion to merge the litigation under K.S.A. 2023 Supp. 60-242(c) (The Supreme Court may order the consolidation of civil actions from different judicial districts upon a party’s request.). We granted that motion and transferred the consolidated cases to Shawnee County District Court.

The RECs’ petition for...