APPEAL from the Circuit Court of Lee County; the Hon. CHARLES
L. BRACKEN, Judge, presiding.
MR. JUSTICE SCHAEFER DELIVERED THE OPINION OF THE COURT:
Rehearing denied November 16, 1959.
The Chicago, Burlington & Quincy Railroad Company brought this action in the circuit court of Lee County to review the 1957 assessment of its Illinois property by the Department of Revenue. It claimed that the assessment at $147,000,000 was excessive by $72,000,000. The circuit court set aside the assessment "at least to the extent" that it exceeded the 1956 assessment of $144,600,000. The Department appealed directly, (Ill. Rev. Stat. 1955, chap. 120, par. 619,) and the plaintiff cross-appealed.
Under the Revenue Act of 1939 it is the duty of the Department to assess the system value of the operating property of railroads doing business in this State, to determine the value of the Illinois portion of such property, and to certify to each taxing district in which operating property of the railroad is located its appropriate portion of the statewide value. (Ill. Rev. Stat. 1955, chap. 120, pars. 560-571.) The tax rates of the local taxing bodies are then applied to the assessed values so certified. Non-operating property in Illinois is locally assessed.
Plaintiff is an interstate railroad operating in 12 States. In determining the 1957 assessed value of its Illinois operating property, the Department took into account: (1) the capitalized value of the average of net system railway operating income for the past five years; (2) the market value of stock and debt, using a five-year average; (3) the cost of reproduction less depreciation of physical property located in Illinois. An allocation fraction was then applied to the first two items to determine the portion of the total system value represented by Illinois assets, and a judgment factor was used which substantially reduced the average of the three items. This method of valuing railroad operating property is used in assessing all railroads in Illinois, and it complies with the statutory requirements. Chicago and North Western Railway Co. v. Department of Revenue, 6 Ill.2d 278.
This method produced the following results: (1) capitalized earnings value allocated to Illinois, $151,728,000; (2) stock and debt value allocated to Illinois, $135,519,000; (3) reproduction cost, less depreciation, of Illinois property, $298,303,000. The average of these three amounts is $195,183,000. The assessment as finally determined by the Department was $147,000,000.
Mere differences of opinion, however pronounced, do not warrant judicial impeachment of a valuation determined by the Department of Revenue. (St. Louis Bridge and Tunnel Railroad Co. v. People ex rel. Baker, 127 Ill. 627.) An entire railway system is seldom bought and sold and any process of determining its fair cash value must necessarily depend more on informed judgment than on hard and fast rules. "Facts of great variety and number, estimates that are exact and those that are approximations, forecasts based on probabilities and contingencies have bearing and properly may be taken into account to guide judgment in determining what is the money equivalent the actual value of the property." (Rowley v. Chicago & Northwestern Railway Co. 293 U.S. 102, 109, 79 L.ed. 222.) The plaintiff contends that its property was so grossly overvalued by deliberate miscalculations and the selection of improper factors designed to inflate value as to constitute constructive fraud. Such an allegation, if proved, merits judicial relief. (Chicago and North Western Railway Co. v. Department of Revenue, 6 Ill.2d 278.) A detailed review of the procedure followed by the Department in valuing the plaintiff's property is therefore necessary.
The first test of value to be examined is the determination of the capitalized net railway operating income of the plaintiff. The data used by the Department was supplied by the plaintiff in the return required of all railroads by section 82 of the Revenue Act. (Ill. Rev. Stat. 1955, chap. 120, par. 563.) Plaintiff's net operating income for the years 1952 through 1956 as reported to the Interstate Commerce Commission ranged from $31,744,000 in 1952 to $25,542,000 in 1956. The five-year average was $28,281,000. This amount was capitalized at a rate of 6% to arrive at a system valuation of $471,350,000. Application of an allocation fraction of 31.19% resulted in a determination by the Department that a value of $151,728,000 on the plaintiff's operating property in Illinois was indicated by the capitalized earnings method of valuation.
The plaintiff contends that this valuation is excessive and that the proper Illinois value indicated by its capitalized net operating income is $60,842,000. Each step of the Department's determination is attacked: it is suggested instead that an income figure of $17,394,000 should have been capitalized at 8% for a system value of $217,425,000 and an allocation factor of 27.98% then applied.
In computing net railway operating income, the Department allows a deduction to be taken for amounts that are accrued for Federal income taxes. This deduction is the source of most of the disagreement between the plaintiff and the Department over the amount of income to be capitalized. The plaintiff complains that the tax return form furnished by the Department for its use is inadequate to record properly the Federal tax deduction to which it is entitled. As an example of this inadequacy, plaintiff points to its reported Federal tax accruals of $20,000,000 for 1956. It is contended that this figure, which is an estimate of its Federal income tax liability as a corporate entity, included tax deductions produced by non-operating property. These tax deductions allegedly decreased by $3,658,000 the tax accruals reported in 1956, and thereby caused an overstatement of net railway operating income. However, the plaintiff admits that its corporate Federal tax accruals for 1956 also took into account income of $1,146,000 derived from non-operating property which tended to understate its net railway operating income. Such evidence does not bolster the plaintiff's charge of gross miscalculations indicative of constructive fraud. Moreover, it appears that the Department does not agree with the plaintiff that the items in question are properly classified as non-operating, and plaintiff's briefs do not shed any light on that basic controversy.
A much more important dispute arising from the Federal tax accrual item concerns the rate of depreciation to be allowed in determining net income. For Federal income tax purposes the plaintiff used an accelerated rate of depreciation on certain operating property, a practice authorized with respect to new facilities deemed essential to national defense. The Department, in accordance with the practice followed by the Interstate Commerce Commission, limits depreciation accounting to a straight-line method reflecting normal service life. The plaintiff contends that a requirement that it use a long-term rate of depreciation in valuing its property when it is using a short-term rate to take deductions from the Federal income tax results in a deflation of Federal tax accruals and an overstatement of net operating income. We do not think this contention merits serious attention. A straight-line method of depreciation may be used for income tax purposes if the taxpayer desires, and the plaintiff can continue to depreciate its property in its reports to the Department even after the cost had been amortized in Federal income tax deductions. The allegation that inaccuracies in plaintiff's reported operating income caused by different accounting methods may not level off in the future because of changing Federal tax rates need not be explored. Such a result would be due to the manner in which the plaintiff has chosen to report its income to the Federal government rather than to deliberate miscalculations of the Illinois Department of Revenue.
The plaintiff's objection to the Department's use of a 6% rate in capitalizing its net railway operating income is more troublesome. In defense of this rate the Department's railroad assessor testified that "for 26 years I have used 6 per cent as the rate of capitalization for all railroads in the State of Illinois which have income to capitalize. It may not be correct. On the other hand, it has at least been uniformly applied to all railroads during periods of depression and periods of inflation. * * * It is a capitalization figure which most or a great many not most but a great many people, I believe, like to consider as a fair return on the property, whether it is or it is not, is another question." We are troubled by the inadequacy of this explanation. The capitalized earnings method of valuation translates expected income into the market value of the income-producing property by estimating the rate of interest a purchaser of an annuity equal to the expected income would demand on his investment. The reliability of this method as a measure of value is therefore keyed to the rate at which expected income is capitalized. Cf. Bonbright, Valuation of Property, 1st ed., vol. 1, p. 259.
The plaintiff contends that its operating income should be capitalized at a rate of 8%, which would reduce its capitalized net income value by 25%. To support this contention the plaintiff presented evidence at the formal hearing before the Department which tended to show: (1) that the yield on relatively riskless investments such as U.S. Treasury three-month notes and high grade corporate bonds had increased substantially in 1957; (2) that the average rate of capitalization on the earnings of 57 manufacturing corporations listed on the New York Stock Exchange in 1956 should be 7.67%; (3) that the average rate of capitalization on the earnings of 12 railroads, including the plaintiff, for the years ...