Filed 6/26/20; Certified for Publication 7/16/20 (order attached)




              IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

                                     FIRST APPELLATE DISTRICT

                                               DIVISION FOUR


 MARK CHURCH, as County Assessor, etc.,
          Plaintiff and Respondent,
 v.
 SAN MATEO COUNTY ASSESSMENT                                        A155034
 APPEALS BOARD,
                                                                    (San Mateo County
          Defendant and Respondent;                                 Super. Ct. No. 16-CIV-01058)
 GENENTECH, INC.,
          Real Party in Interest and Appellant.

         Genentech, Inc. (Genentech) appeals a writ of mandate overturning a decision of
the San Mateo County Assessment Appeals Board (the appeals board) which invalidated
escape assessments imposed by the San Mateo County Assessor (the assessor) based on
the value of machinery and equipment (M&E) at Genentech’s San Mateo County facility.
The fair market value of the M&E on which property tax is imposed is determined with
reference to either the cost of equipment purchased in a finished state or, if the equipment
is not purchased in a finished state, costs incurred to bring the equipment to a finished
state, including the cost of labor and materials plus certain additional costs such as the
costs of actual or implied financing, debugging, and engineering. Based on substantial
evidence, the appeals board determined that Genentech purchased all of the M&E in
question in a finished state, and that the assembly of these pieces of equipment into a
production line did not render the equipment “self-constructed property” justifying
inclusion of the additional costs in determining fair market value of the equipment. In


                                                          1
disregard of the appeals board’s factual findings, the trial court determined that none of
the equipment was in a finished state until put to use in a functioning production line, and
that the additional costs capitalized for accounting purposes add to the value of the
property for purposes of the property tax. We conclude that the trial court adopted a
standard for determining when equipment is in a finished state for which there is no
justification, and erroneously rejected the appeals board’s findings that are supported by
substantial evidence. We agree with the appeals board that fair market value and net book
value are separate concepts with separate purposes, and that the assessor may not rely on
Genentech’s capitalization of expenses for accounting purposes to establish that those
expenses increase the value of the equipment and are subject to assessment. Accordingly,
we shall reverse the judgment and direct the trial court to enter a new judgment denying
the assessor’s petition for writ of mandate.
       Because the trial court ruled in the assessor’s favor with regard to the valuation of
Genentech’s M&E and remanded the matter to the appeals board for recalculation of the
fair market value of Genentech’s M&E, the court did not address the assessor’s separate
cause of action regarding the calculation of the fair market value of Genentech’s
laboratory and manufacturing fixtures. The trial court concluded that any issue regarding
that calculation could be addressed before the appeals board on remand. Accordingly, we
shall reverse the judgment and remand with directions that the trial court address in the
first instance the assessor’s cause of action regarding Genentech’s fixtures and deny the
petition as to the remaining causes of action.

                                        Background

   A. Legal Background

       In California, personal property used in a business is taxable unless exempt.
(Cal. Const., art. XIII, § 1.) All taxable personal property must be assessed at its “fair
market” or “full cash” value. (Cal. Const., art. XIII, § l; Rev. & Tax Code, § 110,
subd. (a).) State law requires Genentech to ﬁle an annual statement reporting its taxable
personal property. The assessor, in turn, is required to audit Genentech’s “books and


                                               2
records” at least once every four years. (Rev. & Tax Code, § 469, subds. (a), (b)(1)(B).)
If a taxpayer’s books and records reveal taxable personal property that has not been
reported on the taxpayer’s annual statement, the assessor issues an escape assessment for
the unreported property. (Rev. & Tax Code, § 532.)
       “The Legislature has authorized the state’s Board of Equalization to prescribe
rules and regulations to govern the operation and functioning of local tax assessors and
boards of equalization. [Citation.] Those regulations are found in the California Code of
Regulations, title 18.” (Dreyer’s Grand Ice Cream, Inc. v. County of Kern (2013) 218
Cal.App.4th 828, 836, fn. 1.) According to the regulations, “the words ‘full value’, ‘full
cash value’, ‘cash value’, ‘actual value’, and ‘fair market value’ mean the price at which
a property, if exposed for sale in the open market with a reasonable time for the seller to
find a purchaser, would transfer for cash or its equivalent under prevailing market
conditions.” (Cal. Code Regs., tit. 18, § 2(a).) The parties agree that the fair market value
of the equipment at issue should be determined by using the cost method prescribed by
California Code of Regulations, title 18, section 6 (hereafter, Rule 6). Under section (b)
of Rule 6, the assessor assesses the property by either “(1) adjusting the property’s
original cost for price level changes and for abnormalities, if any, or (2) applying current
prices to the property’s labor and material components, with appropriate additions for
entrepreneurial services, interest on borrowed or owner-supplied funds, and other costs
typically incurred in bringing the property to a finished state (or to a lesser state if
unﬁnished on the lien date).”
       The state Board of Equalization issues a handbook to “serve as a primary
reference and basic guide for assessors.” (Sky River LLC v. County of Kern (2013) 214
Cal.App.4th 720, 735; SHC Half Moon Bay v. County of San Mateo, supra, 226
Cal.App.4th at p. 485.) Section 504 of the handbook provides guidance for valuing
property under Rule 6. (Bd. of Equalization, Assessors’ Handbook (Jan. 2015),
Assessment of Personal Property and Fixtures
<http://www.boe.ca.gov/proptaxes/pdf/ah504.pdf> [as of May 27, 2020] (assessors’
handbook).) It explains, “Cost for assessment purposes may be thought of as full


                                               3
economic cost. Full economic cost should include all market costs, both direct and
indirect, necessary to purchase or construct equipment and make it ready for its intended
use. Costs which add value, direct and indirect, associated with manufacturing the
equipment and/or making it ready for its intended use should be included in the full
economic cost. Not all costs add value, for example, relocation costs are not costs
contributing to the assessable value of the property. Direct costs, or ‘hard’ costs, are
expenditures for the labor, materials, and direct factory overhead required to construct the
property whether purchased in the form of raw materials or a finished product. Indirect
costs, or ‘soft’ costs, include expenditures other than labor and material necessary to
make the equipment ready for its intended use.” (Id. at p. 53.) The assessors’ handbook
includes a chart that differentiates between indirect costs that should be included in the
value of “purchased equipment” and those indirect costs that should be included in the
value of “self-constructed equipment.” (Id. at p. 54.) Capitalized interest, debugging
expenses and engineering fees are all examples of costs that should be included in
assessing self-constructed property but not purchased property. (Ibid.) For example, with
respect to capitalized interest the assessors’ handbook explains, “Self-constructed
property, property constructed by the user and put to productive use in that business, has
an interest cost associated with it regardless of whether the source of funds is debt or
equity and whether or not the interest is actually incurred. Therefore, an increment of
interest must be identified and included when valuing self-constructed property. This
only applies to financing costs during the construction period. Financing costs, actual or
imputed, attributable to the holding of the property after the completion of construction,
including purchase financing, should not be included in the cost of construction. Care
must be taken to include only the interest attributable to the piece of equipment under
construction.” (Id. at pp. 57-58, fn. omitted.)

   B. Factual and Procedural Background

       Genentech is a biotechnology company that produces various medicines. During
the relevant time period, Genentech purchased from various suppliers manufacturing and


                                              4
storage equipment, including among other things bioreactors (tanks), fermenters,
centrifuges, autoclaves, and chromatography columns, all used in the production of the
medicines. This equipment was arrayed throughout Genentech’s buildings and
incorporated in various production lines.
       In addition to the purchase price of its M&E, Genentech recorded in its general
ledger additional equipment costs (as distinguished from production costs) that were
charged as expenses over the life of the equipment. Pursuant to the Statement of
Financial Accounting Standards No. 34 (FASB 34), Capitalization of Interest Cost, issued
by the Financial Accounting Standards Board (FASB)1
(<https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220130361&ac
ceptedDisclaimer=true> [as of June 25, 2020]), Genentech imputed an interest charge on
the equipment as if Genentech had financed the various acquisitions with a loan.
Genentech also booked “debugging” costs that were incurred after the installation of
equipment to evaluate and monitor the operation of the equipment. Finally, Genentech
booked professional and engineering costs that similarly were incurred after installation
of the equipment to adjust and test the installed equipment.
       Whether these additional costs should be included in determining the value of
Genentech’s M&E for property tax purposes was the subject of prior litigation. For each


       1
          Paragraphs 6 through 8 of FASB 34 read: “STANDARDS OF FINANCIAL
ACCOUNTING AND REPORTING [¶] 6. The historical cost of acquiring an asset
includes the costs necessarily incurred to bring it to the condition and location necessary
for its intended use. If an asset requires a period of time in which to carry out the
activities necessary to bring it to that condition and location, the interest cost incurred
during that period as a result of expenditures for the asset is a part of the historical cost of
acquiring the asset. [¶] 7. The objectives of capitalizing interest are (a) to obtain a
measure of acquisition cost that more closely reflects the enterprise’s total investment in
the asset and (b) to charge a cost that relates to the acquisition of a resource that will
benefit future periods against the revenues of the periods benefited. [¶] 8. In concept,
interest cost is capitalizable for all assets that require a period of time to get them ready
for their intended use (an ‘acquisition period’). However, in many cases, the benefit in
terms of information about enterprise resources and earnings may not justify the
additional accounting and administrative cost involved in providing the information. . . .”


                                               5
of the tax years between 1990 and 1999, Genentech paid property taxes based on the
adjusted purchase costs of its equipment. The assessor, after reviewing Genentech’s
books and records, issued an escape assessment asserting that the additional costs booked
against the equipment in Genentech’s general ledger should be included in the assessed
value of Genentech’s equipment. Genentech appealed the assessments, resulting in three
decisions by the appeals board. Ultimately, in 2010, the superior court issued a judgment
in favor of Genentech for tax year 1990-1991. In its statement of decision, the court held
that capitalized interest should not be included in the assessed value of Genentech’s
equipment. The court found that Genentech’s equipment had been purchased in its
finished state, so that “including an additional charge for capitalized interest after the
purchase would be improper.” The court rejected the assessor’s argument that
Genentech’s assemblage of the equipment into a production line constituted self-
construction of that equipment. No appeal was taken and the parties accepted the superior
court’s ruling in settling the issues for the remaining tax years.
       The current proceedings concern tax years 2000-2005, in which the assessor again
issued escape assessments asserting that additional costs should be included in the
assessed value of Genentech’s equipment. Following an extended evidentiary hearing, the
appeals board concluded that the additional costs should not be included. The appeals
board found that each individual piece of equipment is a distinct marketable item that
should be separately appraised, rejecting the assessor’s argument that the equipment
should be valued collectively as part of a completed production line. Based on its review
of the evidentiary record, the appeals board determined that Genentech’s equipment was
purchased in a finished state and was not self-constructed. According to the appeals
board, “the preponderance of the evidence demonstrates that Genentech did not self-
construct the M&E at issue. Although evidence was presented that Genentech played a
role in directing its contractors to assemble its equipment into a product line, the board
was not persuaded that [Genentech] played the role of a ‘general contractor’ such that [it]
can be deemed to have self-constructed its M&E. The board was persuaded that, during
the relevant time period for the equipment at issue, [Genentech] did not participate in the


                                              6
engineering or design of the M&E itself but played a more limited role of giving the
necessary speciﬁcations to its contractors. . . . The board further notes that the evidence
showed that Genentech does not pull its own building permits for its construction. Rather,
such permits are instead taken out by Genentech’s contractors. Additionally, the board
concludes that the preponderance of the evidence supports a ﬁnding that [Genentech’s]
acquisition and installation of such equipment during the 2000-2005 tax years consisted
of purchasing the M&E ‘in a ﬁnished state, ready to use’ and that the purported self-
construction consisted of the ‘assemblage of equipment into a production line.’
[Genentech’s] witnesses, including James Panek, Genentech’s former Senior Vice
President of Product Operations, testiﬁed that ‘Genentech did not self-construct its
equipment,’ and that its M&E installation practices were consistent during all relevant
periods. The board found this testimony persuasive. [¶] The board notes that the assessor
did not offer support for his general argument that the mere installation and connection of
[Genentech’s] equipment constitutes ‘self-construction’ for the purposes of the applicable
law. Rather, the assessor simply opined that one piece of equipment could not function on
its own and, therefore, is not in its finished state until it is part of a product line.
Additionally, while the assessor argued that the capitalized interest recorded in
[Genentech’s] ﬁxed asset ledger pursuant to FASB 34 should be included in valid costs,
this board was not persuaded that the standards for FASB and the standards for Rule 6
were the same. To the contrary, [Genentech] provided evidence that the calculation of
capitalized interest differs under FASB as opposed to Rule 6.”2
       The assessor filed the present petition for writ of administrative mandamus
challenging, among other things, the conclusion that amounts described as “capitalized
interest” (first cause of action), “start-up and debugging costs” (second cause of action)




       2
      As discussed, post, Genentech presented expert testimony that the scope of
FASB 34 is materially broader than that of Rule 6.


                                                 7
and “capitalized labor” (third cause of action) are not assessable as part of the value of
Genentech’s equipment.3 The trial court granted the assessor’s petition.
       The trial court rejected the standard applied by the appeals board in determining
whether the additional costs should be included. The court held that whether an asset is
“self-constructed” is irrelevant to the determination: “[T]he exact nature of the method by
which the property is acquired or brought to a finished state is irrelevant, providing that
on the date the property is acquired, the property is not ready for its intended use, and,
therefore, that some series of actions or events must occur before the property will reach
its finished state. . . . If the criteria is met, i.e. the property is not in a finished state when
acquired; the costs of bringing the property to its finished state must be capitalized and
included in the assessed valuation.” The trial court held that the proper standard to be
applied in determining when an asset reaches its “finished state” is when “the asset is
placed in service and . . . becomes ‘income producing.’ ” In denying Genentech’s motion
for new trial, the court clarified that it viewed the equipment as part of an assembly line,
not as individual pieces of equipment. The court explained, “In the context of an
assembly line constructed to manufacture pharmaceutical products, the assembly line is
not in its finished state until it is ready to be placed in service to manufacture
pharmaceutical products. If modification must be made or additional costs incurred
before that equipment can be placed in service, the assembly line obviously has not
reached a finished state. The court’s interpretation of Rule 6 is consistent with the typical
costs of self-construction cited in the assessors’ handbook as including ‘other costs
required to make equipment ready for its intended use.’ ”
       The trial court’s decision goes on at great length to emphasize that Genentech
capitalizes the additional expenses and includes the capitalized amounts as equipment


       3
         The assessor’s petition alleged as a fourth cause of action that the appeals board
failed to take into account a change in ownership of certain buildings in calculating the
assessed value of Genentech’s fixtures. This cause of action is largely unrelated to the
board’s decision regarding assessment of Genentech’s M&E and is addressed separately
in section 7 of the discussion.


                                                 8
costs in its general ledger, financial statements, income tax returns, and filings with the
Securities and Exchange Commission. The court concluded, contrary to the appeals
board, that these financial records establish that the additional expenses were incurred to
bring the equipment to its finished state.
       With respect to capitalized interest, the court held that the criteria for including
additional costs in the value of an asset under Rule 6—that is, “costs typically incurred in
bringing the property to a finished state,” is the same as the criteria under FASB 34 for
determining whether interest should be capitalized rather than taken as a current expense.
Accordingly, the court considered the inclusion of capitalized interest in Genentech’s
financial records to “constitute[] an extremely strong evidentiary showing” that these
costs were required to ready the equipment for its intended use and added to the value of
the equipment.4 In denying Genentech’s motion for a new trial, the court confirmed that
“the assessor appeared to have satisfied his prima facie burden under Rule 6 by showing
Genentech’s own books and records, Securities and Exchange Commission filing and its
audited financials all show capitalized interest, labor, and startup and debugging costs
were booked to the machinery and equipment account.”
       Genentech timely filed a notice of appeal.

                                         Discussion

1. Standard of Review

       The appeals board is a constitutional agency exercising quasi-judicial powers
delegated to it by the California Constitution. (Shell Western E & P, Inc. v. County of
Lake (1990) 224 Cal.App.3d 974, 979.) The board’s “ ‘factual determinations are entitled
on appeal to the same deference due a judicial decision, i.e., review under the substantial
evidence standard.’ ” (Ibid.) However, when the appeals board purports to decide a
question of law, the decision is reviewed de novo. (Id. at p. 980.) “Where the taxpayer

       4
        The court even questioned whether the doctrines of judicial estoppel or equitable
estoppel would preclude Genentech from offering evidence to rebut the inference drawn
from the financial statements.


                                              9
claims a valid valuation method was improperly applied, the trial court is limited to
reviewing the administrative record. [Citation.] The court may overturn the assessment
appeals board’s decision only if there is no substantial evidence in the administrative
record to support it. [Citation.] However, where the taxpayer challenges the validity of
the valuation method itself, the court is faced with a question of law. In such a case, the
court does not evaluate whether substantial evidence supports the board’s decision, but
rather must inquire into whether the challenged valuation method is arbitrary, in excess of
discretion, or in violation of the standards prescribed by law.” (Maples v. Kern County
Assessment Appeals Bd. (2002) 96 Cal.App.4th 1007, 1013; see also Carlson v.
Assessment Appeals Bd. I (1985) 167 Cal.App.3d 1004, 1009.)

2.     Issue Preclusion5

       Initially, Genentech contends the trial court erred in failing to apply the Superior
Court’s 2010 Decision and prior final decisions of the appeals board to preclude the
assessor from including the additional costs in the assessable value of its M&E. We agree
that the trial court properly rejected this argument.
       Issue preclusion applies when “ ‘an issue of ultimate fact’ ” has been previously
and finally decided. (People v. Santamaria (1994) 8 Cal.4th 903, 912.) An ultimate fact is
one that involves application of law to fact, such as an essential element of a claim or a
defense, as distinguished from an evidentiary fact or a legal conclusion. (Metis
Development LLC v. Bohacek (2011) 200 Cal.App.4th 679, 689.) For an issue to be
precluded from relitigation, the following requirements must be satisfied: (1) the issue
must be identical to an issue decided in a prior proceeding; (2) the issue must have been
actually litigated in the prior proceeding; (3) the issue must have been necessarily
decided in the prior proceeding; (4) the decision in the prior proceeding must be final and


       5
         In the proceedings below, the doctrine of issue preclusion was referred to as
collateral estoppel. We follow our Supreme Court by using “ ‘issue preclusion’ in place
of ‘direct or collateral estoppel.’ ” (Samara v. Matar (2018) 5 Cal.5th 322, 326; DKN
Holdings LLC v. Faerber (2015) 61 Cal.4th 813, 824.)


                                              10
on the merits; and (5) the party against whom preclusion is sought must have been a party
to or in privity with a party to the prior proceeding. (People v. Garcia (2006) 39 Cal.4th
1070, 1077.)
       The proper standard to be applied under Rule 6 is a legal question not subject to
issue preclusion. (See Maples v. Kern County Assessment Appeals Bd., supra, 96
Cal.App.4th at pp. 1012–1013 [validity of the valuation method applied by assessor is
question of law.].) The trial court’s prior factual determination that Genentech’s
equipment was purchased in a finished state is also not entitled to preclusive effect
because the equipment being valued is not the same equipment that was the subject of the
prior proceedings and was not necessarily purchased in the same condition. While the
doctrine may apply where an issue has been decided for one set of years and then the
same issue is again challenged in a subsequent year (see, e.g., County of Los Angeles v.
County of Los Angeles Assessment Appeals Bd. (1993) 13 Cal.App.4th 102), the doctrine
does not apply where material changes in the controlling facts have occurred during the
intervening time period. As the appeals board explained, “With respect to the M&E at
issue in the court’s statement of decision (i.e., the M&E as of the 1991 lien date), this
board agrees that the court has already determined that such equipment was not self-
constructed. As such, the collateral estoppel doctrine prohibits the inclusion of capitalized
interest in such equipment’s cost basis. With respect to Genentech’s M&E acquired after
1991, however, it is not as simple as ﬁnding that collateral estoppel prevents capitalized
interest from ever being included in the M&E’s cost basis as Genentech contends. During
the 2000-2005 tax years, for example, Genentech could have taken a different approach
to installing or connecting its equipment which might constitute ‘self-construction.’ In
other words, the mere fact that [Genentech’s] equipment was not self-constructed in one
tax year does not automatically require a ﬁnding that different equipment in a subsequent
year also was not self-constructed.” (Underscoring and italics omitted.) The appeals
board and the trial court both properly concluded that the issue before us is not governed
by the doctrine of issue preclusion.



                                             11
3.     Unit of Appraisal

       Under the Code of Regulations, the proper unit of appraisal for property tax
purposes is that unit which “persons in the marketplace commonly buy and sell as a
single unit, or that is normally valued in the marketplace separately from other property,
or that is speciﬁcally designated as such by law.” (Cal. Code Regs., tit. 18, § 324,
subd. (b).) As set forth above, the equipment at issue in this case includes a variety of
generators, machines, and measuring devices that are arranged throughout Genentech’s
buildings and used together to produce various medications. Before the appeals board, the
assessor argued the equipment would most likely be sold as part of a product line or “as a
complete manufacturing facility,” so that the proper unit of appraisal is “the entire
property.” Genentech argued that each individual piece of equipment is a distinct
marketable product that should be appraised separately. The appeals board agreed with
Genentech, and its finding is supported by substantial evidence. The board relied upon
evidence of numerous sales of individual pieces of Genentech’s laboratory and
manufacturing equipment and expert testimony that there are more buyers for individual
pieces of equipment than for entire of production or manufacturing lines. Despite the
appeal board’s finding, the trial court’s decision repeatedly refers to the equipment in the
“context of an assembly line.” It should be clear that the assessments in question are to be
based on the fair market value of each individual piece of equipment, not the collective
value of the equipment as part of a product or manufacturing line.

4.     Rule 6(b) Standard

       To determine the value based on the full cost of each piece of equipment, the
appeals board applied the standard found in the assessors’ handbook—that is, whether
Genentech purchased the equipment in a finished state or whether the equipment was
“self-constructed” by Genentech. The trial court rejected this standard, holding instead
that an asset reaches its “finished state” when “the asset is placed in service and …
becomes ‘income producing.’ ” The proper standard is a question of law subject to our de
novo review.


                                             12
       “Although assessors’ handbooks are not regulations and do not possess the force
of law, they serve as a primary reference and basic guide for assessors, and have been
relied upon and accorded great weight in interpreting valuation questions. [Citation.]
‘The interpretations and opinions of an agency administrator, while not controlling upon
the courts, constitute a body of experience and informed judgment to which courts and
litigants may properly resort for guidance. [Citation.] “Because the agency will often be
interpreting a statute within its administrative jurisdiction, it may possess special
familiarity with satellite legal and regulatory issues. It is this ‘expertise,’ expressed as an
interpretation (whether in a regulation or less formally . . .), that is the source of the
presumptive value of the agency’s views.” ’ ” (Sky River LLC v. County of Kern, supra,
214 Cal.App.4th at pp. 735-736.) As indicated above, the assessors’ handbook advises
that equipment has not reached a finished state if some portion of it remains to be
constructed by the purchaser. The handbook warns that “care must be taken to include
only the interest attributable to the piece of equipment under construction” and provides
as examples that “relocation costs are not costs contributing to the assessable value of the
property” nor are costs “attributable to the holding of the property after the completion of
construction.” (Assessors’ Handbook, at pp. 53, 57.) This standard is reasonably designed
to determine the “fair market” or “full cash” value of a piece of equipment (Cal. Const.,
art. XIII, § l; Rev. & Tax Code, § 110, subd. (a)) and reflects an appreciation of the
practical realities faced by businesses.
       The trial court held, however, that equipment reaches a “finished state” when “the
asset is placed in service and . . . becomes ‘income producing.’ ” The court derived this
standard from an inapposite decision of the United States Supreme Court, Commissioner
of Internal Revenue v. Idaho Power Co. (1974) 418 U.S. 1, 13-15. In that case, the court
addressed whether, for income tax purposes, “a taxpayer is entitled to a deduction from
gross income … for depreciation on equipment the taxpayer owns and uses in the
construction of its own capital facilities.” (Id. at p. 3.) The court held that the taxpayer
could not deduct from current gross income depreciation on such equipment, and that the
depreciation is an expense that must be capitalized to the value of the asset and amortized


                                               13
over the life of the asset.6 This approach was not designed to determine the value or cost
of the capital asset but to prevent distortion of income and ensure equal treatment of
taxpayers for purposes of the federal income tax.7 While capitalizing the costs incurred in
producing an asset until the asset is put into service and becomes income producing may


       6
         Recognizing the “necessity to treat construction-related depreciation in a manner
that comports with accounting and taxation realities,” the court explained, “[w]hen the
asset is used to further the taxpayer’s day-to-day business operations, the periods of
benefit usually correlate with the production of income. Thus, to the extent that
equipment is used in such operations, a current depreciation deduction is an appropriate
offset to gross income currently produced. It is clear, however, that different principles
are implicated when the consumption of the asset takes place in the construction of other
assets that, in the future, will produce income themselves. In this latter situation, the cost
represented by depreciation does not correlate with production of current income. Rather,
the cost, although certainly presently incurred, is related to the future and is appropriately
allocated as part of the cost of acquiring an income-producing capital asset.”
(Commissioner of Internal Revenue v. Idaho Power Co., supra, 418 U.S. at pp. 10-11.)
The court reasoned that depreciation on equipment used to construct a capital asset
should be treated for income tax purposes in the same manner as other costs of acquiring
a capital asset, such as financing interest, tools, materials, and wages paid construction
workers. (Id. at pp. 12-13.) The court observed, based on the facts at issue in that case,
that “[t]he taxpayer’s own accounting procedure reflects this treatment, for on its books
the construction-related depreciation was capitalized by a credit to the equipment account
and a debit to the capital facility account.” (Id. at p. 14.)
       7
         According to the court, “this capitalization prevents the distortion of income that
would otherwise occur if depreciation properly allocable to asset acquisition were
deducted from gross income currently realized.” (Commissioner of Internal Revenue v.
Idaho Power Co., supra, 418 U.S. at p. 14.) “It serves to prevent a taxpayer from utilizing
currently a deduction properly attributable, through amortization, to later tax years when
the capital asset becomes income producing.” (Id. at p. 16.) “An additional pertinent
factor is that capitalization of construction-related depreciation by the taxpayer who does
its own construction work maintains tax parity with the taxpayer who has its construction
work done by an independent contractor. The depreciation on the contractor's equipment
incurred during the performance of the job will be an element of cost charged by the
contractor for his construction services, and the entire cost, of course, must be capitalized
by the taxpayer having the construction work performed. The Court of Appeals’ holding
would lead to disparate treatment among taxpayers because it would allow the firm with
sufficient resources to construct its own facilities and to obtain a current deduction,
whereas another firm without such resources would be required to capitalize its entire
cost including depreciation charged to it by the contractor.” (Id. at p. 14.)


                                             14
be necessary to avoid distorting current income, the capitalization does not affect the
actual cost or current value of the asset and has no relevance for purposes of a property
tax. There are many reasons for which equipment may be in a “finished state” and not yet
placed into service and income producing. Spare equipment may be retained to replace
current aging equipment or may be stored while other construction takes place. The
finished equipment is then an asset subject to taxation, but the costs associated with
holding the equipment, including any interest accruing on financing, do not add to the
economic value of the equipment.8 Genentech offers the example of a tank or a freezer.
When Genentech “buys a completely-manufactured piece of equipment [such as a freezer
or a tank], that item is accurately described as being in its ‘finished state’—even before it
may be integrated into a broader system, plugged in, and switched on.” Accordingly, the
trial court erred in substituting its own definition of a finished product for that prescribed
by the assessors’ handbook and applied by the appeals board.

5.     The relationship between FASB 34 and Rule 6

       Underlying the trial court’s error is its mistaken “find[ing], as a matter of law, that
the criteria for capitalization of expenses under FASB 34 and Rule 6(b) are the same.”
While the language in FASB 34 and Rule 6(b) is comparable, there are significant
differences in the treatment of interest under the two provisions. For example, under
FASB 34, capitalized interest accrues until the asset can be used, which in Genentech’s
case, includes through subsequent validation by the federal Food and Drug
Administration. (FASB 34, p. 8, ¶¶ 17, 18.)9 In contrast, under Rule 6(b), imputed


       8
        Moreover, after the asset has been held for an extended period, market conditions
may be such that the asset’s current value bears little correspondence to its capitalized
book value less depreciation.
       9
         Paragraph 17 of FASB 34 reads: “The capitalization period shall begin when
three conditions are present: [¶] a. Expenditures . . . for the asset have been made.
[¶] b. Activities that are necessary to get the asset ready for its intended use are in
progress. [¶] c. Interest cost is being incurred. [¶] Interest capitalization shall continue as
long as those three conditions are present. The term activities is to be construed broadly.


                                              15
interest accrues only until the equipment reaches “a finished state” or “during the
construction period.” (Assessors’ Handbook, at pp. 57, 59.) For that reason, interest
expenses prior to the commencement of manufacturing are “capitalized interest” under
FASB 34 but are not included in valuation under Rule 6.
       Similarly, FASB 34 considers the whole production facility for accounting
purposes while Rule 6 seeks to determine the value of individual pieces of equipment.
Thus, a piece of equipment may be in its “finished state” though not yet put to its
“intended use” as part of an assembly line. The cost of maintaining that equipment must
be considered under FASB 34 in determining the net income of the equipment’s owner.
The fact that actual or implied interest incurred in maintaining the idle equipment is
capitalized under FASB 34 does not indicate, under Rule 6, that the interest expense




It encompasses more than physical construction; it includes all the steps required to
prepare the asset for its intended use. For example, it includes administrative and
technical activities during the preconstruction stage, such as the development of plans or
the process of obtaining permits from governmental authorities; it includes activities
undertaken after construction has begun in order to overcome unforeseen obstacles, such
as technical problems, labor disputes, or litigation. If the enterprise suspends substantially
all activities related to acquisition of the asset, interest capitalization shall cease until
activities are resumed. However, brief interruptions in activities, interruptions that are
externally imposed, and delays that are inherent in the asset acquisition process shall not
require cessation of interest capitalization.”
        Paragraph 18 of FASB 34 reads: “The capitalization period shall end when the
asset is substantially complete and ready for its intended use. Some assets are completed
in parts, and each part is capable of being used independently while work is continuing
on other parts. An example is a condominium. For such assets, interest capitalization
shall stop on each part when it is substantially complete and ready for use. Some assets
must be completed in their entirety before any part of the asset can be used. An example
is a facility designed to manufacture products by sequential processes. For such assets,
interest capitalization shall continue until the entire asset is substantially complete and
ready for use. Some assets cannot be used effectively until a separate facility has been
completed. Examples are the oil wells drilled in Alaska before completion of the pipeline.
For such assets, interest capitalization shall continue until the separate facility is
substantially complete and ready for use.”


                                             16
affects the value of the equipment or should be considered in determining the amount of
property tax.10
       The two rules also serve considerably different purposes. The FASB standards are
used “ ‘for purposes of financial reporting,’ ” not for determining property value. (SHC
Half Moon Bay, LLC v. City of San Mateo (2014) 226 Cal.App.4th 471, 478.) The
assessors’ handbook makes clear that “the accountant’s concept of value . . . may or may
not be the same as market value.” (Assessors’ Handbook, at p. 50.) “[N]ot all costs
contributing to value are booked and not all costs booked contribute to value.” (Id. at
p. 53.) The purpose of FASB 34 is to accurately reflect a business’s income each year,
distinguishing between costs that should be charged against current income and costs that
should be “capitalized” and written off against income over a longer period of time.
(FASB, Statement of Financial Accounting Concepts No. 8, OB2, p. 1
<https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176157498129&ac
ceptedDisclaimer=true > [“The objective of general purpose financial reporting is to
provide financial information about the reporting entity that is useful to existing and
potential investors, lenders, and other creditors in making decisions about providing
resources to the entity.”].) Rule 6(b) on the other hand is designed to determine the value
of property at a given point in time. As the assessors’ handbook states, “The annual lien
date value of personal property, which must reflect market value, is unrelated to net book
value (capitalized cost less depreciation) reflected on an assessee’s books. Fair market
value as defined in appraisal terms and net book value as defined in accounting terms are
separate concepts. Any similarity is merely coincidental. It is important to recognize the


       10
         Genentech also notes that interest is calculated differently under the two rules.
While the interest rate used under FASB 34 is “based on the rates applicable to
borrowings outstanding during the period” by the company (FASB 34, ¶ 13), the interest
rate used to calculate imputed interest pursuant to Rule 6(b) is based on a weighted
average cost of capital for the assessee’s entire industry. (See Assessors’ Handbook, at
p. 58 [“The rate derived should be the typical rate for the specific industry of the
assessee” and “[t]he rate should be the weighted average cost of capital, taking into
consideration the typical debt-equity ratio for the industry.”].)


                                             17
difference.” (Assessors’ Handbook, at p. 49, see also De Luz Homes, Inc. v. County of
San Diego (1955) 45 Cal.2d 546, 567 [“The accountant deals with past historical cost to
the present owner and by the process of amortization spreads the cost of property over its
useful life. [Citation.] The unamortized cost reflected on the balance sheet has no relation
to the ‘full cash value,’ i.e., the price that a willing buyer would pay a willing seller.”].)
In King v. State Bd. of Equalization (1972) 22 Cal.App.3d 1006, 1010-1011, the court
explained, “Like many tax statutes, the [property] tax law employs relatively artificial,
relatively self-contained, concepts. If it utilizes popular meaning or concepts from other
fields of law, it does so only by force of its own objectives and definitions. . . . To pursue
the will-o'-the-wisp of definitions, concepts and distinctions from other areas of law --
where they are shaped by purposes and by social and economic factors unrelated to
[property] taxation -- leads to false goals. The coverage of [property] tax law is shaped by
its own provisions and definitions and, where these are unclear, by applying its own
perceived policies and concepts.”11
       Accordingly, the taxpayer’s capitalization of interest in its accounting records is
not substantial evidence that the interest should be imputed for purposes of assessing the
fair market value of the equipment under Rule 6(b).




       11
          The assessor’s reliance on Lockheed Aircraft Corp. v. County of Los Angeles
(1962) 207 Cal.App.2d 119, 129, for the proposition that “California courts have long
‘recognize[d] that the assessor may properly consider book values in determining market
value’ ” is misplaced. The court in that case acknowledged that “the object of the
assessor's search is value, not cost” and that “[i]t is a truism that cost is not necessarily
value.” (Id. at p. 128.) The court held nonetheless that there was “nothing inherently
improbable in the assessor’s statement that he regarded the book value assigned by the
manufacturer as a valid basis from which to arrive at the ‘actual cash value’ of these
unique and unmarketable items of property.” (Id. at p. 130.) Nothing in the record
suggests that Genentech’s M&E was unique and unmarketable so that there was any need
to rely on book value to determine market value.


                                               18
6.     Substantial evidence supports the finding by the appeals board that the additional
       costs identified by the assessor should not have been included in the assessment of
       the equipment.

       Genentech presented substantial evidence, found credible by the appeals board,
establishing that it purchases its M&E in a finished state. Genentech’s Senior Vice
President of Product Operations reviewed the types of devices that constitute
Genentech’s M&E, and testified that each of them was purchased in a finished state, not
self-constructed. He testified that although Genentech would provide vendors with design
specifications as to what its finished state should be, the M&E would be designed,
manufactured, and installed by third parties. For example, with respect to its bioreactor
tanks, he testified that Genentech “would determine the size . . . the materials . . . what
kind of agitator . . . . That would all be specified. It would be sent to—normally two,
three vendors for tanks. . . . They would bid, and we would select based on the best
economics and the best fit for what we needed . . . .That vendor would then be
responsible for the complete design. [¶] . . . [W]e didn’t get involved in determining . . .
what type of welds, where the welds would be, how thick the stainless steel would be, but
they would do that fabrication and provide us with a finished tank.” Other M&E such as
chromatography columns and autoclaves “are available . . . in a variety of sizes, a variety
of materials from . . . a handful of commercial vendors.” Genentech’s Director for the
Drug Acceptance Manufacturing Group explained that Genentech contracts with an
engineering firm to design the product line and it hires contractors to install the M&E in
the buildings. Contrary to the assessor’s argument, the fact that the equipment was
constructed to Genentech’s specifications does not mean that the individual pieces of
equipment were not purchased in a finished state. Similarly, because each piece of
equipment is subject to assessment, not the production line as a whole, the appeals board
was certainly justified in determining that assembly of the custom-ordered equipment
into a production line did not amount to “self-construction” under Rule 6.
       Nor does Genentech’s inclusion of capitalized interest, debugging costs and
capitalized labor in its accounting records prove that these costs were necessary to bring


                                              19
the equipment to a finished state, as the trial court found. As discussed above,
Genentech’s capitalization of interest under FASB 34 does not establish that the interest
expense affects the value of the equipment. With respect to the remaining costs, while the
board was “sympathetic to the claim that problems in determining valid costs arise
because [Genetech] disavows its own general ledger entries,” the appeals board
concluded that based on the record before it, the general ledger entries were insufficient
to satisfy the assessor’s burden. The appeals board acknowledged that it had previously
expressed concern “regarding taxpayers potentially exploiting deﬁciencies in their books
and records” to avoid assessment, but the appeals board faulted the assessor in this
instance for failing to conduct a proper investigation. The decision explains that the
assessor’s appraiser did not “investigate what any of the questionable items were and ‘did
not investigate these costs beyond what their description is.’ [The witness] did not know,
for example, whether any of the costs were incurred after the equipment was installed. He
also conceded that he did not know what kind of labor was involved with any of the
capitalized labor which he had included in [Genentech’s] laboratory M&E cost basis.”
       Ultimately, the appeals board found that the amounts identiﬁed by the assessor as
start-up and debugging costs in Genentech’s ledger were more likely for testing those
product lines as opposed to testing the individual pieces of equipment. This conclusion is
supported by the testimony of the assessor’s witness that Genentech’s engineers told him
that the start-up and debugging costs at issue were incurred to confirm that Genentech’s
product “doesn’t have any mutations or deformities” or that Genentech’s product “is
exactly like it should be” and that “the expected yield is as it should be.” The appeals
board also found that the assessor “did not establish by a preponderance of the evidence
that the capitalized labor, professional, and engineering costs at issue were incurred to
bring [Genentech’s] M&E to its ﬁnished state.” As noted, the assessor failed to identify
or investigate the labor costs and Genentech presented testimony establishing that the
labor costs were incurred when Genentech made product-specific modifications to
installed equipment, which resulted in product-oriented capitalized labor costs
“associated with that modification and a retesting and revalidation of that equipment.”


                                             20
       The assessor contends the trial court properly found that Genentech, rather than
the assessor, has the burden to show that the costs booked to capitalized accounts should
not be assessable. The assessor argues that the appeals board improperly required the
assessor to investigate the costs reflected in Genentech’s books “to determine whether
they were incurred for testing of the product, or for the machinery and equipment.” The
assessors argument, however, ignores the distinction between the individual pieces of
equipment and the production line as a whole. As noted above, substantial evidence
supports the appeals board’s findings that the individual pieces of equipment were
purchased in a finished state and that the additional costs were incurred in connection
with installation, testing and modification of the product line.
       In sum, the appeals board reasonably determined on the record before it that the
additional costs identified by the assessor should not have been included in the escape
assessment.

7.     Fixtures

       Before the appeals board, the parties also disputed the proper standard for valuing
Genentech’s laboratory and manufacturing ﬁxtures. Ultimately, the board rejected the
competing methodologies presented by both parties and concluded instead that “the
proper methodology for assessing the value of Genentech’s ﬁxtures for the 2000-2005 tax
years is to apply the [Board of Equalization’s] 1999 Interim Guidelines.” The assessor’s
writ petition alleges the appeals board’s calculation of the cost basis for fixtures for
buildings 1 and 4 failed to account for a change in ownership of the buildings in 1993.
The parties disagreed as to whether the appeals board determined that the change in
ownership did not affect valuation or erroneously overlooked the issue. The trial court did
not address the fixtures issue in its decision and noted in response to Genentech’s motion
for a new trial that “those issues would be addressed by the assessment appeals board on
remand in a manner consistent with this court’s ruling.” Although we reverse the
judgment and direct the denial of relief on petitioner’s first three causes of action on




                                              21
remand the trial court must consider and rule on the fixtures issue set forth in the fourth
cause of action.
                                         Disposition
          The judgment is reversed and remanded for further proceedings consistent with
this opinion. The trial court shall enter an order denying relief on the first three causes of
action in the petition and shall consider and rule upon the claim in the fourth cause of
action.

                                                   POLLAK, P. J.

WE CONCUR:

STREETER, J.
BROWN, J.




                                              22
Filed 7/16/20
                            CERTIFIED FOR PUBLICATION

                IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

                              FIRST APPELLATE DISTRICT

                                      DIVISION FOUR


 MARK CHURCH, as County Assessor, etc.,
          Plaintiff and Respondent,
                                                       A155034
 v.
 SAN MATEO COUNTY ASSESSMENT                           (San Mateo County
 APPEALS BOARD,                                        Super. Ct. No. 16-CIV-01058)
          Defendant and Respondent;                    ORDER CERTIFYING OPINION
 GENENTECH, INC.,                                      FOR PUBLICATION
          Real Party in Interest and Appellant.



THE COURT:

        The opinion in the above-entitled matter filed on June 26, 2020, was not certified
for publication in the Official Reports. For good cause it now appears that the opinion
should be published in the Official Reports and it is so ordered.




Date:                                                            POLLAK, P.J.




                                              1
Trial court:                             San Mateo County Superior Court

Trial judge:                             Honorable George A. Miram

Counsel for real party in interest and   Mcdermott Will & Emery LLP
Appellant:                               Charles J. Moll III
                                         Troy M. Van Dongen

Counsel for plaintiff and respondent:    John C. Beiers, County Counsel
                                         Rebecca M. Archer, Lead Deputy
                                         Brian E. Kulich, Deputy

Counsel for defendant and respondent:    No appearance.




A155034




                                         2
