Administrative Rules of the State of Montana

BEFORE THE DEPARTMENT OF REVENUE

OF THE STATE OF MONTANA

In the matter of the amendment of ARM 42.20.701, 42.20.705, 42.20.715, 42.20.720, 42.20.725, and 42.20.745 relating to forest land property

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NOTICE OF AMENDMENT

TO: All Concerned Persons

1. On October 29, 2009, the department published MAR Notice No. 42-2-814 regarding the proposed amendment of the above-stated rules at page 1961 of the 2009 Montana Administrative Register, issue no. 20.

2. A public hearing was held on November 23, 2009, to consider the proposed amendment. Oral and written testimony was received at the hearing and prior to the close of comment period is summarized as follows along with the response of the department:

COMMENT NO. 1: Confusing process - Mr. Chuck Roady, F H Stoltze Land and Lumber and on behalf of the Montana Wood Products Association; Mr. Paul McKenzie, Montana Tree Farm System; Ms. Debra Parker Foley, Montana Forest Owners Association, and Mr. Kevin Stowe, Stimson Lumber Company submitted comments regarding the reappraisal process this past year. They stated that it has been very frustrating, confusing and extremely difficult for the private forest land owners of Montana to even start to verify the valuation of their forest lands to determine if it is fair or correct. Much of the information provided by the department in regards to valuation, calculations, the assessments, and the productivity classifications have been constantly changing and all are extremely difficult for a landowner to verify if their valuation is accurate and fair. To date, nearly all of the information that has been provided by the department regarding productivity classification, valuation, and assessments has been either erroneous or has changed since the time the information was provided and the calculations of taxable value are actually made. It has been extremely difficult for a landowner to verify if the valuation of their forest land is correct and fair.

Mr. Stowe further stated that it would be good to have a better understanding how the department calculates board foot productivity for forest land.

RESPONSE NO. 1: The department has worked with a number of the agricultural advisory committees and those advisory committees have always taken a look back in time to try to come up with a new method of valuing agricultural land and to review the methodologies that are used for valuing agricultural land.

The department provided its initial estimate of the impacts of reappraisal on forest land to the Select Committee on Reappraisal. During the Select Committee hearings, members of various forest land groups and organizations testified about the valuation impacts associated with the statutory requirements concerning the capitalization rate used to determine the value of forest land. Based on the foresters' testimony, the Select Committee included language in House Bill 658 (HB 658), the reappraisal mitigation bill. That language included a statutory change to the capitalization rate and directed the department to use an 8% cap rate for the 2009 – 2014 appraisal cycle. There is an inverse relationship between cap rates and values and the use of a higher cap rate results in a lower per-acre value for forest land.

Based on recommendations presented by the department to the Select Committee, and agreed to by the Select Committee, the department also incorporated the use of the "weighted mean board foot productivity" when determining the value of a forested polygon. This is a change from the assignment of a "grade" per-forested polygon. A grade represents a range of production while the weighted mean productivity represents an actual productivity. For most forested polygons in Montana this change also resulted in a lower per-acre value when compared to the value associated with the former grade. Please see Response 5 for more detailed information related to the change from a grade to the weighted mean volumetric averages.

COMMENT NO. 2: Definitions - Mr. Roady and Ms. Parker Foley stated that some of the rule definitions are completely different from the intent of the legislative language in House Bill 658.

RESPONSE NO. 2: The department cannot discern a difference in the proposed rules and the legislative intent of HB 658. The only noticeable difference is the opinion regarding the timing of the appointment of the Forest Land Advisory Committee. The other proposed rules are consistent with the discussions and direction provided by the Select Committee on Reappraisal and the language contained in HB 658.

COMMENT NO. 3: Cap Rate - Mr. Corey Swanson, Plum Creek Timber Company, Mr. Roady, and Ms. Parker Foley stated that the language in 15-44-103(6), MCA, is very explicit in regards to the capitalization rate calculations. It states that the capitalization rate is to be determined by the department after consultation with the Forest Lands Advisory Committee. The statute is mandating the formation and utilization of the Advisory Committee and that cannot continue to be ignored. Also, the capitalization rate is not statutorily established at 8%. Section 15-44-103(6), MCA clearly states: "[h]owever the capitalization rate for each year of the base period for tax years 2009-2014 may not be less than 8%."

Mr. McKenzie stated that in ARM 42.20.715(5)(c)(i), the department states that the capitalization rate is statutorily established at 8%. That is incorrect and clearly inconsistent with the legislation which states that the capitalization rate may not be less than 8%. He stated that this issue was to be determined by the department after consultation with the Forest Lands Taxation Advisory Committee plus the effective tax rate. The capitalization rate must be adopted by rule. However, the capitalization rate for each year in the base year, for tax years 2009-2014, may not be less than 8%. It is very clear that this is a cooperative process between the committee and the department, not an arbitrary rate that's set by the department.

Mr. Bill Frings, Plum Creek Timber Company stated that the department must follow House Bill 658 with regard to the cap rate and nothing says it has to be 8%, it is nothing less than 8%, so in today's external environment with the changes that have occurred in the forest products industry over the last 18 months and some of the macro-economic things being seen, means there has to be some flexibility and consideration on an annual basis with the cap rate, just because of those external factors that have been seen. When the housing starts drop 10.5% in one month, those are the types of things that have to be considered for a viable long term forest products industry here in Montana.

RESPONSE NO. 3: House Bill 658 refers to the "base period for tax years 2009-2014". That base period is comprised of years 2003 through 2007. That base period has expired, so no further adjustments can be made. Dr. David Jackson from the University of Montana worked to develop and determine the capitalization rate per the statute, prior to the 2009 legislative session. That cap rate for the base period on a statewide basis came out somewhere in the neighborhood of 6.2%, and it was going to cause a pretty substantial increase in the value of forest land, and so per the input of the forest industry with the Subcommittee on Reappraisal, the Legislature directed the department to not use the calculated cap rates of 6.2% in determining the value for the base period, but to use the 8% cap rate. The department understood the legislative intent was to use that cap rate rather than the calculated cap rate, so the department incorporated that into the administrative rules. The proposal that the cap rate would change each year of the appraisal cycle is in error. If the department were to change the cap rate of forest land each year of the appraisal cycle, that would be a selective reappraisal of forest land which is contrary to Montana Law and court decisions and the department would not do that.

Forest land is appraised on a cyclical basis, the same as agricultural land and class 4 lands. Those values are determined based on historical information for the base period, prior to the implementation of the appraisal cycle, so any change to that a cap rate going forward for each year, 2009, 2010, and 2011, would be contrary to existing law, and would not be something that could be implemented without some major changes to the laws or through a court ruling.

COMMENT NO. 4: Advisory Committee - Mr. Jeff Clausen, F.H. Stoltze; Mr. Bill Frings; Ms. Mary Whittinghill, Montana Taxpayers Association; Mr. Ronald Buentemeier, Columbia Falls; Ms. Ellen Simpson, Montana Wood Products Association; Mr. Roady; Mr. McKenzie; Mr. Swanson; and Ms. Debra Parker Foley stated that the department should convene the Forest Land Taxation Advisory Committee immediately.

Mr. Roady further stated that his association definitely believes and the history has proven that a better more accurate product will result for the forest landowners of Montana, if the department and the representatives of this advisory committee work cooperatively. He asked for clarification regarding the department's interpretation of the advisory committee's roll with regard to taking a look back at the calculations only as it applies to changes the future legislation? He stated that he thought it was to be a cooperative effort between the department and advisory committee. He stated that he wanted to emphasize that they want to work together with the department and the advisory committee.

Mr. Jeff Clausen further stated that in the early 1990's. F. H. Stoltze was one of the timberland owners that together with the State and the University of Montana put together the productivity tax model as it is used today. He said that they did it willingly and everyone was reasonably happy with the final product. Their guiding light, so to speak, was that it was equitable, transparent, and defensible. In this last reappraisal cycle, the department contracted with the University of Montana again to revamp the underlying GIS data in part for technological advances. This was done and Dr. Jackson also did a little bit of revamping of the economic model. The industry and timberland owners as a whole were excluded from this process. As an example, the industry and timberland owners were invited to an informational meeting on December 31, 2008 to lay out the final product, which in turn was in fact not the final product. During the legislative session, they came again for another informational meeting, which they thought was the final product. There were several changes before it went before the Legislature. This process of excluding timberland owners forced a lot of major players to petition the Legislature to set up an advisory committee, which in fact they did in House Bill 658. The industry and landowners have wanted to be a cooperator in the process. He stated that their goal is to have tax equity and they do not want to evade taxes.

Ms. Whittinghill further stated that according to the compiler's notes the advisory committee could have been appointed as early as May 10th of this year. She stated that she believes having had the committee involved with the rules would have been very helpful in explaining the process to the taxpayers, and the county tax appeal boards. It is a complicated process and the department has started with a set of rules that could be broadened and clarified.

Ms. Parker Foley further stated that the lack of reference to the "Forest Lands Taxation Advisory Committee" is egregious. She stated that under 15-44-103(6), MCA, the department was to establish the cap rate "after consultation with the Forest Lands Taxation Advisory Committee."

Ms. Simpson stated they would like a group of stakeholders be invited to meet with the department to correct the numerous errors and inconsistencies contained in the current version of the rules. She further stated they feel a meeting would greatly benefit the end product.

RESPONSE NO. 4: Montana law requires the department to establish productivity, per-acre net income, mean annual net wood productivity and other valuation data based upon prior year data. The information must be reviewed and analyzed in a timely manner to allow the department to apply the results to the subsequent reappraisal cycle. For the 2009-2014 cycle, the department reviewed and analyzed information from 2003 – 2007. The results of that review and analysis were compiled for use by July, 2008 and were applied to the January 1, 2009 valuation of forest lands. Section 15-7-111(3), MCA, states "[t]he revaluation of class three, four and ten property is complete on December 31, 2008." Prior to December 31, 2008, the Forest Land Tax Advisory Committee did not exist.

House Bill 658 which established the Forest Land Tax Advisory Committee was not adopted until April 30, 2009. By that time, the department had already begun applying the 2009 valuations to all property within the state. In order for the department to meet its statutory deadlines for property valuation, it was not feasible to convene the committee or to consider recalculation of the prior cycle data.

Section 15-44-103(10)(c), MCA, establishes the committee's duty to review the data referenced in sections 15-44-103(2) through (6), (8) and (9), MCA. The committee is required to review all of the data that accumulates over the five-year period between 2009 and 2013 and to advise the department as it establishes values for the 2015 – 2020 cycle. Because limited data will be available until at least mid-way through the 2009 – 2014 cycle, the department has determined that the committee should be convened early in 2012. At that point in time the committee will have a reasonable amount of data available to it for review and analysis. The committee will also have an adequate amount of time in which to establish goals, review data, compile alternatives, and to develop suggestions for the department as it undertakes its cyclical revaluation of property for the 2015 – 2020 cycle. The department fully intends to work cooperatively with the committee as it undertakes its statutory duties.

COMMENT NO. 5: Productivity - Mr. Roady, Mr. McKenzie, Ms. Whittinghill, Mr. Swanson, and Ms. Parker Foley all stated that the reference in the rules to forest productivity is a concern because it is not clear what is exactly a weighted mean volumetric average. It is impossible for a landowner to understand this concept to determine what productivity class was used to calculate their productivity values.

Mr. McKenzie further stated the proposed rule changes add to the continuation of that frustrating process. He stated it appears there are a variety of problems in the proposed rules, ranging from minor technical errors in the definitions to complete misrepresentations of the legislative language included in House Bill 658. Specifically under the definition in ARM 42.20.701(7), the definition of forest site productivity, the definition as offered is completely inadequate. He questioned the department's basis of the weighted mean volumetric average. For example, is it based on ownership boundaries, is it based on former productivity classes? It is very unclear how the process was undertaken to take the information from the productivity formula that was produced by the university and then transferred into a weighted mean volumetric average for a landowner. This definition needs work to clearly identify how those productivity values were calculated and upon what basis and using what data set.

Ms. Whittinghill suggested there appears to be an error in ARM 42.20.725(5) because the term "potential productivity" does not appear in the statutes in House Bill 658. She suggested, at a minimum, that reference should be stricken.

Ms. Parker Foley further stated the explanation in ARM 42.20.715 of how productivity will be assigned is inadequate. There is no basis cited for the "weighted mean volumetric average."

RESPONSE NO. 5: A polygon represents an area of forest land that meets the statutory requirements to be considered for forest land classification. The potential productivity and ultimately a "grade" are determined on a polygon by polygon basis.

Since the creation of the forest land productivity information in the early 1990s, the department has used GIS technology to identify both the potential productivity of forest land and the assignment of a "grade" associated with the potential productivity. The first step in determining the grade of the forest land is to determine the volumetric output productivity of the forested polygon. The volumetric output is expressed as the maximum average annual growth of wood that could be expected from a natural, fully stocked stand of coniferous trees over the biological rotation age, after adjusting for average annual mortality based on yield tables. A GIS function (map algebra) combines all acreage within the forested polygon and determines the weighted mean volumetric average by averaging the potential productivity. The weighted mean volumetric average represents the average forest land production within a specific timber stand expressed in board feet per acre.

A grade represents a "range of potential production". Once the weighted mean volumetric average has been determined, a grade for the forested polygon can be assigned based on a range of production associated with the indicated grade. Grades are arbitrary production ranges and may not be good expressions of the potential forest land productivity.

For example, a grade of "V" (five) represents a range of production between 100 board feet per acre to 175 board feet per acre (bf/ac). Any forested polygon with an estimated production that falls within the 100 bf/ac to 175 bf/ac range of production would be assigned a grade V. In determining the per-acre value of all forest land with a grade of V, the midpoint of the range of production would be used {(100 bf/ac + 175 bf/ac)/2 = 137.5 bf/ac} for the productivity component of the forest land valuation formula identified in statute. Using a grade assigns a per-acre value of all forest land with the same grade, regardless of the actual weighted mean volumetric average potential production. In reality, two forest stands that are side by side, could have significantly different potential productivity, i.e., one forest stand on the low end of the productivity range associated with a grade and the other near the high end of the productivity range. But because they fall within the same grade range they would have the same per-acre value.

The "weighted mean volumetric average" is the actual average potential production for a forest polygon. In effect, it eliminates the step of assigning a grade to the forested polygon. In the determination of the per-acre value of the forested polygon, the actual weighted mean volumetric average production is used for the productivity component of the forest land valuation formula identified in statute.

The University of Montana is using the Forest Projection System (FPS) Model to predict the potential productivity for forest land production. The department believes it is important to include the definition of "potential productivity" in the administrative rules because that's what the model predicts. In addition, 15-44-102,(6), MCA states "'Forest productivity value' means the value of forest land for assessment purposes, which value is determined only on the basis of its potential to produce timber, other forest products, and associated agricultural products through an income approach provided for in 15-44-103." (emphasis added)

COMMENT NO. 6: Delay rule action - Mr. Roady, Mr. Clausen, Mr. McKenzie, Ms. Whittinghill, Ms. Parker Foley, Mr. Stowe, and Ms. Stimpson strongly request the department delay the rulemaking process until the Forest Land Advisory Committee can be assembled and have an opportunity to review the rules and can make the appropriate recommendations to clarify the rules to meet the legislative intent of House Bill 658.

Mr. McKenzie also stated the members of the Montana Tree Farm System still feel that the productivity based valuation method is the correct and most equitable method to assess forest land values and tax liabilities in our state. However, the department has sufficiently succeeded in sufficiently clouding the waters in the process used to implement the program that the landowners don't have the confidence that the program is working properly or as intended by this Legislature.

Mr. Kevin Stowe added that delaying the rulemaking process would allow discussion on topics such as: establishment of the Forest Lands Taxation Advisory Committee as cited in House Bill 658; the definition of capitalization rate as defined in House Bill 658 versus the rate proposed in ARM 42.20.725; and forest productivity assignations.

RESPONSE NO. 6: The Forest Land Advisory Committee will not be convened until 2012, at the earliest. Advisory committees review historical information and make recommendations for changes for the future appraisal cycle. They do not make recommendations for the current appraisal cycle.

COMMENT NO. 7: Appeals - Mr. Al Kington stated that he represents two landowners who own about seven thousand acres on two different ranches of forest land. He stated that he was also involved in the forest land productivity start up in 1993, and he served on the governor's tax advisory committee.

Mr. Kington further stated that at the present time he could not support the rules because he has been involved with the appeals process of Montana's forest lands and he feels that the rules, as they are written now, with the ambiguity and misstatements, would be very difficult for the local people and the local appeal boards to get their hands around. It would not be to the benefit of the department to lose a bunch of appeals and it could even jeopardize the productivity we've known since 1993. He stated that the biggest concern would be the wasted time and effort by both the department and the appeal boards whether they be local or statewide.

RESPONSE NO. 7: The department attempts to draft rules that clearly and completely implement the laws under which the department operates. Montana law requires the department to adopt certain rules relating to the valuation of forest lands as well as all other types of property subject to taxation. While the department regrets the fact that Mr. Kington cannot support the department's forest land rules as they are written, the department believes that these rules meet the department's statutory mandated rule adoption requirements and that they will assist both the department and the public in understanding how the forest land statutes have been and will be implemented by the department.

COMMENT NO. 8: Technical Problems - Ms. Whittinghill stated there are some technical problems with ARM 42.20.725(4). She suggested that this section may not even belong in this rule. She stated the language contained in this amendment is something that has already been done. This rule also references a rule that deals with class 4 property, therefore it appears there is an incorrect internal reference in this rule.

RESPONSE NO. 8: The department has used the change in language included in ARM 42.20.725(1)(b) to clarify that forest lands are subject to phase-in provisions in Montana statutes. The language is also used to clarify that the "full phase down" provisions are applicable should there be a decrease in value caused by the reappraisal.

COMMENT NO. 9: Legal Opinion - Mr. Swanson asked if there had been any discussion about the legal requirement to have the advisory committee involved before the department set the cap rate. He asked if the position in the rules was considered a legal opinion of the department because the statute seems to be saying that the cap rate, in this cycle, will be set by the department after consultation with the committee rather than for the next cycle, which may be completely changed by the Legislature. He stated that the statutory language seems clear and conflicts with the proposed rule language.

RESPONSE NO. 9: As noted in the department's response to Comment No. 4, the Forest Lands Taxation Advisory Committee was not established until the adoption of House Bill 658 in April of 2009. Because the committee did not exist at the time the department was required to establish its cap rate for the 2009 – 2014 cycle, the department could not have consulted the committee.

The cap rate used in the 2009 – 2014 cycle was established by the department based upon the cap rates that existed in 2003 – 2007. The use of these prior year cap rates as a basis for the current year cap rate calculation is required by 15-44-103(6), MCA. A review of the prior year cap rates indicated that the cap rate for each of was lower than 8%. Because 15-44-103(6), MCA provides that capitalization rate for each of the base years used to establish the cap rate for the 2009 – 2014 cycle may not be lower than 8%, the department adjusted each year's cap rate to 8% minimum rate. This resulted in the overall cap rate of 8% that was used to value forest lands for the 2009 – 2014 cycle.

The language in the proposed rule does not conflict with existing law. The cap rate established by the department was established in accordance with Montana law. If the Legislature chooses to amend 15-44-103(6), MCA in the future, the department will amend its process and rules to comport with the Legislature's mandate at that time.

COMMENT NO. 10: Retroactive Applicablilty - Ms. Patty Lovaas, Missoula stated the proposed rules are an attempt to provide some legal authority for the manipulation of values and limit mitigation rights following the legislative session ex post facto (retroactively). She further stated a rule is designed to implement or interpret prescribed law, not create it. Committees do not have the legislative authority to adopt rules which in essence increase property taxes without full enabling legislation.

Ms. Lovaas further stated the Revenue and Transportation Interim Committee members should require an economic impact statement of the adoption of these rules, many of which were adopted by the department in the 2009 appraisal assessments without enabling legislation.

Ms. Lovaas suggested that unless there is a full legislative analysis of the impact of these proposals, they should be rejected.

RESPONSE NO. 10: The amendment of these rules has nothing to do with retroactive applicability of an enacted statute. This rule action is in compliance with the requirements of the Montana Administrative Procedure Act.

3. The department amends ARM 42.20.701, 42.20.705, 42.20.715, 42.20.720, 42.20.725, and 42.20.745 as proposed.

4. An electronic copy of this Adoption Notice is available through the department's site on the World Wide Web at www.mt.gov/revenue, under "for your reference", "DOR administrative rules"; and "upcoming events and proposed rule changes." The department strives to make the electronic copy of this Adoption Notice conform to the official version of the Notice, as printed in the Montana Administrative Register, but advises all concerned persons that in the event of a discrepancy between the official printed text of the Notice and the electronic version of the Notice, only the official printed text will be considered. In addition, although the department strives to keep its web site accessible at all times, concerned persons should be aware that the web site may be unavailable during some periods, due to system maintenance or technical problems.

/s/ Cleo Anderson /s/ Dan R. Bucks

CLEO ANDERSON DAN R. BUCKS

Rule Reviewer Director of Revenue

Certified to Secretary of State February 16, 2010