Bowater Canadian Forest Products Inc. v. Municipal Property Assessment Corporation, 2015 CanLII 38435

Assessment Review Board

Commission de révision de l’évaluation foncière

ISSUE DATE: July 3, 2015

FILE NO.: WR 129844

Assessed Person(s): Bowater Canadian Forest Products Inc.

Appellant(s): Bowater Canadian Forest Products Inc.

Respondent(s): Municipal Property Assessment Corporation ("MPAC") Region 32

Respondent(s): City of Thunder Bay

Property Location(s): 2001 Neebing Avenue

Municipality(ies): City of Thunder Bay

Roll Number(s): 5804-030-107-00100-0000

Appeal Number(s): 2024720, 2348878, 2695972 and 2923401

Taxation Year(s): 2009, 2010, 2011 and 2012

Hearing Event No. 570115

Legislative Authority: Section 40 of the Assessment Act, R.S.O. 1990, c. A.31, as amended

Heard: September 9, 10, 11 and 12, 2014 in Thunder Bay, Ontario; September 17, 18, 19, 23, 24, 29 and 30, 2014 in Toronto, Ontario; October 1, 2, 3, 6, 7 and 8, 2014 in Toronto, Ontario and November 10, 12 and 14, 2014 in Toronto, Ontario

APPEARANCES:

Parties Counsel

Resolute FP Canada Inc. Richard Minster

MPAC Jack Jamieson

City of Thunder Bay Tom Halinski

DECISION OF THE BOARD DELIVERED BY BERNARD COWAN AND SCOTT McANSH

1This appeal concerns what was once the largest pulp and paper mill in Ontario. The mill, currently owned by Resolute FP Canada Inc. ("Resolute"), was constructed in 1926 and has had a colourful and varied history. The pulp and paper industry has changed dramatically over the past 90 years and so has the viability of operations at the mill. The forestry industry in northern Ontario has undergone a devastating decline since the turn of the century. Both MPAC and Resolute argue that this should be reflected in the value of the property and necessitates substantial reductions to the assessment as returned. The City of Thunder Bay (the "City") agrees that the industry has been hard hit, but argues that the property is still worth the assessed value of $72,232,000.

2Prior to the hearing the parties reached agreement on a number of issues and filed an Agreed Statement (the "Agreement") at its commencement. The Agreement lists 16 elements upon which they agree. Based on the evidence and argument before us, we accept each element of the Agreement as agreement among the parties.

3Of particular importance, the parties agreed that the property should be assessed using the cost approach to value, and agreed on the reproduction costs new of the buildings and yardworks. This panel must determine the state and condition of the property for each taxation year under appeal and the appropriate amount of depreciation to be removed from the agreed reproduction costs new.

4The subject property is a 268.37 acres site with a number of buildings built between 1926 and 2012 to support pulp and paper production on the site. The mill currently produces newsprint and kraft pulp. The current state of the mill has large areas that contain machines not in use. This is the result of a series of phases of construction and closure over the mill’s 90 year history.

5The mill has had a total of five newsprint lines, numbered 1 through 5, and two kraft pulp lines, labelled Kraft A and Kraft B. Only two paper machines and one pulp line were in operation during the assessment period. Newsprint machines number 1 and 2 were removed many years ago and the buildings that housed those machines have been demolished. Paper Machine 3 began operations in 1957, was idled in 2003 and permanently closed in 2006. Kraft A began operations in 1966 and was permanently closed in 2006. The three machines in production at any time during the relevant time frame for these appeals were Paper Machine 4, Paper Machine 5 and Kraft B.

6The paper machines need a form of pulp in order to operate and the source of pulp supplied to those machines has changed over time. Historically the paper machines were supplied with groundwood and sulphite pulp, but those machines now sit idle on the site. In 1989 the mill underwent a substantial upgrade, which included the construction of a thermo-mechanical pulper ("TMP") which is a collection of modern, energy intensive, machines that create pulp through the application of heat and mechanical force. Pulp from the TMP is currently the only pulp used in this mill’s newsprint production. In 1991 the mill opened a recycle plant, which can create pulp from old newsprint and that pulp was used with pulp from the TMP to produce newsprint.

7In addition to newsprint, the mill produces Kraft pulp, which is a chemically produced pulp used primarily in tissues, paper towels and similar products. Kraft is a very strong pulp sold to other producers in the market. The mill produces both a hardwood and a softwood kraft, which command different prices in the pulp market. The mill ran one kraft pulp production line, Kraft B, producing both hardwood and softwood kraft, throughout the assessment period. The Kraft A line sits idle on the site.

8The paper industry has fallen on difficult economic times and the newsprint industry has been devastated by changes in advertising and circulation triggered by the internet. Paper mills have closed across the province, having a great impact on northern communities. The mill went through a difficult time before and during the 2009 to 2012 assessment period. The newsprint market has been in sharp decline since 2000 and by 2007 the mill was attempting to use its specialized newsprint machines to produce other types of paper products, with limited success. Paper Machine 5 was used to make a variety of specialty paper, including book paper and paper bags. During that time Paper Machine 5 was also used to make a basesheet for coated paper, which was then shipped to another plant in Michigan for coating. Neither specialty paper nor basesheet production were profitable and both plans were abandoned in late 2008.

9From January 2009 until August 2009 Paper Machine 4 and Paper Machine 5 were not operated simultaneously, but were producing newsprint alternatively for two weeks periods and then shut off for two weeks. In August 2009 both machines were shut down when the owner of the mill, at that time Abitibi-Bowater Consolidated, went into creditor protection pursuant to the Companies' Creditors Arrangement Act, RSC 1985, c. C-36 (the "CCAA"). Resolute emerged from this protection in December of 2010. While subject to the CCAA, operations could only be restarted subject to approval by a court appointed monitor. It was in that situation that mill personnel developed what was referred to at the hearing of this matter as "the plan that saved the mill."

10The plan that saved the mill, largely credited to Peter Giardetti, the mill’s manager of manufacturing services, involved restarting Paper Machine 5 to produce newsprint. The plan was to use the time sensitive pricing of electricity in Ontario to keep costs down. This would be done by only running the energy intensive TMP during off-peak pricing times, 7:00 PM to 7:00 AM and all weekend, and run the recycle plant when the TMP was not running. In this way they would only need one pulping staff as neither pulping facility would be running at the same time and they could produce enough pulp to run Paper Machine 5 constantly. This plan was approved by the monitor and is how the mill operated for the bulk of the assessment period under appeal. In 2011 the cost of old newsprint became prohibitively expensive and the recycle plant was shut down.

11Against this background we must determine the appropriate current value of the mill.

ISSUES

12The overriding issue in this appeal is the current value of the mill. The parties made many concessions before the hearing began, and we commend them for those efforts. However, there are a number of issues that must be determined by this panel in determining the current value of the mill.

13The parties have agreed that the cost approach to value should be used. The cost approach determines value by asking what it would cost to build a structure of similar utility to the mill. The parties agree that the cost of rebuilding the mill as it exists, or the reproduction cost new, is $200,791,000 for the buildings and $37,234,815 for the yardworks. We must decide the appropriate amount of depreciation to deduct from these amounts in order to determine the current value of the mill as at the valuation day January 1, 2008.

14One deduction is due to the fact that a person would not rebuild the mill as it stands today because it contains many inefficiencies, referred to as functional obsolescence. This is expressed in two forms: excess capital costs and excess operating costs. The reproduction cost new includes buildings that would be not be built in a new mill, or built in a different way. We must determine the amount of the excess capital cost contained in the agreed reproduction cost new. The existing mill also costs more to operate than a model mill because of its less than ideal layout. We must determine an appropriate reduction to the reproduction cost new to reflect that reality. A deduction is also necessary to reflect the age of the buildings. We must determine the appropriate amount of this physical depreciation. Finally, we must determine an appropriate deduction for the economic obsolescence resulting from the impact of the decline in the pulp and paper industry on the value of the mill. Once those deductions are determined the agreed land value of $1,288,176 must be added to arrive at the current value for the property.

15The parties each take a different approach to this valuation problem. MPAC, represented by Jack Jamieson, argues that the current value of the mill is $37,433,000 based upon its expert’s approach, which used a mathematical factor in estimating a replacement mill. The City, represented by Tom Halinski, argues that the current value of the mill should be as returned, $72,232,000, based on its experts’ return on capital methodology. Resolute, represented by Richard Minster, argues that the current value of the mill should be $27,464,000, based upon its expert’s modified greenfield assessment model.

16However, before turning to current value we must determine the state and condition of the mill for each taxation year’s assessment. The mill underwent changes in its operations and production volume throughout the assessment period, though it was always used as a pulp and paper mill. MPAC and Resolute urge us to value the mill for all of the taxation years as if it were operating under the plan that saved the mill. The City takes the position that the changes in production over the assessment period should be reflected in differing current values for each taxation year.

17Finally, Resolute argued that a downward adjustment to the current value should be made in order to make the assessment equitable with other properties in the vicinity. Both MPAC and the City disagree. We must also address this issue.

DECISION

18We find that the assessed value of the property should be reduced from $72,232,000 to $32,620,000 for the 2009, 2010, 2011 and 2012 taxation years. Additionally, we find that this current value is not indicated by the evidence to be inequitable with the assessments of similar lands in the vicinity.

REASONS FOR DECISION

Legislation

19Section 36.(1) of the Assessment Act ("Act") requires assessments to be made annually and s. 32.(2) requires that the assessment roll be returned to the municipality "not later than the second Tuesday following December 1 in the year in which the assessment is made."

20Section 44.(3)(a) of the Act requires the Board to "determine the current value of the land." Current value is defined in section 1 as "the amount of money the fee simple, if unencumbered, would realize if sold at arm’s length by a willing seller to a willing buyer." That is, for each taxation year the Board must determine what the mill would have sold for in an arms-length transaction on the January 1, 2008 valuation day set by the Act for the 2009-2012 taxation years. For a special purpose property such as this, it is important to note that s. 3(1)(17) of the Act excludes from assessment "all machinery and equipment used for manufacturing… purposes… including the foundations on which they rest."

21Section 44.(3)(b) of the Act requires that the Board "have reference to the value at which similar lands in the vicinity are assessed and adjust the assessment of the land to make it equitable that of similar lands in the vicinity."

Current Value

22The cost approach to value operates on the principle of substitution. It is assumed that the value of a property does not exceed the amount that it would cost to replace that property with a substitute of similar utility. This means that the utility of the property is important in determining its value and this is why our first step in this analysis is determining the utility of the property, which may change with its state and condition on each roll return date.

State and Condition

23Property is assessed each year as of the roll return date for that taxation year, which is the second Tuesday following December 1 of the previous year. Thus, the state and condition date is December 9, 2008 for the 2009 taxation year, December 15, 2009 for the 2010 taxation year, December 14, 2010 for the 2011 taxation year, and December 13, 2011 for the 2012 taxation year. The mill is to be assessed based on its condition on those dates.

24Section 36.(1) of the Act, and its predecessor, have been interpreted to apply in a strict manner. In Williams v. Regimbal, 1935 CanLII 91 (ON CA), [1935] O.R. 199 the Court of Appeal fixed the date of return of the assessment roll, stating "any changes that take place after that date in the ownership of the property must be ignored in the assessment for that year at least." In Gilbey Canada Inc. v. Regional Assessment Commissioner, Region No. 12 (1996), 33 O.M.B.R. 323 ("Gilbey") the Ontario Municipal Board ("OMB") applied Williams v. Regimbal in holding that "the assessment of real property is determined by the situation and facts as they were at the time of the return of the roll." In that case the property was a distillery that was announced to be closing in August 1990. It closed on December 20, 1990 and the roll had closed on December 18, 1990. The OMB found that because the distillery had operated on the roll return date, it should be assessed as a distillery for the subsequent taxation year. Similarly, in Inmet Mining Corp. v. Municipal Property Assessment Corp, Region No. 32, [2001] O.A.R.B.D. No. 1006, a differently constituted panel of this Board held that the roll return date is "when a ‘snapshot’ of use and occupation may be taken for use in the determination of an assessment". That case also dealt with a closure shortly after the condition date. The Board’s decision in Inmet was upheld by the Divisional Court, (2002) 2002 CanLII 7325 (ON SCDC), 163 O.A.C. 59.

25This jurisprudence makes it clear that the use and ownership of a property are fixed as they are at the date the tax roll is returned for the next taxation year. The use of the mill was always as a pulp and paper mill and the ownership of the mill was consistent throughout the assessment period. However, the evidence before us is that the configuration of the mill has an impact on value and thus the snapshot must not only be of the use, which did not change, but of the configuration of that use. That is, we must determine the general operation of the mill on each condition date.

26The mill went through a number of changes over the four taxation years at issue here. The mill operated Kraft B throughout the entire assessment period, but there were changes to the operation of the paper machines. On December 9, 2008 the mill was running Paper Machine 4 for newsprint and running Paper Machine 5 for specialty papers with limited success. On December 15, 2009 the paper machines were shut down because the company was subject to CCAA protection. On both December 14, 2010 and December 13, 2011 the plan that saved the mill was in effect. That is, the TMP was running at off-peak electricity hours and the recycle plant was running during peak electricity hours, both to feed Paper Machine 5.

27Notwithstanding this evidence, Resolute and MPAC urge us to treat the mill for all four years as though it was configured as it was for the 2011 and 2012 condition dates. That is, they urge us to ignore the condition of the mill on the 2009 and 2010 condition dates. They state that the plan that saved the mill is the highest and best use of the mill and should therefore be the configuration on which it is valued. We cannot accept this position. "Highest and best use" is an assessment valuation principle requiring a great deal of market evidence to prove. State and condition, on the other hand, is a factual finding. The highest and best use of a property does not necessarily have any bearing on its state and condition. It would be difficult to argue that the highest and best use of the property in Gilbey was a distillery four months after its closure had been announced and two days before it shut down.

28The City urges us to use the installed capacity of the mill for each taxation year as its state and condition. It takes the position that the mill should be treated as having two paper machines for both the 2009 and 2010 taxation years as Paper Machine 4 was not fully shut down until the final quarter of 2010, even though it has not been used for production since August 19, 2009. The argument of the City is that the installed capacity is the utility of the mill, which is the basis for value under the cost approach to value. They argue that is does not matter that Paper Machine 4 and Paper Machine 5 were both shut down on December 15, 2009 because the installed capacity was still present and could have been used.

29We agree that the utility of a property is not dependent on how it currently operates per se. For instance, it would be illogical to treat the mill as a one pulp line facility for the 2010 taxation year because it had no paper machines operating on the condition date. However, utility is also not limited to the physical existence of machines in the mill. There are certain economic situations in which machines will have no utility. The evidence before us is that the mill was not operating at a profit when both paper machines shut down and it went into CCAA protection in 2009. The paper production process only restarted under the plan that saved the mill. That configuration, developed under the pressures of CCAA proceedings, is very likely the highest utility of the installed capacity at the mill. We accept that it was a discoverable configuration throughout the assessment period and would have been considered by many theoretical buyers. Thus, the utility that a purchaser would have paid no more to achieve was the utility achieved through the plan that saved the mill.

30For those reasons the use of the subject property was as a pulp and paper mill for each condition date. The value of the mill should be based on the utility of the property, which was a one kraft pulp line, one paper machine mill with an off-peak TMP and an on-peak recycle plant for each taxation year under appeal. In making this finding, we are aware that we have reached the conclusion advocated by MPAC and Resolute, but for different reasons.

Functional Obsolescence - Excess Capital Costs

31Excess capital costs are the difference between the reproduction cost new of the buildings on the site and the replacement cost new of a building with like utility. The agreed reproduction cost new, $200,791,000, is the cost as of the valuation date to construct the buildings that currently exist on the site. However, someone building a mill of like utility would not build the vacant and unused buildings that exist on the site. Rather, a modern mill would be smaller and more efficiently built than the mill that exists. An estimate of what it would cost to construct a modern mill of similar utility is the replacement cost new. The difference between the reproduction cost new and the replacement cost new represents the excess capital costs, being the costs to construct the buildings that are not currently used.

32Each party took a different approach to the excess capital cost. Malcolm Stadig was the valuation expert for MPAC. He estimated the replacement cost new using a mathematical factor, based on Member Wyger’s decision in Domtar Inc. v. Municipal Property Assessment Corporation, Region No. 30, [2013] O.A.R.B.D. No. 27 ("Domtar"), applied to installed capacity. Bob McNally and Chris Perret of MNP LLP were the valuation experts for the City. They did not attempt to estimate the excess capital cost and in general did not approach the valuation problem the same way as the other valuation experts. Finally, Mathias Hintikka of Ryan ULC was the valuation expert for Resolute. He used a modified greenfield method that looked to the operation of the subject mill and removed buildings or portions thereof that had little or no utility.

33For the reasons that follow we prefer and adopt Mr. Hintikka’s method of determining excess capital costs, with a small modification respecting the TMP and recycle plant. This approach leads to our determination that the excess capital costs are $94,307,831.

34Mr. Stadig reviewed the decision in Domtar where Member Wyger accepted Domtar’s position that they could produce the same amount of pulp and paper annually at their large mill in Espanola in a modern mill with a much smaller floor area. Mr. Stadig then divided the floor area of the Domtar model mill by the production capacity of the Espanola mill to create a factor of 1.831556, which he conceded could be treated as 1.83 as it was not overly precise. Mr. Stadig indicated that this factor could be multiplied by the installed capacity at any mill to yield an estimate of the square footage of a modern replacement mill. He stated that this factor had been used in various negotiated settlements with other mills in northern Ontario and that it provides a fair proxy for a model mill, which would be very complex and costly to actually calculate. Mr. Stadig applied the calculated gross floor area of a model mill for the subject property by applying the factor to its production capacity and multiplied the result by the $71.81 average reproduction cost new per square foot. This yielded the replacement cost new, and hence his calculation of the excess capital costs.

35Mr. Stadig was a very candid and believable witness and readily admitted weaknesses in his method. He conceded that it presumes a linear relationship between area and production which may not exist. He also acknowledged that different parts of the mill have greatly differing construction costs, which raises doubts about his average value. This is due to his further admission that the mathematical model does not apportion between the types of buildings or the layout of the model. This means that there is no way to say what each portion costs, bringing into question the validity of using the average cost per square foot of the reproduction cost new, which includes mostly underused areas of the mill.

36Mr. Hintikka used the existing mill to create an estimate of the replacement cost of a mill of similar utility. He indicated that he consulted with the mill’s engineers to determine which buildings were actively used in its operations. He provided a map of the mill with the used portions shaded blue, the marginally used portions shaded orange and the unused portions in brown. Mr. Hintikka then went through the list of buildings and removed the reproduction cost of those buildings shaded orange or brown. The reproduction cost new of remaining buildings constitutes the replacement cost of the model mill, with two exceptions: the TMP and the recycle plant.

37Mr. Hintikka was of the opinion that the time limited nature of the TMP and recycle plant in the plan that saved the mill should lead to a reduced reproduction cost new. His position was that because one cannot run the TMP constantly due to the high peak price of electricity in Ontario, one cannot use the full capacity of the TMP. He argued that the TMP replacement cost should be 2/3 of its full cost. We disagree. The cost of a mill with the same utility as the subject in Ontario would most probably require a TMP the same size as the subject. Enough pulp for Paper Machine 5 can likely only be produced during off-peak hours with a full sized TMP. A 2/3 TMP would provide the same utility in another economic situation, but it is not the purpose of the excess capital cost exercise to account for external economic limitations. The utility of the subject mill can only be achieved with a full sized TMP. The same reasoning would apply to the recycle plant, which was only operated when the TMP was not, for staff cost reasons, which goes to the utility of the operation.

38The City raised another concern with Mr. Hintikka’s method. Mr. Hintikka removed a standalone building known as the waferboard building. This is a building that was historically used to manufacture waferboard, but has not been used for that purpose for some time. Mr. Giardetti indicated that the building is currently used for storage purposes, but would not be used for that purpose if it were not there. In his cross-examination by the City he conceded that a dry industry could likely use the building, but was clear that it has no sewer connection, which would limit the uses to which the building could theoretically be put. He also thought there may be some Ministry of Environment use limitations, but he was not sure. The City takes the position that this building should be assigned a value, both because it is used for storage and because it has another potential use.

39We are not persuaded that the waferboard building should be valued in the model mill. The cost approach looks to the utility of the property and Mr. Giardetti was clear that mill staff see no utility in the waferboard building. While it is possible to imagine the building being put to another use, mere speculation is not enough evidence to prove that the waferboard building has another highest and best use not connected to the utility of the mill. We did not hear any compelling evidence on what that use might be or how that potential use would be valued. We therefore accept Mr. Hintikka’s conclusion to remove the waferboard building from his modified greenfield model.

40We accordingly adopt Mr. Hintikka’s testimony in cross examination that including the entire TMP and recycle plant in the modified greenfield model leads to a replacement mill of 1,411,066 square feet, with $94,307,831 in excess capital costs.

Physical Depreciation

41Physical depreciation is a reduction in the value of buildings due to the wear and tear that takes place over time. The age of a building and its condition both contribute to how much physical depreciation is appropriate. Each of the three parties advocated different approaches to physical depreciation. Mr. Stadig used MPAC’s 50 year useful life tables from its Automated Costing System ("ACS"). He calculated an age of 21 years for the mill, which is a production weighted average of the age of Paper Machine 5 and Kraft B. Mr. McNally and Mr. Perret used depreciation tables from the Marshall and Swift valuation service and applied the percentage reduction to each building based on 90% of the building’s age. Mr. Hintikka applied MPAC’s ACS tables to the buildings remaining in his modified greenfield model based on the actual age of those buildings.

42We prefer the physical depreciation calculated by Mr. Hintikka.

43The agreed reproduction cost new of $200,791,000 is based on the ACS system so it is more logical to apply those depreciation tables than to use tables from another service, such as Marshall and Swift. MNP was candid that the results of the two services vary. MNP’s use of 90% of a building’s age was not adequately justified, as there was no evidence of exceptional maintenance practices or other factors that would make the buildings seem newer than their actual age. We also prefer Mr. Hintikka’s application of depreciation to each building in the replacement mill over Mr. Stadig’s use of the average age of the machines inside the buildings, which are exempt from taxation. The buildings vary greatly in age and would therefore have different amounts of physical depreciation, which would not be captured in Mr. Stadig’s approach to physical depreciation.

44Mr. Hintikka’s calculation of physical depreciation when the full TMP and recycle plant are included in his model is $37,261,472 and we accept this as the correct value for physical depreciation.

Functional Obsolescence – Excess Operating Costs

45Functional obsolescence occurs not only because of the excess capital costs of buildings. Poor layout of a facility can increase the operating costs of the business, reducing the value of the property to any potential buyer. The parties drew our attention to a number of these inefficiencies on our tour of the mill, which was conducted with all three parties present. These included heating large areas for the sole purpose of preventing frozen pipes, maintaining large empty buildings for safety reasons, and moving finished rolls of paper down a lowerator (reverse elevator) and across an empty space to get them to a shipping area. All of these issues arise from the stages of construction and closure that have happened over the life of the mill and all increase the operating costs for any potential purchaser of the mill.

46Mr. Stadig stated that he did not have the data required to quantify the excess operating costs and therefore suggested a 5% reduction. This was in accordance with the use of 5% for excess operating costs in Domtar and is an MPAC standard reduction for piecemeal construction. Mr. McNally and Mr. Perret did not estimate excess operating costs. Instead they estimated a percentage reduction for functional obsolescence on a building by building basis with no objective justification. They were candid that this process lacked rigor. Mr. Hintikka was the only expert to attempt to quantify excess operating costs using financial data from the mill.

47We cannot put any weight on the unsupported qualitative estimates of functional obsolescence provided by Mr. Stadig, Mr. McNally and Mr. Perret. We accept Mr. Hintikka’s calculation of functional obsolescence, with some modification, as the best evidence of excess operating costs.

48Mr. Hintikka provided a quantified method for determining excess operating costs. He obtained a list of "fixed" costs for the mill for 2007 and 2008, converted those costs to Canadian dollars and averaged them over those two years, yielding the annual costs he utilized. The categories of fixed costs used were labour (maintenance), benefits, repairs, taxes and insurance, other mill costs, power and fuel. The total, averaged over 2007 and 2008 and converted to Canadian dollars, was $115,396,000.

49To determine the excess operating costs Mr. Hintikka estimated that 10% of these costs could be attributed to the buildings. A cost per foot of building area was then calculated by dividing that value by the agreed area of the mill to arrive at a cost per square foot of $4.14, which Mr. Hintikka rounded to $4.00 per square foot. This was applied to the excess building area, which he calculated as 1,391,967 square feet, for an annual excess operating cost of $5,567,869. Mr. Hintikka removed 32% in corporate income tax from this amount because these expenses have income tax impacts. He calculated the current value of the excess operating costs to be $27,866,402 using a discounted cash flow with a discount period of 10 years and a discount rate of 6%.

50Mr. Hintikka acknowledged the limitations of this approach. He agreed that his average assumes costs are constant over all buildings, even though we heard evidence of a lower maintenance standard in dark areas. A similar issue was acknowledged with insurance costs. MPAC’s counsel suggested that taxes would not apply to the dark areas of the plant as they produce no income. He also suggested that the costs outlined are not fixed as they vary a great deal from year to year and 2007 and 2008 were expensive years, as the plan that saved the mill had not yet been implemented. He urged us to reject this method for those reasons.

51While we acknowledge weaknesses in Mr. Hintikka’s data, we consider it to be the best evidence and approach offered in this particular matter. The method he proposes makes a great deal of sense in quantifying excess costs. We agree with MPAC that taxes likely have a very minimal application to dark areas of the mill. We do not have any evidence as to the insurance requirements on the dark areas or any indication of how to split that cost category between its two components. Given that, we find that the exclusion of taxes and insurance is more preferable for this calculation. We also agree with MPAC that 2007 and 2008 were expensive years due to the constant use of the TMP. In particular, it is of note that the 2007 power cost was $25,631,000, while the 2008 cost was $38,626,000, a 30% difference. This certainly raises concerns with the stability of these supposedly fixed excess costs. The lower 2007 power cost of $25,631,000 is adopted by us in lieu of the $32,129,000 average and and we have removed the taxes and insurance average of $5,820,000, leading to a cost per square foot of $3.69.

52Mr. Skiffington and Mr. Giardetti, mill supervisors, indicated that 2007 and 2008 were challenging times for the mill, when it seemed that the mill may be shut down at any time. Various configurations of the paper machines were tried and the newsprint mill only restarted under CCAA protection due to the greatly reduced costs of operation under the plan that saved the mill. We were never given a firm percentage on how much that plan reduced costs, but off-peak electricity pricing is much lower than peak pricing, and a reduction in staff would have accompanied the new plan. These cost reductions reasonably support rounding $3.69 down 5% to $3.50 for the purposes of calculating the excess costs. On a balance of probabilities, this represents the most likely excess operating cost per square foot.

53We have modified Mr. Hintikka’s model mill so the square footage of the excess area is different from the one he used in his calculations. We have determined in paragraph 40 above that the area of the model mill is 1,411,066 square feet. Mr. Hintikka conceded that the unheated and unmaintained Woodroom and Fuji King buildings should be removed from the excess area because they are detached from the main structure and would not likely incur any of the fixed costs. We agree that it is appropriate to remove the square footage of those structures. The excess area of the mill for this method is calculated as the 2,796,174 square feet of the existing mill, less the 1,411,066 square feet of the model mill, less the 124,065 square feet of the Woodroom and Fuji King, for a remainder of 1,261,043 square feet in excess area.

54Multiplying $3.50 per square foot by 1,261,043 square feet of excess building area yields an annual excess operating cost of $4,413,651. Removing 32% in income tax indicates net annual excess operating costs of $3,001,283.

55In order to change this annual amount to a present value we use the discounted cash flow method that was used by Mr. Hintikka, with a 10 year discount period and a 6% discount rate. The factor for that analysis can be determined by dividing his present value by his annual costs. Applying that method yields a reduction of $22,089,704 for functional obsolescence, excess operating costs.

External Obsolescence

56External obsolescence is an impairment in the utility or value of a property due to influences outside of the property. There is no question that the dramatic decline in the newsprint business has had an impact on the value of the mill. The challenge is in quantifying the appropriate amount of obsolescence to apply. External obsolescence is the most difficult form of obsolescence to quantify due to the diffuse nature of its causes and the difficulty in applying those external factors to the subject property. There is no generally accepted technique to place a value on external obsolescence, though each of the parties to this appeal offered at least one method for our consideration.

57Mr. Stadig put forward two methods for determining external obsolescence. First, he proposed that the total depreciation could be calculated by applying the ratio of the effective age of the mill to its total economic life and multiplying that ratio by the replacement cost new. He assumed an effective age of the mill of 27 years and looked at five mills that had closed in Ontario in 2006 and 2007 to determine an economic life expectancy of 46 years. Based on those assumptions he calculated a total depreciation of 58.7%, from which he removed the other forms of depreciation he had calculated. The remaining 24.9% depreciation was allocated to external obsolescence.

58Mr. Stadig’s second method was a gross margin analysis. He looked at the gross margins for five forest product companies from 2002 through 2008. He then determined the percentage difference between the best performing year and the average performance of 2007 and 2008, to best correlate to the January 1, 2008 valuation date. The theory behind this approach is that a decline in an industry will be observable in the changing profit margins of the players in that industry. His calculation found declines ranging from 10% to 64%, with a median of 27.6%.

59In the cross-examination of Mr. Stadig we were made aware of an undated internal MPAC memorandum which states that "for the 2008 base year MPAC has put in place an economic obsolescence of 40% on most purpose built wood fibre industrial facilities." Mr. Stadig did not accept that as an appropriate reduction for external obsolescence at the subject mill because it was issued before MPAC had begun using a hypothetical replacement cost new model for the valuation of pulp and paper mills whose assessments were appealed. It was Mr. Stadig’s position that MPAC’s change in methodology made previous guidance irrelevant.

60Both Mr. McNally and Mr. Perret stated repeatedly that their less than thorough functional obsolescence analysis was not material due to the robust nature of their external obsolescence method. They referred to their method as the return on capital method. The first step was to estimate the ratio of buildings to machinery and equipment and apply an expected rate of return to each. Multiplying the values by the expected rate of return leads to an expected return. They would then look at an estimate of the actual return achieved at the mill and calculate the difference between that return and what was expected. The shortfall was the external obsolescence.

61It was made very clear through their cross-examination that this method applied by MNP to the subject property was only sensitive to three inputs: (1) the expected rate of return; (2) the percentage of value assigned to buildings versus that assigned to machinery and equipment; and (3) the estimated return achieved. Mr. Perret consistently insisted that the method could not apply when the rate of return exceeded the expected rate of return. However, the evidence still demonstrated that the depreciated value of the buildings was irrelevant to their calculation. We are of the opinion that this is not a cost approach, but rather an income approach to value. An income approach determines value by applying a capitalization rate to a property’s income. The MNP method calculated an income and effectively applied a capitalization rate of 13.6%. The outcome of their method did not depend on any other input.

62While the income approach is a valid approach to value in many applications, it is very difficult to apply to a special purpose property such as the mill. A mill is purchased to earn an income, but not by renting the mill in a stable way. Operating a large complex process in a volatile market does not lend itself well to a stabilized income, which is essential in accurately using the income approach. It is also very difficult to say what the capitalization rate would be on a mill as there is a very limited market, if any, to canvass for that information. There is no such supporting evidence in this instance. Mr. Perret stated that the expected rates of return used by MNP were based on his expertise and not on any other market data that he could provide to the Board. We did not find that assertion credible.

63Mr. Perret was a somewhat evasive and difficult witness in cross-examination. He made few concessions, even when confronted with compelling evidence of a weakness in his calculations. While Mr. McNally was a much more believable witness, he did not appear to have the same familiarity of the method and material utilized by Mr. Perret and did not provide any sufficiently compelling rationale as to why this panel should put determinative weight on the MNP method.

64Both Mr. Perret and Mr. McNally emphasized the difficulty they had in obtaining financial information from Resolute and stated that they had to proceed on estimated income as a result. The City had pre-hearing remedies if they required more data and it was not useful to have those concerns raised at the hearing. The City was provided with financial information some time before the hearing and MNP provided this panel with an exhibit summarizing the Resolute financial data to support their income estimates. That exhibit only supported their estimates by using inflated sale prices for newsprint and kraft. When prices closer to those achieved where used, any significant income from the mill for the 2008 time period vanished.

65We heard from a number of witnesses on the price of newsprint and kraft. The City called Todd Nash, a management consultant with MNP. His analysis of price was based primarily on a review of RISI, a pulp and paper industry publication. He presented a market analysis supporting a January 1, 2008 price of $745 per tonne for newsprint, $795 per tonne for hardwood kraft, and $870 per tonne for softwood kraft.

66We also heard pricing data from a panel of Resolute executives: John Ovanessian, Vice-President of National Account Sales, John McDonald, Vice-President of Pulp Sales, and John Valley, special advisor the President and CEO.

67Mr. McDonald indicated that in 2007 and 2008 Resolute was receiving $748.20 per tonne for softwood kraft and that the sale price included freight, which averaged approximately $65 per tonne. He testified that the discount from the RISI list price was usually 12-15% on softwood kraft and would have been more on hardwood kraft. Mr. Ovanessian indicated that newsprint demand was declining rapidly from 2000 onward, losing 5-6% per year until 2007 when demand fell by 10% in one year. Mr. Ovanessian was clear that RISI lists prices higher than what can be expected in the market. Mr. Valley described how the downturn in the paper industry was tied to the decrease in US housing starts, due to the interconnectedness of the fiber industry. This was aggravated by the softwood lumber dispute between Canada and the United States. Mr. Valley also alluded to large discounts from industry list prices as standard practice in the pulp and paper industry.

68The combined effect of the evidence from the Resolute executives was to make it clear that the stabilized prices used by MNP were greatly inflated from what would actually have been achieved by the mill. MNP’s valuation is based solely on its calculated cash flow and assumed capitalization rate.

69Mr. Perret and Mr. McNally also highlighted Note 6 to the Abitibibowater Inc. consolidated financial statements filed with their Form 10-K filing to the Unitized States Security and Exchange Commission for the fiscal year ending December 31, 2007. That note stated, in part: "The implied goodwill related to our Thunder Bay reporting unit… was approximately $296 million; therefore we recorded a goodwill impairment charge of $200 million in 2006." MNP argued that this demonstrated that there remained $96 million in goodwill at the Thunder Bay mill in 2008. This may be true, but goodwill is part of the total value of a business, while our obligation is to determine the value of the buildings, which primarily serve as a shelter for the machinery and equipment, the major assets of the business.

70Mr. Perret and Mr. McNally valued the mill as a going concern, meaning that they valued the entire enterprise and assumed that 20% of that value could be fairly assigned to the buildings. However, they did not include an allocation in that going concern to goodwill, despite bringing $96,000,000 of goodwill to the attention of this panel. Mr. Hintikka demonstrated that if an allocation for $90,000,000 in goodwill is incorporated into their return on capital method, the indicated current value of the mill is $25,999,879. Resolute called another valuation witness, Alan Beatty, who calculated that the inclusion of $96,000,000 in goodwill in the MNP method led to an indicated current value of $30,800,000. This is a significant change in the MNP valuation.

71We are concerned that Mr. Perret and Mr. McNally have failed to address the purported goodwill in their calculations. This gap in their methodology brings their conclusion into doubt. We lack evidence to properly evaluate the presence or impact of goodwill on the mill’s current value, but note the dramatic impact from this one adjustment to MNP’s value, which brings their valuation closer to that sought by the other two parties.

72We cannot conceptually accept their income method for calculating external obsolescence. Further, the assumptions MNP used in calculating their external obsolescence are undermined by other evidence, which we prefer. Finally, we have concerns regarding the soundness of MNP’s methodology. For those reasons, the MNP return on capital method is rejected as a method to establish external obsolescence for this mill.

73Mr. Hintikka put forward two methods for quantifying external obsolescence. First he presented evidence on the reduced returns on capital invested in the North American paper industry. His evidence showed that the return on invested capital in the industry was approximately 5% in the time-frame in question, while the weighted average cost of capital at the time was close to 10%. That is, it cost 10% to borrow money and the return expected was only 5%. The theory is then that a purchaser would only pay half price for an asset in the industry in order to break even on the capital investment. This indicates a minimum 50% reduction for external obsolescence. Mr. Hintikka noted that the only significant capital investment at the mill since 1991 was the construction of a Turbo Generator in 2012, which had government funding for approximately half of its cost. This supported his contention that a 50% reduction for external obsolescence is warranted.

74Secondly, Mr. Hintikka suggested that the declining operating margins of companies in the industry could be used to quantify external obsolescence. We heard a great deal of evidence on the dramatic decline in the newsprint industry since the late 1990s. Mr. Hintikka provided evidence that the inflation-adjusted sales from Ontario paper mills declined 41.81% from 2000 to 2008. He took the position that the economic obsolescence at the subject mill would be higher than 40% due to its location, which had a more limited harvesting area due to its proximity to both Lake Superior and the American border.

75We are also mindful of the statement of Member Wyger in Domtar at para. 55: "Given the general uncertain state of the industry… it seems to me that 45 per cent sets a floor level for [external obsolescence] in the pulp and paper industry."

76Based on the evidence and argument before us, we agree with Member Wyger that the decline in the pulp and paper industry justifies at least a 45% reduction for external obsolescence. We find the cost of capital method the most compelling way of quantifying external obsolescence for this property. Looking at the cost and returns on capital in this industry provides strong, readily comprehensible evidence of the discount a purchaser would expect on a capital purchase in the industry. The evidence we heard on the decline in newsprint in particular was shocking. This is an industry that has been demonstrably devastated by the digital age and global competition. Since 2001, many of the pulp and paper mills in Ontario have closed. The external obsolescence in this industry is significant. We accept 50% as a reasonable reduction for external obsolescence.

Yardworks

77Not all of the structures on the subject property are buildings. A large portion of the site is covered with tanks, pipes, purifiers and conveyors. These are known as the yardworks. The parties agreed that the reproduction cost new of the yardworks is $37,234,825. They differed in how they applied depreciation to that amount.

78Mr. Stadig, for MPAC, applied a 62% excess capital cost reduction, as he assumed that the yardworks would have a similar amount of excess capital as the buildings. He then used MPAC tables to determine physical depreciation of 49%. He did not apply any excess operating cost adjustment and applied his 28% external obsolescence to reach his value of $5,140,672.

79Mr. Perret and Mr. McNally calculated the depreciated value of the yardworks to be $16,587,663. They treated depreciation of the yardworks in a manner similar to the depreciation of the buildings. They then applied the 30% external obsolescence they calculated with their return on capital method to reach a value of $11,611,364.

80Mr. Hintikka indicated that he reviewed the yardworks in detail with mill personnel and was told which yardworks were used and which would be removed in a more efficient mill. He provided a tally which shows that those yardworks utilized had a reproduction cost new of $15,534,430, which would then have a 50% external obsolescence reduction applied for a value of $7,767,215.

81While it would have been preferable to have the mill personnel describe the useful yardworks to us directly, we accept Mr. Hintikka’s hearsay evidence on that issue. We prefer the detail provided in that method to the other parties’ assumption that their calculations for the buildings would have the same application to the yardworks. The detailed analysis of which yardworks would be used in a more efficient mill is compelling. For those reasons we accept that the depreciated value of the yardworks is $7,767,215.

Current Value Conclusion

82We find the current value for the subject property to be $32,620,000 calculated as follows:

Agreed Reproduction Cost New $200,791,000

Excess capital costs ($94,307,831)

Physical depreciation ($37,261,472)

Excess operating costs ($22,089,704)

Depreciated Building Value $47,131,993

External Obsolescence (50%) ($23,565,997)

Buildings $23,565,997

Yardworks $7,767,215

Agreed Land Value $1,288,176

Total Current Value $32,621,388

Rounded Current Value $32,620,000

Equity

83Section 44.(3)(b) of the Act requires that the Board "have reference to the value at which similar lands in the vicinity are assessed and adjust the assessment of the land to make it equitable that of similar lands in the vicinity." For the purpose of this mandate, we concur with the unchallenged contention that "vicinity", for this appeal, be restricted to Ontario properties north of the French River.

84Resolute advanced two arguments related to equity. Neither MPAC nor the City introduced any evidence in this regard, but urged us not to make any adjustment for equity. For the reasons set out in this section we do not conclude that the current value of $32,620,000 is inequitable.

85Mr. Hintikka’s first argument is that the mill is inequitably assessed compared to other industrial properties in the vicinity. MPAC has historically used a market adjustment factor ("MAF") as its external obsolescence adjustment for industrial properties. This adjustment varied by region within the province and was significantly lower in northern Ontario than in other parts of the province. For the 2008 base year reassessment MPAC modified the MAF, based on sales data, and a significantly higher reduction was applied to industrial properties in northern Ontario. However, the 2008 base year reassessment also saw the MAF removed from the pulp and paper industry, and replaced by a 40% external obsolescence reduction in initially establishing assessments for these properties.

86Mr. Hintikka indicated that the Bombardier light rail manufacturing facility near the mill received a 62% MAF. He contended that this 22% differential rendered the mill’s assessment inequitable. We do not accept this submission. External obsolescence is one part of a cost analysis and there is no statutory requirement that properties be assessed in the same manner. Section 44.(3)(b) requires us to "have reference to the value at which similar lands in the vicinity are assessed." The Act says nothing of the manner in which similar lands are assessed. We are not convinced that MPAC’s decision to not apply the MAF to pulp and paper mills necessarily means that pulp and paper mill assessments are inequitable.

87Mr. Hintikka’s second and more compelling argument related to the assessment of other pulp and paper mills north of the French River. His analysis compared the assessment per tonne of installed annual paper production capacity at six mills in the determined vicinity. We find that this basis of comparison constitutes the best evidence before us to compare the equity among assessed values of other mills to the subject mill, because that constitutes a rational, predictable and comprehensible approach that overrides the complexity of attempting to compare properties having different machines in different configurations producing different quantities of different product. Converting annual capacity to an assessment per tonne presents us with a meaningful basis to undertake our s.44(3)(b) reference.

88The six mills Mr. Hintikka presented to the panel were:

Location Assessment per Tonne

Fort Francis $42

Iroquois Falls $56

Terrace Bay $66

Kapuskasing $58

Dryden $45

Espanola $26

89The subject property’s current value of $32,620,000 equates to $57 per tonne of capacity, based on its total capacity of 574,000 tonnes. This falls within the range of assessments per tonne of the six mills, and accordingly does not demonstrate the current value for the subject property to be inequitable.

90For the reasons set out above, we are not persuaded that an adjustment is required to the current value of $32,620,000 in order to make it equitable with similar properties in the vicinity.

CONCLUSION

91We reduce the assessment of the subject property from $72,232,000 to $32,620,000 in the Large Industrial tax class for the 2009, 2010, 2011 and 2012 taxation years. No additional reduction is necessary to achieve an equitable assessment with those of similar properties in the vicinity.