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FILED
SAN MATEO COUNTY
MAY 0 4 2018
Clerk of the Superior Court
[€019,m
SUPERIOR COURT OF THE STATE OF CALIFORNIA
IN AND FOR THE COUNTY OF SAN MATEO
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MARK CHURCH, SAN MATEO Case No.: l6-CIV-01058
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COUNTY AS SESSOR,
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Petitioner,
14 Order Re Petition for Writ of
Adminlstrative Mandate
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SAN MATEO COUNTY
ASSESSMENT APPEALS BOARD, ebrula ' 22, 2018
17 133%. '
Respondent. Dept; 28
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Hon. George A. Miram
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GENENTECH, 'INC.
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Real Party in Interest 0RD
Order
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1131
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H 111111111111111
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The Petition for Writ of Administrative Mandate brought by Petitioner Mark
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Church, San Mateo County Assessor, came on regularly for hearing at 2:00 PM.
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on February 22, 2018 in Department 28 of the San Mateo Superior Court, the Hon.
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George A. Miram presiding.
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Order re Petition for Writ of Administrative Mandate - 1
Rebecca Archer, Esq. and Brian Kulich, Esq. of the San Mateo County
Counsel, appeared on behalf Petitioner Mark Church, San Mateo County Assessor.
Charles J. M011 and Troy M. Van Dongen appeared on behalf of real party in
interest, Genentech, Inc. (“Genentech”). There was no appearance by Respondent
San Mateo County Assessment Appeals Board.
After receiving the papers filed by the parties including the lodging of the
Administrative Record, and after hearing the arguments of counsel, the matter was
submitted.
INTRODUCTION
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This petition raises three important issues of first impression that have yet to
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be resolved, either directly or indirectly, in the prior litigation between these
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parties. All three are issues of pure law.
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The First issue requires interpretation of Rule 6, 18 Cal. Code of Reg. §6
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(“Rule 6”) and whether it uses the same or different criteria concerning the
l6 capitalization of expenses that are used in Financial Accounting Standards Board
17 Interpretation (“FASBI”) Rule 34 relating to the Capitalization of Interest. If the
18 rules use the same criteria, what is the burden of proof that a finder of fact must
19 use when weighing evidence concerning whether capitalized expenses should be
20 included in an assessment owned by a publically traded corporation if Audited
21 Financial Statements and SEC Filings issued by such corporations provide for the
22 capitalization of expenses pursuant to FASBI 34 and other accounting principles
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23 generally accepted in the United States?
24 The Second issue concerns the evidentiary import of statements of fact made
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by a publiCally traded corporation in its Audited Financial Statements and in filings
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with the Securities and Exchange Commission (“SEC”). Are such statements of"
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fact binding on the corporation in any way? Are they merely evidence that the
,
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corporation can dispute, refute, contradict, or modify with testimony by a Person
Order re Petition for Writ of Administrative Mandate - 2
Most Knowledgeable, an expert witness, or testimony by percipient Witnesses? To
the extent, a corporation may contradict such statements of fact, What is the burden
of proof that a finder of fact must use when weighing evidence offered in
contradiction of Audited Financial Statements or SEC filings?
The third issue concerns the applicable burden of proof when the trial
balance or general ledger of a publically traded corporation reflects that expenses
have been capitalized, but the Audited Financial Statements and SEC Filings
issued by such corporation do not expressly address or disclose the extent to which
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expenses were capitalized in the Financial Statements themselves. If the general
ledger shows that expenses were capitalized, which party bears the burden of
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proving whether or not those expenses were ultimately capitalized in the Audited
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Financial Statements and SEC Filings as well?
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DISCUSSION
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While the California appellate courts have not issued an opinion resolving
l6 the above issues, the controversy is hardly new. Almost 44 years ago, the United
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l7 States Supreme Court issued its opinion in Commissioner of Internal Revenue v.
l8 Idaho Power (1974) 418 US. 1, 94 S.Ct. 2757,41 L.Ed.2d 535, a case involving
19 the capitalization of depreciation expense for federal income tax purposes by a
20 regulated utility. That opinion includes the following analysis:
21 Construction-related depreciation is not unlike expenditures for wages
22
for construction workers. The significant fact is that the exhaustion of
construction equipment does not represent the final disposition of the
23 taxpayer’s investment in that equipment; rather, the investment in the
24 equipment is assimilated into the cost of the capital asset constructed.
Construction-related depreciation on the equipment is not an expense
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to the taxpayer of its day-to-day business. It is, however, appropriately
26 recognized as a part of the taxpayer’s cost or investment in the capital
asset. The taxpayer’s own accounting procedure reflects this
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treatment, for on its books the '00nstruction-related depreciation was
28 capitalized by a credit to the equipment account and a debit to the
capital facility account. By the same token, this capitalization prevents .
Order re Petition for Writ of Administrative Mandate - 3
the distortion of income that would otherwise occur if depreciation
properly allocable to asset acquisition were deducted from gross
income currently realized. See, e.g., Coors V. Commissioner, 60 TC,
at 398; Southern Natural Gas Co. V. United States, 412 F.2d, at 1265,
188 Ct.Cl., at 373—374.
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
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construction services, and the entire cost; of course, must be
capitalized by the taxpayer having the construction work performed.
11 The Court of Appeals’ holding would lead to disparate treatment
12 among taxpayers because it would allow the firm with sufficient
resources to construct its own facilities and to obtain a current
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deduction, whereas another firm without such resources would be
14 required to capitalize its entire cost includingdepreciation charged to
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it by the contractor.
16 Some, although not controlling, weight must be given to the fact that
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the Federal Power Commission and the Idaho Public Utilities
Commission required the taxpayer to use accounting procedures that
‘18 capitalized construction-related depreciation. Although agency-
19 imposed compulsory accounting practices do not necessarily dictate
tax consequences, Old Colony R. Co. v. Commissioner of Internal
2o
Revenue, 284 US. 552, 562, 52 S.Ct. 211, 214, 76 L.Ed. 484 (1932),
21 they are not irrelevant and may be accorded some significance.
22
Commissioner of Internal Revenue V. Lincoln Savings & Loan Ass’n.,
403 US. 345, 355—356, 91 S.Ct. 1893, 1899—1900, 29 L.Ed.2d 519
23
(1971).The opinions in American Automobile Ass’n v. United States,
24 367 US. 687, 81 S.Ct. 1727, 6 L.Ed.2d 1109 (1961), and Schlude v.
Commissioner of Internal Revenue, 372 US. 128, 83 S.Ct. 601, 9
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L.Ed.2d 633 (1963), urged upon us by the taxpayer here, are not to the
26 contrary. In the former case it was observed that merely because the
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method of accounting a taxpayer employs is in accordance with *
generally accepted accounting procedures, this ‘is not to hold that for
28 income tax purposes it so clearly reflects income as to be binding on
the Treasury.’ 367 U.S., at 693, 81 S.Ct., at 1730. See also Cincinnati,
Order re Petition for Writ of Administrative Mandate - 4
N.O. & T.P.R. Co. V. United States, 424 F.2d 563, 570, 191 Ct.Cl.
572, 583—584 (1970). Nonetheless, where a taxpayer’s generally
accepted method of accounting is made compulsory by the regulatory
agency and that method clearly reflects income, [footnote omitted] it is
almost presumptively controlling of federal income tax consequences.
(Commissioner ofInternal Revenue v. Idaho Power (1974) 418 U.S. 1, 13-15, 94
S.Ct. 2757, 2765-2766, 41 L.Ed.2d 535.)
.The Supreme Court interpreted Internal Revenue Code § 263 “to reflect the
basic principle that a capital expenditure may not be deducted from current
10 income” and “serves to prevent a taxpayer from utilizing currently a deduction
ll properly attributable through amortization, to later tax years when the capital asset
12 becomes income producing.” (Commissioner of Internal Revenue v. Idaho Power
1.,
13 (1974) 418 U.S. 16, 94 S.Ct. 2757, 2766, 41 L.Ed.2d 535.) The court concluded
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as follows: “We hold that the equipment depreciation allocable to taxpayer’s
l5 construction of capital facilities is to be capitalized.” (Commissioner of Internal
l6 Revenue v. Idaho Power (1974) 418 U.S. l, 19, 94 S.Ct. 2757, 2767, 41 L.Ed.2d
17
535.)
18
Four years after the U.S. Supreme Court issued the Idaho Power Opinion
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quoted above, in October of 1979, the Financial Accounting Standards Board
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issued Statement of Financial Accounting Standards No. 34 entitled Capitalization
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of Interest Cost, the Introduction to which states as follows:
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This Statement establishes standards for capitalizing interest cost as
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part of the historical cost of acquiring certain assets. To qualify for
25 interest capitalization, assets must require a period of time to get them
ready for their intended use. Examples are assets that an enterprise
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constructs for its own use (such as facilities) and assets intended for
27 sale or lease that are constructed as discrete projects (such as ships or
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real estate projects). Interest capitalization is required for those assets
if its effect, Compared with the effect of expensing interest, is
Order re Petition for Writ of Administrative Mandate - 5
material. If the net effect is not material, interest capitalization is not
required. However, interest cannot be capitalized for inventories that
are routinely manufactured or otherwise produced in large quantities
on a repetitive basis.
(Statement of Financial Accounting Standards No. 34 (1979) Page 1.)
The sole criteria for the capitalization of interest costs pursuant to Statement
of Financial Accounting Standards No. 34 is (1) that the “assets must require a
period of time to get them ready for their intended use”; and (2) that the “effect [of
capitalizing interest], compared with the effect of expensing interest, is material.”
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The exact nature of the method by which the property is acquired or brought to a
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finished state is irrelevant, providing that on the date acquired, the property is not
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ready for its intended use. The language of Financial Accounting Standards No. 34
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'is mandatory, not permissive: If the two criteria are satisfied, interest must be
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capitalized.
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l6 The mandatory capitalization provision of Financial Accounting Standard
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No. 34 is consistent with the Supreme Court opinion issued in Commissioner of
18 Internal Revenue v. Idaho Power which concluded that a depreciation expense
19 deduction should be deferred “to later tax years when the capital asset becomes
20 income producing.” (Commissioner of Internal Revenue v. Idaho Power (1974)
21 418 US. l, 16, 94 S.Ct. 2757, 2766, 41 L.Ed.2d 535.)
22 The regulations establishing the rules for applying the Reproduction and
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Replacement Cost Approaches to Value for California Property Tax Purposes were
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originally filed on September 7, 1967, and became effective thirteen days
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thereafter, more than seven years before the Supreme Court’s opinion in
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Commissioner of Internal Revenue v. Idaho Power. Rule 6(b), l8 CCR § 6(b)
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provides as follows:
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Order re Petition for Writ of Administrative Mandate - 6
(b) The reproduction cost of a reproducible property may be estimated
either by (l) 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
if
property to a finished state (or to a lesser state unfinished on the lien
date). Estimates made under (2) above may be made by using square—
foot, cubic—foot, or other unit costs; a summation of the in—place costs
of all components; a quantity survey of all material, labor, and other
cost elements; or a combination of these methods.
(18 CCR § 6(b).)
10 This court finds that the Rule 6(b) language “applying current prices to the
11 property’s labor and material components, with appropriate additions for
12
entrepreneurial services, interest on borrowed or owner-supplied funds, and other
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costs typically incurred in bringing the property to a finished state (or to a lesser
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state if unfinished on the lien date)” contains the same criteria as Statement of
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Financial Accounting Standards No. 34, i.e. that the “assets must require a period
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of time to get them ready for their intended use.”
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Genentech argues that:
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The plain language of Property Tax Rule 6(b) indicates the costs
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incurred after the property is in a finished state are not part of the
2O ‘reproduction and replacement costs’ of the property, but, rather are
costs incurred in the use of the property. Accordingly, as this Court
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ruled in the Statement of Decision and as the Fourth Decision
22 followed, costs should not be assessed when they are incurred after
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the property is in its finished state. (2016AR53~52:5-7) Property Tax
Rule 6 further specifies that ‘interest on borrowed or owner-supplied
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funds’ should be included, but only those ‘typically incurred in
25 bringing the property to a finished state.’ 18 CCR § 6.”
26
(Genentech, Inc.’s Response to Assessor’s Opening Brief Page 724—10 [emphasis in
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original].)
Order re Petition for Writ of Administrative Mandate - 7
Genentech argues that the criteria imposed by Rule 6(b) is significantly
different from the criteria imposed by FASBI 34. (See Genentech, Inc’s Response
to Assessor’s Opening Brief Page 1222-8 [“scope of FASB 34 is materially broader
than that or Rule 6”].) Genentech offers no authority for its interpretation of Rule
6(b). It argues, in essence, that under Rule 6(b), capitalization of costs incurred in
connection with developing a long-term asset should stop when the asset has
reached a hypothetical “finished state.” Genentech contends that once an asset is in
a hypothetical “finished state,” the fact that the taxpayer elects to fiirther develop
the asset to get it ready for its intended use would result in additional capitalization
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of such expense under FASBI 34, but not under Rule 6(b). This court disagrees.
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As stated above, this court finds, as a matter of law, that the criteria for
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capitalization of expenses under FASBI 34 and Rule 6(b) are the same.
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Rule 6(b), the Supreme Court holding in Commissioner of Internal Revenue
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v. Idaho Power, and FASBI 34 all deal with the same accounting principal, i.e. that
l6 expenses incurred in bringing a long term asset to its finished state should be
17 capitalized. The date that an asset reaches its finished state is readily ascertainable
18 as it is the date that the asset is placed in service and, as noted by the Supreme
19 Court, becomes “income producing.” (Commissioner of Internal Revenue v. Idaho
20 Power (1974) 418 US 1, 16, 94 S.Ct. 2757, 2766, 41 L.Ed.2d 535.) In the case
21 of the mechanical components comprising an assembly line or production process,
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the equipment has reached its finished state when production commences. There is
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no legal authority supporting the interpretation asserted by Genentech, and
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implementation of such a rule would be highly arbitrary because fifteen experts
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might have fifteen different opinions on when an asset reached a hypothetical
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“finished state” prior to the asset being ready for its intended use and placed in
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service.
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Order re Petition for Writ of Administrative Mandate - 8
Under both Rule 6(b) and Statement of FASBI 34, the 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. Thus, inquiry as to whether
an entity acted as its own contractor, its own general contractor or whether an
entity self—constructed assets is irrelevant. The language of both Rule 6(b) and
FASBI 34 is mandatory, not permissive: If the criteria is met, i.e. the property is
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not in a finished state when acquired; the costs of bringing the property to its
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finished state must be capitalized and included in the assessed valuation.
12 On April 12, 2010, this court [Hon. Mittlesteadt] issued an order following a
l3 de novo trial concerning, among other things, whether capitalized interest should
14 be included in the cost basis of the M&E for the 1990—1991 tax years. That order
.15 provides, in part, as follows:
16 Here, the evidence showed that Genentech’s M&E was purchased in
17
its finished state. Therefore, including an additional charge for
capitalized interest after the purchase would be improper. In addition,
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the Court was not persuaded by the County’s argument that
19 Genentech’s assemblage of equipment into a production—line
constituted a form of self—construction that would allow the inclusion
20
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of capitalized interest as a component of the M&E cost. Based upon
21 the evidence presented at trial, the Court finds that Genentech did not
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self—construct any of its M&E, either by its own employees or by any
independent contractors. Rather Genentech purchased its M&E in a
23 finished state, ready to use. Genentech’s act of installing and
24 connecting together different pieces of M&E does not constitute self-
construction or subject that equipment to an additional charge of
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imputed interest pursuant to Rule 6(b).
26
27
(April 10, 2010 Order, San Mateo Superior Court Case 456781, Administrative
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Record 2016AR05390 — 2016AR05406.)
Order re Petition for Writ of Administrative Mandate - 9
While the April '10, 2010 Order contains a finding that “M&E was purchased
in its finished state,” the Order concedes that “assemblage of equipment into a
production-line” was necessary before the asset could be placed in service. The
finding that self-construction did or did not occur, utilizes criteria that does not
appear in either FASBI 34 or Rule 6(b). This'Court declines to apply the standard
articulated in the April 10, 2010 Order because its finding that property that is not
ready to be placed in service is nonetheless purchased in its finished state is not
consistent with this court’s interpretation of Rule 6(b).
10
ll On July 30, 2002, the Sarbanes-Oxley Act of 2002, was enacted to require
12 top management to individually certify the accuracy of financial information
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l3 increasing the oversight role of directors and the independence of outside auditOrs
14 who review the accuracy of corporate financial statements.
15 Section 906(b) of the Act, 18 U.S.C. § 1350(b), provides: “Content—The
l6 statement required under subsection (a) shall certify that the periodic report
17
containing the financial statements fully complies with the requirements of section
18
13(a) or 15(d) of the Securities Exchange Act of 1934 *(15 U.S.C. § 78m(a) or
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780(d) and that information contained in the period report fairly presents, in all
20
material aspects, the financial condition and results of operations of the issuer.”
21
Section 906(c) of the -Act, 18 U.S.C. § 1350(c) further provides:
22
“Whoever... (l) certifies any statement as set forth in subsections (a) and (b) of
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this section knowing that the periodic report accompanying the statement does not
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comport with all the requirements set forth in this section shall be fined not more
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than $1,000,000 or imprisoned not more than lOVyears, or both, or (2) willfully
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certifies any statement as set forth in subsections (a) and (b) of this section
.28 knowing that the periodic report accompanying the statement dOes not comport
Order re Petition for Writ of Administrative Mandate —
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with all the requirements set forth in this section shall be fined not more than
$5,000,000 or imprisoned not more than 20 years, or both.
Thus, while the audited financial statements of a publically traded
corporation or the financial statements filed by a publically traded corporation with
the Securities and Exchange Commission (“SEC”) are not sworn under penalty of
perjury under the laws of the State of California, the penalty pursuant to 18 U.S.C.
§ 1350(c) for a “knowing” false statement or a “willful” false statement far exceeds
the penalty for perjury under California law.
'10 Accordingly, this court finds that a California Administrative Body or a
11
California Court should be able to place the same reliance on the truthfulness of
12 the information reported in the audited financial statements and SEC filings of a
l3 publically traded corporation as it would if that same information was provided in
14 sworn declarations filed with the court.
15 The Administrative Record lodged herein contains what appear to be
l6 excerpts from the Annual Report issued by Genentech for the year 2000
17 (2016AR039l2—2016AR03919), the year 2001 (2016AR03920-2016AR03923),
18 the year 2002 (2016AR039240-2016AR03932), the year 2003 (2016AR03933-
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2016AR03934), the year 2004 (2016AR03938—2016AR03939), and the year 2005
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(2016AR03942—201603958).
21
The Administrative Record also contains what appears to be excerpts from
22
Form 10-K filed by Genentech with the SEC for the fiscal year ended December
23
31, 2000 (2016AR0395l-2016AR03962), for the fiscal year ended December 31,
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2001 (2016AR03964-2016AR03977), for the fiscal year ended December 31, 2002
25
(2016AR03979-2016AR03998), for the fiscal year ’ended December 31, 2003
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(2016AR03935-2016AR03937 and 2016AR04000-2016AR04009), for the fiscal
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year ended December 31, 2004 (2016AR03940—2016AR03941 and 2016AR04011—
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Order re Petition for Writ of Administrative Mandate - 1_1
2016AR04024), and for the fiscal year ended December 31, 2005 (2016AR04026—
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2016AR04042).
The Genentech 2000 Annual Report contains the Report of Ernst & Young,
Independent Auditors, signed by Ernst & Young LLP, that provides as follows:
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Genentech, Inc.
We have audited the accompanying consolidated balance sheets of
10 Genentech, Inc. as of December 31, 2000 and 1999, and the related
consolidated statements of operations, stockholders’ equity and cash
11
flows for the year ended December 31, 2000, and for the period from
12 June 30, 1999 to December 31, 1999 (all “New Basis”). We have also
13
audited the related consolidated statements of operations,
stockholders’ equity and cash flows for the period from January 1,
14
1999 to June 30, 1999, and for the year ended December 31, 1998 (all
15 “Old Basis”). These financial statements are the responsibility of
Genentech, Inc’s management. Our responsibility is to express an
16
opinion on these financial statements based on our audits.
17
18
We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require that
19
we plan and perform the audit to obtain reasonable assurance about
20 whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the.
21
amounts and disclosures in the financial statements. An audit also
22 includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
23
financial statement presentation. We believe that our audits provide a
24 reasonable basis for our opinion.
25
In our opinion, the financial statements referred to above present
26
fairly, in all material respects, the consolidated financial position of
27 Genentech, Inc. at December 31, 2000 and 1999, and the consolidated
results of its operations and its cash flows for the year ended
28
December 31, 2000, the period from June 30, 1999 to December
Order re Petition for Writ of Administrative Mandate - 12
31,1999, the period from January 1, 1999 to June 30, 1999, and for the
year ended December 31, 1998 in conformity with accounting
principles generally accepted in the United States.
As discussed in the notes to the consolidated financial statements, the
balance sheet as of December 31, 1999, and the statements of
operations, stockholders’ equity and cash flows for the periods in the
year ended December 31, 1999 have been restated. In addition, in
2000_the Company changed its method of accounting for revenue
recognition.
(Administrative Record 2016AR03 915.)
The Genentech 2000 Annual Report contains the Report of Management .
10
which provides as follows:
11
REPORT OF MANAGEMENT
12 Genentech, Inc. is responsible for the preparation, integrity and fair
13 presentation of its published financial statements. We have prepared
the financial statements in accordance with accounting principles
14
generally accepted in the United States. As such, these statements
15 include amounts based on judgments and estimates made by
management. We also prepared the other information included in the ‘
16.
annual report and are responsible for its accuracy and consistency
17 with the financial statements.
18
The financial statements have been audited by the independent
19
auditing firm, Ernst & Young LLP, which was given unrestricted
2O access to all financial records and related data, including minutes of
all meetings of stockholders, the Board of Directors and committees
21
of the Board. We believe that all representations made to the
22 independent auditors during their audit were valid and appropriate.
23
Ernst & Young LLP's audit report is included in this Annual Report.
24
Systems of internal accounting controls, applied by operatingand
25 financial management, are designed to provide reasonable assurance
as to the integrity and reliability of the financial statements and
26
reasonable, but not absolute, assurance that assets are safeguarded
27 from unauthorized use or disposition, and that transactions are
recorded according to management’s policies and procedures. We
28
continually review and modify these systems, where appropriate, to
Order re Petition for Writ of Administrative Mandate - 13
maintain such assurance. Through our general audit activities, the
adequacy and effectiveness of the systems and controls are reviewed
and the resultant findings are communicated to management and the
Audit Committee of the Board of Directors.
T
The selection of Ernst & Young LLP as our independent auditors has
been approved by our Board of Directors and ratified by the
stockholders. The Audit Committee of the Board of Directors Is
composed of three non-management directors who meet regularly
with management, the independent auditors and the general auditor,
jointly and separately, to review the adequacy of internal accounting
controls and auditing and financial reporting matters to ascertain that
each is properly discharging its responsibilities.
10
ll /s/Arthur D. Levinson Louis J. Lavigne,Jr. John M. Whiting
.12
Arthur D. Levinson Ph.D. Louis J. Lavigne, Jr. John M. Whiting
l3 Chairman Executive Vice President Vice President,
and and Controller, and
14 Chief Executive Officer Chief Financial Officer Chief Accounting Officer
15 (Administrative Record 201 6AR03 91 5 .)
l6
The Report of the Independent Auditors states that “the financial statements
17
referred to above present fairly, in all material aspects, the consolidated financial
18
19
position of Genentech, Inc....in conformity with accounting principles generally
20
accepted in the United States.” (Administrative Record 2016AR03915.) Similarly,
21 the Report of Management states that “We have prepared the financial statements
22 in accordance with accounting principles generally accepted in the United States.”
23 (Administrative Record 201 6AR03 91 5 .)
24 The Notes to the 2000 Consolidated Financial Statements state as follows:
25 “capitalized interest on construction-iarogress is included in property, plant, and
26 equipment” and show that the amount of interest capitalized in 2000 was $2.2
27 Million, the amount of interest capitalized in 1999 was $2.1 Million, and the
28
Order re Petition for Writ of Administrative Mandate —
l4
amount of interest capitalized in 1998 was $3.0 Million. (Administrative Record
2016AR03919.)
The Form 10—K filed by Genentech, Inc. with the Securities and Exchange
Commission for the fiscal year ended December 31, 2000 (See Administrative
Record 2016AR03951) contains the same Report of Ernst & Young LLP,
Independent Auditors, as is quoted above in the audited financial statement.
(Administrative Record 201 6AR03 853 .)
The Form 10—K filed by Genentech, Inc. with the Securities and Exchange
Commission for the fiscal year ended December 31, 2000 provides as follows:
10
FDA Validation Costs: U .8. Food and Drug Administration, or FDA,
ll validation costs- are capitalized as part of the effort required to
12 acquire and construct long—lived assets, including readying them for
13
their intended use and are amortized over the estimated useful life of
the asset or the term of the lease whichever is shorter.
14
15 (Administrative Record 2016AR03 961 .)
l6 The Form 10-K filed by Genentech, Inc. with the Securities and Exchange
l7 Commission for the fiscal year ended December 31, 2000 also provides the same
l8 information concerning capitalization interest provided in the financial statements,
19 i.e. the amount of interest capitalized in 2000 was $2.2 Million, the amount of
2O interestcapitalized in 1999 was $2.1 Million, and the amount of interest capitalized
21 in 1998 was $3.0 Million. (Administrative Record 2016AR03961.)
22 The Report of the Independent Auditors in both the Audited Financial
23
Statements and the Form' 10-K expressly represents that the audit included
24
“assessing the accounting principles used,” and since the Audit Report concluded
25
that the financial statements “present fairly, in all material aspects, the consolidated
26
financial position of Genentech, Inc....in conformity with accounting principles.”
27
Similarly, the Form 10-K contains a certification by Arthur Levison Ph.D.,
28
Chairman and Chief Executive Officer of Genentech, Inc., Louis J. Lavigne Jr.,
Order re Petition for Writ of Administrative Mandate - 15
Executive Vice President and Chief Financial Officer of Genentech, Inc., and John
M. Whiting, Vice President, Controller, and Chief Accounting Officer of
Genentech Inc. provided subject to the criminal sanctions provided in the
Sarbanes—Oxley Act of 2002, 18 U.S.C. § 1350(0), that they “have prepared the
financial statements in accordance with accounting principles generally accepted in
the United States.”
The above evidence constitutes an extremely strong evidentiary showing that
(1) FDA Validati‘On costs were properly capitalized as part of the effort to acquire
and construct long—lived assets, including readying them for their intended use, and
10
ll (2) that the criteria for Statement of Financial Accounting Standards No. 34 was
12
met, i.e. that the assets required a period of time to get them ready for their
-
13 intended use.
14 Furthermore, since this court has concluded above that the criteria for
15 capitalizing expenses pursuant to Rule 6(b) is the same as the criteria (i.e. bringing
16 the property to a finished state) for capitalizing interest pursuant to Statement of
17 Financial Accounting Standards No. 34, the above evidence also makes an
18 extremely strong showing that the criteria for (1) Capitalizing Validation Costs,
19 (2) Capitalizing expenses, and (3) Capitalizing interest pursuant to Rule 6(b) have
20 been satisfied for the years 1998, 1999 and 2000. .
21 The Form 10—K filed by Genentech, Inc. with the Securities and Exchange
22
Commission for the fiscal year ended December 31, 2001 reports capitalized
23
interest of $1.8 Million for 2001, $2.2 Million for 2000, and $2.1 Million for 1999.
24
(Administrative Record 2016AR03976) The 2001 10-K also provides that “FDA
25
validation costs are capitalized as part of the effort required to acquire and
26
construct long-lived assets including readying them for their intended use, and are
27
amortized over the estimated useful life of the asset or the term of the lease,
28
whichever is shorter.” (Administrative Record 201 6AR03 976)
Order re Petition for Writ of Administrative Mandate - 16
The 2001 lO-K contains a Report of Ernst & Young LLP stating that
financial statements “present fairly” “in conformity with accounting principles
generally accepted in the United States” (Administrative Record 2016AR03967)
and a certification by Arthur Levinson, Louis J. Lavigne Jr., and John M. Whiting
-
that they “have prepared the financial statements in accordance with accounting
principles generally accepted in the United States.” (Administrative Record
2016AR03968.) The above evidence makes an extremely strong showing that the
'
criteria for capitalizing expenses pursuant to Rule 6(b) have been satisfied for the
10
years 2001, as well as 1999 and 2000.
ll The Form 10—K filed by Genentech, Inc. with the Securities and Exchange
12 Commission for the fiscal year ended December 31, 2002 reports capitalized
l3 interest of $1.0 Million for 2002, $1.8 Million for 2001, and $2.2 Million for 2000.
l4 (Administrative Record 2016AR03996) The 2002 10—K also provides that “FDA
l5 validation costs are capitalized as part of the effort required to acquire and
l6 construct long-lived assets including readying them for their intended use, and are
17
amortized over the estimated useful life of the asset or the term of the lease,
'18
whichever is shorter.” (Administrative Record 2016AR03997)
19
The 2002 lO-K contains a Report of Ernst & Young ‘LLP stating that
20
financial statements “present fairly” “in conformity. with accounting principles
21
generally accepted in the United States” (Administrative Record 2016AR03983—
22
2016AR0984.) The above evidence makes an extremely strong showing that the
23
criteria for capitalizing expenses pursuant to Rule 6(b) have been satisfied for the
24
years 2002, as well as 2000 and 2001.
25
The excerpts from the Audited Financial Statements issued by Genentech
26
and the Form 10-K filed by Genentech, Inc. with the Securities and Exchange
27
28
Commission for the fiscal years ending December 31, 2003, December 31, 2004,
and December 31, 2005 provided in the Administrative Record do not appear to
Order re Petition for Writ of Administrative Mandate - 17
include any express statement concerning the amount of expense, if any,
capitalized in the period covered by those statements.
However, the Administrative Record contains portions of the Genentech
General Ledger, and portions of the Trial Balances that summarize portions of the
Genentech General Ledger that indicate that Genentech capitalized interest,
debugging costs, start-up costs, testing costs, labor, professional and engineering
costs, and validation costs. (See e.g. Administrative Record 2016AR04801 [Trial
Balance showing capitalized interest and validation accounts]; Recap of San Mateo
10
County’s Classification of Personal Property Fixed Assets (Administrative Record
11' 2016AR048120 to 2016AR04830); Fixed Asset Detail of Production Equipment
12 Over $25K (Administrative Record 2016AR04846 to 2016AR04895); and Fixed
13 Assets Re-Classified To Production Equipment by SMC (Administrative Record
'
14. 2016AR04898 to 2016AR04916 [Analysis of Fixed Asset Accounts Including
15 Capitalized Labor, Capitalized Engineering Services, Capitalized Prefabrication
16 Costs, Capitalized Professional Services, Capitalized Consulting Services,
17
Capitalized Conceptual Design Engineering services, and other Capitalized
18
Expenses].)
19
The fact that the General Ledger Genentech used to prepare Audited
20
Financial Statements issued by Genentech and the Form 10-K filed by Genentech,
21
Inc. with the Securities and Exchange Commission for the fiscal years ending
22
December 31, 2003, December 31, 2004, and December 31, 2005 is strong, but not
23
conclusive, evidence that such capitalized expenses were included in the Audited
24
Financial Statements issued by Genentech and the Form 10-K filed by Genentech,
25
Inc. with the Securities and Exchange Commission for the fiscal years ending
26
27
December 31, 2003, December 31, 2004, and December 31, 2005. Genentech has
28
not provided any credible evidence that the expenses capitalized on its general
‘
Order re Petition for Writ of Administrative Mandate —
18
ledger were not also capitalized in its Audited Financial Statements and Securities
and Exchange Commission Filings.
In Genentech, Inc.’s Response to Assessor’s Opening Brief, Genentech
states the following:
Although Genentech generally purchased this equipment from the
various vendors for cash, accounting rules required Genentech to
record on its books an imputed interest charge as if Genentech had
financed the acquisitions with a loan. (2016AR04257—72 [Financial
Accounting Standard No. 34 (“FASB 34”)].) This imputed interest
was recorded in an account titled “capitalized interest,” for the years
1984 through 2005. (2016AR04722—23.)
10
ll During the years 1987 to 1992, in addition to capitalized interest
12
under FASB 34, Genentech also booked “start-up” and “debugging”
costs in its accounting records. These were product-related costs
l3 incurred, after the installation of a manufacturing asset to evaluate and
14 monitor those assets to see that the quality of the product being
manufactured and the product yields were acceptable.
15
(2016AR04734-35; 2016AR02886: 5—24; 2016AR02740: 14-22.)
l6 Genentech also booked certain “capitalized labor” costs, which were
l7 incurred after installment of manufacturing assets and related to labor
used in adjusting and testing installed equipment for the manufacture
;
l8 of particular products. (2016AR02838—39.)
19
20 (Genentech, Inc.’s Response to Assessor’s Opening Brief Page 1:25-2:11.)
21 The above statement concedes that for fiscal years 1987 to 1992 Interest was
22 Capitalized or Imputed in compliance with FASBI 34 which in turn concedes that
23 the criteria of FASBI 34 were satisfied and therefore that (1) that the “assets must
24 require a period of time to get them ready for their intended use”; and (2) that the
25 “effect [of capitalizing interest], compared with the effect of expensing interest, is
26
material.”
27
The above statement also concedes that during the years 1987 to 1992 start
28
up, debugging costs, as
Preview
FILED SAN MATEO COUNTY MAY 0 4 2018 Clerk of the Superior Court [€019,m SUPERIOR COURT OF THE STATE OF CALIFORNIA IN AND FOR THE COUNTY OF SAN MATEO 10 MARK CHURCH, SAN MATEO Case No.: l6-CIV-01058 ll 12 COUNTY AS SESSOR, l3 Petitioner, 14 Order Re Petition for Writ of Adminlstrative Mandate 15 l6 SAN MATEO COUNTY ASSESSMENT APPEALS BOARD, ebrula ' 22, 2018 17 133%. ' Respondent. Dept; 28 18 . Hon. George A. Miram 19 GENENTECH, 'INC. 20 Real Party in Interest 0RD Order 21 1131 22 H 111111111111111 23 24 The Petition for Writ of Administrative Mandate brought by Petitioner Mark 25 Church, San Mateo County Assessor, came on regularly for hearing at 2:00 PM. 26 on February 22, 2018 in Department 28 of the San Mateo Superior Court, the Hon. 27 George A. Miram presiding. 28 Order re Petition for Writ of Administrative Mandate - 1 Rebecca Archer, Esq. and Brian Kulich, Esq. of the San Mateo County Counsel, appeared on behalf Petitioner Mark Church, San Mateo County Assessor. Charles J. M011 and Troy M. Van Dongen appeared on behalf of real party in interest, Genentech, Inc. (“Genentech”). There was no appearance by Respondent San Mateo County Assessment Appeals Board. After receiving the papers filed by the parties including the lodging of the Administrative Record, and after hearing the arguments of counsel, the matter was submitted. INTRODUCTION 10 This petition raises three important issues of first impression that have yet to ll be resolved, either directly or indirectly, in the prior litigation between these 12 l3 parties. All three are issues of pure law. 14 The First issue requires interpretation of Rule 6, 18 Cal. Code of Reg. §6 15 (“Rule 6”) and whether it uses the same or different criteria concerning the l6 capitalization of expenses that are used in Financial Accounting Standards Board 17 Interpretation (“FASBI”) Rule 34 relating to the Capitalization of Interest. If the 18 rules use the same criteria, what is the burden of proof that a finder of fact must 19 use when weighing evidence concerning whether capitalized expenses should be 20 included in an assessment owned by a publically traded corporation if Audited 21 Financial Statements and SEC Filings issued by such corporations provide for the 22 capitalization of expenses pursuant to FASBI 34 and other accounting principles I 23 generally accepted in the United States? 24 The Second issue concerns the evidentiary import of statements of fact made 25 by a publiCally traded corporation in its Audited Financial Statements and in filings 26 with the Securities and Exchange Commission (“SEC”). Are such statements of" 27 fact binding on the corporation in any way? Are they merely evidence that the , 28 corporation can dispute, refute, contradict, or modify with testimony by a Person Order re Petition for Writ of Administrative Mandate - 2 Most Knowledgeable, an expert witness, or testimony by percipient Witnesses? To the extent, a corporation may contradict such statements of fact, What is the burden of proof that a finder of fact must use when weighing evidence offered in contradiction of Audited Financial Statements or SEC filings? The third issue concerns the applicable burden of proof when the trial balance or general ledger of a publically traded corporation reflects that expenses have been capitalized, but the Audited Financial Statements and SEC Filings issued by such corporation do not expressly address or disclose the extent to which 10 expenses were capitalized in the Financial Statements themselves. If the general ledger shows that expenses were capitalized, which party bears the burden of ll proving whether or not those expenses were ultimately capitalized in the Audited l2 Financial Statements and SEC Filings as well? l3 14 DISCUSSION '15 \ While the California appellate courts have not issued an opinion resolving l6 the above issues, the controversy is hardly new. Almost 44 years ago, the United I l7 States Supreme Court issued its opinion in Commissioner of Internal Revenue v. l8 Idaho Power (1974) 418 US. 1, 94 S.Ct. 2757,41 L.Ed.2d 535, a case involving 19 the capitalization of depreciation expense for federal income tax purposes by a 20 regulated utility. That opinion includes the following analysis: 21 Construction-related depreciation is not unlike expenditures for wages 22 for construction workers. The significant fact is that the exhaustion of construction equipment does not represent the final disposition of the 23 taxpayer’s investment in that equipment; rather, the investment in the 24 equipment is assimilated into the cost of the capital asset constructed. Construction-related depreciation on the equipment is not an expense 25 to the taxpayer of its day-to-day business. It is, however, appropriately 26 recognized as a part of the taxpayer’s cost or investment in the capital asset. The taxpayer’s own accounting procedure reflects this 27 treatment, for on its books the '00nstruction-related depreciation was 28 capitalized by a credit to the equipment account and a debit to the capital facility account. By the same token, this capitalization prevents . Order re Petition for Writ of Administrative Mandate - 3 the distortion of income that would otherwise occur if depreciation properly allocable to asset acquisition were deducted from gross income currently realized. See, e.g., Coors V. Commissioner, 60 TC, at 398; Southern Natural Gas Co. V. United States, 412 F.2d, at 1265, 188 Ct.Cl., at 373—374. 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 1o construction services, and the entire cost; of course, must be capitalized by the taxpayer having the construction work performed. 11 The Court of Appeals’ holding would lead to disparate treatment 12 among taxpayers because it would allow the firm with sufficient resources to construct its own facilities and to obtain a current 13 deduction, whereas another firm without such resources would be 14 required to capitalize its entire cost includingdepreciation charged to 15 it by the contractor. 16 Some, although not controlling, weight must be given to the fact that 17 the Federal Power Commission and the Idaho Public Utilities Commission required the taxpayer to use accounting procedures that ‘18 capitalized construction-related depreciation. Although agency- 19 imposed compulsory accounting practices do not necessarily dictate tax consequences, Old Colony R. Co. v. Commissioner of Internal 2o Revenue, 284 US. 552, 562, 52 S.Ct. 211, 214, 76 L.Ed. 484 (1932), 21 they are not irrelevant and may be accorded some significance. 22 Commissioner of Internal Revenue V. Lincoln Savings & Loan Ass’n., 403 US. 345, 355—356, 91 S.Ct. 1893, 1899—1900, 29 L.Ed.2d 519 23 (1971).The opinions in American Automobile Ass’n v. United States, 24 367 US. 687, 81 S.Ct. 1727, 6 L.Ed.2d 1109 (1961), and Schlude v. Commissioner of Internal Revenue, 372 US. 128, 83 S.Ct. 601, 9 25 L.Ed.2d 633 (1963), urged upon us by the taxpayer here, are not to the 26 contrary. In the former case it was observed that merely because the 27 method of accounting a taxpayer employs is in accordance with * generally accepted accounting procedures, this ‘is not to hold that for 28 income tax purposes it so clearly reflects income as to be binding on the Treasury.’ 367 U.S., at 693, 81 S.Ct., at 1730. See also Cincinnati, Order re Petition for Writ of Administrative Mandate - 4 N.O. & T.P.R. Co. V. United States, 424 F.2d 563, 570, 191 Ct.Cl. 572, 583—584 (1970). Nonetheless, where a taxpayer’s generally accepted method of accounting is made compulsory by the regulatory agency and that method clearly reflects income, [footnote omitted] it is almost presumptively controlling of federal income tax consequences. (Commissioner ofInternal Revenue v. Idaho Power (1974) 418 U.S. 1, 13-15, 94 S.Ct. 2757, 2765-2766, 41 L.Ed.2d 535.) .The Supreme Court interpreted Internal Revenue Code § 263 “to reflect the basic principle that a capital expenditure may not be deducted from current 10 income” and “serves to prevent a taxpayer from utilizing currently a deduction ll properly attributable through amortization, to later tax years when the capital asset 12 becomes income producing.” (Commissioner of Internal Revenue v. Idaho Power 1., 13 (1974) 418 U.S. 16, 94 S.Ct. 2757, 2766, 41 L.Ed.2d 535.) The court concluded 14' as follows: “We hold that the equipment depreciation allocable to taxpayer’s l5 construction of capital facilities is to be capitalized.” (Commissioner of Internal l6 Revenue v. Idaho Power (1974) 418 U.S. l, 19, 94 S.Ct. 2757, 2767, 41 L.Ed.2d 17 535.) 18 Four years after the U.S. Supreme Court issued the Idaho Power Opinion 19 quoted above, in October of 1979, the Financial Accounting Standards Board 20 issued Statement of Financial Accounting Standards No. 34 entitled Capitalization 21 of Interest Cost, the Introduction to which states as follows: 22 23 This Statement establishes standards for capitalizing interest cost as 24 part of the historical cost of acquiring certain assets. To qualify for 25 interest capitalization, assets must require a period of time to get them ready for their intended use. Examples are assets that an enterprise 26 constructs for its own use (such as facilities) and assets intended for 27 sale or lease that are constructed as discrete projects (such as ships or 28 real estate projects). Interest capitalization is required for those assets if its effect, Compared with the effect of expensing interest, is Order re Petition for Writ of Administrative Mandate - 5 material. If the net effect is not material, interest capitalization is not required. However, interest cannot be capitalized for inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis. (Statement of Financial Accounting Standards No. 34 (1979) Page 1.) The sole criteria for the capitalization of interest costs pursuant to Statement of Financial Accounting Standards No. 34 is (1) that the “assets must require a period of time to get them ready for their intended use”; and (2) that the “effect [of capitalizing interest], compared with the effect of expensing interest, is material.” 10 The exact nature of the method by which the property is acquired or brought to a 11 finished state is irrelevant, providing that on the date acquired, the property is not 12 ready for its intended use. The language of Financial Accounting Standards No. 34 13 'is mandatory, not permissive: If the two criteria are satisfied, interest must be 14 f capitalized. 15 l6 The mandatory capitalization provision of Financial Accounting Standard 17 No. 34 is consistent with the Supreme Court opinion issued in Commissioner of 18 Internal Revenue v. Idaho Power which concluded that a depreciation expense 19 deduction should be deferred “to later tax years when the capital asset becomes 20 income producing.” (Commissioner of Internal Revenue v. Idaho Power (1974) 21 418 US. l, 16, 94 S.Ct. 2757, 2766, 41 L.Ed.2d 535.) 22 The regulations establishing the rules for applying the Reproduction and 23 Replacement Cost Approaches to Value for California Property Tax Purposes were 24 originally filed on September 7, 1967, and became effective thirteen days 25 thereafter, more than seven years before the Supreme Court’s opinion in 26 Commissioner of Internal Revenue v. Idaho Power. Rule 6(b), l8 CCR § 6(b) 27 provides as follows: 28 Order re Petition for Writ of Administrative Mandate - 6 (b) The reproduction cost of a reproducible property may be estimated either by (l) 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 if property to a finished state (or to a lesser state unfinished on the lien date). Estimates made under (2) above may be made by using square— foot, cubic—foot, or other unit costs; a summation of the in—place costs of all components; a quantity survey of all material, labor, and other cost elements; or a combination of these methods. (18 CCR § 6(b).) 10 This court finds that the Rule 6(b) language “applying current prices to the 11 property’s labor and material components, with appropriate additions for 12 entrepreneurial services, interest on borrowed or owner-supplied funds, and other 13 costs typically incurred in bringing the property to a finished state (or to a lesser 14‘ state if unfinished on the lien date)” contains the same criteria as Statement of 15 Financial Accounting Standards No. 34, i.e. that the “assets must require a period 16 of time to get them ready for their intended use.” 17 Genentech argues that: 18 The plain language of Property Tax Rule 6(b) indicates the costs 19 incurred after the property is in a finished state are not part of the 2O ‘reproduction and replacement costs’ of the property, but, rather are costs incurred in the use of the property. Accordingly, as this Court 21 ruled in the Statement of Decision and as the Fourth Decision 22 followed, costs should not be assessed when they are incurred after 23 the property is in its finished state. (2016AR53~52:5-7) Property Tax Rule 6 further specifies that ‘interest on borrowed or owner-supplied 24 funds’ should be included, but only those ‘typically incurred in 25 bringing the property to a finished state.’ 18 CCR § 6.” 26 (Genentech, Inc.’s Response to Assessor’s Opening Brief Page 724—10 [emphasis in 27 28 original].) Order re Petition for Writ of Administrative Mandate - 7 Genentech argues that the criteria imposed by Rule 6(b) is significantly different from the criteria imposed by FASBI 34. (See Genentech, Inc’s Response to Assessor’s Opening Brief Page 1222-8 [“scope of FASB 34 is materially broader than that or Rule 6”].) Genentech offers no authority for its interpretation of Rule 6(b). It argues, in essence, that under Rule 6(b), capitalization of costs incurred in connection with developing a long-term asset should stop when the asset has reached a hypothetical “finished state.” Genentech contends that once an asset is in a hypothetical “finished state,” the fact that the taxpayer elects to fiirther develop the asset to get it ready for its intended use would result in additional capitalization 10 of such expense under FASBI 34, but not under Rule 6(b). This court disagrees. ll 12 As stated above, this court finds, as a matter of law, that the criteria for 13 capitalization of expenses under FASBI 34 and Rule 6(b) are the same. 14 Rule 6(b), the Supreme Court holding in Commissioner of Internal Revenue 15 v. Idaho Power, and FASBI 34 all deal with the same accounting principal, i.e. that l6 expenses incurred in bringing a long term asset to its finished state should be 17 capitalized. The date that an asset reaches its finished state is readily ascertainable 18 as it is the date that the asset is placed in service and, as noted by the Supreme 19 Court, becomes “income producing.” (Commissioner of Internal Revenue v. Idaho 20 Power (1974) 418 US 1, 16, 94 S.Ct. 2757, 2766, 41 L.Ed.2d 535.) In the case 21 of the mechanical components comprising an assembly line or production process, 22 the equipment has reached its finished state when production commences. There is 23 no legal authority supporting the interpretation asserted by Genentech, and 24 implementation of such a rule would be highly arbitrary because fifteen experts 25 might have fifteen different opinions on when an asset reached a hypothetical 26 “finished state” prior to the asset being ready for its intended use and placed in 27 service. 28 Order re Petition for Writ of Administrative Mandate - 8 Under both Rule 6(b) and Statement of FASBI 34, the 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. Thus, inquiry as to whether an entity acted as its own contractor, its own general contractor or whether an entity self—constructed assets is irrelevant. The language of both Rule 6(b) and FASBI 34 is mandatory, not permissive: If the criteria is met, i.e. the property is 10 not in a finished state when acquired; the costs of bringing the property to its 11 finished state must be capitalized and included in the assessed valuation. 12 On April 12, 2010, this court [Hon. Mittlesteadt] issued an order following a l3 de novo trial concerning, among other things, whether capitalized interest should 14 be included in the cost basis of the M&E for the 1990—1991 tax years. That order .15 provides, in part, as follows: 16 Here, the evidence showed that Genentech’s M&E was purchased in 17 its finished state. Therefore, including an additional charge for capitalized interest after the purchase would be improper. In addition, 18 the Court was not persuaded by the County’s argument that 19 Genentech’s assemblage of equipment into a production—line constituted a form of self—construction that would allow the inclusion 20 i of capitalized interest as a component of the M&E cost. Based upon 21 the evidence presented at trial, the Court finds that Genentech did not 22 self—construct any of its M&E, either by its own employees or by any independent contractors. Rather Genentech purchased its M&E in a 23 finished state, ready to use. Genentech’s act of installing and 24 connecting together different pieces of M&E does not constitute self- construction or subject that equipment to an additional charge of 25 imputed interest pursuant to Rule 6(b). 26 27 (April 10, 2010 Order, San Mateo Superior Court Case 456781, Administrative 28 Record 2016AR05390 — 2016AR05406.) Order re Petition for Writ of Administrative Mandate - 9 While the April '10, 2010 Order contains a finding that “M&E was purchased in its finished state,” the Order concedes that “assemblage of equipment into a production-line” was necessary before the asset could be placed in service. The finding that self-construction did or did not occur, utilizes criteria that does not appear in either FASBI 34 or Rule 6(b). This'Court declines to apply the standard articulated in the April 10, 2010 Order because its finding that property that is not ready to be placed in service is nonetheless purchased in its finished state is not consistent with this court’s interpretation of Rule 6(b). 10 ll On July 30, 2002, the Sarbanes-Oxley Act of 2002, was enacted to require 12 top management to individually certify the accuracy of financial information ' l3 increasing the oversight role of directors and the independence of outside auditOrs 14 who review the accuracy of corporate financial statements. 15 Section 906(b) of the Act, 18 U.S.C. § 1350(b), provides: “Content—The l6 statement required under subsection (a) shall certify that the periodic report 17 containing the financial statements fully complies with the requirements of section 18 13(a) or 15(d) of the Securities Exchange Act of 1934 *(15 U.S.C. § 78m(a) or 19 780(d) and that information contained in the period report fairly presents, in all 20 material aspects, the financial condition and results of operations of the issuer.” 21 Section 906(c) of the -Act, 18 U.S.C. § 1350(c) further provides: 22 “Whoever... (l) certifies any statement as set forth in subsections (a) and (b) of 23 this section knowing that the periodic report accompanying the statement does not 24 comport with all the requirements set forth in this section shall be fined not more 25 26 than $1,000,000 or imprisoned not more than lOVyears, or both, or (2) willfully 27 certifies any statement as set forth in subsections (a) and (b) of this section .28 knowing that the periodic report accompanying the statement dOes not comport Order re Petition for Writ of Administrative Mandate — 10 with all the requirements set forth in this section shall be fined not more than $5,000,000 or imprisoned not more than 20 years, or both. Thus, while the audited financial statements of a publically traded corporation or the financial statements filed by a publically traded corporation with the Securities and Exchange Commission (“SEC”) are not sworn under penalty of perjury under the laws of the State of California, the penalty pursuant to 18 U.S.C. § 1350(c) for a “knowing” false statement or a “willful” false statement far exceeds the penalty for perjury under California law. '10 Accordingly, this court finds that a California Administrative Body or a 11 California Court should be able to place the same reliance on the truthfulness of 12 the information reported in the audited financial statements and SEC filings of a l3 publically traded corporation as it would if that same information was provided in 14 sworn declarations filed with the court. 15 The Administrative Record lodged herein contains what appear to be l6 excerpts from the Annual Report issued by Genentech for the year 2000 17 (2016AR039l2—2016AR03919), the year 2001 (2016AR03920-2016AR03923), 18 the year 2002 (2016AR039240-2016AR03932), the year 2003 (2016AR03933- 19 2016AR03934), the year 2004 (2016AR03938—2016AR03939), and the year 2005 20 (2016AR03942—201603958). 21 The Administrative Record also contains what appears to be excerpts from 22 Form 10-K filed by Genentech with the SEC for the fiscal year ended December 23 31, 2000 (2016AR0395l-2016AR03962), for the fiscal year ended December 31, 24 2001 (2016AR03964-2016AR03977), for the fiscal year ended December 31, 2002 25 (2016AR03979-2016AR03998), for the fiscal year ’ended December 31, 2003 26 (2016AR03935-2016AR03937 and 2016AR04000-2016AR04009), for the fiscal 27 year ended December 31, 2004 (2016AR03940—2016AR03941 and 2016AR04011— 28 Order re Petition for Writ of Administrative Mandate - 1_1 2016AR04024), and for the fiscal year ended December 31, 2005 (2016AR04026— ' 2016AR04042). The Genentech 2000 Annual Report contains the Report of Ernst & Young, Independent Auditors, signed by Ernst & Young LLP, that provides as follows: REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders of Genentech, Inc. We have audited the accompanying consolidated balance sheets of 10 Genentech, Inc. as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders’ equity and cash 11 flows for the year ended December 31, 2000, and for the period from 12 June 30, 1999 to December 31, 1999 (all “New Basis”). We have also 13 audited the related consolidated statements of operations, stockholders’ equity and cash flows for the period from January 1, 14 1999 to June 30, 1999, and for the year ended December 31, 1998 (all 15 “Old Basis”). These financial statements are the responsibility of Genentech, Inc’s management. Our responsibility is to express an 16 opinion on these financial statements based on our audits. 17 18 We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that 19 we plan and perform the audit to obtain reasonable assurance about 20 whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the. 21 amounts and disclosures in the financial statements. An audit also 22 includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 23 financial statement presentation. We believe that our audits provide a 24 reasonable basis for our opinion. 25 In our opinion, the financial statements referred to above present 26 fairly, in all material respects, the consolidated financial position of 27 Genentech, Inc. at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for the year ended 28 December 31, 2000, the period from June 30, 1999 to December Order re Petition for Writ of Administrative Mandate - 12 31,1999, the period from January 1, 1999 to June 30, 1999, and for the year ended December 31, 1998 in conformity with accounting principles generally accepted in the United States. As discussed in the notes to the consolidated financial statements, the balance sheet as of December 31, 1999, and the statements of operations, stockholders’ equity and cash flows for the periods in the year ended December 31, 1999 have been restated. In addition, in 2000_the Company changed its method of accounting for revenue recognition. (Administrative Record 2016AR03 915.) The Genentech 2000 Annual Report contains the Report of Management . 10 which provides as follows: 11 REPORT OF MANAGEMENT 12 Genentech, Inc. is responsible for the preparation, integrity and fair 13 presentation of its published financial statements. We have prepared the financial statements in accordance with accounting principles 14 generally accepted in the United States. As such, these statements 15 include amounts based on judgments and estimates made by management. We also prepared the other information included in the ‘ 16. annual report and are responsible for its accuracy and consistency 17 with the financial statements. 18 The financial statements have been audited by the independent 19 auditing firm, Ernst & Young LLP, which was given unrestricted 2O access to all financial records and related data, including minutes of all meetings of stockholders, the Board of Directors and committees 21 of the Board. We believe that all representations made to the 22 independent auditors during their audit were valid and appropriate. 23 Ernst & Young LLP's audit report is included in this Annual Report. 24 Systems of internal accounting controls, applied by operatingand 25 financial management, are designed to provide reasonable assurance as to the integrity and reliability of the financial statements and 26 reasonable, but not absolute, assurance that assets are safeguarded 27 from unauthorized use or disposition, and that transactions are recorded according to management’s policies and procedures. We 28 continually review and modify these systems, where appropriate, to Order re Petition for Writ of Administrative Mandate - 13 maintain such assurance. Through our general audit activities, the adequacy and effectiveness of the systems and controls are reviewed and the resultant findings are communicated to management and the Audit Committee of the Board of Directors. T The selection of Ernst & Young LLP as our independent auditors has been approved by our Board of Directors and ratified by the stockholders. The Audit Committee of the Board of Directors Is composed of three non-management directors who meet regularly with management, the independent auditors and the general auditor, jointly and separately, to review the adequacy of internal accounting controls and auditing and financial reporting matters to ascertain that each is properly discharging its responsibilities. 10 ll /s/Arthur D. Levinson Louis J. Lavigne,Jr. John M. Whiting .12 Arthur D. Levinson Ph.D. Louis J. Lavigne, Jr. John M. Whiting l3 Chairman Executive Vice President Vice President, and and Controller, and 14 Chief Executive Officer Chief Financial Officer Chief Accounting Officer 15 (Administrative Record 201 6AR03 91 5 .) l6 The Report of the Independent Auditors states that “the financial statements 17 referred to above present fairly, in all material aspects, the consolidated financial 18 19 position of Genentech, Inc....in conformity with accounting principles generally 20 accepted in the United States.” (Administrative Record 2016AR03915.) Similarly, 21 the Report of Management states that “We have prepared the financial statements 22 in accordance with accounting principles generally accepted in the United States.” 23 (Administrative Record 201 6AR03 91 5 .) 24 The Notes to the 2000 Consolidated Financial Statements state as follows: 25 “capitalized interest on construction-iarogress is included in property, plant, and 26 equipment” and show that the amount of interest capitalized in 2000 was $2.2 27 Million, the amount of interest capitalized in 1999 was $2.1 Million, and the 28 Order re Petition for Writ of Administrative Mandate — l4 amount of interest capitalized in 1998 was $3.0 Million. (Administrative Record 2016AR03919.) The Form 10—K filed by Genentech, Inc. with the Securities and Exchange Commission for the fiscal year ended December 31, 2000 (See Administrative Record 2016AR03951) contains the same Report of Ernst & Young LLP, Independent Auditors, as is quoted above in the audited financial statement. (Administrative Record 201 6AR03 853 .) The Form 10—K filed by Genentech, Inc. with the Securities and Exchange Commission for the fiscal year ended December 31, 2000 provides as follows: 10 FDA Validation Costs: U .8. Food and Drug Administration, or FDA, ll validation costs- are capitalized as part of the effort required to 12 acquire and construct long—lived assets, including readying them for 13 their intended use and are amortized over the estimated useful life of the asset or the term of the lease whichever is shorter. 14 15 (Administrative Record 2016AR03 961 .) l6 The Form 10-K filed by Genentech, Inc. with the Securities and Exchange l7 Commission for the fiscal year ended December 31, 2000 also provides the same l8 information concerning capitalization interest provided in the financial statements, 19 i.e. the amount of interest capitalized in 2000 was $2.2 Million, the amount of 2O interestcapitalized in 1999 was $2.1 Million, and the amount of interest capitalized 21 in 1998 was $3.0 Million. (Administrative Record 2016AR03961.) 22 The Report of the Independent Auditors in both the Audited Financial 23 Statements and the Form' 10-K expressly represents that the audit included 24 “assessing the accounting principles used,” and since the Audit Report concluded 25 that the financial statements “present fairly, in all material aspects, the consolidated 26 financial position of Genentech, Inc....in conformity with accounting principles.” 27 Similarly, the Form 10-K contains a certification by Arthur Levison Ph.D., 28 Chairman and Chief Executive Officer of Genentech, Inc., Louis J. Lavigne Jr., Order re Petition for Writ of Administrative Mandate - 15 Executive Vice President and Chief Financial Officer of Genentech, Inc., and John M. Whiting, Vice President, Controller, and Chief Accounting Officer of Genentech Inc. provided subject to the criminal sanctions provided in the Sarbanes—Oxley Act of 2002, 18 U.S.C. § 1350(0), that they “have prepared the financial statements in accordance with accounting principles generally accepted in the United States.” The above evidence constitutes an extremely strong evidentiary showing that (1) FDA Validati‘On costs were properly capitalized as part of the effort to acquire and construct long—lived assets, including readying them for their intended use, and 10 ll (2) that the criteria for Statement of Financial Accounting Standards No. 34 was 12 met, i.e. that the assets required a period of time to get them ready for their - 13 intended use. 14 Furthermore, since this court has concluded above that the criteria for 15 capitalizing expenses pursuant to Rule 6(b) is the same as the criteria (i.e. bringing 16 the property to a finished state) for capitalizing interest pursuant to Statement of 17 Financial Accounting Standards No. 34, the above evidence also makes an 18 extremely strong showing that the criteria for (1) Capitalizing Validation Costs, 19 (2) Capitalizing expenses, and (3) Capitalizing interest pursuant to Rule 6(b) have 20 been satisfied for the years 1998, 1999 and 2000. . 21 The Form 10—K filed by Genentech, Inc. with the Securities and Exchange 22 Commission for the fiscal year ended December 31, 2001 reports capitalized 23 interest of $1.8 Million for 2001, $2.2 Million for 2000, and $2.1 Million for 1999. 24 (Administrative Record 2016AR03976) The 2001 10-K also provides that “FDA 25 validation costs are capitalized as part of the effort required to acquire and 26 construct long-lived assets including readying them for their intended use, and are 27 amortized over the estimated useful life of the asset or the term of the lease, 28 whichever is shorter.” (Administrative Record 201 6AR03 976) Order re Petition for Writ of Administrative Mandate - 16 The 2001 lO-K contains a Report of Ernst & Young LLP stating that financial statements “present fairly” “in conformity with accounting principles generally accepted in the United States” (Administrative Record 2016AR03967) and a certification by Arthur Levinson, Louis J. Lavigne Jr., and John M. Whiting - that they “have prepared the financial statements in accordance with accounting principles generally accepted in the United States.” (Administrative Record 2016AR03968.) The above evidence makes an extremely strong showing that the ' criteria for capitalizing expenses pursuant to Rule 6(b) have been satisfied for the 10 years 2001, as well as 1999 and 2000. ll The Form 10—K filed by Genentech, Inc. with the Securities and Exchange 12 Commission for the fiscal year ended December 31, 2002 reports capitalized l3 interest of $1.0 Million for 2002, $1.8 Million for 2001, and $2.2 Million for 2000. l4 (Administrative Record 2016AR03996) The 2002 10—K also provides that “FDA l5 validation costs are capitalized as part of the effort required to acquire and l6 construct long-lived assets including readying them for their intended use, and are 17 amortized over the estimated useful life of the asset or the term of the lease, '18 whichever is shorter.” (Administrative Record 2016AR03997) 19 The 2002 lO-K contains a Report of Ernst & Young ‘LLP stating that 20 financial statements “present fairly” “in conformity. with accounting principles 21 generally accepted in the United States” (Administrative Record 2016AR03983— 22 2016AR0984.) The above evidence makes an extremely strong showing that the 23 criteria for capitalizing expenses pursuant to Rule 6(b) have been satisfied for the 24 years 2002, as well as 2000 and 2001. 25 The excerpts from the Audited Financial Statements issued by Genentech 26 and the Form 10-K filed by Genentech, Inc. with the Securities and Exchange 27 28 Commission for the fiscal years ending December 31, 2003, December 31, 2004, and December 31, 2005 provided in the Administrative Record do not appear to Order re Petition for Writ of Administrative Mandate - 17 include any express statement concerning the amount of expense, if any, capitalized in the period covered by those statements. However, the Administrative Record contains portions of the Genentech General Ledger, and portions of the Trial Balances that summarize portions of the Genentech General Ledger that indicate that Genentech capitalized interest, debugging costs, start-up costs, testing costs, labor, professional and engineering costs, and validation costs. (See e.g. Administrative Record 2016AR04801 [Trial Balance showing capitalized interest and validation accounts]; Recap of San Mateo 10 County’s Classification of Personal Property Fixed Assets (Administrative Record 11' 2016AR048120 to 2016AR04830); Fixed Asset Detail of Production Equipment 12 Over $25K (Administrative Record 2016AR04846 to 2016AR04895); and Fixed 13 Assets Re-Classified To Production Equipment by SMC (Administrative Record ' 14. 2016AR04898 to 2016AR04916 [Analysis of Fixed Asset Accounts Including 15 Capitalized Labor, Capitalized Engineering Services, Capitalized Prefabrication 16 Costs, Capitalized Professional Services, Capitalized Consulting Services, 17 Capitalized Conceptual Design Engineering services, and other Capitalized 18 Expenses].) 19 The fact that the General Ledger Genentech used to prepare Audited 20 Financial Statements issued by Genentech and the Form 10-K filed by Genentech, 21 Inc. with the Securities and Exchange Commission for the fiscal years ending 22 December 31, 2003, December 31, 2004, and December 31, 2005 is strong, but not 23 conclusive, evidence that such capitalized expenses were included in the Audited 24 Financial Statements issued by Genentech and the Form 10-K filed by Genentech, 25 Inc. with the Securities and Exchange Commission for the fiscal years ending 26 27 December 31, 2003, December 31, 2004, and December 31, 2005. Genentech has 28 not provided any credible evidence that the expenses capitalized on its general ‘ Order re Petition for Writ of Administrative Mandate — 18 ledger were not also capitalized in its Audited Financial Statements and Securities and Exchange Commission Filings. In Genentech, Inc.’s Response to Assessor’s Opening Brief, Genentech states the following: Although Genentech generally purchased this equipment from the various vendors for cash, accounting rules required Genentech to record on its books an imputed interest charge as if Genentech had financed the acquisitions with a loan. (2016AR04257—72 [Financial Accounting Standard No. 34 (“FASB 34”)].) This imputed interest was recorded in an account titled “capitalized interest,” for the years 1984 through 2005. (2016AR04722—23.) 10 ll During the years 1987 to 1992, in addition to capitalized interest 12 under FASB 34, Genentech also booked “start-up” and “debugging” costs in its accounting records. These were product-related costs l3 incurred, after the installation of a manufacturing asset to evaluate and 14 monitor those assets to see that the quality of the product being manufactured and the product yields were acceptable. 15 (2016AR04734-35; 2016AR02886: 5—24; 2016AR02740: 14-22.) l6 Genentech also booked certain “capitalized labor” costs, which were l7 incurred after installment of manufacturing assets and related to labor used in adjusting and testing installed equipment for the manufacture ; l8 of particular products. (2016AR02838—39.) 19 20 (Genentech, Inc.’s Response to Assessor’s Opening Brief Page 1:25-2:11.) 21 The above statement concedes that for fiscal years 1987 to 1992 Interest was 22 Capitalized or Imputed in compliance with FASBI 34 which in turn concedes that 23 the criteria of FASBI 34 were satisfied and therefore that (1) that the “assets must 24 require a period of time to get them ready for their intended use”; and (2) that the 25 “effect [of capitalizing interest], compared with the effect of expensing interest, is 26 material.” 27 The above statement also concedes that during the years 1987 to 1992 start 28 up, debugging costs, as