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STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
June 23, 2017 Edition
NEWS
FTA Annual Conference
If you couldn’t make it to Seattle for this year’s annual conference, presentations on the wide range of topics discussed can be found on FTA’s website.
MTC Seeking Contact Info For State Tax Attorneys
The Multistate Tax Commission is updating its state attorney listing—both DOR and AG attorneys—who practice in the tax area and would like to receive notice of MTC attorney meetings, training and other events. The MTC welcomes participation in its Litigation Committee and other activities from all states. There is typically no charge for the in-person information and training sessions held in March and July, or the occasional telephonic sessions. If you or a colleague would like to receive this information, just send an email to [email protected] and they will put you on their mailing list.
MTC Appellate Practice and Brief-Writing Workshop
The Multistate Tax Commission will hold an appellate practice and brief-writing workshop on Monday, July 31, 2017 in Louisville, Kentucky. Join some of the top state tax appellate experts in the country for this hands-on one day workshop designed to help state tax attorneys think about appellate strategy, choose winning arguments and make them persuasively, and respond effectively to taxpayers’ arguments. The workshop is only open to attorneys working for state revenue departments or offices of the attorney general or solicitor general. Information is available here: http://www.mtc.gov/Events-Training/2017/50th-Annual-Meeting
Proposed Partnership Audit Regs Rereleased
The proposed partnership audit regulations released and withdrawn in January were released again June 13 to implement changes made to partnership audits by the Bipartisan Budget Act of 2015 (BBA). The new version contains only a few changes from the January release. The deadline for comments is August 14th.
Bill to Overhaul California BOE
The California legislature has approved a budget bill that radically reforms the State Board of Equalization. The BOE is the nations only elected tax commission and S.B. 86 and its identical companion bill A.B. 102 proposed a major overhaul of the agency that administers sales, gasoline, tobacco, alcohol and other tax programs in the state.
The bills strip most of BOE’s statutory authority, transferring its tax administration duties to a new California Department of Tax and Fee Administration and shifting its authority to hear and decide tax appeals to a new Office of Tax Appeals. The governor would appoint leadership for these new bodies, with directors confirmed by the Senate. The BOE’s role would be focused on its core constitutional duties, including reviewing and equalizing property tax assessments and collecting alcohol excise taxes and taxes on insurers. It would also refocus on education outreach efforts.
Indictments in ID Theft Scheme Targeting Federal Student Loan Website
A federal grand jury has handed down a 23-count indictment against two men who allegedly used the data retrieval tool on the Free Application for Federal Student Aid (FAFSA) website to obtain nearly $12.7 million in fraudulent tax refunds from the IRS. The indictment alleges that Taiwo K. Onamuti and Muideen Adeboyejo Adebule conspired with each other to defraud the United States by obtaining and using stolen personal identifying information to prepare and submit to the IRS false and fraudulent federal tax returns that generated refunds that were loaded on prepaid debit cards.
U.S. SUPREME COURT UPDATE
Cert Denied
Diversified Ingredients Inc. v. Testa, U.S. Supreme Court Docket No. 16-1266. Petition denied 6/12/17. Issue: The taxpayer was appealing a decision by the U.S. Court of Appeals for the Eighth Circuit that dismissed its claim that an Ohio commercial activity tax assessment was prohibited under the federal Interstate Income Act (IIA). The Eighth Circuit held that the Tax Injunction Act (TIA) deprived the federal court of jurisdiction in the matter and the denial of certiorari here means that the taxpayer’s challenge must now make its way through the state appeals process.
Nacchio v. United States, U.S. Supreme Court Docket No. 16-810. Petition denied June 12, 2017. Issue: Whether former CEO of Qwest Communications International Inc. was entitled to a deduction for funds he was ordered to forfeit after being convicted of insider trading. The taxpayer had argued that the decision of U.S. Court of Appeals for the Federal Circuit that the forfeited funds are not deductible conflicts with the Second Circuit's holding in Stephens v. Comm'r, 905 F.2d 667 (2d Cir. 1990) and the First Circuit's holding in Fresenius Med. Care Holdings, Inc. v. United States, 763 F.3d 64 (1st Cir. 2014) and warranted Supreme Court review.
R.J. Reynolds Tobacco Co. v. MI Dept. of Treasury, U.S. Supreme Court Docket No. 16-1260. Petition denied June 19, 2017. Issue: The case was another challenge to the Michigan Court of Appeals' decision in Gillette Commercial Operations N.Am. v. Dep’t of Treasury upholding the state’s retroactive repeal of the Multistate Tax Compact. This is the seventh certiorari denial by the Court in these related cases.
Petition for Cert Filed
Washington Dep’t of Licensing v. Cougar Den, Inc., U.S. Supreme Court Docket No. 16-1498. Filed June 14, 2017. Issue: Whether a 19th century treaty barred the state from taxing fuel transported from out of state to a Native American reservation in the state by a company owned by a member of the Yakama Indian Nation. The Washington Supreme Court held that the treaty barred the imposition of the fuel tax.
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FEDERAL CASES OF INTEREST
IRS Can’t Charge Fees for PTINs
The U.S. District Court for the District of Columbia held that the Internal Revenue Service (IRS) has the authority to require a return preparer to use a preparer tax identification number (PTIN). The court found, however, that the IRS cannot charge fees for the issuance of PTINs because they are not a service or thing of value provided by the IRS. The court held that the regulations requiring payment of fees for PTINs are unlawful.
The plaintiffs in this case brought a class action against the United States to challenge regulations promulgated by the Treasury Department and the IRS in 2010-2011 regarding tax return preparers, imposing certain requirements on them including obtaining and paying for a PTIN. The plaintiffs argued that the government lacked legal authority to require PTINs and PTIN fees, and alternatively, argued that the fee imposed was excessive and impermissible.
In 2016, the Court certified the proposed class of “all individuals and entities who have paid an initial and/or renewal fee for a PTIN, excluding Allen Buckley, Allen Buckley LLC, and Christopher Rizek.” The court noted a statutory provision that was in effect prior to the new regulations requiring the PTIN and PTIN fee required that “[a]ny return or claim for refund prepared by a tax return preparer shall bear such identifying number for securing proper identification of such preparer, his employer, or both, as may be prescribed.” 26 U.S.C. Sec. 6109(a)(4). The regulations required, for the first time, that tax return preparers must obtain and exclusively use the PTIN, rather than a social security number (SSN), as the identifying number to be included with the tax return preparer’s signature on a tax return or claim for refund. The court noted that as justification for the requirement that preparers must obtain and use a PTIN, the IRS repeatedly cited to the need to identify individuals involved in preparing a tax return for others so as to aid their ability to oversee such individuals and to administer requirements intended to ensure that tax return preparers are competent, trained, and conform to rules of practice. The IRS believed that mandating the exclusive use of these PTINs was critical to effective oversight and would help maintain the confidentiality of SSNs. The regulations also imposed a user fee requirement for obtaining a PTIN, and relied on the authority under the Independent Offices Appropriations Act of 1952 (IOAA) to do so, arguing that the PTIN was a “service or thing of value” because without one a return preparer could not receive compensation for preparing returns.
The court discussed prior case law interpreting the tax return preparer regulations and the exam and education requirements, which invalidated the regulations requiring competency testing and continuing education and leaving only the PTIN requirement and fee intact.
While the IOAA permits agencies to charge user fees for a service of thing of value provided for the agency, the court noted that the Supreme Court has read that language narrowly in order to distinguish between fees and taxes. Agencies may impose fees for bestowing special benefits on individuals not shared by the general public, but there must be a sufficient nexus between the agency service for which the fee is charged and the individuals who are assessed.
The court found that the agency action was reviewable by the court and found that the IRS was authorized to issue regulations requiring the exclusive use of PTINs under prior case law.
The court pointed out that the statute specifically says that the Secretary has the authority to specify the required identifying number to be used on prepared tax returns and said that the court must give effect to the unambiguous intent of Congress that the Secretary may require the use of such a number. It held, additionally, that the decision to require the use of PTINs was not arbitrary or capricious, noting the several justifications offered by the IRS for requiring the exclusive use of PTINs. The court found that there was a rational connection between the regulations requiring the use of PTINs and the stated rationales, effective administration and oversight. It also noted that this was not an unexplained change in policy and pointed to case law where other courts had considered this issue and found that the PTIN requirement was authorized by law.
The court then turned to the question of whether the IRS was authorized to charge user fees for the PTINs and determined that it was not because the PTINs did not pass must as a “service or thing of value.” The court said that although the IRS may require the use of PTINs, it may not charge fees for PTINs because this would be equivalent to imposing a regulatory licensing scheme and the IRS does not have that authority since the courts struck it down previously. The court acknowledged that courts in the Eleventh Circuit have found that the PTIN fees are permissible under the IOAA but said those decisions were made prior to the D.C circuit’s decision finding that the IRS lacked the authority to regulate tax return preparers and the striking down of the regulations attempting to do so. The court said that that case made it clear that the IRS may not regulate in this area or require that tax return preparers obtain an occupational license and said it was unaware of similar cases in which an agency has been allowed to charge fees under the IOAA for issuing some sort of identifier when that agency is not allowed to regulate those to whom the identifier is issued. Steele, Adam et al. v. United States, U.S. District Court for the District of Columbia, No. 1:14-cv-01523. 6/1/17
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Use of Local Motor Fuel Sales Taxes Upheld
The Georgia Supreme Court has upheld the dismissal of a lawsuit filed by the Georgia Motor Trucking Association (MTA) that alleged revenues from local sales taxes on motor fuel were required by the state constitution to be used for funding public roads and bridges. The court held that the referenced constitutional requirement was limited to motor fuel excise tax revenues.
The Georgia constitution provides that an amount equal to all money derived from “motor fuel taxes” received by the state is appropriated for activities incident to providing and maintaining roads and bridges in the state. During the 2015 session of the state’s legislation the Transportation Funding Act of 2015 (TFA) was enacted, amending provisions related to the funding of transportation infrastructure, including taxes that related to motor fuel.
The MTA soon thereafter filed suit against the state Department of Revenue (DOR) alleging that TFA impermissibly allowed the revenue from local sales and use taxes on the retail sale of motor fuel to be used for purposes other than for building and maintaining public roads.
The trial court held for DOR, granting the motion to dismiss and concluding that the plaintiffs’ mandamus claims failed because plaintiffs had an adequate legal remedy to challenge illegally or unconstitutionally assessed and collected taxes under a refund statute, and neither the Commissioner nor the Treasurer had a clear legal duty to monitor or control local spending for roads and bridges or could appropriate state funds to offset local spending of local motor fuel tax revenues. MTA filed this appeal.
The parties raise a number of issues about jurisdiction, procedure, and the merits, but the court said that one issue is dispositive, i.e., whether local sales and use taxes imposed on the retail sale of motor fuel are “motor fuel taxes” as that term is used in the constitutional provision described above. The court said that the general rule in the state prohibits earmarking revenues for a specific purpose, noting exceptions to that general rule including the one for “motor fuel taxes.” The court generally applies the ordinary signification to words in construing a constitutional provision and the court said that a constitutional provision must be presumed to have been framed and adopted in the light and understanding of prior and existing laws and with reference to them. To discern the meaning of “motor fuel taxes” at the time the term entered the Constitution, the court said it must consider the history of taxes on motor fuels and the context that history provided at the time the relevant constitutional provision was adopted. In 1927 the state legislature passed legislation authorizing state taxes on motor fuels and earmarked a portion of the revenues from this tax for the state’s roads and bridges. The statute was amended in 1929 and in 1937 the legislature revised the statutes related to the taxation of distributors of motor fuels and defined these statutes as the “Motor-Fuel Tax Law. The mandated distribution of the funds from these taxes on distributors, but removed this mandate from the tax levy provision and set it out in a separate statute. In 1979, the General Assembly imposed an additional tax on distributors, and designated this additional tax the “second motor fuel tax.” Beginning in 1929, the legislature enacted a sales tax and the tax was held to apply to retail sales of gasoline and did not dedicate any of the revenues to the state highway system. That statute has been amended throughout the subsequent years and permitted the local subdivisions to impose a sales and use tax and later amendment specifically provided that it was the intent of the General Assembly that taxation imposed on sales of motor fuel wholly or partially subject to taxation under that section shall not constitute motor fuel taxes for purposes of any provision of the Constitution providing for the automatic or mandatory appropriation of any amount of funds equal to funds derived from motor fuel taxes. The 2015 legislation, the impetus for this suit, again amended the tax structure on motor fuels reducing from two to one the taxes on distributors but increasing the tax rate and exempting the sale of gasoline from the state sales and use taxes but not the local sales and use taxes.
The court found that the local sales and use taxes authorized by HB 170 were separate and distinct and were not “motor fuel taxes” as that term is used in the Motor Fuel Provision. As a result, the court found that DOR had no duty to appropriate for public roads an amount of revenue equal to the proceeds from local sales and use taxes, and the plaintiffs’ mandamus claims failed. The court held that the Constitution’s automatic appropriation of “motor fuel taxes” did not apply to generally applicable retail sales taxes that incidentally applied to sales of motor fuel. Georgia Motor Trucking Ass'n v. Dep't of Revenue, Georgia Supreme Court, No. S17A0430. 6/5/17
Audit Method Risked Overstating Kiosk's Liability
The Minnesota Tax Court dismissed the Department of Revenue's (DOR) motion for summary judgment, finding that a retail kiosk operator provided sufficient evidence to prove that DOR’s audit method for determining the taxpayer's sales and use tax liability risked overstating its liability.
The taxpayer, during the period January 2011 through September 2015 operated retail kiosks in two malls in the state selling sunglasses, handbags, and radio-controlled helicopters. For those tax periods, the taxpayer filed state sales and use tax returns and remitted the tax shown due on those returns. In September 2014 DOR commenced a sales and use tax audit and requesting certain documents from the taxpayer, including point-of-sale reports. The taxpayer initially provided only its bank and merchant account statements that verified its gross receipts but did not indicate why the gross receipts exceeded its reported taxable sales. Taxpayer’s owner told the auditor that cash sales represented approximately 10-15 percent of its overall sales and cash receipts were not deposited into the taxpayer’s bank account and it maintained no specific record of cash sales. DOR issued a subpoena for sales records, but the taxpayer failed to respond and did not provide any additional sales records. DOR issued an assessment, taxing the taxpayer on the difference between it reported gross receipts and its reported taxable sales, arguing that there was a statutory presumption that all gross receipts were subject to the tax. The taxpayer filed an appealing arguing that some of its gross receipts were a result of sales of clothing and certain non-taxable services such as knife sharpening and eyeglass repair. During discovery DOR requested documentation to support these sales but the taxpayer’s responses were incomplete and in December 2016 and again in January 2017, the Commissioner asked to meet and confer concerning taxpayer’s discovery responses. The taxpayer did not respond to either communication and onFebruary 10, 2017, the Commissioner moved for summary judgment on the ground that the taxpayer presented no evidence supporting its contention DOR’s action was erroneous. The taxpayer opposed summary judgment arguing that it had provided documentationof exempt labor sales, "bundled transactions," Internet sales, and sales of "special tooling."
The court noted that the order of the Commissioner shall be prima facie valid, putting the burden on the taxpayer to rebut the presumption. This can be done by presenting evidence of its own calculation of a lower tax liability or by challenging the Commissioner’s methodology arriving at the assessment. The Commissioner argued there were no disputed issues of material fact because the taxpayer failed to identify any evidence to rebut the prima facie validity of the its order. The court focused its inquiry on whether the taxpayer presented substantial evidence that it made non-taxable clothing sales, which would indicate that some of the gross receipts taxed by the assessment derived from non-taxable sales. During oral argument the Commissioner contended that purchase records for hundreds of pairs of pants did not establish that the taxpayer actually sold these pants and that the taxpayer did not present sales records establishing a lower tax liability because of these non-taxable sales.
The court agreed that the purchase records for the pants did not prove that the taxpayer actually sold those items of clothing at retail, but found the implication of the hundreds of pair of pants purchased were inventory for subsequent sale at retail more plausible that the implication that they were purchased for the taxpayer’s personal use. Citing case law on the issue of summary judgment, the court said that it must view the evidence in the light most favorable to the nonmoving party, and must resolve all doubts and factual inferences against the movant and in favor of the party opposing summary judgment. The court found that the clothing purchase invoices the taxpayer furnished the Commissioner constituted substantial evidence that it made non-taxable clothing sales. The court said that because it must resolve any doubt as to whether a dispute of material fact exists in favor of trial, it concluded that whether the taxpayer actually made such sales is a disputed issue of material fact. The court agreed with the Commissioner that without records documenting its clothing sales, the taxpayer may have a difficult time establishing a tax liability lower than the assessment and that may prove fatal at trial. The court held that the taxpayer had shown that the Commissioner's method of assessment risked overstating taxpayer’s liability by taxing exempt clothing sales. Paris Handbag LLC v. Comm'r of Revenue, Minnesota Tax Court, File No. 8934-R. 5/31/17
Personal Income Tax Decisions
Income Tax Petition Untimely Filed
The West Virginia Supreme Court of Appeals found that a circuit court properly dismissed a taxpayer's petition for personal income tax reassessment as untimely filed. The court determined that the taxpayer had filed the petition with the tax assessment office outside the statutorily prescribed 60-day timeframe.
In June of 2015, the taxpayer was sent an assessment for an income tax deficiency and he subsequently filed a petition for reassessment with the state’s Office of Tax Assessment (OTA), in which he admitted that his filing was beyond the 60-day deadline set forth in the statute for filing for reassessment. The state Tax Department (Department) filed a motion to dismiss with OTA based on the taxpayer’s untimely filing. The taxpayer did not respond to the Department’s motion and did not seek to provide any additional evidence. In November of 2015, an OTA Administrative Law Judge (ALJ) issued an order of dismissal based upon petitioner’s untimely filing of his petition. In January of 2016, the taxpayer appealed to the circuit court, which affirmed the ALJ decision. Taxpayer then filed this appeal, arguing that the circuit court erred in affirming the motion to dismiss his petition for reassessment because it did not have personal jurisdiction over him.
The court said that it was well settled law that an appeal from a dismissal is not reviewed on the merits, but rather, a determination is made as to whether the pleadings below are sufficient to withstand the motion to dismiss. Citing prior case lase, the court said that it previously held that to allow the circuit court to determine an issue on evidence not considered at the administrative hearing would cast the court in the role of performing an executive function, and under the principle of separation of powers this could not be permitted. The circuit court was required to decide the case on the evidence in the record as it was received. The court said that it was clear from the record on appeal that the taxpayer’s assessment was delivered on June 8, 2015 and, therefore, the statutory deadline for petitioner to timely file his petition for reassessment with the OTA was approximately August 7, 2015. The taxpayer filed his petition for reassessment on September 2, 2015, clearly outside the statutorily prescribed timeframe. The court noted that the taxpayer admitted in his petition for reassessment that he missed the applicable statutory deadline for filing his petition. Thus, the court found that the circuit court properly affirmed the OTA’s dismissal of petitioner’s petition for reassessment.
The court also discussed cases in which it had specifically addressed statutory appeal deadlines in tax cases, noting that it had long held that filing requirements established by statute are not readily susceptible to equitable modification or tempering.
The court also rejected the taxpayer’s argument that he objected to the Tax Department’s personal jurisdiction over him from the outset of his petition, finding it was clear from the record on appeal that he only generally mentioned personal jurisdiction in his time-barred petition for reassessment. Pursuant to Rule 12(b)(2) of the West Virginia Rules of Civil Procedure, a litigant must file a motion challenging personal jurisdiction from the outset of the case, and the court found that it was clear from the record on appeal that the taxpayer had filed no such motion. Cate v. Steager, West Virginia Supreme Court, No. 16-0599. 6/16/17
Corporate Income and Business Tax Decisions
No cases to report.
Property Tax Decisions
Standing Not Limited to Property Taxpayers
The California Supreme Court reversed a lower court decision that an individual must pay property tax in order to have standing to pursue an injunction for improper expenditures by a locality. The court found that paying, or being liable to pay, any tax assessed by the locality on the individual was sufficient for standing.
Under the state’s Code of Civil Procedure section 526a,certain individuals and corporations have a right to pursue legal actions enjoining wasteful or illegal expenditures by government entities, but whether someone can use this provision to begin a lawsuit depends on whether the person has standing to do so. At issue here is whether an individual’s standing to sue under section 526a requires the payment of a property tax, and if not, what types of tax payments satisfy the statute.
The plaintiff resides in the City of San Rafael and the County of Marin. She did not own real property in the city or county, but lived with her daughter in a rental apartment in the city when she began this lawsuit. On January 9, 2013, she filed a complaint for declaratory and injunctive relief challenging the manner in which the City of San Rafael and County of Marin enforced Vehicle Code section 14602.6, contending that the city’s and county’s practice of impounding vehicles without providing adequate notice violates both the state and federal Constitutions. Because she had not been personally subject to this allegedly unconstitutional practice, she averred that she had taxpayer standing under section 526a because she had paid sales tax, gasoline tax, water and sewage fees, and “other taxes, charges and fees routinely imposed” in the City of San Rafael and the County of Marin. She conceded that she had not paid property taxes. The trial court dismissed the plaintiff’s complaint, and cited two prior Court of Appeals opinions that contained language suggesting that section 526a requires a plaintiff to pay property taxes to satisfy the taxpayer standing requirement. The plaintiff filed an appeal and the Court of Appeals affirmed the judgment of dismissal, reasoning that while some plaintiffs might be able to invoke the statute without paying property taxes, an individual plaintiff must be liable to pay a property tax within the relevant locality or have paid such a tax during the previous year in order to have standing. The plaintiff filed this appeal.
The court said the heart of this case is a portion of Section 526a that provides, in relevant part that in order to have standing to file suit to prevent any illegal expenditure a person must be one “who is assessed for and is liable to pay . . . or, has paid, a tax therein,” a phrase in section 526a the court said they have not previously construed. The court discussed the rules of statutory construction. The court said that the statutory language defines two particular classes of taxpayers that may maintain an action under section 526a, and further specifies the type of tax that they must be liable to pay and where they must pay it. The court also reviewed the rules regarding standing to file suit in the state, noting that a party is required to show that he or she is sufficiently interested as a prerequisite to deciding, on the merits, whether a party’s challenge to legislative or executive action independently has merit. The court said that section 526a provides a mechanism for controlling illegal, injurious, or wasteful actions by officials and remains available even where the injury is insufficient to satisfy general state standing requirements under section 367. The court said that section 526a represented a legislative effort to codify a more limited version of the common law right and was a means for certain people to pursue an action enjoining some expenditures of public funds even when those people had not been injured, but was also a measure narrowing the category of taxpayers that are eligible to commence such actions relative to what the common law allowed. The court said that while section 526a narrows the category of taxpayers able to sue
to enjoin certain expenditures of governmental funds, the Court of Appeal traveled a step too far when it held that the statute requires individual plaintiffs to pay a property tax. The court concluded that limiting its application to property taxpayers reflected an unduly constrained view of the statute’s requirements.
The court said it was true that the statute’s conception of an “assessed” tax encompasses property taxes, but the conclusion that property taxes satisfy the statute’s requirement for standing does not suggest that only such taxes suffice. The court noted that as a matter of statutory drafting, the legislature could easily have written the statute to restrict standing only to those who pay property taxes, but that limitation did not appear in the statute. The court found that was a strong indication that the statute’s invocation of an “assessed” tax is a general description, not a proxy for the term “property tax.” The court found that the legislature’s purpose, at a minimum, was for the statute to apply where plaintiffs are directly taxed by the defendant locality, but remanded the matter to ascertain whether the plaintiff’s allegations that she has paid taxes in and to the city and county and therefore satisfy the requirements for standing. A concurring opinion urged the legislature to clarify what kinds of taxes are sufficient to establish standing in suits against a government for wasteful or illegal expenditures. Weatherford v. City of San Rafael, California Supreme Court, No. S219567. 6/5/17
Abnormal Obsolescence Claim Denied
The Indiana Tax Court affirmed a county board's decision denying a newspaper company's property tax deduction claims for a printing press and its related equipment. The court concluded that the taxpayer did not make a prima facie case of abnormal obsolescence.
The taxpayer is a daily newspaper publisher located in in the state, with its primary paper published daily that has experienced the economic downturn over the last decade with an overall decline of nearly 60% in circulation since the 1990s. In 1989, the newspaper purchased a new 12-position flexographic printer, which at that time was expected to become the predominant method of printing newspapers. Within a few years, it became apparent that the industry preferred using an offset press rather than a flexographic press, which was more expensive to operate, and only 12 of these printers remain in use. The newspaper can no longer buy parts for the printing press from the manufacturer, and it must have parts specially manufactured or purchase used parts from newspaper companies that once operated similar presses.
In July 2011, the newspaper filed its 2011 tax return and included a separate schedule applying an abnormal obsolescence deduction to the printing press and related equipment. It filed similar returns for the 2013 and 2014 tax years. The abnormal obsolescence adjustments were disallowed by the county for each of the three years. For each year the taxpayer and the county went through the administrative appeal process. On January 26, 2016, the Board of Tax Appeals (BTA) held a combined evidentiary hearing on each of the pending petitions.
The taxpayer submitted appraisals prepared by an accredited senior appraiser in support of its deduction and he relied most heavily on the market approach because he felt that approach most accurately quantified all forms of depreciation and obsolescence. He researched the market by talking with the original equipment manufacturer, used equipment dealers, and other operators of two presses that are similar to the Printing Press and that research indicated that the original equipment manufacturer would attach a value of $865,000 to the printing press for the 2011 tax year, that no used equipment dealer had any interest in purchasing the equipment or any indications of recent comparable sales, and other newspaper companies had discontinued operations of their flexographic presses and have sold the component parts for their scrap value. He concluded that it would be impractical to use the printing press for anything other than printing newspapers and that it lacks functionality for its best use because of an inherent inability to print color copy on both sides of the page. He therefore determined that it is not possible to cure the causes of the press’s obsolescence. He placed a value on the press and related equipment for 2011 of $1.2 million, and he calculated abnormal obsolescence by using a mathematical computation equal to the difference between the reportable value of the printing press and its equipment and the appraised value.
The county offered as evidence and evaluation of the appraiser’s work performed by the county assessor and the newspaper objected to the exhibit because it had not been provided to it five days before the hearing as required by the Indiana Administrative Code and because it was hearsay evidence. The County responded that the exhibit was rebuttal testimony and therefore did not have to comply with the five-day timeline and the Board took the issue under advisement and completed the hearing. On September 19, 2016, the Board issued its final determination, denying the newspaper’s petitions, including its objection to the introduction of the county’s exhibit. The taxpayer filed this appeal.
The court first addressed the untimely submission of the exhibit by the county and agreed with the taxpayer that the BTA erred by admitting the document into evidence because it was not provided to the newspaper according to the requisite timeline. The court said that the Indiana Administrative Code mandates that a party to an administrative appeal before the BTA must provide copies of documentary evidence to all other parties at least five business days before the hearing and failure to do so may serve as grounds to exclude the evidence. The court disagreed with the BTA’s holding that because the evidence was rebuttal evidence, its disclosure was not required, citing McCullough v. Archbold Ladder Co., 605 N.E.2d 175, 179 (Ind. 1993) for the principle that nondisclosure of a rebuttal witness is excused only when that witness was unknown and unanticipated. Known and anticipated witnesses, even if presented in rebuttal, must be identified pursuant to a court order, such as a pre-trial order, or to a proper discovery request. The court noted that the exhibit in question was dated January 20, 2016, and the hearing occurred on January 26, 2016, meaning that this exhibit was known, anticipated, and actually available to be disclosed to the newspaper within the requisite timeline.
Under the state statute regarding personal property,a tax return must be filed in each taxing district where property has a tax situs subject to certain qualifications. Taxpayers must record the cost of depreciable property, both real and personal, and use that cost in determining the value of the depreciable personal property subject to assessment. Ordinary depreciation of personal property is calculated pursuant to a set schedule contained in the Indiana Administrative Code, which automatically reflects all adjustments for Indiana property tax purposes except for abnormal obsolescence. Taxpayers are not permitted a deduction for “normal obsolescence” which means the anticipated or expected reduction in the value of business personal property that can be foreseen by a reasonable, prudent businessman when property is acquired and placed into service. Taxpayers are, however, allowed adjustments to personal property assessments for abnormal obsolescence, which means obsolescence which occurs as a result of factors over which the taxpayer has no control and is unanticipated, unexpected, and cannot reasonably beforeseen by a prudent businessman prior to the occurrence and is of a nonrecurring nature.
The BTA concluded that the newspaper failed to establish the abnormal obsolescence of the press and its related equipment because it failed to point to a single, specific, non-recurring triggering event justifying a determination of abnormal obsolescence and the printing press is still operable and has five years remaining of predicted useful service life. The court here noted that there are two possible ways in which the printing press could qualify for an abnormal obsolescence adjustment: unforeseen changes in market values or exceptional technological obsolescence. For exceptional technological obsolescence to apply, the state code requires that the personal property must not be still capable of performing the function for which it was acquired and must not still be in operation on and before the assessment date. The court said it was undisputed that the printing press was still capable of performing the function for which it was acquired, was still producing output both on and before the assessment dates, and still had at least five years left of continuing functionality.
Consequently, the court said, the plain terms of the administrative code mandated that the newspaper was not entitled to claim abnormal obsolescence because of exceptional technological obsolescence. The court then turned to the question of whether there were unforeseen changes in market values of the personal property, noting the example set forth in the code for the case of a pharmaceutical manufacturer that produces a drug that is suddenly banned in the United States, rendering the company’s equipment used to produce that drug abnormally obsolescent. The court also pointed to the examples provided by the BTA in its decision that involved two corporate entities that suffered a substantial decline in business following the 9/11 terrorist attacks. The court said that even if it agreed that the dramatic change in the newspaper industry over the past decade has been unanticipated, unexpected, and unforeseen, it was far more difficult to conclude that it was “non-recurring,” a requirement for this deduction, but more logically characterized as “ongoing.” The court held that the newspaper had not established that the obsolescence of its property was non-recurring in nature. Evansville Courier Co. Inc. v. Vanderburgh Cnty. Assessor, Indiana Tax Court, Tax Court Case No. 02T10-1611-TA-55. 6/5/17
Other Taxes and Procedural Issues
Refund Claim a “Collateral Attack”
The Michigan Court of Appeals affirmed an order assessing the president of a plumbing and heating company for failure to pay delinquent taxes. The court concluded that the taxpayer's attempt to challenge a conclusive assessment through a claim for refund was a "collateral attack" barred by state code.
The taxpayer was the president of a plumbing and heating company that failed to pay certain taxes to the Department of Treasury (DOT) for many years. DOT assessed those delinquent taxes against the taxpayer personally as a responsible person under the statute. The statute provided that the taxpayer could file an appeal within 35 days of the assessment to the Michigan Tax Tribunal (Tribunal) for by filing an appeal with the Court of Claims within 90 days. The taxpayer failed to file a timely appeal and tax liens were issued against him personally. He then paid a divisible portion of each of the 16 withholding tax assessments in an effort to challenge all of the assessments by then submitting a claim for refund with DOT.
DOT denied the claim for refund, finding that the taxpayer’s action was a “collateral attack” of the final assessments, barred by the statute. The taxpayer filed an appeal with the Tribunal, which dismissed taxpayer’s appeal concluding that once the time for appeal of the assessments had expired, the assessments became final and could not be attacked via the refund procedure. The taxpayer filed this appeal.
The court noted that, absent fraud, the court’s review of a Tribunal decision was limited to determining whether it made an error of law or adopted a wrong legal principle. The Tribunal’s factual findings are upheld unless they are not supported by competent, material, and substantial evidence. The statute in MCL 205.22(4), provides that an “assessment, decision, or order of the department, if not appealed in accordance with this section, is final and is not reviewable in any court by mandamus, appeal, or other method of direct or collateral attack.” Another section, MCL 205.30, governs the procedure by which a taxpayer may request a refund and provides, in part, that DOT shall refund an overpayment if the payment is found to be unjustly assessed and another provision requires that the refund application be filed within four years of the payment of the tax. The taxpayer argued that his claim was wrongly denied because there was no evidence that he was responsible for the taxes at issue and DOT unjustly assessed the tax against him. While the taxpayer acknowledged that the deadline for appealing the assessments had passed, the refund section entitles him to challenge the underlying assessments as “unjustly assessed.”
The court said that the taxpayer admitted that his purpose in filing the refund claim was to challenge the underlying assessment, and, accordingly, plainly admitted to attacking collaterally the assessment, an action barred by the statute for his failure to avail himself of his appeal rights. The court rejected the taxpayer’s argument that his refund claim, even filed outside the time window for an appeal, is not the type of collateral attack envisioned by the statute and would render nugatory the words “unjustly assessed” in the refund provision if not permitted here. The court said that while it is true that the court must avoid an interpretation that negates any portion of the statute, if found that the taxpayer’s argument overlooked another section, MCL 205.21(5), which allows a taxpayer to pay an assessment and any interest or penalties during the pendency of his challenge of that assessment, thereby rendering his challenge of the assessment a claim for refund. Under that section a taxpayer may still seek a refund for an assessment unjustly assessed before the assessment becomes conclusive. Jenks v. Dep't of Treasury, Michigan Court of Appeals, No. 332787; LC No. 15-004522-TT. 6/15/17
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected]. |
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STATE TAXHIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
May 26, 2017 Edition
NEWS
MTC’s Work on New Partnership Audit Regulations
The Multistate Tax Commission has a uniformity working group focusing on drafting model provisions allowing states to adapt to the recent federal audit and adjustment rules for partnerships, enacted by Congress under the 2015 Bipartisan Budget Act (BBA). The IRS had issued regulations earlier this year, which were withdrawn under the new administration's regulatory freeze. It is generally expected that those regulations will be reissued soon, and in the same form, and that the IRS will want to take any comments fairly quickly in order to be able to have rules for implementing the changes in place by the end of this year. Because of the effects of the BBA's changes on state tax assessments, states may want to consider whether to submit comments. The MTC's uniformity committee may also consider submitting comments on the regulations when they are reissued. The regulations are available for review on the MTC's partnership project webpage here: http://www.mtc.gov/getattachment/Uniformity/Project-Teams/Partnership-Informational-Project/Proposed-IRS-Regulations-1-18-2017.pdf.aspx.
On the agenda for FTA’s annual conference in Seattle in June is an afternoon session on the new partnership audit rules and the potential impact on the states. Helen Hecht, MTC’s general counsel, will moderate the panel and will be joined by Tracee Abel from Montana,
Sue Leighton from Pennsylvania, and Nikki Dobay with COST.
U.S. SUPREME COURT UPDATE
Cert Denied
Gillette Commercial Operations v. Michigan Dept of Treasury, U.S. Supreme Court Docket No. 16-697. Petition for certiorari denied May 22, 2017. Issue: Taxpayers in a number of consolidated cases were challenging Michigan’s retroactive repeal of the Multistate Tax Compact and its three-factor apportionment formula, arguing that the court should use these cases to clarify the scope of a legitimate legislative purpose for enacting retroactive tax legislation and to provide guidance on a constitutionally acceptable length of time for retroactive tax changes.
Dot Foods, Inc. v. Dept of Revenue, U.S. Supreme Court Docket No. 16-308. Petition for certiorari denied May 22, 2017. Issue: The taxpayer was challenging the state of Washington’s retroactive amendment of a state tax law to reverse an unfavorable outcome for the state in tax litigation.
FEDERAL CASES OF INTEREST
Officers Not Reckless Regarding Trust Fund Tax
The U. S. Court of Appeals for the Sixth Circuit vacated a decision that held two company officers liable for trust fund recovery penalties because they recklessly disregarded the risk that the taxes would not be paid. The court held that the officers’ negligence in believing the trust fund taxes were being paid did not rise to the level of recklessness and remanded the matter to the district court.
The court had previously held that the two officers, the president and CEO, respectively, of a company, were responsible for paying the company’s delinquent trust fund taxes, but had remanded the matter to the district court on the question of whether their failure to pay these taxes was willful and, therefore, subject to penalties. After a bench trial the district court concluded that they willfully failed to pay the company’s trust-fund taxes by recklessly disregarding the risk that the taxes were not being paid. The officers appealed that determination.
In 1998, the two taxpayers assembled a group of investors and negotiated the purchase of a division of a large manufacturing company that produced interior trim products for automobiles and subsequent to the purchase one became the chairman and CEO of the company and the other the president. As part of the financing arrangement for the purchase, they had a line of credit with GMAC and they borrowed against the line of credit to pay operating expenses including trust fund taxes. As part of the financing agreement GMAC had the right to audit the company and in March 2000 GMAC’s auditors sent them a letter stating that the company had failed to provide adequate supporting documentation for their review and recommended, among other things, that the company implement procedures to ensure that all tax payments are made in a timely manner with supporting documentation retained. GMAC forwarded that letter to the company and the controller responded acknowledging that the company had missed two trust fund tax deposits during the transition from one bank to another but was current with all tax payments and the controller copied the two officers on his response. The company, in response to recommendations received, hired an assistant controller in April 2000 and in July 2000 hired a chief financial officer to whom the controller reported. Another audit company issued a “clean” audit report in December 2000, finding that the company was current in its taxes although the audit firm was aware that the company had been later in its first and second quarter trust fund payments. Despite the clean audit report, in January 2001, the audit firm sent a letter to the CEO, copying the president, CFO and controller, identifying flaws in the company’s accounting practices observed in the course of its 2000 audit, including a section devoted to the company’s failure to pay trust-fund taxes in a timely manner. The firm recommended that the company take the measures necessary to ensure that all payroll taxes and withholdings are deposited in a timely manner and offered to its assistance in this endeavor. In January 2001, the first audit firm discovered that the company’s financial statements were fraudulently overstated and the company, rather than being profitable, was losing money, finding that the controller had falsified certain receivables by adding digits to the invoice.
The company entered into a Forbearance Agreement with GMAC, dated January 31, 2001, and an Access and Accommodation Agreement with GM, dated February 2, 2001, under which GM hired a crisis management company. At the time the Forbearance and Accommodation Agreements were executed, the two officers were unaware that the company was delinquent on trust-fund taxes for the second, third, and fourth quarters of 2000. After execution of the agreements, both GMAC and the crisis management company reviewed and approved all funding for the company and had complete control over the flow of money in and out of it. When the officers learned of the tax delinquencies, they asked for permission to pay them but the crisis management reviewers refused to approve this expenditure. The controller was then fired. In April 2001, the CEO signed a Chapter 11 bankruptcy petition on behalf of the company in the Eastern District of Michigan and the company was ultimately liquidated through this bankruptcy proceeding, which eventually yielded payments to the IRS for the unpaid trust-fund taxes for the second quarter of 2000. The IRS assessed the two officers in 2005 for the IRC § 6672 penalties for the company’s outstanding trust-fund tax liability for the year 2000.
Under § 6672(a) any person required to collect and pay over any tax who willfully fails to collect or pay over the tax is liable for a penalty. Person is defined to include an officer of a corporation who is under a duty to perform an act. The taxpayer bears the burden of proving by a preponderance of the evidence either that he is not a responsible person or that his failure to pay taxes was not willful. The court said that a responsible person will be found liable under § 6672(a) if the government can demonstrate that he had either actual knowledge that the trust-fund taxes were not paid and the ability to pay the taxes, or he recklessly disregarded known risks that the trust-fund taxes were not paid. The court cited prior case law to determine “actual knowledge” and said that a responsible person who first becomes aware of a past due withholding tax liability after the liability has accrued is considered willful for the purposes of this section if he fails to use all unencumbered funds that come into his possession thereafter to pay the delinquent taxes. The court said that while other circuits have enunciated tests for recklessness under § 6672(a), it was a case of first impression for this circuit. After reviewing the cases in other circuits, the court reiterate its previous holding that a responsible person is reckless and therefore willful under § 6672(a) when he disregards obvious or known risks that trust-fund taxes are not being paid to the Treasury and fails to investigate. The court said it was adopting the Second Circuit’s “reasonable cause” exception to § 6672(a) liability, finding that a responsible person’s failure to cause the withholding taxes to be paid is not willful if he believed that the taxes were in fact being paid, as long as that belief was a reasonable one.
The court said that the district court correctly determined that the officers did not have actual knowledge that the trust-fund taxes were not being paid, finding that the record clearly indicated that they did not acquire actual knowledge of the delinquency until after the Forbearance Agreement was executed and GMAC and BBK assumed control of the company’s finances. The court further found that the district court incorrectly determined that the officers recklessly disregarded the risk that the company’s trust-fund taxes were not being paid in the third and fourth quarters of 2000 and found that they did not act unreasonably.
The court found that they took reasonable steps to ensure the timely payment of trust-fund taxes and reasonably believed that the taxes were being paid, citing their hiring of an assistant for the controller in performing his duties including the payment of trust fund taxes and the addition of a CFO to oversee the controller’s work. The court said these were important considerations in determining whether the officers reasonably believed the company was making timely payment of trust-fund taxes. The court also cited the hiring of an independent
professional accounting firm to assist in tax matters and conduct annual, full-scope audits as a further demonstration that they took reasonable steps to comply with all of the company’s legal tax obligations, including the timely payment of trust-fund taxes. The court said it found nothing in the record that would cause it to question the reasonableness of the officers’ reliance on the accounting firm’s competency. The court held that based on its review of the record, the officers had met their burden in demonstrating that their negligence in believing that the company’s trust-fund taxes were being paid for the third and fourth quarters of 2000 did not rise to the level of recklessness and remanded the matter. Byrne, Roger v. United States et al., U.S. Court of Appeals for the Sixth Circuit, No. 15-2396. 5/15/17
Late Filer's Taxes Not Dischargeable
The U.S. Court of Appeals for the Third Circuit held that returns a debtor filed after the IRS had assessed taxes against him didn't constitute returns for bankruptcy purposes. The court held that the late-filed returns were not an honest and reasonable effort to comply with the tax law and found that his taxes were not dischargeable.
The taxpayer failed to file personal income tax returns for 2000, 2001, and 2002 in a timely manner and in 2004, the IRS issued assessments against him for 2000 and 2001. Approximately one month later the taxpayer filed Forms 1040 for 2000 and 2001. The IRS assessed his 2002 tax liability in 2005, and he submitted a Form 1040 for 2002 in 2006. Based on information in the forms the taxpayer filed, the IRS abated a portion of the assessment it had made for those years. In 2010, taxpayer filed a voluntary Chapter 7 bankruptcy petition and received a discharge of his Pennsylvania tax liability. In 2012, he filed a Chapter 13 bankruptcy petition and brought this adversary proceeding against the federal government to seek a judgment that his assessed federal income tax liabilities for the years 2000, 2001, and 2002 had been discharged in his Chapter 7 bankruptcy. The Bankruptcy Court concluded that the federal tax debt at was non-dischargeable under 11 U.S.C. § 523(a)(1)(B) because the taxpayer had failed to file tax returns for 2000, 2001, and 2002, and his belatedly filed documents were not “returns” within the meaning of § 523(a)(1)(B) and other applicable law.
The district court affirmed that holding and the taxpayer filed this appeal.
The court noted that the general rule that a debtor who files a Chapter 7 bankruptcy petition is discharged from personal liability for all debts incurred before the filing of the petition is subject to several exceptions, including any debt for tax for which a required return has not been filed. The court said it was undisputed that the taxpayer had not filed timely returns, but at issue was whether the late-filed forms constituted returns for purposes of discharge. The court noted that this was an issue of first impression for the court. In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) added a definition of “return” to the Bankruptcy Code, which reads, in pertinent part, “[f]or purposes of this subsection, the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” The court noted that several circuits have interpreted “applicable filing requirements” to include filing deadlines so that late-filed forms cannot be “returns.” The court cited Beard v. Commissioner of Internal Revenue, which set forth the requirements of applicable non-bankruptcy law, and the court concluded that the taxpayer’s tax debts were nondischargeable.
The court said that under Beard, in order for a document to be a tax return it must satisfy four requirement, including representing an honest and reasonable attempt to satisfy the requirements of the tax law, a factor the court in the current case said was at issue. The court said that forms filed after their due dates and after an IRS assessment rarely, if ever, qualify as an honest or reasonable attempt to satisfy the tax law because the purpose of a tax return is for the taxpayer to provide information to the government regarding the amount of tax due. Once the IRS assesses the taxpayer’s liability, a subsequent filing can no longer serve the tax return’s purpose, and thus could not be an honest and reasonable attempt to comply with the tax law. The court rejected the taxpayer’s argument that the tardiness of his filings did not render them any less of an honest and reasonable attempt to comply with tax law, focusing on the content of the form and not the circumstances of its filing. The court said it agreed with the weight of authority that the timing of the filing of a tax form is relevant to determining whether the form evinces an honest and reasonable attempt to comply with tax law. The taxpayer also argued that, because his late-filed forms showed less tax liability and the IRS abated the tax assessment based on those filings, the filings served a tax purpose and therefore constituted returns, but the court said that the taxpayer’s belated filings were merely self-serving bids to reduce his tax liabilities, rather than attempts to comply with the requirements and objectives of prompt self-reporting and self-assessment. Giacchi, Thomas v. United States, U.S. Court of Appeals for the Third Circuit, No. 15-3761. 5/5/17
Individual’s Deficiency Affirmed
The U.S. Court of Appeals for the Ninth Circuit, in an unpublished per curiam opinion, found that the Tax Court did not err in holding that an individual wasn't engaged in a horse activity for profit. The court found that the taxpayer was not entitled to a casualty loss deduction for the death of a horse, and that she could not deduct expenses for a lawsuit. The court also held that the Tax Court didn't abuse its discretion by refusing to reopen the record after the trial.
At issue were the taxpayer’s income tax deficiencies for 2007 and 2008. The court noted that a taxpayer claiming a deduction bears the burden of proof, and the court reviews for clear error the Tax Court’s factual determination that the taxpayer failed to produce sufficient evidence to substantiate a deduction. The court found that the Tax Court properly considered the factors set forth in 26 C.F.R. § 1.183-2(b)(1)-(9) and did not clearly err in finding that the taxpayer did not engage in horse activity for profit in 2007 and 2008, and therefore was not entitled to take income tax deductions for expenses arising from that activity. The court also found that theta Court did not err in disallowing a casualty loss deduction on the basis of the death of the taxpayer’s horse from disease, citing United States v. Flynn, 481 F.2d 11, 13 (1st Cir. 1973) which held that casualty losses to horses, largely due to illness or disease, were clearly not allowable. The court also found that the Tax Court did not clearly err in finding that the expenses of a lawsuit were not directly connected with the taxpayer’s information technology business, and, therefore, were not deductible as ordinary and necessary business expenses. Denise Celeste McMillan v. Commissioner, U.S. Court of Appeals for the Ninth Circuit, No. 13-73139. 5/15/17
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
No cases to report
Personal Income Tax Decisions
Cameraman's Business Expense Deductions Partially Granted
The Oregon Tax Court found a cameraman provided sufficient evidence to show he was entitled to business expense deductions for certain expenses but not for others.
In 2011, the tax year at issue here, the taxpayer was employed as a full-time cameraman for a television station in Los Angeles and he also operated his own aerial and sports photography business. The taxpayer and his wife claimed a number of deductions for unreimbursed employee expenses and self-employment business expenses. The state Department of Revenue (DOR) conducted an audit and denied many of these deductions. Taxpayer filed this appeal.
The state’s personal income tax law is modeled after the Internal Revenue Code (IRC) for the purpose of determining taxable income of individuals. The IRC allows a deduction for all ordinary and necessary expenses paid or incurred in carrying on any trade or business. In order to qualify as a necessary expense, it must be appropriate and helpful to the taxpayer’s business and in order to qualify as ordinary the transaction must be of a common or frequent occurrence in the type of business involved. Generally, deductions for personal, living or family expenses are disallowed. Taxpayers must keep records substantiating the claimed deductions, but the taxpayer testified that his business record keeping and accounting skills were poor. The court pointed out that it is the taxpayers’ burden to show eligibility for the deduction and prove the amount by a preponderance of the evidence. The court noted that while the taxpayer’s testimony appeared sincere, his lack of organized recordkeeping and his failure to follow court rules that resulted in the exclusion of most of his documentary evidence were significant impediments to his appeal. The court concluded, after a lengthy review of the testimony and documentation, that the taxpayer was entitled to deductions for a portion of their claimed business expenses, but disallowed deductions for photo digital processing, out of town travel, and unreimbursed employee expenses. Lafoca v. Dep't of Revenue, Oregon Tax Court, TC-MD 160022R. 5/9/17
Court Declines to Hear Appeal
The Indiana Supreme Court denied a petition appealing a a state Court of Appeals decision issued January 13, 2017 that the state's Religious Freedom Restoration Act cannot be used as a defense by a defendant charged with tax evasion. The Court of Appeals had held that the state had a compelling governmental interest in collecting revenue and collecting the tax was the least restrictive means of furthering that compelling interest. See the March 3, 2017 issue of State Tax Highlights for a discussion of the Court of Appeals decision in this case. Tyms-Bey v. Indiana, Indiana Supreme Court, 5/18/17
Corporate Income and Business Tax Decisions
Tax Appeal Properly Dismissed
The Missouri Court of Appeals found that the Administrative Hearing Commission properly dismissed as untimely a fireworks distributor's appeal of a determination assessing tax on unreported income, after determining that the taxpayer received proper notice of their final determination and was not prevented by extraordinary circumstances from asserting the right to appeal.
In June of 2016, the Missouri Department of Revenue (DOR) issued a Final Decision finding that the taxpayer had not remitted withholding tax for unreported income of various employees and had not reported tax on commissions and mailed the decision to the taxpayer on June 24, 2016. The decision also advised the taxpayer of its right to appeal the decision by filing a petition with the Administrative Hearing Commission within 30 days after the date the decision was mailed or delivered, whichever was earlier. The taxpayer conceded that the decision was received via certified mail but argued that a copy of the decision was not mailed to its attorney of record. The counsel filed an appeal on September 6, 2016 and on September 20, 2016 DOR filed a motion to dismiss on the grounds that the appeal was not timely. The Commission granted summary judgment to DOR and the taxpayer filed this appeal.
The taxpayer argued that Missouri Supreme Court Rule 4-4.2 requires parties to communicate through counsel when represented and DOR failed to send a copy of the decision to the counsel of record for the taxpayer. Therefore, the taxpayer asserts that the Commission erred in granted DOR’s request for summary judgment and the matter should be remanded for a hearing. The court found that because Rule 4-4.2 applies exclusively to communication between attorneys and neither the Administrator of DOR nor the taxpayer was an attorney, the act of mailing the decision to the taxpayer instead of its counsel of record did not violate the rule. In addition, the court noted that the statute only requires that notice of DOR’s decision be mailed to the taxpayer by certified or registered mail which the taxpayer concedes was done. The court said that the taxpayer was made aware of the thirty-day appeal window as it was written in plain language within the copy of the Director’s Final Decision mailed to and received by the taxpayer. The record on appeal clearly showed that the taxpayer’s counsel did not file an appeal with the Commission until September 6, 2016, well beyond the 30-day period.
The taxpayer also argued that the Commission failed to apply the equitable tolling doctrine established under state law. The court noted that the doctrine of equitable estoppel is rarely applied in cases involving a governmental entity, and then only to avoid manifest injustice, and its use is not justified unless the governmental conduct complained of amounts to affirmative misconduct. The court found that the act of notifying a taxpayer of his or her right to appeal a decision by the DOR in compliance with the statutory provisions does not qualify as an extraordinary circumstance which would justify permitting the taxpayer an equitable exemption from filing his appeal by the statutory deadline. Hale Fireworks v. Dep't of Revenue, Missouri Court of Appeals, WD80178. 5/16/17
Property Tax Decisions
Company Entitled to Refund
The Virginia Supreme Court held that a company was entitled to a refund for 2008 personal property taxes because the county did not raise the timeliness of the taxpayer’s appeal in the administrative proceedings.
The court found that the circuit court erred in granting in part the county’s motion for summary judgment because the county had not argued the issue of whether the taxpayer had appealed the 2008 property tax assessment within the time period provided in the statute in the proceedings before the state Tax Commissioner. The court said that the county could not, therefore, raise the issue of timeliness for the first time in the proceedings for judicial review by the circuit court. The court held that because the issue regarding the timeliness of the taxpayer’s local appeal was not preserved for review by the circuit court, the circuit court erred in ruling that the taxpayer was not entitled to a refund of the taxes paid for tax year 2008 and remanded the matter to the circuit court to direct the county to issue a refund to the taxpayer. Verizon Online LLC v. Walter, Virginia Supreme Court, Record No. 161006; Record No. 161000. 5/5/17
Value of Low-Income Housing Properties Reduced
The Ohio Supreme Court reversed a Board of Tax Appeals ruling interpreting a state supreme court decision as preventing an appraiser from using market rent values in its income approach. The court reinstated lower values for 42 parcels improved with low-income housing.
At issue in the case are 42 parcels scattered throughout the county, some of which have been improved with renovated low-income housing that consists of 35 buildings with 150 rental units. For tax year 2008, the county auditor valued the properties individually, combining a cost approach and a “gross rent multiplier” approach to arrive at a value for each parcel. For tax year 2009, the auditor increased the values because some of the properties had been renovated and this valuation carried over to tax year 2010. The taxpayer filed an appeal and offered testimony at the BTA that in order to participate in the low-income-housing tax credit program, the owner was required to execute and record a restrictive covenant that bound the current owner and its successors to continue to use the property to provide low-income housing on very specific terms over a 30-year period. The taxpayer’s expert witness’s opinion of value rested on his finding of highest and best use. He noted the blight in the neighborhoods in which the parcels were located, and found that the highest and best use would be intensive residential if special funding is made available. The BTA reversed the county Board of Revision (BOR) decision and restored the auditor’s higher appraisal value, finding that the taxpayer’s expert witness did not appraise the property in compliance with the legal standards set forth in Woda Ivy Glen Ltd. Partnership v. Fayette Cty. Bd. of Revision, 121 Ohio St.3d 175, 2009-Ohio-762, 902 N.E.2d 984. This appeal was filed.
The court said that the state statute requires county auditors to appraise real property “at its true value in money,” which it has construed to equate in most situations with the amount for which the property would sell on the open market in an arm’s length sale. The court said that determining the value of government-subsidized low-income housing presents the tax assessor with a problem in the application of the typically-motived-party principle. The court noted that the case law resolves this issue by establishing three rules for valuing low-income housing. The first rule is that in applying the income approach, market rents and expenses, as opposed to the actual rents of the properties at issue, are used because the actual rents reflect government subsidies that are atypical of the rental market generally and the expenses incurred are atypical of what the unsubsidized market would bear. The second rule is that government subsidies should not be taken into account in a way that would increase the value of the property. The court also said that the case law disfavors a cost approach for valuing government-subsidized low-income housing, even for a newly constructed property because without the government subsidies, ordinary market participants would not have incurred the construction costs in the first place, so using the cost approach overvalues the property.
The court held that Woda did not require an actual-rent income approach rather than a market-rent income approach in appraising low income housing subject to the credits, as the BTA decision seemed to suggest. The court found that unlike the situation in Woda, the BOR in this case adopted the owner’s appraisal, which the BTA rejected on erroneous legal grounds. Because the appraisal formed the basis for the BOR’s reduced valuation, the court had no compunction in restoring that decision as a proper finding of fact. The court also found that the increase valuation ordered by the BOR for 2009 and 2010 was proper. Columbus City Schools Bd. of Educ. v. Franklin Cnty. Bd. of Revision, Ohio Supreme Court, Slip Opinion No. 2017-Ohio-2734; No. 2014-0807. 5/11/17
Dismissal of Ad Valorem Tax Appeal An Error
The Alabama Court of Civil Appeals determined that a taxpayer’s notice of appeal was timely mailed and received by the county board of equalization (BOE) and held that the trial court erred in dismissing the taxpayer’s appeal.
On May 31, 2016, the county BOE issued its final ad valorem tax assessment on real property owned by the taxpayer and on June 22, 2016 the taxpayer filed a notice of appeal with the circuit court, posted the required bond and requested that the clerk serve the notice of appeal on the secretary of the BOE by certified mail. The clerk sent the notice of appeal, addressed to the secretary of the BOE, by certified mail on June 28, 2016 and the secretary received it on July 1, 2016. On September 30, 2016, the BOE moved to dismiss the taxpayer’s appeal, arguing that the taxpayer had failed to satisfy the requirements of the statute because the notice of appeal had not been filed with the secretary of the BOE within 30 days of the assessment. The taxpayer contended that, pursuant to the statute, the timely mailing of the notice of appeal to the secretary of the BOE satisfied the requirement of timely filing of the notice of appeal. The trial court entered a judgment for the county, dismissing the taxpayer’s appeal. The taxpayer filed this appeal.
The undisputed facts show that the clerk mailed the notice of appeal to the secretary of the BOE via certified mail on June 28, 2016, within the 30-day appeal period, but the notice was not received by the secretary until July 1, 2016, after the expiration of the 30-day appeal period. Thus, the court said that the issue was whether § 40-3-25 of the statute requires that the notice of appeal be received by the secretary of the BOE before the expiration of the 30-day appeal period or whether, as the taxpayer contends, § 40-1-45 operates to make the notice of appeal timely under § 40-3-25 if the notice is timely mailed within the 30-day appeal period but received after the expiration of the period, an issue of statutory construction.
§ 40-3-25 provides in pertinent part that a taxpayer shall file a notice of appeal with the secretary of the BOA and with the clerk of the circuit court within the 30-day appeal period, along with a bond. § 40-1-45(a) provides, with certain enumerated exceptions, that the date of mailing of a document required to be filed under the revenue code will be considered the date of filing, provided that the document is mailed within the applicable prescribed period and is actually delivered to the appropriate officer or agency. The taxpayer argued that the language of § 40-1-45 clearly indicated that it applies to nearly every document required to be filed under the revenue code and pointed out that a notice of appeal was not among the enumerated exceptions to the general rule. The court agreed, rejecting the BOE’s contention that § 40-1-45 does not apply to notices of appeal filed under § 40-3-25. The court also rejected BOE’s argument that case law supported its construction of the provision, noting that the court was not presented in the case cited with the precise argument that the taxpayer made in the present appeal and stating that the court was not convinced that the case cited required an affirmative dismissal of the taxpayer’s appeal.
The BOE also cited Ex parte Shelby County Board of Equalization as support for its argument that a notice of appeal must be timely received by the secretary of BOE in order to satisfy § 40-3-25. The court distinguished that case from the current one and found that nothing in the opinion prevented the appealing party from relying on the circuit clerk for service of the notice of appeal, provided that the notice of appeal is timely mailed. The court said that the clerk in the present case mailed the notice of appeal to the secretary of BOE within the 30-day appeal period, but the circuit clerk in Ex parte Shelby County did not. The court found that because the undisputed facts demonstrated that the taxpayer’s notice of appeal was timely mailed to and was received by the secretary of BOE, § 40-1-45(a) operated to make the date of mailing of the notice of appeal the date the notice of appeal was filed with the secretary of BOE. The court, therefore, concluded that the trial court erred in dismissing the taxpayer’s appeal. The Shoals Mill Dev. Ltd. v. Shelby Cnty. Bd. of Equalization, Alabama Court of Civil Appeals, 2160237. 5/12/17
Church Day Care Center Exemption Denied
Illinois Appellate Court affirmed the Department of Revenue's (DOR) denial of the religious property tax exemption for a church's day care center, finding the denial was not clear error. The court said DOR could reasonably find the day care more characteristic of a commercial day care than a facility used primarily for religious instruction and found that the church failed to demonstrate any constitutional violations. The court also rejected the taxpayer’s argument that DOR’s decision should be voided because the determination was issued by an administrative law judge who did not preside over the case.
In November 2010 the taxpayer, a church which had purchased land and moved its day care center, which had been in operation as a not-for-profit since 1984, onto that property, filed for a property tax exemption under the state code. The county Board of Review (Board) recommended a partial-year exemption, but DOR denied the taxpayer’s application and the taxpayer requested a full hearing on the denial. The administrative law judge (ALJ) who presided over the requested hearing was not the same ALJ who entered a recommendation to DOR, which denied the taxpayer’s exemption in July 2013. The taxpayer filed an appeal with the circuit court, which affirmed DOR’s decision. The taxpayer filed this appeal.
The finding of facts by the ALJ included the fact that the Center’s charitable policy provides fee waivers for low-income students and in 2010, 1 student received a reduced rate and 13 students had waivers of holiday fees. Members of the Center's Board of Directors must be members of the taxpayer’s church, and all teachers must be Christian. While the Center's attendees need not be members of the taxpayer’s church or of a specific religious background, the taxpayer reserved the ability to give priority to members of its church or its church affiliates if necessary. Taxpayer’s evidence of a total revenue for the Center in 2010 showed that 99.7% resulted from tuition and fees. The Center's had a loss for 2010, which was paid from the church’s reserves. The children's daily lesson plans included discussions of stories from the Bible. The ALJ concluded that the primary use of the property was to provide superior-quality childcare, which was not traditionally a "religious purpose" and noted religious services were not conducted at the Center. The ALJ also determined the property could not be primarily used for religious purposes where the Center was open to all children, regardless of religious affiliation. The ALJ also found that the Center did not fit into the State's general educational scheme, because preschool is not mandated, so there was no corresponding tax burden the Center could lessen. The ALJ also found the Center did not qualify for a charitable exemption because it did not derive its funds primarily from charitable donations. According to the ALJ, the payment schedule for students and penalty provisions if payments were late suggested a businesslike operation rather than a charitable one.
The taxpayer first argued that DOR’s decision was void because the ALJ who recommended the decision was not the same one that presided over the hearing. The court distinguished the case cited by the taxpayer to support its argument, finding that the case involved the Human Rights Act,whichcontained specific statutory language prohibiting an ALJ other than the presiding ALJ to make a finding unless certain enumerated circumstances applied. The court found that there was no similar code provision in the current case and found that this case was similar to Starkey v. Civil Service Comm'n, 97 Ill. 2d 91, 454 N.E.2d 265 (1983) which held that in the absence of statutory provisions to the contrary, it was not necessary that testimony in administrative proceedings be taken before the same officers who have the ultimate decision-making authority. The court said that the record demonstrated the ALJ who issued the recommendation first reviewed the record from the hearing and found that the ALJ’s decision was not void.
The court then turned to the issued of whether the denial of the exemption was improperly denied. The state code provides an exemption for property used exclusively for religious purposes or school and religious purposes if it is not used with a view to profit. The court cited Zehnder, 306 Ill. App. 3d at 1116, 715 N.E.2d at 1211 for the principle that exclusive-use requirement of the statute is satisfied if the property is primarilyused for the exempted purpose. The taxpayer argued that its evidence demonstrated an exclusive religious purpose, as religion is a core tenet of its mission statement and the Center's daily instruction. The ALJ noted, however, that the primary purpose of the property was to provide "superior quality" day care services. The court noted that although the mission statement explained the curriculum is Christ-centered, it also went on to state the Center provided social interaction, intellectual stimulation, physical development, and emotional growth, which are secular services. The court noted that while lesson plans demonstrated a particular period of daily Bible study and weekly Bible journals, DOR determined such study encompassed but a fraction of the day, with the remaining hours devoted to secular activity. The court also pointed out that the arrangement between the Center and parents is more businesslike than religious, as it focuses on a timely payment schedule, regardless of whether a child is in attendance. Parents who make delinquent payments are assessed late fees, turned over to a collection agency, or their children could be withdrawn from the school. The court found it reasonable to conclude the Center did not serve a primarily religious purpose.
The court also rejected the taxpayer’s constitutional issues that it argued required the court to reverse DOR’s determination. The taxpayer asserted that the code provision violated the established clause of the U. S. Constitution because DOR engaged in an excessive entanglement with religion. The court noted that when considering an entity’s request for a tax exemption it must consider the entity’s religious beliefs and the use of the property. The court said that in this case DOR did not question the sincerity of the taxpayer’s religious beliefs, but, instead, analyzed whether its use of the Center was for a primarily religious purpose and the court found this acceptable. The court also rejected the taxpayer’s due process argument, finding that it failed to elaborate on its conclusory argument or cite any authority to support it and therefore forfeited the argument. West Side Christian Church v. Dep't of Revenue, Illinois Appellate Court, No. 4-15-0907. 5/15/17
Other Taxes and Procedural Issues
No cases to report.
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected].
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STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
May 12, 2017 Edition
NEWS
FTA Annual Conference
There is still time to register for the Annual Conference in Seattle June 11 through 14. Topics and speakers for the legal breakout sessions have been set and include panels on recent cases, implementation issues surrounding marijuana legalization, the new partnership audit regulations and the states’ efforts to challenge Quill. Go to the FTA’s website, www.taxadmin.org, for more complete information on the conference.
Legislature Prohibits Enforcement of Tennessee DOR's Economic Nexus Rule
The Tennessee legislature has approved a bill, H.B. 261 that would prohibit the Department of Revenue from enforcing its economic nexus rule without final legislative approval. The legislature prohibits DOR from collecting sales taxes under its recently promulgated Rule 129 until a pending lawsuit over the rule is decided and the rule is approved by the legislature. The governor has indicated that he will review the legislation before deciding whether to sign it. The Rule, which provides that out-of-state sellers with sales exceeding a $500,000 annual threshold were required to register with DOR and begin collecting the sales tax, has been challenged in court by the American Catalog Mailers Association and NetChoice who are arguing that the rule violates the physical presence test of Quill. On April 10 the court ordered DOR not to enforce the rule pending a final judgment in the matter. See prior issues of State Tax Highlights for a discussion of the rule.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
Railroad Diesel Fuel Tax Regime Upheld
The United States District Court for the Middle District of Tennessee found that Tennessee’s sales tax on diesel fuel purchased by rail carriers did not violate the 4-R Act because an excise tax on motor carrier fuel was roughly equivalent.
The Court held a bench trial in this matter in 2012 and held that the imposition of the state’s imposition of sales and use tax on railroad diesel fuel, but not on diesel fuel used by interstate motor carriers, placed rail carriers at an overall disadvantage and that the state had not provided sufficient evidence that the differential tax treatment was justified, concluding that the imposition of the tax violated the Railroad Revitalization and Regulatory Reform Act of 1976 (4-R Act). The state filed an appeal to the U.S. Court of Appeals for the Sixth Circuit.
After briefing and oral argument, but before the issuance of an opinion by the Sixth Circuit, the U. S. Supreme Court issued its opinion in Alabama Dept. of Revenue v. CSX Transportation, Inc., 135 S.Ct. 1136, 1143 (2015) (CSXT II), ruling that “an alternative, roughly equivalent tax is one possible justification that renders a tax disparity nondiscriminatory.” The taxpayer subsequently filed a motion in the Sixth Circuit to remand the matter to the district court for further proceedings in light of CSXT II, which was granted.
The taxpayer, an Illinois corporation with its principal office in Homewood, Illinois, is engaged in interstate commerce as a common carrier by railroad. Railroads are subject to the state’s sales or use tax on their purchase, consumption, or use of diesel fuel in the state and for the years at issue here the tax was imposed at the rate of 7% of the retail price. The taxpayer held a direct pay permit issued by the Department of Revenue (DOR) and paid the tax on its purchase of diesel fuel with the state directly to DOR’s Commissioner. Motor carriers, who compete with rail carriers for the transportation of property in interstate commerce in the state, are exempt from the state’s sales and use tax on the purchase or consumption of diesel fuel in Tennessee. In lieu of the sales tax, motor carriers pay a motor fuel tax, first enacted in 1941, totaling 18.4¢ a gallon. Under the respective tax rates in effect since before 2006 through June 30, 2014, motor carriers were taxed more per gallon of diesel fuel than railroads were taxed unless fuel prices exceeded $2.62 per gallon. The court noted that, from 1941 through 2010, motor carriers actually paid more tax per gallon than railroads paid in every year except one, which was in 2008 when fuel prices spiked.
Before addressing the substantive issues in the case, the court discussed DOR’s motion to exclude the affidavit of the taxpayer’s expert, Professor Richard Pomp in which it argued that the affidavit was legal argument and advocacy and was not reliable. The court found that the taxpayer’s expert displayed sufficient knowledge of the subject matter that his opinion will assist the trier of fact in evaluating this case, mindful that it could weigh its probative value and reject any improper inferences. The court found that DOR’s complaints about Professor Pomp’s opinions went to the weight of the testimony as opposed to their admissibility. The court found that Professor Pomp’s opinions were re reliable and denied DOR’s motion.
The court said that the issue before it was whether DOR couldoffer sufficient justification for subjecting railroads and motor carriers to different tax treatment of their purchases and consumption of diesel fuel for transportation purposes, noting that the Supreme Court had instructed that an alternative roughly equivalent tax was one possible justification rendering a tax disparity nondiscriminatory. DOR argued that for 61 successive years the per gallon level of the sales tax on fuel purchases by railroads was less than the per-gallon level of motor fuel tax paid by trucks, but the taxpayer argued that reliance only on the tax rates was misleading because the sales and use tax rate was based on the price of motor fuel which fluctuates. The court found that the motor fuel taxes and sales and use taxes were roughly equivalent taxes. The court said that it was undisputed that from 1941 through 2010 motor carriers actually paid more tax per gallon than railroads paid in every year except one when fuel prices spiked. The court said that, on average, motor carriers have a higher tax burden, which refutes the railroads being at an overall disadvantage. The court also found that the railroads chose to use dyed diesel fuel, which was not exempt from the sales and use taxes, instead of clear diesel fuel, which is subject to the motor fuel tax. The taxpayer argued that if it chose to use clear diesel fuel for off highway purposes, it would have to pay the state motor fuel tax and the federal excise tax and subsequently apply to the federal government for a refund of the federal tax because it was used for off-highway purposes. The taxpayer also pointed out practical problems in using the clear fuel in Tennessee, but the dyed fuel in other states. The court agreed with DOR’s argument, finding that DOR had offered sufficient justification that its tax structures for diesel are not discriminatory against railroads, and granted DOR’s motion for summary judgment. Illinois Central Railroad Co. v. Tennessee Dep't of Revenue, U.S. District Court for the Middle District of Tennessee, No. 3:10-cv-00197. 4/12/17
Whistleblower Case Remanded
The U.S. Court of Appeals for the Third Circuit reversed a district court's decision that a whistleblower was collaterally estopped from raising his claims in Pennsylvania after a New York court had dismissed them. The court said that the first court had ruled on the sufficiency of the whistleblower’s complaint rather than on its merits and he had, therefore, not received the full and fair hearing required. See prior issues of State Tax Highlights for a discussion of the New York decisions.
The whistleblower worked as a tax lawyer for an investment services firm and came to believe that the firm was violating certain tax and corporate laws. He informed various senior employees of the firm of his belief, but the firm’s officers disagreed with his assessment of the law. After he continued to inform the firm’s employees of his legal conclusions, the firm informed him that he would be terminated and should seek other employment and he then sued the firm in New York state court, alleging, among other things, that the firm’s action was retaliatory. His case was dismissed because it did not adequately plead facts relating to the firm’s knowledge of his activities. He subsequently sued the firm in federal court for retaliation, but the district court dismissed his case finding that he was precluded from relitigating whether there was a causal connection between his firing and his activities. He filed this appeal.
The court here said that for preclusion to apply, there must be an identity of issue which has necessarily been decided in the prior action and there must have been a full and fair opportunity to contest the decision now said to be controlling. The court noted that the issue
decided in the New York case was whether the whistleblower’s complaint adequately alleged facts regarding the firm’s knowledge of his whistleblowing activities but court did not decide whether, in fact, the firm knew about his activities. The appeals court found, therefore, that the whistleblower was not precluded from asserting that the firm knew about his activities in this case because that factual issue was not decided. The court held that the New York decision can give rise to issue preclusion only insofar as his complaint suffers from the same defects as the New York complaint did and the court found that the federal complaint did allege knowledge, so it does not suffer from the same defect. The court remanded the matter for further proceedings consistent with the opinion. Danon v. Vanguard Group Inc., U.S. Court of Appeals for the Third Circuit, No. 16-2881. 4/12/17
TABOR Challenge Dismissed
The U. S. District Court for the District of Colorado, on remand from the U.S. Court of Appeals for the Tenth Circuit, has held that none of the plaintiffs in Kerr v. Hickenlooper have standing to pursue a suit alleging that Colorado's Taxpayer Bill of Rights (TABOR) violates the federal and state constitutions. See prior issues of State Tax Highlights for a discussion of the various decisions in this matter.
On June 3, 2016, the Tenth Circuit Court of Appeals vacated this court’s Order finding certain legislator-plaintiffs had standing, concluding that the legislator-plaintiffs did not have standing. The appeals court remanded for the district court to determine whether any non-legislator plaintiffs have standing. On December 6, 2016 the plaintiffs filed a Fourth Amended Complaint (FAC) seeking declaratory and injunctive relief with respect to TABOR, an amendment to the state’s constitution passed by voter initiative in 1992, alleging that it violated provisions of both the federal and state constitutions. TABOR requires voter approval before state and local governments can increase taxes and spending. The court said that the defendant facially attacked the sufficiency of the allegations in the FAC, and the court, therefore, accepted the allegations in the FAC as true for purposes of its jurisdictional analysis. The court also noted that the case has been thoroughly litigated and received various opinions that set forth the alleged facts concerning the effect of TABOR on the revenue-raising power of state and local governments in the state and it would, therefore, not repeat those facts. The court said that what had changed is the pertinence of the non-legislator plaintiffs and the court summarized the facts as to those plaintiffs and the injuries they have been alleged to suffer. Several of the plaintiffs are political subdivisions of the State of Colorado, such as county commissions, boards of education, and special districts, and alleged that TABOR has injured them by impairing their fiscal powers and responsibilities, and undermining a Republican form of government. Attached to the plaintiffs’ response to the motion to dismiss are resolutions or affidavits stating that TABOR has caused the respective political subdivisions to incur costs and expenses in presenting matters to voters for decision that without TABOR, would not have been presented to voters. Plaintiffs alleged that citizens have protectable interests in a Republican form of government and allege that TABOR has injured citizens by injuring their elected representatives’ responsibilities and authority. Educator-plaintiffs alleged that TABOR has injured them by impairing their ability to properly educate students.
The court first address the question of whether the plaintiffs who are elected officials, educators and/or citizens had standing in this matter, and noted that these plaintiffs spent little effort in their response to the motion to dismiss addressing how they had standing and the court declined to do the analysis for them, saying that the court should not have to engage in a detailed inquiry of these issues, when the plaintiffs have not done so.
The court held that the political subdivisions challenging TABOR had Article III standing by incurring costs to present matters to voters as required by TABOR, and that declaring TABOR unconstitutional would redress the monetary injury. The court then turned to whether they had political-subdivision standing and looked at what it said were two relevant Tenth Circuit cases. The court said that the standing issue for the political-subdivision plaintiffs is whether they are enforcing rights granted to them by the Colorado Statehood Enabling Act of 1875. The court said that it was a completely different inquiry to whether a Republican form of government has been undermined by TABOR, an argument that was for the benefit of the people of the state and not the political subdivisions. The court said that the political subdivision plaintiff made not effort in the FAC to sufficiently allege that they are seeking to enforce rights granted to them in the Enabling Act. The court found that the political-subdivision plaintiffs are asserting the rights of another in alleging that TABOR violates the Enabling Act. It concluded that none of the named plaintiffs had standing to pursue the action. Kerr v. Hickenlooper, U.S. District Court for the District of Colorado, Case No. 11-cv-01350-RM-NYW. 5/4/17
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
No cases to report.
Personal Income Tax Decisions
Taxpayer Not Entitled to Armed Services Salary Exemption
The New Mexico Court of Appeals held that a taxpayer's income from the U.S. Public Health Service did not qualify as income earned from active duty service in the United States armed forces and was, therefore, subject to personal income tax.
For the tax years 2009-2012, the taxpayer was employed as an active duty commissioned officer for the United State Public Health Service (USPHS). During that period of time he was a New Mexico resident and his regular place of employment for USPHS was in Arizona. For tax years 2009-2012, he and his wife filed joint New Mexico personal income tax returns and claimed an exemption for his wages, omitting them from their joint return. The Department of Revenue (DOR) issued notices of assessment for the years at issued and the taxpayer filed a timely protest, asserting that the husband’s wages were exempt from New Mexico income tax under the armed forces salaries exemption. The taxpayers claimed that when the husband contacted DOR in 2009 an employee confirmed that his wages were exempt. The hearing officer concluded that the husband was not in the armed forces for the tax years at issue and therefore did not qualify for the armed forces salaries exemption, but abated the penalty assessed for tax year 2009. The taxpayer filed this appeal.
The state statute exempts from state income taxation salaries paid by the United States to a taxpayer for active duty service in the armed forces of the United States and the taxpayers argued that they are eligible for this exemption because the husband’s service, as a commissioned officer of the USPHS, is considered active military service in the armed forces of the United States under federal law.
The court noted that the Surgeon General administers the USPHS under the supervision and direction of the Secretary of Health and Human Services. The USPHS maintains a Regular Corps and a Ready Reserve Corps, both of which consist of commissioned officers.
The commissioned corps of the USPHS is part of the United States’ “uniformed services” under the federal code. In times of war or emergency involving national defense, the president may declare the commissioned corps of the USPHS to be a military service and commissioned officers of the USPHS can be detailed for duty with other government departments including the armed forces. The court was unpersuaded that because the husband’s service in the USPHS is considered active military service under the federal code it should also be considered active military service under the state exemption provision. The court said that by specifically granting USPHS officers the same status of officers in the armed forces in only limited circumstances and for only limited purposes, Congress has recognized that USPHS officers are not regularly considered to be officers in the armed forces. The court also said that although “armed forces” is not defined in the state tax code, the state statutory provision allowing for tuition for veterans defines “armed forces” as “the United States army, navy, air force, marine corps or coast guard.” The court also pointed out that the federal government, which governs the armed forces, has defined “armed forces” in Title 10 of U.S.C. as the army, navy, air force, marine corps, and coast guard. The court also rejected the taxpayer’s argument that regulations adopted by DOR supported their position.
Finally, the taxpayers argued that DOR already recognized the husband as a member of the armed forces because the state income tax was withheld from his USPHS wages earned out of state, relying on a federal provision, 5 U.S.C. § 5517, regarding withholding of state income tax from a federal employee’s wages where an employee is subject to the tax and the employee’s place of federal employment is within the state, or where the employee is a resident of the state and a member of the armed forces. Taxpayers argued that the USPHS must have withheld state income tax under the second option for members of the armed forces. The court said the taxpayer’s regular place of federal employment was not within New Mexico, and his employment was not considered “service as a member of the armed forces” for the purposes of 5 U.S.C. § 5517 and the section did not require that the USPHS withhold New Mexico income tax from the taxpayer’s compensation. The court said that if USPHS withheld New Mexico income tax despite the fact that it was not required to under 5 U.S.C. § 5517, there is no indication in the record that it did so because DOR considered the taxpayer to be a member of the armed forces. Hammack v. New Mexico Taxation and Revenue Dep't, New Mexico Court of Appeals, No. 34,432. 5/1/17
Marital Debts Disallowed as Deductions
The Oregon Tax Court held that payments a taxpayer made to a credit union did not qualify as allowable deductions for alimony under the Internal Revenue Code (IRC). The payments were assigned to the taxpayer in a divorce as part of marital debts owed, rather than as separate spousal support.
The facts in the case show that the taxpayer divorced his spouse in 2012 and as part of the dissolution of the marriage was ordered to assume two debts owed to SELCO Credit Union (SELCO), the first of which was a line credit debt of approximately $370 and the second of which was a Visa debt with a balance of approximately $4700. The taxpayer’s ex-spouse was the sole “authorized signer” on both SELCO accounts. The court ordered the wife to assume the debt of the second mortgage. The court noted that the section of the Judgment of Dissolution ordering the taxpayer to assume the two SELCO debts was entitled “Debts and Liabilities,” a section that was distinct from other sections in the Judgment of Dissolution entitled “Property Division” and “Spousal Support.” The section entitled “Spousal Support” ordered the taxpayer to make monthly support payments to his ex-spouse, which would terminate upon the death of either the husband or the wife. The taxpayer paid both SELCO debts in full during the 2012 tax year, and included both in calculating his alimony deduction for tax year 2012. The Department of Revenue (DOR) issued a notice of deficiency arguing that the taxpayer’s payment of the SELCO debt was not deductible under IRC section 71(b)(1) because the obligations were a nontaxable division of marital property. The taxpayer filed an appeal but the hearing officer upheld the adjustment.
The court noted that the taxpayer was the party seeking affirmative relief and, therefore, had the burden of proving his claim by the preponderance of the evidence. The court then turned to an analysis of the law governing allowable deductions for alimony payments, and noted the legislature’s expressed intent “to make the Oregon personal income tax law identical in effect to the provisions of the Internal Revenue Code (IRC) relating to the measurement of taxable income of individuals * * *.” ORS 316.007. The court said that while the characterization of payments in a divorce is not dispositive, the way the Judgment of Dissolution in this matter was organized indicated, at a minimum, that the SELCO debts were not in the same category as spousal support. In addition, the court noted that during the divorce trial the judge ordered the taxpayer to assume the SELCO debts, explaining that these marital debts would be distributed to the taxpayer in order to offset an otherwise unequal debt of a second mortgage on real property awarded to his ex-spouse. The court found that this explanation showed that the SELCO debts more closely resembled part of an equitable property division than alimony.
IRC section 71 defines alimony as “any payment in cash if —“(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument, (B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under section 215, (C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and (D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.” In order for a payment to qualify as alimony, each of these four elements must be satisfied. The court found that the taxpayer’s payments to SELCO satisfied the first, second and third element of the test, but held that the payments did not satisfy the fourth element, i.e. that the liability to make the payments ended upon the payee spouse’s death. The court noted that the Judgment of Dissolution was silent on that question, but rejected the taxpayer’s argument that the terminate on death provision in the spousal support section of the judgment absolved him of any duty to pay the SELCO debts after the death of his ex-spouse, citing a decision in a case with similar facts. The taxpayer argued that he had no personal liability for these debts under Oregon law because they are in his ex-spouse’s name and that debts incurred during the marriage by one spouse are not the other spouse’s responsibility. DOR contended that if he had failed to pay these debts before his ex-spouse’s death, his obligation to pay them would have continued. The court rejected the taxpayer’s argument, finding that an Oregon court may, as part of its authority to divide property in a divorce, divide the debts that the parties incurred during the marriage. The court found that in this case, at the moment the Judgment of Dissolution was filed, the taxpayer became liable for the SELCO debts, which were explicitly characterized as an equitable apportionment of marital debt and the death of the taxpayer’s ex-spouse would have no legal effect on that liability. The court concluded that the taxpayer’s payments to SELCO did not meet the IRC section 71 definition of alimony and were therefore not allowable deductions under section 215. West v. Dep't of Revenue, Oregon Tax Court, TC-MD 160254N; TC-MD 160254N. 5/2/17
Corporate Income and Business Tax Decisions
Deduction for Professional Employer Organization Denied
The Washington Court of Appeals found an employment services company was not qualified for a business and occupation tax deduction for professional employer organizations. The court said that the company did not provide the required written notice to its employees regarding a co-employment relationship and was, therefore, not entitled to the deduction.
The taxpayer is an employment services company that provides services for a number of affiliated entities that operate nursing and assisted living centers nationwide, including in the state. It provides its clients with personnel and administers their payroll and benefits and in consideration is paid an amount equal to the direct wage and compensation expenses, including administrative expenses, incurred by it to provide these services. It provides personnel to its clients pursuant to a written agreement titled “Employee Leasing Agreement,” which specifies that all personnel provided will be its employees. The agreement also provides that the taxpayer has the right and responsibility to direct and control the personnel consistent with each client’s employee policies.
In October 2012, the Department of Revenue (DOR) learned that the taxpayer was reporting wages to the Washington Employment Security Department (ESD) for unemployment insurance purposes, but was on active non-reporting filing status with DOR, informed the taxpayer that it would be examining its records for excise taxes. The taxpayer responded, describing itself as a professional employee organization (PEO) that qualified it for a tax deduction under the statute. DOR conducted an audit and the taxpayer supplied documents it argued demonstrated that its written agreement with its clients complied with the statute and that employees received written notice of co-employment. DOR concluded that the taxpayer did not qualified for the PEO deduction and issued an assessment and the taxpayer filed suit seeking a refund of tax it paid with its May 2013 B&O tax return. It argued that it was a PEO, and therefore, was not subject to B&O taxes on payroll and benefit costs of employees employed at its clients’ facilities. The trial court granted summary judgment for DOR and the taxpayer filed this appeal.
The state’s B&O tax is applied to the gross income of virtually all businesses for the privilege of engaging in business activities. PEOs, however, are allowed a deduction from gross income for certain amounts derived from performing PEO services and statutory provision RCW 82.04.540 governs whether an entity meets the requirements of a PEO and is, thus, entitled to such a deduction. That provision specifies, among other things that in order for the taxpayer to qualify as a PEO, its covered employees must receive both written notice, and have its co-employment relationship with the taxpayer and the client expressed pursuant to a professional employer agreement.
The taxpayer argued that employees received written notice of their co-employment relationship with it and its clients from the employee handbook, paystubs, letter of understanding, and the notice to employees posted on its intranet. The court said that the written notice requirement is explained in DOR’s Excise Tax Advisory (ETA), and although no specific language is required, the notice must clearly identify the PEO and the client. It must put the employee on notice, either actually or constructively, that he or she is co-employed by both the PEO and the client and provides that an employee can only be co-employed by one client and one PEO. The court said that the statutory provision unambiguously requires that the employee be given written notice of the employee’s co-employment relationship with the PEO and the client, and that even if there was ambiguity, DOR’s ETA explains the requirement. The court found that none of the documents the taxpayer produced at summary judgment gives employees notice of their co-employment relationship with it and the client facility. The court took note of the language in the employee handbook that stated, “most employees are employed” by the taxpayer, pointing out that the statement did not specify if a particular employee fell within that category. The court also referenced the employees’ paystubs that list the name of the taxpayer, the client and the owner of the affiliated clients, noting that an employee reading the paystub would not know with which entities it has a co-employment relationship. The court found that listing the names of three entities on the paystub does not give actual or constructive notice to the employee of a co-employment relationship with the taxpayer and the client facility.
The court also rejected the taxpayer’s argument that receiving and signing the letter of understanding meant that employees acknowledge that they were employees of the taxpayer and the client, finding that the letter does not give actual or constructive notice to the employee of a co-employment relationship with the taxpayer and the client. The court said that although the letter mentions the client facility, the owner of the client, and the taxpayer, it does not state with which entities the employee has a co-employment relationship. The court concluded that the taxpayer did not meet the statutory requirement for written notice because it was unclear from the documents who the PEO was and who the employee had a co-employment relationship with. Heartland Emp't Servs. LLC v. Dep't of Revenue, Washington Court of Appeals, No. 48893-1-II. 5/2/17
Property Tax Decisions
Property Exemption for For-Profit Corporation Improperly Denied
The Michigan Supreme Court held that the Tax Tribunal erred when it denied a personal property tax exemption to a for-profit corporation that operates a college. The court found that the statutory provisions, when read together, clearly showed legislative intent to exempt personal property of all educational institutions. The court remanded the matter to the tribunal to determine if the organization met educational institution requirements under MCL 211.9(1)(a) for a property tax exemption.
The taxpayer, a Delaware for-profit corporation, requested a property tax exemption
under MCL 211.9(1)(a) for personal property used to operate the Sanford-Brown College Grand Rapids. The tax tribunal determined that the exemption provided by that section applied only to nonprofit educational institutions and the taxpayer filed an appeal. The Court of Appeals reversed the tribunal in an unpublished per curiam opinion, reasoning that the unambiguous language of that section provides a tax exemption for the personal property of an educational institution operated in the state regardless of its for-profit status and remanded the case to the tribunal to determine whether the taxpayer qualified for the exemption as an educational institution. The Supreme Court granted the city’s application for leave to appeal the Court of Appeals’ decision.
The court said that plain and unambiguous language of MCL 211.9(1)(a) exempts from taxation the personal property of charitable, educational, and scientific institutions, and the section authorizes a tax exemption for educational institution without regard to the institution’s nonprofit or for-profit status. MCL 211.7n, specifically exempts from taxation the real or personal property owned and occupied by nonprofit educational institutions.
The court reviewed rules of statutory construction and noted that MCL 211.7n exemplified the legislature’s intent to limit the content of that statute to nonprofit institutions, but omitted any requirement that the institutions referred to in MCL 211.9(1)(a) be nonprofit institutions. The absence of that requirement is presumed to be intentional. The court held that reading the two statutes together and recognizing that each addresses a tax exemption for an educational institution’s personal property means that a nonprofit educational institution has two paths to tax exemption, while a for-profit educational institution is limited to the path in MCL 211.9(1)(a). The court also said that the tax exemption available under MCL 211.9(1)(a) did not conflict with the constitutional mandate that nonprofit educational organizations be exempt from real and personal property taxes and does not prevent the legislature from passing laws that provide tax benefits for other organizations. SBC Health Midwest Inc. v. City of Kentwood, Michigan Supreme Court, Docket No. 151524. 5/1/17
Tax on Natural Gas Supplier Affirmed
The Texas Supreme Court held that a county's ad valorem tax on natural gas stored in the state while waiting for future sale and shipment out-of-state does not violate the commerce clause. The court found that the tax met all four prongs of the Complete Auto Transit Inc. v. Brady test.
The taxpayer buys and sells natural gas, purchasing it at a marketing hub located in the state. The taxpayer immediately entrusts the gas to its affiliate, a pipeline operator authorized by the federal regulatory agency to transport the gas. The pipeline system does not extend beyond the borders of the state but connects to several other interstate pipelines, allowing the taxpayer to market and sell gas across the country. The affiliate stores the taxpayer’s gas at a facility owned by it in the state. The taxpayer purchased a dedicated storage capacity in the reservoir from the affiliate and pursuant to the storage agreement the affiliate pumps the taxpayer’s gas that exceed the pipeline capacity into the reservoir and the gas remains there pending orders from the taxpayer to ship certain volumes to downstream consumers. The taxpayer begins to accumulate gas in April and effectively sells all of the accumulated gas by the end of the winter season. Although the taxpayer intends to and does sell a majority of this stored gas outside the state, it is not obligated to do so. In September 2009 the county appraisal district (District) appraised the value of gas allocated to the taxpayer and stored in the reservoir and then assessed ad valorem taxes on that value for the 2010 tax year. The taxpayer appeals to the county appraisal review board arguing that the stored gas was in the stream of interstate commerce and therefore immune from taxation.
The board denied the taxpayer’s appeal and that decision was appealed to the district court which found for the county. The court of appeals affirmed that decision and the taxpayer filed this appeal.
The court first addressed the taxpayer’s argument that under the state code provision that a taxing unit may tax only property located in the unit for more than a temporary period, the gas was not subject to tax because its stored gas is not located in the state for longer than a temporary period. The court found that the taxpayer had waived its temporary-period argument in the trial court and could not raise it now. The court then turned to the taxpayer’s commerce clause argument and discussed whether the gas was in interstate commerce and whether the tax met the four-prong test set forth in Complete Auto. The court cited a number of cases in finding that gas crossing a state line at any stage of its movement to the ultimate consumer is in interstate commerce during the entire journey. The facts in this case show that the taxpayer places its gas in an intrastate pipeline that is connected to an interstate pipeline network, which eventually conveys a majority of the gas through those pipelines to the taxpayer’s out-of-state customers downstream. The court then turned to the four-prong test. It concluded that the taxpayer’s storage of the gas broke continuity of transit, and the court, therefore, found the gas bore a substantial nexus to the state satisfying the first prong of the test. The court also found that the tax satisfied the second prong, that the tax must be fairly apportioned to activities occurring within the state to ensure that each state taxes only its fair share of an interstate transaction. The court also determined that the tax did not provide differential treatment of in-state and out-of-state economic interest that benefits in-state and places a burden on out-of-state. It said that the ad valorem tax targets all qualifying personal property and does not pay attention to the property’s intended destination. Finally, the court concluded that the tax was reasonably related to the services provided by the state. The court said that since the tax met all the prongs of Complete Auto it withstood constitutional scrutiny. A dissenting opinion foundthat the temporary stoppage of natural gas is an integral part of interstate shipping of the gas, and is excluded from state taxation by the dormant commerce clause. ETC Mktg. Ltd. v. Harris Cnty. Appraisal Dist., Texas Supreme Court, No. 15-0687. 4/28/17
Other Taxes and Procedural Issues
Casino Operator Entitled to Refund of Hotel Tax
The Louisiana Supreme Court found that the appellate court erred when it found that a taxpayer was not entitled to mandamus relief and the court compelled a refund of overpaid hotel and occupancy taxes, together with applicable interest, to a casino operator.
The taxpayer operated a land-based casino in New Orleans and entered into contracts with various hotels for rooms made available to casino patrons on a complimentary or discounted basis. The taxpayer was required to pay for a specific number of rooms for the duration of the contract even if its patrons did not use the rooms. As a result of these hotel room rentals, hotel occupancy taxes were remitted to the state Department of Revenue (DOR), collected on behalf of the Louisiana Tourism Promotion District, the Louisiana Stadium and Exposition District and the New Orleans Exhibition Hall Authority. In August 2004, the taxpayer filed three claims for refund with DOR, alleging that it overpaid hotel occupancy taxes for various hotel room rentals between October 1, 1999, and June 30, 2004. The claims were denied by DOR and the taxpayer filed suit with the Louisiana Board of Tax Appeals (BTA). The BTA held for the taxpayer, finding that under the terms of its contracts with the local hotels, the rental of hotel rooms was not found to be a “transient guest.” The BTA ordered DOR to refund the tax with interest. That decision was not appealed and DOR refunded the portions of the judgment related to state general sales taxes and the taxes collected on behalf of the Tourism District. When DOR did not refund the amounts overpaid to the Stadium District and Hall Authority the taxpayer filed a petition for a writ of mandamus to compel satisfaction of the refund judgment, alleging that the refund of the taxes was a statutorily-mandated duty enforceable by the judiciary. The district court granted the taxpayer’s writ. On appeal, the mandamus judgment was reversed and the writ of mandamus was recalled, based on a finding that the taxpayer had failed to prove it was unable to obtain relief by ordinary means or that the delay in obtaining such relief would cause injustice as required by the statute. The taxpayer filed this appeal.
Mandamus is a writ directing a public officer to perform a ministerial duty, a duty in which no element of discretion is left to the public officer, required by law. The court said that a writ of mandamus is an extraordinary remedy and may be issued in all cases where the law provides no relief by ordinary means or where delay in obtaining ordinary relief may cause injustice.
The statute provides that where there has been a determination that an overpayment has been made, the refund of overpaid taxes “shall be made out of any current collections of the particular tax which was overpaid.” The Secretary of DOR may refund the refund of overpayments that occurred in multiple years incrementally, but the number of increments shall not exceed the total number of years the tax was overpaid. With regard to incremental payments, the statute provides that the first payments must be made within 45 days of the judgment becoming final. The court said that in this case the judgment is final and the Secretary of DOR is, therefore, statutorily required to promptly make the refund of the taxpayer’s overpayments. The Secretary’s duties here are ministerial and are not afforded any discretion relative to the return of taxes.
The court said that the mandatory nature of the overpayment refund, like the compensation that is required in expropriation cases, distinguishes an overpayment refund proceeding under the statute from cases requiring a legislative appropriation for payment of a judgment in matters arising out of contract or tort. The court found that the legislature afforded the judiciary authority to issue a mandamus in a proceeding under the statute to compel enforcement of a final refund judgment. The court cited Wallace C. Drennan, Inc. v. St. Charles Parish, 14-89, pp. 5-6 (La.App. 5 Cir. 8/28/14), 164 So.3d 186, 190 for the proposition that when a writ of mandamus is specifically provided as a remedy by statute, the general rules for a mandamus action do not apply, and, therefore, the taxpayer is not required to show that relief is not available by ordinary means or that the delay involved in obtaining ordinary relief may cause injustice. The court found that mandamus was an appropriate remedy to compel the Secretary to the perform duties owed under La. R.S. 47:1621. Jazz Casino Co. LLC v. Bridges, Louisiana Supreme Court, 2016-C-1663. 5/3/17
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected]. |
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STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
April 28, 2017 Edition
NEWS
Executive Order Requires Review of Significant Tax Regulations
On April 21, 2017, President Trump signed an executive order requiring an immediate review of “all significant tax regulations" since the beginning of 2016. The order requires Treasury to provide an interim report on its findings within 60 days in which it identifies regulations that impose an undue burden on taxpayers, add undue complexity to the tax laws, or exceed the statutory authority of the IRS. The EO also requests Treasury to submit a report within 150 days, recommending specific actions to lessen the burden of the regulations highlighted in the interim report.
First Tax on Cigarettes
Jerry Leonard, Deputy Director of the Oklahoma Tax Commission noted that in April 1921, Iowa became the first state to enact a tax on cigarettes, rolling paper and associated paraphernalia. The tax rate was modest, set at just $1 per 1,000 cigarettes. Iowa today collects $1.36 per pack, ranking it just below the middle of states. Jerry pointed out that the highest excise tax is levied by New York, at $4.35 and the lowest is found in Missouri at just $.17 cents per pack. There are 29 cigarette manufacturers in the U.S., and some 126 cigarette brands on the market, with annual sales of over $31 billion.
Class Action Suit Filed Against Tax Preparers
An individual has filed a class-action suit in the U.S. District Court for the Central District of California against tax return preparation businesses including Jackson Hewitt, contending that they fraudulently obtained refunds from the IRS by stealing their clients’ identities.
The plaintiff claimed that Jackson Hewitt systematically represented its
trustworthiness to the public, and repeatedly and systematically violated that trust and used plaintiff’s identity to fraudulently obtain thousands of dollars from the IRS in plaintiff’s name. He argued that the defendants altered his tax returns in several years in order to artificially decrease his tax liability, thereby permitting the defendants to create a refund that was then deposited into a bank account the defendants had created without the plaintiff’s knowledge and cashed by the defendants without plaintiff’s knowledge or involvement.
U.S. SUPREME COURT UPDATE
Cert filed
Steager v. CSX Transportation Inc., U.S. Supreme Court Docket No. 16-1251. Petition for certiorari filed 4/17/17. Issue: Whether the corporation is due a use tax credit for sales taxes paid to other jurisdictions. The taxpayer is arguing that the dormant commerce clause requires states imposing a use tax provide a credit for out-of-state sales taxes, citing Comptroller v. Wynne, decided by the U.S. Supreme Court in 2015. See the 12/9/16 issue of State Tax Highlights for a discussion of the West Virginia Supreme Court of Appeals’ decision in this case.
FEDERAL CASES OF INTEREST
Real Estate Professional Deductions Denied
The U.S. Tax Court held that a couple could not deduct losses from their real estate activities because the husband wasn’t a real estate professional. The court found that the couple did not sufficiently substantiate their claim that the husband worked more hours in his real estate activities than in his full-time employment.
The facts in the case show that the taxpayers, for the pertinent period, resided in Colorado and the husband was a full-time employee of HSS, Inc. (HSS). Although he performed many of his duties from his home, he would travel to client sites as needed. These trips could take under half an hour in the case of a local client, or they could on occasion require him to travel several hours throughout Colorado. In total, he spent at least 2,194 hours, including occasional overtime, during 2012 performing his duties for HSS. During 2012, he was also actively engaged as a Colorado licensed real estate broker, and he had an active business marketing commercial and residential properties for several clients. The couple also conducted a rental real estate activity through a subchapter S corporation named Harvey Herbert, Inc. (HHI), with each owning 50% of HHI. During the taxable years 2010-12 HHI owned two single-family residential properties in Colorado. They also held a warehouse in the state in a self-directed individual retirement account through a limited liability company, Flying Bee Ranch, LLC. They spent time performing various tasks in the course of managing HHI’s affairs such as finding tenants, managing the Corporation’s finances, and making repairs to the properties. HHI filed a 2012 Form 1120S, U.S. Income Tax Return for an S Corporation, on which it reported a nonpassive ordinary business loss which was reported to the taxpayers on Schedules K-1. The return did not report any passive loss from real estate activities. The taxpayers filed a joint income tax return for 2012 on Form 1040, U.S. Individual Income Tax Return, and reported a nonpassive loss from HHI. The IRS performed an audit for taxable years 2010 through 2012 and determined that the 2012 loss was a passive loss from real estate activities and the husband did not qualify as a real estate professional under section 469(c)(7). The taxpayers filed an appeal arguing that the husband was a real estate professional.
The Internal Revenue Code generally permits taxpayers to deduct business and investment expenses under sections 162 and 212, but section 469 puts strict limits on current deductibility if a taxpayer incurs those expenses in a “passive activity,” which is any trade or business in which the taxpayer does not materially participate. A passive activity loss is the excess of the aggregate losses from all passive activities for the year over the aggregate income from all passive activities for that year and a rental activity is generally treated as a per se passive activity regardless of whether the taxpayer materially participates. There are special rules under the section that allow a taxpayer who is a real estate professional to deduct rental losses against other income provided that the taxpayer materially participates in the rental activity.
The taxpayers argued that the husband qualified as a real estate professional under section 469(c)(7) and that he materially participated in his real estate activities. Under the section a taxpayer qualifies as a real estate professional and a real estate activity of the taxpayer is not a per se passive activity if more than one-half of the personal services performed in trades or businesses by the taxpayer during the taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and the taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.
The taxpayer claimed that the husband spent approximately 2,520 hours on his real estate activities during the taxable year 2012, with approximately 1,000 of the claimed hours relating to the rehabilitation of one property the husband acted as a realtor for the purchaser.
The court acknowledged that the husband expended significant efforts on his real estate activities in 2012, but was unable to credit his testimony concerning the number of hours he spent on those activities. The court noted that a taxpayer can use any reasonable means to prove the extent of his participation in real estate activities, but said that the taxpayers’ primary substantiation at trial for the hours the husband worked during 2012 was a monthly calendar that indicated the property where he worked on a particular day and contained a brief description of the work performed, an estimate of the number of hours worked, and the number of miles driven to and from the property. The court found that the calendar greatly exaggerated the time the husband spent on his real estate business activities, noting that the calendar would suggest that he work 10-14 hours each weekend day during the year on his real estate activities and an additional 4-6 hours most weekdays, in addition to his full time job. The court concluded that the calendar was untrustworthy, noting virtually all of the entries were rounded to the nearest hour or half-hour, did not specify a start or end time for the work, included the time spent driving to and from the property, and did not separate out any time for meals or other breaks. Based on the record before it the court concluded that the taxpayers had not sufficiently substantiated their claim that the husband spent more time during 2012 in his real estate activities than in his employment with HSS, as required by the statute. Penley, Zane W. et ux. v. Commissioner, U.S. Tax Court, No. 13243-15; T.C. Memo. 2017-65. 4.17.17
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Individual Personally Liable for Sales Tax
The Minnesota Supreme Court held a 50 percent shareholder of a corporation that owned a restaurant was personally liable for back sales tax. The court found that he had financial control of aspects of the restaurant and satisfied the control requirements under the statute.
The taxpayer and his wife owned a business and were directors of the corporation. He was the chief executive officer, president, and secretary of the corporation, and his wife was the vice president and treasurer. Beginning in 1990, the taxpayer and his wife operated several restaurants through the corporation, the last of which they sold in 2005. In 2002, the taxpayer and his wife purchased a building with a restaurant on the ground floor and leased the space to the restaurant’s owner. When that restaurant closed in 2004 the taxpayer ultimate permitted his son to open another restaurant through the corporation owned by him and his wife, permitting the son to benefit from the corporation’s established credit history and supplier relationships. The taxpayer agreed to let the son be in charge, but secured bank loans for the corporation to permit the son to remodel the space and secure new equipment. He also secured the liquor license as an officer of the corporation. The restaurant opened in June 2006 and the taxpayer characterized his son as the president of the restaurant. The taxpayer remained a director and officer of the corporation throughout the restaurant’s existence. He received a salary from the restaurant for occasional work there. He was an authorized signer on the corporation’s bank accounts and regularly signed checks on the restaurant’s behalf. The Department of Revenue (DOR) audited the restaurant in 2008. The son closed the business in 2011 because it was not generating business and the taxpayer and his wife subsequently sold the building that housed the restaurant and formally dissolved the corporation. DOR levied an assessment against the corporation in 2008 for sales and use tax deficiency. When the corporation failed to pay the assessment, DOR assessed the taxpayer personally for the liability. The taxpayer appealed the assessments and the tax court found for the taxpayer. DOR filed this appeal.
The state statute authorized DOR to assess an individual with personal liability for the unpaid tax liability of a business entity and provides that a person who, either singly or jointly with others, has the control of, supervision of, or responsibility for filing returns or reports, paying taxes, or collecting or withholding and remitting taxes and who fails to do so, or a person who is liable under any other law, is liable for the payment of taxes. A person is defined to include an officer or director of a corporation. The taxpayer did not dispute that he was an officer, but argued that he did not exercise the required control or responsibility for filing the returns. He contended, and the tax court agreed, that he did not have the requisite degree of functional control over the restaurant’s operations to be held personally liable for the corporation’s unpaid sales taxes.
The court cited Benoit v. Comm’r of Revenue, 453 N.W.2d 336, 344 (Minn. 1990), which set forth factors to determine whether a person is personally liable for a corporation’s unpaid sales tax and said that while these Benoit factors are informative, the court has never said that the Benoit factors define the statutory standard. It has, instead, relied on the plain language of the statute. The court said that an individual’s de minimis functional role in a business cannot outweigh evidence that the individual has the formal authority to file tax returns and pay taxes and concluded that the tax court committed an error of law by overemphasizing the Benoit factors at the expense of the plain language of the statute. The court rejected the taxpayer’s argument that he was not personally liable because he orally agreed to allow his son to manage the restaurant, finding that regardless of the son’s control of the restaurant the evidence established that the taxpayer had control of and responsibility for filing tax returns and paying the corporation’s taxes. The court noted that the taxpayer signed the corporation’s state S corporation tax returns for tax years 2005 through 2007 and 2010 and its U.S. income tax returns for 2006, 2007 and 2010. The court also found that the taxpayer’s financial involvement with the restaurant also confirmed his control and responsibility, pointing to the loans totaling $600,000 that were used to remodel the restaurant and purchase necessary equipment and the taxpayer’s securing of the liquor license.The court said that although the taxpayer did not manage the restaurant’s daily operations, his financial responsibilities with the company were significant and regular. The court noted that the taxpayer also possessed expansive authority and responsibility over the corporate taxpayer that operated the restaurant, and pointed out that the son never held an officer position at the corporation.
The court concluded that as a 50 percent shareholder with general active management authority and significant financial authority over the corporation’s business, the taxpayer had the requisite control of, supervision of, or responsibility for the corporation’s tax returns and tax payments to establish personal liability for the unpaid sales tax liability of the corporation.
Lo v. Comm'r of Revenue, Minnesota Supreme Court, A16-0918. 4/12/17
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Asbestos Claim Payments Not Deductible
The Texas Fourth Court of Appeals held a company was not entitled to take a cost of goods sold deduction for a $2 billion payment for product liability damages paid into a trust. The court found that the payment was not made to improve the quality of the asbestos-containing products or goods themselves, but was instead used to pay personal-injury claims.
In 2008 the taxpayer may a one-time payment in excess of $2 billion as part of an asbestos product liability settlement during its bankruptcy reorganization into an asbestos trust fund. The taxpayer subsequently filed a franchise tax refund claim that included the trust fund payment as a cost of goods sold under costs of quality control. The state Comptroller denied the claim and the taxpayer filed an appeal. The parties filed competing motions for summary judgment and stipulated to a series of facts. One of the stipulated facts was that until 1973 the taxpayer sold products containing asbestos and many of those products remained in use after 1973. Many plaintiffs sued the taxpayer alleging those products were defective and cause them personal injuries. In 2008, the taxpayer took advantage of a federal law which allowed it to be free of all pending and future asbestos product-liability lawsuits in return for the more than $2 billion payment into an asbestos trust fund, the purpose of which is to pay personal-injury claims in pending and future asbestos product-liability lawsuits. The trial court found for the Comptroller and granted the motion for summary judgment, finding that the costs at issue were not the costs of quality control that would be deductible under the statute.
The parties’ first dispute relates to whether section 171.1012, which deals with the cost of goods sold (COGS) calculation, should be construed strictly against the taxpayer.The court noted that case law generally holds that statutes imposing a tax must be strictly construed against the taxing authority and liberally construed in favor of the taxpayer. Deductions and exemptions, however, are matters of legislative grace and are, therefore, strictly construed against the taxpayer and in favor of the taxing authority. The court said that since section 171.1012 allows a taxpayer to deduct cost of goods sold from its total revenue in calculating its margin, it must be strictly construed against the taxpayer.
The section at issue effective in 2008 included definitions and formulas pertaining to calculating the cost of goods sold and listed categories of items included in the COGS. It specifically provided that COGS included the costs of quality control, including replacement of defective components pursuant to standard warranty policies. The taxpayer argued that “costs of quality control” is a technical term that should be given the meaning of experts in the field and contended the use of the word “of” in costs of quality control does not limit the costs to the performance of successful quality control but also includes costs from failed quality control. The Comptroller argued that the taxpayer’s expert opinion is unreliable and incorrect. The court said that it was not persuaded by the arguments of either party and, instead, looked to the rules of statutory construction. The court said the three examples the legislature provided to assist in the court’s understanding of its use of the term costs of quality control must be examined knowing the legislature viewed the term as a subset of COGS and as a cost that is in relation to the taxable entity’s goods. The court concluded that each example provided by the legislature involved a cost spent on the product or good itself to improve its quality.
The cost of replacing defective components pursuant to standard warranty policies involves money spent on replacing a component of the product or good itself to improve its quality. The cost of inspection directly allocable to the production of the goods involves money spent during production to improve the quality of the product or good itself and the cost of repair and maintenance of goods is money spent on repairing or maintaining the product or good itself to improve its quality. The court said that in contrast to these examples, the payment made by the taxpayer to the asbestos trust fund to compensate plaintiffs for personal injuries caused by the asbestos-containing products it stopped producing in 1973 was not money spent to improve the quality of the asbestos-containing products or goods themselves. The court held that the taxpayer’s payment to the asbestos trust fund was not a cost of quality control.
Owens Corning v. Hegar, Texas Fourth Court of Appeals, No. 04-16-00211-CV. 4/5/17
Out-of-State Company Excluded From Consolidated Tax Return
The Iowa Supreme Court held the Department of Revenue (DOR) did not err in determining an affiliated group's out-of-state parent company could not be included in its consolidated tax return. The parent’s business activities only consisted of owning and controlling subsidiaries, which are not taxable activities in the state.
The parentis a Delaware corporation with its primary place of business in Texas and holds an ownership interest in several subsidiaries, including two Delaware limited liability companies (LLCs) doing business in the state. The parent and its subsidiaries are in the business of
natural gas pipeline transmission and storage. During tax year 2009 the parent received payments from its subsidiaries of distributions of earnings and payments of each member’s allocated tax liability. The parent received the allocated tax payments under a February 2008 Tax Allocation Agreement that apportioned the affiliated group’s tax liability among its members. Pursuant to that agreement, the parent agreed to join a federal consolidated tax return with its subsidiaries, prepare and file all appropriate documents for the consolidated return, and pay the group’s consolidated tax liability. If the payments to the parent over the course of the tax year exceeded the actual apportioned tax liabilities, the parent promised to refund any overpayment. In addition, the subsidiaries assumed liability for and agreed to indemnify the parent against responsibility for any subsidiary’s tax obligations, protecting the parent from the risk of underpayment.
The parent filed a federal consolidated return for tax year 2009 and the group reported a net loss. The group also filed an Iowa consolidated return for that year and reported an apportioned net loss to the state and an estimated overpayment, which it applied to its estimated liability for tax year 2010. The Department of Revenue (DOR) determined that the parent was ineligible to be included in the consolidated return because it had not derived taxable income from within the state under the state statute requirement and issued an assessment against the group for a corporate income tax deficiency. The group protested the assessment, arguing that the parent was eligible to be included in the consolidated return because it derived taxable income from within the state. The matter was heard by an administrative law judge (ALJ) who issued a proposed decision upholding DOR’s assessment and DOR issued a final order adopting that decision with certain clarifications. DOR’s final order concluded the parent was ineligible to join in the group’s consolidated tax return because it did not derive taxable income under the state statute, concluding that the distributed earnings the parent received incident to its ownership interest in the subsidiaries amounted to an activity of owning and controlling a subsidiary corporation and therefore did not constitute doing business in the state or deriving income from sources within the state within the meaning of the statute. DOR concluded that although the subsidiaries doing business in the state are limited liability companies, they must be treated as corporations for purposes of the state’s tax laws since they elected to be taxed as corporations in the group’s federal consolidated return. DOR’s final order also determined the payments the parent received from the subsidiaries under the tax allocation agreement did not constitute income to it because those payments amounted to pass-through tax expenses of the subsidiaries based on the subsidiaries’ income. The taxpayer filed this appeal.
The issue in the case was whether the state could subject a foreign corporation to income taxation when the corporation has no physical presence in the state but receives revenue from entities that do business within the state. In Iowa, an affiliated corporation may join a consolidated return to the extent its income is taxable under the code but cannot join the return if it is exempt from taxation. An affiliated corporation’s income is taxable under Iowa Code section 422.33 if the corporation has both a taxable nexus with the state and taxable net income. If a common parent lacks a taxable nexus with Iowa or does not receive taxable income, it may designate a subsidiary that is subject to Iowa’s income tax to act on the consolidated group’s behalf. The parties agreed that the parent is a parent company lacking a physical presence in Iowa related to its ownership and control, and the court said that the resolution of the case, therefore, turned on whether DOR correctly concluded the parent’s activities with the in-state subsidiaries constituted activities of “[o]wning and controlling a subsidiary corporation” within the meaning of Iowa Code section 422.34A(5).
The court said that the terms “owning” and “controlling” as they are used in section here are not defined by statute or interpreted in the associated regulations, and the court, therefore, assign to the words their common, ordinary meaning, in the context of the statute and its history. The court also noted that it construes statutes harmoniously with other statutes related to the same subject matter or to closely allied subjects. The group argued that the parent was not exempt from taxation under section 422.34A(5) because it provided significant managerial, administrative, strategic planning, and financial support to its in-state subsidiaries in tax year 2009, functions the group insisted extended beyond activities of owning and controlling a subsidiary corporation. While the parent has no employees, the group argued that it performed these functions through a management-services agreement with a third party. The group also asserted the parent had a taxable nexus in the state because it owned two types of intangible property with a situs in Iowa, i.e., shares of stock and money. The court concluded that the activities the parent performed for the subsidiaries were all activities of owning and controlling a subsidiary corporation. The court found that all the various oversight and management activities the parent performed for the subsidiaries were routine features of a parent corporation’s ownership and control of its subsidiaries. The court dismissed the group’s argument that because the subsidiaries’ tax obligations accrued daily but were paid to the parent on a quarterly basis, it provided working capital to the subsidiaries and thus engaged in an activity distinct from the routine functions of ownership and control, finding that the parent’s implementation of a tax allocation agreement in furtherance of its legal responsibility as parent is no less an activity of ownership and control than it would have been if it had required payments on a daily basis. The court also rejected the contention that the parent has a taxable nexus with the state because it owns two types of intangible property, shares of stock and money, with a situs in Iowa. The court held that because the parent lacked a taxable nexus with the state in tax year 2009, DOR correctly concluded it could not join the consolidated return. Myria Holdings Inc. v. Dep't of Revenue, Iowa Supreme Court, No. 15-0296. 3/24/17
Alternative Apportionment Against Bank Rejected
The Minnesota Tax Court held the Commissioner of Revenue (Commissioner) erred in using alternative apportionment to include interest income in a unitary group's combined report for tax years 2007 and 2008. The court found that the taxpayer properly used the general apportionment rules and it was not up to the Commissioner or the courts to create tax policy.
The appellant was a nationally chartered bank headquartered in Wisconsin during the years at issue here and was a wholly-owned subsidiary of a bank holding company. Appellant was engaged in the business of banking, with banking locations in Wisconsin, Illinois, and Minnesota and with loan production offices in other states. In May 2007, the appellant advised the federal Office of the Comptroller of Currency (Comptroller) that it proposed creating two limited partnerships for the purposes of holding real estate loans related to assets held by the appellant and a related entity. Appellant advised the Comptroller that there would be no change in the management of the transferred assets and therefore, the safety and soundness of the assets would be unaffected by the transaction. The proposed structure would also be federal tax neutral, but have an impact on the state tax liability.
The Minnesota statute imposes a franchise tax on corporations that produce gross income attributable to sources with the state. In computing the tax due it uses a statutory unitary business formula that combines the income and apportions based on a three-factor formula of sales, property and payroll. A separate provision of the statute provided, however,
that if the apportionment method described does not fairly reflect all or any part of taxable net income allocable to this state, the Commissioner was authorized to use another method if that method fairly reflects net income. The Commissioner applied an alternative method in this case and adjusted apportionment factors for three of the appellant’s members. The appellant filed an appeal.
The court noted that the two LLCs are not financial institutions and are treated as partnerships for state income tax purposes. Under the state statute,general apportionment rules apply to the LLCs, which means that interest income is excluded when calculating the sales factor and intangible property is excluded when calculating the property factor. The Commissioner argued the general apportionment method did not fairly capture the LLCs', and, therefore, Appellants', state taxable income. The statute provides that the methods prescribing the allocation method shall be presumed to determine fairly and correctly the taxpayer's taxable net income allocable to this state. The court cited a Minnesota Supreme Court case, HMN Financial, Inc. v. Commissioner of Revenue, examined this provision and determined that the statute's plain meaning presumes that a taxpayer has ‘fairly and correctly’ determined its Minnesota taxable income if that taxpayer used the reporting methods outlined in section 290.191. The court noted that in this case the Commissioner did not assert that the appellants did not properly follow the methods prescribed by section 290.191. but, instead, tried to rebut the presumption of fair allocation.
In HMN Financial, the court said that the taxpayers organized their businesses in compliance with relevant statutes with the sole purpose of minimizing their tax liabilities. While the benefits to the taxpayer were considerable, the court in HMN Financial concluded that the Commissioner failed to rebut Minn. Stat. § 290.20's presumption of fairness and correctness. The court noted in that case that the Commissioner appeared to take issue with the result rather than the methods HMN used to reach that result, and held that the Commissioner could not invoke the alternative apportionment provision to disregard the taxpayers’ corporate structure. The court similarly concluded in the current case that the Commissioner could meet her burden by disregarding the business structure the appellants attained by means of the lawfully created LLCs. The court ruled that the Commissioner could not circumvent the statute and the ruling in HMN Financial by applying the financial institution apportionment rules, rather than the general apportionment rules, to the LLCs. The court agreed that by creating the LLCs in Wisconsin, the appellants were taking advantage of a tax loophole to minimize their Minnesota tax liability, but said it was up to the legislature to close tax loopholes, not the Commissioner or the courts. Associated Bank N.A. v. Comm'r of Revenue, Minnesota Tax Court, Docket No. 8551-R. 4/18/17
Property Tax Decisions
No cases to report.
Other Taxes and Procedural Issues
Local Business Tax Assessment Unconstitutional
The Commonwealth Court of Pennsylvania held a local gross receipts assessment violated the fair apportionment prong of the Complete Auto Transit v. Brady test and was externally inconsistent. The court said the assessment taxed 100 percent of the taxpayer’s receipts, even though some of the receipts were derived from interstate activity.
The taxpayer is a Texas corporation and owns and operates convenience stores throughout the United States. Some of its stores are corporate stores, owned and operated by the taxpayer directly and other stores are franchise stores, which are licensed to franchisees and operated according to the terms of a franchise agreement. Pursuant to the franchise agreement, franchise store pay the taxpayer a fee in exchange for various services provided to franchise stores by the taxpayer. During the relevant tax years the taxpayer maintained a regional office for its Northeast Division, which includes stores in Pennsylvania and New England, in a township in the state. There was one corporate store and one franchise store within the township. During the years at issue, the taxpayer filed business privilege tax (BPT) returns with the township that reported receipts generated by sales at the corporate store within the township, but did not include the taxpayer’s charges collected from franchise stores in the Northeast Division. The township issued an assessment of delinquent BPT tax based on the taxpayer’s receipt of charges from stores in the Northeast Division, to which it applied an apportionment factor of receipts in the township as a percentage of total receipts. The taxpayer filed an appeal to the Tax Review Board and a hearing officer for the Board sustained the assessment. The taxpayer appealed that decision and the trial court held for the taxpayer finding the tax imposed was unconstitutional based on an application of Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) and its 4-prong test to determine whether a local tax on interstate commerce is constitutionally permissible. The trial court found that the township’s assessment failed to satisfy the fair apportionment prong of the Complete Auto test that requires that a local tax on interstate commerce be both internally and externally consistent. The township filed this appeal.
The court found that the taxpayer presented extensive evidence before the trial court of the various services that the taxpayer provides to franchise stores in exchange for payment of the Charge. For example, the taxpayer’s marketing department is situated entirely in Texas and manages the advertising for all of taxpayer’s stores in the country. The court found that the evidence presented by the taxpayer showed that many services provided to Pennsylvania franchise stores are produced by activity from beyond Pennsylvania and said there was substantial evidence to support the trial court’s finding that the Charges collected from Pennsylvania franchise stores were the product of interstate commerce.
The court also rejected the township’s argument that the taxpayer had the burden of proving what portion of the Pennsylvania Charges resulted from interstate commerce, finding that the constitutional challenge does not require a taxpayer to prove what portion of receipts is derived from interstate verses intrastate commerce. The court found that the trial court heard substantial evidence from which to conclude that the township’s assessment was disproportionate because it failed to fairly apportion the Pennsylvania Charges when those charges reflected both intrastate and interstate activities. The court affirmed the trial court’s ruling that the township’s assessment violated the Commerce Clause, but found that the trial court erred after reaching that conclusion in invalidating the assessment. It, therefore remanded the matter for a recalculation of the tax due. Upper Moreland Twp. v. 7 Eleven Inc., Commonwealth Court of Pennsylvania, No. 11 C.D. 2016. 4/13/17
Tax Treatment of Satellite Companies Constitutional
The Florida Supreme Court held that the different treatment of satellite and cable TV companies under the communications service tax. The court found that while they were similarly situated, both providers' services were interstate in nature.
The Communications Services Tax (CST) was enacted in 2001 and imposed a 6.8 percent tax rate on cable service and a 10.8 percent tax rate on satellite service. Presently, cable service is taxed at 4.92 percent and satellite is taxed at 9.07 percent, and it is this difference, according to the satellite companies, that violates the dormant Commerce Clause. The trial court found that the statute did not violate the Commerce Clause because it did not benefit in-state economic interests or similarly situated entities. The satellite companies appealed the decision, arguing that the statute unconstitutionally discriminates against interstate commerce in both its effect and purpose. The First District agreed with the satellite companies and reversed the decision of the trial court, finding that the satellite companies and cable companies were similarly situated because they both operate in the same market and are direct competitors within that market. The district court found cable companies to be in-state interests due to their local infrastructure and local employment and held that because the CST favors communications that use local infrastructure, it has a discriminatory effect on interstate commerce. The state Department of Revenue (DOR) filed this appeal and argued that the statute does not discriminate in its effect or its purpose.
The court noted that case law has held that state law is discriminatory in effect if it affects similarly situated entities in a market by imposing disproportionate burdens on out-of-state interests and conferring advantages upon in-state interests. DOR argued that cable companies and satellite companies are not similarly situated entities, contending that cable and satellite providers offer different communications services using different technologies and are subject to different regulatory burdens. The taxpayer argued that cable and satellite providers compete directly and offer virtually identical products, and consumers view their products as similar and substitutable. The court said that courts have not extensively considered what is required for entities to be considered “substantially similar,” but noted that at the very least the entities must be in competition with one another. The court found that cable and satellite providers are similarly situated for the purposes of the Commerce Clause because they both provide television service and compete directly in the pay-television market for the same customers.
Citing American Trucking Ass’ns v. Scheiner, 483 U.S. 266, 286 (1987), the court said that the U.S. Supreme Court has identified “in-state” and “out-of-state” businesses based on a distinct geographic connection, or lack thereof, to the home state. DOR argued that cable and satellite companies are both out-of-state interests because they each have corporate headquarters and principal places of business located outside the state and they each have employees and property in state that facilitate the provision of their services to customers. The taxpayers argued, on the other hand, that cable companies are in-state interests because they employ more state residents and utilize local infrastructure to produce and distribute their programming. The court found that cable companies were not in-state interests for the purpose of the dormant Commerce Clause. The court held that both businesses are interstate in nature, noting that the state’s largest cable companies have their headquarters out-of-state and the state’s two largest satellite providers have their headquarters in California and Colorado, respectively. The cable and satellite companies have employees and property both inside and outside the state to facilitate their operations and earn income and they both employ in-state residents to sell, maintain, or repair their service to state customers. They also own and lease a significant amount of property in the state. They are both service providers and employ the use of ground infrastructure in the state. The court noted that while it may be true that cable employs more in-state residents and uses more local infrastructure to provide its services, the Supreme Court has never found a company to be an in-state interest because it had a greater presence in a state. The court pointed out that the Supreme Court has affirmed the prerogative of state and local governments to treat different business models differently.
Neither cable nor satellite is produced in Florida, and neither business is headquartered in the state and the court found that cable was not an in-state interest for the purpose of the dormant Commerce Clause, and therefore, the discriminatory effect argument put forth by the satellite companies failed.
The court then turned to the issue of whether the statutory provision had a discriminatory purpose, and said that in order to determine discriminatory purpose, courts look to the language and the legislative history of the statute in question. The court said that in this case the section of the code provides the legislative intent of the CST, when it provided in pertinent part that a specific legislative finding was that the creation of this chapter fulfills important state interests by reforming the tax laws to provide a fair, efficient, and uniform method for taxing communications services sold in this state. The court said there was no evidence from the text of the statute that it was enacted with a discriminatory purpose, but, instead, analysts believed the CST’s impact would have the benefit of a simplified tax structure for all communication providers. The court found that the CST was not enacted with a discriminatory purpose, and because the CST is not discriminatory in either its purpose or effect, the satellite companies’ facial challenge failed. Dep't of Revenue v. DirecTV Inc., Florida Supreme Court, No. SC15-1249. 4/13/17
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected]. |
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