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:
September 15, 2017 Edition
NEWS Hyatt’s California Tax Hearing After 24 years of legal battles in multiple jurisdictions, Gilbert Hyatt has largely succeeded in his fight against the California Franchise Tax Board (FTB). Following a hearing before the state’s Board of Equalization on August 29, BOE members held that Hyatt hadn’t committed tax fraud, that he was not a resident of California between 1991 and 1992, and that his income from patent royalties for his microchip design could be sourced to California only in 1991. The FTB had originally argued that Hyatt owed over $13.2 million in taxes and penalties for fraud, plus interest. Instead, this ruling means that he instead owes approximately $1.9 million plus interest. Hyatt’s case has become legendary in the tax world, twice going to the U.S. Supreme Court. See prior issues of State Tax Highlights for a discussion of the various decisions. Massachusetts DOR Releases Remote Sales Tax Regulation On September 13th, the Massachusetts Department of Revenue released the final version of its remote sales tax collection regulation, 830 CMR 64H.1.7, which is expected to take effect September 22, 2017. The final version, which followed a hearing held on August 24 and the collection of public comments, is nearly identical to DOR’s initial proposal issued July 28, 2017 and can be found on DOR’s website, www.mass.gov/dor. It will require out-of-state and internet retailers with over $500,000 in sales into Massachusetts and 100 or more transactional sales into the state during the past 12 months to collect and remit sales tax. NetChoice and the American Catalog Mailers Association (ACMA) filed a lawsuit against DOR over an earlier similar directive and it is expected that they will challenge the implementation of this regulation. Supreme Court to Hear Gerrymandering Case The U.S. Supreme Court is scheduled to hear oral arguments on October 3rd in Whitford v. Gill, U.S. Supreme Court Docket No. 16-1161, a case challenging Wisconsin's state legislative districts. The plaintiffs in this case complained that the legislative map unfairly protects Republican lawmakers from partisan competition and the U.S. District Court for the Western District of Wisconsin agreed in its November 21, 2016 decision. Experts in this field noted that the Supreme Court has ruled against racial gerrymandering repeatedly but never against partisan gerrymandering. U.S. SUPREME COURT UPDATE No cases to report. FEDERAL CASES OF INTEREST Parents Can't Deduct Child's Pageant Expenses The U.S. Tax Court has disallowed a couple's loss deductions pertaining to their child's pageant expenses, finding that the child’s prize winnings are compensation for her services in the pageants that is includable in her income. The court said that section 73(b) treats related expenditures as paid or incurred by the child, even if the parent makes the expenditure. The husband and wife taxpayers have several children, including a child who began competing at the age of 9 in beauty pageants to further her performing career. In order for the child to participate in the pageants at a competitive level, the taxpayers incurred several thousand dollars of expenses for travel, outfits, and similar items. In 2011 and 2012 the child won several of these events and received cash prizes, paid by check made payable to the child and deposited by the family into her college savings account. The pageant expenses for the two years in question exceeded these winnings. The taxpayers used a tax preparer to file their 2011 and 2012 returns and the preparer believed that the pageant winnings and expenses were allocable to the taxpayers and prepared their returns accordingly. The IRS issued a notice of deficiency for tax years 2011 and 2012 disallowing deductions for the child’s pageant expenses as well as a capital loss for tax year 2011. The taxpayers filed this appeal. The court noted that Section 73(a) of the IRC requires inclusion of “amounts received in respect of the services of a child” in the child’s own gross income rather than that of the parents and court cases provide that “amounts received in respect of the services of a child” encompassdirect and indirect payments for services. Section 73(b) treats all expenditures attributable to amounts includable in the child’s gross income solely by reason of section 73(a) as paid or incurred by the child, even if a parent made the expenditure. The court said that in the past, it has specifically treated pageant-related remunerations, including those named as scholarships, as compensation for services. The court found that the pageant winnings were clearly earned by the child and, therefore, only the child could deduct the pageant-related expenses. The court held that the taxpayers were not liable for accuracy related penalties finding that they had acted with reasonable cause and in good faith. Lopez, Tony Pedregon et ux. v. Commissioner, U.S. Tax Court, No. 21842-15; No. 6794-16; T.C. Memo. 2017-171. 8/30/17 Individual Personally Liable for Foundation’s Liabilities The U.S. District Court for the Middle District of North Carolina held that an individual had complete control over a foundation that received fraudulent tax refunds in 2009 and 2010 and was personally liable for its tax liabilities. The court held that the government can foreclose on his real property. The foundation sought and received more than $600,000 in fraudulent tax returns for tax years 2009 and 2010. The taxpayer was the foundation’s trustee and exercised complete control over the foundation. The facts showed that he used the foundation’s refund for personal purposes, including paying off a car loan and a mortgage. The U.S. Government sought a judgment against him arguing that he was the foundation’s alter ego and was personally liable for its tax liabilities. The government also sought to foreclose on real property in North Carolina that the taxpayer and his wife acquired in 1983. The taxpayer’s wife transferred her share of the property to him in 2011 and he subsequently transferred the property for a nominal price to a trust over which his son-in-law is a trustee. After the transfer, he continued to reside in the property and paid the expenses of the property and took personal income tax deductions on his federal return for the property. The government sought a declaratory judgment that the trust is the taxpayer’s nominee for the purpose of a federal tax lien and an order allowing the United States to sell the property to satisfy the foundation's tax liabilities. The court dealt first with procedural issues and found that the government had submitted sworn declaration and other factual evidence detailing the taxpayer’s tax liability and the relationship among the various defendants and concluded that default judgment was appropriate. The court also concluded that the government had proffered sufficient evidence to allow the court to decide the issue of damages without an evidentiary hearing. The court found that the foundation’s liability is attributable to the taxpayer in his individual capacity because under North Carolina law he was the legal alter ego of the foundation, meeting the state’s requirements that he had complete control of the entity, used that control to commit fraud or violate a statutory duty and the fraud or violation cause the injury at issue in the matter. The court found that the facts showed that the taxpayer met all three criteria set forth in the state’s law. The taxpayer’s tax liabilities gave rise to a federal tax lien, which attached to all property owned by him, and the government has the authority to foreclose on that property if the taxpayer failed to satisfy the liability. The government argued that the trust for the property in North Carolina was the taxpayer’s nominee for the purpose of his tax lien. The court cited case law that set forth eight factors it used to determine nominee status and found that the taxpayer met these requirements and ordered the sale of the property to satisfy the taxpayer’s tax liabilities. Williams, Marlowe v. United States, U.S. District Court for the Middle District of North Carolina, No. 1:17-cv-00278. 8/25/17 Disallowance of Charitable Deductions Affirmed The U.S. Tax Court sustained the Internal Revenue Service’s (IRS) disallowance of the majority of a taxpayer’s $1.4 million charitable contribution deduction for specimens donated to an ecological foundation. The court found that the comparable sales method, rather than the replacement cost method used by the taxpayer, was the appropriate method for determining the fair market value of the specimens. The taxpayer, an avid big-game hunter who has participated in numerous safaris, decided in 2006 to downsize his trophy collection by donating many of his less desirable hunting specimens to an ecological foundation. He relied on an appraisal performed and claimed a charitable contribution deduction of more than $1.4 million. This amount exceeded the maximum allowable as a deduction for 2006 and he carried the balance of the deduction to 2007 and 2008.ed The IRS determined that the value of the hunting specimens the taxpayer had contributed was at most $163,045 and, accordingly, determined deficiencies for 2007 and 2008. The taxpayer filed this appeal arguing that the proper methodology for determining the fair market value (FMV) of his donated specimens was replacement cost and not comparable sales as the IRS contended. Like many hunters the taxpayer preserved the remains of the animals he shot in a professionally designed “trophy room” in his house. When he decided to downsize his collection he contacted an appraiser who had been recommended by another hunter, and subsequently selected a total of 177 items from his collection for donation to a nonprofit foundation recommended by that hunter. Certain hunting organizations maintain record books of big-game kills using proprietary scoring systems, and a specimen may qualify for listing in record books on the basis of the animal’s size or other features, or the animal’s unusual provenance. At the time the taxpayer selected the 177 specimens for donation, he appears to have had three kills ranked in one of record books, but did not select any listed one for contribution. The appraiser engaged by the taxpayer to determine his charitable contribution deduction used the “replacement cost” method to determine the FMV of these items, estimating what it would cost to replace each item with a specimen of like quality by tallying up the expected out-of-pocket expenses for traveling to the hunting site, being on safari for the requisite number of days, killing the animal, removing and preserving the given body part, shipping it back to the United States, and defraying the taxidermy costs of stuffing, mounting, or otherwise preparing the item for display. Using this method, the appraiser determined the FMV of the 177 specimens was $1,425,900. The Internal Revenue Code regulations define FMV as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Determining the FMV of donated property entails a factual inquiry, and the taxpayer bears the burden of proving the FMV of the donated items. The taxpayer argued that the items he donated are museum-quality hunting specimens endowed with special value for study and research, that they have no true comparables in the open market, and that the court must determine their value by estimating what it would cost to replace them. The government argued that the court should determine FMV by considering market prices for comparable items. The court said that in deciding who is right, an important factor is whether the items are “commodities” or “collectibles.” If a hunting trophy is properly considered a collectible, the “provenance” of the items is important, i.e., it will matter who shot the animal, precisely where it was shot, and which collectors owned it previously. The “provenance” of the items, however, will be largely irrelevant if they are valued as commodities because their value can be determined, assuming there is an active market, by consulting the prices that comparable items fetch in the marketplace. The appraiser’s report was part of the record in this matter, but the taxpayer did not engage the appraiser as an expert for the trial or seek to move his report into evidence. The court noted that while the report left much to be desired, the appraiser did point out that none of the specimens had “record book” status. The report accorded each item a rating for specimen quality and taxidermy quality, giving every item a rating of excellent on both scores although the court noted that the photographs attached for each items often suggested that a lower rating would have been appropriate. At trial, the IRS provide an expert witness in taxidermy and the appraisal of taxidermy items and he prepared an appraisal report that used the market approach to determine the FMV of the 177 animal specimens, taking into account defects he determined from the photographs. One of the taxpayer’s expert witnesses opined that the specimens the taxpayer donated would be “incredibly valuable to museum collections” because of their “high quality and known points of origin and other information associated with them,” but the court found this assertion devoid of any factual foundation. Citing prior cases, the court said that for it to eschew comparable sales in favor of replacement cost, the taxpayer must establish, not only the absence of an active market for comparable items, but also a “probative correlation” between replacement cost and FMV. The court found that the 177 donated items were neither world-class trophies nor museum-quality research specimens, but were mostly “remnants, leftovers, and scraps” of the collection displayed in petitioner’s trophy room, citing the taxpayer’s own testimony indicating that he wished to “downsize” his collection by deaccessioning unwanted items. Although his experts asserted that all specimens were of “excellent” quality, they offered no factual backing for that assertion and admitted that the appraiser’s photographs often indicated the opposite. The court concluded that the 177 specimens were commodities and that the government’s market price approach supplied the proper methodology for ascertaining their value. Gardner, Paul A. v. Commissioner, U.S. Tax Court, No. 14695-12; T.C. Memo. 2017-165. 8/24/17 Pilot Has Abode in U.S. The U.S. Tax Court held that a commercial airline pilot was not a qualified individual for purposes of the foreign earned income exclusion under Section 911(a) of the Internal Revenue Code. The court found that the taxpayer’s abode was within the United States and he was not a bona fide resident of South Korea. The taxpayer flew airplanes through a contract with a U.S. entity for a South Korean airline (KAL) company in 2011 and 2012, and spent about a third of each year in South Korea and more than 40% of each year in the United States. He spent most of his days off in the United States where his wife and house remained. He stayed in South Korea only when work required it, and stayed in the United States whenever he could. When he stayed in South Korea, he always stayed in the same hotel, provided to him at no cost by the airline, but stayed in various rooms in that hotel. He retained his U.S. citizenship, voting registration, driver’s license, bank accounts, and church membership in the U.S. On their tax returns for 2011 and 2012, the taxpayer and his wife claimed an exclusion for “foreign earned income” under I.R.C. Section 911(a)(1). The IRS disallowed the exclusion finding that the taxpayer’s abode was in the U.S, and assessed the taxpayer for deficiencies. The taxpayer filed this appeal. The taxpayer’s flight schedule was set by KAL, and his flights either originated or terminated at Incheon. Under the terms of his employment agreement, he received nine days off per month, in addition to his vacation days and could spend those days in any country he wanted and flights at the beginning or end of his days off were free of charge to him. The airline filed and paid the taxpayer’s South Korean tax returns and taxes on his behalf without consulting him about the content thereof. He testified that, during the time he spent in South Korea, he played tennis and golf and participated in dinner engagements, largely with other airplane pilots or other airline-related staff and had the same barber for most of his seven years working out of South Korea. He testified that he took assorted lessons from individuals as well as KAL to learn various phrases in Korean as well as other things about South Korea. During the years at issue he retained his U.S. citizenship and believed he was a “resident alien” under South Korean law. During 2011 and 2012 he was married and his wife lived in a house in New Hampshire that she owned jointly with the taxpayer, the same house in which he lived before and after his employment at KAL. She worked as a schoolteacher at a nearby school and they had three children who lived in the U.S. and abroad. The taxpayer had a U.S. driver’s license and did not apply for or receive a driver’s license in South Korea. He and his wife jointly owned two cars which remained in New Hampshire. He remained registered to vote in New Hampshire, and he did not register to vote in South Korea. He retained his U.S. bank accounts, into which KAL deposited his wages and retained his membership in a church in New Hampshire. In 2011 the taxpayer had 46 stays in South Korea, consisting of 91 days on duty and 22 days off duty and had 20 stays in the United States, consisting of 26 days on duty and 133 days off duty. In 2012 he had 40 stays in South Korea, consisting of 108 days on duty and 27 days off duty and had 28 stays in the United States, consisting of 58 days on duty and 116 days off duty. The court noted that taxpayers claiming a Section 911exclusion bear a higher than ordinary standard of proof, i.e. a “strong proof” of resident status in a foreign country. Section 911(a) provides that a qualified individual may elect to exclude from gross income his “foreign earned income,” but to qualify for the FEIE the taxpayer must satisfy three conditions: the taxpayer’s “tax home” must be in a foreign country, the taxpayer must be a U.S. citizen who is a bona fide resident of a foreign country for the entire taxable year or present in a foreign country during at least 330 days in a 12-month period, and the taxpayer must have earned income from personal services rendered in a foreign country. The Commissioner did not dispute that the compensation the taxpayer received for flying planes for KAL was “foreign earned income.” The court, therefore, looked to whether the taxpayer was a “qualified individual.” The parties’ stipulations show that the taxpayer did not satisfy the 330-day test described above, and he, therefore, has the burden of proving that his “tax home” was in a foreign country and that he was a “bona fide resident” of a foreign country for an uninterrupted period. The court noted that Section 911(d)(3) provides that an individual shall not be treated as having a tax home in a foreign country for any period in which his abode is within the U.S. The court found that “abode” has a domestic rather than vocational meaning and said one’s abode is where he resides. Saying that the word connotes stability, not transience, the court pointed out that the taxpayer’s housing in Seoul was a hotel and not even a particular room in a hotel, the quintessence of transience. The court noted that even though a taxpayer may have some limited ties to a foreign country, if the taxpayer’s ties to the United States remain strong, the court has held that his or her abode remained in the United States, especially when his or her ties to the foreign country were transitory or limited. The court found that the taxpayer’s ties to South Korea were indeed limited and his ties to the United States indeed remained strong and the record clearly indicated that when the taxpayer had a choice, he preferred to spend his time in the U.S. The court held that the taxpayer did not satisfy the “tax home” requirement of the “qualified individual” definition. The court then turned to the questions of whether the taxpayer had taken up a “bona fide residence” in South Korea and looked at the factors courts have previously considered in analyzing the facts of each case. After reviewing those factors, the court found that the taxpayer was not a bona fide resident of a foreign country during the years at issue and was, therefore, not entitled to the FEIE. Acone, Gregory L. et ux. v. Commissioner, U.S. Tax Court, No. 7632-15; T.C. Memo. 2017-162. 8/22/17 DECISION HIGHLIGHTS Sales and Use Tax Decisions South Dakota Remote Sales Tax Legislation Unconstitutional The South Dakota Supreme Court has upheld a lower court ruling that legislation requiring remote sellers to collect and remit sales tax regardless of physical presence in the state is unconstitutional. See the March 31, 2017 issue of State Tax Highlights for a discussion of the lower court decision. The 2016 South Dakota Legislature passed S.B. 106, which extended the obligation to collect and remit sales tax to sellers with no physical presence in the state. Soon after the Governor signed Senate Bill 106 into law, the DOR began issuing written notices to sellers it believed met the requirements of the legislation, informing the sellers of the passage of the law, explaining its requirements, and advising the sellers to register for South Dakota sales tax licenses by a date certain. The notice warned that the failure to register could result in a declaratory judgment action as authorized by the law. The three sellers in this appeal received notices, but they did not register for sales tax licenses and the state filed a declaratory judgment action against them in circuit court on April 28, 2016. The sellers sought to remove the state’s action to the United States District Court for South Dakota on the basis of federal question jurisdiction but the District Court rejected removal and remanded the case to the state’s circuit court in January 2017. The sellers then filed a motion for summary judgment and statement of material facts admitting that each lacked a physical presence in South Dakota, that each met the sales and transaction requirements for application of the legislation, and none were registered to collect state’s sales tax. The sellers argued that the legislation was unconstitutional under the U.S. Commerce Clause. The State filed a response agreeing with Sellers’ statement of material facts and further agreeing that the court would have to grant the sellers’ motion for summary judgment based upon Bellas Hess and Quill and indicated its intention to pursue review of the issue by the United States Supreme Court. Without holding a hearing on the matter, the circuit court entered its decision based on undisputed statements of material fact and the parties’ briefs. The court observed its obligation to adhere to Supreme Court precedent prohibiting the imposition of an obligation to collect and remit sales tax on sellers with no physical presence in the State and granted sellers’ motion for summary judgment, enjoining the State from enforcing the obligation to collect and remit sales tax against the sellers. The State filed a timely notice of appeal. The court said the material facts are not in dispute. The parties agreed that each seller had a principal place of business outside of the state and each lacked a physical presence in the state. The parties agreed that in the previous calendar year, each seller had gross revenue from the sale of tangible personal property in South Dakota in excess of $100,000 and/or sold tangible personal property in the state in 200 or more separate transactions, and, therefore, met the requirements of the legislation. The parties agreed that none of the sellers were registered to collect South Dakota sales tax. The court found that in view of these undisputed facts and the Supreme Court’s holdings in Bellas Hess and Quill, Senate Bill 106 could not impose a valid obligation on the sellers to collect and remit sales tax to the state because none of them had a physical presence in the state. The court found no distinction between the collection obligations invalidated in Quill and those imposed by Senate Bill 106, and held that the circuit court correctly applied the law when it granted sellers’ motion for summary judgment. The court noted the state’s argument that the Supreme Court should reconsider Bellas Hess and Quill, and that in bringing this suit, the state has accepted Justice Kennedy’s invitation in Direct Marketing for “[t]he legal system [to] find an appropriate case for [the Supreme] Court to reexamine” those decisions. __ U.S. at __, 135 S. Ct. at 1135 (Kennedy, J., concurring). The court said that however persuasive the state’s arguments on the merits of revisiting the issue, Quill has not been overruled and remains the controlling precedent on the issue of Commerce Clause limitations on interstate collection of sales and use taxes. South Dakota v. Wayfair Inc., South Dakota Supreme Court, 28160-a-GAS. 8/13/17 Truck Leasing Company Not Entitled to Exemption The Indiana Tax Court has determined that a truck leasing corporation did not qualify for a public transportation exemption, finding that the taxpayer's unitary business argument did not apply in a sales and use tax matter. The taxpayer is located in the state and is a full-service truck leasing company owned by Thomas R. Schilli. The company leases vehicles to third-parties, including four other companies owned by Mr. Schilli. Three of those companies are engaged in hauling freight for hire and the fourth is a freight preparation company, hired by common carriers to load, tarp and secure their customer’s freight onto trailers and move those trailers a short distance for pickup by the motor carriers. While all five companies are owned by Mr. Schilli, they have been se up as separate corporations. In conjunction with its leasing program, the taxpayer operates numerous garage facilities throughout the country where it provides maintenance and repair services for its vehicles. The taxpayer also provides services to the three leasing companies owned by Mr. Schilli that it does not provide to its other lessees, including purchasing all their fuel and providing them with temporary freight storage. The taxpayer also operates at each of its garage facilities overnight accommodations, showers, laundry facilities, and use of a “courtesy car” to the drivers of all four of the related companies while their vehicles are being serviced, while they are on federally-mandated rest periods, or while they are attending employment orientation/training. While the In 2012, the Department of Revenue (DOR) conducted an audit and determined that the taxpayer was deficient in remitting sales and use taxes during the years at issue on its leases and support services to the four other companies owned by Mr. Schilli. The taxpayer protested the Proposed Assessments, claiming that the retail transactions identified by DOR in its audit and upon which the Proposed Assessments were based were exempt from taxation under the public transportation exemption in the state statute. DOR conducted a hearing and subsequently issued a final determination upholding the assessment. The taxpayer filed this appeal. The state’s sales and use tax statute provides numerous exemptions from the tax including one for tangible personal property if the person acquiring it uses or consumes it is directly in providing public transportation for persons or property. DOR has defined “public transportation” for the purposes of this exemption as “the movement, transportation, or carrying of persons and/or property for consideration by a common carrier, contract carrier, household goods carrier, carriers of exempt commodities, and other specialized carriers performing public transportation service for compensation by highway, rail, air, or water.” The taxpayer has stipulated that it does not transport property owned by others for consideration, but argued that it does not owe sales and use tax on these transactions because its business activities fall squarely within the express language of the public transportation exemption statute. It argued that the language of the exemption simply applies to all transportation-related transactions and because it has shown that everything it does is related to the transportation industry and the transport of freight, the transactions picked up in the assessment are exempt. The court rejected this argument, holding that the plain language of the exemption necessarily links the person who acquired property to the use or consumption of it in his provision of public transportation and finding that DOR’s definition of public transportation was consistent with the statute and did not impermissibly narrow the scope of the exemption. Alternatively, the taxpayer argued that while each company was a separate corporate entity, there were “interdependent,” relying on each other to succeed and exist, and suggesting that the court should, therefore, treat the five companies as a single diverse ground transportation company whose “inter-company transactions” qualify for the public transportation exemption. The court noted that, as support for its position, the taxpayer relied entirely upon the “unitary business principle,” under which affiliated corporate entities may be taxed as a unitary business when they are functionally integrated, centrally managed, and benefit from economies of scale. The court rejected this argument noting that the unitary business principle is a corporate income tax concept that has no application in the sales and use tax arena. Schilli Leasing Inc. v. Dep't of Revenue, Indiana Tax Court, Cause No. 49T10-1306-TA-00054. 8/31/17 Partial Repeal of Vehicle Exemption Is Constitutional The Oklahoma Supreme Court held that a bill that repealed a portion of the state’s sales tax exemption on the purchase of motor vehicles did not levy a tax in the strict sense of the word. The court held that the legislation, therefore, did not violate a provision of the state constitution imposing requirements for revenue-raising bills. The petitioners were a not-for-profit trade association of automobile dealers, an automobile dealer, and a prospective consumer in Oklahoma, and challenged House Bill 2433, alleging that it is a revenue bill enacted outside of the procedure mandated in Article V, Section 33 of the Oklahoma Constitution. Article V, Section 33 of the state constitution requires that revenue bills originate in the House chamber, be enacted prior to the final five days of the legislative session and be approved by either the people or by a three-fourths majority of each legislative chamber. This case was the second of several cases that challenged various measures enacted by the legislature in the prior legislative session in response to the state’s budget crisis. The test utilized by the courts in the state for the last century to determine whether a measure is a “revenue bill” is whether the primary purpose of the legislation is raising revenue for the support of state government and whether the measure levied a new tax in the strict sense of the word. This case involves House Bill 2433,which was enacted during the final five days of the session and did not receive three-fourths support in either legislative chamber, and the issue presented was whether a measure revoking an exemption from an already levied tax is a "revenue bill" subject to Article V, Section 33's requirements. When the state’s sales and use tax statute was enacted in 1933, the tax was levied on all tangible personal property including automobiles. In 1935 the legislature enacted an exemption for automobiles that were thereafter subject only to an excise tax. HB 2433 amended that sales tax exemption so that sales of automobiles were once again subject to the sales tax, but at a reduced rate. The court determined that HB 2433 was not a “revenue bill” because, although it had a revenue producing purpose, it did not levy a tax in the strict sense of the word. It reached that result citing cases that held that measures making property that were previously exempt from the tax then subject to tax were not “revenue bills” because removal of an exemption from an already levied tax is difference from levying a tax in the first place. In addition, the court pointed out the constitution’s related policies that disfavor special exemptions from taxationand promote uniformity of taxation-policies that are also designed to protect the taxpayers.The court noted that it had never before held that a measure revoking a tax exemption is a "revenue bill," to hold otherwise would require the court to break new ground and overrule well-established precedents.Justices filed two dissenting opinions. Oklahoma Automobile Dealers Ass'n v. Oklahoma, Oklahoma Supreme Court, 116143; 2017 OK 64. 8/31/17 Personal Income Tax Decisions No cases to report. Corporate Income and Business Tax Decisions COGS Deduction Case Reversed, Remanded The Texas Court of Appeals, Third District, held that a manufacturer was permitted to include subcontractor payments in its cost of goods deduction. The court, however, reversed and remanded the lower court’s decision concluding that the evidence supporting the refund amount that the taxpayer was entitled to was insufficient. The taxpayer, which is primarily engaged in the business of surveying, manufacturing, upgrading, and repairing offshore drilling rigs, filed suit against the state Comptroller arguing that it was due a refund of franchise taxes it paid under protest when the Comptroller denied it a revenue exclusion the taxpayer had claimed for payments made to its subcontractors. The taxpayer argued alternatively that it was entitled to deduct the subcontractor payments as “cost of goods sold” (COGS). The trial court held for the taxpayer and the Comptroller filed this appeal. The state’s franchise tax is imposed on a taxable entity’s “taxable margin.” In making that computation, a taxpayer begins with its “total revenue” and then determines its margin as a step in calculating its “taxable margin.” The margin is defined as the lesser o 70% of the entity’s total revenue or the total revenue minus either COGS or compensation. After applicable deductions have been taken, “taxable margin” is determined by apportioning the adjusted revenue between in-state and out-of-state business and then subtracting any other allowable deductions. Then the applicable tax rate is applied. This case concerns the taxpayer’s 2009 franchise-tax report in which it excluded from its total gross revenue more than $79 million in flow-through payments to its subcontractors. It then elected to use the COGS deduction to calculate its margin. The Comptroller determined that the deduction of the payments to subcontractors did not meet the statutory requirements, and argued that these payments should be considered in the calculation of the taxpayer’s COGS. The Comptroller also audited the amount that the taxpayer had calculated as its COGS deduction, concluding that only costs either directly or indirectly related to “fabrication” of goods could properly be included in the calculation of the taxpayer’s COGS deduction. The taxpayer claimed that the subcontractors were engaged in providing services, labor, and materials in the form of manufacturing, constructing, developing, improving, creating, and installing component parts for offshore drilling rigs used to construct, remodel, or repair oil and gas wells, which it contended are improvements on real property. The taxpayer argued that the payments to its subcontractors satisfied the statutory requirements The (g)(3) revenue exclusion requires that a taxpayer exclude from total revenue certain flow-through funds “that are mandated by contract to be distributed to other entities.” During franchise tax year 2009, the taxpayer used subcontractors to perform a significant portion of the work it did for its customers, including “labor” subcontractors that provided workers who performed the same types of tasks performed by the taxpayer’s employees and “outside specialty” subcontractors hired to provide workers to perform certain specialized tasks. The Comptroller agreed that the amounts paid to the “outside specialty” contractors constituted flow-through funds includable in the exclusion, but argued that payment to the “labor” contractors did not. The court found that the Comptroller’s position was contrary to the plain language of the statute and to the court’s prior holdings and that the labor charges met the requirements of the exclusion. The court then turned to the COGS deduction. The statute provides that an entity may take a COGS deduction for “all direct costs of acquiring or producing the goods.” A taxable entity may also take a COGS deduction for post-production direct costs. The statute specifically excludes certain items from COGS eligibility. A COGS deduction is generally available only to the taxable entity that owns the “goods” in question, but under certain circumstances the legislature has extended access to the deduction. One of those is that an entity furnishing labor or materials to a project for the construction or improvement of real property is considered the owner of that labor or materials and may include those costs in COGS. Determining whether a particular ‘labor cost’ is includable as a cost of goods sold under subsection this provision requires determining whether the particular activity is an essential and direct component of the project for the construction of real property. The court said that in calculating its COGS deduction, the taxpayer did not engage in a cost-by-cost analysis of each expense to determine whether it fit into one of the categories of costs the statute provides may properly be included in the calculation of cost of goods sold, nor did it employ the analytic framework to determine whether its particular activities that involved furnishing labor to a project for construction or improvement of real property (as opposed to its activities that produced “goods”) were “an essential and direct component” of a particular project. The court said that by using its federal income tax COGS deduction as the “starting point,” the taxpayer offered insufficient evidence that the expenses included in that calculation actually correspond to the types and categories of expenses permitted to be included in the calculation of a taxable entity’s state franchise tax COGS deduction, and found that the taxpayer’s method for calculating its state COGS deduction failed to provide evidence that the expenses included in its starting point were deductions that are also permitted to be included in the calculation of the COGS deduction under the state statute. The court rejected the taxpayer’s argument that its interpretation permits it to avoid the “incredibly burdensome” task of identifying which of the expenses of its integrated business activities actually constitute a cost of “acquiring or producing” a “good” such that it is eligible to be included in the calculation of its COGS deduction, noting that it must give the statute its plain meaning and the statute provided three alternative methods for determining the taxpayer’s margin. The court said that the plain language of the statute confirms that calculating the COGS deduction for Texas franchise tax purposes requires a cost-by-cost analysis to determine whether the cost fits one of the types and categories eligible for inclusion in the calculation. The court also found, however, that the Comptroller presented the trial court with a flawed view of what qualified for inclusion in the taxpayer’s calculation of its COGS deduction. The court reversed the trial court’s judgment ordering the State to pay the taxpayer the full amount it paid under protest and remanded the cause to the trial court for further proceedings to determine the exact amount of refund to which it was entitled. Hegar et al. v. Gulf Copper and Mfg. Corp., Texas Court of Appeals, Third District, No. 03-16-00250-CV. 8/11/17 To Qualify for Addback Exception Income Must Be Taxed The Virginia Supreme Court held that royalty payments made by a related member to a parent corporation must be taxed in order for the state’s “subject-to-tax” addback safe harbor exception to apply. The court did hold, however, that the lower court erred when it determined that the related member must be the entity that pays the tax for the exception to apply. The court remanded the matter to the lower court to determine the portion of royalty payments that was actually taxed. The taxpayer is a corporation organized under the laws of Delaware and operates retail stores throughout the country, including Virginia. A corporation organized under the laws of Nevada, is an affiliate of the taxpayer and operates retail stores in select states, none of which are in Virginia, and also owns, manages, and licenses certain intellectual property. The taxpayer entered into a license agreement with this affiliate for the use of this intellectual property, and pursuant to this agreement, paid $441,942,347 in royalties to the affiliate during the taxable year that ended on January 31, 2009 and $481,788,205 during the taxable year that ended on January 30, 2010. When calculating its federal taxable income for these years, the taxpayer deducted these royalty payments from its income as an ordinary and necessary business expense under 26 U.S.C. § 162(a) and the affiliate included the royalties as income in its taxable income calculations. The affiliate did not ultimately pay state income taxes on a substantial portion of the royalties because these royalties not fairly attributable to the affiliate’s activities in most states, a mechanism referred to as an intangible holding company (IHC). This mechanism operates to avoid state taxation in “separate reporting states” for corporate income tax purposes. Generally speaking, Virginia is a separate reporting state and in 2004, the legislature sought to close the IHC loophole by enacting an “add back” statute, Under this provision, corporate taxpayers calculate their state taxable income by starting with their federal taxable income and then making certain adjustments, including adding to their federal taxable income “the amount of any intangible expenses and costs” paid to their “related members to the extent such expenses and costs were . . . deducted in computing federal taxable income.” Code § 58.1-402(B)(8)(a). The parties do not contest that the taxpayer’s royalty payments were “intangible expenses and costs” paid to a “related member,” but claim that they fall within the “subject-to-tax” exception in the add back statute. This exception provides that the “addition shall not be required for any portion of the intangible expenses and costs if . . . [t]he corresponding item of income received by the related member is subject to a tax based on or measured by net income or capital imposed by . . . another state.” Code § 58.1-402(B)(8)(a)(1). The taxpayer argued that because its affiliate included the royalties as income in each of its state tax returns, and this income was then apportioned and taxed by each of these states, the royalties, therefore, qualified for the subject-to-tax exception, and the taxpayer did not add them back when calculating its Virginia taxable income for the taxable year that ended on January 31, 2009. The taxpayer further argued that it was due a refund for the royalties it mistakenly added back to its taxable income for the taxable year that ended on January 30, 2010. When it conducted its audit of the taxpayer, the state Department of Taxation (Department) recognized that the affiliate paid income tax on a portion of the royalties, through the apportionment process, in many of the state in which it filed separate returns, and the auditor allowed a “partial exception” to the add back statute corresponding to the amount of the royalties that was actually taxed in these states. Because the affiliate did not pay taxes on most of the royalties, the auditor required that this untaxed portion be added back to the taxpayer’s taxable income, and the Department issued a Notice of Assessment for the taxable years that ended on January 31, 2009 and on January 30, 2012. The taxpayer filed an appeal to the circuit court arguing that the royalty payments only needed to be included in the affiliate’s taxable income, regardless of whether they were actually taxed, to fall within the subject-to-tax exception. The Department responded that only the portion of the royalty payments that was actually taxed by other states qualifies for the exception. The circuit court issued an opinion denying the taxpayer’s motion for summary judgment and granting the Department’s. The taxpayer filed this appeal. The court began by noting that because the Department is charged with the responsibility of administering and enforcing the tax laws of the Commonwealth, its interpretation of a tax statute is entitled to great weight. When a tax statute is clear on its face, however, the court said it will look no further than the plain meaning of the statute’s words. The court reviewed the statute and said it was not clear whether the legislature intended the exception to apply on a pre- or post-apportionment basis, noting that the phrase “subject to a tax” was not defined in the code. The taxpayer points to the definition of “taxable” as “subject to taxation” and argued that the royalty payments needed only to be taxable to fall within the exception, regardless of whether they were actually taxed. The court found that an interpretation of the subject-to-tax exception that would result in a taxpayer’s ability to avoid the add back statute would be unreasonable in light of the statute’s purpose and intent. The court, therefore, held that the subject-to-tax exception applies only to the extent that the royalty payments were actually taxed by another state. The taxpayer alternatively argues that the Department erred in calculating the amount of the royalties that falls within the subject-to-tax exception. While the Department allowed a “partial exception” to the add back statute to the extent that the royalty payments were apportioned and taxed in many of the Separate Return States, but the affiliate’s income was also included in the taxpayer’s taxable income calculations in the Combined Return States. Additionally, the taxpayer was required to add the royalties back to its taxable income when calculating its taxable income for Connecticut, Maryland, and Massachusetts, and it added a portion of the royalties back when calculating its taxable income for Georgia and New Jersey (addback states). The court agreed with the taxpayer’s argument that to the extent the royalties were apportioned to and taxed by all of the above states, they fall within the subject-to-tax exception and remanded the matter for a determination of what portion of the royalty payments was actually taxed by another state and, therefore, excepted from the add back statute. Three justices filed a dissent arguing that the court’s decision had inserted an apportionment calculation into the statute that was not supported by the clear language of the code. Kohl's Dept. Stores Inc. v. Dep't of Taxation, Virginia Supreme Court, Record No. 160681. 8/31/17 Property Tax Decisions No cases to report. Other Taxes and Procedural Issues Cigarette Fee Unconstitutional The Oklahoma Supreme Court ruled that a cigarette fee passed the last day of the legislative session was unconstitutional. It found that the enacting legislation was primarily intended to raise revenue and violated state constitutional requirements that revenue-raising bills be passed prior to the last five days of the session and approved by three-fourths of both chambers. The petitioners were manufacturers, wholesalers, and consumers of cigarettes and challenged Senate Bill 845, the “Smoking Cessation and Prevention Act of 2017,” arguing that it is a revenue bill enacted outside of the procedure mandated in Article V, Section 33 of the Oklahoma Constitution. That provision requires that revenue-producing measures originate in the House of Representative, be enacted prior to the last five days of the legislative session and be approved either by the people or by a three-fourths majority in each legislative chamber. The parties to the matter agreed that the passage of SB 845 did not comply with Article V, Section 33, having originated in the Senate, passed on the last day of the session with only a bare majority of votes in each chamber. The case, therefore, turned on whether SB 845 is the kind of “revenue bill” that Article V, Section 33 governs. The court said that whether SB 845 is subject to Article V, Section 33’s requirements depends on whether its principal object is the raising of revenue and whether it levies taxes in the strict sense of the word. The court did not find the state’s arguments that the primary purpose of the legislation was to reduce the incidence of smoking and compensate the state for the harms cause by smoking and that any revenue raised was incidental to those purposes. The state also argued that the legislation does not levy a tax, but instead assesses a fee, the proceeds of which will be used to offset the costs of State-provided healthcare for those who smoke. The court found that the petitioners presented compelling evidence in support of their claim that the legislature’s primary purpose in enacting the legislation was to raise new revenues in order to satisfy the legislature’s constitutional obligation to enact a balanced budget, and cited the actual text of the bill in support of this conclusion. The court said that looking solely to the text of SB 845, its nine sections demonstrated a purported purpose of reducing the incidence of smoking, but the court said the text simultaneously demonstrated that the smoking-reduction purpose is effectuated through the collection of revenue from wholesalers, and ultimately consumers, of cigarettes. The court noted that the $1.50-per-pack assessment was the only provision in SB 845 that the text directly links to its stated purpose of reducing smoking, and the state conceded that the assessment is the linchpin of SB 845’s regulatory framework. The court found that because the revenue to be collected was so substantial the bill’s allocation of those revenues made up a significant part of the measure’s actual effect. The court rejected the state’s argument that the revenues will be put to the “regulatory” use of offsetting the financial burdens that smoking imposes on the State, noting that the bill doesn’t actually allocate the revenue to pay for smoking-related costs, earmarking less that 0.5% of the projected revenue to programs designed to reduce smoking. The court held that the raising of revenue for the general support of state government was the primary effect of SB 845, and thus its primary purpose. The court said thatthe people did not intend that the legislature could blatantly tax them without complying with Article V, Section 33, by merely wordsmithing their bills to describe some “regulatory” purpose for the tax. The court found that whether a measure is “intended to raise revenue” must be the overarching consideration in determining whether a measure is a “revenue bill.” Finally, the court found that the “smoking cessation fee” in the legislation was not truly a fee, but was an excise tax under the alias of a fee. The court noted that “tobacco cessation fee” is not paid in exchange for any specific government-conferred benefit, but, instead, it is paid to the Oklahoma Tax Commission rather than to any state health agency that might be able to confer a smoking-related benefit. The consumer who ultimately bears the costs of the assessment is paying the retailer consideration in exchange for a pack of cigarettes, rather than the government in exchange for healthcare for his smoking-related illnesses. The “fee” also could not be considered a fee intended to cover the cost of administering a specific regulatory program. The $225 million estimated to be raised by this “fee” was proportionate to the amount of revenue the legislature needed to balance the budget rather than to the cost of administering the State’s cigarette regulatory regime. Finally, the court noted that several sections of the legislation were not revenue raising in effect, severed those from the unconstitutional provisions and left that portion of the measure intact. Naifeh v. Oklahoma, Oklahoma Supreme Court, No. 116,102. 8/10/17 Protests of Assessments Not Affected by Payment The New Jersey Tax Court denied a taxpayer’s motion to find a 2014 assessment invalid for tax years already included in a 2006 jeopardy assessment that the taxpayer had paid. The taxpayer had argued that it had not filed a valid protest to the 2006 assessment making the assessment final, but the court held that the payment of the jeopardy assessment did not prevent the taxpayer from filing a valid protest. The taxpayeris a wholesale produce distributor operating warehouses in South Philadelphia, selling a variety of fruits, vegetables, plants, and similar items, delivered to customers in multiple states, including New Jersey. The taxpayer did not file Corporation Business Tax (CBT) returns in New Jersey for tax years 2002 through 2008. In 2006, the Division of Taxation (Division) conducted an audit and issued a CBT jeopardy assessment for the years 2001 through 2005, which included notice of the right to file an appeal within 90 days of the date of the assessment. The taxpayer paid the assessment on the date it was issued in order to obtain the release of its truck and subsequently filed a protest of the assessment dated March 20, 2006. The Division sent the taxpayer a letter advising that his protest had been received April 17, 2006. The envelope in which the taxpayer’s protest letter was mailed was postmarked April 7, 2006. In June 2009, while the protest was pending, the taxpayer took advantage of the state’s 2009 amnesty program and filed CBT returns for years 2002 through 2008. Upon accepting the taxpayer’s amnesty request, the Division noted its position and understanding that the taxpayer waived its right to any further conference and appeal action relative to its March 20, 2006 protest. The Division reviewed the CBT returns and issued a Notice of Assessment Related to Final Audit Determination, which the taxpayer protested. The Division adjusted the CBT and issued its Final Determination, dated August 20, 2014, assessing CBT, interests, and penalties totaling $1,444,374.48 for the period of 2002 through 2008. On November 18, 2014, the taxpayer filed an appeal with the Tax Court, challenging this assessment. On February 17, 2017, the taxpayer then filed a motion for partial summary judgment, arguing that the 2014 Assessment was invalid as to tax years 2002 through 2005 because the 2006 Assessment constituted a final assessment which the taxpayer failed to timely protest and therefore the years in question were closed for the purpose of the 2014 assessment. The taxpayer also argued that if its protest of the 2006 assessment was timely, it was invalid because it had paid the tax demanded in the assessment prior to making protest and it was, therefore, not an aggrieved taxpayer entitled to file a protest once the tax was paid. The court noted that summary judgment is appropriate if there is no genuine issue as to any material fact and concluded in this matter that there was no genuine issue of material fact, and that the matter was, therefore, ripe for partial summary judgment. The taxpayer argued that the 2006 Assessment became a final assessment because it did not timely exercise its appeal rights, citing Peoples Express Co., Inc. v. Director, Div. of Taxation, 10 N.J. Tax 417 (Tax 1989). In that case the court held that if a taxpayer does not file a protest and request a hearing within the requisite appeal period, the original preliminary or proposed assessment assumes the role of a final assessment without the necessity of any additional action by the Director. In order to have timely appealed the 2006 Assessment, the protest must have been filed no later than April 11, 2006 and the record reflects that it was received by the Division after that date. The statute provides that in determining the timeliness of the service of a protest, however, that a return, report, protest or other document to be filed within a prescribed period is deemed to be delivered on the date of the United States postmark stamped on the envelope if the postmark date falls within the prescribed period. The parties conceded that the postmark on the envelope within which the plaintiff filed its appeal is dated April 7, 2006, well within the 90-day period. The taxpayer argued, however, that it was not entitled to file a protest because it had paid the assessment. The court noted that the taxpayer paid the 2006 Jeopardy Assessment in order to obtain the release of its property. It rejected the taxpayer’s argument finding that neither the statute or the cases decided under it require that the tax demanded in an assessment be unpaid in order to find the taxpayer “aggrieved.” The court found that the taxpayer’s argument that a taxpayer is not aggrieved once the tax demanded is paid unpersuasive, saying that such an argument is counter-intuitive and that a taxpayer is clearly aggrieved to the extent a tax is demanded and regardless of when it is paid. Procacci Bros. Sales Corp. v. Dir. of Taxation, New Jersey Tax Court, No. 015626-2014. 8/30/17 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]. |
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:
September 1, 2017 Edition
NEWS Court to Review Tax Transparency Case The Kentucky Supreme Court on August 16, 2017 agreed to review the state’s Court of Appeals ruling in January of this year in Dep’t of Revenue v. Sommer, which required the Department of Revenue to make public all of its final tax rulings including that that were not appealed. The DOR and the Finance and Administration Cabinet had petitioned the court to review the case, noting their concerns that the required redaction of personal information would put DOR’s employees at risk of taxpayer lawsuits. The state argued that it needed guidance on the information that should be redacted, asking for a bright-line test for differentiating between confidential information and nonexempt information. See the February 3, 2017 issue of State Tax Highlights for a discussion of the Court of Appeals decision. Former Tampa Police Officers Guilty of Tax Refund Fraud Scheme A former sergeant and former detective with the Tampa, Florida police department and two others pleaded guilty on August 23rd to taking part in an identity theft scheme involving fraudulent tax returns. The sergeant and her detective husband were alleged to have used access to local, state, and federal law enforcement databases to look up personally identifiable information of witnesses and others. They then provided that information to another person who used it to file fraudulent income tax returns with the refunds, totaling more than $284,000 in 20011 and 2012, loaded onto debit cards and deposited into bank accounts. The plea agreement calls for full restitution to the IRS. U.S. SUPREME COURT UPDATE Cert Filed Washington Department of Licensing v. Cougar Den, U.S. Supreme Court Docket No. 16-1498. Filed 6/14/17. Issue: Whether fuel a Native-American owned company imported for sale on a reservation is exempt from the state’s wholesale tax. FEDERAL CASES OF INTEREST 'Too Good to Be True' Refund The U.S. Tax Court upheld an accuracy-related penalty against an individual who admitted that the $20,000 refund his return preparer said she could get for him sounded "too good to be true." The court found that the taxpayer did not act in good faith and that his underpayment was due to negligence. The taxpayer resided in California, was a college graduate and during the year at issue here worked as a sales representative for two separate companies and received a Form W-2, Wage and Tax Statement, from each of his employers, reflecting wages totaling $127,858. He did not operate a sole proprietorship, have gross receipts, or pay any expenses relating to a business activity in 2014, the year at issue. For some years before 2015 the taxpayer used a tax preparer for his federal income tax returns, but in 2015 contacted a new preparer recommended by a friend who told him that the new preparer could do better for him. He contacted the new preparer by email and the preparer, after a cursory review of his information told him she could get him a refund of about $20,000, for a 20% fee. The taxpayer’s return was filed timely and attached to the Form 1040 was a Schedule C, Profit or Loss From Business, under the business name Sales Lead Generation for Marketing Companies. The Schedule C reported gross receipts of $14,250 and total expenses of $68,477, resulting in a net loss of $54,227, which offset the taxpayer’s reported wages. A Schedule A was also attached, claiming a deduction of $29,728 for unreimbursed employee business expenses. The return reflected an overpayment of $17,663. The IRS disallowed $6,712 of the deduction for unreimbursed employee business expenses and $63,145 of the deduction for Schedule C expenses and imposed the accuracy-related penalty. The taxpayer filed a timely petition in which he did not dispute the adjustments made but argued that the accuracy-related penalty should not have been imposed because the return was fraudulently prepared and filed by the tax return preparer without his consent. Section 6662(a) and (b)(1) and (2) of the Internal Revenue Code imposes an accuracy-related penalty on any portion of an underpayment of Federal income tax that is attributable to the taxpayer’s “negligence or disregard of rules or regulations” or “substantial understatement of income tax.” An understatement of Federal income tax is substantial if the amount of the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the return for the taxable year or $5,000. The term “negligence” includes any failure to make a reasonable attempt to comply with the Code and any failure to keep adequate books and records or to substantiate items properly. The court noted that negligence has also been defined in case law as the failure to exercise due care or the failure to do what a reasonable person would do under the circumstances. The burden on proof in a case involving a Section 6662 penalty is on the Commissioner. The court said that the IRS met the burden in this matter because the amount of the taxpayer’s understatement for 2014 was substantial. The court noted that a taxpayer may rebut the evidence that the accuracy-related penalty is appropriate if he can demonstrate reasonable cause for the underpayment and that he acted in good faith with respect to the underpayment, and this determination is made on a case-by-case basis. The court said that generally the most important factor in this determination is the extent of the taxpayer’s effort to assess his or her proper tax liability, noting that the general rule is that a taxpayer has a duty to file a complete and accurate tax return and cannot avoid that duty by placing responsibility with an agent. The taxpayer argued that he relied on the representations of a friend and the tax preparer about the preparer’s knowledge and experience and was convinced that “everything was legitimate.” But he also admitted that the preparer’s promise of a $20,000refund seemed “extremely high” and raised a “majored flag.” He did not perform any research as to the preparer’s qualifications. The court concluded that the taxpayer, who was a college graduate with prior experience in filing his income tax returns, did not make sufficient efforts to determine his proper tax liability. He did not receive a copy of his return before it was filed and did not request a copy of it after he learned that it had been filed or attempt to learn what was reported on the return. The court also found that the taxpayer did not act as a reasonable person by failing to investigate the preparer’s assertions that she could obtain for him a $20,000 income tax refund, which he admits was “too good to be true” and noted that the fact of the preparer’s arrangement to receive 20% of his refund reflects her conflict of interest. The court said thatthe taxpayerapparently accepted and cashed his refund check for $17,663, less the preparer’s fee, and did not concern himself with the accuracy of his 2014 Form 1040. The court concluded that the taxpayer did not act with reasonable cause and in good faith and sustained the accuracy-related penalty. Bell, Matthew v. Commissioner, U.S. Tax Court, No. 15546-16S; T.C. Summ. Op. 2017-63. 8/16/17 DECISION HIGHLIGHTS Sales and Use Tax Decisions Prepaid Wireless Using PINs Subject to Tax The Michigan Court of Appeals held that a retailer was required to pay state sales tax on its sales of prepaid wireless calling arrangements that use personal identification numbers (PINs) for prepaid cellphones. The court found that they qualified as sales of prepaid authorization numbers for telephone use. The court, however, reversed that part of the Michigan Tax Tribunal’s (Tribunal) decision with regard to prepaid calling arrangements that did not use PINS, finding they were not subject to sales tax because no sale of a prepaid authorization number occurred. The taxpayeris a gas station and convenience store that sells gas, cigarettes, lottery tickets, phone cards, groceries, and other miscellaneous items, including “wireless calling arrangements” for the prepaid cellphones. These arrangements include PINless minutes which allow the addition of minutes upon completion of payment and electronic personal identification numbers (EPIN), which require the entering of a PIN to refill minutes. The taxpayer is able to provide this service through a contract with a third-party provider that provides an entirely electronic system. The Department of Treasury (Department) conducted an audit of the taxpayer’s reported sales tax for a 4-year period between 2007 and 2011 and utilized a sampling methodology because the taxpayer failed to maintain adequate records. The taxpayer filed a protest to the assessment arguing that the gross sales of the wireless calling arrangements were not taxable. The Department argued that these sales were subject to the tax under a statutory provision that applies the tax to a sale of a prepaid telephone calling card or a prepaid authorization number for telephone use, including the reauthorization of a prepaid telephone calling card or a prepaid authorization number. The hearing referee issued a recommendation that the EPIN transactions were taxable but the PINless ones were not, but the Department issued a decision imposing the tax on both transactions. The taxpayer filed an appeal to the Tribunal arguing that the PINless top-up sales were not subject to sales tax because no calling card or PIN is used and further that the EPIN sales were not subject to sales tax because the EPIN technology did not exist when the statute was enacted. The Department argued that both PINless top-up sales and EPIN sales were taxable, because in both instances customer was “re-authorizing an existing account of credit balance for prepaid telephone use.” The Department also argued that the audit was based on the best evidence available and that the taxpayer had not submitted any evidence showing that the audit was inaccurate. The Tribunal affirmed the assessment and the taxpayer filed this appeal. The court noted that there is no state case law that has interpreted the meaning of the provision at issue in this case and the court, therefore looked to discern the legislature’s intent using the plain and ordinary language used. The court said that the language of MCL 205.52(2)(b) was unambiguous. Under this provision, only the sale of a “prepaid telephone calling card” or a “prepaid authorization number for telephone use,” or the “reauthorization” of either of the foregoing is subject to sales tax. Therefore, to be subject to the sales tax, the EPIN and PINless top-up transactions must fall within the meaning of any of these statutory terms. Because the statute does not define “prepaid telephone calling card” or “prepaid authorization number for telephone use,” the court relied on dictionary definitions to discern the ordinary meaning of language used. The court said that the industry understanding of the term “telephone calling card” is a plastic scratch-off card containing a PIN necessary to access the prepaid minutes, and found that the Department fails to point to any statutory language indicating that a “prepaid telephone calling card” is anything other than a credit-card-sized-stiff card with a PIN. The court also said that a “prepaid authorization number for telephone use” is a number representing a prepaid account used by the owner to access the purchased telephone services. The court found that it was clear that the legislature, when the statutory provision was read as a whole, intended to tax the sale of both prepaid tangible, calling cards and intangible authorization numbers for telephone services, as well as the reauthorization of those numbers. But the court said that neither the PINless top-up nor the EPIN calling arrangements at issue here are “telephone calling cards” as that term is used in the statute. Neither of these prepaid calling arrangements involves the sale of scratch-off plastic or credit-card-type calling cards that contain a pre-printed authorization number that represents the minutes purchased. The court found that the Tribunal’s conclusion that these calling arrangements constituted such calling cards was error and contrary to the plain and ordinary meaning of the term “prepaid telephone calling card,” but the court said that the wireless calling arrangements may be subject to sales tax if they constitute the sale of a “prepaid authorization number for telephone use” or the “reauthorization” of a prepaid authorization number. The court concluded that an EPIN transaction is the sale of a prepaid authorization number for telephone use. When a customer purchases an EPIN, he or she receives a PIN on the receipt that must be entered on the customer’s cellphone in order to access the telephone services associated with the PIN. The court said that because the EPIN represents a prepaid account used by the owner to access the purchased telephone services associated with the EPIN, it falls within the definition of prepaid authorization number and is, therefore, taxable. The court found, however, that the sale of a PINless top-up is not subject to sales tax because the additional minutes are downloaded instantly to the customer’s cellphone upon purchase and no authorization number or PIN is necessary to access the purchased telephone services. The court said that if the legislature wants to tax the sale of the PINless services, then it must amend the statute to do so. Garfield Mart Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 333094; LC No. 14-005162-R. 8/8/17 Private Prison Facility Not Tax-Exempt Residence The Texas Court of Appeals denied a refund for sales tax paid for gas and electricity by a company specializing in privatized corrections, determining that a prison did not qualify as a tax-exempt residence. The taxpayer is a private company that operates facilities that house government detainees, and during the time period at issue operated facilities owned by governmental entities and owned by the taxpayer and its affiliates. The Comptroller conducted an audit and assessed sales and use tax determining that the taxpayer did not qualify for the residential-use exemption for taxes imposed on gas and electricity purchases. The taxpayer paid the assessment under protest and also identified additional gas and electricity purchases on which it had paid sales and use tax during the audit period, and it sought a refund of those amounts. The Comptroller denied the taxpayer’s request and the taxpayer appealed to the district court which held for the Comptroller. The taxpayer filed this appeal. Purchases of gas and electricity are generally subject to the state’s sales and use tax, but the statute provides an exemption for gas and electricity sold for “residential use,” which is defined in the statute and in Comptroller Rule 3.295. During the relevant tax period, however, neither provision explicitly addressed whether detention facilities were eligible under that definition, and the taxpayer argued that the trial court misconstrued the statutory definition of “residential use.” The court focused on that part of the definition of residential use that provides that in order for the exemption to apply the use of gas and electricity in the detention facilities must have been in a structure occupied as a home or residence, and the use must have been by the owner of the occupied structure. The taxpayer argued that because prisoners resided in the detention facilities, the facilities were being occupied as a residence, fulfilling the first element. It further argues that the owner of each facility, the taxpayer, one of its affiliates, or a governmental body, used the gas or electricity to house government prisoners, satisfying the second element. The Comptroller argued that the facilities were not occupied as a home or residence because the term “occupied” requires more active control of the space than the prisoners exercised, and because the prisoners enjoyed none of the rights that generally accompany the occupation of a home or residence. The Comptroller further argues that the use of the gas and electricity was by the prisoners, who were not the owners, so the “by the owner” element is not satisfied and the exemption does not apply. The court noted that it must interpret the language of the statute as a whole, in a manner that harmonizes and effectuates all provisions such that none are rendered meaningless, and, therefore, the court said it needed to interpret the two requirements together to determine that the use by the owner must be related to the occupation as a home or residence. The court agreed with the Comptroller that there was a qualitative difference between occupying a private dwelling, such as a home or residence, and occupying a detention facility. It said that because the statute does not specifically define the terms “home” or “residence,” we must give these words their common, ordinary meaning unless the statute clearly indicates a different result. The court said the facilities at issue here are buildings used for confinement and detention, with housing being a necessary component of that detention and the common definitions of the words used in the statute tend to support the Comptroller’s argument that the detention facilities are not “occupied as a home or residence.” The court concluded that the detention facilities at issue were not occupied as a home or residence for purposes of this tax exemption. Further, the court found thatevenif the detention facilities at issue were occupied as a home or residence, in order to qualify for the residential-use exemption, the gas and electricity use within the facilities also must be “by the owner” and the taxpayer did not meet this requirement. The court said that to the extent that the taxpayer or its affiliates, as owners, used the gas and electricity, they did so as part of a commercial venture and as part of the service it provided to the government pursuant to contract, not in a residential manner. GEO Group Inc. v. Hegar et al., Texas Court of Appeals, Third District, No. 03-15-00726-CV. 8/10/17 Personal Income Tax Decisions Court Holds Taxpayer a Resident The Minnesota Tax Court held that a physician was liable for assessed individual income tax for the years between 2010 and 2014 because he was a resident of the state for those years and received sufficient income to require filing income tax returns. The undisputed facts showed that the taxpayer was a Minnesota resident from 2010 to at least 2014 and failed to file state income tax returns for those years. The Commissioner of Revenue (Commissioner) conducted an audit and based on available information regarding the taxpayer’s gross income, concluded that he was required to file a return for those years. The commissioner sent the taxpayer notices regarding his legal requirements to file and requesting his returns. When he failed to respond, the Commissioner issued an assessment based on information received from the IRS regarding the taxpayer’s income. The taxpayer filed an appeal asserting the assessment was incorrect but did not provide any documentation in support of his assertion. The Commissioner affirmed the assessment and the taxpayer filed this appeal. The Commissioner served the taxpayer with discovery requests and the taxpayer answered a small number, invoking his rights under the Fifth Amendment of the Constitution in response to the others. He admitted only that he had not filed Minnesota income tax returns for the years at issue. The court rejected the taxpayer’s argument that the Commissioner should bear the burden of proving his income, noting that orders of the Commissioner are prima facie valid and the taxpayer bears the burden of going forward with evidence to rebut or meet it. The taxpayer further claims that the Commissioner's assessment is baseless and arbitrary and it would be a violation of his right to due process, under both the United States and Minnesota Constitutions, for him to bear the burden to prove the assessment invalid. The court pointed out that the Commissioner's assessment was based on evidence provided by the IRS. The taxpayer also opposed the Commissioner’s motion for summary judgment but the court found that the taxpayer made little attempt to present specific facts showing that there was a genuine issue for trial, but instead attacked the admissibility of the evidence offered by the Commissioner in support of the motion, including that he was a resident of the state during the relevant years, was an active licensed physician in the state and was paid taxable income as reflected by the IRS forms. The court said, however, that the taxpayer did not demonstrate a genuine issue of fact as to any of these assumptions. The court noted that the fact that the taxpayer owns property in Minnesota or uses a Minnesota mailing address does not establish that he was a resident of Minnesota during the years at issue, but pointed out that property ownership was not the only evidence supporting the Commissioner's motion. The Commissioner submitted the taxpayer’s discovery responses and, particularly, his responses to the Commissioner's requests for admission, which asked the taxpayer to admit or deny that he was a Minnesota resident for each of the years at issue. Instead, he invoked his rights under the Fifth Amendment to the United States Constitution, but the court noted that a party in a civil case such as this one, and particularly a party bearing the burden of proof, cannot avoid liability by invoking the Fifth Amendment. The court said that because the taxpayer did not specifically deny any of the Commissioner's requests for admission, including that he was a full-time Minnesota resident during each of the years at issue, they are each deemed admitted. The court also rejected the taxpayer’s argument that the Commissioner had not properly authenticated his professional profile as a physician, citing the public records that were available. Finally, the court found that the Commissioner's assessment was supported, in part, by documentation of the monies paid to the taxpayer from various sources during the tax years at issue and rejected the taxpayer’s claim that the documentation was inadmissible and irrelevant. Meyer v. Comm'r of Revenue, Minnesota Tax Court, Docket No. 8970-R. 8/11/17 Corporate Income and Business Tax Decisions Foreign Disregarded Entity's Income Allowed on Combined Return The Minnesota Supreme Court held that a domestic parent company properly included on its state combined return the net income and apportionment factors of a foreign disregarded entity owned by a domestic subsidiary. The court found that the disregarded entity was treated as having been liquidated and its assets and liabilities distributed to its single owner. The taxpayer is a Kentucky corporation that does business in Minnesota, among other states. In November 2008, it acquired Hercules, a C corporation incorporated under the laws of Delaware, and since then the income of Hercules has been included in the taxpayer’s consolidated federal income tax return and in Minnesota’s income tax return. Since 1999 the Hercules has owned 100 percent of a Luxembourg entity, Hercules SARL. It was undisputed that Hercules SARL was the type of eligible entity under federal regulations that can “elect its classification for federal tax purposes, and in 1999, Hercules SARL elected to be “disregarded as a separate entity,” and was therefore no longer considered separate from its owner, and this election remained in effect during all the tax years at issue here. The facts showed that over the 3 tax years at issue in this appeal, Hercules SARL operated at a total net loss and because Hercules SARL elected to disregard its status as an entity separate from its owner, on its federal returns, the taxpayer treated Hercules SARL as a sole proprietorship, branch, or division of Hercules and included the income, losses, and deductions of Hercules SARL for the 3 years at issue as the income, losses, and deductions of Hercules itself when it filed returns with the IRS. When the taxpayer filed its state return it relied on the state statute that defines net income as “federal taxable income . . . incorporating . . . any elections made by the taxpayer,” and factored in the election by Hercules SARL to be disregarded as an entity separate from its owner, Hercules. The income, losses, and deductions of Hercules SARL were accordingly included as the income, losses, and deductions of Hercules on the combined report of state net income for the taxpayer’s unitary business. After an audit, the Commissioner determined that the taxpayer improperly included the income, losses, and deductions of Hercules SARL in its calculation of its unitary business income in 2009, 2010, and 2011. After excluding Hercules SARL’s income, losses, and deductions, the Commissioner recalculated the Minnesota net income of the taxpayer’s unitary business, and issued an assessment. The taxpayer filed an appeal and the Tax Court found for the taxpayer. The Commissioner filed this appeal. The court said that the facts of this case are undisputed and the question presented is a question of statutory interpretation involving one federal regulation and two state statutes. The parties agreed that Hercules SARL is an eligible entity under the federal regulations and agreed that under this regulation, it elected to be disregarded as an entity separate from its owner, Hercules, under federal tax law and that the taxpayer filed its federal returns in accordance with the regulation. The court then looked at the definition of “net income” under Minnesota income tax law. The court said that the plain language of the state’s “net income” definition unambiguously incorporates federal elections made by a taxpayer and the elected classification of entities for federal income tax purposes is, therefore, part of the calculation of net income under state law. The third relevant law the court looked at is the state’s water’s edge rule, which, during the tax years at issue, excluded foreign entities from the combined report of a unitary business. The Commissioner argued that even if federal elections are recognized as the starting point for calculating “net income” under the state tax law, the federal consequences of those elections are not necessarily given force under Minnesota law, and to do so in this case, results in casting aside the water’s edge rule entirely. The court said that the statute’s broad reference to “any election” in the definition of net income is sufficient to conclude that the election Hercules SARL made under the Treasury, including its consequences, is properly incorporated in the net income reported on the taxpayer’s combined report. The court agreed with the tax court’s conclusion that recognizing the consequences of Hercules SARL’s election “harmonizes” the legislative directives in both statutes because the income and apportionment factors of Hercules SARL become the income and apportionment factors of its domestic parent, Hercules. It said that it recognized that this holding contradicted Commissioner’s Revenue Notice 98-08, which announced that the Department of Revenue would not “recognize the ‘check the box’ election made by” an eligible entity with a single owner, such as Hercules SARL, saying that reliance on the Revenue Notice would render superfluous the directive in Minn. Stat. § 290.01, subd. 19, to recognize “any elections” made by a taxpayer. Citing prior case law, the Commissioner also argued that even if state tax law recognizes the election by Hercules SARL to be disregarded as an entity separate from its owner, Hercules SARL still retains its foreign nationality and cannot be included on the taxpayer’s combined report under the water’s edge rule. The court held that the Commissioner read the prior cases too broadly and the current case was distinguishable because Hercules SARL is not an independent entity. When it elected to have its status disregarded as a separate entity from Hercules, Hercules SARL, for purposes of federal tax law, ceased to exist on its own and became part of its domestic owner, Hercules, and the nationality of Hercules SARL became irrelevant to determining the taxpayer’s state tax liability. Ashland Inc. v. Comm'r of Revenue, Minnesota Supreme Court, A16-1257. 8/2/17 Company Not Entitled to Disaster Loss Deduction The Massachusetts Appeals Court held that an electric company was not entitled to a disaster loss deduction for the 2007 tax year, even though the company was able to deduct the loss for federal tax purposes. The court found that the company's $62 million loss occurred during the 2008 tax year and state law does not allow deductions for losses that occur in years other than the tax year in which they are claimed. The undisputed facts are that in December 2008, New England experienced a severe ice storm, after which the Federal Emergency Management Agency (FEMA) declared various Massachusetts counties Federal disaster areas. The storm caused the taxpayer in this case to suffer a loss of approximately $62,000,000, which met the requirements of a "disaster loss" under the Internal Revenue Code, which provides in pertinent part that the loss may be "taken into account for the taxable year immediately preceding the taxable year in which the disaster occurred" at the election of the taxpayer. 26 U.S.C. § 165(i)(1) (§ 165). When a taxpayer makes this election, the disaster loss is "treated for purposes of this title as having occurred in the taxable year for which the deduction is claimed." In June, 2009, the taxpayer amended its Federal return, electing to take a disaster loss deduction for the 2008 storm in taxable year 2007, and as a result of the election, the loss was "deemed to have been sustained" in taxable year 2007 for Federal tax purposes. In September 2009, the taxpayer sought to similarly amend its 2007 Massachusetts return, claiming a deduction for the disaster loss and an abatement in the amount of approximately $4,000,000. The commissioner denied the taxpayer’s application, arguing that the Massachusetts tax code expressly excluded deductions for "losses sustained in other taxable years." The taxpayer filed an appeal with the Appellate Tax Board (Board), which concluded that the unambiguous language of § 52A in the statute supported the commissioner's position. The taxpayer filed this appeal arguing that the Board misapplied the clear language of the tax statute. The court said that Section 52A generally incorporates deductions allowable under § 165, while specifically excluding deductions for "losses sustained in other taxable years." The Board determined that § 52A's requirement that deductible losses be sustained in the same taxable year is "clear and unambiguous," and that the language is conclusive as to the legislature's intent and the court agreed with the Board's interpretation that the language provided for an "explicit and plainly-worded departure from deductions allowed for Federal tax purposes." The court found that the taxpayer’s argument that the legislature did not intend to exclude disaster losses was undermined by the plain language of § 52A, as well as by the construction of an analogous section relating to business corporations and concluded that the legislature intended to exclude all losses sustained in other taxable years. Further, the court said that it was not persuaded, as the taxpayer argued, that the meaning of the term "sustained," or the timing of when a loss is sustained for Massachusetts tax purposes, necessarily flows from the loss's treatment under the Federal code or corresponding Federal regulations and rejected the taxpayer’s argument that once a taxpayer has elected under the Federal code to take a disaster loss in the preceding year, Massachusetts must also treat the loss as if it occurred in the preceding year. The court noted that Massachusetts courts have concluded that Federal tax concepts "are not always dispositive" of the interpretation of Massachusetts statutes, citing FMR Corp. v. Commissioner of Rev., 441 Mass. 810, 818 (2004). Massachusetts Elec. Co. v. Comm'r of Revenue, Massachusetts Court of Appeals, No. 16-P-854. 8/15/17 No Deduction for Bank’s Market Discount Income The North Carolina Supreme Court upheld the state business court's interpretation of a state statute precluding a banking corporation from deducting on its state income tax return market discount income related to U.S. obligations for North Carolina. The taxpayer is a wholly owned subsidiary of Fidelity Bancshares, Inc. and it acquired United States government bonds at a discount to face value and held those discounted bonds until maturity, thereby earning income, generally referred to as Market Discount Income, consisting of the difference between the amount that Fidelity Bank initially paid for the bonds and the amount that it received relating to those discounted bonds at maturity. Five of these bonds matured during the 2001 tax year and the taxpayer treated this Market Discount Income as taxable income and then deducted this Market Discount Income as interest earned on United States government obligations for the purposes of determining its 2001 state net taxable income. The Department of Revenue (DOR) issued an assessment based upon a determination that the taxpayer was not entitled to deduct this Market Discount Income for the 2001 tax year. The taxpayer filed an appeal, which DOR denied and issued a final determination upholding the assessment. The taxpayer appealed that decision and on 30 June 2009, the Administrative Law Judge entered an order granting partial summary judgment in favor of DOR on the grounds that the Market Discount Income relating to the discounted bonds was not deductible for North Carolina corporate income tax purposes. DOR adopted the ALJ’s decision with respect to the deductibility issue and remanded the case to the Administrative Law Judge for the making of further findings of fact relating to the interest abatement issue.The taxpayer filed an appeal to the superior court, which affirmed DOR’s decision with regard to the deductibility issue. After a number of appeals and a remand to the ALJ, the matter was designated a mandatory complex business case and referred to the state’s business court. On 23 June 2016, the Business Court entered a final judgment and order granting the Department’s motions to dismiss the second judicial review petition and entering final judgment with respect to the deductibility issue consistent with the court’s determination in the proceeding stemming from the first judicial review petition. Fidelity Bank v. N.C. Dep’t of Revenue, Nos. 10 CVS 3405, 15 CVS 11311, 2016 WL 3917735 (N.C. Super. Ct. Wake County (Bus. Ct.) June 20, 2016). The taxpayer filed this appeal. The principal substantive issue before the court was whether the Business Court erred by affirming that portion of DOR’s final agency decision in which DOR determined that the taxpayer was not entitled to deduct the Market Discount Income that it earned during the 2001 tax year as interest on United States obligations for North Carolina corporate income taxation purposes. The court first reviewed the rules of statutory construction and the taxpayer’s argument that the statutory language at issue in the case and plain and unambiguous. The court noted that there was no statutory definition of the word “interest” as used in the relevant statute, but said the Business Court defined the term in question in the context of bonds as “periodic payments received by the holder of a bond.” The court ruled that in view of the fact that the term “interest” has a definite and well-known sense in the law, and that this “plain meaning” definition is consistent with the manner in which “interest” is used in other statutory provisions and judicial decisions, the undefined term “interest” as used in the relevant statute is unambiguous and should be understood in accordance with its plain meaning as involving “periodic payments received by the holder of a bond.” The court held that because the Business Court did not err by defining the term “interest” in this matter, it found that the Business Court correctly concluded that the Market Discount Income that the taxpayer received on the discounted bonds that matured during 2001 was not deductible for North Carolina corporate income tax purposes. The Fidelity Bank v. Dep't of Revenue, North Carolina Supreme Court, No. 392A16; No. 393PA16. 8/18/17 Property Tax Decisions Retirement Home Not Entitled to Exemption The New Mexico Supreme Court held that a retirement home was not entitled to a property tax exemption finding that it was not used primarily for substantial public benefit furthering charitable purposes. The taxpayer is a self-sustaining retirement and continuing care community, funded entirely by admission and monthly fees paid by residents who have met the facility’s requirements for sufficient financial resources, including a minimum net worth, and have satisfied specific health criteria. It does not accept residents who are Medicare-dependent, Medicaid-dependent, or charity-dependent or any residents who cannot afford to buy their way into the community. It is funded primarily by resident fees calculated at the time of admission and based on each resident’s life expectancy and projected level of required care. Fees are calculated to cover all of the operating costs of the facility and to provide additional reserves that can be drawn on to make up deficits. It is possible that particular residents will outlive their predicted life spans or require more expensive medical care than anticipated so that the fees they pay would not be enough to cover the entire cost of their lifetime care. Other residents may live fewer years than expected, and the entry fee and monthly fees they pay to El Castillo will exceed the total cost of their lifetime care. The taxpayer was assessed for tax year 2009 and filed a claim for exemption of property used for charitable purposes under the state’s code. The Assessor denied the claim finding that the taxpayer’s donation of services or facilities was minimal. The Assessor acknowledged that the legislature did not textually set forth a minimum level of charitable donation in Section 7-36-7(B)(1)(d) but concluded that “because the constitutional grant of exemption requires primary and substantial charitable use of the property, so must the statute.” The taxpayer protested the Assessor’s denial to the county’s Valuation Protests Board (Board), which upheld the Assessor’s denial of the property-tax exemption after finding that the taxpayer had not donated or rendered gratuitously a portion of its services or facilities as the terms of the statute required. The taxpayer appealed the Board’s decision to the district court, arguing that the Board’s decision was not supported by substantial evidence and was reached in an arbitrary and capricious manner. The district court held for the taxpayer and the county filed an appeal to the court of appeals which reversed the district court’s conclusion that the taxpayer was constitutionally exempt from property taxation and held that the taxpayer “did not directly and immediately use its property primarily and substantially for a charitable purpose recognized under Article VIII, Section 3 of the New Mexico Constitution because it does not confer a substantial benefit of real worth and importance to an indefinite class of persons who are members of the general public.” Because the Court of Appeals refused jurisdiction to review whether the taxpayer was eligible for tax exemption under the statute, it did not discuss the relationship between Article VIII, Section 3 and Section 7-36-7(B)(1)(d) or specify whether its reversal of the district court on constitutional grounds left intact the district court’s ruling that the taxpayer was entitled to exemption under the statute. The state’s supreme court granted certiorari to consider both the constitutional and statutory provisions. Article VIII, Section 3 of the New Mexico Constitution provides an exemption from property tax for “all property used for. . charitable purposes”, but provides no specifics. The legislature recognized in Section 7-36-7(B)(1) that taxes may not be imposed on “property exempt from property taxation under the federal or state constitution, federal law, the Property Tax Code or other laws.” It added an amendment to the statute in 2008, providing that the exemption includes property that is operated either as a community to which the Continuing Care Act . . . applies or as a facility licensed by the department of health to operate as a nursing facility, a skilled nursing facility, an adult residential care facility, an intermediate care facility or an intermediate care facility for the developmentally disabled, if it met certain requirements including that it donates or renders gratuitously a portion of its services or facilities. The statute provides no guidelines for determining what level of charitable donations will satisfy this requirement. The taxpayer argued that it was entitled to be exempt from taxation because it has met the terms of the statute but it did not challenge the Court of Appeals holding that it is not exempt under Article VIII, Section 3 of the state Constitution. The county argued that the taxpayer’s failure to meet the requirements of Article VIII, Section 3 necessarily means that Section 7-36-7(B)(1)(d) cannot be constitutionally applied to grant it an exemption. As an initial issue, the court concluded that the Assessor had standing to bring before the appellate courts the statutory and constitutional issues relating to whether the taxpayer is entitled to an exemption from real property taxation. The court next turned to the jurisdictional issues in the matter and concluded that the district court should have exercised its appellate jurisdiction over the Board’s determination regarding the applicability of Section 7-36-7(B)(1)(d) to the taxpayer and reviewed whether the Board’s decision was arbitrary and capricious, unsupported by substantial evidence, or otherwise contrary to law. The court said that in issuing new findings of fact, the district court acted outside its proper appellate jurisdiction. The court also determined that the state’s court of appeals erred when it refused jurisdiction to review the constitutionality of the Section 7-36-7(B)(1)(d) exemption as applied to the taxpayer. The court also said that the granting of tax exemptions must be interpreted in light of restrictions set forth in Article VIII of the state Constitution, noting that Article VIII, Section 3 operates as a limit on the legislature’s power to redefine categories of property which will be exempt from taxation. Finally, the court found that under the facts presented in this record, the taxpayer does not provide any benefit to an indefinite class of persons who are members of the general public and that it cannot be entitled to exemption from taxation under Section 7-36-7(B)(1)(d) simply by being a continuing care facility without also creating a substantial public benefit that would entitle it to exemption from equal taxation as authorized by Article VIII, Section 3 of the state Constitution. El Castillo Retirement Residences v. Martinez, New Mexico Supreme Court, No. S-1-SC-35148. 8/17/17 Taxpayers Ordered to Repay Homestead Benefits The New Jersey Tax Court held that a couple had to repay homestead benefits erroneously paid to them for the 2010 and 2011 tax years and denied them the benefit for the 2012 tax year, finding they were ineligible for the benefit because they were nonresidents and their income exceeded the threshold. The couple had filed nonresident New Jersey income tax returns, but then attempted to claim they were residents eligible for the homestead benefit. For tax years 2010-2012, the taxpayers, a husband and wife, filed non-resident New Jersey income tax returns, showing a street address in New Orleans, Louisiana and noting their state of residency was Louisiana. The couple’s joint federal income tax returns had similar information, as well as their resident Louisiana returns. For tax years 2010-2012, the taxpayers filed applications for homestead benefit electronically with respect to the New Jersey property, listing the New Jersey property as being owned by the wife, Rose Ann Citron. For tax years 2010 and 2011 the Department of Taxation (Taxation) granted the couple homestead benefits, but denied the 2012 application. The couple protested that denial on May 27, 2015, and on February 1, 2016, Taxation issued a lengthy final determination upholding the denial and further seeking a repayment of the 2010 and 2011 benefits as being erroneously paid. Taxation noted that during 2010 the Social Security Administration had determined Rose Ann Citron no longer met the definition of disabled, as she was able to engage in substantial gainful activity. Since Taxation followed the SSA’s definition of a disabled individual, Mrs. Citron was ineligible to claim a homestead benefit. Taxation noted that the couple were further ineligible because their gross income was over the $75,000 income limit, and that for all three years, the taxpayers filed New Jersey gross income tax returns as non-residents of the State and resident income tax returns in Louisiana. As nonresidents they were, therefore, ineligible for the homestead benefit for all three tax years 2010-2012. At the hearing on this matter, the husband argued that only he was a resident of Louisiana and claimed that the homestead benefit applications filed by them jointly were in error since the New Jersey property was always owned only by his wife. He also argued that his wife was always a New Jersey resident as evidenced by her New Jersey driver’s license, license issued by the New Jersey Division of Consumer Affairs which licensed her to practice as a respiratory care practitioner, and license issued by the New Jersey Department of Banking and Insurance for her to be an insurance agent. Further, the New Jersey property address was listed on her W-2s and the 2010 social security benefit earning information report. He argued that these documents should trump the inconsistent tax return filings which were done to reduce income tax since filing with the status of “married filing separate” as opposed to “married filing joint” would entail higher income taxes. The state statute permits a homestead rebate or credit to a New Jersey “resident,” calculated as a percentage of property taxes paid by the claimant, with a sliding scale of benefit depending on the claimant’s income. A different computation is used for a resident claimant who is allowed to claim a personal deduction as a disabled taxpayer. The term “homestead” is defined in the statute as “a dwelling house and the land on which that dwelling house is located which constitutes the place of the claimant’s domicile and is owned and used by the claimant as the claimant’s principal residence.” The term “principal residence” is defined as a “homestead actually and continually occupied by a claimant as the claimant’s permanent residence, as distinguished from a vacation home, property owned and rented or offered for rent by the claimant. The state statute has defined a “disabled” person who can claim an exemption on their income tax returns as one who has a total and permanent inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment, and this definition is the same for the property tax credit. The court said the primary issue was whether the taxpayers or even the wife were eligible for homestead benefit for each tax year because of the inconsistent income tax filings. The court rejected the taxpayers’ argument that their non-resident income tax filings have no bearing on the eligibility for the homestead benefit, noting that the returns were filed under penalties of perjury and they never amended the New Jersey or Louisiana returns to reflect their current claims. The court also noted that by claiming to be non-residents of New Jersey, they paid lower income taxes by having only New Jersey sourced income taxed, because a married couple filing joint resident income tax returns would be taxed upon income from all sources. The court also pointed out that the documents showing the New Jersey address do not by themselves establish that the wife was a resident of New Jersey under the statutory definitions and said that they were not persuasive because they did not relate to the tax years at issue. The court held that the taxpayers must accept the consequences of their deliberate decision to file income tax returns as a resident or non-resident. Citron v. Dir. of Taxation, New Jersey Tax Court, No. 007787-2016. 8/17/17 Other Taxes and Procedural Issues Seattle Firearms Tax Constitutional The Washington Supreme Court held that a Seattle ordinance imposing a tax on each firearm and round of ammunition sold within the city limits was constitutional and that the ordinance imposes an authorized tax that is not preempted by law. The court determined that the charge was intended to raise revenue for public benefit and did not have a regulatory purpose or intent. Seattle Ordinance 124833 (Ordinance) imposes a "Firearms and Ammunition Tax" on each firearm and round of ammunition sold within the city limits, applies only to licensed retail sellers of guns and ammunition, and its stated purpose is to raise revenue for public health research relating to gun violence and to fund related social programs. Two individual gun purchasers, Phillip Watson and Ray Carter, along with various organizations (collectively referred to as Watson), filed suit challenging the constitutionality of the Ordinance, arguing that the Ordinance is actually a regulation, not a tax, and is preempted by RCW 9.41.290 which forbids the local regulation of guns. Watson also argued that even if the Ordinance is a tax, it exceeds Seattle's delegated taxing authority. The superior court found in favor of the City finding that the Ordinance imposes an authorized tax and that the tax was not preempted by RCW 9.41.290. Watson filed an appeal and the Court of Appeals certified the matter to this court. The court affirmed the lower court ruling, noting that under state law,a charge intended to raise revenue for the public benefit is a tax.It noted that while courts should be dubious of regulations masquerading as taxes, Watson had offered no convincing evidence that the Ordinance has a regulatory purpose or intent. The court held that it was a tax and found that the Ordinance was authorized by the broad grant of taxing authority delegated to cities like Seattle. It said that the tax was specifically authorized under RCW 35.22.280(32), which grants first class cities broad tax powers, including the authority to levy a flat tax on gun sales. It also held that state law did not preempt the Ordinance, finding that RCW 9.41.290 preempts only municipal gun regulation, not taxation. One justice dissented saying that RCW 9.41.290, which forbids the local regulation of guns, is an explicit preemption provision and a complete preemption provision. Watson v. Cty. of Seattle, Washington Supreme Court, No. 93723-1. 8/10/17 Dismissal of Qui Tam Suit Against Telecom Companies Upheld The Minnesota Court of Appeals affirmed the dismissal of a qui tam suit against telecommunications services providers brought under the Minnesota False Claims Act (FCA). The court found that the 911, Telecommunications Access Minnesota, and Telephone Access Plan charges were taxes, and false claims actions based on tax violations are prohibited. In May 2014, appellant initiated a qui tam action pursuant to the FCA, which imposes civil liability on a person who wrongfully acquires money or property from the state or a political subdivision, or wrongfully avoids an obligation to transmit money or property to the state or a political subdivision. The complaint alleged that the respondents, who were telecommunications service providers, undercharged their customers with respect to 911 charges, TAM charges and/or TAP charges. The district court sealed the complaint and the state conducted an investigation and, in September 2015, the state declined to intervene in the action. In October 2015, the district court ordered that the complaint be unsealed. After a hearing, the district court concluded that appellant’s claims were barred by Minn. Stat. § 15C.03 and dismissed the amended complaint. Appellants filed this appeal. The court noted that to determine whether the district court erred by granting respondents’ joint motion to dismiss, it must limit its consideration to the facts alleged in the amended complaint, accept those facts as true, and construe all reasonable inferences in favor of appellant. The state FCA prohibits FCA claims based on tax violations and the district court concluded that the 911, TAM, and TAP charges were taxes and dismissed appellant’s claims. On appeal the appellant argued that the district court erred because the 911, TAM, and TAP charges are not taxes, the statutes that require service providers to collect and remit the 911, TAM, and TAP charges, are not statutes relating to taxation for purposes of FCA’s tax bar, applying the tax bar to appellant’s claims nullifies the reverse-false-claims provisions of the FCA, contrary to the legislature’s intent. The court said that to determine whether the charges are taxes or fees required engagement in statutory interpretation. The 911 fee, assessed on customers who purchase telecommunications access lines that can be used to make 911 calls, is based on the number of telephone lines, or their equivalents, and is used to cover the costs of the emergency telecommunications system. Telecommunications service providers are required to collect the monthly fee from customers and remit the collected amount to the commissioner of public safety. The TAM charge funds the program that provides devices and services to persons with communications disabilities. Providers of services capable of originating a telecommunications-relay-services (TRS) call must collect monthly surcharges from customers, with the amount of the charge established by the public utilities commission and remitted to the commissioner of public safety. The TAP charge funds a program that provides telephone assistance to low-income individuals. It is funded by assessing a uniform recurring monthly surcharge on access lines provided by each local service provider in the state, and again is remitted to the department of public safety. The court noted that the legislature used different language to describe the 911, TAM, and TAP charges. The 911 charge is called a fee and the TAM and TAP charges are called surcharges, but they are collected and remitted in a similar fashion and each is imposed on customers who purchase telecommunications access lines. The state statute defines “tax” to mean “any fee, charge, exaction, or assessment imposed by a governmental entity on an individual, person, entity, transaction, good, service, or other thing.” The statute further provides that a price that an individual volunteers to pay in exchange for goods or services provided by a governmental entity, such as a license to engage in a trade or business, is not a tax. The court found that because the 911, TAM, and TAP charges are fees, charges, exactions, or assessments imposed by a governmental entity on an individual, person, entity, transaction, good, service, or other thing, they come within the general statutory definition of “tax.” It rejected the appellant’s argument that these charges were not taxes because they are only assessed on people and entities that choose to voluntarily pay the charges in return for receipt of governmental goods or services. The court said that the mere act of voluntarily purchasing, from a private entity, a telecommunications service does not make the charge a fee. The court also found that those who pay the 911, TAM, and TAP charges do not necessarily receive governmental goods or services because the services provided are based on need. The appellant also argued that the legislature chose to describe the 911, TAM, and TAP charges as “fees” and “surcharges” and that, if the legislature intended the charges to be taxes, it could have simply called the charges “taxes,” but the court pointed out that the legislature has specifically defined “tax” to include certain fees, charges, or other similar terms, and that definition controls over the common usage. The court said that if it were to conclude that the legislature’s failure to explicitly call the 911, TAM, and TAP charges “taxes” was sufficient to show that the legislature intended the charges to be treated as something other than taxes, we would render the definition of “tax” meaningless. The fact that the legislature did not refer to the charges as “taxes” does not establish that it did not intend the charges to be taxes. The court also noted that even if it were to accept appellant’s argument that the definition of tax in the statute does not apply here, it would nonetheless conclude that the 911, TAM, and TAP charges are taxes under the common law. The court also rejected the appellant’s argument that the statutes that require service providers to collect and remit the 911, TAM, and TAP charges are not “Minnesota Statutes relating to taxation” within the meaning of the FCA tax bar, finding that a statute is one “relating to taxation” within the plain meaning of the phrase if the statute has a connection, relation, or reference to or concerns the imposition of a tax, the amount assessed as tax, or the revenue gained from taxes. Finally, the court rejected the appellant’s claim that applying the tax bar to its claims nullifies the reverse-false-claims provisions of the FCA, finding that these provisions will continue to be effective where the alleged violations involve claims, records, or statements that are not made under portions of Minnesota Statutes relating to taxation. Phone Recovery Serv. LLC v. Qwest Corp. et al., Minnesota Court of Appeals, A17-0078; File No. 62-CV-14-3768. 8/7/17 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:
August 18, 2017 Edition
NEWS Just in Time for the Eclipse! Airbnb has agreed to collect and remit the sales and use tax on lodging in Wyoming effective August 1, 2017, just in time for a potential windfall from the upcoming solar eclipse. The state’s Department of Revenue had been negotiating with the company for some months, according to Dan Noble, head of DOR. The central line of the eclipse will pass through the state, and Noble said it is expected to generate a substantial boost in short-term stays in August. According to Airbnb, it has now agreed to collect and remit taxes owed by rental owners in a number of states and territories in and outside the United States, with a total of over 310 governments worldwide. U.S. SUPREME COURT UPDATE Cert Filed CMSG Restaurant Grp. LLC d/b/a Larry Flynt's Hustler Club v. Charland and Murphy, U.S. Supreme Court Docket No. 17-147. Filed July 26, 2017. Issue: Whether the First and Fourteenth Amendments permitted a state to selectively administer a tax exclusion for live entertainment but imposing the tax on performances with certain content. The petition asked the Court to review an unreported order of the Court of Appeals for New York dismissing the taxpayer’s appeal. FEDERAL CASES OF INTEREST Tax Protester's Complaint Dismissed The U.S. Court of Appeals for the Eleventh Circuit, in an unpublished per curiam opinion, affirmed a district court decision dismissing a tax protester's complaint. The protestor was challenging the authority of the IRS and its employees to impose and collect taxes, and the court found that the lower court was required to dismiss the action as frivolous. The taxpayer filed an appeal pro se from the sua sponte dismissal without prejudice of his complaint as frivolous by the district court. The court here noted that pro se pleadings are held to a less stringent standard than pleadings filed by attorneys and the court was reviewing the lower court decision for abuse of discretion. Prior case law has held that a lawsuit is frivolous if the plaintiff’s realistic chances of success are slight. The court ruled that the lower court did not abuse its discretion when it sua sponte dismissed the taxpayer’s complaint and noted that the circuit has repeatedly rejected the arguments set forth by the taxpayer that he was not a “taxpayer” and was immune from prosecution because he is not a citizen of the United States. The court also pointed out that the taxpayer’s complaint was “virtually unintelligible,” as described by the lower court. Because he had no realistic chance of success, the court found that the district court was required to dismiss his action as frivolous. Garrett, Aubrey Maurice v. IRS et al., U.S. Court of Appeals for the Eleventh Circuit, No. 16-15779. 8/3/17 Federal Tax Liens Have Priority Over Other Estate Claims The U.S. District Court for the Southern District of Indiana, Indianapolis Division, overruled an objection filed by the surviving spouse and personal representative of a decedent's estate, and held that federal tax liens have priority over other claims to the estate's assets. The facts in the matter were undisputed. Frederick Alan Simmons (Simmons), a resident of Zionsville, Indiana, died on June 5, 2014, and his surviving spouse, and Personal Representative (PR) of the Estate, opened a probate action in the county’s Superior Court on June 11, 2014. She retained an attorney to represent her in her Personal Representative duties. The principal asset of the Estate was property located in Zionsville, Indiana. Simmons’ first wife was Deborah Scott (Scott) and they had one child, Erik Simmons who was born in 1991. They divorced on May 22, 1998 and their divorce decree provided, in relevant part, that Simmons would pay child support, maintenance and health insurance for the child. He also agreed to hold his ex-wife harmless from any encumbrance on the property and she turned over her interest in the property to him. Once the Estate was opened in state court, a number of claims were filed, including a claim by Scott for alleged past due child support, alimony, medical expenses, and insurance expenses, a claim from a former employees of Simmons, stemming from unpaid wages and benefits, claims from two individuals for default of promissory notes, a claim from a credit card company, and claims by both the state and the IRS for unpaid taxes. On March 16, 2015, the widow and PR filed a petition to approve the sale of the property but failed to serve notice on the United State pursuant to federal statute. The court approved the sale on April 16, 2015 and several weeks later she filed a petition to close the estate as insolvent with claims far exceeding the total distributable assets. Again, this petition was not served on the United States, which would trigger the 30-day removal time. On July 10, 2015, the state court issued an order closing the Estate as insolvent and ordered distribution of the proceeds from the sale of the property with the federal tax lien listed as seventh in priority among creditors. On July 14, 2015, the United States removed the state court action to this federal court with a challenge of the state court’s disposition of its tax lien. The U.S. sought to reduce Simmons’ unpaid federal tax liabilities to judgment and to determine the priority of liens encumbering the Estate’s property. The history of the case shows that on May 27, 2016, the Court issued an Order authorizing the sale of the Property and subsequently received the net proceeds of the sale. The PR requested a hearing to determine the claim priorities and the court requested briefs from the affected parties and set the motion for hearing. In light of Partial Motion for Summary Judgment filed by several of the parties involved in the case, the court vacated its oral argument and ordered all parties to file motions for summary judgment on or before January 27, 2017 and the district judge referred the Motions for Partial Summary Judgment to a magistrate who issued his Report and Recommendation, which allowed the Government priority interest for the proceeds from the sale of the property. After a magistrate judge makes a report and recommendation, either party may object within fourteen days and this appeal resulted. The only objection to the Report and Recommendation is the plaintiff’s objection that the Magistrate Judge erred by ignoring undisputed facts and in applying the law incorrectly. She argued that the Magistrate Judge erred in his findings of fact by failing to acknowledge the extensive services that she provided and funds she advanced for maintenance and preservation of the property at issue, contending that without her extensive efforts the property would not have sold. The Government contended that the exclusion of the additional facts requested by the plaintiff did not amount to error because those facts were irrelevant to the determination of priority. The court agreed, finding that the additional facts were irrelevant to the issue before the court. The plaintiff also objected to the Magistrate Judge’s conclusions of law because the Report and Recommendation relies on the Federal Tax Lien Act, 26 U.S.C. §§ 6321-6323, rather than the Federal Priority Statute, 31 U.S.C. § 3713. The court said that the plaintiff relied on In re Estate of Funk when she argued, under the Federal Priority Statute, that the Government’s federal tax lien does not have priority over her claim for preserving the property because compensation for services provided to the estate are debts of the estate, rather than debts of the debtor. She also asserted that, as Personal Representative, she and her counsel were entitled to just and reasonable compensation for their services pursuant to the state code. The Government argued that state law governs the majority of conflicts between lienholders competing for the same property, but when one of those lienholders is the federal government holding a lien for unpaid taxes, federal law governs, and the Government argued that the Federal Tax Lien Act, and not the Federal Priority Statute, is the basis for the Government’s claim to priority over the proceeds from the Estate, and that Act provides, in pertinent part, that a federal tax lien prevails over all other interests, except for purchasers, holders of security interests, mechanics lienors, and judgment lien creditors whose interests are choate at the time that the notice of federal tax lien is filed. There is no dispute that the Government properly filed notice of its federal tax liens, and the Government, therefore, argued that its liens prevail over the plaintiff’s interest because she is not a purchaser, holder of security interest, mechanics lienor, or judgment lien creditor. The Magistrate Judge found in favor of the Government and stated that funeral and administrative expenses have no priority over a federal tax lien. The court adopted the Magistrate Judge’s recommendation and concluded that the Federal Tax Lien Act, rather than the Federal Priority Statute, governed whether the Government tax liens have preference to the proceeds from the property. Because the plaintiff’s interest did not fall under any of the exceptions listed the Government’s tax liens have priority. The court rejected the plaintiff’s argument that under this conclusion no reasonable personal representative or counsel would provide services under such impositions, noting that the procedures set out in the Internal Revenue Manual make it clear that if documentation is provided, evidencing payments made by the plaintiff to maintain the property, the Government would allow her unreimbursed expenses to be paid ahead of the federal tax liens. Spiekhout, Raelinn M. et al. v. United States, U.S. District Court for the Southern District of Indiana, Indianapolis Division, No. 1:15-cv-01097. 7/31/17 Denial of Tax Refund to Railroad Company Reversed The U.S. Court of Appeals for the Eighth Circuit reversed then lower court’s summary judgment to the government in a suit filed by a railroad company seeking a refund of about $75 million in employment taxes it paid under the Railroad Retirement Tax Act (RRTA). The court held that the RRTA doesn't require payment of taxes on remuneration in stock or on ratification payments for collective bargaining agreements. Rail carriers and their employees are not subject to FICA taxation, but, instead, pay a tax under the RRTA that is used to fund benefits under the Railroad Retirement Act (RRA). The court said that today the RRA and RRTA resemble both a social welfare plan and a private pension program, with one tier of benefits and taxes corresponding to what one would expect to receive from and to pay for social security and Medicare, and the other tier ties benefits to earnings and career service. The railroad sought a refund of taxes that it paid the federal government from 1991 to 2007 under the RRTA, arguing that the act did not require it to pay taxes when it paid employees in stock or made what are called ratification payments to union-member employees. During the time at issue, the company paid its employees in a monetary salary and in company stock and paid the taxes on the stock payments. The government argued that employers who pay employment taxes under the FICA are obligated to pay taxes on stock payments, and the Internal Revenue Service, by regulation, treats the FICA and the RRTA the same on this matter. The district court rejected the refund requests and granted summary judgment to the government. The taxpayer filed this appeal. The court reviewed the statutory text of RRTA and FICA. The RRTA tax is based on an employee’s “compensation” which is generally defined as any form of money remuneration paid to an individual for services rendered as an employee. The FICA statute levies a tax on an employee’s “wages” which is defined as “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash." The court noted that the FICA’s impact is broader than the RRTA when it expressly mentions the cash value of remuneration not paid in cash. The parties disputed why the word "money" precedes "remuneration" in the RRTA, with the taxpayer arguing that "money" took on the ordinary meaning it had at the time the RRTA was enacted since the RRTA does not define it. The court agreed with the taxpayer, finding that the expansive definition of “money” that the government argued did not reflect the ordinary, common meaning of the term. The court also noted a regulation adopted about four months after the passage of the RRTA that explained the term compensation meant all remuneration in money, or in something which may be used in lieu of money which is earned by an individual for services performed as an employee, and used scrip and merchandise orders as examples. The court said that if money meant either nothing or all property, as the government asserted, then there would be no reason to note that scrip or merchandise orders also constituted "compensation." The court pointed out that another circuit recently held that payments in stock are a form of money remuneration because stock has become practically equivalent to cash, but the court said that it respectfully disagreed with that decision. The court said that because it concluded that the RRTA unambiguously does not require payment of RRTA taxes on remuneration in stock, it owed no deference to the IRS's regulation defining the RRTA's "compensation" and the FICA's "wages" identically. The court then turned to the question of whether the RRTA required the taxpayer to pay taxes when it made so-called ratification payments to employees when their unions ratified collective bargaining agreements. These payments were intended to encourage unions to ratify collective bargaining agreements, were tied to the number of hours that the employee had worked the previous year, and typically required the recipient to be employed with the taxpayer on a certain date. While the taxpayer agreed that the ratification payments are “money remuneration”, it argued that tax was due on these payments because they were not “for services rendered” by the employee. The court concluded that the ratification payments were not made to employees for services rendered to the taxpayer because the taxpayer did not exercise control over whether a union ratified a collective bargaining agreement. The court said that ratification is a union activity that the Railway Labor Act protects from employer interference since that law is designed to provide for the complete independence of carriers and of employees in self-organization. Union Pacific Railroad Co. v. United States, U.S. Court of Appeals for the Eighth Circuit, No. 16-3574. 8/1/17 DECISION HIGHLIGHTS Sales and Use Tax Decisions Sales Tax Assessments Vacated The Indiana Tax Court has vacated a sales tax assessment, determining that a recreational vehicle dealer’s sales to out-of-state customers residing in states without reciprocal agreements with the state were not taxable because the sales transactions took place in Michigan. The taxpayer is an Indiana corporation that owns and operates a recreational vehicle dealership in the state. During the years at issue, the taxpayer sold camper trailers, travel trailers, motor homes, fifth wheels, and toy haulers (RVs) as well as related repair parts and repair services and maintained a website that allowed out-of-state customers to shop for RVs. In a typical sales transaction from the taxpayer’s website, once a price was agreed upon, the taxpayer would send a purchase order to the customer to be signed and returned with the deposit. It would then arrange a time for the customer to come to the dealership to walk through the vehicle, and if the vehicle met the customer’s expectations, the customer completed the paperwork in the dealership office. The taxpayer’s regular business practice for transferring physical possession of the vehicle to a customer varied based on whether the customer resided in a state with a reciprocal agreement with the state. If a customer resided in a state with a reciprocal agreement with the state, the taxpayer transferred physical possession of the vehicle to the customer at its dealership. When a customer did not reside in a state with a reciprocal agreement, the taxpayer informed them of the state sales tax rate and asked them whether they preferred to pay their home state’s sales/use tax or Indiana’s sales tax on their purchase. If the non-reciprocal customer chose to pay the tax to their home state, the taxpayer transferred possession of the vehicle to the customer at a location seven miles away from the dealership in Michigan, a state without a reciprocal agreement with the state, and did not collect the state’s sales tax from those customers. The Department of Taxation (Department) performed a sales tax audit of the taxpayer’s business and concluded that the taxpayer should have collected and remitted Indiana sales tax on 139 sales to non-reciprocal customers. The taxpayer filed a Motion for Summary Judgment in response to the assessment. The state imposes the sales tax on retail transactions made in the state and the state’s Uniform Commercial Code (UCC) defines a “sale” as the passing of title from the seller to the buyer for a price. The state statute provides that title passes to the buyer at the time and place at which the seller completes his performance with reference to the physical delivery of the goods, even if the title is to be delivered at a difference time or place. The general rule is that title passes, and a sale is completed, at the location of delivery of the goods themselves, if they are moved for delivery, or of the title documents, if they are not. The court said the issue presented was whether the taxpayer’s sales of RVs to non-reciprocal customers were made “in Indiana” as a matter of law, subjecting them to Indiana sales tax. The taxpayer argued that its sales to non-reciprocal customers were not made “in Indiana” because it provided physical delivery of the RVs in Michigan. The Department contended that the sales were made in the state because the title was delivered in the state and the delivery of possession out of state should be disregarded as tax avoidance. The court said that generally title to goods passes from the seller to the buyer in accordance with the explicit agreement of the parties, but without an explicit agreement title passes upon delivery. The court noted that the provisions cited by each party in support of their argument opens with the words “Unless otherwise explicitly agreed,” indicating that an explicit agreement between the buyer and seller would trump the provisions of either subsection. The parties did not provide a written contract that explicitly expressed an agreement between them, but the court said that the designated evidence indicated that an explicit agreement to deliver the vehicles in Michigan was made and the court found that the sales at issue were made and title passed upon physical delivery in Michigan. The Department argued, alternatively, that even if Indiana Code § 26-1-401(3) does not apply, delivery to non-reciprocal customers must have occurred in Indiana because delivery precedes inspection and acceptance in a “typical” sales transaction and inspection and acceptance took place when the taxpayer’s customers walked through the RVs and signed title, financing, and warranty documents at the Indiana dealership. Therefore, the Department argued that delivery necessarily had to have occurred in Indiana. The court said that determining the location of a sale is a fact sensitive determination and the designated evidence in this case demonstrated that the transactions at issue were not typical. The taxpayer’s owner and several employees testified in affidavits that taxpayer’s employees drove or towed the RVs at issue to a location in Michigan where the non-reciprocal customers took physical possession. The court found, therefore, that delivery occurred in Michigan and title passed outside of Indiana and as a matter of law the sales transactions at issue were not made in Indiana. The court also rejected the Department’s argument that the taxpayer’s physical delivery of RVs to non-reciprocal customers in Michigan should be disregarded as an impermissible attempt to avoid Indiana sales tax, finding, instead, that the evidence showed that the purpose of the Michigan deliveries was to ensure its customers incurred tax liability in the proper jurisdiction, where the vehicles would ultimately be used. The court found that the taxpayer had legitimate business purposes for delivering RVs to its non-reciprocal customers in Michigan. Richardson's RV Inc. v. Dep't of Revenue, Indiana Tax Court, Cause No. 49T10-1504-TA-00016. 8/1/17 Team Owes Tax on Total Ticket Price The Missouri Supreme Court held that the St. Louis Rams professional football team was required to pay state sales tax on amounts collected for a local entertainment license tax that was included in the price of admission to games. Underordinance No. 65669, ordinance No. 68380, and St. Louis’s revised code chapter 8.08, the city imposed upon the team an entertainment license tax (ELT). The ELT is imposed on the gross receipts of an entity in the business of admitting persons who pay an admission charge to a sporting event. The taxpayer in this case elected to pass their obligation to pay the ELT through to the ticket purchasers to the games and the city issued the team a gross receipt license to operate in the city when they remitted the tax. The taxpayer collected and remitted the ELT from February 1, 2007, through January 31, 2013 and included the ELT they collected as part of their gross receipts with their sales tax returns filed for the period February 1, 2007, through January 31, 2010. For the period February 1, 2010 through January 31, 2013 the taxpayer did not include the ELT they collected in their gross receipts when calculating state sales tax. In April 2011, the Rams applied for a refund of state sales tax paid equal to the ELT they included in their gross receipts, arguing the ELT was erroneously included. The Department of Taxation (Department) conducted an audit and determined the taxpayer failed to collect or remit sales tax on five percent of the ticket sales, which the taxpayer challenged and the Commission consolidated the refund and assessment cases. The Commission held for the taxpayer, finding the ELT was an occupational tax because it required the taxpayer to obtain a license to conduct the business of charging admission to professional football games and, as a condition of maintaining the license, to pay a portion of their gross receipts to the city through the ELT. The Commission determined the taxing statute was ambiguous and construed it against the Department, finding, in both cases, the director attempted to impose a tax upon a tax. The Department filed this appeal, arguing the Commission erred in finding the portion of the ticket sales the taxpayer used to pay the ELT was not subject to sales tax because the ELT was included in the amount ticket purchasers paid for admission via the fixed ticket price charged by the taxpayer. The state sales tax is a gross receipts tax imposed upon the seller and gross receipts is defined as the total amount of the sale price of the retail sale. The court found that no language in the stipulations filed by the parties at the Commission hearing or the Commission’s finding resolves whether the ELT was included in the price of admission or whether it constituted a separate charge, especially when there was no dispute the taxpayer passed their obligation to pay the ELT through to ticket purchasers. The court said that the taxpayer structured the collection of the ELT in such a way that it was included in “the amount paid for admission” as contemplated under the sales tax statute. The Department argued that the statutory definition of “admission” expressly excluded any admission tax imposed by the federal government or the sales tax statute, but does not exclude the ELT and the ELT does not come within these exclusions. The court held that a plain reading of the statute supported the Department’s argument, and rejected the taxpayer’s argument that these exclusions were simply illustrative and the definition included taxes not listed expressly and distinguished the facts in this case from the cases cited by the taxpayer. The court found that the sales at retail occurred between the taxpayer and ticket purchasers who paid a fixed admission price to view football games, and these are the transactions upon which the gross receipts are based and upon which the sales tax should be calculated. The court said the total amount the taxpayer received from the ticket purchasers is subject to sales tax and does not constitute a tax upon a tax. St. Louis Rams LLC v. Dir. of Revenue, Missouri Supreme Court, SC95910. 8/1/17 Hotel’s Sales Tax Refund Case Dismissed The Texas Court of Appeals, Third District, granted a taxpayer’s motion to dismiss an appeal by the Comptroller, finding that the court lacked subject matter jurisdiction over the appeal because it was moot. Both parties had filed an appeal from the trial court’s judgment concerning the issues of the sale-for-resale exemption for amenities placed in hotel guest rooms and the “deemed sale” of those amenities to hotel guests. The Comptroller had conducted an audit of the taxpayer’s sales and use tax paid on various categories of items covering the period of June 1, 2007 through August 31, 2010. The auditor originally granted the taxpayer a sales-tax refund on the basis that its purchases of the amenities qualified for the sale-for-resale exemption, relying on the decision in DWTC v. Combs, 400 S.W.3d 149 (Tex. App.—Austin 2013, no pet.). The Comptroller then amended its audit to include an assessment of sales tax based on the taxpayer’s “deemed sale” of the amenities to hotel guests. The assessed amount was slightly less that the refund amount, resulting in a small net refund to the taxpayer. After an administrative hearing, the administrative-law judge ruled in the Comptroller’s favor on this issue, and the Comptroller issued a decision adopting the administrative-law judge’s proposal for decision. The taxpayer appealed challenging the assessment on the “deemed sale” issue. The Comptroller counterclaimed, seeking to recover the taxpayer’s refund related to the purchase of the amenities, arguing that the Court incorrectly decided DTWC. The trial court’s judgment upheld the assessment on the “deemed sale” of the amenities and denied the State’s counterclaim. The State filed this appeal, asking the court to reverse its ruling in DTWC that hotels resell amenities. The taxpayer moved to dismiss the appeal stating that it conceded the offset requested by the Comptroller in its brief, which it claimed rendered the appeal moot. The court agreed with the taxpayer that the appeal had been rendered moot and granted the taxpayer’s motion to dismiss. Hegar v. Anatole Partners III LLC, Texas Court of Appeals, Third District, Docket no. 03-17-00097-CV. 7/31/17 Personal Income Tax Decisions No cases to report. Corporate Income and Business Tax Decisions Transportation Contractor’s Refund Denied The New Mexico Court of Appeals held that a contractor's transportation of an interstate railroad company’s crew members from one point to another in New Mexico is not considered transporting passengers traveling by motor carrier in interstate commerce. As a result, the taxpayer was not entitled to a refund of the gross receipts taxes it paid on the revenue it derived from its transportation services. The taxpayer contracted with Union Pacific Railroad and Burlington Northern Santa Fe (the railroads) to transport railroad employees to and from railroad trains both within New Mexico and from New Mexico to another state. Both railroads carried freight across state lines in the country and the taxpayer argued that its service was necessary for the interstate railroad carriers to comply with federal safety regulations and union rules. The state Taxation and Revenue Department (Department) conducted an audit and assessed the taxpayer the gross receipts tax on revenue derived from transportation between locations in New Mexico/ The taxpayer paid the tax and filed for a refund. The Department denied the refund claim and the taxpayer filed an appeal to the district court. The district court denied the taxpayer’s motion and granted the Department’s motion and the taxpayer filed this appeal. In 1995, Congress passed the Interstate Commerce Commission Termination Act (ICCTA) with the intent of deregulating certain industries and as part of that enacted provisions to restrict states and local governments from burdening interstate passenger travel by motor carrier. Those provisions specify, in pertinent part, that a state or political subdivision may not levy a tax on the transportation of a passenger traveling in interstate commerce by motor carrier or on the gross receipts derived from that transportation. In recognition of this, the state enacted legislation providing that receipts from transaction in interstate commerce maybe deducted from gross receipts to the extent that imposition of the gross receipts tax would be unlawful under the federal Constitution. It was clear in this case that the Department deducted receipts from taxpayer’s service revenues that included transportation between locations in New Mexico and locations in other states. The issue here is whether the federal statute preempts the Department’s assessment of gross receipts tax on the revenues from taxpayer’s service between locations in New Mexico. If so, the taxpayer would be entitled to also deduct revenues for transportation between locations in New Mexico. The court focused its analysis on the language “a passenger traveling in interstate commerce by motor carrier[.]” The court said that it did not disagree with the taxpayer that the Commerce Clause of the United States Constitution permits Congress to regulate intrastate activity that substantially affects or performs an integral part of interstate commerce. But it disagreed with the taxpayer’s contention that commerce clause jurisprudence requires an analysis of the effect on interstate commerce whenever Congress uses the term “in interstate commerce,” as it has done in the relevant provisions here. The court said that by virtue of the United States Supreme Court’s interpretation of the phrase “in interstate commerce,” it interpreted Congress’s intent in 49 U.S.C. § 14505 to address only “the flow of interstate commerce” and said that the taxpayer’s arguments that its service falls within 49 U.S.C. § 14505 because it affects interstate commerce is contrary to long-standing United States Supreme Court precedent. The court then turned to the meaning of the words “passenger” and “motor carrier” as used in the federal statute. The district court held that the crew members the taxpayer transported were not “passengers” under this provision, but the taxpayer argued that its service fell within the preemption in the federal statute because the crew members, although not passengers of the railroads, were its passengers and although the railroads are not motor carriers, the taxpayer is a motor carrier under the statute. The court noted the ambiguity and, therefore, looked to the context in which the terms are used, the purpose of 49 U.S.C. § 14505, and its legislative history. It said that the purpose of 49 U.S.C. § 14505 was to address taxation of interstate travel by bus passengers who had purchased tickets to travel between states and did not relate to passengers who, like the railroad crew members, were not “passengers” before and after they were transported within a single state by a motor carrier. The court noted that furthermore, “passenger” is used in conjunction with, and juxtaposed to, “traveling in interstate commerce” and said that the interstate commerce involved here is that of the railroads. Taxpayer’s transportation of railroad crewmembers is not part of ticketed travel between states, a circumstance that places its business activity outside the scope of 49 U.S.C. § 14505. The court said that the congressional purpose of correcting the Jefferson Lines decision comports with the reading that Congress intended to address passengers of a motor carrier who were traveling as passengers in interstate commerce. The court found that the railroad crew members are not “passenger[s] traveling in interstate commerce traveling by motor carrier” within the purpose of 49 U.S.C. § 14505(2), and if the crew members were not “passengers traveling in interstate commerce,” it followed that the taxpayer’s activity is not an integral part of the flow of commerce that Congress addressed in 49 U.S.C. § 14505. Renzenberger Inc. v. New Mexico Taxation and Revenue Dep't, New Mexico Court of Appeals, No. 34,999. 7/26/17 Property Tax Decisions Spouse Erroneously Assessed for Husband's Personal Property The Oregon Tax Court granted a taxpayer's property tax appeal, finding that the county assessor erroneously assessed the taxpayer for personal property that belonged to her estranged husband, who previously removed the property from her home. In August 2010, the taxpayer registered a diesel service business with her home as the business address. Her husband was a certified diesel mechanic and performed all duties of the business using equipment that included a truck with a box, an air compressor, and other tools. The taxpayer did not use the equipment and considered it to belong to her husband. She registered the business in her name at the request of her husband, who was then receiving financial aid contingent on his not working. Her husband left her home in August 2011 and removed all the equipment, at which time the business and its business license was not renewed. The issues here are whether the county’s assessment of the subject property to the taxpayer is in error and whether the court has jurisdiction to order a correction of the tax roll. The court noted that although the taxpayer initially believed the subject property was her home, it appeared more likely that it was personal property used by her husband in the business. Although title to her home was not in the business name or even in the taxpayer’s name, the tax account printout she attached to her appeal was addressed to the business, and although she pays property taxes on her home with her mortgage, the printout indicated a 2015 real market value of the home was $-0-. The taxpayer also reported that she had in her possession letters from the county identifying the subject property as a personal property account and the court said it was satisfied by a preponderance of the evidence that the subject property was personal property. The statute provides that the county has a duty to assess personal property to those persons owning or having possession or control over taxable personal property as of January 1 of the taxable year. The court noted that the taxpayer’s testimony showed that her husband owned the subject property and she did not have possession or control of it on January 1, 2012 and the assessment was in error. Before the court granted the relief requested, however, it discussed whether it had jurisdiction and reviewed the statutory appeal provisions. It noted that the taxpayer could not have appealed to the Board of Property Tax Appeals (BOPTA) because she did not own the property at issue here, a requirement of the statute. The court said that she was affected by the county’s action here because even though she did not own the property, the assessment made against her for the property tax was a personal liability and she, therefore, met the statutory conditions to appeal. The court found that although the taxpayer’s appeal was untimely, the county did not assert a timeliness defense. Failure to commence an action within the time limited by statute is a defense to be raised by a defendant, and that defense is waived if a defendant does not raise it. By failing to answer the taxpayer’s complaint, the county waived its defense of untimeliness. The court concluded that it had jurisdiction to award the taxpayer relief for the tax years in question, and found that the uncontested facts showed that she was entitled to relief. Griffith v. Douglas Cnty. Assessor, Oregon Tax Court, TC-MD 170083G. 7/31/17 Assessment of Taxpayers' Manufactured Home Set Aside The Illinois Appellate Court, Fifth District, reversed a decision by the state's Property Tax Appeal Board (PTAB) to assess and tax a manufactured home as real property for the 2011 tax year. The court found that a law that went into effect on January 1, 2011, did not show clear legislative intent of how to treat manufactured homes installed prior to the law's effective date, but not assessed for the previous tax year. Prior to January 1, 2011, mobile homes and manufactured homes were taxed as real property only if they were resting on a permanent foundation. All other mobile homes were subject to a privilege tax based on square footage. Effective January 1, 2011, all mobile homes and manufactured homes located outside of mobile home parks are taxed as real property. The law that went into effect in 2011 contains a “grandfather clause,” which provides that mobile homes and manufactured homes that were taxed as personal property on the effective date of the amendment will continue to be taxed as personal property until they are sold or transferred or moved to a different location outside of a mobile home park. At issue here is the applicability of this provision to a manufactured home that was installed before the effective date of the new law but was not assessed or taxed either as real property or as personal property in 2010. The taxpayers purchased a vacant lot in 2009 while they lived in Mississippi with the intention to install a modular manufactured home on the lot and live there. They were issued a building permit in September 2009 for a 3000 square foot manufactured home. In March 2010, they completed vehicle registrations for each of the three modules of the home with the Secretary of State and in April, they filed a vehicle use tax transaction return and paid sales tax for the home. They installed a manufactured home on their property in May or June of 2010, but did not comply with a requirement that they register the home with the local tax assessor within 30 days. The tax assessor ordinarily completes his assessments by July 1 of each year and did not conduct a new assessment of the taxpayers’ property after the manufactured home was installed, and the property was therefore assessed and taxed as a vacant lot in 2010. In June 2011, the township assessor performed an assessment of the property and believing that the home on the property was a stick-built house, assessed it as real estate. The taxpayers filed an appeal. The PTAB upheld the assessment, finding the fact that the petitioners failed to register their manufactured home was decisive and, upon further appeal, the circuit court affirmed this decision. The taxpayers filed this appeal, arguing that because their home was installed before the effective date of the new law, it should be taxed and assessed under the old law. A memorandum from the Illinois Department of Revenue (DOR) explaining the implementation of the new legislation at issue in this appeal was admitted into evidence at the administrative hearing and specifically addressed the assessment and taxation of mobile or manufactured homes that were installed “after the assessment cycle was completed” in 2010 and were “not on the tax rolls.” The memo provided that DOR advised that these homes should be assessed uniformly with other mobile and manufactured homes in the county as provided in the Property Tax Code and Mobile Home Local Services Tax Act in effect for assessment year 2010. The PTAB hearing officer issued a final administrative decision and noted that it was undisputed to the taxpayers’ home was a mobile or manufactured home, that it was placed on their property in May or June 2010 and that the property was assessed as a vacant lot in 2010. The hearing officer found credible evidence that the water and electric service and usage began during 2010, but found that the crucial issue was the fact that the home was never registered as required by the Mobile Home Local Services Tax Act, a prerequisite to taxation under that act, and concluded that the home was properly taxed as real property. The court here began its analysis of the 2011 law change by discussing the rules of statutory construction. Beginning January 1, 2011, the new legislation eliminated the distinction between mobile homes resting on permanent foundations and those not resting on permanent foundations and provided that all mobile homes and manufactured homes installed outside of mobile home parks on or after its effective date were to be assessed and taxed as real estate. At issue in this matter is a “grandfather clause” for mobile homes that were assessed and taxed as personal property under the Mobile Home Tax Act before the new law went into effect. Three relevant statutes address the taxation of mobile homes and manufactured homes that were taxed as real property before the new law went into effect and provide that they continue to be taxed as real property and manufactured homes that were taxed as personal property under the Mobile Home Tax Act prior to the effective date of the new law continue to be taxed under that act. None of the provisions address the assessment or taxation of mobile homes or manufactured homes that were installed prior to the effective date of the new law but not taxed or assessed under either provision of the old law because they were installed after the local assessor completed assessments for the year. The taxpayers’ home was not taxed either as real property or as a mobile home prior to January 1, 2011. The court concluded that the legislature failed to address that particular situation and presumed that this omission was a legislative oversight. The county argued that any ambiguity created by this omission should be resolved in favor of a less preferential tax treatment, but the court said that consideration of the interpretation given to this legislative scheme by one of the agencies charged with administering it, DOR, lead the court to a different conclusion. The guidelines supplied by DOR directed local taxing authorities to treat mobile homes that were not on the 2010 tax rolls the same way similar mobile homes that were on the tax rolls were treated. The court noted that, prior to the taxpayers’ challenge in this case, the county supervisor of assessments appeared to agree with the interpretation of DOR. The court said that the home was not on the county tax rolls for 2010 because it was installed too late for it realistically to be assessed before the assessment cycle was complete, and, as such, fit squarely within the category addressed by the DOR’s memorandum. The relevant statute in effect in 2010 required the owners of “inhabited mobile homes” to file a registration with the local tax assessor within 30 days after initial placement of the home, and the county argued that the taxpayers’ failure to comply with this requirement was dispositive. The court said that it could find no language in the statute to support the hearing officer’s finding that the registration was a prerequisite to eligibility for the privilege tax, finding instead that the statute makes it clear that assessing officials must assess and tax property according to its proper classification regardless of whether homeowners comply with the registration requirement. The court also noted that failure to comply with the registration requirement is a Class A misdemeanor and said holding that the petitioners’ home must be assessed and taxed at a higher rate than would otherwise be applicable on an ongoing basis would be an arbitrarily harsh penalty for a minor infraction. Jones v. Property Tax Appeal Bd., Illinois Appellate Court, Fifth District, No. 5-16-0199; No. 14-MR-25. 8/1/17 Other Taxes and Procedural Issues Tobacco Products Tax Act Violation Case Remanded The Michigan Court of Appeals reversed and remanded a case, finding that the evidence offered by the parties to the dispute presented a factual dispute making the motions for summary judgment inappropriate. The matter involved the Department of Treasury's (Treasury) seizure of tobacco products from a wholesaler for violation of the Tobacco Products Tax Act (TPTA). On November 3, 2014, the Michigan State Police, acting on behalf of Treasury, conducted an inspection of the taxpayer’s facility in Oak Park, and, after observing various purported violations of the TPTA, seized approximately $77,000 in OTP from the taxpayer. The taxpayer appealed this action and Treasury conducted a hearing to determine whether the OTP had been legally seized and should be forfeited to the state. Treasury argued, in part, that the taxpayer violated MCL 205.426(6) by possessing OTP that failed to identify the first purchaser of the product and asserted that law enforcement therefore properly seized the OTP and that it should be forfeited. The taxpayer argued that it purchased the OTP from Basik Trading, that Basik had removed the required labels, that the taxpayer had invoices to prove that the purchases were made legally, and that the product should be returned. The hearing referee concluded that the seizure and forfeiture were lawful and that the product should not be returned, reasoning that it was undisputed that the OTP lacked the required markings, so the OTP was lawfully seized and subject to forfeiture under the statute. The referee’s recommendation was adopted in a Decision and Order of Determination issued by the Treasury and the taxpayer filed an appeal to the circuit court that concluded that the OTP lacked the name and address of the person making the first purchase, but noted that Treasury had conceded that the required taxes had been paid on the product, thereby overcoming the presumption in the statute that the OTP was held by the taxpayer in violation of the TPTA. As a result, the court concluded that the taxpayer was entitled to a return of the OTP. The taxpayer contended that the OTP had gone stale or deteriorated while in the care of the Treasury and argued that it was therefore entitled to the monetary value of the seized OTP, which it asserted consisted of approximately $77,000 in product value and about $24,000 in taxes paid. The Treasury argued that the circuit court only had jurisdiction to order the return of the product, and that, alternatively, the taxpayer was only entitled to the base amount of the product, not a return of the product’s value plus the taxes paid on it. The circuit court held that, due to spoilage, the taxpayer was entitled to receive the value of the product, but because the court said the taxpayer as equally at fault for the spoilage, it only awarded it half the product’s value and rejected the argument that the taxpayer was entitled to a return on the taxes paid on the product. The court quoted a prior case for the proposition that the TPTA is a revenue statute designed to assure that tobacco taxes levied in support of the state’s schools are not evaded. In order for the seizure of the tobacco products by the state police to be legal, the possession of the OTP must have violated the TPTA, and Treasury argued that the seized OTP did not have labels identifying the first purchaser or a tax stamp as prescribed by the Department and required by the statute. The court reviewed the appropriate statutory provisions in this area and concluded that if an unclassified acquirer like the taxpayer has possession of OTP “without proper markings,” including labels identifying the first purchaser, the presumption is that the tobacco product is kept in violation of this act, and because the OTP in this case indisputably failed to identify the first purchaser or to have a stamp affixed to it as prescribed by Treasury, the taxpayer’s possession of the OTP was a presumed violation of the TPTA, making it subject to seizure. The court then turned to the issue of whether the OTP seized here should have been forfeited. It said that the statute clearly provides that forfeiture is not automatic, but is merely subject to forfeiture. Because the taxpayer made a timely appeal to Treasury and then to the circuit court, the OTP could not be forfeited for failure to appeal. The court noted that at the circuit court, the taxpayer presented evidence allegedly showing that it had paid taxes on the seized OTP, including invoices that it argued showed who it had acquired the seized OTP from and why the seized OTP lacked the proper markings. In response, Treasury contended that without the required markings on the OTP, i.e., the labels identifying the first purchaser, it could not conclusively determine whether the taxes had actually been paid on the seized OTP or whether they were paid on some other OTP, and in support of this argument attached an affidavit from a state police trooper who stated that without the shipping labels there was no way for him to determine whether the seized OTP came from Basik. The court found that although the taxpayer presented evidence that allowed an inference that the seized OTP came from Basik and that it had paid taxes on the seized product, Treasury rebutted that evidence with the trooper’s affidavit explaining the inherent deficiency of that evidence, and as a result, there was a factual dispute with regard to whether the presumption in the statute could be rebutted by the evidence submitted by the taxpayer. Because of this factual dispute, the court held that summary disposition was inappropriate and remanded the matter to the circuit court to hold an evidentiary hearing to determine whether the taxpayer could rebut the presumption that it possessed the OTP in violation of the TPTA. The court said that in order to rebut the presumption, the taxpayer must present evidence establishing that it lawfully obtained the OTP and that it properly paid taxes on the seized OTP. If the circuit court finds that the presumption in the statute was rebutted, it may order the return of the seized OTP. Otherwise, the property must be forfeited. Value Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 331581; LC No. 2015-144863-AA. 8/1/17 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]. |
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:
July 21, 2017 Edition
NEWS Arkansas Judge Fails to Pay Taxes, Facing Disciplinary Action, Felony Charges An Arkansas circuit court judge has allegedly failed to file tax returns and pay taxes due and now faces disciplinary action and several felony charges. He is accused of filing only four tax returns over the last 22 years according to a news release issued by the Arkansas Judicial Discipline and Disability Commission. The matter is a result of his 2015 divorce litigation during which he testified that he had not filed tax returns for most years since 1995, when he said he did not have enough money to pay the taxes due and “panicked.” He was elected to the county circuit court in 2009. MTC Proposal for Voluntary Disclosure for Marketplace Sellers The Multistate Tax Commission (MTC) Nexus Committee will be considering at its July 31, 2017 meeting in Louisville, Kentucky approval of a limited-time voluntary disclosure proposal for marketplace sellers (such as Amazon FBA sellers) with nexus, allowing those coming forward to register and comply prospectively with sales/use tax collection and income/franchise tax obligations (if applicable), in return for relief from back tax liability or at least a shortened lookback period. Information on the states considering participation, terms and timeframes for the proposal under consideration are available in the report on the agenda for the July 31 Nexus Committee meeting, downloadable from the MTC website at www.mtc.gov under the 50th Annual Meeting materials, here: http://link.taxadmin.org/mtcnx. For more information, please contact the MTC Nexus Program Director, Richard Cram, at email address [email protected] or telephone number 202-695-8139. Notice Issued Upon Conclusion of MTC Litigation On July 12, 2017, the Michigan Department of Treasury issued a release following the conclusion of the litigation over the Multistate Tax Compact's alternative apportionment formula election, discussing DOT’s audit policy, pending litigation on the issue and how informal conferences being held in abeyance pending the outcome of the litigation will be handled. The release can be found at http://link.taxadmin.org/7d9e Business Owner Sentenced in Cigarette Evasion Scheme A Massachusetts business owner was sentenced to a year and a day in prison in a U.S. District Court in Boston for evading federal income taxes and defrauding the Commonwealth of Massachusetts of millions of dollars in connection with the sale of cigarettes and other tobacco products. The taxpayer was also ordered to pay a fine of $30,000, pay restitution, and forfeit all property involved in the offense, including a warehouse-full of tobacco products and over $160,000 seized during the investigation. He was one of three people who operated a wholesale business that sold tobacco products, including cigars, smoking tobacco and smokeless tobacco to convenience stores, gas stations and other retail businesses. The Commonwealth imposes excise tax at the wholesale level on smokeless tobacco, smoking tobacco and cigars. The defendants in this matter repeatedly purchased smoking tobacco, smokeless tobacco and cigars in Pennsylvania, where no taxes are imposed on these products and then transported the products to the state for resale without filing the required reports and paying the tax. U.S. SUPREME COURT UPDATE No cases to report. FEDERAL CASES OF INTEREST Scheduling Order Issued in PTIN Matter The U.S. District Court for the District of Columbia has issued a post-judgment scheduling order in the class action suit regarding the IRS’s fees charged for the issuance of preparer tax identification numbers (PTINs). The court on July 7, 2017 ruled that the IRS cannot charge fees for the issuance or renewal of PTINs and ordered the government to refund all PTIN fees paid since September 1, 2010. The order set forth time limits for class members to obtained their PTIN and paid fees after August 20, 2016 and did not receive notice of the pending suit to file their claims. The order also set time frames for submitting a plan for attorneys fee and costs and for the IRS’s payment of the refund for the PTIN fees. Adam Steele et al. v. United States, U.S. District Court for the District of Columbia, No. 1:14-cv-01523. 7/10/17 DECISION HIGHLIGHTS Sales and Use Tax Decisions Crane Operator's Use Tax Assessment Affirmed The Louisiana Court of Appeals, First Circuit, affirmed, in part, a decision upholding a crane operator's use tax assessment and denial of claim for refund. The court reversed and remanded the decision to determine the amount of credit to which the taxpayer was entitled. The taxpayer owned and operated a company, which leased cranes to different entities. Its principal place of business was in Oklahoma but it also operated in Texas and imported large cranes into Louisiana for use on various jobs in several parishes, and in 2004, it leased space at a yard in Ascension Parish to store some of its cranes. The taxpayer was audited by the parish for use tax on its cranes in Ascension Parish for the tax period from December 1, 2000 through June 30, 2004. The parish later filed suit to collect those taxes and the parties settled the claims for a lump-sum settlement of 250,000, memorialized in a Settlement Agreement. After the settlement, the taxpayer continued to use the storage yard in Ascension Parish and imported cranes to perform jobs or be stored there. The taxpayer was audited for a second time for the tax period from July 1, 2004 through December 31, 2008, and was assessed taxes for nine cranes owned by it. It is this audit and its findings that are the basis of the issues involved in this matter. The taxable moment for a use tax occurs when out-of-state purchased goods have been withdrawn from interstate commerce and come to rest in the state, imposed on the “cost price” defined as the actual cost of the article of tangible personal property. The statute provides that a taxing authority grant the taxpayer a credit against the use tax for sales or use tax previously paid by the taxpayer to another taxing jurisdiction on the same article of personal property, thereby preventing multiple taxation by multiple jurisdictions. The nine cranes at issue here incurred a taxable use in the parish and, therefore, absent some exclusion or exemption, the taxpayer owed use taxes on the "cost price" of those cranes, subject to any credit. The taxpayer claimed it was owed a credit for taxes it paid to other similar taxing authorities through self-assessments and as a result of various settlements, including the settlement of the earlier audit with the parish. The taxpayer filed a petition to appeal the Authority's tax assessment and the denial of its claim for refund. The trial court ruled for the parish and the taxpayer filed this appeal noting eight separate assignments of error made by the trial court. The taxpayer argued that five of the nine cranes were improperly taxed by the Authority because they were part of a transaction referred to as the Saw Mill Transaction and were subject to the isolated and occasional sale exclusion. The taxpayer characterized the Saw Mill Transaction as a sale for sales tax purposes, and it contended that the isolated and occasional sales tax exclusion applies, and if no sales tax could be imposed, the use tax cannot be imposed on an article of tangible personal property. The taxpayer argued that the isolated or occasional sale classification is an exclusion, not an exemption, and therefore is construed liberally in its favor as the taxpayer and against the taxing authority. The court found that the taxpayer failed to prove that it was entitled to the isolated or occasional sale exclusion, even assuming for the purposes of this appeal that the Saw Mill Transaction was a sale. While documents supporting the Saw Mill Transaction were entered into evidence at trial, the court noted that the CEO of the taxpayer who was the main signatory on these documents did not testify at the trial and no testimony or documentary evidence was offered to establish what the taxpayer was regularly in the business of doing when the Saw Mill Transaction took place. The taxpayer and the taxing authority signed a Settlement Agreement, which settled the earlier lawsuit filed by the Authority against the taxpayer for the tax period from December 1, 2000 through June 30, 2004. The taxpayer argued that the settlement extinguished the Authority's right to impose use tax for the tax periods on five of the nine cranes sought to be taxed in this suit. The trial court did not find that the settlement extinguished use tax claims as to certain cranes because the Settlement Agreement was silent as to which cranes were involved. The trial court also noted that the Settlement Agreement was silent as to what part of the $250,000 payment, if any, represented taxes, penalties, interest, attorney's fees, audit costs, or any other items. The taxpayer argued that because the settlement resolved all claims that were or could have been asserted, any claims the Authority may have had for use tax on five of the nine cranes it alleges were in Ascension Parish at the time of the audit were satisfied. It relied on the testimony of a former employee who contended that the settlement agreement included the five cranes because they were present in the parish during the first audit period. The court noted, however that the agreement did not specifically identify any cranes subject to the agreement. The Authority testified that it attempted to perform the audit after an auditor observed cranes in the parish and the Authority encouraged the taxpayer to provide documentation for all the assets in the parish. When the taxpayer failed to do so, it made an estimate of the tax due that resulted in a final assessment subject to the settlement agreement. The Authority contended that it could not grant the taxpayer credit for taxes paid on the cranes allegedly involved in the settlement because the taxpayer did not prove that use taxes were paid on those cranes through the settlement, and it did not have records at the time of the settlement that would have enabled it to determine how many and /or which cranes were in the parish during the first audit period. The court said it could not say that the trial court's finding that the taxpayer was not entitled to any credit for taxes paid to the Authority for any portion of the settlement from the first audit was manifestly erroneous, noting again that the Settlement Agreement was silent as to which cranes it covered and as to which part, if any, of the settlement was for taxes as opposed to penalties, interest, attorney's fees, and audit costs. The taxpayer also contended that the trial court erred by failing to give it the appropriate credits for all sales and use tax it paid on each crane to other local taxing jurisdictions, arguing that the trial court erred in imposing a requirement that the taxpayer must file refund claims for all previous taxes paid for which it wished to receive a credit. The taxpayer argued that the trial court erred in affirming the Authority's assignments of credits for tax paid by it to other local taxing jurisdictions based on the dates that the taxpayer paid the tax, instead of on the dates the tax was allegedly due and payable. The court discussed the statutory provisions setting forth credit for taxes paid to other jurisdictions, as well as the rules of statutory construction and the testimony at the trial court level from taxpayer’s witness and the Authority’s witness. The court found the trial court erred in reading the state statute to require the taxpayer to file claims for refunds, saying that it did not apply to the circumstances of the case because the use taxes assessed by other parishes and the sales tax assessed by Texas on the cranes were for different taxable moments, concerned different events, and were paid to the correct taxing authorities. The court found, however, that the taxpayer’s argument that the Authority erred when it based the credits on payments of taxes instead of when the taxes were due and payable, had no merit because the language of the statute expressly refers to "taxpayers who have paid," "the taxing authority to which a similar tax has been paid," monies "paid," "whether or not paid in error," and "for which the taxpayer has paid a similar tax." The judgment of the trial court was affirmed insofar as it upheld the assessment of use tax on and the denial of a claim for refund by the taxpayer but was reversed insofar as it determined that the total credits to which the taxpayer was entitled and the court remanded the matter for the trial court to determine the credits. Turner Bros. Crane and Rigging LLC of Delaware v. Ascension Parish Sales and Use Tax Auth., Louisiana Court of Appeals, First Circuit, 2016 CA 0673; No. 106791 Div. E. 7/5/17 Proper Audit Procedures Used The Indiana Tax Court held that the state Department of Revenue (DOR) used proper methods and procedures when auditing and assessing a heating equipment manufacturer for sales and use tax. The taxpayer is a manufacturer of heating equipment and is located in the state. In July of 2010, DOR notified it that in August it would be conducting a compliance audit for tax years 2007 through 2009 and indicated that it would need access to, among other things, the taxpayer’s federal income tax returns, sales reports showing total and exempt sales, and withholding tax forms. At the taxpayer’s request the audit start date was postponed several times and, in the meantime, the taxpayer did not provide DOR with any of the requested documents. In January 2011, DOR sent the taxpayer a letter stating that it was necessary for the audit to be completed by the end of the month and warned that if the requested records were not forthcoming, it would complete the audit based on the “best information available.” There was no further communication between the taxpayer and DOR until April of 2011 when the DOR issued both an audit summary and Proposed Assessments against the taxpayer imposing approximately $70,000 in sales and use tax liabilities for the 2008, 2009, and 2010 tax years based on figures DOR extrapolated from the taxpayer’s 2007-2009 federal tax returns. The taxpayer protested the Proposed Assessments, claiming that they were void as a matter of law because DOR did not follow the statutorily prescribed audit procedure. In the alternative, the taxpayer claimed that the amount of the tax liabilities set forth in the Proposed Assessments were improper because they were based on certain erroneous mathematical calculations. After an administrative hearing DOR issued a Letter of Findings in which it denied taxpayer’s void as a matter of law argument, but granted that portion of taxpayer’s protest relating to the propriety of the mathematical calculations subject to a supplemental audit. DOR conducted a supplemental audit and issued revised Proposed Assessments that reduced the taxpayer’s total sales and use tax liabilities for the years at issue. The taxpayer filed an original tax appeal on October 19, 2011 and in 2013 while the case was pending, DOR conducted a second supplemental audit and further reduced the assessments. Pursuant to the state statute, DOR when conducting an audit may inspect any books, records or property of any taxpayer which is relevant to the determination of the taxpayer’s tax liabilities. Taxpayers are obligated to keep books and records to enable DOR to determine the amount of tax due and must allow inspection of his books, records, and returns by the DOR at all reasonable times. When the taxpayer fails to maintain or provide DOR with its records, DOR may determine the taxpayer’s tax liability based on the best information available to it. During the course of its audit, DOR may subpoena the production of documents and witnesses and may enforce its audit by petitioning for a court order. The taxpayer initially argued that DOR’s proposed assessments were void because it was mandated, and failed, to get a subpoena and court order before it could complete its audit. The court rejected this argument, noting that the use of the word “may” in these statutory provisions indicates that while DOR has the power to both issue and enforce a subpoena, it is not required to exercise either of those powers before proceeding with its audit. The taxpayer also asserted that DOR’s power to conduct a best information audit can be exercised only after it has formulated a reasonable belief that a taxpayer has underreported its sales and use tax liabilities, arguing that because DOR indicated in July of 2010 that it was conducting a compliance audit, it would not have had any reasonable belief at that time that the taxpayer had underreported its sales and use tax liabilities. The court held that the taxpayer misconstrued the statute upon which it relies, pointing out that the statute simply provides that if DOR reasonably believes that a person has not paid the proper tax due, it shall make a proposed assessment on the basis of the best information available. The court said that in this case DOR issued its proposed assessment because the only information available, the taxpayer’s federal income tax returns, lead it to reasonably believe that the proper tax had not been paid. The court found that DOR’s action was proper because the taxpayer did not provide DOR with access to any of its requested books and records. Finally, the taxpayer argued that the expansion of the audit to tax year 2010 was void as a matter of law because it violated its constitutional right to procedural due process since DOR never requested documents for that year. The court held that the evidence before it indicated that the taxpayer had not suffered any procedural due process violation with respect to DOR’s 2010 Proposed Assessment. While the taxpayer may not have known that 2010 “was on the table” before it received the Proposed Assessment for that year, it acknowledged that prior to suffering any deprivation of its property, it was given the opportunity to protest the 2010 Proposed Assessment and to present evidence contesting that Proposed Assessment at an administrative hearing. The court noted that since then, the taxpayer has not only filed an appeal with the court challenging the 2010 Proposed Assessment, but also received another opportunity to present DOR with evidence related thereto during the second supplemental audit and found that due process had been satisfied. Thermo-Cycler Indus. Inc. v. Dep't of Revenue, Indiana Tax Court, Cause No. 71T10-1110-TA-00062. 6/15/17 Personal Income Tax Decisions Taxpayer Entitled to Net Capital Gain Deduction The Oklahoma Supreme Court has determined that a taxpayer's sale of stock assets constituted a sale of an indirect ownership interest and, therefore, qualified for the capital gain deduction. In November 2004, state voters passed State Question 713-Legislative Referendum 336, which implemented certain changes to the state’s Tax Code, including an income tax deduction for net capital gains derived from in-state property and business sales. Specifically the law authorized a deduction for selected capital gains that were included in a taxpayer's federal adjusted gross income for the relevant taxable year and was available for "taxable years beginning after December 31, 2004. In 2007 the legislature enacted legislation that it said clarified the income tax exemption for certain capital gains contained changes and was applicable to tax returns filed after December 31, 2004. This section modified the capital gain deduction to clarify holding period requirements as well as the treatment of capital gains that arise when intangible assets are sold. The taxpayer held a small percentage of stock in two Oklahoma S-corporations and the companies sold substantially all of the corporate assets to a third party. The sale of companies' assets included both tangible and intangible property interests. In 2008, the taxpayer filed a U.S. Individual Income Tax Return and an Oklahoma Resident Income Tax Return for tax year 2007. Both returns included pass-through income from the sale of the companies' assets. The taxpayer designated the income as a capital gain on his federal return, but his Oklahoma return listed an adjusted gross income (AGI) of $10,271,884.00. No net capital gain deduction was claimed on the original Oklahoma return, and the taxpayer’s total tax liability for 2007 was $539,431.00. In 2012 he filed an amended federal return reducing his AGI due to proceeds attributable to the companies’ sale, which were held in escrow and were not constructively received until after the 2007 tax year. He later filed an amended state return noting the reduced federal AGI and claiming an "omitted capital gain deduction" of $5,691,896.00. This resulted in a tax overpayment and a refund due. On September 18, 2012, the Oklahoma Tax Commission (OTC) sent an adjustment letter to the taxpayer notifying him that the agency had disallowed the net capital gain deduction, denying those amounts connected to the sale of the companies' goodwill. The taxpayer timely filed a formal protest of OTC's adjustment. The administrative law judge ruled for the OTC denying a net capital gain deduction for the sale of companies' goodwill. On March 24, 2016, OTC entered an order adopting the ALJ's findings of fact and legal conclusions and the taxpayer filed this appeal. The court began its analysis with an examination of the statutory provision in effect at the time the companies’ assets were sold. That provision stated that for taxable years beginning after December 31, 2004, a deduction from the state adjusted gross income of any individual taxpayer shall be allowed for qualifying gains receiving capital treatment that are included in the federal adjusted gross income of the individual taxpayer. Qualifying gains receiving capital treatment was defined to means the amount of net capital gains defined in Section 1222(11) of the IRC and included in an individual taxpayer’s federal income tax return resulted from the sale of real or tangible personal property located within the state owned by the taxpayer for at least five years. The OTC did not dispute that the sale of the companies' goodwill resulted in a net capital gain, which was included on the taxpayer’s federal income tax return. The court said that because the transaction in this case involved the sale of companies' assets rather than stock, the dispositive issue was whether the taxpayer’s capital gain resulted from the "sale of a direct or indirect ownership interest in an Oklahoma company" per § 2358(F)(2)(a)(2). The court held that the inclusion of the terms "direct or indirect" preceding "ownership interest" eliminated any question about the taxpayer’s entitlement to the deduction. The court said that § 2358(F)(2)(a)(2) clearly allowed a net capital gain deduction for either the sale of stock/equity or company assets. The court said that OTC consciously disregarded the terms "direct or indirect" and the impact of those terms on the sale of an ownership interest. Indirect ownership means the individual taxpayer owns an interest in a pass-through entity that sells the asset that gives rise to the qualifying gains receiving capital treatment. The court noted that section 2358(F)(2)(a)(2) placed no limitations on what particular pass-through company assets qualify for the capital gain deduction, with the only limitation that any earnings realized must qualify for capital gain treatment under the IRC. Because the companies were S-corporations, pass-through entities for purposes of taxation, the sale of companies' assets amounted to the sale of an indirect ownership interest under § 2358(F)(2)(a)(2). The taxpayer maintained his ownership interest for more than three (3) years preceding the sale of Companies' assets, and the court found that OTC, therefore, erred by disallowing the full net capital gain deduction claimed on his 2007 amended state return. The court said that although its holding was not premised on a finding that the 2006 version of the statute was ambiguous, its interpretation of the statute was bolstered by the 2007 amendment. The court agreed with the taxpayer that the 2007 legislative changes were intended to clarify the original enactment and to carry out the law's original purpose and in amending the statute, the legislature retained the introductory paragraph to § 2358(F), which kept the statute controlling for all individual tax returns filed in "taxable years beginning after December 31, 2004." The court found that the 2007 changes to solidified the court's belief that the legislature always intended to afford a deduction for net capital gains arising out the sale of an Oklahoma company's assets, including goodwill. Hare v. Oklahoma Tax Comm'n, Oklahoma Supreme Court, Case Number: 114893; 2017 OK 60. 6/27/17 Corporate Income and Business Tax Decisions Adult Bookstore Lacked Nexus to Join Subsidiaries' Consolidated Returns The Iowa Court of Appeals has determined that a holding company for an adult bookstore chain that operated subsidiaries and managed its trademark could not join its in-state subsidiaries' consolidated state income tax returns finding that it lacked taxable nexus with the state. The court also held the in-state subsidiaries could not deduct interest expenses that the parent corporation paid. The taxpayer is a holding company that owns and operates numerous subsidiaries as well as the company’s trademark. Each individual subsidiary performs a function in the overall business. Some own RomantixTM adult book stores, nine of which are located in Iowa. Another subsidiary, Romantix Inc. (Inc.), acts as a management company. All the revenue from the stores is transferred to Inc. daily, and Inc. then uses this money to pay the stores’ expenses. Another subsidiary, RMI Aviation (RMI), owns an airplane hangar and an airplane, which is used by the stores located in the Midwest for business travel. The holding company/taxpayer does not, by itself, sell products or provide services in Iowa. At issue here are the 2009 and 2010 consolidated Iowa income tax returns of the Iowa Subsidiaries. The 2009 Iowa consolidated return included the holding company and all of its subsidiaries, including non-Iowa subsidiaries, but did not include the interest and amortization as expenses for the subsidiaries because the entirety of the expense was allocated to the holding company. The 2010 consolidated Iowa return included the Iowa subsidiaries, but not the holding company, and the interest and amortization expenses were allocated to the Iowa Subsidiaries based on a percentage of revenue approach. DOR disallowed the expenses, and the taxpayers filed a protest. The administrative law judge (ALJ) reversed DOR’s income tax assessments pertaining to the expenses and DOR appealed the ALJ’s proposed decision to the Director who issued a final order ruling that the holding company should not be included on the Iowa Subsidiaries’ consolidated Iowa income tax returns and that the Iowa Subsidiaries were not allowed to deduct the holding company’s acquisition debt and covenant not to sue expenses because the subsidiaries did not owe and did not pay the expenses. The taxpayers filed an appeal and the district court held that the Director’s finding that Iowa Subsidiaries did not owe the acquisition and covenant not to compete debt was not supported by substantial evidence and remanded the matter to the Director to give more specific reasoning for his decision. The district court affirmed the Director’s finding that the holding company was not subject to Iowa income tax and was therefore prohibited from being included in the Iowa Subsidiaries’ consolidated tax return. On remand, the Director ordered that the Iowa Subsidiaries were not entitled to deduct interest and amortization expenses related to redemption of the holding company’s stock. The taxpayers again filed a petition for judicial review, which was denied by the district court and this appeal was filed. The taxpayers argued that because the Iowa subsidiaries do business within the state, the holding company, in effect, also does business within the state and should, therefore, be included in the consolidated state tax returns. They argued that the holding company directly owned intangible property that was utilized by its subsidiaries in their Iowa business activities. The court noted that the Iowa Supreme Court had recently rejected a similar argument in Myria Holdings Inc., ___ N.W.2d at ___, 2017. Based upon the court’s ruling in Myria Holdings Inc., the court said it was clear the Iowa Subsidiaries and their intangible property are not enough to establish a taxable nexus with Iowa sufficient to remove it from the safe harbor. The court said that like Myria, by electing to have the Iowa Subsidiaries taxed as corporations, the holding company chose to receive not only the tax advantages of corporate taxation but any disadvantages as well, and all of of the holding company’s activities with its subsidiaries doing business in Iowa in the relevant tax years were activities of owning and controlling a subsidiary corporation within the meaning of Iowa Code section 422.34A(5). The court held that because the holding companylacked a taxable nexus with the state in the relevant tax years, DOR correctly concluded it could not join the consolidated return. The taxpayer then argued, alternatively, that even if the holding company was not included, the subsidiaries were responsible for and paid the disputed expenses and should be able to claim them. They asserted that the holding company allocated the disputed expenses to the in-state subsidiaries for tax purposes, but the court said that mere allocation was not sufficient under the state’s taxation structure and is not binding on the state for tax purposes. The court found that upon review of the record, it was clear DOR’s position was that expenses not owed and paid by the subsidiaries could not be claimed as expenses of the subsidiaries and noted that nothing in the record indicated the taxpayers ever claimed, until the hearing, that the Iowa Subsidiaries paid the disputed expenses. The court said that DOR could not formally reject an assertion that was never made by the taxpayers and they had the burden of proving that the in-state subsidiaries actually paid the disputed expenses. The court agreed with the lower court’s conclusion that even if the internal allocation of the amortization expense amongst the in-state subsidiaries constituted “payment” of the expenses, DOR was correct in disallowing the deductions because the amortization expenses were not a “necessary and reasonable expense” of the subsidiaries in generating taxable income. Romantix Holdings Inc. v. Dep't of Revenue, Iowa Court of Appeals, No. 16-0416. 5/3/17 Property Tax Decisions Oil Producer's Exemption Denied The Kansas Court of Appeals has determined that a taxpayer’s equipment used in low-production oil wells was not part of an oil lease and was not exempt from property taxes. The taxpayer leased an oil and gas interest on land that his parents owned. After the death of his mother, ownership of the land transferred by operation of a transfer on death deed. In two prior cases, the court examined whether the oil lease was terminated by operation of law under the merger doctrine. The issue in this case, however, relates to the family’s receipts of a tax exemption for low production leases under the state statute. The Board of Tax Appeals (BOTA) found the term "oil lease" included wells operated by the surface owner and found the taxpayers’ low production oil wells exempt. But after they obtained that tax exemption, the county assessed a tax on the equipment they used to produce oil from those exempted low production wells and the taxpayer filed an appeal to BOTA, arguing that equipment is defined as personal property in the statute and is part of an oil lease and is, therefore, exempt. The county objected and asserted that a hearing was necessary because no authority had conclusively addressed whether equipment is part of an oil lease for purposes of the low production tax exemption. The taxpayers asserted that the county’s opportunity to dispute the meaning of "oil lease" had lapsed because it had not appealed the exemption order. BOTA held a hearing and concluded that equipment is not included in the term "oil lease" as that term is used in the exemption for low production leases under K.S.A. 2016 Supp. 79-201t(a). The taxpayers filed this appeal. The court first addressed a number of procedural issues raised. The taxpayers contended that the county erred in relying on an oil and gas appraisal guide that that provided that the royalty interest and production equipment did not qualify for the exemption because its conclusion is not supported by legal authority. The court noted that case law and the statute did not expressly address the equipment issue raised in this case, but the guide specifically did. The court pointed out that the relevant statute states that the director of the DPV shall adopt "rules and regulations or appraiser directives prescribing appropriate standards for the performance of appraisals in connection with ad valorem taxation." K.S.A. 2016 Supp. 79-505(a). And the court noted that it may take judicial notice of any official state document prepared by a state official, including appraisal guides. The court found that the Oil and Gas Appraisal Guide which permits exemption of low producing oil leases, but not of the equipment used in such production, was consistent with K.S.A. 2016 Supp. 79-201t, and the county did not err in consulting it. The taxpayer also argued that the BOTA became an advocate for the county because it denied the taxpayer’s summary judgment motion despite the fact that the county filed no response to it. The court noted that while the statute states that a response must set out specific facts showing a genuine issue for trial, nothing requires a party to file a response to a summary judgment motion. Here, the uncontroverted facts had already been determined in the tax exemption hearing, and the parties agreed that the facts relating to this matter were uncontroverted. The only dispute remaining was whether the taxpayer’s equipment was exempt, and that issue presented a question of law. While the county did not file a response brief, BOTA accepted the county's written objection in lieu of a response. The court found that it would have been inappropriate as a matter of law for the district court to have granted the taxpayer’s motion despite the lack of a response by the county. The taxpayer’s primary argument in this matter is that the exemption for a low production "oil lease" under K.S.A. 2016 Supp. 79-201t(a) includes the equipment used in producing the oil from that lease. However, the court found that the relevant statutory provisions, read together, suggest that equipment is not part of an oil lease for purposes of the tax exemption at issue here. The tax statute provides that an oil lease "together with . . . tubing . . . and all other equipment" used to operate wells is personal property for purposes of taxation. The court found that this provision did not compel the conclusion that equipment is part of an oil lease for purposes of the relevant tax exemption. The court read the personal property statute as distinguishing between equipment and the oil lease itself. Matter of Barker, Kansas Court of Appeals, No. 116,034. Military Veteran's Property Tax Exemption Claim Denied The New Jersey Superior Court, Appellate Division, held that a military veteran had been was not entitled to the disabled veteran's property tax exemption finding her injuries resulting in the disability were not sustained during active service in time of war. In October 2002, the taxpayer suffered injuries during an Army training exercise, when she fell from a two-story building at an army facility in Missouri. The injuries did not preclude her continued military service, and she was transferred to Fort Stewart, Georgia, in March 2003, where she was assigned to a unit scheduled to deploy to Afghanistan. In light of her injuries, however, she was not sent overseas and remained at Fort Stewart, assigned to a support function for her unit in Afghanistan. During this period, she continued to train for potential deployment to Afghanistan as part of the military police. She was honorably discharged on December 20, 2003 and was declared 100 percent disabled by the United States Department of Veterans Affairs on May 21, 2014. The taxpayer submitted an application to the City of Millville claiming a disabled veteran's property tax exemption. The city’s Tax Assessor issued a notice of disallowance on June 26, 2014 and the taxpayer filed an appeal to the Cumberland County Board of Taxation, which concluded the exemption was properly denied. The taxpayer appealed to the Tax Court, which conducted a hearing and concluded the taxpayer’s injury was not suffered "in direct support" of military operations in Afghanistan, pursuant to the statutory exemption. This appeal was filed. The state statute provides two types of property tax benefits for veterans. The first is a partial deduction for veterans, honorably discharged, who served in “active service in time of war,” and the second is a total exemption for veterans, honorably discharged, who served in "active service in time of war," and who have been declared disabled as a result of their service. The term "active service in time of war" is defined in N.J.S.A. 54:4-8.10(a) and is used to determine eligibility for both the ordinary and disabled veterans exemptions. The legislature listed sixteen separate military conflicts, starting with the Civil War up to Operation Iraqi Freedom, encompassed within the definition of "active service in time of war, " to discern eligibility of disabled veterans seeking tax exemptions and deductions. The court said that the only question in this matter is whether the taxpayer’s disability resulted "from active service, in time of war." Many of these periods of war or conflict set forth by the legislature are defined with a beginning and end date during which the disabling injury must occur, regardless of cause or location. Recent military conflicts were more narrowly circumscribed and the one applicable to the taxpayer’s time of service requires service after September 11, 2001, in a “theater of operation and in director support of that operation” and an injury or disability incurred while engaged in that service. The court rejected the taxpayer’s argument that the benefits were intended by the legislature to be extended without regard to geographic limitations, finding instead that the statute circumscribes the definition of “active service in time of war” limiting eligibility to those injured in a theater of operation and in direct support of that operation. The court said this limitation was purposeful. The court said that members of the military who are physically present on the battlefield during a military conflict serve in the theater of operation of that conflict within the meaning of the statute and it is this exposure to risk for the benefit of national security that warrants a property tax exemption for veterans who are 100% permanently disabled as the result of their military service. The taxpayer also argued for a "more balanced" interpretation of “direct support” of a “theater of operation,” contending that she was exposed to the experiences of war and, being disabled as a consequence of such service, as a matter of policy, should result in entitlement to the claimed tax relief. The court rejected that arguing, pointing out that exemptions from tax are strictly construed against those claiming them. It said it could not agree that the taxpayer’s injury experienced in a fall during her Missouri basic training or her role performing the Rear Detachment services performed in Georgia satisfied the statutory requisites of service "in a theater of operations and in direct support of that operation . . .." Fisher v. City of Millville, New Jersey Superior Court Appellate Division, No. A-3351-15T3. 7/7/17 Counties Can Retroactively Assess Tax on Underreported Property The Colorado Supreme Court ruled that a county properly assessed an oil and gas company additional property taxes for underreporting the selling price of carbon dioxide gas it extracted, finding that it had the authority to retroactively assess property taxes on oil and gas leaseholds. The taxpayer produces, transports, and sells carbon dioxide (CO2) for use in oil and gas operations and is the operator of a large CO2 deposit in the state, near the Four Corners area. At the time of the assessment the taxpayer owned a 50 percent interest in the pipeline company though which the CO2 is shipped. The pipeline company charged a fixed tariff to any entity that shipped CO2 through the pipeline and the taxpayer in calculating its wellhead selling price deduced the full 22-cent transportation tariff charged by the pipeline company. In 2009 the assessor for Montezuma County issued a corrective tax assessment on these leaseholds for the previous tax year, retroactively assessing over $2 million in property taxes, after an auditor concluded that the taxpayer underreported the value of gas produced at the leaseholds. This determination was largely based on the auditor’s discovery of the taxpayer’s 50% partnership interest in the pipeline company and the auditor concluded that the taxpayer and the pipeline company were “related parties.” The taxpayer argued that the assessor lacked authority to retroactively assess these taxes because the statutory scheme for property taxation of oil and gas leaseholds, which authorizes retroactive assessments when “taxable property has been omitted from the assessment roll,” does not authorize a retroactive assessment when an operator has correctly reported the volume of oil and gas sold but has underreported the selling price at the wellhead. An estate in minerals such as oil and gas is a form of real property and the owner of this mineral estate can lease the right to extract oil and gas from the land. Oil and gas leaseholds are subject to taxation as real property and are also subject to severance taxes assessed when the nonrenewable natural resources are removed. Section 3 of article X of the state’s Constitution limits the legislature’s ability to assess property taxes by requiring that taxes be based on the “actual value” of the property, but the legislature has the authority to prescribe appropriate methods for determining the “actual value” of property. For most types of real property, the legislature has required the county assessor to consider and document three approaches to determine the “actual value” of the property: the cost approach, the market approach, and the income approach. By contrast, oil and gas leaseholds and lands are valued under the provisions of article 7 of title 39. § 39-1-103(2), under which the holder of an oil and gas lease must submit an annual statement including a statement on the volume of gas or oil sold and the selling price of it “at the wellhead.” The court noted, however, that the sale of unprocessed oil or gas rarely occurs at the wellhead, but, instead, the oil or gas is typically gathered from multiple wells, processed, and transported away from the wellsite before sale. As a result, an operator typically must estimate its selling price at the wellhead by deducting from its final, downstream selling price the costs of gathering, processing, and transporting the extracted material. A leasehold operator’s netback calculation depends on whether the operator contracts with a related or an unrelated party to perform these gathering, processing, and transportation services. If the operator enters into a bona fide, arm’s-length transaction with an unrelated party to perform these services, then the operator may deduct the full amount paid for these services from its final, downstream sales price in its netback calculation. If it instead enters into a transaction with a related party to perform these services, then it may deduct only a portion of the amount paid for these services. The state’s Property Tax Administrator is required to prepare and publish guidelines providing procedures for county assessors to audit oil and gas leaseholds and under these guidelines an assessor may initiate an audit and request source documents regarding sales volume and sales price from which the operator prepared its annual statement. The assessor then determines whether a change in the property’s valuation is warranted and may issue a corrective assessment or abatement. The guidelines state that retroactive assessments are authorized under the statutes providing for assessments on property that has been previously “omitted from the assessment roll.” The Montezuma County Board of Commissioners denied the petitions filed by the taxpayer and it filed an appeal with the state Board of Assessment Appeals (Board), which held a hearing and affirmed the ruling of the Commissioners, concluding that the county had authority to issue the retroactive assessment and further concluded that the taxpayer and the pipeline company were “related parties” and the taxpayer was not entitled to deduct the full tariff in its netback calculation. The taxpayer filed an appeal to the court of appeals, which affirmed the decision of the Board. The taxpayer then filed this appeal. The court first considered whether the statutory scheme governing property taxation of oil and gas leaseholds authorized retroactive assessments when a leaseholder has correctly reported the volume of oil or gas sold but has underreported the wellhead selling price of the oil or gas and concluded that the statutory scheme authorized these retroactive assessments, given the self-reporting scheme for property taxation in this context and the legislature’s amendments to that scheme, which describe the “underreporting of the selling price or the quantity of oil and gas sold” from a leasehold as a form of omitted property. The court held that amendments to the statute in 1990 demonstrated the legislature’s intent to treat the underreporting of the selling price of oil and gas as omitted property under the statutory scheme governing oil and gas taxation by providing special procedures for handling taxes that had been retroactively assessed based on underreported selling price or volume. The court then considered whether the BTA erred in concluding that the taxpayer was not entitled to deduct the full price paid for transportation of gas because it and the pipeline company were “related parties,” and concluded that the 50 percent ownership interest in the pipeline company made then “related parties” and the taxpayer was not entitled to deduct the full price paid for transportation. Kinder Morgan Co2 Co. L.P. v. Montezuma Cty Bd of Comm’rs, Colorado Supreme Court, No. 15SC595. 6/19/17 Other Taxes and Procedural Issues Dispute Between Localities Over Tax Revenue From Airport Remanded The Georgia Supreme Court remanded a case to the trial court to consider whether sovereign immunity barred a city's lawsuit against a county for collecting 50 percent of the alcohol taxes on sales made in an airport located within both jurisdictions. The city claimed that the constitution prohibits the county from collecting taxes within the city’s corporate limits. This case involves the taxation of alcoholic beverages sold at Hartsfield-Jackson Atlanta International Airport (Airport), which is owned and operated by the City of Atlanta but is located primarily within Clayton County (County). Some of the many businesses located within the airport are located in the unincorporated sections of the County while others are located in the County within the incorporated limits of the City of College Park. The City of College Park filed a motion for summary judgment asserting that it has not been receiving the proper amount of alcoholic beverages taxes and that the County improperly infringed on its authority to tax by instructing vendors to remit to the County 50% of the taxes due from the sale of alcohol in those portions of the Airport located within the City limits. The County argued that the City’s claims were barred by sovereign immunity. The lower court granted the City’s motion for partial summary judgment, finding that neither the City or County can impose and collect alcoholic beverage taxes within the other’s taxing jurisdiction, and that the taxpayer defendants must submit tax monies only to the entity authorized to collect the funds. The court found further that once the City and the County have exercised the power to impose and collect taxes within these guidelines, the statute requires that they then remit to the other one-half of the collected proceeds. The County filed this appeal. The County argued that the trial court erred in denying its motion for judgment because it is entitled to sovereign immunity from suit and the City argued that sovereign immunity does not apply to its claims. The trial court said that it had carefully considered the law on sovereign immunity, including recent opinions cited by the County and found that sovereign immunity did not apply. The court here noted that none of the cases the trial court cited involved constitutional claims, but following the trial court’s ruling and while this appeal to the state supreme court was pending, the court decided Lathrop v. Deal, Ga. (Case No. S17A0196; decided June 19, 2017), which squarely addressed whether sovereign immunity bars a claim involving the alleged violation of the Constitution other than a takings claim for just compensation and the court concluded that such a claim is barred and reiterated that the State and its officials in their official capacities cannot be sued without consent. As a result of this ruling, the court said that the trial court’s holding that sovereign immunity did not apply for the reason argued by the City is erroneous. However, the court noted that there is a threshold question of whether sovereign immunity applies at all in suits between political subdivisions of the same sovereign, a question that the trial court did not address and the parties did not adequately briefed. The court said this this is a complex and important question, and one that it was reluctant to address in the first instance without affording the trial court an opportunity to consider the question and without complete briefing by the parties. To permit a more thorough consideration of this question, the court remanded the matter for the trial court to address it, with the benefit of full briefing, including briefing by amici curiae with an interest in this issue. Clayton Cnty. v. City of College Park, Georgia Supreme Court, No. S17A0076. 6/30/17 Individuals Lack Standing to Pursue Claims Against Tax Credit Program The Georgia Supreme Court held that taxpayers who argued that the state’s tax credit for contributions to scholarship organizations violates the state constitution did not have standing to pursue those claims. The court also held that the Department or Revenue’s (DOR) motion to dismiss a claim which sought to compel DOR to enforce a provision of the tax code prohibiting scholarship organizations from representing that contributions can go to particular individuals should be granted. Four Georgia taxpayers filed a complaint challenging the constitutionality of Georgia’s Qualified Education Tax Credit, Ga. L. 2008, p. 1108, as amended (HB 1133), naming the state Department of Revenue (DOR) and the Revenue Commissioner (Commissioner) as defendants. The trial court later permitted four individuals who identified themselves as parents of children who have benefited from the tax-credit-funded scholarship program that is challenged by the plaintiffs to intervene as defendants. HB 1133 set up a tax credit program that allows individuals and business entities to receive a Georgia income tax credit for donations made to approved not-for-profit student scholarship organizations (SSOs), up to $1,000 per individual taxpayer or $2,500 for joint filers. Corporate taxpayers are allowed a credit of the actual amount donated or 75 percent of the corporation’s income tax liability, whichever is less. The total aggregate amount of tax credits allowed under the statute is currently limited to $58 million per tax year and the Commissioner is directed to allow these tax credits “on a first come, first served basis.” The SSO is required to distribute the donated funds as scholarships or tuition grants for the benefit of students who meet certain eligibility requirements set forth in the statute. The plaintiffs challenged the constitutionality of HB 1133 on several grounds. The defendants filed a motion to dismiss challenging the plaintiffs standing to bring the suit. In general, to establish standing to challenge the constitutionality of a statute, a plaintiff must show actual harm in that that his or her rights have been injured. In this case, the plaintiffs claimed they have standing to challenge the constitutionality of the statutes in question because they can show injury by virtue of their status as taxpayers. They also claim standing is conferred by OCGA § 9-6-24. The court said that the plaintiffs’ allegations regarding the constitutionality of HB 1133 assumed that the grant of tax credits for student scholarships amounts to a diversion of public revenue that leaves the plaintiffs shouldering a greater portion of Georgia’s tax burden. Plaintiffs also assumed that the tax credits amount to an unconstitutional expenditure of public funds because these funds actually represent tax revenue, or because the revenue department bears the costs of administratively processing these credits. The court said that the notion that a tax credit from state income tax liability decreases the total revenue pool and increases the tax burden on the remaining taxpayers is purely speculative. Even assuming an adverse effect on the state’s budget, the court said it requires pure speculation that lawmakers will make up any shortfalls in revenue by increasing the plaintiffs’ tax liability, since they could just as easily make up shortfalls by reducing the budget. The court cited case that considered and rejected this argument relating to budget shortfalls as a basis for creating standing to assert a constitutional challenge to similar scholarship programs in other states. The court also rejected the assertion that plaintiffs have standing because the tax credits actually amount to unconstitutional expenditures of tax revenues or public funds, finding that the statutes that govern the program demonstrate that only private funds, and not public revenue, are used. In support of its conclusions, the court cited a number of cases from federal and other state courts that have considered the issue of taxpayer standing to challenge the constitutionality of similar scholarship programs established by legislatures in other states. The plaintiffs argued that cases from other jurisdictions that have ruled on constitutional challenges to similar state programs are distinguishable because, unlike some other states, the Establishment Clause of the Georgia Constitution prohibits the taking of money from the public treasury either “directly or indirectly” for the aid of religious institutions. The court noted, however, that Florida has an almost identically worded anti-use clause in its Constitution that prohibits the taking of public money either “directly or indirectly” to aid any religious institution and its legislature adopted an almost identical scholarship program as the one involved in this case, and the dismissal of a taxpayer challenge to the constitutionality of that program for lack of standing was affirmed on appeal. The plaintiffs also claimed standing was conferred by OCGA § 9-6-24 to any citizen attempting to enforce compliance with the Constitution. By its terms this statute does not require the plaintiff to show any special interest to have standing to seek to enforce a public duty, but the court noted that the plaintiffs do not seek to enforce any statute, instead seeking to block enforcement of a statute by having it declared unconstitutional. The court found that the trial court did not err in finding plaintiffs lack standing to pursue their constitutional claims, or their prayer for declaratory relief with respect to those claims, either by virtue of their status as taxpayers or by operation of OCGA § 9-6-24. Gaddy v. Dep't of Revenue, Georgia Supreme Court, S17A0177; S17X0178. 6/26/17 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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