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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:
November 11, 2016 Edition
NEWS
Settlement Reached With D.C. in Tax Office Embezzlement Case
On October 25, 2016, the D.C. Attorney General announced a settlement with the Bank of America regarding the bank’s role in the case of Harriette Walters, the former Office of Tax and Revenue (OTR) employee who was sentenced in 2009 to a 17-year prison term for embezzling almost $50 million over 18 years. The District sued the bank in 2008 alleging that it had inadequate controls in place that contributed to the District’s monetary loss. A Bank of America assistant branch manager who assisted Walters and her cohorts in the scheme pleaded guilty. The bank has agreed to pay the District $13 million to settle the suit.
Cert Granted by Virginia Court on Addback Exemption Case
On October 31, 2016, the Virginia Supreme Court granted certiorari October 31 in Kohl's Department Stores Inc. v. Virginia Dep't of Taxation, a case involving the state's "subject to tax" addback exemption. The case involves whether royalties paid to a related company should be exempt from the addback statute pursuant to the state exemption for income received by a related company that is subject to a tax imposed by another state. See the February 19, 2016 issue of State Tax Highlights for a discussion of this case.
U.S. SUPREME COURT UPDATE
Cert Filed
American Business USA v. Dep’t of Revenue, U.S. Supreme Court Docket No. 16-567. Filed October 24, 2016. Issue: whether a Florida company must collect and remit the state’s sales tax on the sale of inventory grown, stored, and delivered out of state. American Business is a Florida corporation that received orders for flowers and gift baskets from online customers. The company did not maintain an inventory of flowers or other items of tangible personal property. The company collected the Florida sales tax on purchases shipped to locations in Florida but did not collect sales tax on purchases filled and delivered out of state. See June 10, 2016 issue of State Tax Highlights for a more detailed discussion of the Florida Supreme Court’s decision.
FEDERAL CASES OF INTEREST
Denial of Whistleblower's Petitions Affirmed
The U.S. Court of Appeals for the Eleventh Circuit, in an unpublished per curiam opinion, affirmed the lower court’s denial of a whistleblower's petitions for injunctive relief against the IRS, finding no abuse of discretion by the lower court. The suit was filed to compel the IRS to conduct an investigation regarding information the whistleblower provided.
Section 7623 of the Internal Revenue Code (IRC) created a whistleblower program and a whistleblower office within the IRS to administer the award program. That section provides that the IRS Commissioner may proceed with administrative or judicial action based on information brought to light via a Form 211 application and the Whistleblower Office may award a claimant at least 15 percent, but not more than 30 percent, of the collected proceeds or from settlement with the taxpayer. Upon receiving information from a claimant, the Whistleblower Office makes a final decision regarding a claim and communicates its decision, in writing, to the claimant, who may appeal the Whistleblower Office's final administrative decision to the United States Tax Court within thirty days.
The court found no abuse of discretion in the lower court’s denial of the whistleblower’s petition in Case 1 or Case 2, finding in Case 1 that the lower court correctly determined that it lacked authority to grant the requested injunctive relief and finding in Case 2 that the court correctly determined that it lacked authority to review the Whistleblower Office’s decision denying the application. In addition, as to Case 1 the found said that the record showed that the petitioner did appeal the denial of his application to the Tax Court and later to the U.S. Court of Appeals for the District of Columbia and noted that both courts agreed that he was not due to receive an award because the IRS did not collect any proceeds as a result of the information he provided.
The initial petition and second motion for reconsideration argued that certain healthcare providers were engaged in improper tax practices, and asserted that the IRS had a duty to investigate those practices. Both the petition and the motion for reconsideration asserted that the IRS Whistleblower's Office had erred in denying the petitioner’s application for an award, The court found that it was not an abuse of discretion for the district court to deny the petitioner’s motion for reconsideration as he was essentially using the motion to relitigate old matters, previously addressed in the court's order denying his petition. Roy J. Meidinger v. Commissioner, U.S. Court of Appeals for the Eleventh Circuit, Nos. 15-15465, 16-10071. 10/24/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Pre-2005 Prewritten Software Not Taxable
The New Jersey Tax Court held that the state's sales tax couldn't be applied to services provided before the effective date of a law making prewritten computer software subject to sales tax.
The taxpayer, a New Jersey entity, is in the business of providing information technology solutions and the services it provides are wide ranging from remote or onsite network access support, consulting, design and implementation of IT and telephone related projects, troubleshooting, training, maintenance and repair services, and backup of data. The services are provided on either an hourly charge, a monthly maintenance package or a pre-paid maintenance package for certain blocks of time. The Department of Taxation (Taxation) audited the taxpayer sometime in 2009 for tax periods January 2004 through December 2010 and the parties agreed that 2007 would be the sample year since it was deemed representative of the audit period. The taxpayer provided Taxation with sales and purchase invoices for 2007, a few client maintenance contracts, but had no sales tax exemption certificates. The maintenance contracts were all similar in that they offered a whole range of services for a fixed per-month charge. On October 25, 2011, Taxation issued a Notice of Assessment and the taxpayer filed a timely administrative protest arguing that 90% of its services were non-taxable consulting, contract programming, design and support services. The taxpayer failed to appear at the scheduled conference and the conferee concluded that the taxpayer sold lump sum hours, which could be used for either taxable or nontaxable transactions and found the entire transaction taxable. Taxpayer filed an appeal and provided a certification from its accountant who said he had reviewed the audit report and spread sheets and performed his own analysis and determined that only 35% of the total sales were taxable because the taxpayer’s maintenance contract hours which were dedicated to consulting would not be subject to tax, along with other nontaxable services provided.
Initially, the court found that Taxation's statement of material facts were not in genuine dispute for purposes of considering its summary judgment motion. For the tax years at issue here, the sales and use tax was imposed on receipts from every retail sale of tangible personal property, unless exempted or excluded. Effective October 1, 2005, "prewritten computer software" was deemed to be "tangible personal property," and its sales became subject to sales tax, and, effective 2006, "prewritten computer software delivered electronically" was included as tangible personal property, and was, therefore, taxable when sold. Receipts, however, from sales of prewritten software delivered electronically and used directly and exclusively in the conduct of the purchaser's business, trade or occupation were exempt, unless the software was delivered by a load and leave method. "Load and leave" was defined to mean delivering the software by using a "tangible storage medium where the tangible storage medium is not physically transferred to the purchaser." Prior to 2005, sales of, or receipts from, enumerated services upon prewritten computer software were not taxable. After the 2005 and 2006 changes, Taxation issued several publications on the taxability of computer software sales and services.
The first issue addressed by the court was whether Taxation's assessment for tax years 2004 and a portion of 2005 was proper. Taxation contended that the law always taxed sales of, or services upon, tangible personal property, which was defined to include prewritten computer software. However, the court noted that law including prewritten computer software was effective only as of October 1, 2005 and found as a matter of law that the audit on the taxpayer’s receipts for 2004 and for the first three quarters of 2005 should not be subject to sales tax regardless of the lack of breakdown on the invoices for taxable versus non-taxable services because the taxpayer’s business for the audit years at issue was providing IT solutions such as upgrades, installations, repairs, and maintenance to software, and at that time the tangible personal property being sold was prewritten computer software. The court said that as to the remaining tax periods in the audit, the only question was whether the accountant's re-computation of the auditor's figures was sufficient to overcome the presumptive correctness of Taxation's final determination and the court found that the taxpayer had not overcome its burden on most sales. The count found that the accountant's allocation of a portion of the charges on several of the audited invoices as non-taxable was not substantiated or supported by any independent ascertainable facts and there was no factual explanation or basis as to how he arrived at such an allocation. The court noted that the sample contract provided to the court, and the taxpayer’s own representations to Taxation in its administrative protest, showed that there was no breakdown or itemization of the services being billed. The court pointed out that statutory and administrative law places an obligation on a corporate taxpayer to retain adequate business records for examination and inspection by Taxation, and, absent records, Taxation is afforded broad authority in determining the tax due from any information that may be available, including external information. The auditor's schedule for sales tax liability in this matter showed that to the extent the taxpayer provided documentation, Taxation reviewed the it and used what was reliable to deem a charge taxable or otherwise. To the extent invoices were missing, the court said the auditor's methodology was reasonable. The court noted that Taxation conceded that it was very likely that many charges, had they been itemized on the contracts and invoices, would have been non-taxable charges for services pursuant to Taxation's bulletins and regulations, and Taxation said that to the extent it was satisfied, it did not include those sales in its audited sample. The court did note, however, that some of the charges included by the auditor were for out-of-state clients and should not have been included as taxable for purposes of sales tax. The court also found that the taxpayer’s opposition of the use tax portion of the assessment was unsubstantiated.
Premier Netcomm Solutions LLC v. Director, Div. of Taxation, New Jersey Tax Court, No. 016307-2012. 10/25/16
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
CAT Credit Dispute
The Ohio Supreme Court held the tax commissioner was required to issue an assessment or final determination when it reduced a company's commercial activity tax credit for unused net operating losses under the now repealed franchise tax. The court also held, however, that the revenue commissioner timely issued the determination by journalizing it, and not mailing it.
Net operating losses (NOLs) were potential deductions under the state’s former corporate-franchise tax and they were carried on a corporation’s books as tax-deferral assets. In 2005 legislation phased out the corporate-franchise tax and replaced it with the commercial-activity tax (CAT) and the NOLs lost their value in the state. As a result, the CAT/NOL credit was created to insulate taxpayers that had accumulated NOLs from losing them. The statute provides that a taxpayer's first step in claiming the CAT/NOL credit is filing a report to establish the total amount of credit that might be taken over a ten- to twenty-year period.
That report proposes the "amortizable amount," which is then subject to review by the tax commissioner (Commissioner).
In the current case, the taxpayer timely filed its Amortizable Amount Report with the Commissioner in 2006. The report was mailed on June 29, 2006 and received on July 3, 2006. The Commissioner, in a final determination journalized on June 8, 2010, significantly reduced the amortizable amount that the taxpayer had reported. However, the Commissioner's letter to the taxpayer memorializing this determination, dated June 8, 2010, was not mailed until July 12. The taxpayer filed an appeal to the Board of Tax Appeals (BTA), which reinstated the taxpayer’s amortizable amount after concluding that the tax commissioner had violated the statute by failing to notify the taxpayer of its assessment by the June 30, 2010 deadline. The Commissioner filed this appeal.
The Commissioner argued that even failure to comply with the deadline for issuing the final determination has no effect so long as he has actually performed and completed his audit and his adjustment of the amortizable amount by the June 30, 2010 deadline. He further argued that the deadline is merely directory rather than mandatory. The court found that the statute does require that a reduction in the amortizable amount be embodied in a timely issued final determination and that a failure to comply with that requirement means that the taxpayer is entitled to claim the NOL credit in accordance with its originally reported amortizable amount. It then turned to the issue of whether the requirement that the Commissioner's determination be "issued" by the June 30 deadline means that the determination must be mailed as well as journalized by that date. The court reviewed the language of the statutory provision and found fault with the Commissioner’s reading that the insertion of “or” in the provision makes the issuance of an assessment or final determination completely optional and any taxpayer communication in relation to the audit was sufficient to reduce the CAT credit. The court said the practical effect of that reading of the statute was that the taxpayer would not be able to appeal a reduced amount of potential credit until some later date when the tax commissioner disallows the amount of credit claimed. Because that date would not arrive until the taxpayer had exhausted the entire amount of potential credit, the occurrence might come relatively late during the long ten- to twenty-year period during which the credit might be taken. The court rejected the Commissioner’s reading because the use of the word “necessary” in the provision strongly implies that the issuance of a final determination is required if the Commissioner is going to reduce the amount of the credit. The court held that the June 30, 2010 deadline was mandatory, but concluded that the journalization of the final determination on June 8, 2010, sufficed to constitute "issuance" and thereby satisfied the deadline.
The court cited prior case law and said that the significance of those cases was to establish that the term "issue" in the provision at the center of this dispute is ambiguous with regard to the issue presented and the important canon is that of liberal construction of remedial statutes, which has been applied to construe procedural statutes in favor of the tax assessor's ability to properly impose tax obligations. Therefore, construing the provision liberally in favor of the Commissioner means construing it to require him to have completed fewer, rather than more, actions by June 30, 2010, leading the court to conclude that the journalization of the final determination on June 8, 2010, sufficed to constitute "issuance" and thereby satisfied the deadline. The courtreversed the decision of the BTA and remanded with instructions that the BTA consider the taxpayer’s substantive challenge to the tax commissioner's determination.
The dissent argued that the statute required the Commissioner to issue a final determination by June 30, 2010 in order to reduce the amortizable amount claimed by the taxpayer. Int'l Paper Co. v. Testa, Ohio Supreme Court, Slip Opinion No. 2016-Ohio-7454; No. 2014-1614. 10/26/16
State's Dividend Exclusion Regime Is Unconstitutional
The Mississippi Supreme Court held that the state's dividend exclusion, which applied to payments made to the taxpayer from in-state subsidiaries, but not to dividends received from out-of-state subsidiaries without nexus in the state, violated the dormant commerce clause's internal consistency test.
The state statute exempts from taxation income from dividends “that has already borne a tax as dividend income under the provisions of this article, when such dividends may be specifically identified in the possession of the recipient." Miss. Code Ann. § 27-7-15(4)(i) (Rev. 2013). In 2003, the then-Mississippi State Tax Commission (now the Department of Revenue) assessed additional income tax, penalties, and interest against the taxpayer based on its income from dividends from non-Mississippi subsidiaries. The auditors included in business income dividends received by the taxpayer from certain subsidiaries, which were deemed non-taxable in the state in the year of the distribution. The auditors excluded from business income dividends received by the taxpayer from subsidiaries, which were deemed taxable in the state in the year of the distribution. Because of its unitary multistate activities, the business income of the taxpayer was apportioned to the state using a single sales factor formula. The taxpayer noted an appeal and the administrative review process ruled against the taxpayer who then appealed to the Chancery Court of the First Judicial District of Hinds County, arguing that a portion of statute at issue here discriminated against interstate commerce in violation of the dormant commerce clause, arguing that the scheme allowed an income tax exemption for dividends received from the taxpayer’s Mississippi subsidiaries while denying an exemption to similarly situated non-Mississippi subsidiaries. The tax commission filed a counter claim to the taxpayer’s appeal and the record indicates that the parties agreed to an order holding the case in abeyance on April 6, 2006 due to similar litigation in the chancery court, which ultimately was appealed to the Mississippi Supreme Court. See Miss. Dep't of Revenue v. AT&T Corp., 101 So. 3d 1139 (Miss. 2012) (AT&T 1). In that case, the chancery court had ruled, inter alia, that Mississippi Code Section 27-7-15(4)(i) violated the Commerce Clause. AT&T 1, 101 So. 3d at 1142. Because AT&T had not followed statutory procedures for contesting tax assessments and had not posted a bond, but instead had paid the assessed taxes "under protest," this court reversed and rendered the judgment, holding that the chancery court was without jurisdiction. See a 2012 issue of State Tax Highlights for a discussion of that decision. The chancery court ultimately declared unconstitutional the offensive portion of the section of the statute and DOR filed this appeal.
For the tax years in issue, the stipulation of facts specified the amounts of dividends excluded from gross income for the taxpayer’s Mississippi subsidiaries (nexus subsidiaries), called nexus dividends, and the amounts of dividends included in gross income for the taxpayer’s non-Mississippi subsidiaries (non-nexus subsidiaries), termed non-nexus dividends. The taxpayer was permitted to exclude the nexus dividends from its gross income pursuant to the statute, according to the DOR, because the distributing companies were subject to Mississippi income tax by doing business in Mississippi during those tax years and being included in the group state income tax returns for those years. The dividends it received from non-nexus subsidiaries were not excluded from gross income because none of the distributing companies were doing business in the state for the years in question and did not file Mississippi corporate income tax returns for those tax years.
The lower court cited Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279, 97 S. Ct. 1076, 51 L. Ed. 2d 326 (1977), and discussed the four-prong test for evaluating the constitutionality of state tax statutes. The lower court found that the section at issue here denies taxpayers the benefit of deducting dividends from gross income "based solely upon the choice of the taxpayer and its subsidiaries not to locate any operations in Mississippi or to file a Mississippi income tax return" and noted that the U.S. Supreme Court has defined
discrimination as the differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter. That court determined that the section was facially discriminatory and then turned to whether it could survive scrutiny because it constituted a “compensatory tax” designed to make interstate commerce bear a burden already borne by interstate commerce. It held that DOR had failed to present evidence demonstrating that the section at issue us a compensatory tax, and, ultimately granted the taxpayer summary judgment.
The Supreme Court first discussed whether the code section violated the dormant commerce clause which the court said, citing Md. v. Wynne, __U.S.__, 135 S. Ct. 1787, 1794, 191 L. Ed. 2d 813 (2015), does not permit a state to tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the state. The court also references the four-prong test and rejected DOR’s claim that this analysis addresses when a tax, not a deduction, is constitutional, agreeing with the taxpayer’s argument that the test has applied to invalidate a wide range of state tax credits, deductions and exemptions. The court analyzed the cases cited by the parties and found that the four-prong analysis should be applied to the case. The court addressed only the issue of whether the dividend-received exemption was fairly apportioned, asking whether the tax was internally and externally consistent, because it found that issue to be dispositive. Internal consistency is preserved when the imposition of
a tax identical to the one in question by every other state would add no burden to interstate commerce that intrastate commerce would not also bear. External consistency looks at the economic justification for the state's claim upon the value taxed, to discover whether a state's tax reaches beyond the portion of value that is fairly attributable to economic activity within the taxing state. The court again cited Wynne and the U.S. Supreme Court’s discussion of the internal consistency test and its conclusion that the Maryland statute at issue in that case failed the internal consistency test.
After a lengthy discussion of the cases cited by both parties in the matter, the court distilled the question before it to whether the state possesses the constitutional ability to tax differently two categories of business income that are completely identical except for the geographical footprint of the distributing corporation. The court found that the code section failed the internal consistency test, concluding that the total tax burden for the taxpayer was disparate because, with regard to its non-nexus subsidiaries, the taxpayer bears an additional burden from which its nexus subsidiaries are exempt. The court said that, having determined the section to be internally inconsistent, it held that its application results in malapportionment and, therefore, it violates the dormant aspect of the commerce clause. Because it found that the statute violated the commerce clause, it declined to address the taxpayer’s companion arguments that the dividend-received exemption violates the Due Process and Equal Protection Clauses of the Fourteenth Amendment of the United States Constitution.
Having found the section of the statute unconstitutional, the court then turned to the remedy issue. The state’s severability statute provides that, absent contrary intent, when a portion of a statue is declared unconstitutional, the remaining sections continue in effect. DOR argued that if the unconstitutional language were stricken, the section would be rendered meaningless. The court agreed with the taxpayer’s proposal and held that the phrase “under the provisions of this article" be struck from Section 27-7-15(4)(i) and that this severance be applied to the taxpayer for the tax years in issue. Dep't of Revenue v. AT&T Corp., Mississippi Supreme Court, No. 2015-CA-00600-SCT. 10/27/16
Alternative Apportionment Not Justified
The South Carolina Court of Appeals found that the Department of Revenue (DOR) failed to show that the statutory apportionment formula did not accurately reflect a taxpayer’s activities in the state and, therefore, was not justified in using an alternative apportionment method.
The taxpayer is a subsidiary of a rent-to-own business that provides consumer goods to customers for rent. The taxpayer operates retail stores in western states and does not own or operate any stores in the state. It does, however, own and license the parent’s intellectual property including the trademarks and trade names to all of the parent’s companies. These royalty payments for the use of the intellectual property by the South Carolina stores are the taxpayer’s only activity in the state. The licensing agreement sets the amount of a royalty fee equal to 3% of the gross revenues of the stores, an amount based upon a transfer pricing study. The taxpayer filed their state corporate income tax returns for 2003, 2004, and 2005 using the three-factor apportionment formula, consisting of property, payroll, and sales. DOR conducted an audit of the taxpayer’s 2003-2005 initial tax returns and found that the only income in the state was the royalty income it obtained from the parent’s other subsidiary. DOR applied an alternative apportionment method resulting in an assessment against the taxpayer, arguing that the alternative method more fairly represented the taxpayer’s activity in the state. The taxpayer filed an appeal and requested a hearing before the ALC. Prior to the hearing on the matter the taxpayer filed amended state income tax returns, changing the apportionment method from the three-factor apportionment formula for dealers of tangible personal property to the gross-receipts method under section 12-6-2290 of the South Carolina Code. The use of this single-factor apportionment formula resulted in payment of an additional $1,326 in taxes. At the hearing on the matter, DOR argued that the taxpayer diluted the sales/gross receipts ratio by including the retail sales of the taxpayer in the denominator because no retail sales were included in the numerator because the taxpayer does not make sales in the state. DOR’s expert witness testified that the gross receipts ratio did not provide an accurate reflection of the economic connection of the taxpayer to the state. He also testified the DOR's alternative method was economically reasonable and excluding the retail operations from the calculations was essential in order to arrive with a tax burden that fairly represented the economic nexus of the entity with the state. The taxpayer argued there was a unitary relationship between the business activities of the retail stores in the western states and the licensing of intellectual property in other states because the same management is over both businesses and the stores contribute to the profitability of the intellectual property and vice versa. It also argued that it does not separately track the costs of the intellectual property and this audit was the first time it had been asked to do so. The taxpayer’s expert witness testified that the taxpayer was a single unitary business based upon the mutual interdependence of the trademark and retail business and said that the standard apportionment method fairly represented the taxpayer’s activities in the state. The ALC found for the DOR and the taxpayer filed a motion for reconsideration that was denied. Taxpayer filed an appeal and requested, with DOR’s consent, a stay until a final decision in Carmax Auto Superstores West Coast, Inc. v. South Carolina Department of Revenue (Carmax I), 397 S.C. 604, 725 S.E.2d 711 (Ct. App. 2012), aff'd as modified, 411 S.C. 79, 767 S.E.2d 195 (2014), asserting that some or all of the issues could be decided or affected by the final decision in that case. The stay was granted on April 16, 2012, and, following a decision by the Supreme Court in that case, this appeal proceeded.
In this case, the court said the burden was on DOR to show the statutory formula did not fairly represent the taxpayer’s business activity in the state. The court found that DOR presented the same level of evidence in this case as in CarMax, and based on the supreme court's holding in CarMax the evidence was insufficient to meet the DOR's burden for the threshold issue, the court concluded the DOR failed to meet its burden in this case. The court found that substantial evidence did not support finding the statutory apportionment method fairly reflected the taxpayer’s business activities in the state, noting that although DOR’s auditor testified that he believe a management services fee was too high, he did not point to any specific evidence that the standard apportionment method did not fairly represent the taxpayer’s business activities. The court said that a very small amount of the taxpayer’s business comes from the royalties, and, therefore, this should only comprise a small amount of its taxes. Because the DOR did not meet its burden in proving the threshold issue of whether the statutory formula fairly represented the taxpayer’s business activities in the state, the court said that it did not need to decide whether the ALC erred in finding the DOR's alternative method was reasonable. Rent-A-Center West Inc. v. Dep't of Revenue, South Carolina Court of Appeals, No. 2012-208608. 10/26/16
Property Tax Decisions
Taxpayer Entitled to Postponed Delinquency Date
The Texas Court of Appeals, First District, held that the Harris County Tax Assessor-Collector failed to mail tax notices to a taxpayer and its authorized agent. As a result, the taxpayer was entitled a refund of interest and penalties on those assessments. The court remanded the case for factual determinations related to two remaining properties.
The county property taxes must be paid each year before the February 1st delinquency date to avoid the imposition of penalty and interest. The statute provides, however, that if the tax bill is mailed after January 10, the default delinquency date is postponed for at least 21 days. The taxpayer, who owned seven properties in the county, paid the taxes on February 13, 2013 but by that time, the county had imposed more than $630,000 in penalty and interest for the taxpayer’s delinquency. The taxpayer paid the penalty and interest and filed suit for a declaratory judgment, arguing that it was entitled to a postponed delinquency date because the county tax assessor failed to timely send a bill to both the taxpayer and its authorized agent for each of the properties at issue, as required by the state statute. The trial court granted the county’s summary-judgment motion and rendered a take-nothing judgment and the taxpayer filed an appeal.
An affidavit filed by the director of the county’s property tax division stated that a tax bill for each of the taxpayer’s seven properties was timely filed mailed in November 2012, and she further averred that five of the seven tax bills were mailed to Duff & Phelps, L.L.C., the taxpayer’s authorized agent for those five properties. The affidavit stated that the remaining two tax bills were mailed directly to the taxpayer because it had not appointed an authorized agent for those two properties. The parties agreed that none of the seven tax bills were mailed to both the taxpayer and Duff & Phelps. The taxpayer said it determined the amount of property taxes it owed on its seven properties by checking the county appraisal district website, and mailed the county a check on January 23, 2013. The county received the check on January 28, 2013, but learned on February 5, 2013, that the taxpayer’s bank did not honor the check due to internal fraud prevention protocols. The county then sent the taxpayer a "delinquent tax bill," assessing the penalty and interest.
Initially before addressing the merits of the case, the court rejected the county’s contention that the trial court lacked subject-matter jurisdiction because the taxpayer failed to establish a waiver of sovereign immunity, finding that because the taxpayer was seeking a declaratory judgment and alleged that it paid the penalties and interest under duress, no legislative consent to sue was required.
The court agreed with the taxpayer thatthe use of “and” in the statutory provision requiring the mailing of the tax bill required the tax assessor to prepare and mail a tax bill to both the person in whose name the property is listed on the tax roll and its authorized agent, if any has been duly appointed. The county conceded that Duff & Phelps was the taxpayer’s authorized agent for five of the seven properties at issue and that it did not mail a tax bill to both the taxpayer and Duff & Phelps for any of the seven properties at issue. The taxpayer contended that the statute postponed the default February 1 delinquency date in this case because the county failed to mail a tax bill to both it and Duff & Phelps by January 10, but the county argued that the default delinquency date was not postponed because it substantially complied with the statute by mailing a tax bill for each property to either the taxpayer or Duff & Phelps.
The county also pointed out that section 31.01(g) of the code provided that the "failure to send or receive the tax bill required by this section . . . does not affect the validity of the tax, penalty, or interest, the due date, the existence of a tax lien, or any procedure instituted to collect a tax." The court noted, however, that the first section has previously been construed to govern only in instances in which a tax bill can be sent, but is mailed late and has no application in a situation in which no tax bill can be sent because the name or address of the delinquent taxpayer is unknown, in which event section 31.01(g) rules. Thus, the court said that if a tax assessor has the information necessary to mail the required tax bills to the property owner and its duly-appointed authorized agent, but fails to mail a bill to both by January 10, the February 1 default delinquency date is postponed and penalties and interest do not begin to accrue on February 1. The court also rejected the county’s argument that it substantially complied with the requirements of the statute and that substantial compliance should be deemed sufficient, finding that the provisions of the tax code in this case did not expressly state that substantial compliance was sufficient. The court pointed out that the legislature amended subsection 31.01(a) to require tax assessors to mail a tax bill to a property owner and its authorized agent, if any, and when it did so, it did not alter the consequence of a tax assessor's failure to timely mail a required tax bill, which is set forth in section 31.04.
The court said thatthe plain language of section 31.04 provided that the consequence of a tax assessor's failure to timely mail the required tax bills is that penalties and interest may not be assessed as of the February 1 default delinquency date, and the court was not at liberty to rewrite the statute to avoid that consequence.
The court also rejected the county’s argument that the summary judgment should be affirmed based on the taxpayer’s waiver. The county asserted that the taxpayer waived any complaint about imperfect notice by attempting to pay its tax bill before the default February 1 delinquency date, but the court found that there was no evident that the taxpayer intended to relinquish its right to avoid penalties and interest by paying its 2012 tax bills before the default delinquency date. If anything, the court said, the taxpayer’s attempt to pay its tax bills before the February 1 default delinquency date demonstrates that it sought to preserve its right to avoid penalties and interest. Finally, the court rejected the county’s argument that the voluntary payment rule prevented the taxpayer from complaining of lack of notice because it issued a check to the county before the default delinquency date, holding hat the taxpayer did not seek recovery of the property taxes it voluntarily paid in February, 2013, but only the penalty and interest which it tendered under protest and duress to prevent accrual of additional interest.
The court noted that the parties agreed that the taxpayer had duly appointed Duff & Phelps as its authorized agent for five of the seven properties at issue here and, for the reasons discussed above, the court reversed the lower court ruling as to those properties, ruling that the taxpayer did not owe penalty and interest on the taxes for those properties. With regard to the remaining two properties, the court found that there was a material factual dispute regarding whether the taxpayer had an authorized agent, which prevented it from rendering judgment with respect to the remaining two properties and the court remanded the resolution of that issue for further proceedings consistent with their opinion. Anheuser-Busch LLC v. Harris Cnty. Tax Assessor-Collector, Texas Court of Appeals, First District, No. 01-15-00422-CV. 10/11/16
Fiber-Optic Installations Not Taxable Real Estate
The New York Supreme Court, Appellate Division, Third Judicial District held that a telecommunications company's fiber-optic installations were not taxable real property because the installations did not distribute light. The court, however, denied the taxpayer's refund requests because the taxes were paid voluntarily.
The taxpayer is a telecommunications company that owns fiber optic installations located on private rights-of-way at various locations within Clinton County in the state. In May 2013, the First Department issued a ruling that petitioner's fiber optic installations are not taxable real property (Matter of RCN N.Y. Communications, LLC v. Tax Commn. of the City of N.Y., 95 AD3d 456 [2012], lv denied 20 NY3d 855 [2012]), and the taxpayer subsequently filed applications with seven tax-assessing entities within the County seeking refunds of real property taxes paid on such installations for the years 2010-2012 and sought removal of those properties from the tax rolls. The applications were not granted and the taxpayer filed suit for declaratory judgment. The lower court ruled that the taxpayer’s fiber optic installation were taxable real property and that, further, the taxpayer was precluded from recovering the requested refunds on the ground that it had paid the taxes voluntarily. The taxpayer filed this appeal.
The court first addressed the taxpayer’s application for a judgment declaring that its fiber optic installations are not taxable real property under the statutory section which provides that real property shall include, among other things, equipment for the distribution of heat, light, power, gases and liquids. The parties agreed that the fiber optic cables at issue consist of filaments of glass through which light beams are used to transport information and data from one point to another, but they disagreed as to whether this constitutes the "distribution" of light within the meaning of the statute. The court looked to the legislative intent and noted that since the statute did not define the term “distribution,” it needed to construe the word with its usual and commonly understood meaning. It cited the definition in the Merriam-Webster Online Dictionary to “spread out so as to cover something” and “to give out or deliver especially to members of a group” and pointed out that the fiber optic cables do not distribute lights within these commonly understood meanings of the term. While the fiber optic cables at issue undeniably transmit light signals from one end of the network to the other, such transmission does not result in the "distribution" of light, but rather data.
The court did find that the lower court reasoning that there was no meaningful distinction
between the words "transmit" and "distribute" as applied to the telecommunications industry failed to take into account that those words were independently used in separate provisions of the pertinent statute and noted that where the legislature uses different terms in various parts of a statute, courts may reasonable infer that different concepts are intended. The court said that to attribute the same meaning to "distribution" and "transmission" would render one of these terms superfluous, an outcome that is to be avoided. The court concluded, construing the statute narrowly and resolving any doubt as to its scope in favor of the taxpayer, that the fiber optic cables did not constitute equipment for the distribution of light within the meaning of the statute.
The court found, however, that the taxpayer that failed to demonstrate its entitlement to a refund for the tax years under review, citing case law that holds to obtain a refund of taxes paid under a mistake of law, it is incumbent upon the taxpayer to establish appropriate legal protest prior to or at the time of payment as a prerequisite to recovery. The court said it was undisputed in this case that the taxpayer paid all of the relevant taxes and there was nothing in the record indicating that these payments were made under protest or were otherwise involuntary. Level 3 Communications Inc. v. Clinton Cnty., New York Supreme Court, Appellate Division, Third Judicial District, 522214. 10/2016
Notice Issue Case Remanded
The Tennessee Court of Appeals has ruled that the record did not establish that the Board of Equalization (BOE) provided a taxpayer with notice of the personal property tax assessment sufficient to satisfy due process. The court remanded the matter for a determination on whether notice was sufficient.
The taxpayer, owned by an LLC family trust, operates a commercial passenger vessel on the Tennessee River and has its principal offices in the state and is authorized to conduct business in the state. The Office of State Assessed Properties (OSAP), a division of the Comptroller of the Treasury in the state, conducts annual assessments of personal property owned or leased by companies, including water transportation carrier companies, and these assessments are used by the counties and cities to determined property taxes. The statute further provides that it is the duty of certain property owners to file property tax reporting schedules each year. The taxpayer did not file a property tax reporting schedule with OSAP in 2008 because the chief executive was under the mistaken belief that it was not liable for property taxes.
On August 2, 2010, OSAP sent a letter to the taxpayer with its 2010 ad valorem tax property assessment in the amount of $741,000, and the taxpayer filed an initial exception to the assessment and, in a letter dated August 17, 2010, informed OSAP that it would not attend the informal hearing the next day but would rely on its exception and previously filed documents. OSAP affirmed the assessment and the taxpayer failed to file further exceptions to that year.
The taxpayer handled the 2011 property tax assessment in the same fashion and, similarly, failed to file further exceptions after OSAP affirmed the assessment. On September 24, 2012, the taxpayer timely filed an appeal with the BOE to challenge the tax year 2012 assessment, and also challenged the 2008 and 2009 back assessments and the 2010 and 2011 regular assessments. The ALJ held a hearing and determined that the BOE had jurisdiction to hear the 2009 and 2012 tax years and scheduled a hearing to address those appeals. The ALJ dismissed the taxpayer’s appeals of the 2008 back year assessment and the regular assessments for 2010 and 2011, and the taxpayer filed an appeal to the Assessment Appeals Commission and the Commission subsequently orders that the appeals relating to the 2008, 2010, and 2011 tax years be dismissed and that this decision was a final judgment. The taxpayer filed this appeal.
With regard to the 2010 and 2011 exception review notices, the court found that the ALJ failed to make sufficient findings on the issue of notice. The court detailed the record in the matter, including the testimony of the taxpayer’s attorney regarding receipt of notice of the Comptroller’s determination of the exception filed by the taxpayer. The court said that the ALJ did not address the issue of whether the taxpayer received adequate notice because, according to the ALJ, "the Comptroller was only required to issue the notices,” and went on to suggest that even "a failure to issue the notices would be of questionable legal import in light of the strict deadlines imposed on taxpayers” by the state statute. The court declined to adopt this reasoning, concluding, instead, that the BOE must determine whether the taxpayer received notice sufficient to satisfy the requirements of due process. It, therefore, vacated the ALJ’s dismissal of the taxpayer’s claims as to 2010 and 2011 and remanded the matter for a determination of whether the taxpayer received proper notice.
The court rejected the taxpayer’s argument that the 2008 back assessment/reassessment was arbitrary and capricious, agreeing with the ALJ’s findings and concluding that documents in the record permit it to infer that the taxpayer received timely notice of the back assessment from the county trustee and could have appealed within the sixty-day period. It also rejected the taxpayer’s argument that the back assessment was not brought within the statute of limitations, noting that the statute provides an exception to the standard statute of limitations when a taxpayer fails to file the reporting schedule required by law and found that the BOE met the requirements of this exception. Volunteer Princess Cruises LLC v. Bd. of Equalization, Tennessee Court of Appeals, No. M2016-00364-COA-R12-CV. 10/31/16
Other Taxes and Procedural Issues
No cases to report.
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected]. |
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STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
October 28, 2016 Edition
NEWS
Former California Senator Sentenced
Former California State Sen. Ron Calderon has been sentenced to three and a half years in prison and 150 hours of community service after pleading guilty to accepting bribes in exchange for supporting film tax credit legislation. The sentence was the result of a FBI investigation and sting operation involving Calderon and his brother, former Assembly member Tom Calderon. Tom Calderon, who plead guilty to laundering bribes through his firm, was sentenced to six months in prison and 100 hours of community service in September.
Tax Fraud Guilty Plea From Former Tax Court Judge
Former Tax Court Judge Diane L. Kroupa pleaded guilty in a U.S. district court to conspiring with her husband Robert E. Fackler to defraud the government. In the plea agreement filed with the court, Kroupa admitted to falsely reporting personal expenses as business expenses for Grassroots Consulting, failing to report income, and making false representations during IRS audits. The indictment alleged that beginning in 2002, Kroupa and Fackler began inflating the business expenses deducted by Grassroots Consulting. Resulting in reduced income declared on their annual tax returns.
U.S. SUPREME COURT UPDATE
Cert Filed
Kimberly-Clark Corp. v. Comm'r of Revenue, U.S. Supreme Court Docket No. 16A254. Petition for Certiorari filed 10/20/16. Issue: The taxpayer argues that the Minnesota Supreme Court's ruling that enactment of Multistate Tax Compact Articles III and IV did not create a contractual obligation prohibiting later unilateral repeal of the provisions from the state's code should be overruled.
FEDERAL CASES OF INTEREST
'Love Offerings' From Church Were Taxable Compensation
The Tax Court, in a summary opinion, held that amounts a pastor received from his church were taxable compensation. The taxpayer argued that the payments were nontaxable "love offerings" or "love gifts" but the court found that the Form 1099-MISC issued to the pastor by the church's bookkeeper was evidence that the church considered the amounts nonemployee compensation.
In 2012, the year at issue in the case, the taxpayer was the pastor, a director, and the registered agent for Triumph Church of God. His wife was also a church director. The church had approximately 25 to 30 active members, with as many as seven ministers. It offered services three days each week. The taxpayer had informed the church's board of directors that he did not want to be paid a salary for his pastoral services but that he would not be opposed to receiving "love offerings", gifts, or loans from the church. The taxpayer and his wife managed the church's checking account, and it appears that they jointly signed all of the church's checks, including a number of checks made payable to the taxpayer, with handwritten notations such as "Love Offering" or "Love Gift" on the memo line. The church’s bookkeeper, who had served in that role since 1993, sent the taxpayer a form 1099-MISC for tax year 2012 reporting that he had received nonemployee compensation of $4,815 from the church. When the bookkeeper left the church in late 2015, the taxpayer’s daughter replaced her as the church’s bookkeeper.
When the husband and wife filed a joint Federal income tax return for 2012 they claimed a deduction for a charitable contribution of $6,478 to the church, but did not include as income the $4,815 reported on the form 1099-MISC. While the taxpayer does not dispute receiving these monies from the church, he argued that the amounts were improperly reported as nonemployee compensation. He testified that he requested that the bookkeeper retract the form, but said the process was never completed. The bookkeeper did not testify at the hearing. The taxpayer argued that the amounts that received from the church represent nontaxable "love offerings", gifts, or loans.
The court noted that the taxpayer had the burden of proving that the liability in a notice of deficiency is incorrect. It was stipulated that the taxpayer received $4,815 from the church and that the church through its bookkeeper characterized that amount as nonemployee compensation for tax purposes. Thus, the court said, the taxpayer must show the nontaxable character of the payment. The court noted that “gross income” is broadly defined in the Internal Revenue Code (IRC), but excludes amounts acquired by gift. Whether a payment is a gift or gross income under the IRC is a factual question. The Supreme Court has concluded that, in cases such as this one, the transferor's intention is the most critical consideration, and the court must focus on the objective facts and circumstances.
The court found that the record showed that the transfers were made to compensate the taxpayer for his services as pastor and said that the taxpayer’s subjective characterization of the transfers as nontaxable "love offerings" and "love gifts" was misguided. The court said that the taxpayer and his wife did not offer the testimony of any members of the congregation or the bookkeeper that would allow the court to conclude that the transfers were anything other than compensation for services. The frequency of the transfers and the fact that they purport to have been made on behalf of the entire congregation is further objective evidence that the transfers represented a form of compensation. Joseph L. Jackson et ux. v. Commissioner, U.S. Tax Court, T.C. Summ. Op. 2016-69; No. 2034-15S. 10/24/16
Tax Attorney's Conviction Affirmed
The U.S. Court of Appeals for the Second Circuit affirmed a tax attorney’s conviction and sentence for conspiracy to defraud the IRS, client tax evasion, IRS obstruction, and mail fraud for his role in a massive fraudulent tax shelter scheme, rejecting his various arguments challenging his conviction and sentence.
The taxpayer, a certified public accountant (CPÅ) and tax attorney, throughout his career designed and sold a variety of tax shelters, beginning in the early 1990s when he was a partner at Arthur Andersen. Although the transactions underlying the shelters changed over time, the court found that the facts surrounding their marketing and implementation varied little. As an essential part of the marketing of all the tax shelters, the taxpayer and his colleagues issued "more-likely-than-not" opinion letters to clients who purchased the shelters. Such letters stated that "under current U.S. federal income tax law it is more likely than not that" the transactions comprising the shelters are legal and will have the effect sought by the clients. The letters stated that the clients had knowledge of the particular transactions underlying the shelter and that the clients were entering into the shelter for non-tax business reasons. These letters protect clients from the IRS's imposition of a financial penalty in the event that the IRS does not permit the losses generated by the shelter to reduce the client's tax liability. Multiple clients testified that they never made representations of knowledge to the taxpayer or his associates and that, in any event, these representations were false because the clients knew little or nothing about the underlying transactions and entered into the shelters only to reduce their tax liability. In addition, these letters falsely stated that some of the transactions had a reasonable possibility of producing a profit when, in reality, they had a low profit potential which disappeared entirely when the fees charged were taken into account.
The record also reflects that as part of the implementation of the shelters, the taxpayer either directly or through his team participated in the correction and backdating of certain tax shelters. Further, the taxpayer also used tax shelters to reduce his personal tax liability, using the Short Sale Shelter from 1993 to 1998 to shelter more than $26 million in income earned during those years. As a result he paid only $7,315 in federal personal income tax during those years. From 1999 to 2001, when he earned more than $79 million in income, he used the Short Option Shelter to offset this income and paid no income tax.
In 2009 the taxpayer and others involved in these shelters were indicted for conspiracy, tax evasion, obstructing the IRS, and mail fraud, and the taxpayer was convicted on all of the counts with which he was charged. In May 2014, the district court sentenced the taxpayer to 180 months' imprisonment, three years' supervised release, $164,737,500 in forfeiture, and $371,006,397 in restitution. The taxpayer raised a number of issues on appeal, including whether the evidence was sufficient to support his convictions, whether the accumulation of errors at trial violated his due process right to a fair trial, whether his sentence was procedurally and substantively reasonable, and whether the government proved the requisite nexus between his crimes and the property sought in forfeiture. The court said that for a jury to conclude that the taxpayer had the necessary mens rea to commit tax evasion, mail fraud, and obstruction of the IRS on the basis of violations of the economic substance rule, they would have to find both that he knew the rule and knew that the transactions lacked economic substance. The inquiry required the court to examine whether the taxpayer’s clients had an objectively reasonable expectation of profit, apart from the tax benefits, and whether the clients had a subjective non-tax business purpose in entering into the transaction. The court concluded that a rational jury could have concluded that the taxpayer was familiar with the economic substance rule and knew that the transactions lacked economic substance because he knew that the clients in the cases at issue had no objectively reasonable expectation of making a profit from the Swaps Shelter and they did not have a subjective non-tax business purpose in entering the transaction.
Next, the court rejected the taxpayer’s arguments that the evidence was insufficient to sustain his convictions because there was no evidence that he participated in the scheme involving illegal backdating and the federal government failed to prove that the mail fraud affected a financial institution, finding each without merit because the record belied his arguments.
The court also rejected the taxpayer’s argument that the trial was so riddled with errors that his due process right to a fair trial was violated, finding that the taxpayer did not point to an error or combination of errors that were so prejudicial as to warrant a new trial. The court examined the taxpayer’s argument that the sentence was unreasonable and said that the taxpayer failed to identify a procedural error that we have recognized in prior cases and, further, misrepresented the record in the case. The court found that the district court's conclusion was reasonable, and the taxpayer’s procedural and substantive challenges, therefore, failed. Finally, the court rejected the taxpayer’s argument regarding the forfeiture, finding that the district court correctly concluded that the money sought to be forfeited had been obtained through the taxpayer’s mail fraud. United States v. Paul M. Daugerdas, U.S. Court of Appeals for the Second Circuit, No. 14-2437. 9/21/16
Emotional Distress Award for IRS Collection Action Reversed
A U.S. district court reversed a bankruptcy court decision granting damages for emotional distress for the violation of the automatic stay by the IRS who sent the taxpayers notices of intent to levy during their bankruptcy case. The court found that the couple's claim against the IRS was barred by sovereign immunity. See the February 5, 2016 issue of State Tax Highlights for a discussion of the bankruptcy court’s decision.
The taxpayers filed for Chapter 13 bankruptcy protection on November 5, 2012 and this filing triggered the automatic stay contained in 11 U.S.C. § 362(a), which blocks creditors from collection attempts outside of court-supervised reorganization proceedings. The parties agreed the IRS violated the automatic stay four times, sending notices demanding payment for back taxes. The bankruptcy court concluded the IRS's repeated violations of the automatic stay contained in § 362(a) caused the taxpayers significant emotional harm. The IRS argued in this appeal that the taxpayers’ emotional distress was insufficient to award emotional distress damages, in the alternative, that sovereign immunity bars their claims altogether. The court found that the IRS presented compelling arguments regarding the merits of the taxpayers’ claims for emotional distress damages. The husband alleged only brief losses of appetite, stress, and mounting frustration after receiving the IRS notices, the court said, therefore likely never suffered an injury sufficient to support an award of emotional distress damages under § 362(k). Further, the court said that although the wife likely suffered legally sufficient harm in the form of debilitating migraine headaches, the evidence in the record did not necessarily connect her migraines to the IRS's violations. Neither the husband nor the wife could remember if, or when, any specific IRS notice triggered a debilitating migraine. The court was skeptical whether the wife established the required causal connection between the notices and her migraines but said it did not need to reach those issues, however, because sovereign immunity bars the taxpayers’ claims. The court noted that the issue of whether the United States waived sovereign immunity for emotional distress damages under § 362(k), was a matter of first impression in the Ninth Circuit. Sovereign immunity limits a district court’s subject matter jurisdiction over actions brought against the United States and can only be waived by unequivocal, clear statutory language. The party suing the United States bears the burden of demonstrating the existence of an unequivocal waiver of immunity. The court noted that Section 106(a) of the Bankruptcy Code clearly waives sovereign immunity for some claims under § 362(k), but found that the term “actual damages” did not include damages for emotional distress against the federal government. The court said that Section 362(k) contains, at best, an ambiguous waiver for emotional distress damages. Ambiguities must be resolved in favor of immunity and the court held that sovereign immunity, therefore, barred the taxpayers’ claims. Jonathan Eldon Hunsaker et ux. v. United States, U.S. District Court for the District of Oregon, No. 6:16-cv-00386. 10/20/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Court Upholds Assessment Against Bar
The Iowa Court of Appeals upheld a sales tax assessment against a bar finding that the owners failed to properly account for sales. The court rejected the taxpayer's claim that the Department of Revenue (DOR) was not entitled to use the percentage markup method to compute sales tax owed to the state.
The taxpayer, an LLC, operated a bar in Iowa City. Two of its owners were in charge of the day-to-day operations of the bar, but were inexperienced and apparently unfamiliar with general accounting methods and the records required by DOR to determine sales tax. They used available cash during the week to pay expenses, and subsequently made entries on their records on the basis of their memories. When audited, the business had no daily summary of deposits and had no daily cash register tapes. Expenses were paid by check or cash, the receipts and expenses were transferred to QuickBooks, and a profit and loss statement was generated. The sales tax returns were computed from the profit and loss statement. DOR initiated an audit when it noted the gross income reported on the 2006 income tax return was $115,000.00 more than reported on their sales tax return and sent an initial interview questionnaire to the taxpayer. When the assigned auditor visited taxpayer’s place of business all the owners including the two managers, were present and the questionnaire was delivered to the auditor. Information on the interview questionnaire and further information obtained from taxpayer’s managers and agents became the basis for the audit, including the sale price for beer and mixed drinks, the size of shots and mixed drinks, and the frequency of "specials," which involved reduced pricing. The DOR agent examined the state and federal income tax returns, sales tax returns, profit and loss statements, general ledger, bank deposits, and purchase invoices provided by the taxpayer, but because there were not cash register tapes or records of original entry, the auditor concluded the information insufficient to determine the tax due and reliance on "external indices" was required. The percentage markup method of external indices was used to establish taxpayer’s sales, taking the purchases made by the taxpayer from its suppliers, computing the average markup on the items purchased, and multiplying the average markup by the purchases made. The auditor in calculating the under-reported sales subject to tax took into account numerous factors included changes in purchase price throughout the sample period, payment under a business interruption policy for closure for storm damage, and cover charges received by the bar that were not reported. The taxpayer objected to the use of the markup method of calculating gross sales, specifically asserting it involved unwarranted assumptions and estimates, and was incorrectly applied. The taxpayer also contended the method used by DOR involved a sampling technique that is only permitted by agreement of the parties. The taxpayer filed a protest, which was denied administratively, and then heard by an administrative law judge (ALJ), who filed a proposed order, affirming the audit. The taxpayer filed a petition for judicial review in the district court, which affirmed the audit and this appeal was filed.
The first issue addressed by the court was a determination of what constituted “insufficient records” under the state statute. The court noted that the taxpayer was unable to provide any cash register tapes or records of the daily receipts, but instead computed its receipts from its QuickBooks, which were dependent on the cash available whenever it chose to deposit its receipts. The taxpayer admitted that expenses were paid out of available cash and reported if and when remembered. The record showed that product was available to employees when on duty at no charge, and their consumption was not included in the sales tax report as required.
The court said that the taxpayer could not seriously contend its method of determining sales complied with the DOR rules, but instead, apparently contended the quasi-direct method of accounting it used was more accurate in determining sales than the method used by DOR. The court agreed with DOR that the taxpayer’s records were insufficient to determine sales subject to the state sales tax and did not comply with DOR rules.
The court then turned to the sampling method that DOR utilized and the taxpayer’s argument that DOR was not entitled to use it because the taxpayer did not agree to the method as required by statute. DOR argued that it acted under the provision of Section 423.37(2) which provides that it may determine the amount of tax due from information it may be able to obtain and, if necessary may estimate the amount due on the basis of external indices. That section also provides that the determination may be made using any generally recognized sampling technique as mutually agreed by the parties. DOR argued that it did not use a sampling technique as contemplated by the statute and its interpretation is entitled to deference. The taxpayer argued that the sampling method was involved in DOR's method of determining sales, because after determining the percentage markup for the year 2008, DOR applied the percentage to each of the quarters under audit to calculate the tax due.
The court said that the statute permits DOR to estimate based on external indices and to use a sampling technique as mutually agreed upon by the parties. The use of a sampling technique is optional if the taxpayer and DOR can agree on an acceptable sampling technique. If there is no agreement, DOR is mandated to determine the tax due from the available information and may estimate the tax from external indices, and the court said that in the absence of meaningful records, it was difficult to envision an estimate that did not depend on averaging or "sampling" at some point in the calculation. The court found nothing in the statute that prohibits the use of sampling when the term is used in its broad context, whether or not it is pursuant to an agreement. Absent complete records, if all methods of determining sales that included some measure of sampling were prohibited unless approved by agreement, the court said it was difficult to see how DOR would be able to fulfill its mandated mission. The court noted that a statute is not to be interpreted in such a manner as to produce absurd results and held that DOR’s interpretation of the statute was correct.
Finally, the taxpayer argued that the evidence does not support the findings of fact on which the audit was based or, alternatively, the sales markup method was not correctly computed. The court pointed out that under the state statute findings of fact made by an agency are binding on the reviewing court if supported by substantial evidence and noted that the taxpayer offered no other method of computing its sales except for the quasi-direct method that it used in the report it filed. The court rejected the taxpayer’s arguments, finding that the test was whether substantial evidence exists to support DOR'S conclusion, and evidence is not insubstantial merely because it could support a contrary inference. The courtsaid it could not find that the conclusion by DOR was so illogical as to render it irrational, as required by the statute. The court said that while the assessment may appear to be excessive and the adjustment made by the auditors inadequate, the taxpayer was unable to give any documentation or firm information that would support the adjustments the auditor had already made, let alone the requested adjustments for thefts, spoilage, oversized shots, reduction in income because of specials, drinks given away, or the amount consumed by themselves or employees. The burden was on the taxpayer challenging the assessment to prove the assessment is erroneous and not on DOR to prove its validity. Cream LLC v. Dep't of Revenue, Iowa Court of Appeals, No. 15-0993. 10/12/16
Club Subject to Transaction Privilege Tax
The Arizona Court of Appeals, Division One, held that a strip club was liable for transaction privilege taxes because its live shows fell under the amusement classification. The court held that all of the fees derived from the business were subject to tax.
The taxpayer operated an adult club offering non-alcoholic beverages and live nude performances. The taxpayer filed amended tax returns requesting a refund of transaction privilege taxes, the Department of Revenue (DOR) commenced an audit for the period from February 1, 2008 through August 31, 2011. The audit resulted in the issuance of a deficiency assessed under the amusement classification of the transaction privilege tax and the taxpayer filed an appeal. After exhausting its administrative remedies, the taxpayer filed a complaint in tax court. The tax court held for DOR, concluding that the club’s performances constituted “shows” and the income the taxpayer realized was subject to the amusement tax. The taxpayer filed this appeal.
State law imposes a transaction privilege tax upon the privilege of engaging in business within the state, levied on the amount or volume of business transacted. The issue in this case is whether the taxpayer’s operation of an adult cabaret rendered it liable for a transaction privilege tax under the amusement classification. The plain language of the statute provided the court with the best evidence of legislative intent. Pursuant to the statute, the amusement classification is comprised of "the business of operating or conducting theaters, movies, operas, shows of any type or nature" and other specified activities. DOR argued, and the tax court found, that the club was in the business of conducting "shows." The court looked to the plain and ordinary meaning of “shows,” citing the online version of the Merriam-Webster dictionary which offered three meanings for "show" relevant in this matter: (1) "a performance in a theater that usually includes singing and dancing," (2) "a public performance that is intended to entertain people," (3) "a television or radio program." The court applied the second meaning in this case, noting that the club was licensed as an adult cabaret, a term defined by state law to include clubs that feature “live performances.” The court pointed out that the taxpayer at the tax court hearing referred to its dancers as “performers” or “entertainers” and to the dances as “stage performances.” The court concluded thatapplying the plain meaning of the word “show,” the taxpayer was in the business of conducting shows and its business, therefore, fell within the scope of the amusement tax.
The taxpayer argued that certain fees it collected from performers were license fees for the lease of physical space and that the licensing revenues were not taxable as amusement receipts. Pursuant to the statute, the amusement tax applies to "the gross proceeds of sales or gross income derived from the business." A.R.S. § 42-5073(B). The statutes define "business" broadly to include “all activities or acts, personal or corporate, engaged in or caused to be engaged in with the object of gain, benefit or advantage, eitherdirectly or indirectly."5 A.R.S. § 42-5001(A)(1) (Supp. 2016). The statute provides a presumption that all gross proceeds of sales and gross income comprise the tax base for the business until the contrary is established.
At issue are four fees the club collected from the performers. A "house fee" and a "manager fee" were collected by the cub at the end of each night, and were not tied to a particular performance and were adjusted downward if the performer had a slow night. A "couch fee" was collected for each one-on-one dance and a "VIP fee" for "more private" performances of "greater duration." The customer paid the couch fee to the performer, who in turn paid a portion to the club. The customer paid the VIP fee directly to the club. The court found that these fees all constituted income derived from the club’s nude dancing shows whether received directly from the customers or indirectly through the performers. Accordingly, the court said, the income generated from these fees was taxable under the statute. Ziegfield Inc. v. Dep't of Revenue, Arizona Court of Appeals, Division One, No. 1 CA-TX 16-0001. 10/6/16
Personal Income Tax Decisions
Nonavoidance Common Law Doctrines Don’t Apply
The Nebraska Supreme Court held that the economic substance and sham transaction doctrines did not apply to disallow a special capital gains election on the sale of qualified capital stock. The court found that the taxpayers met the election's statutory criteria and the state legislature intentionally omitted nonavoidance doctrines in the statute's plain language.
The Nebraska Revenue Act of 1967 provided for an exclusion from tax for a special capital gains election. The provision permits a taxpayer to make one election during his or her lifetime to exclude from federal adjusted gross income those capital gains from the sale of "capital stock of a corporation acquired by the individual (a) on account of employment by such corporation or (b) while employed by such corporation." A qualified corporation for the purposes of this provision is one that at the time of the first sale or exchange for which the election is made, has at least five shareholders and has at least two shareholders or groups of shareholders who are not related to each other and each of which owns at least ten percent of the capital stock.
The taxpayers in this matter were both residents of the state and attempted to make this election regarding their sales of capital stock in Pioneer Aerial Applicators, Inc. (Pioneer), to Aurora Cooperative Elevator Company (Aurora). On February 26, 2010, the taxpayers and the one other shareholder of Pioneer signed a contract to sell their combined shares of Pioneer to Aurora. The contract closing date was scheduled for March 1. Before the agreement was made, Pioneer had only three shareholders, and therefore, did not meet the first criteria of the definition of qualified corporation. However, prior to the closing date one of the taxpayers was to sell one share of stock to each of three officers of Aurora so that Pioneer was then a qualified corporation for the underlying stock purchase with Aurora. The purchase agreement explicitly laid out the restructuring intended to make the Taxpayers’ sale to Aurora eligible for the special capital gains election, providing that at least three days prior to the closing the shares would be transfer to each of three officers of Aurora in exchange for non-recourse notes due at payable at closing. On February 26, 2010, pursuant to the plan in the purchase agreement, one of the taxpayers entered into separate agreements for the sales of stocks with the three officers, and Pioneer issued new stock certificates for the four of them to reflect the sale. At closing, on March 1, the taxpayers and the officers executed stock powers with Aurora and the taxpayers issued and delivered checks to each in return. The taxpayers filed their federal and state 2010 tax year income tax returns as married filing jointly and, on their state return, made a special capital gains election on the sale of their shares of Pioneer stock to Aurora. They chose not to make the election on the spouse’s February 26, 2010, sale of shares of Pioneer stock to the three officers of Aurora, and paid capital gains tax for that sale.
The state Department of Revenue (DOR) disallowed the taxpayers’ special capital gains election for this transaction, on the basis that the capital stock was not issued from a qualified corporation, and issued the taxpayers a notice of deficiency. The taxpayers filed a petition for redetermination. After an administrative hearing, the Tax Commissioner entered an order denying the taxpayers’ petition for redetermination. The Tax Commissioner acknowledged that the purchase agreement between the Sellers and Buyer intended to add three more shareholders through an additional stock transaction prior to the closing date, but the Tax Commissioner disregarded the spouse’s sale of stock to the three officers by applying the federal common-law "economic substance" and "sham transaction" tax nonavoidance doctrines. The district court affirmed the decision of the Tax Commissioner and the taxpayers filed this appeal. This court granted the taxpayers’ petition to bypass review by the state Court of Appeals.
The court began its discussion with the basic principles of statutory construction. It then looked to the specific statutory language at issue in the case and said the statute sets forth certain requirements for the shareholders at one specific point in time, for the special capital gains election, i.e. at the time of the first sale or exchange for which the election is made.
The court further noted that the statute authorizing the election did not contain language discussing underlying sales and transactions or requiring a purpose for taking actions to comply with the statute other than qualifying for the election. Accordingly, the court found no support in the plain language of the statute to review transactions that came before the "first sale or exchange for which the election is made" for a special capital gains election, and the court said the transactions occurring on February 26 were outside the scope of the statute.
The court rejected DOR’s argument that the economic substance and sham transaction doctrines required the court to find a legitimate business purpose and economic substance in the creation of the qualified corporation, saying that the language of the statute was clear and unambiguous and the court was precluded from looking beyond the words of the statute to apply additional elements. The court cited prior decision in support of this conclusion. The court also took note that the application of these federal tax doctrines in this case is also not supported by the legislative intent evident in the words of the statute. The parties agreed that these tax doctrines had been in place at the federal level for more than 50 years when the special capital gains election statutes were enacted, and, the Legislature did not include any language invoking either of them. The court said the intent of the Legislature may be found through its omission of words from a statute as well as its inclusion of words in a statute.
The court found thatPioneer was a qualified corporation at the time of the first sale or exchange for which the taxpayers made their special capital gains election, and having met all the statutory requirements, they were entitled to make the election. Stewart v. Dep't of Revenue, Nebraska Supreme Court, 294 Neb. 1010, No. S-15-700. 10/14/16
Corporate Income and Business Tax Decisions
Apportionment Case Remanded to Division of Taxation
The New Jersey Tax Court held that the Division of Taxation's (Taxation) 100 percent income allocation method with credits for taxes paid to other states did not accurately reflect a financial service company's business in the state. The court also struck down the use of a three-factor formula as presented by the taxpayer, and remanded the case to the tax department for further proceedings.
The taxpayer is a commercial financial services company headquartered in the state. It is a wholly owned subsidiary of Canon U.S.A., Inc. (Canon U.S.A), which is a wholly owned subsidiary of Canon, Inc. which manufactures digital multifunction devices, copy machines, printers and cameras. Canon U.S.A. is the exclusive importer and distributor of Canon, Inc. products in the United States. The taxpayer offered lease financing to the customers of its parent, Canon U.S.A. and Canon Solutions America, Inc. In addition, leasing through the taxpayer was available to the customers of the independent dealers and resellers. All of the taxpayer’s office functions were performed at its headquarters in the state and all lending decisions were made in New Jersey. The taxpayer maintained no other offices either outside the state. Once a lease application was approved by the taxpayer and a lease agreement executed, taxpayer purchased the equipment to be leased and transferred possession to the customer. The taxpayer apparently never took physical possession of the leased equipment, but it obtained and retained title for the duration of the lease agreement. Upon lease termination, the taxpayer would arrange for the final disposition of the leased property by way of sale to the lessee or other purchaser, or by way of recycling of the property. The taxpayer had customers in all 50 states during the years under review and collected monthly lease payments in all states. The value of the equipment owned by plaintiff and leased to the customers located in the various states was between $0.7 billion and $1.2 billion.
In order to finance its operations the taxpayer borrowed funds from its parent, Canon U.S.A., in amounts determined on projected cash needs and the loans were documented by a single page document, referred to by the taxpayer as a "Note". The taxpayer filed New Jersey Corporation Business Tax (CBT) returns for the tax years 2004 through 2010 and also filed returns for those years in separate reporting states or was included in consolidated tax returns filed by Canon USA and its subsidiaries in combined reporting states. As a result, its income was taxed or taken into account in all 47 states imposing a corporate income or franchise tax during the years at issue here. In each CBT return filed the taxpayer deducted all of the interest it paid to its parent and other related parties on the “Notes” and calculated its taxable income by utilizing a three-factor allocation formula. Taxation conducted an audit of the CBT returns and determined that taxpayer, having no regular place of business located outside the state, was required to allocate 100% of its income to New Jersey. Pursuant to the authority in the statute, the Director of Taxation reviewed the taxpayer’s request to allocate its income in a manner other than the 100% allocation required by the statute. The Director considered several alternatives but ultimately allocated 100% of the income to the state and allowed credits for taxes paid to other jurisdictions where the taxpayer filed a separate return. For the years 2004 through 2009, the Director also added back all interest deducted on loans paid by the plaintiff to related parties on the “Notes”. The taxpayer elected to file this direct appeal of the assessment to the Tax Court rather than file a protest with Taxation and request a hearing.
Initially, the court noted that there were no genuine issues of material fact in dispute, and the matter was, therefore, ripe for summary judgment. The court also pointed out that the review of the matter begins with the presumption that determinations made by the Director are valid as long as they are not plainly unreasonable, because courts have recognized the Director’s expertise in the highly specialized area of taxation.
Under the CBT, if a corporation has multistate income, an allocation factor is applied to determine the amount of its overall income subject to tax in the state, and for the years at issue here, when a taxpayer did not maintain a regular place of business outside the state, the allocation factor was 100%. If a taxpayer maintained a regular place of business outside the state, the proportionate share of the income subject to the CBT was determined by applying a three factor allocation formula taking into account the corporation’s in-state sales, payroll and property. It was recognized that the application of either allocation formula in certain circumstances might not produce a fair approximation of the net income attributable to a corporation's activities in the state, and the Director was, therefore, granted discretionary authority in those cases to adjust the allocation factor. The court noted that the state’s highest court has, in fact, determined that this statutory direction imposes an obligation on the Director to consider requests for adjustment on claims of unfairness that do not attain constitutional dimensions. Under a state regulation, in order to apply for an adjustment to reduce the CBT, a taxpayer must file its return utilizing the statutorily mandated 100% business allocation factor and then apply for a reduction in the amount of its tax. The taxpayer is also required to attach a rider to its return demonstrating that a part of entire net income is duplicated on a return filed with another state, together with other information from the return filed in the other state.
The court said that the question here is not whether one technique as opposed to another should be used, but whether the method selected by the Director produces a degree of unfairness that amounts to “substantial inequity." The court said that applying the 100% allocation formula with the credit for taxes paid to other jurisdictions in this case results in taxes ranging from 221% to 310% of the taxes payable utilizing a three-factor formula. The taxpayer argued that these results are substantially similar to those in a prior case decided by the courts in the state and that they are, therefore, entitled to utilize the three-factor formula. The court agreed that the proposed allocation does not result in an apportionment that fairly and reasonably reflects the plaintiff's business activities in this state. The court, however, disagreed with the taxpayer’s conclusion that they are entitled to utilize the three-factor formula. The court said that the Director has demonstrated the deficiency in the three-factor formula as applied to the plaintiff's business in this matter. The court noted that all of the taxpayer’s office functions are located in New Jersey and all of its lending decisions are made in New Jersey. The wage fraction ranges from 90% to 99%. With the exception of the leased equipment, substantially all of the assets utilized in its business are in New Jersey and the Property Fraction ranges from 80% to 100%. Despite this, the court notes that the application of the three-factor formula would result in allocation formulas of approximately 30% in each of the years under review. While the rental income generated by the leased equipment located out of the state is considered non-New Jersey income, inclusion in the denominator of the receipts fraction and the double weighting of the receipts fraction under the three-factor formula works to allocate the taxpayer’s income away from the state. The court, therefore, found that the Director persuasively argued that strictly applying the three-factor formula does not fairly allocate the taxpayer’s business activities in this State. As a result, the court remanded the matter to the Director for further consideration consistent with the decision.
Canon Fin. Serv. Inc. v. Director, Division of Taxation, New Jersey Tax Court, Docket No. 000404-2014. 10/13/16
Tax Court Finds Taxpayer Subject to Subscriber Apportionment
The Oregon Tax Court held that Comcast was an interstate broadcaster and subject to subscriber apportionment. This conclusion requires inclusion of all gross receipts from broadcasting in the numerator of the sales factor.
The taxpayer is a corporation operating in the state with portions of its revenue derived from the provision of cable television, Internet and voice over Internet protocol services to subscribers in the state and other states. The cable and other facilities used for transmission of television services are also employed for Internet and voice over Internet protocol services.
The issue in this matter is whether the taxpayer is required to determine the sales factor for apportionment of income under the Broadcaster Statutes, ORS 314.680 to ORS 314.684 and OAR 150-314-0465. The taxpayer argued that its sales factor must be determined under the provisions of ORS 314.655 regarding situs of receipts from sales other than sales of tangible personal property. The term "interstate broadcaster" is defined in the statute to mean, "a taxpayer that engages in the for-profit business of broadcasting to subscribers or to an audience located both within and without this state." ORS 314.680(3). The statute further defines "broadcasting" as "the activity of transmitting any one-way electronic signal by radio waves, microwaves, wires, coaxial cables, wave guides or other conduits of communications." ORS 314.680(1). A taxpayer engaged in interstate broadcasting must then include all gross receipts from broadcasting in the numerator of the sales factor for apportionment purposes. The statute then apportions gross receipts from broadcasting according to a ratio of subscribers in state to subscribers both in state and outside the state. The term “gross receipts from broadcasting” to mean all gross receipts of an interstate broadcaster from transactions in the regular course of business, except receipts from sales of real or tangible personal property.
The taxpayer argued that only a portion of its revenues arise from transmission of one-way electronic signals and the taxpayer objected to apportionment of other revenue based on the subscriber ratio. Taxpayer argued that it was not subject to the Broadcaster Statutes as to revenue that, although arising in the ordinary course of its trade or business, did not arise from transmission of one-way electronic signals. The court rejected this argument saying is not what the state statutes allow or require. A taxpayer is an interstate broadcaster pursuant to the statute if it engages in one-way transmission of electronic signals and without a clear indication of legislative intent, the court said it could accept taxpayer's invitation to read the words "only if" or "only to the extent that" into the statutory scheme.
The court said that if the state legislature had intended to separately apportion the revenue streams of a company as between "one-way" and other streams, it would have at least given some signal, if not explicit statutory language, that the "one-way" stream would be apportioned under the Broadcaster Statutes with the remainder subject to ORS 314.665. The court noted that no statutory provision in the Broadcaster Statutes made a cross-reference to ORS 314.665 as a default rule to be applied to the extent the Broadcaster Statutes did not apply and nothing in the general apportionment statutes indicated that those general statutes were to apply to the extent that the special rules of statutes such as the Broadcaster Statutes did not apply. Comcast Corp v. Dep't of Revenue, Oregon Tax Court, TC 5265. 10/11/16
Property Tax Decisions
Exemption for Nonprofit School Denied
The Michigan Court of Appeals held that a nonprofit company offering preschool and kindergarten programs did not qualify for the educational or the charitable institution property tax exemptions. The court made this determination because the nonprofit charged tuition and the court said it did not substantially alleviate the state's educational burden.
The taxpayer is a nonprofit, 501(C)(3) corporation, offering preschool and kindergarten programs to students age 6 and younger. It utilizes a Montessori-style education system and employs teachers specially trained in this style of education. Classrooms have students of different ages, multiple teachers are assigned to each classroom, and the program focuses on each child’s own skill set and abilities. It charges tuition for its various programs and full-day programs generally cost in the range of $7,000 to $8,000 annually. In 2009, the City of Oak Park (City) assessed ad valorem property taxes against the taxpayer, who filed a protest arguing that it was entitled to the educational institution and charitable institution exemption. In September 2012, the tax tribunal held for the City, finding that the taxpayer was not entitled to the educational exemption because it did not substantially alleviate the state’s educational burden. The tribunal also determined that the taxpayer was not a charitable organization because it charged tuition to the vast majority of students and offered reduced pricing to only a few. The taxpayer filed an appeal and this court reversed and remanded, concluding that a question of fact existed with respect to the taxpayer’s entitlement to both exemptions.
On remand, the tribunal conducted an evidentiary hearing and again concluded that the taxpayer was not entitled to either tax exemption. With regard to the educational institution exemption, the tribunal found that a limited number of the taxpayer’s students could possibly attend a state-funded program, but concluded that in the absence of the taxpayer, these children would attend another Montessori-style program rather than enroll in a state-funded program. The tribunal, therefore, concluded that the taxpayer did not relieve a substantial governmental burden and was not entitled to the educational institution exemption.
With regard to the charitable institution exemption, the tribunal focused on this Court's statement that if a budget deficit were to be made up by those receiving the services, the taxpayer would not be charitable. The taxpayer’s co-director and administrator testified that it operated at a loss in some years and when this occurred, the taxpayer would raise tuition in the following year to make up the difference. From this testimony, the tribunal determined that because losses were to be made up by those receiving the taxpayer’s services, the taxpayer was not a charitable institution. The taxpayer filed this appeal.
The state property statute provides an exemption for property owned and occupied by an educational institution and specifically provides that to qualify for the exemption the institution must make a substantial contribution to the relief of the burden of government. An institution makes such a contribution if a substantial portion of the institution's students both could and would attend a state-supported school if the institution did not exist. The court found that the evidentiary record in the case demonstrated that only a relatively small portion of the taxpayer’s students could possibly attend a state-funded school or program.
The evidence introduced at the hearing demonstrated over the course of the years in question, a total of 175 students were enrolled at taxpayer and of these, 47 were old enough to be eligible to attend a state-funded kindergarten program. Therefore, only a small percentage of its students could possibly have attended a state-funded preschool or kindergarten program.
The court also found that the tribunal’s conclusion that if the taxpayer were to cease to exist, the limited number of students who might be able to attend a state-funded program would not do so, and would, instead, attend another Montessori program was based on substantial evidence. The court rejected the taxpayer’s argument that the tribunal erred by emphasizing educational technique rather than examining the coursework provided by it and comparing that to what is available in state-funded programs, finding that the methodology utilized by the taxpayer in conducting its programs was relevant to the question of the quality of the programs. The court also reviewed the variety of additional arguments raised by the taxpayer but found that they lacked merit and determined that the tribunal did not make an error of law or apply a wrong principle when it concluded that the taxpayer failed to demonstrate that a substantial portion of its students both could and would attend a state-funded program if it ceased to exist.
The court then considered the issue of whether the taxpayer was entitled to the charitable institution exemption and discussed prior case law in the state that considered the issue and the factors that come into play when determining whether an institution is a charitable entity.
When the court previously remanded the matter to the tribunal it made it clear that the fact that the taxpayer charged for its services did not necessary preclude it from being a charitable institution, but said conversely that the fact that an institution may be operating at a loss does not automatically make it charitable. The court said when it remanded the matter that if the deficit is to be made up by those receiving the services, it would not be charitable, whereas if the deficit is not being made up by those receiving the services, it might be and noted that there was a genuine question of material fact in the current case that needed to be resolved.
On remand, the tribunal focused on testimony regarding tuition increases and the record showed that each time the taxpayer finished a year at a financial loss, it increased tuition in the following year to make up the difference. Thus, the record demonstrated that deficits were made up by those receiving the taxpayer’s services. Once this fact was established, this Court's prior opinion required the tribunal to conclude that the taxpayer was not entitled to the charitable institution exemption and the court found no legal error or application of a wrong principle in the tribunal’s analysis. A dissenting opinion concluded that the tribunal adopted a wrong principle when it based its decision solely on the fact that the taxpayer charges tuition and fees. Harmony Montessori Center v. City of Oak Park, Michigan Court of Appeals, No. 326870. 10/13/16
Leased Portion of Nonprofit's Property Taxable
The West Virginia Supreme Court of Appeals held that real estate owned by a qualifying charitable organization was not wholly exempt from property tax because it was leased or rented to a private, non-qualifying organization.
The taxpayer, University Healthcare Foundation, Inc., owned property known as the
Dorothy McCormack Cancer Treatment & Rehabilitation Center (Center). The taxpayer applied for a property tax exemption for the Center in 2014 and the county assessor denied the request. The taxpayer then requested a ruling from the Commissioner who subsequently ruled against the availability of the requested tax exemption. The taxpayer appealed the Commissioner's ruling to the circuit court and after a bench trial the court reversed the decisions of both the Assessor and the Commissioner and granted the taxpayer an exemption,
reasoning that the healthcare and recreational services provided in the eighteen different suites of the Center were primarily and immediately related to the joint charitable purposes of the Center and the Berkeley Medical Center (BMC). The Commissioner filed this appeal arguing that only 28% of the Center’s physical space is being used for charitable purposes. The Commissioner further argued that, based on the fact that the taxpayer leased suites within its Center to for-profit tenants, state law prohibits an exemption from ad valorem property taxation.
Citing Central Realty Co. v. Martin, 126 W.Va. 915, 30 S.E.2d 720 (1944) and State v. McDowell Lodge, 96 W.Va. 611, 123 S.E. 561 (1924), the court noted that the issue in this case, whether a charitable entity that leases a portion of its real property to for-profit entities is entitled to a statutory tax exemption from ad valorem property taxes for the entirety of its property, was not a case of first impression. The court said that a review of the state constitution, statutes, and case law demonstrated that the tax relief sought by the taxpayer, and awarded by the circuit court, was prohibited. The court noted that charitable organizations seeking an exemption from ad valorem property taxation based on property usage must demonstrate that the entity is a charitable organization and the property must be used exclusively for charitable purposes and must not be held or leased out for profit. The court said the first prong of this test is not in dispute here, but the property’s use exclusively for charitable purposes had not been established. The court said that in the instance of a lease arrangement, the charitable purposes of the taxpayer are not singularly determinative, but shift to whether the lessee and not the lessor is using the property exclusively for charitable purposes. The court said the usage of the Center by the for-profit lessees was categorically not for charitable purposes and the taxpayer’s secondary usage of rents from profit-oriented tenants to accomplish its charitable purposes does not override the primary usage of the rental space by those tenants. The court held that the physical use of the property, rather than any income derived from such property, is the determining factor as to the usage of such property. Matkovich v. Univ. Healthcare Found. Inc., West Virginia Supreme Court, No. 15-0597. 10/11/16
Other Taxes and Procedural Issues
No cases to report.
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected]. |
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NEWS
Vodafone Americas Holdings Inc. v. Roberts Update
In preparation for the oral arguments in this case, briefing has been completed before the Tennessee Supreme Court in Vodafone Americas Holdings Inc. v. Roberts.
On December 22, 2015, Vodafone filed a brief with the Tennessee Supreme Court arguing the Department of Revenue violated the state's limits on the its authority by applying an alternative method of apportionment when there were no unusual circumstances or incongruous results unique to the company's operations. On January 21, 2015, the Tennessee attorney general filed a brief arguing the Department of Revenue correctly exercised its legislatively granted variance authority to make Vodafone’s income tax receipts factor properly reflect its business activity in Tennessee.
On February 2, 2015, the Institute for Professionals in Taxation filed an amicus brief in the supporting Vodafone Americas. IPT argued that the Court of Appeals opinion upholding the tax commissioner's application of an alternative method of sourcing sales destabilizes state law that allows a cost of performance method. On February 4, 2015 the Council for State Taxation (COST) filed an amicus brief supporting Vodafone, arguing that the commissioner's imposition of an alternative apportionment formula usurped the intent of the General Assembly to allow cost of performance sourcing for multistate service enterprises. On February 4, 2015, the Tennessee Cable Telecommunications Association also filed an amicus brief supporting Vodafone.
On February 4, 2015, Vodafone filed a reply brief with the Tennessee Supreme Court, arguing that it properly applied a statutory cost of performance rule to source its interstate sales and the state's application of a market-based sourcing method for communications services is an abuse of discretion.
On January 30, 2015, The Multistate Tax Commission (MTC) filed an amicus brief with the Tennessee Supreme Court supporting the state and arguing that the commissioner has the authority to use the alternative apportionment method for determining franchise and excise tax liabilities because standard apportionment does not accurately reflect the taxpayer's in-state activities. On February 18, 2015, Vodafone filed a brief with the court responding to the Multistate Tax Commission’s amicus brief. That brief argued that MTC's position is in direct conflict with the MTC's core mission of uniformity and its long history of pursuing that goal by adopting uniform laws and regulations that are proposed for adoption by the states.
In the meantime, on February 2, 2015 a pair of Tennessee bills were introduced and would change the apportionment formula for calculating franchise and excise taxes to more heavily weight the sales factor and also expand the types of income subject to taxes.
New York Files Suit Against UPS for Untaxed Cigarette Delivered into the State
The New York Attorney General and New York City Corporation Counsel filed suit in the U. S. District Court for the Southern District of New York on February 18, 2015, alleging that the United Parcel Service of America Inc. shipped over 136 million untaxed cigarettes, or nearly 700,000 cartons, throughout New York between 2010 and 2014, a practice that the suit alleges cost the state and city $34.4 million in taxes in those years.
UPS denies the allegation that they knowingly shipped cigarettes to consumers and claims that since 2005, it has worked with regulators on this issue.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
Court Allows Stripping of IRS Lien From Home
A U.S. bankruptcy court held that an IRS tax lien could be stripped from a home, finding that the lien was wholly unsecured due to the absence of equity in the home. The court found that the lien stripping was permissible since the lien attached to the debtors' personal property of value.
In December 2013 the IRS filed a Notice of Federal Tax Lien (“Lien”) against the taxpayers. The Lien attaches to the taxpayer’s home and constitutes a lien against certain personal property owned by the taxpayers. The parties agreed that there was no equity in the home to secure the Lien. The United States argued that it had a partially secured claim because its lien attaches to personal property that has some value, and, as a result, the taxpayers’ attempt to strip off its lien on the home is prohibited by the Supreme Court's holding in Dewsnup v. Timm, 502 U.S. 410 (1992). The Court rejected that argument, holding the fact that the IRS lien attaches to both personal property and the home does not mean that the IRS is partially secured on the home. Instead, citing In re McNeal, 735 F.3d 1263 (11th Cir. 2012), the court found that because the lien is wholly unsecured on the home, the lien on the home may be stripped off. Francis J. Gonzon et al. v. Bank of New York Mellon et al., U S Bankruptcy Court for the Southern District of Florida, No. 14-01584. 2/4/15
Motion to Dismiss Class Action Sales Tax Suit Dismissed
The U.S. District Court for the Northern District of Ohio denied a corporation’s motion to dismiss a class action complaint alleging that the retailer did not refund sales tax at the correct local rate. The court rejected the corporation’s argument that the plaintiffs must appeal to the tax commissioner because it is unclear if the tax was remitted to the state.
The Plaintiffs in this matter purchased items at corporation’s stores in Ohio and paid sales taxes on the purchases. The state allows counties to levy additional sales taxes at rates determined by the county. The purchasers then returned the merchandise to stores in different counties and the corporation would only refund sales taxes at the rate used in the area where the merchandise was returned even though Plaintiffs brought receipts showing that they had paid higher sales taxes at the time of purchase. Plaintiffs claim this practice is in breach of the company’s contractual agreement to give full refunds for returns made within 90 days. The court found that while the amount lost was minimal for named plaintiffs, across the large number of returns that the company processes each day, the cumulative amount might be large.
A motion to dismiss under Federal Rule of Civil Procedure 12(b)(1) "may either attack the claim of jurisdiction on its face or it can attack the factual basis of jurisdiction." The corporation makes a facial attack to this Court's jurisdiction, challenging the sufficiency of the pleading itself. The corporation argued that the state requires customer claims for the refund of sales tax is filed exclusively with the state Tax Commissioner (Commissioner). The court noted that the section cited by the corporation in support of its argument seems to limit claims to circumstances where the Commissioner has received the tax. The statute, and the related administrative scheme, limits a consumer's ability to seek an erroneously calculated sales tax to circumstances where the Commissioner holds the funds. The court also distinguished a case cited by the corporation in support of its argument, finding that a vendor's wrongful collection of an existing tax is distinguishable from a vendor's collection of a nonexistent tax in the cited case.
The court noted that at this stage, it is not clear whether the corporation has paid the state the sales tax that it did not refund to Plaintiffs when they returned the merchandise. It further noted that if the state has the not-refunded tax, the corporation likely has a winning argument that Plaintiff must make a claim to the Commissioner. In contrast, if the corporation did not remit the sales tax that was not returned to the Plaintiffs, then the statute does not allow a claim to the Commissioner, and case law allows a direct breach of contract action. The court held that, at this stage, Plaintiffs have stated a claim over which the Court has jurisdiction. Brandewie v. Wal-Mart Stores Inc., U S District Court for the Northern District of Ohio, Case No. 1:14-CV-965. 1/16/15
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Helicopter Leasing Company Owes Use Taxes on Equipment Purchases
The Arizona Court of Appeals held that a company leasing its helicopters from related entities is liable for use taxes for its purchase of dynamic equipment because it did not meet any of the requirements in the aircraft equipment exemption statute. The court also denied the lessor entities' transaction privilege tax exemption claim.
The taxpayer provides on-demand and scheduled helicopter flights in Arizona and Southern Nevada, including daily scenic air tours of the Grand Canyon. It leases helicopters from related entities, hereinafter referred to as the Lessors. Under the lease agreements, taxpayer was responsible for maintaining the helicopters, including the purchase and installation of "dynamic equipment," an industry term for engines, rotors, turbines, blades, and other aircraft parts. The Department of Revenue (DOR) assessed the taxpayer for use tax on its purchase and use of the dynamic equipment. DOR also assessed the Lessors for transaction privilege tax against the lease income earned on these lease transactions.
The state’s transaction privilege tax is an excise tax on the right to engage in business in the state and extends to businesses that lease or rent tangible personal property. The tax is assessed against the income generated by the lease. The state’s use tax, which is complementary to the transaction privilege tax, applies to the storage, use or consumption of tangible personal property purchased from a retailer and is calculated as a percentage of the sales price. The taxpayer and Lessors admit they are engaged in activities that fall within the scope of the transaction privilege tax and the use tax, but assert they are exempt from taxation because the taxpayer holds a "supplemental air carrier certificate under federal aviation regulations." Both the transaction privilege tax and the use tax provide an exemption for "[a]ircraft, navigational and communication instruments and other accessories and related equipment," provided that the aircraft or equipment is sold to:
(a) A person holding a federal certificate of public convenience and necessity, a supplemental air carrier certificate under federal aviation regulations (14 Code of Federal Regulations part 121) or a foreign air carrier permit for air transportation for use as or in conjunction with or becoming a part of aircraft to be used to transport persons, property or United States mail in intrastate, interstate or foreign commerce.
A.R.S. §§ 42-5061.B.7(a), -5159.B.7(a) If a sale of aircraft or related equipment is exempt under this provision, then income realized from the lease of such property is also exempt. It was undisputed that the dynamic equipment and the helicopters themselves qualified as aircraft, navigational and communication instruments and other accessories and related equipment under the exemption. The issue was whether the taxpayer met the second requirement of the provision and held one of the certificates or permits required, and, in particular, whether the taxpayer held a supplemental air carrier certificate under federal aviation regulations. In order to operate as an air carrier or commercial operator an entity must obtain an air carrier-operating certificate from the FAA and the taxpayer obtained that certification. FAA regulations also specify that a carrier must obtain operation specifications that prescribe authorizations, limitations and procedures for their operations and these regulations contain numbered parts that set forth the rules applicable to each kind of operation.
Carriers authorized to operate under Part 121 can conduct "supplemental operations." The taxpayer was not authorized under Part 121 to conduct supplemental operations. Rather, it was authorized under Part 135 to conduct commuter and on-demand operations. It was also authorized under Parts 133 and 137 to provide rotorcraft external-load operations and agricultural aircraft operations. The court found that the plain language of the exemption applied only to an air carrier authorized to conduct supplemental operations under Part 121 and pointed out that the federal regulations made it clear that rotorcraft operations were not “supplemental operations.” The court also rejected the taxpayer’s argument that the language of the statutory exemption was ambiguous, finding that the legislative history reflected that “supplemental operations” are those authorized under Part 121 of the FAA regulations. American Helicopters LLC v. Dep't of Revenue, Arizona Court of Appeals, No. 1 CA-TX 14-0001. 1/29/15
Taxpayer Abandoned Claim for Sales and Use Tax Refund
The Louisiana Court of Appeals upheld a lower court’s dismissal of a company's challenge to sales and use taxes paid under protest finding that the company abandoned its claim by failing to take steps within the three-year statutory requirement.
At issue is whether the taxpayer’s 2007 suit to refund the tax paid under protest was abandoned. Under the state statute an action is abandoned "when the parties fail to take any step in its prosecution or defense in the trial court for a period of three years." La.Code Civ.P. art. 561(A). The Louisiana Supreme Court has interpreted Article 561 as imposing three requirements: (1) a party must take some step in the prosecution or defense of the litigation; (2) the step must be taken in the litigation and must appear in the record, with the exception of formal discovery; and (3) that step must have been taken within three years of the last step taken by either the plaintiff or defendant. Clark v. State Farm Mut. Auto. Ins. Co., 00-3010 (La. 5/15/01), 785 So.2d 779.
Here, the taxpayer filed its petition in December 2007. There were filings in 2008 and 2009, but nothing was filed in 2010 and 2011. The only filing in 2012 was a request for notice filed by the plaintiff on June 19, 2012. Nothing was filed in 2013 until the defendant's November 14, 2013 motion to dismiss due to abandonment. The court noted that a request for notice, such as that filed by the taxpayer on June 19, 2012, is not a step intended to hasten the matter to judgment; rather, it is a request for notification in the event that steps are taken.
As a result, the court found that the last action was taken on September 1, 2009 and steps sufficient to interrupt abandonment had to have occurred by September 1, 2012.
The taxpayer submitted an affidavit attaching several e-mails dated in September 2011, which indicate efforts to set up a settlement meeting for the following month. However, citing prior court decisions, the court noted that informal settlement negotiations between the parties have uniformly been held to be insufficient to constitute a step for purposes of interrupting abandonment.
The taxpayer also argued that verbal discussions and document retrieval was ongoing during this period, which show an intent not to abandon. The taxpayer also asserted that the law changed in 2011, changing the traditional analysis to review certain non-formal actions by Plaintiff as a “step” in the prosecution of a claim. The court rejected these arguments finding taxpayer’s reliance on prior case law misplaced. The court noted two exceptions to the abandonment provision: (1) a plaintiff-oriented exception, based on contra non valentem, that applies when failure to prosecute is caused by circumstances beyond the plaintiff's control; and (2) a defense-oriented exception, based on acknowledgment, that applies when the defendant waives his right to assert abandonment by taking actions inconsistent with an intent to treat the case as abandoned. It was undisputed by the parties that waiver was not alleged in this matter. The taxpayer did raise the other exception, contra non valentem.
The exception based on contra non valentem applies when the plaintiff makes a showing that his failure to prosecute was caused by circumstances beyond his control. This contemplates events that create a legal impediment to pursuit of the matter, such as a natural disaster or a plaintiff's active service in the military or confinement to a mental institution, which makes it impossible for the plaintiff to take the necessary steps to prevent abandonment. In this matter, the taxpayer argues that the Department controlled the litigation and it had no control over when and if the taxpayer's vendors would cooperate in providing documentation. In terms of the documentation difficulties that the taxpayer relied upon to show circumstances beyond its control, the court pointed out that document gathering should have started shortly after the assessment in 2004 and should have yielded some results sufficient to claim that a refund was owed when suit was filed in 2007. The court also noted that the Department did not seek dismissal of the suit for refund until 2013, nine years after the assessment and twelve years after the tax period ended. The court found that these general, business-type delays are not the legal impediments or circumstances described in the jurisprudence that make it impossible for the taxpayer to take steps to hasten his own matter to trial. Hercules Offshore Inc. v. Lafayette Parish School Bd., Louisiana Court of Appeal, 14-701. 2/11/15
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Business Privilege Tax Income Includes Insurer's Annuity Payments
The Alabama Court of Civil Appeals found an out-of-state insurance company was entitled to include annuity considerations in its premium income for business privilege tax (BPT) purposes, finding the Department of Revenue (DOR) inappropriately limited the definition of "premiums" for the BPT to the definition used under insurance premium tax statutes. The taxpayer is an out-of-state insurance company that does business in the state and is subject to the state’s BPT levied on every corporation, limited liability entity, and disregarded entity doing business in the state, or organized, incorporated, qualified, or registered under the laws of the state.
The BPT is based on a taxpayer's net worth in the state, apportioned on the basis of the ratio of the insurer's state premium income to its nationwide total direct premiums, reflected on insurer's annual statement filed for the immediately preceding calendar year. DOR filed an assessment for tax years 2008 and 2009 calculating the taxpayer’s apportionment factor by including only the life insurance premiums collected and excluding any annuity considerations from the calculations. The parties agreed that the material facts were undisputed and that the decision in the case turns on the construction of the statutory provision. DOR argued that “premiums” excludes annuity considerations because the statutes governing BPT and the insurance-premium tax should be read in pari material. The taxpayer argues that the definition of premiums in the insurance premium tax statute was clearly for the purpose of that statute only. The term "premium" is not defined in the BPT, but it is defined in several parts of the state’s code and the term "premium" is, at times, inclusive of "annuity considerations." The court also noted that the ordinary meaning of the word "premium" is "the consideration paid for a contract of insurance." Merriam-Webster's Collegiate Dictionary 980 (11th ed. 2003). Thus, a premium and a consideration are, in this context, the same thing, according to the court. The court also took note of an affidavit presented by the taxpayer of a professor of insurance law who explained that the terms "annuity premiums" and "annuity considerations" are used interchangeably in the insurance industry to refer to the payments made to insurance companies to purchase an annuity and included industry publications that all refer to a payment made by an annuitant for an annuity as a “premium.” The court also noted that the state regulations governing annuity disclosures refer to a payment made for an annuity as a premium.
While the court agreed with DOR that its interpretation of the statute should be given favorable consideration, it noted that deference has its limits, especially when the interpretation is unreasonable or unsupported by the law. The court reviewed the references to the insurance-premium tax in the BPT statutes to discern whether the statutes applicable to each of the taxes should be construed in pari material and determined that a reading of those statutes does not compel the conclusion that the separate statutes governing the BPT and the insurance-premium tax cover the same subject matter. The court held that neither the insurance premium tax statutes nor any of the references in BPT statutes to the insurance-premium tax suggest that the definition of "premiums" from the insurance premium tax statute should be imported into the statutes applicable to the BPT. Finally, the court held that DOR’s restrictive interpretation of “premiums” was not a reasonable interpretation of the statute. Dep't of Revenue v. Am. Equity Inv. Life Ins. Co., Alabama Court of Civil Appeals, 2130933. 1/16/15
DOR's Objections to En Banc Hearing in Apportionment Formula Dispute Overruled
The Minnesota Tax Court overruled the revenue commissioner's (Commissioner) objections to an en banc hearing in the tax court in a case where the company is challenging the state's denial of its ability to use the three-factor apportionment formula for computing corporate income taxes in the state.
The issue in this case concerns calculation of corporate franchise tax under the Multistate Tax Compact, and is one of at least seven other appeals that have been filed in the state raising the same issue (Compact Cases). Counsel agreed that this case will serve as a test case for all the Compact Cases in the state, and the court agreed to stay proceedings in the other related matters pending the outcome of this case. [This issue regarding the Multistate Tax Compact and the calculation of tax using the three-factor formula has been raised in courts in a number of other states as reported in other issues of State Tax Highlights.]
This appeal was originally assigned to The Honorable Joanne H. Turner. As a result of a notice of removal filed by the Commissioner under Rule 63.03 of the state’s Rules of Civil Proceedings, Judge Turner was removed and the matter was reassigned to The Honorable Bradford S. Delapena. The state’s Tax Court is authorized to hear matters en banc, either by request of one of the parties or on its own motion. Given the number of cases pending and the amount of refund dollars involved in these cases, Judge Delapena moved to hear the parties’ cross-motions for summary judgment en banc, and the court unanimously granted that motion. The Commissioner objected to en banc consideration on the ground that he had previously filed a notice of removal of Chief Judge Turner and moved that the matter be reset before Judge Delapena, sitting alone. The taxpayer also urged the Court to re-assign the matter to Judge Delapena alone to avoid the potential for a procedural defect that could complicate and delay resolution of this case.
Most tax court cases are heard and decided by a single judge and Rule 63.03 notices of removal are practicable in these proceedings because a case can simply be re-assigned to one of the court's remaining two judges. The court noted that a different result obtains when the court determines that a particular matter shall be heard en banc. The assignment of the case to the entire court fundamentally alters the character of the decision-maker from a single judge to a panel of judges. The court pointed out that it is well recognized that concerns about the views of any particular judge are substantially mitigated in the collegial context of panel decision-making. See, e.g., State ex rel. Wild v. Otis, 257 N.W.2d 361, 363-64 (Minn. 1977) (citing A.B.A., Standards of Judicial Administration: Standards Relating to Appellate Courts § 3.42 & commentary (Approved Draft, 1977) (hereinafter Standards Relating to Appellate Courts)).
The court held that it is plain that the Rule 63.03 notice procedure would defeat the tax court's statutory authority to assign cases to the entire Tax Court. Consequently, the court held that the Rule 63.03 notice procedure cannot practicably be applied to matters the tax court has The court also held that a Rule 63.03 notice filed before the court decides to hear a case en banc does not bar the affected judge from the en banc panel. Any other rule would prevent both tax court litigants and the court itself from invoking section 271.04 to have a case heard "before the entire Tax Court" in any matter in which a notice of removal had previously been filed. The court agreed with the Commissioner’s argument that his removal of Chief Judge Turner was "a matter of right," but concluded that the argument was fatally incomplete because the Tax Court re-assigned the matter to the entire court. The court also noted that all of the cases the Commissioner cites in support of the argument that his previously filed notice of removal prevented Chief Judge Turner from joining the en banc panel could be distinguished from the facts of the present case because those cases involved affidavits of prejudice.
The court also rejected the Commissioner’s argument that overruling his objections would "create jurisdictional/procedural defects in this proceeding. And although a party has the constitutional right to an unbiased decision-maker, the court noted that the Commissioner had not asserted any bias on the part of Chief Judge Turner, and due process is therefore not implicated. Kimberly-Clark Corp. v. Comm'r of Revenue, Minnesota Tax Court, Docket No. 8670-R. 1/16/15
Subsidiary Subject to Financial Institution Excise Tax
The Massachusetts Supreme Judicial Court held that an out-of-state corporation's subsidiary was a financial institution and entitled to apportion its income as such. The court further held the subsidiary's property subject to the financial institution excise tax should be assigned in-state locations for property factor purposes.
Taxpayer is a wholly owned subsidiary of First Marblehead Corporation (FMC), a publicly traded Delaware corporation with its principal offices in Boston. Taxpayer facilitated and coordinated the issuance and securitization of student loans through a complex process in which loans were purchased from originating banks with financing obtained via the issuance of asset-backed securities (ABS). The taxpayer was not directly involved in loan servicing but outsourced these activities to independent entities in that business, most of which were located outside the state.
The purpose of the taxpayer’s subsidiary within this system was to hold residual beneficial interests in the trusts, either directly or through its own wholly owned subsidiary. By the end of the tax years at issue, the taxpayer’s subsidiary held a beneficial interest in each of sixteen trusts that in turn held all of the student loans that had been securitized by the taxpayer and its affiliates. These interests in the trusts constituted substantially all of the taxpayer-subsidiary’s assets. Income from the trusts, which consisted of interest on the student loans, passed through to the taxpayer subsidiary and comprised substantially all of its gross income for these years. It was essentially a holding company with no employees, payroll, tangible assets, or office space -- either owned or leased. Its tax returns indicated that its principal office was located at the same Boston address as the taxpayer, and its corporate books and tax returns also were maintained and prepared in Boston. There was no dispute that its commercial domicile was in Massachusetts during the tax years at issue. Like taxpayer’s subsidiary, the trusts also had no assets other than the loan portfolios, cash, and other related assets, and they had no employees, payroll, or offices.
On September 15, 2006, FMC and the taxpayer filed a voluntary disclosure request with the Commissioner of Revenue (Commissioner) reporting their conclusion that the taxpayer was a "financial institution," not a corporation as they had previously treated it for Massachusetts excise tax purposes, and their intent to change the taxpayer’s tax filing status accordingly. They then filed financial institution excise tax returns for the years in question and requested refunds of corporate taxes previously paid, which were denied by the Commissioner. Legislation was enacted in 1995 and was intended to reduce the tax burden on state banks by lowering the bank excise tax rate and by permitting financial institutions that derive income from business activities conducted both inside and outside the state to apportion their income, using a three factor formula, thereby avoiding double taxation and reducing incentives for these businesses to move their operations out of the state.
The only issue presented in this matter was how the taxpayer’s property factor was calculated, specifically whether the loan portfolios that represented substantially all of the taxpayer’s property for the tax years at issue should be treated as having been located in whole or in part within the state, and thus included in the numerator of the property factor fraction. The taxpayer argues that all of its loans were located outside the state and the property factor was zero.
Under the statute, a loan is considered to be located within the state if it is properly assigned to a regular place of business of the taxpayer within the state. The parties to this matter agreed that the taxpayer, which had no offices or employees, had no regular place of business either within or outside the state. Thus, the loans could not have been assigned under the statute to a regular place of business belonging to the taxpayer. The court rejected the taxpayer’s argument that the loans should, therefore, be assigned to the locations of the servicers where the preponderance of substantive contacts relating to the loans occurred, noting that the statute provides a default presumption assigning the property to the commercial domicile. The court rejected the taxpayer’s argument that the presumption of commercial domicile applies only in the context of an original lender, finding that reading the language as narrowly as the taxpayer proposed renders the statute unworkable here. The court found that the lower court properly ruled that the presumption in the statute applied to the taxpayer without regard to the sites of origination of the loans in question.
The court noted that because the taxpayer’s commercial domicile was in the state, application of the presumption to the taxpayer means that the preponderance of substantive contacts regarding the loan occurred within the commonwealth for purposes of calculating the taxpayer’s property factor, unless the presumption was rebutted. And the burden of rebuttal is on the taxpayer. The taxpayer points to the provision in the statute that speaks to the types of activities included in the preponderance of substantive contacts of a loan and notes that of those five only “administration” can be considered here because all the other factors listed relate to the origination of loans and the taxpayer played no role in loan origination. The court rejected the taxpayer’s assertion that it had no property in the state because the loan servicers performed all of the administrative activities and all of the servicers’ activities were performed in states other than Massachusetts
The court concluded that an analysis whether the servicers were agents of the taxpayer, and if so, what type of agents they were, is unnecessary in order to locate the "preponderance of substantive contacts" of the loans because none of the types of "activities" regarding a loan that the statute describes reasonably can be understood to encompass the activities of an entity other than the taxpayer. The court found that the language of the statute appears to contemplate that when loan administration is used to determine the "preponderance of substantive contacts" of a taxpayer's loan or loans, only the loan administration activities of the taxpayer are taken into consideration; work performed by agents or independent contractors of the taxpayer, at least where the agents or contractors are separate businesses with their own places of business and their own staff, do not fit within the equation. This reading of loan administration as taxpayer requiring activity at the regular place of business leads to the conclusion that the loans appear to have had no "substantive contacts." The court held that the solution to that problem is application of the presumption of commercial domicile as specified in the statute.
The court noted that the rules set out in the statute seek to produce a reasonable approximation of a financial institution's net income related to the business it carries on in the state. Taxpayer was a holding company, with no employees of its own, with apparently no direct relationship with the loan servicers, whose actual contracts were with FMC. The court found that it is appropriate that the servicers' activities in administering the student loans not be attributed to the taxpayer for the purpose of determining the "preponderance of substantive contacts" regarding the loans. The court held that the taxpayer had not rebutted the presumption in the statute and all of the loans were properly located at taxpayer’s commercial domicile in the state.
The court rejected the taxpayer’s constitutional arguments, holding that the cases cited by the taxpayer were distinguishable from this case where the jurisdictional question is whether any state besides Massachusetts could theoretically impose a tax on the taxpayer. The lower court had found that the taxpayer was taxable in all fifty states and was, thus, entitled to apportion its income. The court reiterated earlier cases, both state and U S Supreme Court, that found that the due process clause and the commerce clause require fairness in apportioning the income of a business that may be taxed in multiple states and found that the taxpayer has did not meet its burden to show that apportionment as applied in this case was unfair or unreasonable. The First Marblehead Corp. v. Comm'r of Revenue, Massachusetts Supreme Judicial Court, SJC-11609. 1/28/15
Property Tax Decisions
Taxpayer Rebutted Town's Presumption of Assessment Validity
The New York Supreme Court, Appellate Division, Third Judicial Department, held an appraisal report using an incorrect date was properly not struck from the record because the date did not alter the final valuation. The court also held that the taxpayer's appraisal report successfully rebutted the assessment's presumption of validity.
The taxpayer is the owner of 4.12 acres of land that includes an approximately 10,000-square-foot banquet facility, a single-family residence and a shed. Taxpayer filed an appraisal report to rebut the city’s appraisal and the city moved to strike it as defective on the ground that taxpayer’s appraiser used a valuation date of March 1, 2011 as opposed to July 1, 2010.
The court agreed that the taxpayer’s appraiser erred in using a date other that the applicable valuation date for the year, but held that the court was not required to strike the report because of this error. The noted prior case law for the proposition that an appraisal report need not be stricken if the appraiser credibly testifies that the report would not have differed if the correct valuation date had been used. In this matter, taxpayer’s appraiser testified that the change in the valuation date did not result in a different final value and the appraisal report was supported by ascertainable and verifiable data and, thus, any questions regarding the propriety of [the] assessment would affect only the weight accorded to the appraisal by the court and did not undermine the validity of the entire appraisal.
The court rejected the city’s argument that the taxpayer did not overcome the presumptive validity of the tax assessment, finding that there was no dispute that taxpayer’s appraiser was qualified and that he used the comparable sales method of valuation, a well accepted methodology where, as here, there was no recent arm's length sale of the subject property.
The appraisal report identified the specific comparable sales transactions used, including the location, sale date and sale price of the proposed comparable properties, and set forth the specific dollar value adjustments for location, acreage, site improvements, building condition and square footage of buildings that were a mix of residential and commercial spaces. The report divided the subject property into four different uses -- the 7,624-square-foot, first floor banquet hall with a bridal suite and kitchen; the 2,500-square-foot walk-up upper floor; the residential cottage; and a 768-square-foot shed. Adjustments were then made based upon whether the comparable properties had similar characteristics or amenities corresponding with each separate component of the subject property.
The court held that the lower court properly found the comparable sales used by taxpayer were superior to those used by the city. One of the city’s comparable sales was remote in distance, another was not the product of an arm's length transaction, and the city’s appraiser failed to set forth the facts, figures and calculations that he used in making adjustments for fixtures and equipment sold with two of the comparable properties. The court found that the lower court's acceptance of taxpayer’s appraisal over that proffered by the city is supported by the weight of the evidence and, thus, its decision must be affirmed. Gran Dev. LLC v. Town of Davenport Bd. of Assessors, New York Supreme Court, No. 518657. 1/15/15
City's Cost-to-Cure Valuation Method Was Reasonable
The Vermont Supreme Court rejected the taxpayer’s evidence as speculative and unconvincing and held that the superior court properly concluded that a city's cost-to-cure valuation method for a former gas station was reasonable.
The property at issue was a gas filling station from the 1940s until the 1970s, when a fire caused the station's removal. The lot was purchased in 1987 by the taxpayer and her business partner to use for their business, Bilmar Team Cleaners. In 1993, petroleum was discovered to be contaminating the property's groundwater, likely due to leaky underground storage tanks from when the property was a gas station. Although taxpayer has had studies done and has installed wells to monitor the contamination, the property remains listed as an unremediated petroleum pollution site because taxpayer has not paid for additional monitoring requested by the Department of Environmental Conservation (DEC). The taxpayer believes the petroleum contamination renders the property valueless, and has not paid city real estate tax on the property for many years. The Vermont Petroleum Cleanup Fund (PCF) provides up to $990,000 in remediation costs once a property owner has paid the initial $10,000. The taxpayer did not believe participating in the PCF was in her best interest and feared that signing up for the PCF would leave her liable for additional expenses if the cost of remediation exceeded the $990,000 cap, or if the fund ran out of money.
In 2011 the Board of Tax Appeals (BTA) appraised the property at $193,500, a figure that included a $10,000 discount because of the property's petroleum pollution. The Board noted that the availability of the PCF is the best predictor for the property's future. Taxpayer argued the $10,000 cost-to-cure reduction did not adequately account for the impact the stigma of pollution had on the property value. The taxpayer's appraiser testified that the BTA’s initial assessment of fair market value was accurate, but asserted that the stigma of petroleum pollution reduced the property's value beyond the $10,000 cost-to-cure.
The lower court ruled in favor of the City, holding that the cost-to-cure methodology was appropriately used by the BTA and that the taxpayer failed to overcome the initial presumption of validity in favor of the BTA’s decision. The lower court found that the $10,000 cost to cure was accurate because the PCF would likely cover all additional expenses. The court also found taxpayer's appraiser's testimony on the stigma of petroleum pollution unconvincing because it was not supported by studies or data. The court did not find taxpayer's claim that the property was valueless credible due to the consistent rental income the property generated, the prices at which taxpayer listed the property to sell, and an investor's previous offer to buy. The current matter is an appeal of that decision.
The court found that the lower court’s determinations regarding the weight of the evidence were reasonable and that the record supported its findings. While the lower court concluded that the taxpayer failed to overcome the presumption that the appraisal was correct, it also weighed the evidence and contemplated the outcome of the case had taxpayer successfully burst the presumption bubble. The court found that the superior court reasonably concluded that the cost-to-cure method accurately calculated the property's fair market value. The superior court accepted the valuation based on the cost to cure method because neither the City nor taxpayer's appraisers could find sufficient comparable properties in the area with similar pollution levels. The superior court noted that appraisers for both parties had used the cost-to-cure method in previous appraisals of polluted properties. Furthermore, both appraisers agreed that the property, if pollutant free, would have a fair market value of $225,000. While their opinions differed over the actual cost of remediating the pollution in this case, they did not dispute the cost-to-cure methodology itself.
The court also held that the superior court's determination that $10,000 was the actual cost to cure was supported by the record because the evidence showed that the costs were unlikely to exceed the PCF's limit of $990,000. The court rejected the taxpayer’s argument that the $10,000 "cost to cure" is arbitrary because the total cost of remediation is unknown, noting the cost of remediation is unknown due precisely to taxpayer's failure to use the PCF fund. Property appraisals in Vermont are based on the highest and best use of the property, and the court said that to reward taxpayer in this case for her refusal to pursue the cleanup of her property would run contrary to the statutory purpose. While taxpayer's appraiser testified that the stigma of petroleum pollution reduced the value beyond $10,000, he offered no studies or data to support this opinion.
Finally, the court rejected taxpayer's argument that the property is valueless, noting that the steady rental income generated by the property and taxpayer's attempts to sell the property for $349,000 to $389,000 diminished the credibility of taxpayer's claim that the property was valueless. In re Bilmar Team Cleaners, Vermont Supreme Court, 2015 VT 10; No. 2013 414. 1/16/15
Court Says It Lacks Jurisdiction for Tax Appeal Due to Improper Service
The Ohio Supreme Court dismissed a real property valuation appeal for lack of jurisdiction because the property owner appealing the Board of Tax Appeals (BTA) decision failed to fully perfect the appeal by not initiating service of the notice to appeal on necessary parties within the 30-day appeal period.
The jurisdictional facts are undisputed. The taxpayer filed the notice of appeal in this case on September 30, 2013. The certificate of service on the notice of appeal indicates certified-mail service on the property owner and the county appellees, but not on the tax commissioner. The appeal was referred to mediation on October 3, 2013, but returned to the regular docket on November 4, 2013. The order returning the case to the regular docket specified that the appellant's brief was due 40 days from the date of the order. Apparently during mediation the school board made its intention to seek dismissal apparent, and the taxpayer responded by serving the tax commissioner on October 24, 2013, before the case was returned to the regular docket. The court noted that the case law is clear that the requirement of service on appellees pursuant to the statute is a jurisdictional prerequisite to pursuing the appeal, with the tax commissioner being one of the persons statutorily required to be served. The court has also held that the service required by that paragraph must be initiated within the 30-day appeal period. In light of those prior decisions, the court dismissed this appeal for lack of jurisdiction. Because we lack jurisdiction, the court did not reach the merits of the appeal.
Two justices issued a dissent in this matter noting that the court applied a previous decision requiring service of the notice of appeal within the appeal period when the statute itself is silent on when service must be performed. The dissenting opinion noted that it remains undisputed that the taxpayer served the notice of appeal on the tax commissioner and that there can have been no prejudice to the commissioner because that official was served before briefing in this matter began. The justice further noted that since the case the court relies on was decided, the court has clarified that a procedural requirement does not constitute a jurisdictional prerequisite unless the requirement is set forth in the statute itself and points out in this instance that not only is there no time limit for service in the relevant statutory provision, but the sole basis for a time limit lies in court rules that contemplate service at the time the notice of appeal is filed and a violation of those rules would typically not be deemed a jurisdictional defect. The dissent also argued that the assessment should be overruled on its merits. Columbus City Schools Bd. of Educ. v. Franklin Cnty. Bd. of Rev., Ohio Supreme Court, Slip Opinion No. 2015-Ohio-150; No. 2013-1544. 1/21/15
Other Taxes and Procedural Issues
Court Overturns Tax Commission Ruling on Severance Tax Liability
The Utah Supreme Court held that the plain meaning and structure of the severance tax statute provides that royalty interests are subtracted from the value of oil and gas interests.
State law imposes a severance tax on owners of oil and gas interests, with the rate of tax dependent on the fair market value of the owner's interest. The issue in this matter is how the value of such an interest is to be calculated under a complicated formula outlined in Utah Code sections 59-5-102 and 59-5-103. The dispute concerns one step of this formula, i.e., what deductions are permitted under the severance tax statute in the unit price calculation. The taxpayer argued that because the statute exempts federal, state, and Indian tribe royalty interests from the severance tax, it also permits taxpayers to deduct such interests from the net taxable value in calculating the per unit price. The Department of Revenue (DOR) argued that the unit price should be calculated based on the prices at which the gas was sold, before the producer paid any exempt royalties.
The court agreed with the taxpayer that the plain meaning and structure of the severance tax statute categorically excludes federal, state, and Indian tribe interests from the unit price calculation. The court acknowledged that the Tax Commission's reading of the severance tax statute is plausible if section 59-5-103.1 is read in isolation. But the court concluded that when that section is read in harmony with section 59-5-102(1)(b), the plain language and structure of the statute categorically excludes federal and Indian tribe interests from the value calculation set forth in section 59-5-103.1.
One justice issued a dissent finding that the statute clearly does not tax the exempted interests, but it says nothing about deducting those interests for the purposes of calculating fair market value. Anadarko Petroleum Corp. v. Utah State Tax Comm'n, Utah Supreme Court, 2015 UT 25; No. 20130192. 1/30/15
Blunt Wraps Not Taxable Tobacco Products
The Colorado Court of Appeals determined a convenience store product distributor did not owe additional tobacco taxes because "Blunt Wraps" are not tobacco products as defined by statute. The taxpayer is a distributor of groceries, tobacco, and other products to convenience stores and in 2003 began distributing Blunt Wraps, which are rolling papers consumers can use to roll their own cigars or cigarettes. They are made from homogenized tobacco leaves and contain between thirty and forty-eight percent tobacco.
In December 2006, the Department of Revenue (DOR), which is responsible for administering and collecting tax on tobacco products, issued a notice advising taxpayers that, despite any prior confusion on the issue, it considered products that contain any amount of tobacco to be "tobacco products" within the meaning of the statute and in early 2007 issued an assessment against the taxpayer for Blunt Wraps. While the court stated it gives deference to a statute's interpretation by the agency charged with its enforcement, it noted that ultimately the agency's view of the law is not binding on the reviewing court.
Tobacco products in the state, other than cigarettes, are taxed at forty percent of the manufacturer's list price and the term "tobacco products" is defined to mean cigars, cheroots, stogies, periques, granulated, plug cut, crimp cut, ready rubbed, and other smoking tobacco, snuff, snuff flour, cavendish, plug and twist tobacco, fine-cut and other chewing tobaccos, shorts, refuse scraps, clippings, cuttings and sweepings of tobacco, and other kinds and forms of tobacco, prepared in such manner as to be suitable for chewing or for smoking in a pipe or otherwise, or for both chewing and smoking, but does not include cigarettes which are taxed separately. The parties to this matter agreed that Blunt Wraps are a form of tobacco not specifically enumerated in the statute. The dispute centers on whether Blunt Wraps are "prepared in such manner as to be suitable for . . . smoking in a pipe or otherwise." The lower court concluded that while Blunt Wraps contain tobacco, they are not particularly well adapted or appropriate for smoking on their own and, thus, are not "prepared in such manner as to be suitable for . . . smoking" unless they are filled with a more flammable material.
This court found that it was not so clear whether the legislature intended products like Blunt Wraps to be subject to the tax. The court noted that they are a form of tobacco suitable for smoking when wrapped around something more suitable for smoking, but if they are "tobacco products" for tax purposes, so are all products that contain any amount of consumable tobacco. The court stated that if this were the legislature’s intent, it could have simply said so, and noted that such an expansive reading of the statute would make the bulk of its language superfluous. To resolve this ambiguity, the court determined that it must look beyond the statutory language. The court discussed the canon of statutory interpretation provides that, when a general term follows a list of specific things, the general term applies only to things of the same general class as those specifically mentioned and held that they must interpret the phrase "other kinds and forms of tobacco, prepared in such manner as to be suitable for chewing or for smoking in a pipe or otherwise” to apply only to those things that share the characteristics of the items listed in the statute.
The court went on to opine that each of the products on the list is a focus of consumption; absent are products that, like Blunt Wraps, contain some tobacco but are only suitable for consuming other products. The court held that because Blunt Wraps do not fall within the same class as the items listed in the statute, the principle of ejusdem generis would exclude them from its scope. The court also noted that when considered in the context of other provisions relating to tobacco products in the state code, it is clear that the term is defined more narrowly in the tax code, which has not be amended since it was enacted. Creager Mercantile Co. Inc. v. Colorado Dep't of Revenue, Colorado Court of Appeals, 2015 COA 10; No. 13CA1580. 2/12/15
Native American's Cigarette Wholesaler License Revoked
The Washington Court of Appeals affirmed the revocation of a Native American individual's cigarette and tobacco wholesaler registration due to the taxpayer's failure to pay an assessment, rejecting the taxpayer's argument that the state may not revoke her license because she is an Idaho resident living on an Indian reservation.
The taxpayer is a Native American residing on an Indian Reservation in Idaho. The Department of Revenue in Washington (DOR) previously ruled that the taxpayer failed to report the purchase and account for the disposition of more than 700,000 packs of unstamped cigarettes that she purchased between 2006 and 2007 from two wholesalers in the state, neither of whom was on a reservation, as required under her certificate of registration. As a result, DOR imposed taxes and penalties on her in excess of $9 million and when she did not pay, DOR filed a warrant and then, after a hearing on the matter, revoked her certificate of registration as authorized in the statute. This court had previously rejected as meritless the taxpayer’s arguments that the tax and penalty assessment was unconstitutional.
Under the state’s Administrative Procedures Act (APA), the party asserting agency error has the burden of demonstrating the invalidity of the agency's action and the APA sets out nine grounds for invalidating an administrative order, four of which the court found potentially applicable in this case. The court rejected the taxpayer’s argument that the revocation of registration provision in the statute is inapplicable to her because she is not a “taxpayer” finding that because under the statutory definition of taxpayer she was and is liable for taxes collected by DOR, there was no question that she fell within the definition. The court also found it was undisputed that she owed the tax and penalties, that DOR had filed the warrant, and that the taxpayer had never paid the warrant. Therefore, DOR had the authority to revoke the taxpayer’s certificate of registration.
The court then addressed several collateral challenges to the revocation order raised by the taxpayer: (1) DOR failed to properly serve her with the revocation notice, (2) DOR lacked jurisdiction because she was an Idaho resident who had no minimum contacts with Washington, (3) the Indian Tribal Court has exclusive jurisdiction over licensing matters involving her, (4) the statute is unconstitutional when applied to her because she is not a resident of Washington, and (5) the ALJ hearing the matter was biased.
The court rejected taxpayer’s argument that DOR lacked jurisdiction because it failed to properly serve her with the notice of revocation hearing when it mailed the notice to her business address rather than her home address. The court pointed to the statutory requirement that a notice shall be mailed to the address of the taxpayer shown on the records of the department. Here, the notice was mailed to the address the taxpayer listed on her registration and license application. The taxpayer also argued that her application for a license in 2006 does not satisfy due process minimum contacts for long arm jurisdiction of an Idaho resident, and that because she is a Native American living on an Indian reservation, she is not subject to state licensing laws. The court agreed with DOR’s argument that when the taxpayer voluntarily applied for and obtained a wholesaler's license, she subjected herself to Washington jurisdiction. The court said that the taxpayer availed herself of the benefits and protections of Washington's laws by applying for and obtaining a cigarette wholesaler license. This license allowed Matheson to purchase and transport unstamped, untaxed cigarettes throughout the state. But for the license, she would not have access to unstamped and untaxed cigarettes and, as a condition of this license, she was required to comply with the state’s cigarette laws and DOR’s rules.
The court dismissed the taxpayer’s argument that because she is a Native American, the case should have been transferred to tribal court, noting that the taxpayer cited no authority for the proposition that federal law grants exclusive jurisdiction to tribal courts of license revocation hearings involving Native Americans. Again, the court pointed out that the taxpayer voluntarily subjected herself to Washington jurisdiction by voluntarily applying for and obtaining a license. The taxpayer also challenged the fundamental premise that, as an Idaho resident and a Native American, she can be subject to another state’s taxation. The court noted case law that holds Native Americans who conduct business off-reservation are subject to state law that is nondiscriminatory and otherwise applicable to all citizens of the state. The court held that the taxation statute is generally applicable to all Washington cigarette wholesalers and does not extend solely to foreign residents who purchase cigarettes wholesale in Washington.
Finally, the court rejected the taxpayer’s argument that the ALJ, who was a DOR employee, was biased, finding that the taxpayer provided no authority that the employment status alone means the ALJ is biased. The court found no evidence that the ALJ was, in fact, biased. We hold that there is no evidence that the ALJ was biased, and therefore that Matheson's due process argument fails. Finally, the court declined to address the taxpayer’s arguments regarding the validity of the assessment because that was not at issue in the revocation hearing. Matheson v. Dep't of Revenue, Washington Court of Appeals, No. 45485-8-II. 2/10/15
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
October 14, 2016 Edition
NEWS
SCOTUS Grants Motion for Leave to Sue Delaware Over Unclaimed Property
On June 9, 2016, the attorneys general in 21 states filed a motion in the U.S. Supreme Court for leave to file a lawsuit against Delaware in which they allege violations to the Federal Disposition Act and seek the return of what has been estimate to be as much as $400 million in unclaimed property. On October 3, 2016, the U.S. Supreme Court granted leave to file the complaints. The suit began in February when the Pennsylvania Treasury Department filed a lawsuit in federal court against Delaware and MoneyGram Inc., alleging that MoneyGram has been improperly submitting unclaimed money to Delaware. The states argue that Delaware has disregarded the federal act by escheating all unpresented and uncashed MoneyGram checks to Delaware instead of to the state where they were purchased.
Colorado Files Cross Petition in Brohl v. Direct Mktg. Assn
The Colorado attorney general has filed a conditional cross-petition for certiorari with the U.S. Supreme Court in Brohl v. Direct Mktg. Assn, U. S. Supreme Court Docket No. 16-267, in an appeal from the U.S. Court of Appeals for the Tenth Circuit’s decision in the case over the state's use tax notice and reporting requirements. Colorado is asking the Court to grant certiorari and overturn the physical presence test in Quill Corp. v. North Dakota.
U.S. SUPREME COURT UPDATE
Cert Denied
Gillette v. Franchise Tax Board, U.S. Supreme Court Docket No. 15-1442. Petition denied October 11, 2016. Gillette is the lead case on whether out-of-state businesses can elect to apportion their business income to Multistate Tax Compact states using the compact's evenly weighted three-factor formula. The denial of the petition for certiorari means that the December 31, 2015 decision by the California Supreme Court stands, holding that the Multistate Tax Compact is state law and not a binding, reciprocal agreement. The court found, therefore, that the state legislature had authority to unilaterally eliminate the compact's elective formula by adopting a mandatory double-weighted sales factor formula, which superseded the compact formula still in the state code. See the January 8, 2016 issue of State Tax Highlights for a discussion of the California Supreme Court’s decision.
NOTE: Litigants out of Michigan and Minnesota are also seeking review by the U.S. Supreme Court on related issues.
Rite Aid Corp. v. Huseby, U.S. Supreme Court Docket No. 16-36. Petition denied October 3, 2016. The taxpayer had protested the assessors' valuation method, which was based on the value of the pharmacy leases instead of the properties' market values.
Vernon v. United States, U.S. Supreme Court Docket. No. 15-1368. Petition denied October 3, 2016. The taxpayer petition the Court to review a Tenth Circuit decision affirming her tax evasion conviction and sentence for tax evasion for failing to pay taxes on income from an S corporation that was owned by her domestic partner.
Rogers v. IRS, U.S. Supreme Court Docket No. 16-82. Petition denied October 3, 2016. The taxpayer sought review of a Sixth Circuit decision affirming a grant of summary judgment to the IRS in the taxpayer’s suit under the Freedom of Information Act because the taxpayer had entered a settlement agreement in civil forfeiture actions against him that contained a release waiving his right to bring the FOIA action.
R.J. Reynolds Tobacco Company, et al. v. Maryland, U.S. Supreme Court Docket No. 15-1537. Petition denied October 11, 2016. The Court let stand lower court rulings allowing Pennsylvania and Maryland to retain millions of dollars in a dispute with tobacco companies involving the 1998 Master Settlement Agreement (MSA) over deceptive marketing and advertising of cigarettes. The cases in Maryland and Pennsylvania centered on the 2003 annual payment that the participating tobacco companies were required to make to the states as part of the agreement. An arbitration panel had ruled that six states, including Pennsylvania and Maryland, had failed to meet the requirements in the MSA to ensure that participating companies did not disproportionately lose market share as a result of the MSA to non-participating companies. As a result, the arbitration panel had reduced the monies payable to the six states by the participating companies for 2003. Pennsylvania and Maryland appealed that ruling and courts in those states reversed the arbitration panel ruling.
Huang v. City of Los Angeles, U.S. Supreme Court Docket No 15-1507. Petition denied October 11, 2016. The court let stand a decision by the U.S. Court of Appeals for the Ninth Circuit that a challenge to a penalty for nonpayment of tax is barred from federal court jurisdiction under the Tax Injunction Act (TIA). The Ninth Circuit held that a tax penalty was itself a tax under the TIA.
FEDERAL CASES OF INTEREST
Unclaimed Property Challenge Dismissed
The United States District Court for the District of Delaware held that claims challenging the Delaware’s unclaimed property audit for unredeemed gift certificates and gift cards were ripe for consideration. The court, however, dismissed the case on the merits.
Delaware' s escheat (or unclaimed property) law authorizes the State Escheator to claim unclaimed property and to conduct examinations of companies' books and records to determine if an entity has properly reported unclaimed property to the state. The plaintiffs here are organized under Delaware law. In May 2007, using a third party auditing firm, the state began an audit of the plaintiffs’ records in order to determine whether these entities had complied with Delaware' s escheat law, and requested detailed financial records covering a period of 35 years. Using document provided by the plaintiffs, the state issued an estimate of the assessment for unredeemed gift certificates for the period of 1986 through 2000. Plaintiffs protested this assessment asserting that gift certificates were only issued in 1987 through 1999 and arguing that because records were produced, estimation was not warranted or authorized by statute. The state responded by expanding the audit to two additional entities and requesting information about their gift card business. The plaintiffs responded arguing that the two new entities were not Delaware entities but were, instead, Ohio limited liability companies, and Delaware, therefore, lacked standing to claim any unredeemed gift cards from those two entities. In response, the third party auditing firm sent plaintiffs a letter stating that continued failure to comply with the document request would result in the matter being referred to the state Attorney General for consideration of enforcement action. Shortly thereafter, the plaintiffs filed their complaint seeking declaratory and injunctive relief and alleging that the defendants’ actions are preempted by and in violation of federal common law and that defendants’ document requests constitute an unreasonable search in violation of the Fourth Amendment. The defendants filed a motion to dismiss plaintiffs' Complaint for lack of subject matter jurisdiction and for failure to state a claim.
The court said the case presented three issues: ripeness, the sufficiency of plaintiffs' preemption claim, and the sufficiency of plaintiffs' Fourth Amendment claim. The court first addressed the issue of ripeness and noted that in order for a claim to be ripe, plaintiffs must stand to suffer an actual or imminent injury if the requested remedy is not granted. The court said that while the factors that go into a ripeness determination are well established, the inquiry in each case depends on the specific facts alleged and the context of the case. The court found that the fats alleged by the plaintiffs in this case are sufficient to render the parties’ disputes ripe for adjudication, agreeing with the plaintiffs’ claim that they were suffering a real harm due to the state’s actions. The court found that the requirements for a ripe dispute--adversity of the parties’ interests, probable conclusiveness of a judgment and utility of a judgment to the parties—were present in the case. The court found that the aggressive and persistent nature of the audit, in conjunction with the letter threatening referral to the Attorney General, placed the plaintiffs in a difficult position, with millions of dollars of funds currently being used for operating expenses implicated in the dispute. The court also noted that the plaintiffs' feud with the state is not an isolated incident, citing many challenges to Delaware' s escheat procedures that have been moving through courts.
The court cited Temple-Inland, Inc. v. Cook, 2016 WL 3536710 (D. Del. June 28, 2016) in which another judge of the Court considered a case involving the same defendants and what this court said appeared to be a similar, if not identical, audit process. The court said that while the underlying facts here differed from those in Temple-Inland, the plaintiffs were involved in a sufficiently similar process to the one in Temple-Inland to make the judge’s findings in that case that the Delaware escheat process “shock[s] the conscience” a pertinent circumstance in this case. The court noted that a significant portion of the plaintiffs’ operating funds are arguably encumbered by the escheat process that another judge found has been used in a shocking and unconstitutional manner, suggesting that the parties' interests are adverse and the disputes presented by plaintiffs are real. The court found that the plaintiffs’ complaint also satisfied the conclusiveness prong of the ripeness inquiry and a decision in this case would be of substantial practical utility to the parties. The court then turned to the plaintiffs’ argument that the audit was preempted by federal common law as a result of three U. S. Supreme Court cases, Delaware v. New York, 507 U.S. 490, 500 (1993); Pennsylvania v. New York, 407 U.S. 206, 216 n.8 (1972); Texas v. New Jersey, 379 U.S. 674 (1965) (the Texas trilogy), that establish a series of “priority rules” used to disburse unclaimed property to competing states. The court agreed with the state’s argument that the Texas trilogy does not preempt their audit, or any eventual escheatment, because the cases apply only to disputes between two states, rather than to disputes between a private entity and a state, citing an earlier opinion by the court in Temple-Inland, Inc. v. Cook, 82 F. Supp. 3d 539, 549-50 (D. Del. 2015). The court applied that reasoning in this case and held that the plaintiffs failed to state a plausible preemption claim on which relief could be granted. The court also rejected the plaintiffs’ argument that the state’s audit constitutes an unreasonable search and seizure in violation of the Fourth Amendment, finding that they had failed to state a plausible claim because they did not allege that they are required to cooperate with the audit. The court likened the state’s request for document to a police officer’s request for permission to search, an action that does not run afoul of the Fourth Amendment. The court granted the state’s motion to dismiss for failure to state a claim. Marathon Petroleum Corp. v. Cook, U.S. District Court for the District of Delaware, C.A. No. 16-80-LPS. 9/23/16
Estate Can Deduct Theft Loss From Madoff Ponzi Scheme
The U.S. Tax Court has ruled that an estate was entitled to a theft loss deduction under Section 2054 of the Internal Revenue Code (IRC) for the decedent's interest in a limited liability company whose only asset was an account with Bernard L. Madoff Investment Securities LLC that became worthless when it was exposed as a Ponzi scheme.
The decedent, a resident of New York, died on January 31, 2008, and at that time owned a 99% interest in James Heller Family, LLC (JHF). His son and daughter each held a 0.5% interest. The only asset of the JHF was an account with Bernard L. Madoff Investment Securities, LLC (Madoff Securities). The son, daughter and the executor of the JHF were appointed coexecutors of the estate of the decedent. Between March 4 and November 28, 2008, $11,500,000 was withdrawn from the JHF Madoff account and distributed according to JHF's ownership interests. The estate's share of the withdrawal, $11,385,000, was used to pay its taxes and administrative expenses.
On December 11, 2008, Bernard Madoff, the chairman of Madoff Securities, was arrested, and the Securities and Exchange Commission issued a press release to alert the public that it had charged him with securities fraud relating to a multibillion-dollar Ponzi scheme. In perpetuating the scheme Mr. Madoff and his associates fabricated monthly and quarterly statements and sent them to Madoff Securities' clients. As a result of the Ponzi scheme, JHF's interest in the JHF Madoff account and the estate's interest in JHF became worthless. The estate on April 1, 2009, timely filed an estate tax return reporting the value of the gross estate including the value of the 99% interest in JHF, but the estate also claimed a theft loss deduction relating to the Ponzi scheme, which reflected the difference between the value of the estate's interest in JHF reported on the estate tax return and the estate's share of the amounts withdrawn from the JHF Madoff account. The IRS issued a notice of deficiency on February 9, 2012, determining that the estate was not entitled to the theft loss deduction because the estate did not incur a theft loss during its settlement. The estate filed this appeal.
Section 2054 of the IRC provides that an estate is entitled to deductions relating to losses incurred during the settlement of the estate arising from theft. The court said that the question of whether an estate is entitled to a section 2054 theft loss deduction relating to property held by an LLC is an issue of first impression, and found that neither regulations nor legislative history addressed the issue. The estate tax is imposed on the value of property transferred to beneficiaries, and, in that context, the court said that a loss refers to a reduction of the value of property held by an estate. The court said that while JHF lost its sole asset as a result of the Ponzi scheme, the estate, during its settlement, also incurred a loss because the value of its interest in JHF decreased from $5,175,990 to zero. The Commissioner argued that the estate is not entitled to the deduction because JHF incurred the loss and argued that pursuant to New York law, JHF and not the estate, was the theft victim. The court found, however, that Section 2054 allows for a broader nexus between the theft and the incurred loss. The court said that pursuant to the phrase "arising from" in section 2054, the estate is entitled to a deduction if there is a sufficient nexus between the theft and the estate's loss, and found that the nexus in this case between the left and the value of the estate’s JHF interest was direct and indisputable. The court found that the theft extinguished the value of the estate's JHF interest, thereby diminishing the value of property available to the heirs, and the estate's entitlement to a section 2054 deduction was consistent with the overall statutory scheme of the estate tax.
Estate of James Heller et al. v. Commissioner, U.S. Tax Court, 147 T.C. No. 11; No. 11390-12. 9/26/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Finance Companies' Bad Debt Deductions Denied
The Michigan Court of Appeals held that financial services companies assigned purchase contracts from auto dealerships were not entitled to bad debt deduction tax credits. The court found that the statute did not allow taxpayers to use repossessed property in claims, and also held that the companies did not properly document who was entitled to the deduction.
Plaintiffs are financing companies that financed the purchase of motor vehicles from various dealerships around the state, providing that under the retail installment contracts, car purchasers would pay the entire amount financed, including sales tax, over a period of time. The dealerships assigned all of their rights under the installment contracts to plaintiffs, including the right to enforce the debt and repossess collateral. In exchange, plaintiffs paid the retailers the entire amount financed under the installment contracts, including the portion of the financed sales tax and the dealerships then remitted the sales tax due to the state. Some purchasers defaulted on their retail installment contracts, without repaying the full amount of the purchase, including the sales tax. In some of these cases plaintiffs repossessed the vehicles and sold them, applying the sale proceeds to the remainder of the purchase price and sales tax, but there were times when the contracts had unpaid balances even after the sale. When the plaintiffs determined these installment contracts worthless, they claimed the remaining balances as "bad debts" under § 166 of the Internal Revenue Code on their federal tax returns.
Plaintiffs sought refunds for bad debts, which the state’s Department of Treasury (Treasury) denied. Plaintiffs then filed an appeal. Treasury sought summary disposition in these cases, noting that claiming a debt as a bad debt under § 166 of the Internal Revenue Code was not the sole determining factor for whether a claimant was entitled to a bad debt deduction under the state’s sales tax statute, MCL 205.54i.
Treasury argued that refunds were not owed because plaintiffs had included repossessed property in its claim and repossessed property was specifically excluded under MCL 205.54i(1)(a). Treasury alsomaintained that plaintiffs failed to submit proper documentation that the sales taxes had been paid in RD-108 forms (Application for Michigan Title & Registration-Statement of Vehicle Sale). Treasury also argued as to one of the plaintiffs that its elections forms were not sufficient to determine whether it or the dealerships were entitled to the refund, noting that under MCL 205.54i, either a retailer or a lender could seek a refund for sales tax on bad debts, but that there had to be a clear election between the retailer and the lender as to who would be entitled to pursue the refund. Treasury argued that
although that financing company had recently provided several documents purporting to be election agreements with retailers, those documents were signed and dated after the date it wrote off the bad debt for federal income tax purposes. The Court of Claims ruled for Treasury and the plaintiffs filed this appeal.
At issue here is the interpretation of the state’s bad debt tax credit provision found in MCL 205.54i. The issues on appeal centered on three primary considerations: (1) whether one of the financing company’s election forms constituted "a written election designating which party may claim the deduction" for purposes of MCL 205.54i(3); (2) whether the Department may limit a taxpayer's ability to prove its right to a refund by requiring the taxpayer to submit RD-108 documents to the exclusion of any other method of proof under MCL 205.54i(4); and, (3) whether "bad debt" includes repossessed property under MCL 205.54i(1)(a).
The court rejected thefinancing company’s argument that its written elections satisfied the requirements of the bad debt statute, noting that the plain language of the statute required that a taxpayer seeking a refund maintain a written election designating which party may claim the deduction, creating a condition precedent to a tax refund. The court said that in the absence of a written election designating which party may claim a deduction, there is no entitlement to a refund. The court found that the language of the parties' later-drafted written election forms was clear and applied to "accounts currently existing or created in the future." The court rejected the company’s request to look beyond the plain language of the forms and consider the relevant surrounding circumstances and found that the lower court did not err when it found that company’s written elections did not satisfy the requirements of the bad debt statute.
The plaintiffs contended that the lower court erred when it found that Treasury was within its right to require plaintiffs to submit RD-108 forms as proof that the taxes had, in fact, been paid, citing MCL 205.54i(4) which provides that any claim for a bad debt deduction shall be supported by evidence required by Treasury. The lower court found that Treasury could require a claimant to submit an RD-108 as proof that the taxes had been paid and held this requirement was not an artificial barrier. The court held that the Court of Claims properly ruled that plaintiffs failed to demonstrate a right to a refund or an exemption, given the rules of statutory construction as well as the rules applicable to tax exemption and deductions.
Further, the court said that the fact that Treasury had not engaged in formal rule-making did not mean that it had been divested of discretion in determining what evidence must be produced to support a taxpayer's claim under the bad credit statute.
Finally, the court rejected the plaintiffs’ argument that the Court of Claims erred when it concluded that repossessed property was excluded as a deduction under the bad debt statute. The court cited the statutory provision that specifically provides that a bad debt “shall not include” repossessed property and rejected the plaintiffs’ argument that they should be entitled to a pro rata deduction. The court held that Court of Claims did not err in affording Treasury consideration when interpreting the bad debt statute, finding that the court did not rely exclusively on, and did not simply defer to, Treasury’s interpretation. The court said the lower court also relied on a prior decision by the court on the issue of whether repossessed vehicles were includable in the calculation of a refund under the bad debt statute where it held that the plain and unambiguous language of the statute provided that for the purpose of the exemption from sales tax a bad debt does not include repossessed property. Ally Fin. Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 327815; No. 327832; No. 327833. 9/20/16
Company Must Exhaust Administrative Remedies in Nexus Case
The Illinois Appellate Court, Second Division, held that a nonresident corporation must first exhaust its administrative remedies before seeking a judicial determination. The corporation was arguing that it did not have sufficient nexus with the state to subject it to the state's sales tax.
The taxpayers, a Delaware corporation headquartered in Florida, purchased a 2013 Ford Flex from an in-state retailer on July 17, 2012. The purchase was made on behalf of the taxpayer by their attorney, an Illinois resident, and at the time of the purchase the seller filed a sales tax return with the state Department of Revenue (DOR) indicating that the taxpayer was a non-resident of the state and, therefore, the seller did not collect sales tax on the transaction. In May 2013, DOR initiated an audit and requested information and documentation from the seller dealing with the sale. In response, the seller provided the DOR with a state of Delaware application for title, a special 30-Day Drive-Away Permit for the car; and a letter from the taxpayer addressed to "DMV Titles" in Delaware asking that a Delaware license be issued and mailed to their attorney in Illinois. DOR generated a CARFAX history report for the vehicle that indicated the vehicle was serviced for "recommended maintenance" in in Illinois two months and four months after the vehicle's purchase. On May 31, 2013, DOR initiated a sales and use tax audit of the taxpayer’s claimed tax exemption and sent the taxpayer an audit records request. The taxpayer provided information on the purchase and registration of the vehicle but argued that the vehicle purchase was the only business transacted in the state and the other information requests were beyond the scope of reasonable. DOR sent a notice demanding copies of the taxpayer’s books and records and the taxpayer argued that it had no nexus with the state sufficient to subject it to the state’s tax laws. The taxpayer also argued that tax was not due on the purchase of the vehicle because it was not being used in the state.
DOR issued a notice of proposed audit findings concluding that use tax was due on the vehicle and finding that based on the best information available the taxpayer was a state resident both at the time of purchase and at the time it claimed a nonresident exemption. Therefore, it did not qualify for the nonresident exemption. The notice advised the taxpayer that if it did not agreement with the findings it could request a review of the proposed liability, or pay the assessment in full and file an appeal to the circuit court. On the same day DOR issued a notice of proposed audit liability in the amount of $3,280. The taxpayer filed an action for declaratory relief in the circuit court requesting a permanent injunction against DOR and its director, alleging that it did not have sufficient nexus with the state to be required to submit to its tax laws. The taxpayer also sent the DOR a notice of "Protest and Request for Administrative Hearing."
DOR filed a motion to dismiss in the circuit court arguing that the taxpayer was prohibited from bringing an equitable action because a challenge to the imposition of the tax is available under the Protest Act (30 ILCS 230/1 (2014)). In the alternative, DOR argued that because the taxpayer filed a "Protest and Request for Administrative Hearing" during the pendency of the Chancery action, there are two pending matters between the same parties for the same cause, the complaint should be dismissed. The circuit court denied the motion to dismiss and stayed all other proceedings pending further order of court explaining that the case involved "a matter of constitutional proportions." The court subsequently issued a written opinion finding that the administrative proceeding and the pending action did not involve the "same cause" because the administrative proceeding addressed a "liability for use tax" whereas this action addressed "the Department's jurisdiction" to assess a use tax. The taxpayer moved for summary judgment arguing that it did not have a substantial nexus with Illinois sufficient to subject it to the Department's jurisdiction and that the use tax only applies to persons residing in or entities engaged in business in Illinois. On September 2, 2015, the circuit court granted summary judgment in favor of the taxpayer. The circuit court enjoined the DOR from collecting tax, penalty or interest with respect to the purchase of this vehicle, and from bringing any action against the taxpayer under the statute for failure to comply with the act. DOR filed this appeal.
The state statute provides an exemption from the use tax for the purchase of a motor vehicle in the state if the vehicle is not to be titled in Illinois and if a drive-away permit is issued to the vehicle, provided the nonresident purchaser executes a statement, signed under penalty of perjury, of their intent to title the vehicle in their resident state within 30-days after sale.
However, if the vehicle remains in Illinois for more than 30-days, its use may be subject to tax under the Act. DOR is empowered DOR to administer and enforce the collection of the use tax through various means, including the power to investigate, audit, assess, correct tax returns, and collect the tax when owed. After audit and imposition of a tax, the statute provides mechanisms to dispute the assessment of a tax in several different ways.
DOR argued that the taxpayer failed to exhaust its administrative remedy and should have waited until DOR issued its final assessment and notice of tax liability and then sought administrative review of DOR’s decision. The court held that DOR had jurisdiction and a duty to inquire, investigate and impose a use tax under the circumstances presented in this appeal. The court said that in revenue cases, applying general equitable principles, it is the rule that a declaratory judgment is not available if the statute provides an adequate remedy at law. The doctrine of exhaustion of administrative remedies prevents courts from entangling themselves in disagreements over administrative policies and protects agencies from judicial review until an administrative decision has been formalized. The court said that the legislature has provided for the assessment and collection of the use tax by the Department and has provided a method for obtaining relief from the tax if the taxpayer disagrees with the action taken by the agency. The court said that while DOR’s audit was pending the taxpayer filed this action to dispute its potential assessment and the circuit court should not have interfered with the administrative proceedings. The court said that in order to dispute the DOR’s assessment of the use tax, the taxpayer had the option to withhold payment of the tax and receive an administrative hearing following receipt of a notice of tax liability from the Department of Revenue, pay the tax and file a claim for credit or refund, and have an administrative hearing after protesting the Department's notice of tentative determination of claim, finally, pay the tax under protest pursuant to the Protest Monies Act and have the circuit court pass upon the protest. The court found that the taxpayer failed to exhaust its administrative remedies and pursue an available a remedy at law and reversed the judgment of the circuit court and vacated the injunction and stay of DOR’s administrative proceedings.
Airris Aviation and Marine Inc. v. Beard, Illinois Appellate Court, Second Division, 2016 IL App (1st) 152834-U; No. 1-15-2834. 9/30/16
Additional Refund Claim Denied in ITFA Matter
The Tennessee Court of Appeals at Nashville held that a taxpayer was not entitled to additional interest on a refund for sales tax erroneously collected and remitted to the state in violation of the Internet Tax Freedom Act because the refund was granted by the commissioner and not by the trial court.
Taxpayer filed a claim with the state Department of Revenue (DOR) for refund of sales taxes on Internet access services it mistakenly charged and collected from approximately 800,000 customers from November 1, 2005 through September 7, 2010 and paid to DOR. Over the course of the next three and a half years, representatives of DOR and the taxpayer worked together to identify and provide information in a format that would facilitate the review. Because the refund claims were not resolved within six months of filing, they were deemed denied and the taxpayer filed suit in chancery court. The parties continued to work to resolve the claim, and the court extended the disposition date of the suit. Ultimately, DOR refunded approximately $19 million, plus a portion of the interest sought by the taxpayer and the case proceeded to trial to determine whether the applicable statute permitted the taxpayer to recover additional interest. The lower court determined that the claim was resolved by the administrative review rather than by the court and awarded interest from the date the taxpayer supplied proper proof to DOR. This appeal was filed.
The state statute provides that when a refund is due, the taxpayer is entitled to interest on the amount of the refund. The date on which interest begins to accrue depends upon how the claim is resolved. When it is determined by administrative review that the refund is due, interest begins 45 days from the date the commissioner receives proof to verify the claim. When a claim is determined by court order, interest begins 45 days from the date of the filing of the claim. The issue in the case was whether, for the purposes of the calculation of interest, the refund resulted from the commissioner’s processing of the claim or from court adjudication.
The taxpayer argued that the statutory provision should be construed to mean that any audit work done by DOR after suit has been filed cannot be constitute an “administrative review,” and since this case was in court when the refund was approved, interest should be awarded accordingly. The court said, however, that its review of the statute did not dictate that the Commissioner’s authority to conduct an administrative review process expired when suit is filed, and the court rejected the taxpayer’s contention. The court said that the taxpayer preserved its right to challenge the Commissioner's determination under the statute by filing suit within one year of filing the refund claim, but noted that at the request of the parties, the chancellor extended the disposition date for the case numerous times in order to allow the review of the refund claim to be completed. The record shows that the process resulted in the refund that was paid in May and September 2014. When the case progressed to trial, the only issue for the court to resolve was the date at which interest began to accrue. The court here noted that the trial court did not adjudicate the taxpayer’s entitlement to a refund or the amount of the refund, and, other than the matter of interest, the taxpayer did not challenge the Commissioner's decision. The court agreed with the lower court that interest on the refund was to be calculated from the date the taxpayer provided proper proof of the claim to the Commissioner.
The court then turned to the question of when the taxpayer provided proper proof of the claim.The lower court held that the Commissioner received proper proof to verify that the refunds were due and payable on March 19, 2014. The taxpayer argued that the court erred in holding that the proper proof standard was only met after a taxpayer provided information responding to the last audit request by the Commissioner, and contended that the record proved that the Commissioner had proof as of the date the refund request was received. DOR argued that the refund could not be made based on the original information received, which was summary in nature and could not be correlated to the taxpayer’s customer invoices. The court noted that “proper proof” is not defined in the relevant statutory provisions and said the case was unique due to the size and nature of the claim. The court noted the lower court’s findings of facts regarding the billing processes of the taxpayer which further complicated the review by DOR providing significant challenges in verifying the amount of tax collected for Internet access and concluded that the evidence supported the lower court’s findings that the data originally provided was not sufficient for the Commissioner to conduct the review of the refund claim.
The court found that in light of the number of Tennessee residents affected and the amount of money at stake in this refund claim, there was no proof in the record from which to conclude the Commissioner's review was unreasonable. The court concluded that the trial court did not err in finding that proper proof, within the meaning of the statute, was not supplied until March 14, 2014. The court also declined to award the taxpayer attorneys’ fees. AT&T Mobility II LLC v. Roberts, Tennessee Appellate Court, No. M2015-01118-COA-R3-CV. 9/30/16
Airline Meals Not Entitled to Reduced Sales Tax Rate
The Missouri Supreme Court held the sale of frozen meals to airline customers should not be taxed at the lower rate, because the food items were not used for home consumption. The court also found that the application of the tax did not violate the state constitution's uniformity clause.
The taxpayer is a global provider of catering and provisioning services for airlines and railroads and operates a facility near the Lambert-St. Louis International Airport from which it sells frozen meals to various commercial airlines. It filed sales tax returns with the state Department of Revenue (DOR) for the relevant period and reported sales of frozen meals to its airline customers at the reduced sales tax rate of 1 percent as provided in section 144.014 of the state statute. DOR performed an audit and concluded that the sales of the airline meals did not qualify for the reduced sales tax rate because sales of food made to airlines for consumption during flight are not sales of food for home consumption. The taxpayer paid all of the assessments under protest and filed protest affidavits with the Director for each assessment. On September 27, 2013, the Director issued a final decision denying the taxpayer’s protests and the taxpayer filed an appeal to the Commission. The Commission upheld the assessment and the taxpayer filed this appeal.
The meals at issue were prepared, packaged, and sold in bulk to commercial airlines pursuant to a contract for catering services between the taxpayer and each airline, preparing meals according the menus approved by the airline. The taxpayer is responsible for purchasing the food products and supplies needed to prepare and cook these meals, which are then plated on trays owned and provided to it by the airline. The meals are flash-frozen and kept frozen until requested by the airline for a particular flight hours before each flight. The meals are then heated onboard the aircraft for approximately 30 minutes before they can be served to the passengers and crew. The taxpayer removes carts from arriving aircraft, disposes of the waste, and cleans the airline's trays for use with future meals.
The court pointed out that findings of fact by the Commission are binding on the court if supported by competent and substantial evidence, but the Commission's construction of a revenue statute is reviewed de novo. The statute taxes retail sales of tangible personal property at the rate of 4%. Some food sales, however, are taxed at a lower rate of 1% if the food is food for which food stamps may be redeemed under the federal code. This federal statute defines food to mean any food or food product for home consumption, except alcoholic beverages, tobacco, hot foods or hot food products ready for immediate consumption. The taxpayer argued that its sales meet the federal definition of food because they are not sold for immediate consumption since the meals are sold frozen and must be reheated onboard the aircraft, and likens the meals to frozen “TV dinners” sold in grocery stores. The court said this argument assumes that the only thing that matters when applying this federal definition of food is the type of food and not the context of the sales transaction and cited Wehrenberg, Inc. v. Dir. of Revenue, 352 S.W.3d 366 (Mo. banc 2011), where this court rejected substantially the same assumption in holding that context plays a necessary role in deciding whether concession items sold at a movie theater qualified for the 1-percent sales tax rate. The court in Wehrenberg held that the only products and types of food subject to the 1 percent sales tax are food items intended for home consumption. The court said that the Commission properly relied on Wehrenberg in rejecting the taxpayer’s refund claim.
Viewed in context, the court said, the frozen meals sold by the taxpayer were expected, and intended, to be eaten exclusively on its customers' aircraft. In the abstract, these meals could be taken home by the passenger and eaten there, but that is not the purpose for which the taxpayer sold these meals.
Finally, the court rejected the taxpayer’s argument that the decision is unexpected under section 143.903.2 of the statute and can, therefore, only apply prospectively, pointing out that a decision is “unexpected” under this provision if a reasonable person would not have expected the decision based on prior law, previous policy or regulation. The court said a
decision is not unexpected, however, merely because a statute was construed less favorably to a taxpayer than the taxpayer may have liked. Gate Gourmet Inc. v. Dir. of Revenue, Missouri Supreme Court, No. SC95388. 10/4/16
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
No cases to report.
Property Tax Decisions
Pharmacy Property Not Overvalued
The Kentucky Court of Appeals affirmed that the property valuation administrator (PVA) didn't overvalue the property by considering the income generated under Walgreen Co.'s triple net lease from Wilgreens LLC. The court said that Walgreen and Wilgreens failed to present convincing evidence that the administrator's assessment overvalued the retail pharmacy.
The commercially zoned property is located in Lexington on a major throughway surrounded by a residential community and high-end retail stores. In 2005 a pharmacy entered into a lease of the property, which at that time was owned by the Ruttenburg family who agreed to oversee and finance the construction of a new pharmacy on the property. The building was built to the exact specifications of the pharmacy company and, in return, the company agreed
to pay all real estate taxes, insurance, and maintenance costs in addition to a monthly rental fee that equated to an annual rent of approximately $404,000.00. The lease was for a period of seventy five (75) years, but the company could terminate it after an initial twenty-five year term and every five years thereafter. The lease also gave the company a right of first refusal to purchase the property outright in the event the owner decided to sell it. After construction was complete the family put the property on the market for sale and Wilgreens offered to purchase the property subject to the lease. The pharmacy company elected not to exercise its right of first refusal, and the property was sold to Wilgreens. The PVA used the 2007 sale value as the assessment for 2007, 2008, and 2009 and the pharmacy company appealed these assessments, contending that the fair cash value was no significantly lower. Prior to a hearing before the tax board, a settlement was reached and the PVA agreed to assess the property at $5,250,000 for 2007, $5,250,000 for 2008 and $5,086,000 for 2009. Within these agreements, the pharmacy company concurred that the income generation approach was the proper method for valuing the property. As required by statute, the PVA reassessed the property for tax year 2010, valuing it at $5,086,000. It did the same for tax years 2011, 2012, and 2013. The pharmacy appealed the PVA's assessed value of $5,086,000 for tax years 2012 and 2013. The local board of assessment appeals upheld the PVA's assessments and the taxpayer appealed to the Board of Tax Appeals (BTA) contending that the value of the property was $4,397,600 for tax years 2012 and 2013. The BTA held an evidentiary hearing on the consolidated years and ruled in favor of the PVA. The taxpayer filed and appeal to the circuit court, which update the ruling of the BTA, and the taxpayer filed this appeal.
The state constitution and statute require that non-exempt property be assessed annually at its fair cash value. The court cited Kentucky Tax Commission v. Jefferson Motel, Inc., 387 S.W.2d 293, 296 (Ky. 1965) for the proposition that the proper criterion of fair cash value for any property is the price the seller willing but not forced to sell would take and the buyer willing but not forced to buy would give for it. The law of the state grants the estimated property tax assessment a presumption of validity and places the burden of establishing that the assessment is incorrect on the taxpayer.
The court noted that the pharmacy had throughout the process focused its attention on the fact that the rents it usually agrees to pay are above the market rate, but the taxpayer, when attempting to value the property, attempted to show the property was overvalued by relying on properties very different from the present. The court said that none of the properties the taxpayer relied on was located on the same major roadway or anywhere similar. The court found that its failure to produce competent, substantive evidence in and of itself justified the BTA’s conclusion. The court found that the taxpayer did not meet its initial evidentiary burden and without competent evidence establishing overvaluation, the taxpayer had no case.
Further, the court said that setting aside the proof issue, it could find no outright fault with the PVA's application of the assessment statutes. The PVA is permitted to use the income generation approach in estimating “fair cash value.” The court noted that the legislature had defined the income approach as a method of appraisal based on estimating the value of future benefits arising from the ownership of property. Therefore, the court said, in using the income generation approach, the PVA is permitted to take into account the present value of all advantages arising out of ownership of the property.
The court observed that the taxpayer wanted a hard and fast rule, asking the court to hold that its leases do not reflect true market value, but the court said that it was for the PVA to determine fair cash value by assessing each individual property. Net rental income could be considered in doing that as well as other factors, including the tenant's creditworthiness. The court noted that the passage of time or change in location demographics might make the income approach inappropriate because it will distort the value of the property, but it did not find this to be the case in the current matter. Wilgreens LLC v. O'Neill, Kentucky Court of Appeals, No. 2015-CA-000407-MR. 9/23/16
Drama Club Denied Exemption
The Illinois Appellate Court, Second District, held that it was not clearly erroneous for the Department of Revenue (DOR) to deny a drama club a property tax exemption because the club was not an institution of public charity and its property was not used exclusively for charitable purposes.
The taxpayer owns a theater located in the state and applied to the county Board of Review (Board) for a non-homestead property tax exemption from 2012 real estate taxes. On July 27, 2012, the Board forwarded the application to DOR with the recommendation to deny it and on September 20, 2012, DOR denied the property tax exemption on the basis that the property was not in exempt ownership or exempt use. The taxpayer timely filed an application for hearing before DOR pursuant to the statute and an administrative hearing was held during which two witnesses affiliated with the taxpayer testified. The record showed that Wheaton Drama’s predecessor was incorporated as a non-profit organization in 1965 with the stated purpose to cultivate an interest in dramatic literature and dramatic technique by the presentation of informal readings of plays and by the production of fully staged theatricals for the public. In 1967 an article of amendment added that the organization was "formed exclusively for literary purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code of 1954." In 1991 the organization changed its name to the current one. It is exempt from income and sales tax. Anyone can audition for the plays and be involved with the productions, but everyone had to be a member to participate in the production because of “insurance issues.” No one was compensated. The bylaws of the organization gave the Board of Governors the authority to adopt membership fees and dues, and the discretion to vary the fees. The taxpayer put on five major stage productions each year with four performances per week for four weeks. Admission was charged except for the opening night when occupants of several retirement homes and a homeless shelter for veterans were invited to attend free of charge. The taxpayer also offered weeklong summer workshops for high school students and children to learn acting, dance, and voice and self-confidence. While there was a fee for the program, it was waived for families that could not afford it. High school students could also help with the children's workshops and receive reduced tuition to attend the high school class. Over 90 children attended annually. Any profits at the end of the fiscal year were put into repairs of the facility or enabled the organization to make additional mortgage payments.
The administrative law judge (ALJ) affirmed the denial of the exemption, holding that the promotion of theatrical arts was not an endeavor that the state courts recognized as charitable. The ALJ said that the statute required that a property be exclusively used for charitable purposes in order to qualify for an exemption, and that while an exclusively charitable purpose was not interpreted as the entity's sole purpose, it did need to be its primary purpose, as opposed to a merely incidental or secondary purpose or effect. The ALJ said that the taxpayer may have provided some charity in 2012, but it appeared to be secondary or incidental to its main purpose, which was the study and promotion of theatrical arts. The taxpayer was a membership-based organization with its members apparently joining because of their mutual interest in the theater, not to assist in the dispensation of charity and the organization's benefits primarily flowed to its members rather than the public. The ALJ said that the only benefit discernible to the local community from taxpayer’s activities was that the public could buy a ticket to the theater and enjoy a performance, similar to enjoying a performance from a for-profit, property tax-paying theater. The ALJ concluded that Wheaton Drama did not possess sufficient distinctive characteristics of a charitable institution and that its property was not used primarily for charitable purposes. On September 22, 2014, the taxpayer filed a complaint for administrative review in the circuit court. The circuit court affirmed DOR’s ruling and the taxpayer filed this appeal.
Section 6 of article IX of the state constitution permits the legislature to exempt property from taxation if, among other things, it is used exclusively for charitable purposes. The property tax statute provides an exemption for property that is actually and exclusively used for charitable or beneficent purposes, a requirement derived from the constitutional provision.
The statute further requires that the organization be an institution of public charity. The court said that the central issue in this case is whether DOR’s determination that taxpayer did not meet its burden of proving that it is an institution of public charity and that its property was exclusively used for charitable purposes was clearly erroneous. The court reviewed case law that has previously articulated characteristics for determining whether an organization is a charitable institution and whether property is used for charitable purposes. The court outlined these criteria: (1) the charity benefits an indefinite number of people for their general welfare or by reducing the government's burdens; (2) the organization does not have any capital, capital stock, or shareholders, and it does not profit from the enterprise; (3) the funds are derived largely from public and private charity, and the organization holds the funds in trust for the purposes expressed in the organization's charter; (4) charity is dispensed to all who need it and apply for it; (5) there are no obstacles placed in the way of people seeking benefits; and (6) the exclusive, i.e., primary, use of the property is for charitable purposes.
The court agreed with the taxpayer that institutions for performing arts can qualify as charitable institutions and that such institutions are not required to use the word "charity" in their articles of incorporation and mission statements, and that charitable institutions can charge fees in many instances, but noted that the ALJ did not rely solely on these contested findings in arriving at his conclusion that the taxpayer was not an institution of public charity and that its property was not primarily used for charitable purposes. Rather, the findings were a part of an examination of the case's facts as a whole.
The court concluded that the first factor listed above weighed against the taxpayer’s position because while the general public could audition for the productions and become members of the taxpayer, there was a $20 annual membership fee, and a witness did not recall any fee waivers in 2012. The taxpayer did provide free shows to a restricted number of people five nights per year. The court found that the second factor favored the taxpayer.
The court found that the taxpayer did not meet the third factor because the court said it obtains only 15% of its funds from contributions and grants. The court concluded that the fourth and fifth factors weigh against a finding that the taxpayer is a charitable institution and that its property is used for charitable purposes. There was a $20 membership fee for the organization, and although its bylaws gave its board discretion to vary fees, a witness did not recall any fee waivers in 2012. The bylaws also stated that ticket charges would be waived upon request if there was financial hardship, but there was no mechanism for the pubic to be alerted to this allowance. The court also found that the sixth factor weighed against the taxpayer, concluding that while the taxpayer benefits some individuals other than its members, the evidence shows that the property was most frequently used for meetings and rehearsals for members, consistent with its stated purposes in its articles of incorporation. The court said that it was apparent from the record that the taxpayer is a non-profit organization that is an asset to its community. However, the limited question in this case was whether the taxpayer qualifies for a property tax exemption and the court could not say that DOR’s ruling was clearly erroneous. Wheaton Drama Inc. v. Dep't of Revenue, Illinois Court of Appeals, Second District, 2016 IL App (2d) 151271-U; No. 2-15-1271. 9/19/16
Other Taxes and Procedural Issues
No cases to report.
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected]. |
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