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STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
August 5, 2016 Edition
NEWS
IRS Issues Temporary Regs on Partnership Audit Regime
On August 4, 2016, the IRS issued temporary regulations (T.D. 9780) regarding the election to apply the new partnership audit regime established by the Bipartisan Budget Act of 2015 (BBA). The regulations affect any partnership that wants to elect to have the new partnership audit regime apply to its returns filed for tax years beginning after the date the BBA was enacted, November 2, 2015, and before January 1, 2018. Effective August 5, 2016, the text of the temporary regulations also serves as the text of concurrently issued proposed regulations (REG-105005-16). The new partnership audit regime that was created by the BBA generally applies to returns filed for partnership tax years beginning after December 31, 2017. However, a partnership may elect for the amendments to apply to any of its partnership returns filed for partnership tax years beginning after November 2, 2015, and before January 1, 2018.
Update on South Dakota Quill Challenge
The South Dakota attorney general has filed a motion with the U.S. District Court for the District of South Dakota, Central Division, to remand the case challenging the state’s law that requires remote sellers to collect and remit sales and use tax to state court. The motion argues that a case on the state's remote sales tax law should be remanded to state court because the federal court lacks removal jurisdiction in declaratory judgment cases.
“Engaged in Business” Model Statute Issued
The Multistate Tax Commission at their annual conference released the text of the proposed model statute clarifying the definition of “engaged in business” for sales and use tax purposes.
The model was originally approved by MTC’s Executive Committee on July 30, 2015 and a public hearing was held. The hearing officer’s report from the hearing was provided to the executive committee who approved the model with one recommended change on December 11, 2015. The proposal is available on www.mtc.gov.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
No cases to report.
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Freezer Tubs Not Entitled to Exemption
The Vermont Supreme Court held that reusable freezer tubs used in the transport of perishable food by a wholesale grocer did not qualify for a sales tax exemption because the tubs were not packaging material pursuant to the state’s regulation. The court also denied the company's claim for a refund of sales tax on diesel used to fuel refrigeration systems on the taxpayer’s tractor-trailers.
The taxpayer, a Vermont corporation headquartered in New Hampshire, is the country’s largest wholesale grocery distributor. It purchases inventory from manufacturers and other suppliers and resells it to national supermarket chains and local grocers. Taxpayer has a warehouse in the state that supplies its New England and New York customers. Since some of the products it supplies require refrigeration for freshness and safety, taxpayer transports perishable products, wrapped in large plastic bags or “shrouds,” in large rectangular fiberglass tubs, referred to as "freezer tubs," which are packed with dry ice and loaded into refrigerated tractor-trailers. The tractor-trailers, or "reefers," are insulated and mounted with a refrigeration system that runs on diesel fuel, or "reefer fuel." During delivery, the freezer tubs are unloaded and the plastic shrouds are cut off the pallets before the boxes of frozen food are removed and taken into the store. Empty freezer tubs are not given or transferred to the grocer customer, but are taken back by the taxpayer for re-use, and each tub is typically used for a period of three to five years. Each of taxpayer's reefers has a fuel tank, separate from the tractor-trailer's fuel tank, which is used only to power the tractor-trailer's refrigeration unit, which in turn keeps the tractor-trailer cool. Unlike the diesel fuel for the tractor-trailers themselves, the reefer fuel is dyed red and held in tanks marked "for off-road use only." It is illegal to use reefer fuel to propel the tractor-trailers on public roads and highways.
The state sales tax statute exempts from the tax materials, containers and other packing, packaging or shipping materials for use in packing, packaging, or shipping tangible personal property by a manufacturer or distributor. The state Department of Revenue (DOR) determined that the freezer tubs owned by the taxpayer did not qualify for the exemption and filed an assessment. During the course of the audit it was also determined that the taxpayer had paid the sales tax on the reefer and DOR held an administrative hearing on the assessment and denial of a refund for the fuel. The Commissioner ruled that the freezer tubs did not qualify as shipping materials exempt from the tax and cited DOR’s regulation, which defined “packing, packaging or shipping materials” but limited the exemption for returnable and reusable packaging to that packaging with a limited life expectancy of not more than three years. Sales and Use Tax Regulations § 1.9741(16)-2, Code of Vt. Rules 10 060 033. The
With regard to the reefer fuel, the Commissioner found that it was not a container or packing material, was not a component of the parcel, which was conveyed to the customer, and was not exempt. The taxpayer subsequently filed a formal request for refund of tax paid on the reefer fuel and DOR denied the request. Taxpayer filed an appeal of both determination and they were consolidated on appeal. The trial court affirmed the Commissioner’s decision and taxpayer filed this appeal.
The taxpayer argued that the statute does not limit the type of materials or containers used to pack or ship and that under the plain language of the statute the freezer tubs are exempt as containers and DOR’s regulation limiting the life span of the containers is arbitrary and capricious. Although DOR acknowledged that the exemption includes some returnable and reusable packaging, it argued that such packaging must have a life expectancy of less than three years. The court recognized the general rule that tax exemptions are strictly construed against the taxpayer, but also said that the construction of the provision must not defeat the purposes of the statute. It also said that it must defer to agency interpretations of statutes the Legislature has entrusted to their administration, and absent compelling indication of error, they uphold the Commissioner's interpretation of tax statutes. It noted that the exemption is potentially extremely broad if it applies to anything involved in packing, packaging, or shipping, and said the court was aided by reference to the DOR’s regulations, adopted in accordance with the state’s Administrative Procedure Act, which specifies that the regulations are valid and binding with the force of law. The court cited case law for the proposition that the regulations constitute prima facie evidence of the proper interpretation of the matter to which they refer. In addition to DOR’s regulation on the matter, a technical bulletin was issued explaining the scope of the exemption and the longstanding position that returnable
and reusable packaging is not exempt from the sales and use tax.
The bulletin provided that packing, packaging, and shipping materials that will continue down the stream of commerce are not taxed, while durable equipment that has come to rest in the stream of commerce can be taxed to the manufacturer or distributor without the risk of double taxation, and further provided that this exclusion was supported by the purpose of the exemption, which is to prevent double taxation. The court said that to exempt all containers, as the taxpayer argued, is not within the necessary scope of the statute. Narrowly construing the statute, the exemption is thus limited to components of the parcel being shipped. The court noted that the freezer tubs do not move through the stream of commerce and if the exemption applies to the freezer tubs they will not be taxed at any point in the distribution process.
The court also said that a limited reading of the scope of the statute prevents an overly broad construction of the exemption, which would otherwise bring within its scope all materials, containers, labels, sacks, cans, boxes, drums, or bags, as well as all packing, packaging, or shipping materials, regardless of whether they were components of the parcel to be shipped. This would have the potential to include under its purview all objects used to transport or hold something, such as the tractor-trailer trucks transporting taxpayer's goods across New England, the freezer units and storage racks at the warehouse used to hold the goods until loaded, and the warehouse itself, which is, in the broadest sense, a "container" when it holds goods for shipment. Finally, the court said that an overly inclusive and broad reading of the exemption would also contravene the purpose of the statute. For this reason, the court said, returnable and reusable packaging materials that have come to rest in the stream of commerce should be taxed to the distributor or manufacturer, lest they avoid taxation altogether, whereas packing, packaging, and shipping materials that will continue down the stream of commerce are not taxed to the manufacturer or transporter and are instead taxed where they come to rest in the stream of commerce as part of the taxable base of the product. Applying the court’s interpretation to this case, the freezer tubs were not within the scope of the exemption.
The taxpayer also argued that DOR’s “three-year rule” was invalid. The court noted that the rule was adopted in response to an increase in the use of disposable materials, an unintended consequence of the exclusion of returnable and reusable packaging in the regulation and DOR adopted the position exempting returnable and reusable packaging with a life expectancy of less than three years to incentivize the use of recyclable materials over disposable materials while still giving effect to the apparent intent of the exemption, i.e., to exempt packaging and not equipment. DOR considered items with a useful life greater than three years to be equipment used and consumed by the manufacturer or distributor. The taxpayer argued that not only is the three-year rule without statutory basis, but that the DOR lacked the authority to adopt the exception in the first place. The court declined to address this challenge to the rule finding that it had no effect on the case because the freezer tubs have a life expectancy of more that three years and are, therefore, excluded regardless of the rule.
The court then turned to the issue of the exemption as it applies to reefer fuel. The taxpayer argued that under the plain language of the statute, the reefer fuel is exempt as "shipping material." The court said that the exemption does not apply to unlimited types of shipping materials, and that, although the reefer fuel is a "material," it is a material under the broadest sense of the word. The fuel is not a component of the parcel being shipped, but is a component used in shipping. The court said that it does not continue down the stream of commerce and can be taxed to the taxpayer without the risk of double taxation. C&S Wholesale Grocers Inc. v. Dep't of Taxes, Vermont Supreme Court, No. 2015-282. 7/15/16
Company Has Nexus for B&O, Sales Tax
The Washington Court of Appeals, Division One, found that a company had a substantial physical presence in the state and the commerce clause doesn't prohibit Washington from obligating the company to collect sales tax. The court also found that the company had sufficient nexus to be subject to the business and occupation tax because its activities helped establish and maintain a market for its products in the state.
The taxpayer is a California company that sells wholesale and retail nutritional supplements to Washington customers. The facts in the case showed that from 2002 through 2009, the taxpayer made wholesale sales to retailers and distributors in the state and during this time, it invested considerable resources into its store presence in the state. Senior company employees spent a considerable amount of time in the state, participating in new item presentation; category review, promotional planning, educating sales staff and trade show exhibitions. The taxpayer also engaged four marketing firms to aid in marketing its products in the state and these firms engaged in a wide variety of activities with the taxpayer’s wholesale customers, such as soliciting sales, receiving product orders, attending retailer shows on the taxpayer’s behalf and acting as an intermediary with its retailers on promotional programs and other business matters.
In 2004 the taxpayer began making retail sales to residents in the state and began operating both a retail sales channel and a wholesale sales channel, which the taxpayer claimed operated completely independently from each other. The taxpayer stated that it handled all of the wholesale advertising and promotion in-house and in-house personnel handled the shipment of orders, collection of payments and inquiries from wholesale customers.
During that period, consumers were not permitted to place online orders and whenever the taxpayer received phone inquiries from individuals who had purchased its products from its wholesale customers, the taxpayer directed the callers back to the retailer. The taxpayer’s strategy for developing retail sales was to offer particular products for sale through infomercials. From 2004 through 2009, the taxpayer’s retail sales used third party companies for its advertising and promotion, solicitation and taking of consumer orders, assembly and shipment, collection of consumer payments, and customer service inquiries. From 2002 through 2009, the taxpayer earned approximately $10 million in gross revenue from wholesale sales, and from 2004 through 2009, it earned approximately $5 million in gross revenue on its retail sales. The Department of Revenue audited the taxpayer for business and occupation and sales taxes and issued an assessment that the taxpayer paid under protest and filed an appeal. The trial court ruled for DOR and the taxpayer filed this appeal.
The taxpayer argued that its retail sales are separate and distinct from its wholesale activities in the state and it, therefore, contends that the commerce clause prohibits the state from imposing either the B&O tax or an obligation to collect a sales tax. In support of its argument on the B&O tax, it relies primarily on Norton Co. v. Dep't of Revenue, State of III., 340 U.S. 534, 71 S.Ct 377, 95 L.Ed 517 (1951) which held that an interstate seller who engages in activities within a state can still avoid taxation on some in-state sales by showing that particular transactions are dissociated from the local business and are solely interstate in nature. With regard to the use tax, the taxpayer concedes that the holding in Nat'l Geographic Soc. v. Cal. Bd. of Equalization, 430 U.S. 551, 97 S.Ct 1386, 51 L.Ed.2d 631 (1977), does not permit it to dissociate its mail order sales from its other sales, but contends that U.S Supreme Court decisions in Complete Auto Transit, Inc. v. Brady, 430 U.S. 374, 97 S.Ct. 1076, 51 LEd.2d 326 (1977) and Quill Corp. 504 U.S. 298, have diminished the ruling in that case and clarified that dissociation applies to all tax types.
DOR argued that dissociation is no longer a viable means for an interstate seller to avoid a tax imposed by a state with which it has a substantial nexus, relying primarily on the ruling in National Geographic. DOR conceded that National Geographic does not expressly apply to a B&O tax but argued that the taxpayer’s reliance on Norton to contest that tax, is misplaced saying its precedential value has been undermined by more recent U.S. Supreme Court cases.
DOR also cited a recent decision by Division Two of the court, which rejected an interstate seller's reliance on dissociation to contest B&O tax liability. Avnet v. State, Dep't of Revenue, 187 Wn. App. 427, 348 P.3d 1273 (2015), review granted. 184 Wn.2d 1026, 364 P.3d 120 (2016).
The court concluded that an out-of-state corporation is not subject to a state tax if it can prove the sales or activity in question does not have a substantial nexus to the taxing state. It said that for purposes of a sales tax, a substantial nexus exists if the corporation has a presence in the taxing state and for purposes of a B&O tax, a substantial nexus exists if the corporation's in-state activity aids in establishing or maintaining a market within the taxing state. The court said it was undisputed that the taxpayer has a substantial physical presence in the state and concluded that the commerce clause does not prohibit the state from imposing on it an obligation to collect the sales tax. With regard to the B&O tax assessed, the court said that the parties agreed that the resolution of the issue turns on whether, as to its retail sales, the taxpayer has a substantial nexus with the state, but disagree on whether the issue of “transactional nexus” is essential to establishing a substantial nexus. The taxpayer conceded that its wholesale activities have a transactional nexus with the state, but argued that its retail sales do not because those retail sales were completely independent from the wholesale sales during the relevant period. DOR argued that under modern commerce clause, establishing a transactional nexus is not essential to finding a substantial nexus, arguing that there does not need to be a direct connection between the taxpayer’s in-state activities and particular sales in order to impose the B&O tax. DOR argued that it was only necessary that the taxpayer’s in-state activities were significant in establishing and maintaining a market for its goods in the state. The court said Tyler Pipe made it clear that for businesseswith a presence in the taxing state, the fact that orders are received and filled out-of-state for delivery within the taxing state does not, by itself, immunize the sales from a B&O tax and the activities that form the nexus with the taxing state need not be tied to specific sales, but instead need only generally support the out-of-state vendor's ability to establish and maintain a market for its goods in the taxing state. The court applied those principles in the current case and found that the taxpayer had failed to meet its burden and prove that it does not have a substantial nexus with the state and it was, therefore, liable for both taxes on its retail sales in the state. Irwin Naturals v. Dep't of Revenue, Washington Court of Appeals, Division One, No. 73966-2-1. 7/25/16
Personal Income Tax Decisions
Aircraft Dispatcher Subject to State Income Tax
The Oregon Supreme Court found that an aircraft dispatcher who works in Oregon did not qualify for an exemption from the state income tax under a federal statute as an employee having regularly assigned duties on aircraft in at least two states.
The taxpayer is an aircraft dispatcher who lives in Washington and works almost entirely in Portland, Oregon. His primary duties were to plan and monitor flights from his employer’s Portland operations center. His listed job duties did not involve any flight time. The Federal Aviation Administration (FAA) has promulgated an administrative rule that prohibits an air carrier from using a person as an aircraft dispatcher unless that person has met certain requirements, including that dispatchers must familiarize themselves with flight deck operations on the planes that they dispatch by spending at least 5 hours observing operations in one of the types of airplanes in each group to be dispatched. The parties stipulated that taxpayer did two observational flights that year, one for each of the two aircraft groups that he monitors. Taxpayer argued that, pursuant to 49 USC § 40116(f), this flight time exempted him from paying Oregon income tax in the tax year 2000.
The state taxes not only the income of residents, but also the income of nonresidents that is derived from sources with the state, and income is derived from sources within the state if it is attributable to the nonresident carrying on an occupation in the state. Federal law limits the extent to which states may ta the income of certain employees of air carriers and 49 USC § 40116(f)(2) provides that employees with regularly assigned duties on aircraft in at least two states may be taxed only by the state where they reside or a state in which they earn more than 50 percent of their pay from the air carrier. The parties stipulated that taxpayer's Oregon earnings were greater than 50 percent of his total pay during 2000. In 2004 the taxpayer filed an application for refund for the state taxes paid for tax year 2000. The Department of Revenue (DOR) denied the claim and the taxpayer filed an appeal to the Magistrate Division which ruled for DOR. Taxpayer appealed to the Regular Division of the Tax Court. Both parties moved for summary judgment, the Tax Court granted the DOR’s motion, and the taxpayer filed this appeal.
The court noted that the taxpayer made no argument under state law that he was not liable for the tax owed, and therefore, the matter at issue turned on the meaning of a federal statute.
The first issue involves whether taxpayer is an "employee of an air carrier having regularly assigned duties on aircraft in at least 2 States," pursuant to the provision in 49 USC § 40116(f)(2). The second issue involves whether, notwithstanding that provision if it applies, the state may tax taxpayer's income because it is a state in which the taxpayer earns more than 50 percent of the pay received by him from the carrier, pursuant to 49 USC § 40116(f)(2)(B).
The court said that the dispositive issue is whether the observation flights required by FAA regulation qualify as "regularly assigned duties on aircraft in at least 2 States." The court said that even if it assumed that the observation flights were assigned duties, the question was whether they were “regularly” assigned. The court noted taxpayer's assigned duty of flight time was approximately 10 hours for the 2000 tax year and this represented 0.5 percent of taxpayer's annual work hours as a fulltime employee. The court said it did not regard such an infrequent and incidental requirement of short duration as normal, typical, or routine, but could only be reasonable viewed as de minimis. The court rejected the taxpayer’s argument that "regularly" means only that the duty occurs at regular but flexible intervals, finding that the cases cited by taxpayer were unpersuasive.
The court concluded that the term "regularly" indicated that the assigned duties must be normal, typical, or routine and noted that the parties stipulated that taxpayer's "primary and regular duties" were on the ground in Oregon. The court said that the taxpayer’s duty to complete the observation flight requirement was not a normal, typical, or routine duty and, therefore, the taxpayer was not "required by the nature of [his] employment to work in more than one State on a regular basis," and did not qualify under the federal statute. Etter v. Dep't of Revenue, Oregon Supreme Court, SC S063061. 7/21/16
Corporate Income and Business Tax Decisions
Decision For IBM in Compact Case
The Michigan Court of Appeals reversed a trial court's denial of refunds to IBM Corp. and remanded the case for entry of judgment in favor of IBM consistent with the Michigan Supreme Court's 2014 decision in Int'l Business Machines Corp. v. Dep't of Treasury, 496 Mich 642; 852 NW2d 865 (2014). See a prior issue of State Tax Highlights for a discussion of that 2014 decision.
The issue in the 2014 case was whether the taxpayer could elect to use the three-factor apportionment formula under the Multistate Tax Compact (Compact) for its 2008 Michigan taxes, or whether it was required to use the sales-factor apportionment formula under the Michigan Business Tax Act and the state Supreme Court held in favor of the taxpayer. The Department of Revenue (DOR) filed a motion for rehearing and before the Supreme Court could rule on that request, the legislature enacted 2014 PA 282, amending the BTA, retroactively rescinding Michigan's membership in the Compact, effective January 1, 2008, and precluding foreign corporations such as the taxpayer from using the three-factor apportionment formula that had been available under the Compact. The court subsequently denied DOR’s motion for rehearing and, on remand, the Court of Claims initially entered judgment in favor of the taxpayer. It later granted the DOR’s motion for reconsideration, determining that 2014 PA 282 represented an intervening change of law, thereby excepting application of the law of the case doctrine.
The court said that the Court of Claims did not have any discretion or authority to rule in favor of DOR in this matter, and was specifically instructed to enter an order granting summary disposition in favor of the taxpayer, and it erred by ultimately failing to do so.
The court said that in Grievance Administrator v. Lopatin, 462 Mich 235, 259-260; 612 NW2d 120 (2000), the state’s Supreme Court explained the nature of the law of the case doctrine, which provides as a general rule, that an appellate court's determination of an issue in a case binds lower tribunals on remand and the appellate court in subsequent appeals.
DOR argued that the law of the case doctrine is not controlling because the legal question concerning the impact of 2014 PA 282 on the taxpayer’s 2008 taxes was not passed on by the Supreme Court in its opinion, nor, expressly, in its order denying the DOR’s motion for rehearing, and because 2014 PA 282 represented an intervening change of law, assuming that the doctrine was initially implicated. The court here concluded that the analysis in this case is not governed by the law of the case doctrine, but that did not mean that the Court of Claims was free to try anew under 2014 PA 282 the issue regarding the apportionment formula applicable to IBM's 2008 taxes. The court held that the principle that a lower court cannot exceed the scope of a remand order controls and is distinguishable from the law of the case doctrine and cited a recent decision by the United States Court of Appeals for the Ninth Circuit in Stacy v. Colvin, __ F3d __, __ (CA 9, 2016) where the federal court, distinguishing the law of the case doctrine from what it coined the "rule of mandate.” That court said that the rule of mandate is similar to, but broader than, the law of the case doctrine, holding that it provides that any district court that has received the mandate of an appellate court cannot vary or examine that mandate for any purpose other than executing it. The Ninth Circuit said the district court may, however, decide anything not foreclosed by the mandate, but the district court commits "jurisdictional error" if it takes actions that contradict the mandate.
The court in the current case said that while the terminology "rule of mandate" has apparently not been used in state caselaw, it plainly embodies the well-accepted principle in state jurisprudence that a lower court must strictly comply with, and may not exceed the scope of, a remand order. The court said that the plain and unambiguous remand directive by the state Supreme Court cannot be construed as having provided any room for the exercise of discretion by the Court of Claims, and it most certainly placed a strict limit on the power of the Court of Claims on remand, which limit it exceeded. The court rejected DOR’s position that the Court of Claims should be able to examine the issue of the taxpayer’s 2008 taxes under 2014 PA 282, saying that under DOR’s theory the issue of the proper apportionment formula relative to the taxpayer’s 2008 taxes could be litigated endlessly on the basis of any future statutory changes bearing on the question. The court said collateral estoppel principles preclude such an approach.
The court also said that its opinion in Gillette Commercial Operations North America & Subsidiaries v. Dep't of Treasury, 312 Mich App 394; __ NW2d __ (2015), did not change its analysis in this case. While the court in Gillette held that 2014 PA 282 was constitutionally sound, it said that opinion could not overrule or reverse the Supreme Court's earlier opinion in Int'l Business Machines and the resolution of the specific tax issues addressed therein. Int'l Bus. Machs. Corp. v. Dep't of Treasury, Michigan Court of Appeals, No. 327359. 7/21/16
Transfer Pricing Dispute Vacated and Remanded
The District of Columbia Court of Appeals has held that the D.C. Office of Administrative Hearings (OAH) abused its discretion in applying offensive non-mutual collateral estoppel in a transfer pricing dispute. The court remanded the case for further proceedings to take into account an earlier court decision on the application of estoppel against the government.
In 2011 and 2012, the District of Columbia Office of Tax and Revenue (OTR) issued a Notice of Proposed Assessment of Tax Deficiency for alleged underpayment of corporate franchise taxes for tax years 2007-2009 to each of the oil companies in this matter and each company filed a protest with OAH arguing that the methodology used by OTR to calculate their deficiencies was contrary to applicable law. Their motion for summary judgment argued that
that OTR was collaterally estopped from defending the legality of the “Chainbridge” methodology by OAH's ruling in a prior case involving Microsoft. At OAH’s direction, OTR filed briefs in each matter addressing the issue of collateral estoppel, arguing that offensive non-mutual collateral estoppel does not apply to the District government or its entities or, alternatively, that it would be an abuse of discretion to apply offensive non-mutual collateral estoppel in these cases, citing Modiri v. 1342 Rest. Grp., Inc., 904 A.2d 391, 400 (D.C. 2006) and the fairness factors identified in that case. After oral argument on the motions, OAH issued nearly identical orders in the three cases granting the taxpayers’ motion for summary judgment, and reversing the three Notices of Proposed Assessment of Tax Deficiency issued by OTR, on the basis that the ruling in Microsoft collaterally estopped OTR from defending the legality of its methodology for calculating the taxpayers’ tax deficiencies. OTR filed this appeal.
The court first addressed the argument put forward by the taxpayers that the court was not bound by its decision in District of Columbia v. Gould, 852 A.2d 50 (D.C. 2004), which directly addressed the applicability of offensive non-mutual collateral estoppel against the District and its entities. The court observed that collateral estoppel, whether mutual or non-mutual, can apply only if "the previously resolved issue [is] identical to the one presented in the current litigation" and then only if "the issue to be concluded [was] raised and litigated, and actually adjudged." Gould, supra, 852 A.2d at 56. The oil companies argued that the court’s discussion in Gould of general principles underlying application of offensive non-mutual collateral estoppel to the District is better read as dicta, and point as support of that argument to a footnote in the case. The court, however, was not persuaded that Gould's discussion of the general applicability of offensive non-mutual collateral estoppel against the District is dicta, but, instead, an independent, alternative holding binding this division of the court. The court held that the Gould decision did pass on the precise question in this here, that is, whether offensive non-mutual collateral estoppel applies to the District of Columbia and its entities and the court concluded that its answer to that question in Gould was binding on this court.
The court said that ordinarily the application of non-mutual offensive collateral estoppel requires a two-step inquiry in which the court determines whether a case meets the traditional requirements invoking collateral estoppel and then balancing the factors to determine whether the offensive use of non-mutual collateral estoppel would be fair. The court, however, said that a further step was required in cases involving the assertion of offensive non-mutual collateral estoppel against the District or one of its entities, determining whether the case was a special one involving exceptional circumstances where the interests of justice clearly require it. The court noted that this further step was a matter for OAH to determine, subject to the court’s deferential review, and said that OAH did not address the question of whether exceptional circumstances existed in this case. As a result, the court held that OAH’s application of offensive non-mutual collateral estoppel against OTR was an abuse of discretion. The court remanded the matter to OAH to address this issue. Dist. of Columbia Office of Tax & Revenue v. Exxonmobile Oil Corp., District of Columbia Court of Appeals, Nos. 14-AA-1401; 14-AA-1403; 14-AA-1404. 6/30/16
Property Tax Decisions
DOR Has Supervisory Jurisdiction Over Case
The Oregon Supreme Court held that the Department of Revenue (DOR) did have supervisory jurisdiction over the taxpayer's petition to reduce the assessed value of the property for the 2008-2009 tax year. The court remanded the case to the DOR to consider the issues in the first instance.
The taxpayer owns an apartment complex built in 1996 and appealed the assessed value for the 2009-10 tax year for that complex on the ground that structural damages resulting from construction defects had substantially reduced the property's value. In 2011, the county assessor and the taxpayer agreed to reduce the assessed value of the complex from over $21 million to $8.5 million for the 2009-10 tax year and because the time for appealing the valuation for the 2008-09 tax year had passed, the taxpayer asked DOR to exercise its supervisory jurisdiction to correct a "likely error" in the 2008-09 assessment. DOR concluded that it had no jurisdiction to consider the taxpayer’s request, and the Tax Court reversed in Oakmont LLC v. Clackamas County Assessor, 21 OTR 375 (2014). Both the county and DOR filed this appeal.
The statute provides that each county assesses the value of all taxable property within the county on an annual basis, determining the real market value of a parcel as of January 1 of the assessment year. A taxpayer who disagrees with the county’s assessment can file a petition with the county's board of property tax appeals by December 31 of that tax year. The taxpayer may then appeal a decision of the board to the tax court within 30 days of the board’s order. The taxpayer, who purchased a 266-unit apartment complex in 1996, did not appeal the assessed value of the property for tax year 2008-2009. In February 2008, a maintenance worker noticed unusual swelling on the exterior surfaces of some of the apartment buildings and the taxpayer hired a forensic building inspection firm to determine the cause of the swelling. The firm inspected the buildings between May and June 2008 and the inspection report, dated July 24, 2008, revealed significant construction defects and associated damage in the building exteriors, including water intrusion and wood rot due to elevated moisture levels.
In November 2008, the taxpayer initiated litigation against various contractors and architects for negligence in the construction and repair of the property and ultimately settled for undisclosed damages. For the 2009-10 tax year, the county valued the property at $21,726,425 and the taxpayer appealed that valuation. The county then conducted an appraisal of the property in 2011 and the county's appraisers initially concluded that construction defects affected the value of the property in the 2009-10 tax year, and they determined an "as is" real market value of $13,065,000 for the property as of January 1, 2009. Later that year, after the taxpayer’s litigation against the contractors and architects concluded, the taxpayer and the assessor agreed that the real market value of the property on January 1, 2009, was $8,500,000, a 60 percent reduction from the initial $21,726,425 valuation for the 2009-10 tax year. They also agreed to an approximately 70 percent reduction for 2010-11 tax year, compared to the initial 2009-10 valuation. When the taxpayer and the county agreed on the value of the property for the 2009-10 tax year, the time for appealing the assessment for the 2008-09 tax year had passed and the taxpayer, therefore, asked DOR to exercise its supervisory authority under ORS 306.115 and OAR 150-306.115 to correct the value on the rolls for the 2008-09 tax year arguing that the construction defects discovered in early 2008 predated the January 1, 2008, valuation date.
The legislature has given DOR “general supervision and control” over the state’s property taxation system, which includes the correction of clerical errors, errors in valuation or the correction of any other kind of error or omission in an assessment. DOR, however, is limited to ordering corrections for the current tax year and for either of the two tax years immediately preceding the current tax year. DOR has promulgated a rule that guides and limits the exercise of its supervisory authority, and provides that a petitioner must demonstrate that the department has "supervisory jurisdiction" over the petition. In order to establish this in the present case, the taxpayer must establish that he has no remaining statutory right of appeal, and the parties to the petition agree to facts indicating likely error on the tax roll. If the taxpayer can establish this, DOR then addresses the question of whether there is actually an error or omission on the rolls and whether the department should exercise its discretion to correct it.
At a hearing on the 2008-2009 assessed valuation, the conference officer denied the taxpayer’s request for valuation reduction and, on appeal, the magistrate division affirmed that decision. On appeal, the Tax Court agreed with the taxpayer and remanded the matter to DOR for a hearing on the merits of the taxpayer’s petition. The Tax Court concluded that DOR abused its discretion in declining to exercise supervisory jurisdiction because DOR was "clearly wrong" in concluding that the parties had not agreed to facts indicating a likely error as of the January 1, 2008, valuation date. This appeal was filed by DOR.
The court began by examining the factual issue in the conference officer’s decision, that is, that the county’s agreement to reduce the valuation for the 2009-10 tax year from over $21 million to $8.5 million did not "indicate the condition of the property" for the 2008-09 tax year. DOR and the county argued that because the assessor did not agree in his hearing testimony that construction defects affected the value of the taxpayer’s property as of January 1, 2008, there is evidence from which the conference officer could have found that no agreed fact indicated a likely error on the rolls regarding the 2008-09 tax year. The court said, however, that the county assessor agreed to facts regarding the value of the property for the 2009-10 tax year that necessarily indicated likely error on the tax rolls for the preceding tax year. The court said that given the magnitude of the agreed reduction in value for the 2009-10 tax year and given that the construction defects were the only identified reason for the county's agreed reduction in value, the Tax Court correctly determined that the only reasonable finding that the conference officer could have made on this record was that the parties agreed to facts indicating a likely error in the valuation for the 2008-09 tax year.
The county and DOR also argued that, when a taxpayer contends that the likely error that gives rise to supervisory jurisdiction is a valuation error, only facts that were actually known on the date of valuation may be considered in determining whether the listed valuation is erroneous. The court noted that the county and the DOR’s argument was difficult to square with the statutory definition of "real market value," stating that the statutory definition does not say that only facts that are actually known on the date of valuation can be considered in determining property's real market value. Rather, the statute says that real market value means "the amount in cash that could reasonably be expected to be paid by an informed buyer to an informed seller, each acting without compulsion in an arm's-length transaction occurring as of the assessment date for the tax year." See ORS 308.205(1) The court said that implicit in the phrase "informed buyer" is the proposition that an "informed buyer" would have engaged in a reasonable inspection of the property and thus would have learned facts that a reasonable inspection on the date of valuation would have revealed, even if those facts did not actually come to light until later. The court rejected the county and DOR’s reliance on a prior case, finding that the court had rejected the assumption that evidence of events subsequent to the assessment date are irrelevant in determining property’s real market value. The court said that the defect in the taxpayer’s property was after-acquired information that reasonably could have been discovered on the valuation date and that bears on whether the assessor correctly valued the property on that date. The court held that the Tax Court correctly held that the department had supervisory jurisdiction over the taxpayer’s petition to reduce the assessed value of the property for the 2008-09 tax year. The taxpayer had no remaining statutory right of appeal, and the parties to the petition agreed to facts indicating a likely error on the tax rolls. It follows that the DOR had supervisory jurisdiction to consider whether there was in fact an error on the tax rolls and whether, if there was, DOR should exercise its discretion to correct any error. Oakmont LLC v. Dep't of Revenue, Oregon Supreme Court, SC S062342. 6/30/16
Income Approach in Valuing Convention Center Upheld
The Oregon Supreme Court upheld the lower court's determination that the income approach was applicable to valuing a convention center, rather than the cost approach or a combination of the cost and income approaches.
The taxpayer who owns a convention center and a hotel across the street appealed the valuation of the convention center for the 2008-2009 tax year. Each property was on a separate tax account. The county assessor (Assessor) and the Department of Taxation (Department) used the cost approach in appraising the convention center at $17,700,000 for that year. The taxpayer’s appraisal applied both the cost approach and the income approach and valued the convention center at $4,130,000. The Tax Court rejected the Department's appraisal for two independent reasons, finding that the state constitution and its enabling statutes required that property in each tax account be valued separately and the court also concluded that the Department's appraisal was unpersuasive because the appraiser lacked good reason for not having used the income approach. The Department and Assessor filed this appeal.
At trial, each side presented an appraisal of the property, neither one of which used the comparable sales approach. The Department's appraiser argued that the highest and best use of the property as improved was as a convention center used in conjunction with the taxpayer's hotel, and used only the cost approach in valuing the property. The appraiser did admit at trial that it would have been possible to use the income approach by valuing the hotel and convention center as a package and then apportioning those values between the two properties, but did not because he didn’t believe it would have been the proper approach.
The taxpayer’s appraiser presented, on the other hand, that the highest and best use of the property was as a stand-alone convention center and use both cost and income approaches in his valuation. The income approach suggested a much lower valued and the taxpayer argued that the income approach represented the more accurate value. The Tax Court agreed that the taxpayer’s appraisal was reasonable and rejected the Department’s appraisal, in large part because the appraiser considered the highest and best use of the property was as a convention center and hotel, which consideration the court said was prohibited by Measure 50 which provides that property means all property within a single property tax account. The convention center and hotel were two separate property tax accounts. The tax court also concluded that the Department's appraisal was unpersuasive, even aside from any Measure 50 issue, because the appraiser’s decision not to perform an income approach analysis was a serious departure from appraisal practice.
The court rejected the arguments of the Department regarding the Tax Court’s misinterpretation of the statute, finding that the court recognized that the especial property rule required an appraiser to consider the various approaches to valuation and that the Department's appraiser had failed to develop an income approach. The court said it was the appraiser's lack of good reason for not using the income approach, however, that was critical to the tax court and it put into question the credibility of the appraisal. The court said that the Tax Court merely held that an appraisal's credibility is harmed when the appraiser declines to use one of the two remaining approaches to valuation in the absence of a credible explanation.
The court further noted that, in this case, the Tax Court explicitly found, when evaluating the taxpayer's appraisal, that the income approach was the more correct approach to valuation. The court said that the weight to be to the various approaches is a question of fact, and evidence in the record supported the Tax Court's determination.
The Department also argued that the Tax Court misinterpreted Measurer 50and the court agreed that there is no support in the pertinent statutes, the court's decisions, or in the evidentiary record in the case, for the proposition that the determination of what constitutes an economic unit, or the appropriate unit to value, for purposes of the income approach valuation corresponds to or is driven by the existence of separate tax accounts. Because there is no indication that tax accounts define an economic unit for the purposes of the income approach, the court said that the Tax Court's reliance on Measure 50 to support its rejection of the Department's appraisal was of questionable validity. But the court also said that it was not necessary to resolve the Measurer 50 issue in this case because the Tax Court had found another independent and fully adequate reason for accepting the real market value proposed by taxpayer. The court found that the Tax Court independently evaluated taxpayer's appraisal, concluded that it was reliable, and accepted it, the only credible appraisal before it. The court concluded that the Department did not successfully challenge any of the Tax Court’s conclusions and, it, therefore affirmed the judgment.
The Department also challenged the Tax Court's award of attorney fees to taxpayer. The court said that the Tax Court is authorized to award attorney fees when the court rules in favor of the taxpayer in a property tax case and in reviewing such an award, the question before the court was whether the Tax Court abused its discretion. The court said that in this case the Tax Court relied on four statutory factors to conclude that it was appropriate to award attorney fees against the Department: that the Department's position was not objectively reasonable, that an award of attorney fees would deter the Department from making meritless arguments, that the Department had not objectively been reasonable or diligent in pursuing settlement, and that an unspecified -- the importance of the Tax Court's Measure 50 determination -- also justified an award. The Department argued on appeal that the award of fees was inappropriate because it acted in good faith and presented objectively reasonable arguments to the Tax Court. The court concluded that in light of its concerns about the Tax Court's holding with respect to Measure 50, it should vacate the attorney fee award and remand that issue to the Tax Court for further consideration. Dep't of Revenue v. River's Edge Investments LLC, Oregon Supreme Court, SC S062829). 6/30/16
Satellite Service Provider Subject to Central Assessment
The Oregon Supreme Court held that a satellite service provider was subject to central assessment as a communications business because it provided data transmission services. The taxpayer is a satellite television provision and transmits video and audio data obtained under licenses from content providers to its subscribers via satellite. The state statute provides for the central assessment of any property in the state used in certain businesses, including communications. For purposes of the statute, "communications" includes "data transmission services." The Department of Revenue (DOR) began to assess the taxpayer on the basis that it was a communications provider, but the taxpayer contested this action arguing, among other things, that it did not provide “data transmission services” as that term is used in the statute. The tax court held for the taxpayer primarily based on an earlier decision it had issued in Comcast Corp. v. Dept. of Rev., 20 OTR 319 (2011), and this appeal was filed by the DOR.
That Comcast case involved a cable TV and internet service provider's challenge to the central assessment of its property and the Tax Court held that, for purposes of the definition of "communications" in ORS 308.505(3), "data transmission services" means the transmission, for a fee, of data or content owned by one party to another party, and does not apply when a company sells the data or content, as a commodity, to the customer, in addition to providing the conduit for it.
The court in this appeal noted that at the time of the Tax Court's decision in this case, the DOR’s direct appeal of the Comcast decision was pending before the court, and it has since issued a decision in the matter. In Comcast Corp. v. Dept. of Rev., 356 Or 282, 337 P3d 768 (2014), the court rejected the definition of "data transmission services" that the Tax Court announced in that case and held that, for purposes of ORS 308.505(3), "data transmission services" means "services that provide the means to send data from one computer or computer-like device to another across a transmission network." Id. at 315. The court also held that that meaning applies whether the data that the customer receives is data directed to it by the service provider or by some third party.
The court said that like the taxpayer in Comcast, the taxpayer here is undisputedly in the business of transmitting electronically coded data between computer-like devices, including set top boxes. The court said that it is of no consequence that the taxpayer licenses or owns the data it transmits and neither is it important that the taxpayer transmits data via satellite rather than via cable. The court found that the taxpayer provides "data transmission services" within the meaning of ORS 308.505(3), and therefore it is a "communications" business that is subject to central assessment under ORS 308.515(1). DIRECTV Inc. v. Dep't of Revenue, Oregon Supreme Court, TC 4939; SC S061294. 7/14/16
Charitable-Use Exemption for Lessor of School Denied
The Ohio Supreme Court found that a lessor could not claim a vicarious charitable-use property tax exemption because of a lessee's activities as a community school. The court found evidence of a for profit activity in the form of surpluses realized through the taxpayer’s leases.
The taxpayer is a property owner and applied for an exemption from property taxes for real property leased to a third party and used as a public “community school” for tax year 2010. The Board of Tax Appeals affirmed the tax commissioner’s (Commissioner) denial of the exemption. The taxpayer is wholly owned by a 50(c)(3) nonprofit corporation whose members include the community school to whom the property is leased. The taxpayer argued that the nonprofit and charitable character of the ownership arrangement should qualify the property for exemption under the public-schoolhouse exemption in former R.C. 5709.07(A)(1) and additionally claims exemption for exclusive charitable use under R.C. 5709.12(B) and 5709.121. BTA rejected the exemption claims primarily on the grounds that the record showed a "view to profit" on the part of the lessor. The taxpayer’s argument on appeal is based on the financial arrangement involving it, the entity leasing the property for the school and the various community schools supported by that entity who have similar leases on other properties. Under this financial arrangement, any excess of rental income is used to subsidize the operations of those community schools, and the taxpayer argued that because the income realized by it and the lessee entity consists of nothing but payments from the very community schools on whose behalf those funds are expended, or to whom they are later distributed, this scheme does not involve a "view to profit."
The court noted that case law bars a claim of “vicarious exemption,” that is that the property owner’s entitlement to the exemption must be judged by its own activities and not by the activities engaged in by the lessee. The court said that the taxpayer is a lessor and nothing more and must be judged on the basis of that activity alone. The court noted that the BTA found a view to profit was in evidence and the findings of fact lie within the BTA’s discretion. Because of that and because the record contained sufficient support for its view-to-profit finding, the court affirmed the decision of the BTA. 250 Shoup Mill LLC v. Testa, Ohio Supreme Court, Slip Opinion No. 2016-Ohio-5012; No. 2015-0340. 7/20/16
Other Taxes and Procedural Issues
State Cannot Tax Out-of-State Trust
The North Carolina Court of Appeals held that a tax on an out-of-state trust that was based only on an in-state beneficiary violated the due process clause finding the trust lacked the necessary minimum contacts with the state. The court declined to rule on whether the tax violated the commerce clause.
In 1992, an inter vivos trust was established by settlor Joseph Lee Rice III, with William B. Matteson as trustee, with the situs of the trust in New York. The primary beneficiaries of the original trust were the settlor's descendants, none of whom lived in North Carolina at the time of the trust's creation. In 2002, the original trust was divided into three separate trusts: one for each of the settlor's children, one of whom, Kimberley Rice Kaestner, was a resident and domiciliary of North Carolina. On 21 December 2005, William B. Matteson resigned as trustee for the three separate trusts and a successor trustee who resided I Connecticut was appointed. Tax returns were filed in North Carolina on behalf of the Kimberley Rice Kaestner 1992 Family Trust for tax years ending in 2005, 2006, 2007, and 2008 for income accumulated by the Trust but not distributed to a North Carolina beneficiary. In 2009, representatives of the Trust filed a claim for a refund of taxes paid to the Department of Revenue (DOR) for tax years 2005, 2006, 2007, and 2008. The claim was denied and trust representatives commenced a contested case action in the Office of Administrative Hearings (OAH). OAH dismissed the case for lack of jurisdiction because the sole issue was the constitutionality of the enabling statute, G.S. § 105-160.2. The current action commenced in Wake County Superior Court. That court granted DOR’s motion to dismiss the Trust’s claim for injunctive relief but denied DOR’s motion to dismiss the Trust’s constitutional claims concluding that there was an argument that the state’s imposition of a tax on a foreign trust based solely on the presence of a beneficiary in the state did not conform with the Due Process Clause, the Commerce Clause or a portion of the state constitution. On 8 July 2014, the Trust moved for summary judgment, alleging there were no genuine issues of material fact, and DOR also filed a motion for summary judgment, citing a case from Connecticut, Chase Manhattan Bank v. Gavin, 249 Conn. 172, 204-05, 733 A.2d 782, 802 (1999), which provided that a state may tax the undistributed income of a trust based on the domicile of the sole noncontingent beneficiary because it gives her the same protections and benefits. The lower court held for the Trust and DOR filed this appeal.
The standard of review in a case like this one requires that the court determine whether the legislature has complied with the constitution and the court begins with the presumption that the laws enacted are valid. A law will be declared invalid only if its unconstitutionality is demonstrated beyond reasonable doubt. The court reviewed prior case law on the issue of due process and noted that the Due Process Clause requires some definite link between a state and the person, property or transaction it seeks to tax, and that the income attributed to the state for tax purposes must be rationally related to values connected with the taxing state. The findings of fact before the lower court indicate that the trust did not maintain any physical presence in North Carolina during the tax years at issue. The undisputed evidence showed that the trust never held real property located in the state, and never invested directly in any state based investments. The record also indicates that no trust records were kept or created in the state, and that the trust could not be said to have a physical presence in the state. DOR conceded that the only connection between the trust and the state was the residence of the beneficiaries.
Representatives of the Trust argued that the DOR’s contention that a beneficiary's domicile alone is sufficient to satisfy the minimum contacts requirement of the Due Process Clause and allow the state to tax a non-resident trust conflates what the law recognizes as separate legal entities, i.e., the trust and the beneficiary. In support of their argument the Trust cited a U.S. Supreme Court decision, Greenough, 331 U.S. 486, 91 L. Ed. 1621 that upheld a Rhode Island law authorizing the levy of an ad valorem tax upon a resident trustee based on a proportionate legal interest of a foreign trust and found no violation of due process. The dissent in that case took note of Brooke v. Norfolk, 277 [U.S.] 27, 72 [L. Ed.] 767, 48 [S. Ct.] 422 and the court here found that case to be controlling in this matter. In Brooke, the petitioner was a Virginia resident and trust beneficiary and appealed to the United States Supreme Court after the City of Norfolk and the State of Virginia assessed taxes upon the corpus of a trust created by a Maryland resident.
The court noted the strong similarities between the facts in Brooke and the instant case. Both trusts were created and governed by laws outside of the state assessing a tax upon the trust and the trustee for both trusts resided outside of the state seeking to tax the trust. The beneficiary of the trust who resided within the taxing state had no control over the trust during the period for which the tax was assessed and the trusts did not own property in the taxing state. The court determined that the authority as set forth by the United States Supreme Court in Brooke controlled the analysis and outcome of this case and found that the assessment of an income tax levied pursuant to the authority in the state statute was in violation of the Due Process Clause of the U.S. Constitution. The Kimberly Rice Kaestner 1992 Family Trust v. Dep't of Revenue, North Carolina Court of Appeals, No. COA15-896. 7/5/16
Motion to Compel in Whistleblower Suit Denied
The Supreme Court of New York, New York County, denied a taxpayer’s motion to compel discovery concerning communications between the Department of Taxation and Finance (Taxation) and third parties on the issue of debundling and taxation. This decision is part of an ongoing whistleblower case over the taxpayer’s alleged failure to properly collect and remit sales tax.
The taxpayer sought documents concerning communications between third-parties and Taxation and internal Taxation communications, on the issues of debundling and component taxation, including the interpretation of the state tax statute and the Mobile Telecommunications Sourcing Act. Taxation objected to producing the requested documents pursuant to the tax secrecy provisions under Tax Law § 1146.
The court rejected the taxpayer’s argument regarding tax secrecy, finding it was not supported by the cases on which it relied, Kooi v. Chu, 517 NYS2d 601 [3d Dept 1987] and The Herald Co v. New York State Dept. of Econ. Devel., No. 4472-2006 [NY Sup Ct Albany Cty Feb 8, 2007]. The court said that both cases were factually inapposite and did not involve the question of whether or what Taxation information concerning a filed tax return is protected by tax secrecy.
The court said that section 1146(a) protects from disclosure not just sales tax returns or reports and any particulars therein, but also any document that would reveal information provided to Taxation in connection with a sales tax return. The court rejected the taxpayer’s argument that Tartan Oil Corp. v. State Dept. of Tax and Fin., 668 NYS2d 76, 78 [3rd Dept 1998]) is not controlling because the concern motivating Tartan Oil, which was protecting sensitive taxpayer information, does not apply to the discovery defendants seek, the interpretation of the tax statute. The court said that Tartan Oil also focuses on the purpose of the statute, facilitating tax enforcement. The court said that permitting disclosure in this case would overburden sales tax enforcement. The court noted that as part of the audit process, vendors like the taxpayer who collect sales tax routinely provide large amounts of factual information to Taxation and Taxation has been assuring such vendors for decades that all their information is protected by tax secrecy, encouraging an open and honest dialogue which Taxation argued is essential to the audit process. People of the State of New York v. Sprint Nextel Corp., Supreme Court of New York, New York County, Index No. 103917/2011. 7/6/16
Court Lacks Jurisdiction Over Mississippi DOR
The Wisconsin Court of Appeals, District IV, held that the attempts by the Department of Revenue (DOR) of Mississippi and a third party collection agency to collect taxes owed in Mississippi by the taxpayer’s Mississippi-based company did not meet the due process requirement of minimum contacts necessary to confer jurisdiction over the out-of-state defendants in Wisconsin.
The taxpayer filed a complaint in the state circuit court alleging that a fraudulent tax lien was filed in Mississippi against him and his Mississippi-based company, and that the out-of-state defendants improperly attempted to collect on the tax lien. DOR argued that the circuit court lacked personal jurisdiction over the defendants in this action. The circuit court dismissed the matter, ruling that the tax enforcement action taken in Wisconsin did not given the court jurisdiction over the matter and that any cause of action by the taxpayer should be taken up in the state of Mississippi. The taxpayer filed this appeal.
The court first examined whether due process requirements had been met to establish jurisdiction, and first looked at whether a non-resident defendant (in this case Mississippi DOR) purposefully established minimum contacts in Wisconsin. If the answer were yes, the court would then look to whether exercising person jurisdiction comports with fair play and substantial justice. The taxpayer alleged that DOR and the third party collection agency made or attempted numerous contacts with him in Wisconsin, resulting in the required sufficient minimum contacts with the state to confer personal jurisdiction. The court noted that these contacts alleged by the taxpayer involved sending letter or making phone calls to him in an attempt to collect the Mississippi debt. The court said that these allegation by the taxpayer would establish only that the out-of-state defendants had a single connection to the state of Wisconsin, namely, their contacts with him alone, arising from transactions initiated within the state of Mississippi, and the contacts spilled over into Wisconsin only as a result of the taxpayer’s decision to move his residence from Mississippi to Wisconsin.
The court, relying on a recent U.S. Supreme Court decision and a recent state decision, Walden v. Fiore, ___ U.S. ___, 134 S. Ct. 1115, 1121 (2014), and Salfinger v. Fairfax Media Ltd., 2016 WI App 17, ¶ 24, 367 Wis. 2d 311, 876 N.W.2d 160, found that even assuming as true all representations the taxpayer made about these contacts, this would be insufficient to show that the out-of-state defendants purposefully established minimum contacts in Wisconsin. The court concluded that the circuit court properly dismissed the action on the ground that it would violate the out-of-state defendants' due process protections to bring them into Wisconsin courts. Bernegger v. Thompson, Wisconsin Court of Appeals, District IV, No. 2015AP2168. 7/21/16
Tax Secrecy Law Protects Information in Returns
The New York Supreme Court, Appellate Division, Third Department, held that a New York tax secrecy provision is intended to protect not only tax returns, but also documents that reflect information in a return.
The petitioner, a Delaware corporation headquartered in New York, operates a credit rating agency that analyzes financial information and generates and publishes opinions concerning debt instruments and securities. In April 2014 the petitioner submitted a Freedom of Information Law (FOIL) request to the Department of Taxation and Finance (Department) for all records “relating to the sourcing of credit rating receipts for tax years 2004 to present.” In June 2014 the Department responded and agreed to release certain documents, including petitioner's audit file, and identified 807 pages that were responsive but were withheld as exempt. When the Department released the audit file in August 2014, five pages were released with redactions and 178 pages were withheld as exempt. Petitioner filed an appeal challenging the Department’s response and the Department conducted a further review and adjusted its findings releasing a few more documents and finding that some of the withheld documents were non-responsive to the request. In December 2014, petitioner initiated this proceeding to challenge the Department's August 2014 and September 2014 determinations, and the Department responded and submitted two privilege logs and all of the documents that had been withheld or redacted to the Supreme Court for its review. After conducting an in camera review of all the responsive documents, the court determined that an additional 13 unredacted pages and four redacted pages should have been provided but otherwise upheld the Department's FOIL response. Both petitioner and the Department filed this appeal.
The court noted the statutory requirements for processing a FOIL request and pointed out that where a party is challenging an administrative determination to withhold or redact documents that are responsive to a FOIL request, as the petitioner is doing in this case, the proper procedure is to commence a CPLR article 78 proceeding where the agency's burden to articulate a specific justification for denying access can be satisfied through submission of relevant documents with a privilege log. The court noted that the Department properly responded to the petitioner’s challenge pursuant to CPLR article 78. The court rejected the petitioner’s argument that the Department raised new grounds in the article 78 proceeding, finding that the record did not support this contention.
With regard to the Supreme Court’s determination that certain records were properly withheld or redacted under the statute, the court cited Tax Law Section 211 which provides that it shall be unlawful for any tax commissioner or employee of the Department to divulge or make know in any manner the amount of income or any particulars set forth or disclosed in any report under filed under Tax Law article 9-A. The court found that, based its in camera review of the documents submitted to Supreme Court, it agreed with the Supreme Court's determination that certain documents, or the redacted portions thereof, were properly withheld. The court found that the confidentially required by the statute necessarily extends to any document that reflects information included in a return, saying that if it were to construe the statute to only protect the secrecy of the return, the purpose of the statute would not be served. The court also found that certain documents were intra- or inter-agency materials and, thus, properly withheld pursuant to Public Officers Law § 87(2)(g), which applies to intra-or inter-agency materials that are not statistical or factual tabulations or data, instructions to staff that affect the public or final agency policy or determinations. The court rejected the petitioner’s argument that the exemption was not applicable because the documents withheld included final agency policy, in particular, records regarding the position taken during audits and with regard to one taxpayer; instructions to staff that affect the public; and/or statistical or factual data, saying that neither internal memoranda used to discuss and advance a position pending negotiations with a party nor a position taken during an audit can be characterized as a final determination by an agency. Finally, the court agreed with the Department that certain documents that the Supreme Court ordered be turned over to the petitioner should not be released, and modified the Supreme Court’s holding accordingly. Moody's Corp. v. Dep't of Taxation and Fin., New York Supreme Court, Appellate Division, Third Department, No. 522169. 7/21/16
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:
July 22, 2016 Edition
NEWS
Bill Would Codify Physical Presence in Quill
On July 14, 2016, Rep. F. James Sensenbrenner Jr., R-Wis., filed H.R. 5893 entitled No Regulation Without Representation Act of 2016 which would require a person to have a physical presence in a state, a defined term in the proposal, for the state to tax or compel that person to collect sales and use taxes. The bill specifies a de minimis threshold for physical presence and persons in the state for less than 15 days per tax year or who have products delivered in-state by a third party would not be liable. This legislation follows several states’ recent challenges to Quill Corp. v. North Dakota.
Pittsburgh casino owner sues state over municipal slots tax
The operator of a Pittsburgh casino is suing the state Department of Revenue (DOR) in the state Supreme Court alleging a municipal tax based on slot machine revenues is illegal, in violation of the state constitution, which requires taxes to be uniform. The lawsuit argues the tax is illegal because casinos must pay $10 million a year to the municipality where they're based if slots revenues are less than $500 million, or 2 percent of annual revenues over $500 million. Philadelphia casinos pay a flat 4 percent, with no $10 million minimum.
New Jersey’s Reciprocal Income Tax Agreement With Pennsylvania
In a June 30 executive order the New Jersey Governor has asked the state treasurer and attorney general to look into terminating the income tax reciprocity agreement with Pennsylvania. That agreement, which dates to 1977, permits residents of both states to avoid paying the other state's personal income tax. The order directed those officials to determine the steps that would be necessary to withdraw from the agreement and to prepare an estimate of the revenue impact on such an action. The executive order also required the director of the Treasury Department's budget and accounting division to place appropriations in reserve to ensure the state's fiscal 2017 budget remains balanced.
Art Dealer Settlement
On July 19, 2016 the New York Attorney General announced that the state reached a $4.28 million sales tax settlement with international art dealer Gagosian Gallery after an investigation into the gallery's sales tax collection practices. According to the press release issued that day, Gagosian is a leading dealer of contemporary art, with estimated sales of more than $1 billion annually, and it is alleged that between 2005 and 2015 an affiliate of the gallery sold and shipped approximately $40 million of art to customers in New York without collecting or remitting the state and local sales tax. It is also alleged that from 2012 to 2015, the gallery sold a large amount of art in New York, with possession taken in New York by the purchaser or the purchaser’s agent, that was later shipped out of state and the gallery failed to collect state and local sales taxes. This settlement follows a $7 million settlement earlier this year with Aby Rosen, a contemporary art collector, who failed to pay millions in sales and use taxes on art acquisitions made by his companies.
Class Action Suit Filed In Florida on Tampon Tax
A class action complaint has been filed in Florida Circuit Court alleging that the state’s sales and use tax on tampons and other feminine hygiene products violates the state and federal constitutions. The suit filed against the state Department of Revenue and several other state agencies and retailers who sell the products at issue here argues that despite the recommended use of tampons and pads in the cure, mitigation, treatment, or prevention of illness or disease in women, the state agencies that are defendants in the matter have excluded tampons and pads from the list of nontaxable medical items.
U.S. SUPREME COURT UPDATE
Cert Filed
On June 24, 2016, the country’s large tobacco companies filed a petition for certiorari with the U.S. Supreme Court in R.J. Reynolds Tobacco Company, et al. v. Maryland, U.S. Supreme Court Docket No. 15-1537. Issue: Whether the Federal Arbitration Act, which governs contract agreements involving interstate commerce, pre-empts contrary state law judicial review standards. The petition asks the justices to settle a legal dispute affecting the Master Settlement Agreement funding. In 2013, an arbitration panel of three retired federal judges ruled that six states, including Maryland, Missouri and Pennsylvania, failed to properly enforce escrow settlement provisions involving manufacturers not participating in the agreement. The petition notes that, on appeal of the arbitration findings, there are conflicting rulings in the state supreme courts, two decisions siding with the states (Maryland and Pennsylvania) and one with the manufacturers (Missouri).
FEDERAL CASES OF INTEREST
Collection Claims Dismissed
A U.S. district court dismissed an individual's complaint against the IRS, a bank, and his employer for wrongful collection of taxes through tax withholdings and a levy on his wages and bank account. The court held that the claim against the IRS was not timely and that the court did not have jurisdiction over the bank and employer.
The plaintiff was employed by Granite Services, one of the defendants in this matter, and claimed on his federal income tax form W-4 that he was exempt from the withholding of federal income taxes. In September 2008, the IRS concluded that plaintiff was not exempt from federal income taxes, and it directed Granite Services to begin withholding amounts for plaintiff's federal income tax obligations at the correct rate. Subsequently, the IRS issued a "Notice of Levy on Wages, Salary, and Other Income" to Granite Services, seeking $215,864.04 for plaintiff's unpaid federal income tax liabilities and outstanding civil penalties for the period of 1998 to 2003, and on June 20, 2011, the employer notified the plaintiff that it would be withholding income tax from his wages pursuant to the IRS's request. The plaintiff responded, claiming that the IRS's enforcement statutes have no force of law against anyone who is not part of the government, and directed the employer not to comply with the IRS's instructions. On September 4, 2012, the IRS sent a revised levy notice to Granite Services, including additional tax liabilities for 2004 through 2008. On November 2, 2009, the IRS issued a levy in the amount of $221,855.89 for the period of 1998 through 2003 upon plaintiff's bank account with First Home Bank and the bank notified the plaintiff of the levy and the IRS took $11,875.51 from his account. Plaintiff filed his complaint and his 63-page brief in support on August 24, 2015, alleging that the IRS's levies were fraudulent because the IRS is without authority to create 1040 form Substitute for Returns, declare what is or is not income, declare Federal wages where none exist, or bestow federal employment upon a non federal, non statutory private worker who doesn’t earn federal wages and provides no federal service. He also insisted that the IRS did not have the authority to override plaintiff’s sworn statement on his w-4 form.
Initially, the court noted that the plaintiff bears the burden of establishing jurisdiction by a preponderance of the evidence and bears the burden of establishing personal jurisdiction over each defendant. To survive a motion to dismiss, a complaint must contain sufficient factual matter to state a claim to relief that is plausible on its face. When considering a motion to dismiss the Court said it is bound to construe a complaint liberally in the plaintiff's favor, and it should grant the plaintiff the benefit of all inferences that can be derived from the facts alleged.
The Court noted that complaints filed by pro se litigants are held to less stringent standards than those applied to formal pleadings drafted by lawyers, but said that even pro se litigants must comply with the Federal Rules of Civil Procedure and Rule 8(a) requires that a complaint contain "a short and plain statement of the grounds for the court's jurisdiction," "a short and plain statement of the claim showing that the pleader is entitled to relief," and a demand for judgment for the relief the pleader seeks. The court said that the purpose of the minimum standard of Rule 8 is to give fair notice to the defendants of the claim being asserted, sufficient to prepare a responsive answer, to prepare an adequate defense and to determine whether the doctrine of res judicata applies. The court found that insofar as plaintiff's complaint and his brief in support are even intelligible, they lacked a short and plain statement of the claim showing that the pleader is entitled to relief and based on his failure to comply with Rule 8 alone, the court said it could dismiss the case in its entirety.
The court said that even if it were to overlook plaintiff's failure to comply with Rule 8, dismissal of this case would still be warranted, noting that he United States had not waived its sovereign immunity with regard to plaintiff's claims, and that the plaintiff’s claims against the IRS were untimely because they were filed well past the two-year statute of limitations period provided by law. In addition, the court said it lacks personal jurisdiction over the defendants Granite Services and First Home Bank, neither of which is a resident of the jurisdiction. The court cited prior decisions of the court that addressed personal jurisdiction over a non-resident and said that the court must first examine whether jurisdiction is applicable under the state's long-arm statute and then determine whether a finding of jurisdiction satisfies the constitutional requirements of due process. The court found that the plaintiff failed to show that either prong is satisfied with regard to either defendant. The court also concluded that plaintiff failed to state a plausible cause of action against Granite Services or First Home Bank, and dismissed the plaintiff's claims against those defendants with prejudice. Ronald Leroy Satterlee v. Commissioner et al., U.S. District Court for the District of Columbia, No. 1:15-cv-01387. 7/5/16
Federal Tax Lien's Priority Affirmed
The U.S. Court of Appeals for the Eighth Circuit held that a federal tax lien had priority over a bank's lien on property because a new deed issued as part of a refinance was recorded more than two months after the release of the original loan and after the filing of the notice of federal tax lien.
The taxpayers in this matter purchased a parcel of real property in Ballwin, Missouri in March 2004 and financed the purchase with a $277,000 loan from New Century Mortgage Corporation (New Century). They then executed a deed of trust to secure the loan, recording the deed of trust on March 29, 2004. Two years later, the taxpayers applied for a new loan for the purpose of debt consolidation, but the application, which indicated a loan request in the amount of $366,350, did not disclose any unpaid federal tax liabilities. When the loan closed a deed of trust to secure the loan was executed but not recorded. There is no evidence in the record that New Century or the closing agent performed a title search on the taxpayer’s property before closing on the new loan. Of the total funds disbursed, $274,410 was used to pay New Century for the remainder of the 2004 loan for the original property purchase, $83,005 went toward settling various other debts, and $8,934 went to the taxpayers. New Century executed a deed of release for the 2004 deed of trust on April 10 and recorded this deed of release in St. Louis County on May 2. The deed of trust for the 2006 loan was not recorded until July 11, 2006. New Century assigned the 2006 deed of trust to U.S. Bank on November 23, 2009, and U.S. Bank subsequently recorded the assignment.
The Internal Revenue Service (IRS) began in November 2005 to assess unpaid income taxes against the husband from tax years 2001, 2002, 2004, and 2006, totaling more than $700,000. The IRS assessed the 2004 taxes that are at issue in this case on November 21, 2005 and recorded a notice of federal tax lien in St. Louis County related to those taxes on March 30, 2006. The federal government initiated this suit in 2013, seeking to reduce to judgment the unpaid federal tax liabilities assessed against the husband, to foreclose on federal tax liens encumbering the property owned by the husband and wife, and to have the proceeds from the foreclosure sale distributed in the amounts determined by the court.
The husband conceded the tax liabilities, and his wife disclaimed any interest in the property. After all competing claims to the property except U.S. Bank's were resolved, the Government moved for summary judgment regarding the priority of its tax lien for unpaid 2004 taxes against U.S. Bank's 2006 deed of trust, arguing that the 2004 tax lien had priority over U.S. Bank’s lien because the notice of the tax lien was recorded on March 30, 2006, more than three months before the 2006 deed of trust was recorded on July 11, 2006. U.S. Bank argued that, because the 2006 loan merely refinanced the 2004 loan, the 2006 deed of trust retained the priority of the 2004 deed of trust for the $277,000 amount of the 2004 loan. The district court granted summary judgment for the Government, finding that the 2006 deed of trust did not retain the priority of the 2004 deed of trust because the 2004 deed of trust had been released more than two months before the 2006 deed of trust was recorded and the 2006 deed of trust, therefore, did not replace the 2004 deed of trust as part of the transaction that released the earlier deed of trust. U.S. Bank filed this appeal.
Summary judgment is appropriate when, viewing the facts in the light most favorable to the nonmoving party, there is no genuine issue of material fact, and the moving party is entitled to judgment as a matter of law. The dispute in this case turns on whether the 2006 deed of trust retained the priority of the released 2004 deed of trust. Citing prior case law, the court said the priority of liens for purposes of federal law is governed by the common-law principle that the first in time is the first in right. The court said that although federal tax liens attach and become choate at assessment, a state-created lien, such as a deed of trust securing a mortgage loan, is choate for “first in time” purposes only when it has been perfected in the sense that there is nothing more to be done. The court noted that under Missouri law, perfection of a deed of trust occurs when it has been recorded in the office of the recorder in the county where the property is located.
Generally, when a higher priority deed of trust is released, the next in priority moves up in priority, and the court noted that under this principle the release of the 2004 deed of trust would allow the federal government’s tax lien to ascend to first priority. However, Missouri adopted a provision from the Restatement of Property that outlines an exception to this general rule when a senior mortgage is released and, as part of the same transaction, is replaced with a new mortgage. That latter mortgage retains the same priority as its predecessor, except when any change in the terms of the mortgage or the obligation it secures is materially prejudicial to the holder of a junior interest in the real estate. U.S Bank argued that the 2006 loan replaced the 2004 loan as part of the same transaction that released the 2004 loan and should be considered a replacement loan for the 2004 deed of trust. The court said, however, that the state statute does not stretch the notion of "same transaction" as far as U.S. Bank argued, and the court would not consider the release of the 2004 deed of trust and recordation of the 2006 deed of trust o have occurred contemporaneously under the law.
The court affirmed the district court’s granting of summary judgment to the federal government. One justice filed a dissent. United States v. Josh P. Tolin et al., U.S. Court of Appeals for the Eighth Circuit, No. 15-2550. 7/5/16
Summary Judgment Affirmed for IRS in FOIA Suit
The U.S. Court of Appeals for the Fourth Circuit affirmed a district court's holding that granted the IRS’s motion for summary judgment in a suit filed by a corporation under the Freedom of Information Act. The corporation filed suit for records that were withheld or redacted by the IRS in response to its request for documents regarding its 2010 tax liabilities.
The corporation-taxpayer, an information technology company, was audited by the IS for its 2010 tax year and the IRS proposed adjustments to the taxpayer’s tax liability. After the IRS closed the audit, the taxpayer submitted a FOIA request to the IRS for all documents in the IRS' administrative file pertaining to its tax liabilities and potential penalties for the 2010 tax year, specifically requesting documents related to the audit, the notice of proposed tax adjustment, the taxpayer’s response to the notice, the taxpayer’s protest of the proposed adjustment, the quality control that was performed on the notice of proposed adjustment, finally, the guidance received by two IRS agents regarding intentional disregard penalties. The IRS located 261 pages that were responsive to the request and initially provided the taxpayer with most of these pages, withholding 26 pages and producing 32 pages with redactions. After the taxpayer filed its complaint, the IRS determined that 17 of the 26 pages previously withheld could be released in full and that 3 additional pages previously withheld could be released with redactions. The IRS also determined that 29 of the 32 redacted pages could be released in full. The taxpayer eventually agreed that the IRS had properly redacted 2 pages, leaving only 10 pages at issue in this case, 6 pages that the IRS withheld and 4 pages that it produced with redactions. After reviewing the unredacted documents in camera, the district court sustained the IRS' position and granted the IRS summary judgment.
The taxpayer argued in this appeal that the IRS produced generic and inadequate affidavits providing no justification for the withholding of any document. The taxpayer contends, therefore, that the IRS disregarded the district court order that the IRS provide all information required in a Vaughan index. The taxpayer argued that because the IRS failed to provide detailed justification for its withholding of the documents in question, the taxpayer was thwarted in its challenge to those documents, an argument that it contended remained even after the district court’s in camera review because the ruling from the bench did not provide it with a detailed analysis and rationale regarding its decision. The court said, however, that a Vaughan index is designed to enable the court to rule on a privilege without having to review the documents themselves and function as a surrogate for the production of the documents. In this case, the court noted, the district court reviewed the documents themselves in camera and ruled that this review had eliminated any issue with the Vaughan index.
The court then turned to the district court’s ruling on the 10 documents at issue here.
The district court determined that the four pages of handwritten notes could be withheld in their entirety, effectively ruling that there were no segregable portions that could be produced.
The court concluded that the district court's factual findings regarding the content of the notes were amply supported by the record. Because the notes were the agent's preliminary evaluation of issues implicated by the audit, the court found that the district court did not err in concluding that they were predecisional and deliberative, thus satisfying the criteria for withholding them. The court concluded that while a summary report that was withheld did
does not specifically name third-party individuals whose tax returns were considered in conjunction with the taxpayer’s audit, the individuals' identities could easily be discerned from the report or any segregable portion of it, therefore justifying its being withheld. Finally, the graph and check sheet withheld specifically identified third-party individuals and entities, and the court concluded that the IRS acted properly in withholding the graph and redacting one line from the check sheet. Solers Inc. v. IRS, U.S. Court of Appeals for the Fourth Circuit, No. 15-1608. 6/30/16
Bankruptcy Late-Filed Returns Case Direct Appeal
A U.S. district court granted a request for a direct appeal of a bankruptcy court decision to the U.S. Court of Appeals for the Third Circuit in which the bankruptcy court held that there is no timeliness requirement when determining whether a late-filed return constituted a return for bankruptcy discharge purposes. The district court said that this was an issue that has not yet been addressed by the Third Circuit.
On July 24, 2012, the taxpayer in this case filed a voluntary petition for relief under Chapter 7 of the United States Bankruptcy Code (Code). In the Chapter 7 Petition, the taxpayer listed the IRS as holding a claim of $103,628.89. On October 26, 2012 the bankruptcy court entered an order discharging the taxpayer in the normal course. Before the taxpayer filed his bankruptcy petition, the IRS had calculated his obligations for the 2005 and 2006 tax years in which he failed to file returns, basing the calculations for those years on Substitutes for Returns (SFR), which the Internal Revenue Code (IRC) allows the Secretary of Treasury to prepare and file for taxpayers who fail to file their own returns. On January 28, 2010, the taxpayer submitted Form 1040s for the 2005 and 2006 tax years, which reduced the 2005 SFR estimated tax by $489.00, and reduced the 2006 SFR estimated tax by $3,646.00.
On August 11, 2014 the taxpayer filed a voluntary petition for relief under Chapter 13 of the Code, in which he proposed to pay allowed priority tax debt in full through the plan. On his attached schedules, he listed the IRS as holding an unsecured priority claim for the tax years 2005, 2006 and 2009, which he marked as disputed. The taxpayer filed a motion to reduce the IRS’s proof of claim for the 2005 and 2006 tax years, arguing that the Chapter 7 petition discharged his obligations for those tax years. The Code contains an exception from discharge when a required return is not filed and the IRS argued that the Form 1040s filed in 2010 for tax years 2005 and 2006 did not constitute “returns” which would be discharged under the Code.
The bankruptcy court issued an Order granting the taxpayer’s motion to reduce the IRS's claim, noting in its decision that until the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the Bankruptcy Code did not define the term "return." Under the BAPCPA, "return" is defined to mean a return that satisfies the requirements of applicable non-bankruptcy law. BAPCPA specifically provides that the "term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law . . . but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or similar State or local law." The bankruptcy court in its decision noted that although the Third Circuit has not yet ruled on the issue, "each of the three circuit courts that have ruled on the issue held that a late return does not satisfy . . . the definition of a return" under the BAPCPA. In re Davis, No. 14-26507, 2015 WL 5734332, at *4 (citing In re Fahey, 779 F.3d 1, 10 (1st Cir. 2015); In re Mallo, 774 F.3d 1313, 1327 (10th Cir. 2014); In re McCoy, 666 F.3d 924, 932 (5th Cir. 2014)). Notwithstanding these decisions, however, the court noted that another bankruptcy court in this district reached a different conclusion. In re Maitland, 531 B.R. 516 (Bankr. D.N.J. 2015)). The bankruptcy court found the analysis in In re Maitland persuasive, and, therefore, ruled that the taxpayer’s late-filed Forms 1040 for the 2005 and 2006 tax years constituted returns, and granted the taxpayer’s motion to reduce the claim of the IRS. The IRS filed this appeal and the taxpayer subsequently moved for certification for direct appeal to the U.S. Court of Appeals for the Third Circuit.
The court cited Section 158(d)(2) which provides that litigants in a bankruptcy proceeding may appeal a bankruptcy court's decision directly to the court of appeals when, among other things, the district court certifies that: "(1) the judgment, order, or decree involves a question of law as to which there is no controlling decision of the court of appeals for the circuit or of the Supreme Court of the United States, or involves a matter of public importance; (2) the judgment, order, or decree involves a question of law requiring resolution of conflicting decisions; or (3) an immediate appeal from the judgment, order, or decree may materially advance the progress of the case or proceeding in which the appeal is taken." 28 U.S.C. § 158(d)(2).
In its opposition to the motion, the IRS agrees that the sole question on appeal is whether the Forms 1040 filed by the taxpayer for 2005 and 2006 are returns under the Code, but disputes whether this question is purely a legal one arguing that the court’s decision was based at least in part on the fact that the taxpayer filed the 1040 forms for a legitimate purpose in advance of filing an offer in compromise with the IRS which required the forms before he could make an offer. The court rejected this argument, finding that the bankruptcy court’s decision was not heavily dependent on the particular facts in the case. The court found that the issue, which has already been addressed by several Circuit Courts, is an issue that is likely to affect a significant proportion of individuals and likely to arise repeatedly, and, accordingly, the case should be certified for direct appeal. IRS v. Mark W. Davis, U.S. District Court for the District of New Jersey, No. 3:15-cv-07601. 6/29/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Tax on Pizza Not Paid Under Duress
The Illinois Appellate Court, Fifth District, upheld the dismissal of a complaint alleging that a tax paid on pizza was unfair and deceptive, finding that the plaintiff's claims were barred by the voluntary payment doctrine and the tax wasn't paid under duress.
The plaintiff filed a complaint for a putative class action against Papa Murphy’s International, LLC (PMI) and P-Cubed Enterprises, LLC (P-Cubed) in which he alleged that both defendants violated the Illinois Consumer Fraud and Deceptive Business Practices Act (Act). PMI is a franchisor that grants franchises for the operation of pizza stores that sell "take-and-bake" pizzas, uncooked pizzas that the consumer takes to bake at home. P-Cubed is a franchisee of PMI. The complaint alleged that on July 30, 2014, PMI charged the plaintiff $.80 tax on his $9 purchase of a pizza from a PMI franchise and the plaintiff attached a copy of his sales receipt indicating that on July 30, 2014, he purchased a pizza in the amount of $11, received a $2 discount, and was charged $9 plus tax in the amount of $.80. The plaintiff cited the state statute that provides that a 1% rate applies to food items that are sold by a retailer without facilities for on-premises consumption of food and that are not ready for immediate consumption. The plaintiff's class action suit against PMI claimed that PMI's 9% tax charge was an unfair and deceptive act in violation of the Consumer Fraud Act and sought to represent a class of Illinois citizens who have been charged excessive sales tax by PMI.
The plaintiff subsequently filed his first amended complaint, adding defendant P-Cubed to the lawsuit. The allegations against PMI in the amended complaint remained unchanged from the original complaint, but a second count made an identical allegation against P-Cubed, and contended that both defendants have a routine practice of charging more than 1% sales tax, and that this unfair and deceptive practice results in collectively substantial losses that will injure the public and the proposed class. The lower court ruled for the defendants, finding that PMI’s pizza did not constitute a “necessity” that would result in the taxpayer’s payment of the tax being made under duress and the court concluded that the voluntary payment doctrine precluded the plaintiff’s claim. The plaintiff filed this appeal.
Initially, the court noted that Illinois courts have long held that a plaintiff may not assert a claim to recover taxes that have been remitted to the state, even if such payment was erroneous and a taxpayer can only recover taxes voluntarily paid if such recovery is authorized by statute or by some showing of unjust enrichment. The court said that the plaintiff here did not plead either that the defendants retained the tax rather than remitting it to the state, or that the defendants recovered the tax through a refund, which appears to be the only basis for seeking such restitution from the retailer. The court found that the plaintiff's contention that his case may proceed even after the funds have been remitted to the state is without support in Illinois law.
The court said further that even if the plaintiff could demonstrate that his case could be maintained against a retailer after the taxes have been remitted to the state, the voluntary payment doctrine bars his claim. To establish an involuntary payment of taxes to the state a procedure is set out in the Protest Fund Act, which provides that a consumer who wishes to contest a collection of the use tax can do so by paying under protest and then suing the retailer, the Director of the Department of Revenue, and the Illinois Treasurer to require that the corresponding retailers' occupation tax be paid under protest into a protest fund. The result of failure to follow the procedure outlined in the Protest Fund Act is the only grounds on which a plaintiff can state a cause of action for a tax refund is to show that the exception to the voluntary payment doctrine applies to his factual situation.
The plaintiff arguedthat multiple exceptions to the voluntary payment doctrine applied to his case, including the exception of statutory fraud, that he did not make a knowing, voluntary payment, and that he made the payment under duress. The court noted that prior case law has rejected the argument that a claim under the Consumer Fraud Act is immune from the voluntary payment doctrine, but further noted that the plaintiff’s amended complaint failed to sufficiently plead a violation of the Consumer Fraud Act. While the plaintiff stated in the amended complaint that the defendants have a "routine practice" of overcharging tax and the charge was intended to cause the Plaintiff to rely on the guise that the sales tax was lawful, the court said the plaintiff offered nothing more than the tax charge he paid in July 2014. The court said these are not factual pleadings that can meet the elements of a cause of action.
The plaintiff attached to his complaint a copy of the receipt for the transaction at issue, which showed the date, form of payment, amount charged, amount paid, and amount taxed and the court said the plaintiff's receipt was sufficient to put him on notice. His payment was not "unknowing" pursuant to the exceptions to the voluntary payment doctrine. Finally, the court rejected the plaintiff’s claim that his payment of the tax was made under duress, saying that the courts have described duress as existing where the taxpayer's refusal to pay the tax would result in a loss of reasonable access to goods or services considered essential. The plaintiff here appears to argue that his purchase of a take-and-bake pizza was made under duress because food is a basic human necessity, but the court said that a Papa Murphy's take-and-bake pizza is not essential and reasonable alternatives exist that fulfill a consumer’s basis need for sustenance. The court also rejected the plaintiff’s argument that the trial court erred in denying leave to file a second amended complaint saying that after final judgment, a plaintiff has no statutory right to amend a complaint, and a court commits no error by denying a motion for leave to amend. Karpowicz v. Papa Murphy's International LLC, Illinois Appellate Court, Fifth District, No. 5-15-0320. 7/5/16
Personal Income Tax Decisions
Income Adjusted But Renter's Credit Amount Affirmed
The Utah Court of Appeals found that an individual qualified for a renter's refund in a reduced amount. The court recalculated his adjusted gross income to include an IRA distribution from a rollover from a traditional to Roth IRA and a loss carryforward. The Utah State Tax Commission (Commission) had incorrectly adjusted the taxpayer’s income, but the court said the correctly adjusted income did not change the Commission’s refund and the court held the Commission’s decision harmless.
In December 2011, the taxpayer applied for a renter's refund, which is determined by an applicant's household income. If an applicant's household income is between $0 and $9,931 the applicant qualifies for an $865 refund, but if the applicant's household income is between $26,289 and $29,210 the schedule allows for a $106 refund. Based on the information the taxpayer reported on his 2010 federal individual income tax return, he had an adjusted gross income (AGI) of $10,619. Not included in his AGI, but reported on his tax return, was $13,842 in Social Security benefits and the nontaxable portion of his traditional IRA distribution of $1,290. He also indicated on a Capital Gains and Losses Schedule D worksheet attached to his tax forms that he had $98,086 in capital losses carried forward from previous years. On his renter's refund application, the taxpayer reported that his total household income was $0 and claimed a refund of $865, arguing that the $98,086 in loss carry forwards offset his AGI and all other nontaxable income.
The Taxpayer Services Division audited the taxpayer’s application and recalculated his imputed household income as $28,657, which included the $4,236 in pensions and annuities, $10,661 in IRA distributions, including the taxable and nontaxable portions, $13,842 in Social Security payments, $12 in interest, and a $94 deduction. The Division sent the taxpayer a notice of the adjustment, explaining that, because the IRA distributions were taxable, it considered his IRA distribution, a rollover from a traditional IRA to a Roth IRA, as income in its calculation. The notice also stated that the taxpayer could not offset his AGI and other nontaxable income with the $98,086 in capital loss carry forwards. The taxpayer filed a petition to the Commission for a redetermination of the refund. At the hearing on his appeal, the taxpayer argued his IRA conversion was not "income" because he did not physically receive the money and that the Division erred in disallowing the $98,086 he claimed as loss carry forwards. The Commission ultimately concluded that the taxpayer was due a refund of $106 and he filed this appeal.
The court rejected the taxpayer’s argument that the Commission improperly included $9,371 in his household income because it was merely a conversion to a Roth IRA and was not physically received, noting that because a taxpayer must pay tax on the conversion from an IRA to a Roth IRA, the taxable amount of the contribution is added to the taxpayer's AGI even though the taxpayer does not physically receive the amount.
The taxpayer also argued that because the term “loss carry forward” is undefined by the state tax code the term should be synonymous to the IRS’s “capital loss carryover” and the Commission should have permitted a deduction of the entire loss he reported. The court looked to the usual and accepted meaning of the term and found by its nature a capital loss can carry over, or carry forward, but the taxpayer may only claim up to $3,000 of the entire capital losses each year pursuant to the tax code. The court also said that the loss carry forward is not a deduction that offsets the taxpayer’s income for the purposes of determining his renter's refund, but is instead added to his AGI to determine his household income. The court found some mistakes in the Commission’s calculation of the taxpayer’s AGI, but said that the error was harmless because even calculated correctly, the taxpayer’s household income fall between $26,289 and $29,210, which entitled him to a refund of $106. Khan v. Tax Commission, Utah Court of Appeals, 2016 UT App 142; No. 20140583-CA. 7/8/16
Corporate Income and Business Tax Decisions
No cases to report.
Property Tax Decisions
Stored Natural Gas Qualifies for Exemption
The Oklahoma Court of Civil Appeals, Division I, held that natural gas stored in the state qualified as "goods, wares, and merchandise" for purposes of the freeport exemption. The court also held that gas stored in the state for over nine months was taxable, and remanded the case for further consideration in accord with the decision.
The taxpayer is a local gas distribution company with its headquarters in Missouri. It purchases gas from suppliers and transports it via interstate pipelines for resale to its customers in Missouri. It has no employees in Oklahoma and does not sell gas in Oklahoma. It has transportation and storage contracts with an interstate pipeline company based in Kentucky with its pipeline extended across parts of Texas, Oklahoma, Kansas, Missouri, Nebraska, Colorado, and Wyoming. When the taxpayer purchases the gas from suppliers it nominates the purchased volumes of gas for receipt into the pipeline systems and the pipeline company, depending on the type of nomination, either transports the gas to the taxpayer’s delivery points in Missouri or credits the gas to the taxpayer’s storage account.
The pipeline company owns and operates eight underground storage facilities, which are connected to its pipeline one of which is located in Oklahoma. The taxpayer claims the gas injected at the Oklahoma facility enters the its pipeline system at meter points in Wyoming, Colorado, Kansas, Texas, and Oklahoma and that the gas stored at the Oklahoma facility does not all physically originate in Oklahoma. While the pipeline company has possession of the gas in storage, title to the gas remains with its customers, including the taxpayer. For ad valorem tax purposes, the pipeline company allocates a volume of gas stored at the Oklahoma storage facility as of January 1 of each calendar year to each of its customers, including the taxpayer and provides copies of these allocations to the county assessor who uses the allocation to assess personal property taxes against the storage volumes. For tax year 2011, the taxpayer received its storage facility allocation and timely filed a Freeport Exemption Declaration for the portion of the gas allocated to it, which it claimed did not originate in Oklahoma. The assessor and the county Board of Equalization (BOE) denied the taxpayer’s application and the taxpayer filed a motion for summary judgment with the state’s district court arguing that it was entitled to the exemption as a matter of law.
The court granted BOE’s summary judgment motion finding the Freeport Exemption in the Oklahoma Constitution did not apply to natural gas in storage because it is not included in the category of "goods, wares and merchandise." The trial court denied the taxpayer’s motion for reconsideration and found that the gas had a taxable situs in the county. The taxpayer filed this appeal. The taxpayer argued that a portion of the natural gas in storage at the Oklahoma storage facility and allocated to it falls under the terms of the second clause of the Freeport Exemption which exempts property originating outside of the state from ad valorem taxation if the property is goods, wares and merchandise held for assembly, storage, manufacturing, processing or fabricating purposes and is held in the state for nine months or less. Finally, in order to qualify for this exemption, the property must be shipped to and sold at a final destination outside of Oklahoma. BOE argued in their summary judgment motion that none of the gas allocated to the taxpayer in this case qualified for the Freeport Exemption because natural gas in storage did not qualify as "goods, wares and merchandise." Appellees relied on a portion of the statute that defined thirteen (13) different categories of personal property for the purposes of ad valorem taxation and said that because "oil, gas, and petroleum products in storage" are defined separately from any other reference to "goods, wares, and merchandise" that "oil, gas, and petroleum products in storage," including natural gas in storage, cannot be considered "goods, wares, and merchandise" for purposes of ad valorem taxation. The court noted that the question of whether natural gas in storage qualifies as "goods, wares, and merchandise" for the purposes of the Freeport Exemption has not been addressed by any appellate court in the state. During the pendency of the case the state legislature changed the definition of personal property impacting this case. HB 1962, codified as 2015 Okla. Sess.Law. Ch 262 stated it was an act providing for inclusion of certain tangible personal property for purposes of the Freeport Exemption and also stated it had both retrospective and prospective effect. It expanded the definition of tangible personal property to include that all goods and capital employed in merchandising, wares, and merchandise, including oil, gas, and petroleum products severed from the realty. The taxpayer argued that this legislation clarified that natural gas in storage qualified as “goods, ware, and merchandise” for purposes of the exemption. The court noted the general rule that statutory amendments are to be applied prospectively only unless the legislature clearly provides for retroactive application and the proposition that if meaning of a statute was in doubt, a presumption arises that the amendatory act was intended to clarify the existing law’s ambiguity.
The court said that the definition of personal property has remained substantively unchanged from the time the Freeport Exemption was placed on the ballot until the 2015 changes and the plain language of HB 1962 established its purpose was to clarify that natural gas severed from the realty was always meant to be included as "goods, wares, and merchandise" for purposes of the Freeport Exemption. The court found that natural gas severed from the realty qualifies as "goods, wares, and merchandise" for purposes of the Freeport Exemption and reversed the decision of the trial court and remanded the matter.
The taxpayer also argued that the appellees could not establish that the gas allocated to it which did not originate in Oklahoma had a taxable situs in Oklahoma as required by the statute which provides that tangible personal property moving through the state from a point outside the state, in transit to a final destination outside the state shall acquire no situs in the state for purposes of taxation. The statute requires the owner, in order to obtain a determination that any property has not acquired a situs in this state, to submit to the appropriate assessing officer documentary proof of the in-transit character and the final destination of the property. The court, citing MGE I, 2008 OK 94, said the court found in that case that taxing the gas stored in Oklahoma for a substantial part of the year was consistent with the exercise of due process, and it, therefore, found that the natural gas at issue in this case, which the record demonstrated was stored at the Oklahoma facility for approximately nine months, had taxable situs in the state, regardless of where the natural gas originated. The court affirmed that portion of the lower court’s decision and directed the lower court, on remand, to determine the amount of gas that is exempt from the tax under the Freeport Exemption. Missouri Gas Energy v. Grant Cty. Assessor, Oklahoma Court of Civil Appeals, Division One, Case No. 114405. 5/13/16
Other Taxes and Procedural Issues
Natural Gas Used to Produce Electricity Is Not Taxable
The Virginia Supreme Court held that a power company's natural gas used to produce electricity was not taxable because the gas was not transmitted through a pipeline for purposes of furnishing heat or light, a statutory requirement for taxability.
The taxpayer operates a gas-fired electric generation station located in Richmond and the city sent a tax assessment for natural gas consumed at the station between 2001 and 2004. The city later sent a second assessment for gas consumed between the years 2005 and 2008. The taxpayer filed timely appeals for each assessment, which were denied by the city. The taxpayer filed an appeal with the Tax Commissioner (Commissioner) who denied the claim, and the taxpayer filed an appeal with the circuit court, arguing that it was not subject to the tax because it consumes natural gas at the station to generate electricity, not to furnish heat or light and, therefore, its consumption was outside the scope of the statute. The circuit court ruled for the taxpayer finding that the taxpayer consumed gas for the purpose of generating electricity and any heat or light created when it consumed the gas at the station was merely incidental. The city filed this appeal, arguing that the term “heat or lights” is not ambiguous and must be given it plain meaning and the taxpayer’s use falls within the meaning because the evidence established that the taxpayer combusts natural gas, thereby creating heat, to power electricity-generating turbines. The City argued that the circuit court should not have construed the term "heat or light" by referring to other parts of the statute not expressly incorporated into Code § 58.1-3814. The court said, however, that it had a duty to interpret the several parts of a statute as a consistent and harmonious whole so as to effectuate the goal of the legislature and said the circuit court was obligated to consider the words used in the definition of “pipeline distribution companies” in context with the words used in other provisions of Code § 58.1-2600(A) to ensure that its interpretation of that definition was consistent with the other provisions. The court said that the lower court correctly noted that the word "power" was used alongside "heat" and "light" in the provision defining "commission" but not in the provision defining "pipeline distribution companies." Because when interpreting a statute it is presumed that the general assembly chose the words it used in the statute with care, the court said the phrase "heat, light and power" in the definition of "commission" must enumerate three separate items and the word "power" must have some meaning independent of what is conveyed by the words "heat" and "light." Consequently, the court said that the omission of "power" from the statutory definition of "pipeline distribution companies" must have significance and the omission of the word "power" from the definition of "pipeline distribution companies" reflected that the legislature did not intend Code § 58.1-3814(H) to permit localities to impose a tax on natural gas consumed solely for the purpose of generating electricity. City of Richmond v. Virginia Electric and Power Co., Virginia Supreme Court, Record No. 150617. 6/30/16
Cigarette Tax Does Not Violate Indian Law
The New York Supreme Court, Appellate Division, Fourth Department, held that a law requiring the taxpayer to prepay the amount of the tax to be assessed on the sale of cigarettes to non-Indians and nonmembers of the Seneca Nation did not violate Indian Law or the U.S. Constitution.
Plaintiffs sought a preliminary injunction enjoining enforcement of Tax § 471, alleging that it imposed requirements on them to pre-pay the amount of the tax to be assessed on the sale of cigarettes to non-Indians and non-members of the Seneca Nation, violates Indian Law § 6 and certain treaties between the Seneca Nation and the United States of America, in particular the Treaty of 1842 (7 US Stat 586). The Supreme Court granted defendants' cross motion pursuant to CPLR 3211(a)(7) and dismissed the complaint, but because the court failed to declare the rights of the parties in the court’s dismissal the matter came before the court for modification.
Plaintiffs argued that the court erred in determining in the Matter of New York State Dept. of Taxation & Fin. v. Bramhall (235 AD2d 75, appeal dismissed 91 NY2d 849) that the Treaty of 1842 and Indian Law § 6 bar the taxation of reservation land, but do not bar the imposition of, among other things, the sales taxes on cigarettes sold to non-Indians on the Senaca Nation’s reservation. The court noted that the Treaty of 1842 provided, in part, that the Senaca Nation would retain certain reservations in the state and the parties to the compact agreed that the Government of the United State would protect these lands within the state from all taxes and assessments for roads, highways, or any other purpose until these same lands are sold and conveyed by the Indians, and they have relinquished possession. The court concluded that the plain language of the treaty supported the court’s decision that that it prohibited the state from imposing taxes on the "lands", i.e., the real property, of the Seneca Nation.
The court concluded that, even construing the statute liberally in favor of the Indians, the statutory history of Indian Law § 6 supported it earlier determination and that Indian Law § 6 was enacted to bar taxes on real property that was part of an Indian nation, tribe or band.
The court further found that even assuming, arguendo, that it had interpreted the language of the Treaty of 1842 and Indian Law § 6 too narrowly, it still concluded that the court properly agreed with defendants that plaintiffs are not entitled to the declaratory relief they sought. It cited Department of Taxation & Fin. of N.Y. v. Milhelm Attea & Bros., Inc., 512 US 61, 73 for the proposition that it was well-established that "the States have a valid interest in ensuring compliance with lawful taxes that might easily be evaded through purchases of tax-exempt cigarettes on reservations . . . States may impose on reservation retailers minimal burdens reasonably tailored to the collection of valid taxes from non-Indians." Citing Moe v. Confederated Salish & Kootenai Tribes of Flathead Reservation, 425 US 463, 483, the court said that although plaintiffs are obligated to pay the amount due as tax from non-Indians who have the tax liability, and from whom the amount is collected at the time of the sale, this burden is not a tax. White v. Schneiderman, New York Supreme Court, Appellant Division, Fourth Department, CA 15-01764. 6/10/16
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:
July 8, 2016 Edition
NEWS
No news to report.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
Due Process Violated in Unclaimed Property Audit
The United States District Court for the District of Delaware ruled that the Delaware Department of Finance's (Finance) unclaimed property audit process violated due process. The court found that Finance, which administers the state’s unclaimed property statute, waited 22 years to begin the audit, exploited loopholes in the statute of limitations, and improperly used the statutory authorization to use estimation to determine the plaintiff's liability.
"Unclaimed" or "abandoned" property refers to any property held by a business, where the business is not the owner of the property, and there has been no contact with the owner for the "dormancy period," which is set by each state’s unclaimed property statute. The plaintiff in this matter is a Delaware corporation that manufactures corrugated packaging. Its principal place of business is in Texas, with operations primarily in Texas and Indiana. In 2008, Finance audited plaintiff for deficiencies in reporting and escheating unclaimed property to the state for the previous 22 year time period. Plaintiff argued that the audit violates certain provisions of the U.S. Constitution, including due process, the takings clause, and the ex post facto clause.
To begin, the court noted three factors that it said contributed to this litigation: Delaware’sdependence on unclaimed property revenue, the U.S. Supreme Court's priority rules for escheating unclaimed property, and Delaware's historically lax enforcement of its unclaimed property laws. Unclaimed property is Delaware's third largest revenue source, making it a "vital element" in the state's operating budget, with the difference between the amount collected by the state and the amount returned to owners a large percentage of unclaimed property revenue remaining with the state.
Because several states can make competing claims for the same unclaimed property, the U.S. Supreme Court, in Texas v. New Jersey, 379 U.S. 674, 678-79 (1965) ruled that the same unclaimed property cannot be escheated by more than one state and set forth a set of rules to determined which state has the right to the property. The first rule is the property is escheated to the state of the last known address of the owner of the property. If that address is unknown, the default rule awards the right to escheat to the state in which the owner is incorporated. Because Delaware is legal home to a large share of the country’s corporations, it receives a large share of all owner/address unknown abandoned property in the country.
The court noted that although the state relies on unclaimed property revenue, it has been lax in enforcing the law with only 14,000 reports received each year from the more than 680,000 entities incorporated in the state. The state has a limited audit staff for unclaimed property and also contracts with outside auditors to conduct these audits.
In December 2008 the plaintiff was notified by Finance that an audit would be conducted and a contract auditor was assigned to this audit. The audit covered a 22-year period, from January 1986 to December 2007 and the plaintiff was only able to produce complete records back to 2003 for accounts payable and 2004 for payroll. All older records had been disposed of in accordance with the plaintiff’s records retention policy. The plaintiff also produced all unclaimed property reports it had filed with the state, some as far back as 1998, and two audits reports by Texas for the periods 1985 to 2005. In conducting the audit, Finance estimated the amount of unclaimed property for the years in which plaintiff did not have complete records. In 2010 the state legislature amended the unclaimed property statute to provide that Finance could use a reasonable method of estimation in unclaimed property audits. The legislature never adopted a document retention provision in the statute, although legislation was proposed but not enacted in 2001, and Finance relied instead on standard retention policies.
Finance asked the court to grant summary judgment in their favor or abstain under the doctrine set forth in Railroad Commission of Texas v. Pullman Co., 312 U.S. 496 (1941) until a state court has the opportunity to interpret Section 1155, which they claimed is an ambiguous statute. While this request for abstention was presented two years into the litigation, the court addressed the issue and rejected it, finding it was not appropriate in this case. Pullman abstention is limited to those exceptional circumstances where construction of an ambiguous state statute by a state court could avoid or modify the federal question. The court said the statute is not ambiguous. Section 1155 clearly provides that the State Escheator has the authority to require a holder to pay the amount the State Escheator "reasonably estimates" to be due and owing.
The court next addressed the plaintiff’s due process argument, where the plaintiff challenged executive action, specifically, Finance’s audit and assessment of plaintiff’s unclaimed property liability. The court noted that executive action violates substantive due process protections "only when it shocks the conscience." The court said there appeared to be no precedent in any court addressing whether a state's executive action with respect to unclaimed property shocks the conscience, which it said was not surprising because most "shock the conscience" cases involve claims of excessive force or physical brutality. Despite the lack of clear precedent, the court found several aspects of Finance’s actions troubling, including the fact that it waited 22 years to conduct an audit, avoided the otherwise applicable 6 year statute of limitations, gave holders no notice that they would need to retain unclaimed property records to defend against audits, and, the court said, applied Section 1155 for a prolonged retroactive period for no obvious purpose other than to raise revenue. The court also said that Finance failed to follow the fundamental principle of estimation where the characteristics of the sample set are extrapolated across the whole, putting plaintiff at risk of multiple liabilities. The court found that it was sufficient that, in combination, Finance’s executive actions shock the conscience.
The court reviewed the estimation methodology used in the audit in which the auditor used the available records to calculate the liability for the reach back years. The court noted a number of issues with that calculation, including the fact that the auditor included in its base period liability both unclaimed property reported to other states and unremediated checks with a known address that was not Delaware. The court noted that the liability for the reach back years was higher than the amounts plaintiff escheated to Delaware for the base years, which neither party had argued was incorrect. The court said that due process violations arise where the estimation methodology creates misleading results, and noted that Finance admitted that for periods where records did not exist in this case, it estimated for all states, not just for Delaware, despite the primary rule in the Texas cases. Finance argued that it did not need to extrapolate the characteristics of the property on which the estimation was based, because, if records do not exist, then the address is unknown, but the court found that this logic stretched the definition of “address unknown” to troubling lengths. The court said the logic was contrary to the fundamental principle of estimation and Finance was not extrapolating the characteristics of the property that would reduce the liability owed to the state. It found that because Finance employed estimation in a manner where the characteristics and qualities of the property within the sample were not replicated across the whole, it created significantly misleading results. The court said it seemed logical that if two states use the same property in the base years to infer the existence of unclaimed property in the reach back years, then a holder is being compelled to escheat the same estimated property to two states, in violation of the principles articulated in the Texas cases. The court rejected Finance’s argument that because Delaware is the state of plaintiff's incorporation and it seeks to escheat address unknown property, it is the only state that can use estimation to calculate plaintiff's unclaimed property liability, saying that is neither the law nor the custom and none of the states whose statutes permit the use of estimation have expressly limited the use of estimation to the secondary rule under Texas. The court held that a reasonable estimation of a holders' unclaimed property liability is not an unconstitutional taking, but that the parties did not present evidence or argument to the court as to whether or not the estimation was reasonable. Thus, there is a dispute of material fact that cannot be resolved on summary judgment.
The court granted the plaintiff’s motion for summary judgment as to the substantive due process claim, and denied it as to the takings claim and ex post facto claim. The court denied Finance’s motion for summary judgment as to the substantive due process and takings claim, and granted it as to the ex post facto claim. Temple-Inland Inc. v. Cook, U.S District Court for the District of Delaware, Civ. No. 14-654-GMS. 6/28/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Prescription Waiver in Sales Tax Audit Upheld
The Louisiana Court of Appeal, Fourth Circuit, held that a sales tax assessment was untimely. The court said that the tax collector did not overcome its burden in demonstrating that a sales tax prescription waiver signed by the parties to a sales and use tax audit was interrupted or suspended.
Beginning in 2008 the City of New Orleans (City) conducted a sales and use tax audit of the taxpayer for the period January 1, 2004 through June 30, 2007. The audit continued for five years and, each year, pursuant to the authority in the statute, the taxpayer signed waivers of the statute of limitations, or prescription, to allow the City to complete the audit. On December 17, 2012 the auditor reached out to the taxpayer to extend the prescription for another year and sent the waiver form to the taxpayer’s director of sales and property tax who, instead, proposed to limit the extension to 90 days from December 31, 2012. The City agreed and requested that an officer of the taxpayer sign the 90-day waiver. During that process, the taxpayer changed the 90 days to 60 days with a notation on the form and signed it. This amended waiver was received by the auditor who sent a scanned copy to the City’s tax collector. No one in the City contacted the taxpayer about the 60-day amendment. On March 4, 2013, three days after the amended waiver expired, the City, apparently unaware of the alteration made to the waiver form, issued the taxpayer a notice of assessment, which is at issue here. In spite of this, the parties continued to work as if the assessment was timely, including communication from the taxpayer requesting arbitration and a partial payment of the assessment with a request for a waiver of penalties associated with that payment. The City responded to that request by granting the penalty waiver. The taxpayer on July 10, 2014 filed a petition for redetermination with the Board of Tax Appeals (BTA), which issued a judgment in favor of the taxpayer, vacating the assessment, and the City filed this appeal.
The City argued that the BTA erred in not recognizing a valid written agreement to suspend the prescriptive period for ninety days, and instead finding that the waiver that was amended by the taxpayer to suspend prescription for 60 days constituted the agreement.
The court reviewed the statutory provisions surrounding the issuance of a sales and use tax assessment, including the normal three year statute of limitations and the prescription period that suspends the normal statute of limitations period when an agreement is entered into between the tax collector (City) and the taxpayer. The court said that when a party raises the defense of prescription, the mover typically bears the burden. If, however, on the face of the pleadings it appears that prescription has run, the burden shifts to the plaintiff to prove an interruption or suspension of the prescriptive period. SS v. State, Dept. of Social Services, 2002-0831, pp. 6-7 (La. 12/4/02), 831 So.2d 926, 931.
The court said it was clear from the face of the pleadings that prescription has run, and the burden, consequently, shifted to the City to prove that prescription has been interrupted or suspended. The City argued that pursuant to the statute there was a written agreement in effect between the taxpayer and the City that the prescriptive period would be suspended for a period of ninety days from and after December 31, 2012, making the Notice of Assessment issued on March 4, 2013 timely, pointing to a phone conversation, together with a series of emails between the parties as evidence of that written agreement. The City cited cases to support the proposition that written agreements may be made via email, but the court said that the City’s argument failed to recognize that both the standard waiver form originally sent to the taxpayer’s representative on December 17, 2012, and the updated form sent by another taxpayer representative via email, contemplated numerous requirements to make the waiver valid, including a signature from someone of authority with the taxpayer, witnessed and notarized.
The court found that, notwithstanding the jurisprudence addressing the validity of written agreements made via email, the email exchange clearly lacked the witnesses and notarization required by the City’s form and cover letter. The court rejected the City’s argument that by “clicking send” on an email was equivalent to signing a paper document and said that the clear language of the emails indicated that a final form agreement would be sent by the City and signed by an officer of the taxpayer. The court noted that the state’s civil code provides that when "the parties have contemplated a certain form, it is presumed that they do not intend to be bound unless the contract is executed in that form." The court found that the evidence in the record clearly demonstrated that the parties intended the City’s standard waiver form to be the final written contract.
The court said the applicable written agreement is the waiver form executed by the taxpayer’s officer on December 21, 2012, waiving prescription for sixty days from December 31, 2012.
The court rejected the parol evidence proffered by the City that it never intended to waive prescription for sixty days. The court said if it viewed the waiver as a valid written agreement, prescription was waived for sixty days and the notice of assessment was issued beyond the end of that period. If, on the other hand, the waiver was not a valid written agreement because it was a “counter offer” that was not accepted by the City, the court said that would mean that no waiver was ever executed to waive prescription passed December 31, 2012, making the assessment notice untimely. The court affirmed the BTA’s granting of the taxpayer’s motion for summary judgment. City of New Orleans v. Jazz Casino Co. LLC, Louisiana Court of Appeals, Fourth Circuit, NO. 2015-CA-1150. 6/22/16
Use Tax Applies to Truck Repair Supplies
The South Dakota Supreme Court affirmed the Department of Revenue’s (DOR) assessment of use tax on shop supplies used during the truck repair process. The court found that the supplies were not purchased for resale to the customers, but, instead, were used and consumed in the repair of customers’ vehicles. The court also held that a hearing examiner did not have to consider an invoice submitted more than 60 days after an audit began because the taxpayers failed to establish that the invoice was material to the case.
The taxpayer corporation owns several truck and trailer dealerships in various cities in the state. These dealerships perform multiple services related to the lease, sale, and repair of trucks, trailers, and similar equipment. The state Department of Revenue (DOR) began an audit of taxpayer in September 2012, requesting a number of documents, including sales reports, expense invoices and sales invoices, for the reporting periods of May 2009 through April 2012. The audit determined that the taxpayer did not pay sales tax on the supplies it used at the time of purchase or use tax at the time the supplies were used and consumed and issued an assessment, which the taxpayer paid under protest. At the administrative hearing on the matter, taxpayer challenged the assessment and offered exhibits in support of its position.
DOR objected to ten of the taxpayer’s exhibits because the taxpayer did not present them to the auditor within 60 days from the beginning of the audit as required by the statute and also
objected because several of the exhibits were dated outside of the audit period. The hearing examiner excluded the exhibits because they were not timely presented.
During the hearing, the Department contended that the taxpayer had purchased shop supplies without payment of sales tax. DOR divided the shop supplies into various categories, including shop supplies consumed during the repair of customer vehicles, shop supplies used to repair customer vehicles that become part of the vehicle, and maintenance items used to repair Taxpayer-owned vehicles. DOR argued that use tax was due and owing on supplies used and consumed in the repair of customer vehicles but did not assess use tax on shop supplies that were put into customers' vehicles and left the shop with the vehicles. DOR assessed use tax on maintenance items put into taxpayer-owned vehicles either being prepared for resale or for items used to repair leased vehicles. Taxpayer argued that none of the items were subject to use tax because they were all purchased for resale and therefore exempt.
The hearing examiner affirmed the assessment, finding that the DOR properly distinguished between the categories of supplies and assessed the tax due on each and the taxpayer filed an appeal.
The taxpayer first alleged that because the DOR had unrestricted access to all of their records during the audit, prior submission of the exhibits was unnecessary and the lower court agreed regarding most of the exhibits holding that all but four were admissible. It held that Exhibit 18, a sales invoice that described the agreement for repair services including the cost of supplies used during the repair, was not from the designated audit period and was not material evidence, and the court affirmed the decision to exclude it. The lower court, however, affirmed the assessment of use tax, finding that the taxpayer was selling the repair service, not the supplies used to fulfill the service. The taxpayer filed this appeal.
The first issue raised by the taxpayer was the exclusion of the sample invoice from outside the audit period, which it argued should have been received into evidence by the hearing examiner. The court noted that the statute required that taxpayers must provide to DOR all documents evidencing reduction, deduction, or exemption of taxation to the auditor within 60 days from initiation of the audit and it was undisputed that the taxpayer was given proper notice. While DOR is not required to consider documents presented to it more than 60 days after the commencement of the audit, the statute further provides that additional pertinent documents shall be considered if they are material, there is good reason for the failure to present them within the proper timeframe, and they are submitted within a reasonable time prior to any hearing. The taxpayer argued that the invoice met all three of these requirements.
The court found that while it was true that the exhibit provided more information about the charges, it did not more clearly illustrate the taxpayer’s resale theory compared to other exhibits that were considered during the audit, and, further, it described a transaction that occurred outside the period of the audit. The court said that admission of the exhibit would not have significantly affected the hearing examiner's analysis and affirmed the hearing examiner’s decision to exclude it.
With regard to the imposition of the use tax, the taxpayers contended that the shop supplies are exempt from use tax because they are resold to customers as a part of taxpayer’s repair services, arguing that the resale of shop supplies occurs in the regular course of business and is, therefore, exempt from the use tax. The taxpayer also argued that because their customers pay the sales tax on the entire bill, the use tax assessment constitutes double taxation.
The court reviewed the definition of “sale,” citing Paul Nelson Farm, 2014 S.D. 31, 847 N.W.2d 550, a case involving customers who purchased a hunting package from an all-inclusive hunting lodge that included unlimited food, beverages and ammunition.
In that decision, the court focused on the "essence of the transaction," and agreed with the taxpayer that the goods were sold in the regular course of business. The court noted in that decision that while the hunting services rendered were likely the most important component of the sale, the customers also placed value on the tangible personal property they received.
The court here found, however, that the taxpayer’s reliance on Paul Nelson Farm was unpersuasive, distinguishing the current case from the facts in that case. The customer here gains no right or interest in the supplies that are used and consumed during the taxpayer’s repair process and the customer does not drive out of the repair shop with pieces of sandpaper, drill bits, or gloves attached to the vehicle. The court said that the supplies are consumed in the repair process, and no change of ownership occurs.
The taxpayer also argued that a "sale" of the shop supplies occurs because it entered into a contract with its customers for the sale of the supplies, relying on the language of the invoice with their customers, which indicates a fee for shop supplies. The court said it is immaterial that the taxpayer’s invoices purport to charge the customer for supplies. This contract is simply a business practice used by taxpayer to recoup the costs of the supplies. There is no "sale" as contemplated by the statute for any of the goods the taxpayer argued were wrongfully assessed. Finally, the court rejected the taxpayer’s “double taxation” argument, finding that in this case there are two separate transactions involved, and each is taxed separately. Black Hills Truck & Trailer Inc. v. Dep't of Revenue, South Dakota Supreme Court, No. 27413-a-JMK. 6/22/16
Personal Income Tax Decisions
Discretion Abused by Not Issuing Refund
The Ohio Supreme Court found that taxpayers had reasonable cause to resist paying a tax based on a reasonable but mistaken interpretation of federal statutes. The court found that the tax commissioner abused his discretion in refusing to refund the double-interest penalty.
The income at issue in this matter was tax year 2000 pass-through distributive-share income from a Subchapter S corporation whose shares were held by an electing small business trust (ESBT) under federal law. The Internal Revenue Code (IRC) permits the owners of qualifying corporations to elect a special tax status permitting the corporation and its shareholders to receive taxation comparable to a partnership. The taxpayers here interpreted the statute as requiring the imposition of the tax on the trust rather than the individual shareholder and did not report the income and pay the tax on their personal state income tax return. The taxpayers relied on a treasury regulation issued by the federal government, codified at 26 C.F.R. 1.641(c)-1(k) for their position. The state Department of Revenue took the contrary position which was ultimately upheld in decisions in Knust v. Wilkins, 111 Ohio St.3d 331, 2006-Ohio-5791, 856 N.E.2d 243; Lovell v. Levin, 116 Ohio St.3d 200, 2007-Ohio-6054, 877 N.E.2d 667; and Brown v. Levin, 119 Ohio St.3d 335, 2008-Ohio-4081, 894 N.E.2d 35. The taxpayers ultimately made payment to the state and pursued a refund of the double-interest penalty imposed on their late payment. The tax commissioner denied the refund claim on the sole ground that the taxpayers "willfully filed their return contrary to a clear Department position." The taxpayers appealed to the Board of Tax Appeals (BTA), which affirmed the denial of the refund claim.
The court first addressed the tax commissioner’s argument that the taxpayers did not have the right to seek a refund of the penalty under the former provision in the statute and found that the wording of the statute in effect at the time opened the door to a claim challenging the penalty without challenging the tax. Because the wording of the statute appeared to broaden the scope of the relief available, the court said it was bound to extend the statute's operation to its full breadth.
The state statute gives the tax commissioner discretion in his decision whether to impose or remit the penalty, and in making that decision, he considers whether the delay in payment was based on "reasonable cause" or "willful neglect." The court said that determining whether a taxpayer had reasonable cause to resist paying a tax required considering whether the taxpayer acted in good-faith reliance on a reasonable interpretation of the law. The taxpayers argued that the tax commissioner abused his discretion under the statute by basing his finding of willful neglect solely on their failure to comply with the precise instructions of an information release. The tax commissioner argued that the taxpayers willfully filed their 2000 return contrary to a clear Department position and that they failed to act in good faith because they were "made aware of the Department's change in policy" through the 2000 information release and then failed to act in accordance with its terms.
The court said that the taxpayers consistently stated throughout the proceedings that they were relying on the interpretation of the federal statute that the tax commissioner had abandoned, i.e., the interpretation that the trust rather than the grantor was to report and pay tax on the distributive-share income. The court said that the fact that the tax commissioner changed his view of the federal statute does not make the earlier reading unreasonable and by failing to acknowledge that federal law constituted an element of the taxpayers’ reasonable cause argument the lower court acted unreasonably and unlawfully in its review of the tax commissioner’s determination. The court stated that the tax commissioner's insistence that any departure from his published instructions negates the taxpayer's good faith is arbitrary. The reasonableness of the taxpayer's interpretation of the federal statute is relevant to the determination whether the taxpayer had reasonable cause to resist the tax commissioner's interpretation. The court said it did not make sense to regard the mere publication by the tax commissioner of his interpretation of federal law as establishing that the taxpayer's contrary view is unreasonable, finding that an information release does not create legal obligations by its own force. The court held that the BTA unreasonably and unlawfully permitted the tax commissioner to predicate the reasonable-cause determination exclusively on compliance with the tax department's information releases that had no force of law. The court here held that the commissioners abused his discretion in denying the refund request, appearing to reject the taxpayers’ assertion that they acted in good-faith reliance on a reasonable interpretation of the law, relying instead on the office’s information releases which the court said have no force of law.
The court heldthat the taxpayers had reasonable cause to resist paying the assessment until the announcement of Lovell, 116 Ohio St.3d 200, 2007-Ohio-6054, 877 N.E.2d 667, on November 20, 2007 (when the taxpayers were already in the process of making their payment), because the taxpayers argued that their situation was not controlled by the treasury regulation, as the claim in Knust was. In Lovell the court addressed and disposed of the claims of taxpayers who claimed to be immune because the federal regulation did not apply.
Renacci v. Testa, Ohio Supreme Court, No. 2014-1893. 6/15/16
Corporate Income and Business Tax Decisions
Court Denies Appeals Challenging Retroactive Apportionment Law
The Michigan Supreme Court has denied appeals in 50 consolidated cases challenging the state's retroactive repeal of the Multistate Tax Compact. The court, in its brief order, said it was not persuaded that the questions presented by the petitioners should be reviewed by the court.
One justice issued a dissent to this decision, saying he would have granted the appeals
because the issues raised are of considerable constitutional significance as to matters affecting the tax policy and procedures, the fiscal and business environments, and the jurisprudence of this state. He said that “[W]hile I do not yet have any firm belief regarding the constitutionality of 2014 PA 282, I do have a firm belief that before retroactive tax burdens such as those set forth in this law are imposed, the arguments of affected taxpayers deserve consideration by the highest court of this state.” Gillette Commercial Operations N. Am. v. Dep't of Treasury, Michigan Supreme Court, No. 152588. 6/24/16
Note: A number of the taxpayers in the above case have indicated that they plan to file a petition for certiorari with the U.S. Supreme Court. In the meantime, the Michigan Court of Appeals has set oral arguments for July 12 in the original compact case brought by IBM for nearly $6 million in refund claims for tax year 2008, appealing the state trial court’s holding that the state's retroactive repeal of the compact following IBM applies to the company itself for tax year 2008.
Multistate Tax Compact Not Binding on Legislature
The Minnesota Supreme Court held that the Multistate Tax Compact is constitutional and denied the taxpayer's refund claim based on the taxpayer's use of the compact's three-factor apportionment formula.
For corporate income tax purposes the state is a combined reporting state. The taxpayer has done business in the state since 1958 and has filed state tax returns since at least 1983.
During the 2007 through 2009 tax years in issue here, the taxpayer engaged in a unitary, multi-state business and therefore used an apportionment method to report its state tax liability. During the tax years in issue, the statute provided that multistate businesses could either apportion income to the state using the heavily weighted sales factor apportionment formula set forth in the statute or petition the Commissioner of Revenue to permit the use of an alternative method to determine the taxpayer's income attributable to the state.
The issue in this case is whether, during the tax years in issue, multistate businesses also enjoyed a third option, to use the apportionment formula that was part of Article IV of Minn. Stat. § 290.171 (1984), between 1983 and its repeal in 1987. This optional equally weighted three-factor apportionment formula, enacted in Minnesota in 1983, was based on model legislation that was part of the Multistate Tax Compact. Article III of the Compact allowed a multistate taxpayer to "elect to apportion and allocate his income in the manner provided by the laws of [a member] state . . . without reference to this compact" or "in accordance with Article IV" of the Compact. This article was also repealed in 1987. The taxpayer argued that by enacting section 290.171 in 1983, the option provided in Article III to use the equally weighted formula provided in Article IV was part of a binding multistate tax compact that the state was obligated to continue to make available to taxpayers unless and until the State fully withdrew from the Compact, which occurred in 2013. The taxpayer argued that the 1987 repeal of only Articles III and IV, without an accompanying full withdrawal from the Compact itself, did not terminate that binding obligation. The Commissioner argued that the Compact is advisory because it does not meet the criteria for a binding contract set out in Northeast Bancorp, Inc. v. Board of Governors of Federal Reserve System, 472 U.S. 159 (1985).
The court said that the legal issue before it was whether the Legislature's enactment of the Compact, and more specifically Articles III and IV, created a contractual obligation that prohibited the Legislature from later repealing Articles III and IV of section 290.171 without withdrawing completely from the Compact. The court said that this argument has no support in the law and that even assuming that the state undertook a contractual obligation to the taxpayer when it enacted Minn. Stat. § 290.171, the obligation was and is invalid. The state constitution, the court pointed out, states that the power of taxation shall never be surrendered, suspended or contracted away. Thus, regardless of the language of Minn. Stat. § 290.171, the state is constitutionally barred from surrendering, suspending, or contracting away its authority to amend or repeal tax provisions.
The court then turned to the language of section 290.171 and discussed the “unmistakability doctrine,” which is a rule of contract construction that provides the sovereign powers of a state cannot be contracted away except in “unmistakable terms.” The doctrine was developed in early Contract Clause cases to protect state regulatory powers. Based on this doctrine, the lower court concluded that noting in the language of section 290.171 evidenced a clear, separate, and distinct promise by the State to refrain from amending or repealing Articles III and IV of the statute without also entirely withdrawing from the Compact. The court rejected the taxpayer’s argument finding no unmistakable or express promise surrendering the state's legislative authority in section 290.171 as enacted in 1983. The court noted that the statute did provide that the Compact is "enacted into law," Minn. Stat. § 290.171 (1984), and that a member state may withdraw from the Compact "by enacting a statute repealing the same." But it pointed out that nothing in the statute dictated the "all or nothing" position advanced by the taxpayer, finding, at best, that the statute was silent on this issue. The court also said it could not conclude that the directive in Article XI to "implement" Article III of the Compact represented an unmistakable, clear promise to allow multistate taxpayers to utilize the optional apportionment formula until the state withdrew from the Compact. The court found that no provision in section 290.171 represented a clear and unmistakable promise by the state to refrain from amending or repealing Articles III and IV of the statute. Kimberly-Clark Corp. v. Comm'r of Revenue, Minnesota Supreme Court, A15-1322. 6/22/16
Property Tax Decisions
Aviation Company's Tax Break Unconstitutional
The Illinois Supreme Court found that a property tax break designed for one specific aviation company was unconstitutional, holding that the state had no reasonable basis for not letting the tax break apply to other similar companies.
The taxpayer, founded in the 1930s, is a fixed based operator (FBO) with three FBO operations in the Midwest, including one in the state. FBOs are commercial businesses allowed to operate at an airport for the purpose of supplying support services to general aviation aircraft, and typical services provided include fueling, hangaring, aircraft maintenance and repair, aircraft rental, restrooms, rest areas, and facilities for conferences and flight planning.
At issue in this case is the constitutionality of Public Act 97-1161 (eff. June 1, 2013), which amended the property tax statute to create an exemption from property taxes on leasehold interests and improvements on real estate owned by the Metropolitan Airport Authority (Authority) of Rock Island County and used by an FBO to provide aeronautical services to the public. When the law was enacted there was only one FBO leasing land from the Authority (the taxpayer) and the law was specifically designed to provide a financial incentive for that company to expand its operations at the Authority’s facilities rather than at the company’s operations out-of-state. Legislative debates were clear and unambiguous that the intent of the law was to provide property tax relief for the taxpayer so that it would have an incentive to expand its operations at the state location, rather than at a location in Iowa or some other state, and thereby improve the local economy. Equally clear was that the General Assembly did not want to extend the same property tax relief to any other operator at any other state airport.
As a direct result of the exemption, the local Board of Education (BOE) faced losing revenue from the taxpayer who had in previous years paid $150,000 annually in property taxes. The law was set to take effect on June 1, 2013 and before that date the BOE sought and obtained a preliminary injunction to block the statute's implementation pending final resolution of the case. The BOE then brought an action to block implementation of the new law on the grounds that it violated various provisions of the state constitution, including the "special legislation" clause of article IV, section 13 (Ill. Const. 1970, art. IV, § 13). The circuit court rejected BOE’s challenge to the law and concluded that it is constitutional. The appellate court reversed and remanded with directions, holding that the law contravenes the article IV, section 13 prohibition against special legislation and the taxpayer filed this appeal.
The court noted, initially, that the constitutionality of a statute is a question of law that the court reviews de novo. Statutes carry a strong presumption of constitutionality and a party claiming that a statute is unconstitutional bears the burden of proof. The special legislation clause of the state constitution states that the General Assembly shall pass no special or local law when a general law is or can be made applicable. The question of whether a general law can be made applicable is a matter of judicial determination. Citing prior case law, the court noted that the special legislation clause prohibits the General Assembly from conferring a special benefit or privilege upon one person or group of persons and excluding others that are similarly situated. Its purpose is to prevent arbitrary legislative classifications that discriminate in favor of a select group without a sound, reasonable basis. The court noted that a law does not automatically run afoul of the prohibition against special legislation merely because it affects only one class of entities and not another. Rather, the statute must confer on a person, entity, or class of persons or entities a special benefit or exclusive privilege that is denied to others who are similarly situated. The court pointed out that in assessing whether a statute violates the prohibition against special legislation, courts apply a two-part analysis. First, they must determine whether the statutory classification at issue discriminates in favor of a select group, and if it does, then they must go on to consider whether the classification is arbitrary.
The court said that the law challenged in this case clearly discriminates in favor of a select group, as the appellate court held. By its terms, the law provides property tax relief only for FBOs providing aeronautical services to the public at the MAA's Quad City International Airport, and there is only one of those, the taxpayer. No other FBO providing aeronautical services to the public at any other Illinois airport was given similar favorable treatment, and under the law, no other FBO providing aeronautical services to the public at any other state airport has the opportunity to ever obtain similar tax treatment. So, the court said, the question was whether the law was rationally related to a legitimate state interest and the court held that it was not. The justification was to induce the taxpayer to undertake an expansion in the state rather than in another state, which the court said was an unquestionably legitimate function of state government. However, the court pointed out that there was no requirement in the law that the taxpayer actually use this tax savings to expand in the state. The court rejected the taxpayer’s argument that its circumstances were unique, citing the fat that the state has many municipal airport authorities and numerous FBOs that operate near other states with a more favorable tax environment and would stand to benefit from tax incentives.
The court said that it could not reasonably conceive of anything that would justify distinguishing FBOs operating at the Quad City airport from any number of other FBOs at other state airports or even from other state businesses which operate on the borders or compete with companies in more tax-friendly jurisdictions, for purposes of property tax liability. The court held that the law presents a paradigm of an arbitrary legislative classification not founded on any substantial difference of situation or condition. Moline Sch. Dist. No. 40 Bd. of Educ. v. Quinn, Illinois Supreme Court, No. 119704. 6/16/16
Other Taxes and Procedural Issues
Landscaping Company's Gas Tax Refund Claim Rejected
The Florida Court of Appeal, First District, held that the tax on gasoline used for off-road purposes by a landscaping company did not violate the equal protection clause, finding that the statute was reasonable and based on a policy decision by lawmakers.
The state statute imposes eight separate taxes on motor fuel which is defined as, all gasoline products, any product blended with gasoline or any fuel placed in the storage supply tank of a gasoline-powered motor vehicle. The tax is precollected for administrative convenience and any taxpayer exempt from the tax may request a refund from the Department of Revenue (DOR). The statute provides an exemption from the tax for any person who uses the fuel for agricultural, aquacultural, commercial fishing, or commercial aviation purposes, as long as none of the fuel is used in any vehicle or equipment driven or operated upon the public highways of the state.
The taxpayer here is a commercial and residential landscaping company and it buys gasoline and diesel fuel from retail gas stations for its lawn care equipment. The taxpayer sought a refund for the fuel taxes it paid on gasoline for its equipment, which DOR denied. It filed an appeal and the trial court granted summary judgment for DOR. Taxpayer filed this appeal.
Article XII, Section 9(c) of the Florida Constitution authorizes a gas tax “ . . . of two cents per gallon upon gasoline and other like products of petroleum and an equivalent tax upon other sources of energy used to propel motor vehicles." Art. XII, § 9(c)(1), Fla. Const. and the taxpayer argued that this constitutional provision restricts the tax to gasoline used in motor vehicles, thereby excluding lawn equipment and other gas-powered products. The court said, however, that the phrase "used to propel motor vehicles” does not limit the scope of the gasoline tax, citing the doctrine of the last antecedent which states that "relative and qualifying words, phrases and clauses are to be applied to the words or phrase immediately preceding." Jacques v. Dep't of Bus. & Prof. Regulation, 15 So. 3d 793, 797 (Fla. 1st DCA 2009) (quoting Kasischke v. State, 991 So. 2d 803, 811 (Fla. 2008)). The court said that the phrase "used to propel motor vehicles," therefore, applies to the "equivalent tax upon other sources of energy," not to the tax "upon gasoline and other like products of petroleum."
The court also found that the plain language of the statute applies to all gasoline and there is no use-based exemption for landscaping equipment, which the taxpayer conceded.
The court also held that DOR’s decision to deny the taxpayer a tax refund did not violate the Equal Protection Clause, noting that legislatures have broad latitude in creating classifications and distinctions in tax statutes. The court noted that a statute favoring a certain class is not arbitrary if the distinction is reasonable or based upon a difference in state policy.
DOR offered non-arbitrary reasons why the Legislature might have exempted some industries from the gasoline tax, but not the landscaping businesses, including the fact that the work of the agricultural, aquacultural, and commercial fishing industries, for example, feed people. The court said that the state’s tax policy, as a result, reflected an attempt to help people afford food, which broadly benefits everyone, and that the landscaping business doesn't offer the same benefit. The court noted that the legislature remained free to extend the availability of tax refunds to gasoline used in lawn maintenance equipment, but the Equal Protection Clause did not demand it. Valleycrest Landscape Maint. Inc. v. Dep't of Revenue, Florida Court of Appeals, Case No. 1D15-3439. 6/24/16
Refunds Issued in Error Can be Recovered
The New Jersey Superior Court, Appellate Division, affirmed that the Division of Taxation (Taxation) erroneously issued refunds to two minor trust beneficiaries. The court further held that Taxation was entitled to recover the funds issued due to a clerical error.
The Plaintiffs, who are minors, are Pennsylvania residents and beneficiaries of New Jersey resident trusts created by their grandparents. The trustee paid New Jersey tax on behalf of each plaintiff on the income from the trusts during 2006 and 2007. The plaintiffs’ father then reported to Taxation that plaintiffs did not receive New Jersey source income during 2006 and 2007 and sought a refund. The refund was denied and the father sent Taxation a notice of the minors’ “wish to appeal,” alleging that they were not residents of the state and were not obligated to pay the state’s income tax for their trust income. The father failed to note that the trust income was from New Jersey resident trusts and taxation subsequently issued a refund in 2008 of all the income tax received from the trusts. A subsequent audit discovered that plaintiffs received New Jersey source income and thus were subject to New Jersey GIT, and in 2010 Taxation sent plaintiffs notices of deficiency, alleging each plaintiff's liability for unpaid 2006 and 2007 taxes including interest and penalties. Plaintiffs appealed their final determinations to the Tax Court, arguing Taxation should be bound by its decision to refund the taxes paid. They also argued it was now too late to report the payment of New Jersey taxes to the Pennsylvania taxing authority to receive a Pennsylvania tax refund, and therefore Taxation should be estopped from seeking payment. The tax court ruled for Taxation finding that there was no issue that the state statute imposes tax on state source trust income distributed or paid to a non-resident beneficiary and that Taxation had erroneously paid the refund and had statutory authority to recoup those refunds.
The court cited prior case law for the proposition that where an agency has the responsibility to take in or disburse money, the state’s common law has typically held that the agency has the inherent power to correct its mistakes. The state’s supreme court narrowed that holding to apply only to clerical errors, as opposed to errors in judgment which the tax court said referred only to an erroneous final determination of the merits of a taxpayer’s liability for tax resulting from a mistaken interpretation of substantive law. In light of these cases, the court found that the tax court properly found that the refunds at issues here were the result of clerical error. The court cited state court rules and prior case law regarding the granting of summary judgment and the limitations on the review of tax court decisions and found that the tax court’s decision granting summary judgment in favor of Taxation was well-reasoned and based on controlling precedent. Hill v. Div. of Taxation, New Jersey Superior Court No. A-1980-13T1. 6/17/16
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:
June 24, 2016 Edition
NEWS
Annual Conference Presentations
If you were unable to attend the Annual Conference this month, all presentations are now available on FTA’s website at www.taxadmin.org./presentations.
Challenge to Alabama's Online Sales Tax Rule Filed
The internet retailer Newegg has filed a notice of appeal with the Alabama Tax Tribunal, arguing the Department of Revenue's (DOR) Sales and Use Tax Rule Number 810-6-2-.90.03, entitled Requirements for Certain Out-of-State Sellers Making Significant Sales into Alabama is unconstitutional and violates U.S. Supreme Court precedent requiring a company to have a physical presence in a state before it can be required to collect and remit sales and use tax to a state. Newegg argues that it does not have physical presence in the state and all of its sales are interstate sales with orders received, processed and filled from locations outside the state.
DOR issued a press release on June 15th announcing the challenge by Newegg to the new regulation and said that the regulation was purposely designed to challenge Quill v. North Dakota and it hopes that the U.S. Supreme Court will see this as an opportunity to reconsider the physical presence standard in light of technology and the new retail economy.
Use Tax Notification Requirement Imposed on Remote Sellers
A Louisiana proposal recently signed into law requires remote retailers with more than $50,000 in in-state sales per calendar year to notify customers of their use tax obligation by January 31 of each year. It also mandates that businesses send a report of their prior year's sales to the Department of Revenue by March 1 each year. The legislation requires that the annual notice to customers contains the total amount paid by the purchaser for purchases in the preceding calendar year and, if known by the retailer, whether the property or service is exempt from the sales and use tax. The notice is required to state that the state use tax may be due on the purchases from the retailer, with payment of the use tax made on the individual’s income tax return. The annual statement submitted by the remote retailer to DOR is due by March 1 of each year and include the total amount paid by each purchaser to the retailer on sales to Louisiana purchasers.
MTC’s Draft Information Exchange Agreement for Transfer Pricing
On June 21 the Multistate Tax Commission Arm’s-Length Adjustment Service Committee reviewed a draft agreement that would facilitate the exchange of confidential taxpayer information among signatory states. That information would include nexus questionnaires, audit reports, and contingent tax liability and workpapers. The information exchanged would not apply to information received directly from the IRS under IRC section 6013(d), unless the IRS authorized the exchange. Lists of taxpayers with potential intercompany transaction issues, private letter ruling requests, and taxpayer responses to interrogatories and depositions are among the additional types of information that would potentially be subject to exchange, as would proprietary taxpayer information on intercompany pricing decisions, intellectual property values and profits, comparable industry profits, transfer pricing reports, charges, royalty rates, and the like. The draft agreement is patterned after the FTA’s Uniform Exchange of Information Agreement. Draft agreement is available on the MYC’s website at
http://www.mtc.gov/getattachment/The-Commission/Committees/ALAS/ALAS-information-exchange-draft-6-17-16.pdf.aspx.
U.S. SUPREME COURT UPDATE
Cert Denied
The U.S. Supreme Court on June 13 declined to hear Seminole Tribe of Florida v. Stranburg, U.S. Supreme Court Docket No. 15-1064, allowing the Eleventh Circuit’s decision to stand. The issue in the case was a Florida law that allows utility taxes to be passed to a federally recognized Indian tribe. The Eleventh Circuit held that Florida’s rental tax violated federal Indian law because it affected activities on tribal land, but the court ruled that the state law permitting utility companies to separately state the utility tax on a retail customer's bill does not violate federal law, finding that the legal incidence of the tax falls on the utility companies and not the tribe. See the September 4, 2015 issue of State Tax Highlights for a discussion of the Eleventh Circuit’s decision.
FEDERAL CASES OF INTEREST
No cases to report.
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Court Says SSUTA Doesn't Create Private Right of Action
The Iowa Supreme Court held that Iowa's version of the Streamlined Sales and Use Tax Agreement (SSUTA) doesn't create a private right of action by a taxpayer against an Internet retailer. The court said the SSUTA provides the exclusive remedy for disputes between consumers and retailers over a retailer’s representations about the tax consequences of transactions.
The state is a member of the SSUTA, and a tax specialist for J.C. Penney Company, Inc. (J.C. Penney) contacted the Department of Revenue (DOR) to obtain a clarification of the company’s internet sales and their “transportation and handling” charges. A DOR employee advised that freight charges are exempt from the sales tax if separately invoiced or separately stated on the bill and that shipping and handling charges, if stated as a single item and mandatory to obtain the merchandise, are part of the purchase price and subject to the sales tax. In September 2015 DOR published a newsletter clarifying the issue and said that delivery charges are exempt from the sales tax a long as they were separately stated, reasonable in amount and related to the cost of transportation.
A customer of J.C. Penney who was charged sales tax on her shipping, handling and delivery charges contacted the company who once again contacted DOR for a clarification and the company concluded that because it charged a flat fee for these charges, it did not qualify for the exemption. Two years later another customer made the same inquiry and the company gave her the same advice, but refunded the tax to her. She ultimately filed a class action lawsuit seeking, among other things, to prevent the company from charging the sales tax on its delivery charges. After that suit was filed the company remitted all the sales tax collected on these charges to DOR. The district court dismissed the injunction claim on the ground that the collection of the tax was not illegal or void but merely irregular, and such irregularity could be adequately compensated by the customer’s administrative remedy with the IDOR. The district court also held that the SSUTA did not create a private right because it would be inconsistent with the purpose of the statute and would intrude on the DOR's exclusive jurisdiction over the interpretation of tax law. The district court, at a later date, also granted the company’s motion for summary judgment on the other counts of the complaint, finding that because the company had remitted the sales tax to the state the customer’s only remedy for allegedly improperly collected tax was with the DOR. The customer filed this appeal.
The court said the first question was whether the SSUTA creates a private right of action either expressly or by implication and the second question is whether the SSUTA extinguishes the plaintiff's remaining causes of action against the retailer when the internet retailer exercises its option to remit collected taxes to the DOR. The court then discussed the history of the SSUTA and the state’s amendments to its sales tax statute to come into compliance with the agreement’s requirements, noting that the intent of the legislation was to simplify the administration of the tax to substantially reduce the burden of tax compliance for all sellers.
The court then took note of the statute’s provisions regarding refunds of the tax that provide that a purchaser can request a refund of the tax from the retailer, with documentation of the overpayment, and the purchaser does not have a cause of action against the retailer if the refund is made within 60 days. The statute also provides that the retailer has the option of remitting the tax to DOR, rather than make the refund to the purchaser. Another section of the statute then provides for the refund of an overpayment by DOR.
In this appeal, the purchaser argued that even if the statute does not expressly create a cause of action, a private cause of action should be implied from the statute under the familiar four-part test presented in Cort v. Ash, 422 U.S. 66, 78, 95 S. Ct. 2080, 2088, 45 L. Ed. 2d 26, 36-37 (1975), as modified in Seeman v. Liberty Mutual Insurance Co., 322 N.W.2d 35, 40 (Iowa 1982), and Shumate v. Drake University, 846 N.W.2d 503, 508 (Iowa 2014). The purchaser argued that a private cause of action is consistent with the purposes of the legislation, and while there might be a remedy for refund of taxes remitted to the DOR by a retailer, nothing in the statute suggests the administrative remedy should be exclusive. J.C. Penney argued that the statute does not expressly or impliedly create a private cause of action against a retailer who remits taxes collected to the DOR and further argued that the statute provides a safe harbor to the retailer. In support of its position, J.C. Penney points to appellate decisions in two states under those states' respective versions of SSUTA, Kawa v. Wakefern Food Corp. Shoprite Supermarkets and Georgia Power Co. v. Cazier, 740 S.E.2d 458, 462-63 (Ga. Ct. App. 2013).
The court noted that while the purpose of the state statute enacting SSUTA was to simplify and modernize sales tax to ease the burden on retailers, the statutory changes did not suggest that the legislation was designed to provide taxpayers with a new statutory remedy, and the court said that it did not believe the language in the statute was designed to create a private cause of action. It said that the uniform provision is best understood as being designed to ensure that in all participating member states retailers are entitled to a sixty-day notice period before a cause of action, if any otherwise exists under local law, may be brought against the retailer and concluded that the district court correctly granted J.C. Penney's motion for summary judgment on the plaintiff's statutory claims grounded in SSUTA.
The plaintiff also asserts that even if the SSUTA does not create a statutory cause of action, she still has other common law and statutory claims against the retailer for collection of excess taxes, including a statutory claim under the Iowa Consumer Frauds Act, Iowa Code chapter 714H, and common law claims of negligent misrepresentation, fraud and fraudulent misrepresentation, unjust enrichment, and conversion. The court held that the statute provides a remedy for the purchaser when the retailer has remitted the tax to DOR. The refund provision in the statute provides that DOR can pay a refund in the event that the payment was made by mistake by the person who made the erroneous payment. The statute also makes it clear that the legal incidence of the tax is on the purchaser and not the retailer who is required to collect and remit the tax to DOR. The court concluded that the state statute provides an exclusive remedy for disputes between consumers and retailers over retailers' representations to consumers about the tax consequences of transactions. SSUTA allows the retailer, when faced with a consumer complaint regarding the imposition of sales tax, to either refund the tax or to pass the funds on to the state. Once the funds are passed on to the state, the consumer has a remedy pursuant to the statute. The court said that allowing retailers to be sued over taxability questions when the retailer has forwarded the funds to the DOR is in conflict with the fundamental statutory purpose of the SSUTA.
Finally, the court rejected the plaintiff’s argument that J.C. Penney made a material misrepresentation regarding the shipping and handling charges. The shipping and handling charges were described on the company’s website as based on the total cost of the items ordered and the type of delivery requested by the purchaser and nowhere on the website did the company claim that these charges were based on actual cost. Bass v. J.C. Penney Co. Inc., Iowa Supreme Court, No. 15-0334. 6/10/16
Portion of Fitness Club's Purchases Exempt
The Texas Court of Appeals, Third District, held that a health club's purchases of items like towels and basketballs qualified for the resale exemption. The court also held that cardio machines and weight racks did not qualify for the exemption because legal title and possession was never transferred to the customers.
The taxpayer owns and operates health clubs in the state selling memberships under Membership Agreements (Agreements) granting customers access to use its facilities and amenities. The Agreements provide that the taxpayer may at its sole discretion and at any time amend the clubs' policies, including the hours of operation and facilities it makes available to members and may, upon notice and refund of pre-paid dues, terminate a member's membership and right to use its facilities and exercise equipment. Use of the large exercise equipment in the taxpayer’s facilities, including cardio machines, is limited to the taxpayer’s hours of operation and the fixed location of the equipment within the facilities, which it determines at its sole discretion. The taxpayer’s employees are charged with cleaning, repairing, and maintaining the exercise equipment although members are encouraged to wipe off equipment after using it. The taxpayer also maintains property and liability insurance covering the exercise equipment.
The taxpayer’s operation of its health clubs come within the provision of taxable "amusement services" as that term is defined in the state’s tax statute and regulations. The taxpayer filed for a refund to sales tax it paid on its purchases of certain tangible personal property for use by its members at its health clubs, claiming that the purchases were exempt at sales for resale.
The trial court rendered judgment that certain of the purchased items were exempt from the tax but that certain other items were not and the taxpayer filed this appeal.
The taxpayer argued in the appeal that the evidence showed that its purchases met the exemption requirements because members paid a monthly fee to “rent” the items. It also argued that the provisions of the statute that the trial court relied on, providing that a person performing services taxable under those provisions is the consumer of machinery and equipment used in performing the services, do not apply here because the taxpayer does not use the items at issue to “perform” any services.
The court first looked to the language of the resale exemption. The statute defines what a “sale for resale” is and specifically provides, in pertinent part, that it means a sale of tangible personal property for the purpose of reselling it with or as a taxable item in the normal course of business or the sale of tangible personal property to a person who acquires it for the purpose of transferring it as an integral part of a taxable service. The court said, therefore, that the ultimate question in the case was whether the taxpayer purchases the items at issue for the purpose of reselling or transferring them to its members as an integral part of the taxable service. The statute did not define transfer or resell and the court, therefore, looked to the plain and common meanings of those words. Based on the common definitions and meanings of these words, the court said it was not reasonable to conclude that the taxpayer purchased the exercise equipment and other items at issue for the purpose of reselling them, transferring them or offering them for lease or rental. The court rejected the witnesses’ direct testimony that the taxpayer’s intent in purchasing the items was so that they could be transferred or rented to members for use in the clubs as not dispositive and at odds with the taxpayer’s business model and operations. The court pointed to the Agreements, which it said could not reasonably be construed as leases or rental agreements. The court found that the taxpayer
retained superior legal possession of the items and merely provided access to and use of its facilities, including whatever exercise equipment may be on site and functioning at any given time, under terms and conditions completely within its own discretion for a specified monthly fee. The court held that the trial court properly determined that the taxpayer was not entitled to the "Sale for Resale" exemption for the items identified as non-exempt in its final judgment. Fitness Int'l LLC v. Hegar, Texas Court of Appeals, Third District, NO. 03-15-00534-CV. 6/16/16
Equipment Used in Extraction Not Exempt From Tax
The Texas Supreme Court affirmed a Court of Appeals decision that equipment used in oil extraction was not exempt from sales tax as manufacturing equipment finding that the equipment did not process the extracted materials by modifying or changing their characteristics. The legal database on the FTA’s website contains a discussion of the Court of Appeals decision.
This is a tax refund case and the issue is whether an oil and gas exploration and production company proved that its purchases of casing, tubing, other well equipment, and associated services were exempt from sales taxes under a statutory exemption. The trial court found that the company did not prove it was entitled to the exemption and the court of appeals affirmed that decision.
The taxpayer is an oil and gas exploration and production company and it purchased and paid sales taxes on equipment, materials, and associated services related to its oil and gas production operations for the period from January 1, 1997, to April 30, 2001. In 2009, it filed a tax refund claim with the Comptroller, contending that it was entitled to the exemption for property used in manufacturing for some of the equipment, including casing, tubing, and pumps, together with associated services. The taxpayer argued that this equipment was used in or during the process of extracting oil, gas, and associated substances (hydrocarbons) from underground mineral reservoirs, separating the hydrocarbons into their component substances, and bringing them to the surface. The Comptroller denied the refund noting a previous determination that the type of equipment at issue was used for transportation and not manufacturing.
The taxpayer asserted that hydrocarbons extracted from an underground reservoir must be separated into their component parts to produce saleable products, and the equipment at issue here was used in separating the hydrocarbons into their different components. The Comptroller argued that the taxpayer was not a manufacturer and extracting minerals and bringing them to the surface is not manufacturing. The appeals court found that the statute was ambiguous regarding what qualifies as property or services used during manufacturing and deferred to the Comptroller’s interpretation, which it said was not plainly erroneous or inconsistent with the statutory language. The taxpayer filed this appeal.
The court first addressed the issue of whether the statutory provision at issue here is ambiguous. It noted that the statute provides that the sales tax exemption applies to tangible personal property used in "the actual manufacturing, processing, or fabrication of tangible personal property." The primary disagreement between the parties was whether the equipment was used for “processing” and the court pointed out that when a statutory term is undefined as it was in this case, the term is typically given its ordinary meaning, but it must also be in harmony and be consistent with other statutory terms. The court, citing prior case law, said that if an undefined term has multiple common meanings, it is not necessarily ambiguous and the court will apply the definition most consistent with the context of the statutory scheme. The court agreed with the taxpayer that the use of the word “processing” must refer to something different from “manufacturing” and “fabrication” and that the use of the separate term “processing” indicates that the legislature understood and intended that “processing” includes matters outside the confines of “manufacturing. The court noted that the Comptroller had defined “processing” in this context as being the physical application of the materials and labor necessary to modify or change the characteristics of tangible personal property. The court found that the essence of all the common meanings of "processing" correlated with the definition adopted by the Comptroller. The court found, in context, the statutory language was not subject to multiple understandings and said the legislature intended "processing" to mean the application of materials and labor necessary to modify or change characteristics of tangible personal property.
The court then turned to the question of whether the equipment at issue here was used in processing. The court said it was undisputed that hydrocarbons undergo physical changes as they move from underground reservoirs to the surface, but the disagreement is about the role the taxpayer’s equipment plays in those changes. Hydrocarbons generally reside within porous formations or reservoirs of rock under great pressure from the overlaying earth. The taxpayer argued that the casing and tubing system both begins and continues the "processing" of hydrocarbons into separate substances of oil, gas, and condensates. The trial court found that the direct causes of the changes in the hydrocarbons were pressure and temperature changes, while the equipment was only an indirect cause of them and the court noted that the evidence supporting those findings was not challenged by the taxpayer. The court found that while the equipment unquestionably was both used in and necessary to the efficient recovery of hydrocarbons from the taxpayer’s reservoirs, there was no evidence that the equipment acted upon the hydrocarbons to modify or change their characteristics. Instead, the court found that the changes in the substances were caused not by the application of equipment and materials to them, but by the natural pressure and temperature changes that occurred as the hydrocarbons traveled from the reservoir through the casing and tubing to the surface. Southwest Royalties Inc. v. Hegar, Texas Supreme Court, No. 14-0743. 6/17/16
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Deduction Denied for Intercompany Payments
The Massachusetts Appeals Court ruled that intercompany transactions between a United Kingdom company and its U.S. subsidiaries did not qualify as true indebtedness and upheld the lower court’s denial of a deduction for the interest payments between the companies.
The taxpayer is a British electric and gas utility company that owns numerous entities in the United States, the United Kingdom, and beyond. The deferred subscription arrangements (DSAs) were financing arrangements designed by the taxpayer to take advantage of the differences in the U.S. and U.K. tax codes. The taxpayer attempted to cast the transactions as indebtedness under U.S. State and Federal tax laws, thereby reducing the taxpayer’s tax liability in the U.S., and as equity, under U.K. law, thereby reducing its taxable income in the U.K. A debenture between a U.K. entity and its foreign subsidiary is strictly prohibited by statute, under threat of criminal sanctions, and, therefore, an overriding concern in the structuring of these arrangements was the avoidance of any appearance of indebtedness in the U.K. As a result, the taxpayer drafted the DSAs as agreements among various related entities to sell and repurchase shares of stock.
The taxpayer entered into the U.S. utility market in 1998 when it acquired two companies.
In order to achieve tax efficiency in the purchase, the taxpayer created a domestic reverse hybrid, resulting in the U.S. entity being taxable as a corporation in the U.S. but was transparent, for tax purposes, in a foreign country. The taxpayer used existing affiliates, and also created several U.K. and U.S. entities in the process that issued various intercompany loans to finance the acquisition of these two companies and permitted the taxpayer to claim interest deductions in the U.S. In February 2001, the U.S. Treasury proposed regulations to restrict the use of domestic reverse hybrids, under which the interest payments made by taxpayer’s subsidiary would be treated as payment of dividends and subject to U.S. tax withholding. In the face of the proposed changes, the taxpayer sought to replace the domestic reverse hybrid with a different structure that would maintain its tax advantages. The taxpayer utilized the DSAs, which were structured as stock purchases, to retain the interest deductions and other tax benefits of the domestic reverse hybrid while avoiding creation of a debenture, as prohibited under U.K law.
Primarily at issue in this case is whether these DSAs constituted true indebtedness so that the interest paid on them qualified for the deduction allowed under the state corporate tax statute, this is, whether the service of the repurchase notice under a clause in the new structure was mandatory or merely a right and, therefore, whether the obligation to repurchase shares under the DSA, and thereby repay the funds, was an unqualified one. The court’s standard of review was whether the BTA applied the correct legal standard in interpreting the relevant documents and whether its conclusion that the DSAs did not constitute indebtedness was supported by substantial evidence.
The court found that the BTA applied the correct legal standard in defining debt as "an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage in interest payable regardless of the debtor's income or lack thereof." Overnite Transp. Co. v. Commissioner of Rev. 54 Mass. App. Ct. 180, 186 (2002), quoting from Gilbert v. Commissioner of Int. Rev. 248 F.2d 399, 402 (2d Cir. 1957). The court said that in considering whether the DSAs qualified as debt, the BTA appropriately looked to the language of the DSAs as well as the circumstances of their creation and performance. The BTA ruled, and the court concurred that the language of the document was inconsistent between the sentence that provided that buyer shall serve” and the language of the sentence that provide that “if the buyer exercises its rights” and undercut the taxpayer’s argument that the document set forth a mandatory obligation. The court said the incongruity between the first sentence and the second sentence in the clause renders the clause ambiguous on its face, because under the second sentence, the obligation to repurchase the shares was not an unqualified one. Rather, it depended on whether the right to serve the final repurchase notice was exercised. The BTA ruled that the DSAs did not mandate service of notice to repurchase the shares and so did not reflect an unqualified obligation to repay and the court concurred with that finding.
The taxpayer argued that, even if there was ambiguity, the BTA should have resolved the ambiguity by reference to extrinsic evidence, in particular the "preliminary negotiations, the conduct of the parties, and interviews between them after the contract is executed. The court found that contrary to the taxpayer’s assertion, the BTA did not apply an improper legal standard in according little weight to evidence of the subjective intent of the taxpayer’s employees and tax advisors. The court cited Alterman Foods, Inc. v. United States, 505 F.2d 873, 877 (5th Cir. 1974), quoting from Fin Hay Realty Co. v. United States, 398 F.2d 694, 697 (3d Cir. 1968) "courts look with great care to the surrounding facts and view with some suspicion declarations of intent which have the effect of maximizing the tax benefit."
The court said that the BTA could consider that these were sophisticated taxpayers whose tax advisors carefully drafted the transactions so as to yield the most beneficial tax consequences, and noted that it looked at the circumstances surrounding the transaction, most notably the legal context in which the DSAs arose. The court noted that the primacy of the taxpayers' concern to avoid a document evincing a debt was repeatedly emphasized by the expert witnesses. The court said that it was the taxpayer’s burden to prove that the DSAs constituted an unqualified obligation to repay, and the BTA properly could find that the taxpayer’s burden was not met with documents, drafted by them, that were ambiguous on that very point.
The court also rejected the taxpayer’s alternative argument that, even if not mandatory, the right to serve a notice to repurchase the shares on a fixed date was sufficient, in itself, to establish an unconditional obligation to repay. The taxpayer also argued that the BTA should have been permitted it to introduce the closing agreement document it had entered into with the IRS, which included a final determination of these deductions for the tax year at issue, and the adjustment made by the IRS in interest deductions pursuant to this agreement were relevant in this matter. The court agreed with the BTA that the closing agreement constituted the settlement of a claim and found that the BTA did not abuse its discretion in excluding the agreement. National Grid Holdings Inc. v. Comm'r of Revenue, Massachusetts Appeals Court, No. 14-P-1662. 6/8/16
State Not Bound By IRS Closing Agreement With Taxpayer
The Massachusetts Appeals Court held that the state did not have to allow a deduction for interest payments in intercompany transactions based on an IRS closing agreement that allowed for the federal deduction. The court found that the state was not bound by the agreement.
The background for this case is the court’s decision in National Grid Holdings, Inc. v. Commissioner of Rev., 89 Mass. App. Ct. (2016) (National Grid Holdings, Inc.). See above discussion of that case. This separate action arose when the Board of Tax Appeals (BTA), in hearing the first appeal, declined to admit the closing agreement taxpayer had entered into with the IRS in evidence. The undisputed facts in the case are that the taxpayer’s tax returns for the 2002 tax year were audited by both the Commissioner of Revenue (Commissioner) and the IRS. On May 1, 2007, the taxpayer entered into a closing agreement with the IRS, pursuant to 26 U.S.C. § 7121 of the Internal Revenue Code (IRC), in connection with the taxpayer’s Federal tax return. As part of that agreement, the IRS allowed a Federal deduction for a portion of the amount claimed by the taxpayer as interest on the deferred subscription arrangements (DSAs). The Commissioner determined that the DSAs on the taxpayer’s 2002 state return were not indebtedness and that payments made in connection therewith were not interest and filed an assessment, which the taxpayer appealed to the BTA. The taxpayer at its hearing attempted to introduce the closing agreement it had entered into with the IRS and the BTA denied that request and subsequently upheld the Commissioner’s assessment. This appeal was filed. The issue before the court was whether the closing agreement between the taxpayer and the IRS is binding on the Commissioner as to the deductions allowed under the state’s corporate excise tax.
The court noted that the BTA determined that the IRS's allowance of a portion of the disputed interest deductions, as part of the closing agreement, did not dictate the Commissioner's treatment of the interest payments for state tax purposes. Massachusetts deductions are determined by reference to those that are "allowable under the provisions of the Federal Internal Revenue Code" and the BTA reasoned that by permitting only some of the claimed Federal interest deductions for the DSA payments, and not all, the closing agreement did not establish that the DSA payments qualified as interest. The court said that the undisputed fact that only a portion of the interest deductions was allowed by the IRS goes against the taxpayer’s argument, noting that the taxpayer provided no proof that the claimed interest payments under the DSAs were anything but homogenous or that there was a factual basis to distinguish among them for Federal tax purposes. The court said that a deduction for the DSA payments cannot be deemed allowable under the code if some of those payments actually were allowed as deductions by the IRS while others were not. It pointed out that the distinction between allowable and allowed is not minor. The court concluded that the interest deduction provided in the closing agreement between the taxpayer and the IRS did not constitute a binding determination of the interest deductions allowable for Massachusetts corporate excise purposes. National Grid USA Serv. Co. Inc. v. Comm'r of Revenue, Massachusetts Appeals Court, No. 14-P-1861. 6/8/16
State’s Supreme Court Denies Cert in Throwout Rule Case
The Supreme Court of New Jersey declined to hear an appeal in Lorillard Licensing Co. LLC v. Div. of Taxation. That case involved the application of the state’s throwout rule, in effect for tax years 2002-2010, which the state’s appellate court ruled was unconstitutional. See the January 8, 2016 issue of State Tax Highights for a discussion of the Court of Appeals decision in this case.
Property Tax Decisions
Lower Court Ignored Evidence in Valuation Dispute
The Kansas Supreme Court held that the Court of Tax Appeals erred in determining the value of the taxpayer's residence for the 2012 tax year because it ignored evidence that the home suffered a 2.94 percent decrease in value from its prior-year valuation. The court remanded the case with directions for its proper valuation.
This case is tied to the taxpayer’s 2011 appeal of her valuation, In re Equalization Appeal of Wagner, No. 107,472, 2012 WL 3290147 (Kan. App. 2012) (unpublished opinion) (Wagner I). In 2011, the taxpayer received a Notice of Value from the County showing that, based on comparable properties and a quality rating of 4.33 good+, the appraised value of her property was $569,000. She appealed, complaining that the appraised value was higher than that of 2006 despite no improvements to the property and a "substantial downturn" in the real estate market during the interim. She filed an appeal and the Court of Tax Appeals determined that the appraised value for tax year 2011 should be reduced to $553,600. The taxpayer disagreed with COTA's determination and appealed. The Wagner I court concluded that COTA had improperly shifted the burden of proof on the quality rating issue and that COTA's underlying factual findings concerning the quality rating were not based on evidence that was substantial when viewed in the light of the record as a whole. Accordingly, the court reversed COTA's decision and remanded with directions that COTA establish the appraised value of the taxpayer’s property for 2011 based on a 4.00 good quality rating. The Wagner I decision became final in September 2012. While that case was pending, the County, utilizing a sales-comparison approach and, once more, a construction quality rating of 4.33 good+, appraised the taxpayer’s property for the 2012 tax year at $537,300 -- a 2.94% decrease from the value assessed in 2011 ($553,600) prior to the taxpayer’s successful appeal to the Court of Appeals. The taxpayer appealed the 2012 appraisal, arguing before the Small Claims and Expedited Hearings Division of COTA that the property's fair market value had fallen to $490,000. The hearing officer found in favor of the County, and the taxpayer appealed.
COTA conducted a hearing on October 11, 2012 -- after the Wagner I opinion had become final.
The taxpayer argued that based on the Court of Appeals' decision in Wagner I (remanding with orders that a 4.00 good quality rating be used for the 2011 appraisal) and the fact that she made no improvements to her home between 2011 and 2012, the County was legally required to use a 4.00 good quality rating to appraise her home in 2012. Because the County had the burden of proof before COTA pursuant to the statute, the taxpayer contends that COTA relieved the County of its burden when it failed to order that the County produce a 2012 appraisal of her property using a 4.00 good quality rating, but the court rejected this argument finding that Wagner I only involved the appraisal of her home for the 2011 tax year and concluded that for that tax year the county had failed to prove that the rating was properly applied to the appraisal. The court said that as long as the county meets its burden, Wagner I did not foreclose the possibility of a 4.33 good+ quality rating being applied to future appraisals of the taxpayer’s home. And when different tax years are involved in matters of taxation, principles of res judicata and collateral estoppel do not apply because taxes are levied annually.
The taxpayer also argued that COTA improperly rejected her argument that her home's 2012 valuation should be 2.94% less than the value assigned to it for 2011 tax year. The statute provides that when "the valuation for real property has been reduced due to a final determination made pursuant to the valuation appeals process," the valuation of the property for the next taxable year will not be increased unless the county appraiser provides "documented substantial and compelling reasons" for increasing the valuation. See K.S.A. 2012 Supp. 79-1460(a)(2). The court said that the record showed that COTA's 2012 valuation resulted from COTA merely adopting the 2011 valuation for 2012. It was never updated for the 2012 tax year to reflect market changes, nor was there a new appraisal conducted for the 2012 tax year. The court found that as evidenced by the 2011 and 2012 appraisals, which were uncontested evidence which the County produced, the taxpayer’s home suffered a 2.94% decrease in value between 2011 and 2012. The court agreed with the taxpayer that her home's 2012 valuation should reflect this reduction and reversed the Court of Appeals' decision and remanded the case to COTA with instructions that the taxpayer’s home be valued at $479,600 for the 2012 tax year. In re Equalization Appeal of Wagner, Kansas Supreme Court, No. 109,783. 6/10/16
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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