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STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
May 13, 2016 Edition
NEWS
South Dakota Sues and is Sued Regarding New Nexus Law
On April 28, 2016 South Dakota filed for declaratory judgment, naming Wayfair, Inc, Systemax, Inc., Overstock.com Inc., and Newegg, Inc., as defendants, seeking a determination that it may require the defendants to collect and remit sales tax on ales of tangible personal property and services for delivery in the state under the new law requiring remote sellers to collect the tax. On that same day groups representing online and catalog retailers filed for declaratory judgment naming the South Dakota Department of Revenue as defendant, arguing that the new law is a direct violation of the decision in Quill v. North Dakota which reaffirmed the physical presence standard for collecting sales tax.
Sales Tax Settlement With Art Collector
On May 3, 2016, the New York attorney general announced a settlement with a contemporary art collector for failure to pay sales and use taxes on art acquisitions made by his companies.
Aby J. Rosen has agreed to pay $7 million for the improper use of sale for resale tax exemption certificates on his acquisition of art by his companies.
The attorney general alleged that beginning in 2002, Mr. Rosen bought or commissioned more than $80 million worth of contemporary art, using two companies to purchase the artwork, claiming an exclusion from the sales tax for sales for resale. The state argued that Mr. Rosen used the artwork for personal enjoyment and the enhancement of his real estate business brand, displaying it throughout his residences in New York State and throughout his real estate business offices and properties.
MTC Action on Market-Based Sourcing Regulations
Multistate Tax Commission Hearing Officer Brian Hamer, former Director of the Illinois Department of Revenue, released a report with recommendations on proposed draft amendments to the MTC's model market-based sourcing regulations. The May 1 report recommends that the MTC revise its proposed market-based sourcing rules to allow taxpayers to adjust their sourcing method year to year, but does not recommend language on mediation. The MTC Executive Committee met on May 12, 2016 to discuss Hamer's report and recommendations and agreed to hold the proposal for further discussion. As a result, the MTC will not vote on adoption of the market-based sourcing model rules at its annual business meeting in July, but instead will hear from the Uniformity Committee on Hamer’s report and recommendations.
U.S. SUPREME COURT UPDATE
Petition for Certiorari Filed
Sprint Nextel Corporation has filed a petition for certiorari with the U.S. Supreme Court arguing that New York State violated the Mobile Telecommunications Sourcing Act (MTSA) by imposing sales tax on interstate mobile voice services only when bundled with other services. The petition asks the court to weigh in on the preemptive scope of the MTSA's unbundling provisions. Under New York law, interstate mobile voice service is not subject to sales tax if sold separately, but the state court of appeals decision in this case held that New York law subjects interstate mobile voice service to sales tax when charges for that service are aggregated with and not separately stated from charges for other services on a customer's bill. As a result, the taxability of interstate mobile voice service in the state turns on whether charges for that service are bundled with charges for other services. The issue is whether this state law conflicts with MTSA and is, therefore, preempted. Sprint Nextel Corp. v. New York, U. S. Supreme Court Docket No. 15-1041. 2/13/16
Note: On April 20, the New York attorney general filed a brief with the court opposing Sprint's petition for review.
FEDERAL CASES OF INTEREST
Property Transferred to LLC Does Not Qualify for Servicemembers Act Relief
The United States Court of Appeals, Third Circuit, ruled that an active-duty service member was not entitled to property tax relief under the Servicemembers Civil Relief Act (SCRA) when he transferred property to a closely held company before deploying because the property was no longer held by the service member.
The taxpayer, a longtime member of the United States Army Reserve, and his wife purchased a two-story, three-bedroom rental property in Philadelphia in 1997. He was called to active duty in December 2004 and a few months later the taxpayer and his wife transferred the property to Global Sales Call Center LLC (Global), a Pennsylvania company that is solely owned and managed by the taxpayer. The taxpayer served six months of active duty in Iraq in 2005 and three years in Afghanistan between 2008 and 2011.
In 2009 the taxpayer and Global petitioned the Philadelphia Department of Revenue (DOR) to have the property tax reduced in accordance with the SCRA, which limits any interest imposed on a servicemember’s delinquent property taxes during a period of active duty and forbids any additional penalties. DOR denied the request arguing that the SCRA does not apply to a business owned by a servicemember. The taxpayer filed an appeal with the Tax Review Board (TRB), which also denied his petition after a hearing in 2011. In 2013 the City initiated foreclosure proceedings on the property because of the failure to pay the delinquent property taxes and penalty and interest and the Court of Common Please entered judgment in the City’s favor. The taxpayer and Global filed this suit, under 42 U.S.C. § 1983, which "provides a recovery mechanism for the deprivation of a federal right by a person acting under color of state law." Hynson By & Through Hynson v. City of Chester Legal Dep't, 864 F.2d 1026, 1029 (3d Cir. 1988). The City argued that it had applied the SCRA to the taxpayer’s personal liabilities that arose during the period between his transition to active duty and his transfer of the property to Global and contended that both the taxpayer and Global lacked standing. The District Court granted the City’s motion to dismiss and this appeal resulted.
The SCRA provides a reduced interest rate on delinquent property taxes for servicemembers on active duty and bars any additional charges or interest in the guise of a penalty. These protections extend only to property owned individually by a servicemember or jointly by a servicemember and a dependent or dependents. SCRA defines a servicemember as a member of the uniformed services. The court held that under a Global I not a servicemember under the SCRA because it is not a “member of the uniformed services, and, thus, lacking standing in this matter. The court found, however, that the taxpayer did have standing to pursue this matter, but has not, and could not, state a claim for relief under the SCRA because it was undisputed that Global owns the property in question and that Global alone is responsible for the tax debt. Under state law, Global has its own legal identity, so the taxpayer may not invoke the SCRA on Global's behalf. The court rejected the taxpayer’s argument that a provision of the SCRA that circumscribed the obligations of servicemember-owned businesses helps him, noting that the provision cited by the taxpayer essentially provides that the assets of the servicemember not held in connection with the member’s trade or business may not be available for satisfaction of the obligation or liability during the servicemember’s military service.
The court did note that it was an unfortunate twist of law that the taxpayer and his wife unwittingly undermined existing safeguards to their interests by transferring their rental
Property to Global in order to protect their financial interests during the taxpayer’s period of military service. Davis v. City of Philadelphia, U.S. Court of Appeals for the Third Circuit, No. 15-2937. 5/4/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Mulch Business Not Entitled to Use Tax Exemption
The Michigan Court of Appeals held that a mulch business was not entitled to the agricultural production exemption because the taxpayer's machinery wasn't used for agricultural or horticultural production. The court did find, however, that some equipment was entitled to the industrial-processing exemption.
The taxpayer is primarily a tree service business, focusing on cutting, trimming, and removing trees and limbs, as well as clearing bushes and brush, for utility entities. At some point, the taxpayer expanded its business, converting the woody remains created by its operations into woodchips, mulch, and a product called "fines," which is highly-fertile composted soil produced as a by-product of making mulch. The Department of Revenue (DOR) issued a use tax assessment for the machinery and equipment used in making the mulch. The taxpayer paid the assessment under protest and filed an appeal, arguing that all of the property was exempt under either the statute’s industrial-processing exemption, the extractive-operations exemption, or the agricultural-production exemption. The trial court found for the taxpayer and DOR filed this appeal.
The court found that the agricultural-production exemption, which exempts, in pertinent part, property used or consumed in the tilling, planting, caring for, or harvesting of the things of the soil did not apply in this matter. The court said that for the agricultural exemption to apply the property must be used for agricultural or horticultural production and the taxpayer was not involved in the planting, growing, cultivation and care of trees and bushes.
The court then turned to the question of whether the taxpayer’s equipment and machinery qualified for the industrial processing exemption. The statute provides the exemption for a industrial processor for use or consumption in industrial processing and defines industrial processing to mean the activity of converting or conditioning tangible personal property by changing the form, composition, quality, combination, or character of the property for ultimate sale at retail use. The statute provides that industrial processing begins when tangible personal property begins movement from raw materials storage to begin industrial processing and ends when finished goods first come to rest in finished goods inventory storage. DOR argued that industrial processing did not begin until the taxpayer began moving, converting, or conditioning truck-stored woodchips.
The court found that under the plain and unambiguous language of this provision, industrial processing cannot commence until there is movement of tangible personal property from raw materials storage. The court agreed with DOR that the trees, limbs, bushes, and other woody vegetation were not being kept or retained by the taxpayer prior to severance, removal, or extraction, and the taxpayer was, therefore, not entitled to an exemption under the industrial-processing exemption for equipment and machinery used to sever, extract, or remove those woody materials. The court disagreed with DOR that the woody materials were not in "raw materials storage" until, at its earliest, when the woodchips were in the taxpayer’s trucks, finding, instead that once the taxpayer finished severing, removing, and extracting the woody materials and was holding them for chipping and grinding at jobsites, the woody or raw materials were in raw materials storage for purposes of the exemption. As a result, equipment used to move, convert, and condition the woody materials, including the chippers and grinders, was generally covered by the industrial-processing exemption.
The extractive-operations exemption defines extractive operations as the activity of taking or extracting for resale, ore, oil, gas, coal, timber, stone, gravel, clay, minerals, or other natural resource material and provides that the operation begins when contact is made with the actual type of natural raw product being recovered and includes all necessary processing operations before shipment from the place of extraction. The court found that since the trail court did not address the taxpayer’s argument regarding its entitlement to this exemption, the proper course was to remand the matter to allow the trial court to address the applicability of the extractive-operations exemption. The court aid the remand was also necessary to address the issue of apportionment between exempt and nonexempt use for the industrial processing and extractive-operations exemptions as mandated in its decision in Detroit Edison, 303 Mich App 612, a decision by the court issued after the trial court’s holding in this case. Kappen Tree Serv. LLC v. Dep't of Treasury, Michigan Court of Appeals, No. 325984. 4/26/16
Photograph Sales Are Not Taxable
The Alabama Court of Civil Appeals held that a commercial photography company did not have to collect and remit sales and use tax on its photograph sales, finding that those sales were incidental to nontaxable services.
The taxpayer operates a photography business that provides photography services to clients that are, primarily, other businesses, such as advertising and marketing firms to assist in providing imagery for advertising campaigns. There was some evidence that the taxpayer provides at least some photography services to noncommercial clients, such as wedding parties. State law requires persons selling tangible personal property to collect and remit the sales tax of the gross proceeds of the sale. The Department of Revenue (DOR) conducted an audit of the taxpayer’s sales and determined that it had not remitted any sales tax during the relevant period and DOR filed an assessment. The DOR argued that the taxpayer owed sales tax for transactions including headshots, flat-rate photography sessions, digital studio photography, portraits, weddings and reception events, without deduction for charges that may have been for creative services. DOR’s position is based in part on one of its regulations which provides that the gross proceeds accruing from retail sales of photographs, blueprints and other similar articles are subject to sales or use tax, without any deduction for any part of the cost of production. The taxpayer filed an appeal and the trial court held for the taxpayer. DOR filed this appeal.
DOR argued that the taxpayer sells tangible personal property to its clients in the form of photographs, which are, undisputedly, tangible personal property for the purposes of this appeal. The taxpayer argued at the lower court level that its transfer of photographs to its clients was merely incidental to the provision of nontaxable services and, therefore, did not constitute a taxable sale of personal property. DOR had adopted a regulation providing that the proceeds from the transfer of photographs are taxable without deduction for amounts attributable to sitting, consultation or any other activity that is done in preparation of the final product. The taxpayer argued, however, that notwithstanding that the gross proceeds of a sale include charges for "labor [and] service cost," it has been established that some transfers of tangible personal property are considered merely incidental to the nontaxable sale of services and, therefore, are not themselves taxable. The court cited Long v. Roberts & Son, 234 Ala. 570, 577, 176 So. 213, 219 (1937) for the proposition that if the transaction is essentially one for service, the fact that some materials are incidentally used in providing that service does not render it a sale of tangible property within the act. But, it noted that where the aim and end of the transaction is the passing of a tangible article from one to the other, the fact that service or materials, or both, have been put into the article, or that it is useful only to the party who receives it, does not remove such business from the scope of the act. The taxpayer cited State v. Kennington, 679 So. 2d 1059 (Ala. Civ. App. 1995), which held that the transfer by a portrait artist of painted portraits to her clients did not constitute taxable sales of personal property because, those transfers were incidental to the sale of the artist’s creative services.
The taxpayer argued that there is no meaningful distinction between the services and personal property Kennington provided to her clients and the services and property that the taxpayer provides to its clients. In support of its position, DOR cited three decisions issued by its own administrative-law division on appeals from sales-tax assessments.
The court noted that although the interpretation of a statute by an administrative agency that is charged with enforcement of the statute is persuasive, that interpretation is not binding on the court. The court was not convinced by the DOR’s attempts to distinguish prior holdings of the court,finding no meaningful difference between the services that the taxpayer provided and the services that were at issue in those cases. "Stare decisis commands, at a minimum, a degree of respect from [an appellate court] that makes it disinclined to overrule controlling precedent when it is not invited to do so." Moore v. Prudential Residential Servs. Ltd. P'ship, 849 So. 2d 914, 926 (Ala. 2002). The court affirmed the trial court’s judgment. Dep't of Revenue v. Omni Studio LLC, Alabama Court of Civil Appeals, 2140889. 4/29/16
Limestone Purchases Qualify for Further Processing Exclusion
The Louisiana Supreme Court held that a power company's purchases of limestone for ash production qualified for the further processing exclusion from sales and use tax. The court found that the dual purpose of raw materials could be considered and a by-product could be analyzed as the end product when determining the purpose of the purchase.
The taxpayer is in the business of generating electric power in the state, and as part of its business sells steam, electricity and ash. It buys limestone for the dual purpose of inhibiting sulfur, or acting as a “scrubbing agent,” in the production of electricity and producing ash. The taxpayer argued that its purchase of limestone, in conjunction with its production of ash, which it sells to LA Ash for an annual profit of approximately $6.8 million, is subject to the further processing exclusion in the state’s sales tax statute. LA Ash sells the ash to its customers for various commercial purposes, including roads, construction projects and environmental remediation.
The taxpayer argued that it was entitled to the further processing exclusion from the sales tax on it purchase of the limestone because it processes it into ash, and did not pay the tax on its purchases. The Department of Revenue (DOR) argued that it was not entitled to the exclusion and assessed the tax, and the trial court ruled for DOR finding the limestone subject to the tax.
The trial court said that it was indisputable that the technology process that the taxpayer employed in its production of electricity and steam required the use of limestone, which, unavoidably, also produces the ash that it sells. That court aid that just because the ash is an incidental by-product of that process, its production does not in and of itself permit the taxpayer to claim the exclusion from the tax. The court of appeals affirmed the trial court’s decision and this appeal was filed.
The state statute excludes from the sales tax sales of materials for further processing into articles of tangible personal property. The court said that litigation concerning the exclusion’s scope and the regulation promulgated by DOR to aid in deciphering the meaning of the exclusion clearly evidence the inherent ambiguity in the provision. Thus, the court turned to the rues of statutory construction for guidance. Tax exclusions relate to a transaction that is not taxable because it falls outside the scope of the statute giving rise to the tax. While exemptions from the tax are strictly construed in favor of the state, exclusions are construed in favor of the taxpayer. The court said that it has previously determined that the further processing exclusion was designed to eliminate the tax on the sale of a material purchased for further processing into finished products and to place the tax on the ultimate consumer of the finished product processed from the raw material. It said that the court's findings regarding the purpose of the provision, together with this provision's placement in the definition section, rather than in the exemptions provisions in the statute indicate that the legislature meant this provision to be a limitation ab initio on the definition of "sale at retail,” and thus an exclusion.
The court in International Paper, Inc. v. Bridges, 07-1151, p. 19 (La. 1/16/08), 972 So.2d 1121 set forth the analysis for determining the "further processing exclusion's" applicability to a raw material in a three-part test. Raw materials further processed into end products ate excluded from the sales and use tax provisions when: (1) the raw materials become recognizable and identifiable components of the end products; (2) the raw materials are beneficial to the end products; (3) the raw materials are materials for further processing, and as such, are purchased with the purpose of inclusion in the end products. The court, therefore, was required to determine whether the end product here was the electricity or the ash. The court said it found nothing in the law that required the end product to be the enterprise's primary product, and found that the lower courts committed legal error in not beginning their analysis with the ash as the end product, regardless of its nature as a by-product or a secondary product. The court then turned to applying the three-part test to the purchase of the limestone for further processing into ash. It found that the limestone, as an integral, component part of the ash, clearly satisfies the "benefit" prong of the test. The court, in ascertaining whether the raw materials were purchased for the purpose of inclusion in the end product (the third prong of the test), rejected the lower court’s primary purpose test, finding, instead, that there could be a dual or multiple purpose test, so long as one of those purposes was "inclusion in the end product."
The court said that the only question to ask is whether the limestone was purchased with the purpose, although not necessarily the primary purpose, of inclusion in the final product of ash, and found that the record undeniably supported an affirmative answer to this inquiry. The court further declined to adopt a compromise approach suggested by DOR, apportioning the tax exclusion based on the percentage of the material that ends up in the final product, finding that no majority opinion has ever adopted this approach, and there wasn’t any statutory authority to support this divisible taxing theory. Additionally, from a practical standpoint, the court said there was no guidance on how to divide the tax.
One justice filed a dissent, arguing the majority's reasoning would exempt all purchases for consumption where the purchaser's process results in an incidental by-product that is salvageable or saleable. Bridges v. Nelson Indus. Steam Co., Louisiana Supreme Court, NO. 2015-C-1439. 5/3/16
Service Charges on Grain Conveyor Subject to Use Tax
The Missouri Supreme Court held that service charges paid to install a grain conveyor were part of the sale of tangible personal property and subject to use tax. The court found that the statutory language was clear and the issue could be resolved without applying the true object test.
The taxpayer purchased a grain dryer and a grain conveyor for its grain elevator in the state. Due to time constraints, the taxpayer decided to hire outside help to install the dryer and conveyor and to fabricate any additional structures necessary to complete the grain elevator.
The Administrative Hearing Commission (AHC) found that the taxpayer purchased from the retailer/seller both the parts for the grain dryer and the services to assemble and install it. In a separate transaction the taxpayer hired a third party to fabricate a support structure and install the conveyor. It is that second transaction that is at issue here.
The taxpayer’s contract with the third party installer stated it was for "labor, materials and rentals to install customer supplied conveying" at the taxpayer’s grain elevator in St. Joseph. The contract delineated the transaction into five interconnected items and quoted prices for the materials and services necessary to accomplish each item. The taxpayer paid use tax on all materials and rentals charged under the contract, and it paid use tax on fabrication listed under the first item in the contract, which reflected the cost to create an extensive support structure for the conveyor. It did not pay use tax for any other service charges, including an engineering charge for the first item and generic labor charges for the remaining four items. The charges on which the taxpayer did not accrue or pay use tax totaled approximately $330,000. The Department of Revenue (DOR) conducted an audit and assessed use tax on the engineering and labor charges of the transaction between the taxpayer and the third party. The taxpayer filed an appeal and the AHC determined that the taxpayer was improperly charged tax on these disputed charges. DOR filed this appeal.
The state statute defines “sales price” as the “consideration including the charges for
services . . . paid or given, or contracted to be paid or given, by the purchaser to the vendor for the tangible personal property, including any services that are a part of the sale. . . ."
The court said that the meaning of this provision is clear and unambiguous, i.e., because charges for any services that are part of the sale of tangible personal property are included in the definition of "sales price," they are subject to use tax under this provision. In determining whether a service is part of the sale of tangible personal property, the court said it looks to the intent of the contracting parties, and it had developed a number of factors that are relevant to determining the intent of the parties, including whether the service charges are separately stated. The taxpayer argued that because the service charges were all separately stated in the contract and invoices, the services were not part of the sale of the tangible materials, and cited May Department Stores Co. v. Director of Revenue, 791 S.W.2d 388, 389 (Mo. banc 1990) in support. The court distinguished this case from the current one, finding that May considered simple transactions, which included only the cost of the purchased goods and the service costs to ship those goods. Conversely, the transaction between the taxpayer and the third party installer was complicated and extensive, involving hundreds of thousands of dollars of goods and services. The contract and invoices also separately stated charges for miscellaneous materials, other specifically listed materials, labor, and rentals. The court said that separately stating the charges for different materials and services in this case was merely a consequence of the size and complexity of the transaction, which necessitated careful bookkeeping and detailed invoices and records. The court said that the act of separately stating these charges did not demonstrate that the parties intended that the engineering and labor charges were not a part of the sale of the tangible materials in their contract. The court found that the parties’ characterization of their transaction clearly evinced their intention to treat the installer’s services as part of the sale of the tangible components of the contract.
The court rejected the finding by the AHC that the disputed charges were not subject to use tax because the materials purchased by Bartlett were negligible and were ancillary to the services, noting that the court has consistently held that the state’s sales and use tax laws do not contain a de minimis exemption or exclusion for sales of tangible personal property when services constitute a much larger percentage of the total sales price than tangible materials.
In addition the court found that the record did not support the AHC’s finding that the materials purchased by the taxpayer in this transaction were negligible, noting that the total of the costs that the taxpayer agreed were taxable accounted for more than 40 percent of the total contract.
Finally, the taxpayer argued that even if the services and tangible goods were part of the sale, under the “true object” test developed by the court, use tax as not owed because the “true object” of the transaction was the installation service. The court rejected this argument, holding that the plain language of the statute resolves the dispute without having to look to the “true object” test. Bartlett Int'l Inc. v. Dir. of Revenue, Missouri Supreme Court, No. SC95205. 5/3/16
Lower Rate Not Applicable to Donut Sales
The Missouri Supreme Court held that the taxpayer’s donut sales did not qualify for the lower sales tax rate for retail food sales because more than 80 percent of its food sales were for immediate consumption. The court said that although the donuts were sometimes consumed at a later time, they could have been consumed immediately.
The taxpayer owns and operates stores in the state that are engaged primarily in the production and retail sale of donuts. The stores offer dine-in accommodations on their premises and, in addition to donuts, the stores sell related food products such as bagged coffee bean and ground coffee, coffee and related coffee drinks and other beverages. Between April 2003 and December 2005 the taxpayer collected and remitted sales tax on its sale at the 4% rate but in 2006 took note of the provision in the statute that imposes the tax at 1% on all retail sales of food and filed an application for refund of sales tax it had remitted on retail sales of donuts, non-hot beverages, juices, milk, coffee beans, and ground coffee during the relevant tax periods. The application was denied by the Department of Revenue (DOR) and the taxpayer filed an appeal with the Administrative Hearing Commission (AHC).
While the statute provides for the reduced rate on retail sales of food, it further provides that food shall not include food or drink sold by any establishment where the gross receipts derived from the sale of food prepared by such establishment for immediate consumption on or off the premises of the establishment constitutes more than eighty percent of the total gross receipts of that establishment, regardless of whether such prepared food is consumed on the premises of that establishment. DOR argued that all of the taxpayer’s donuts should count as food prepared for immediate consumption because they were all capable of being eaten without further preparation by the customers. The taxpayer argued that donuts that were not purchased within an hour of being prepared and ready to eat, donuts sold by the dozen, and donuts that customers did not eat at the store or in transit should not be included in the 80% computation. The AHC ruled in favor of DOR on its motion for summary decision and the taxpayer filed an appeal. On appeal this court rejected both arguments and determined that food prepared for immediate consumption on or off the premises means all food that is eaten at the place of preparation and purchase, or while traveling to, or immediately upon arrival at another location without any further preparation and remanded the matter to the AHC.
On remand the taxpayer conducted an online survey in 2012 that asked its customers where and when they eat their donuts purchased from the taxpayer and introduced those results to conclude that if immediate consumption meant consumed with 60 minutes of purchases, then enough of the donuts were not immediately consumed under the 80% computation. The taxpayer also offered evidence attempting to show the 2012 survey results were equally applicable to the relevant tax periods. The AHC again denied the taxpayer’s refund, ruling that the survey did not establish, by a preponderance of the evidence, that it reflects the taxpayer’s customers eating habits during the relevant period. The taxpayer filed this appeal.
The taxpayer conceded that it had the burden of proof in the matter, but argued that the AHC’s decision was contrary to the only evidence in the record, i.e., the survey it produced.
The court said that the fact that the taxpayer had the burden of proof meant it had both the burden of production and burden of persuasion, and the taxpayer had to convince the fact-finder to view the facts in a way that favors the taxpayer. The court cited State ex rel. Rice v. Pub. Serv. Comm'n, 220 S.W.2d 61, 65 (Mo. banc 1949) for the proposition that the AHC may disregard evidence which in its judgment is not credible, even though there is no countervailing evidence to dispute or contradict it. The court held that because DOR contested the taxpayer’s evidence, it would defer to the AHC’s determinations about persuasiveness of the evidence. The court further rejected the taxpayer’s argument that the decision was against the weight of the evidence, finding that it would only reverse on an against-the-weight-of-the-evidence basis as a check on potential abuse of power in weighing the evidence in rare cases, when it has a firm belief that the decree or judgment is wrong. The court had no such belief in this case.
The taxpayer also argued that the decision was contrary to the reasonable expectations of the Genera Assembly and conflicts with a reasonable interpretation of the statute, urging the court to interpret the words “food prepared for immediate consumption” to mean only food that is prepared specifically for consumption at once, without delay. The court provided a lengthy discussion of the legislative history of the reduced sales tax rate on food and the rationale for the fairly recent addition of the language at issue here. With the addition of this language, food sold by grocery stores, and subject to the reduced rate, is much more effectively distinguished from food sold by restaurants for tax purposes. Because the addition of this language does not limit itself to "hot" food and because it expressly includes the words "on or off the premises," the court said the general purpose of the addition of the language is readily apparent, ensuring that food sold by restaurants is no longer taxable at the lower rate.
Accordingly, the court said that in keeping with the plain language of the provision and the intent of the General Assembly, if food is prepared by an establishment and regularly consumed by the establishment's customers immediately, that is at the place of purchase or while traveling to, or immediately upon arrival at another location without any further preparation, it is food prepared for immediate consumption within the meaning of the statute.
The court noted that a food that is capable of immediate consumption, such as a loaf of bread, is not necessarily a food that is indeed regularly consumed immediately, and that focusing on capability of immediate consumption is an incomplete analysis as it does not fully reach the essence of what restaurants regularly sell. The court found that the taxpayer’s donuts are regularly consumed immediately by its customers and are akin to food sold by restaurants.
The court held that the AHC’s decision denying the refund claim was consistent with the reasonable expectations of the General Assembly and authorized by law. The court concluded that the taxpayer had failed to prove that sales of food prepared for immediate consumption did not constitute more than 80% of its gross receipts. Krispy Kreme Doughnut Corp. v. Dir. of Revenue, Missouri Supreme Court, No. SC95181. 5/3/16
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Unreasonableness Exception to Addback Provision Doesn't Apply
The New Jersey Tax Court upheld the Division of Taxation's determination that a corporation must add back interest income. The court rejected the taxpayer's argument that denying an exception to the addback requirement would be unreasonable.
In 2002 the state legislature eliminated a number of so-called loopholes in the state’s corporation business tax (CBT) statutes allowing profitable companies to avoid taxation in the state. One of the loopholes eliminated was the deduction from taxable income of interest payments a New Jersey corporate taxpayer made to a related company and the legislature established five exceptions to the interest add-back requirement.
The taxpayer is a Delaware corporation with its principal office in Illinois. During the relevant tax years, plaintiff was engaged in the business of processing and marketing retail packaged foods, such as cheese, processed meat products, coffee, and other groceries throughout the United States, including in the state. The taxpayer is a direct subsidiary of its parent corporation, and the parent periodically issued public debt in the form of bonds in an aggregate amount of $9.5 billion. It transferred amounts equal to the proceeds of the bonds to the taxpayer who, in turn, used those funds to pay off a portion of its debt.
The taxpayer concedes that four of the exceptions do not apply here, but argued that it is entitled to claim the exception to the addback provision for tax years 2005 and 2006 where the taxpayer establishes by clear and convincing evidence, as determined by the director of revenue (Director), that the disallowance of the deduction is unreasonable. In this case, the Director determined that the taxpayer did not satisfy the evidentiary burden set forth in the statute to establish entitlement to an exception from the interest add-back requirement.
The substance of the taxpayer’s argument is that for all intents and purposes the debt issued by Kraft Foods Inc. is the taxpayer’s debt, thereby rendering the interest payments by the taxpayer to its parent legitimate business expenses from a transaction that is, in effect, between the taxpayer and Kraft Foods Inc.'s bondholders. From the taxpayer’s point of view, Kraft Foods Inc.'s bonds were effectively the taxpayer’s debt, on which it paid a legitimate rate of interest.
The Director argued that the statute explicitly requires a written guarantee to establish that a related company is merely serving as a conduit for a taxpayer's payment of what is, in effect, interest on the taxpayer's debt. The Director acknowledged that the Unreasonable Exception might encompass situations in which a taxpayer is, for all intents and purposes, using a related company solely as a conduit for the payment of interest on the taxpayer's debt, the Director argued that it is incumbent on the taxpayer to produce clear and convincing evidence of such an arrangement and argued in this case that he did not abuse his discretion by determining that the taxpayer failed to satisfy that burden.
The court noted that the Director viewed Kraft Foods Inc.'s issuance of bonds and the taxpayer’s execution of Promissory Notes in favor of Kraft Foods Inc. as distinct transactions. The Director pointed to the fact that the Promissory Notes do not contain a schedule for the payment of principal, do not reference Kraft Foods Inc.'s bonds, do not contain provisions making Kraft Foods Inc.'s bondholders third-party beneficiaries of the Promissory Notes, and have no recourse provisions for Kraft Foods Inc. or its bondholders in the event that the taxpayer does not make interest payments. The court also noted that bondholders have no recourse against the taxpayer in the event that Kraft Foods Inc. receives interest payments from the taxpayer but does not make interest payments to the bondholders.
The court said it could see the logic in the legislature’s exception in permitting the deduction of interest payments where the taxpayer is the ultimate obligor on the underlying debt and is using a related entity as a mere conduit to benefit from a more favorable interest rate obtained by the related entity than could be secured by the taxpayer. In such circumstances, the taxpayer is the actual debtor paying interest to the unrelated third party lender, either directly or indirectly. To satisfy that exception the taxpayer need provide only a preponderance of evidence that it has guaranteed the underlying loan.
The court said that with this exception the legislature also appeared to have recognized that there may be circumstances in which, even in the absence of evidence of a guarantee, the taxpayer may establish that it is ultimately responsible for paying interest to a third-party lender directly or through a related entity, but the legislature provided that the taxpayer has a higher burden of proof in these circumstances. It must produce clear and convincing evidence that disallowance of the interest deduction is unreasonable, consistent with the general proposition that a taxpayer bears the burden of establishing its entitlement to a claimed statutory exception from a general rule of taxability. The court found that the Director acted reasonably when he determined that the taxpayer did not meet its evidentiary burden. It produced no document suggesting that it is ultimately responsible for Kraft Foods Inc.'s debts to its bondholders. It has no obligation to Kraft Foods Inc. or to its bondholders to make interest payments on Kraft Foods Inc.'s debts, and its only legal obligation is to make periodic interest payments to Kraft Foods Inc. on the Promissory Notes plaintiff signed in favor of Kraft Foods Inc., which do not in any way refer to Kraft Foods Inc.'s bonds. The court said it was reasonable for the Director to determine that Kraft Foods Inc.'s debt was not, legally or effectively, "pushed down" to the taxpayer. Kraft Foods Global Inc. v. Div. of Taxation, New Jersey Tax Court, No. 017974-2009. 4/25/16
Property Tax Decisions
Taxpayer Not Entitled to Charitable Use Exemption
The Supreme Court of Ohio held that a taxpayer wasn't entitled to a charitable use exemption because the entity that owned the property wasn't a charitable institution and the property wasn't used exclusively for charitable or public purposes.
The property at issue here is a 163.09-acre tract owned by Roni Lee who in 2009 leased the property to a 501(c)(3) non-profit (Appellant) for a renewable term of 99 years. Under the lease, the Appellant agreed to pay Roni Lee $1 annually and assumed responsibility for all maintenance and improvements, and, in fact, by 2012 had constructed Olympic-grade athletic facilities and related improvement on about one-fourth of the property. The record reveals a close connection between Roni Lee and Appellant. Appellant’s chief executive officer, Ron Clutter, is the primary owner and managing member of Roni Lee. Clutter owns a 95 percent interest in Roni Lee; his wife owns the remaining interest. In tax year 2010, Appellant sought a real-estate-tax exemption for the entire property under the charitable-use exemption. The Appellant argued before the Commissioner that the complex serves unmet community needs. It cited as an example that the local high school uses its fields for a cost comparable to what it would pay to maintain its own fields. It also asserted that its services are available regardless of ability to pay. The Commissioner found, in denying the requested exemption, that Roni Lee uses the property for land development and commercial leasing and that there was no evidence that the Appellant is engaged in charitable activity in any substantial way, even though it is a non-profit entity. The commissioner also denied the taxpayer’s request for exemption of the undeveloped property under the prospective-use doctrine, which can exempt real property acquired with the intention of devoting it to a use that would exempt it from taxation but that has not yet begun. The commissioner noted that the taxpayer’s own exemption application stated that this land may be sold to developers for commercial use.
The Board of Tax Appeals ("BTA") affirmed and Appellant filed this appeal.
Two provisions of the state statute provide guidance here. One provides an exemption from the property tax for property, belonging to institutions, that is used exclusively for charitable purposes. The statute provides that institutions include both charitable and non-charitable organizations. If a property belongs to a charitable institution, however, it is also necessary to look at the second provision that broadens the meaning of “used exclusively for charitable purposes and was enacted to address situations where ownership and use of property do not coincide. When the legislature enacted this provision is expanded the charitable use exemption to include a situation in which an entity that qualifies as a charitable institution itself leases property to another charitable institution for charitable purposes. It does not apply when exemption is sought for property that belongs to a non-charitable organization.
The court found that the BTA reasonably determined that the property at issue here belong to Roni Lee and not the taxpayer who has a long-term leasehold interest in the property. The court noted that the close relationship between the lessor and lessee made it unclear how much control the lease transferred to the taxpayer and the terms of the lease permitted the taxpayer to improve the property only as specifically contemplated by the agreement. Under these circumstances, the court said it was not unreasonable to conclude that the property continued to belong to Roni Lee.
The court said that the first provision does not apply because the property belongs to Roni Lee who is not a charitable institution, and it then turned to the provision that requires that the owner use the property exclusively for charitable or public purposes. The court found the record supported the tax commissioner's and the BTA's findings that Roni Lee did not use the property exclusively for charitable purposes. The commissioner found that Roni Lee's use of the property is that of land development and commercial leasing and that Roni Lee used the property to lease it and also to contribute to the appreciation and development of the surrounding property owned by Roni Lee that is not subject to the lease. The court noted that the tax commissioner's final determination explained that public records indicated that Roni Lee owns 445 acres of property adjacent to the subject parcels whose value is affected by the taxpayer’s improvement of the parcels it rented. In addition, Roni Lee will retain the taxpayer’s improvements to the property when the taxpayer’s interest reverts to Roni Lee.
Finally, the court rejected the taxpayer’s argument that the undeveloped portions of the property qualify for the exemption under the prospective-use doctrine, noting that is only the prospect of an exempting use that would justify the exemption under the prospective-use doctrine. The court pointed out that even the taxpayer’s witness conceded that some of the property might be sold to developers for commercial use, which would preclude the application of the prospective-use doctrine. Geneva Area Recreational, Educ. & Athletic Trust v. Testa, Tax Comm'r, Supreme Court of Ohio, No. 2014-1778. 4/27/16
Other Taxes and Procedural Issues
Oil, Gas Regulation Struck Down
The Alaska Supreme Court struck down a Department of Revenue (DOR) regulation that separated the appeals process for valuation and taxability challenges. The court said the regulation was inconsistent with the plain language of the statute, which was meant to simplify the appeals process.
Under a DOR regulation, the State Assessment Review Board (SARB) hears appeals of oil and gas property tax valuation, while appeals of oil and gas property taxability must be heard by DOR. Three municipalities challenged this regulation, arguing that it contradicts a statute that grants SARB exclusive jurisdiction over all appeals from DOR’s assessments of oil and gas property. The lower court upheld the regulation, concluding that it was a reasonable interpretation of the statute. This appeal was filed.
After the legislature initially established this assessment scheme, all appeals of DOR’s oil and gas property tax assessments were heard by SARB. In 1986 DOR promulgated a more detailed framework to govern these appeals, creating these two paths for appeals. This regulation also modified who is granted party status in such appeals. Previously, both property owners and affected municipalities were afforded party status in all appeals, while the new regulation provides that in valuation appeals before SARB both property owners and the relevant municipality have party status, but in taxability appeals before DOR only the appellant is afforded party status.
The Trans-Alaska Pipeline System (TAPS), an 800-mile-long oil pipeline system that connects the North Slope oil fields in the state to a shipping terminal in Valdez, and en route passes through three municipalities. In February 2013 Revenue issued a notice of assessment for oil and gas property held by the TAPS owners for Assessment Year 2013 and the owners appealed the assessment, objecting both to DOR’s assessed value of the property and its determination that certain pieces of property were taxable as oil and gas property. The TAPS owners' two appeals proceeded simultaneously on two separate tracks: DOR issued an informal conference decision on the valuation appeal, which the owners appealed to SARB, then further appealed to the superior court for a trial de novo. The affected municipalities also cross-appealed SARB's decision on the valuation appeal to the superior court. Revenue issued a separate, confidential informal conference decision on the TAPS owners' taxability appeal, dismissing the appeal for lack of jurisdiction after it found that the appeal actually raised issues of valuation, which it said are within the exclusive jurisdiction of SARB. After repeatedly attempting but failing to obtain information regarding the status of the TAPS owners' taxability appeal, the affected municipalities filed complaints for declaratory and injunctive relief with the superior court, challenging the validity of DOR’s regulation governing taxability appeals from assessments of oil and gas property. The lower court denied the municipalities’ motion for summary judgment and they filed this appeal.
The court pointed out that, in the absence of any contention that the agency failed to comply with the required procedures for promulgation, the court will presume that a regulation is valid and place the burden on the challenging party to prove otherwise. The court said it considers whether the regulation is consistent with and reasonably necessary to carry out the purposes of the enabling statute and whether it is reasonable and not arbitrary. If the issue involves agency expertise the court seeks to determine whether the agency’s decision is supported by the facts and has a reasonable basis in law, even if the court may not agree with the agency's ultimate determination. If no agency expertise is involved in the agency's interpretation, the court will apply the substitution of judgment standard, where the court exercises its independent judgment substituting its judgment for that of the agency.
The court concluded that this regulation does not involve DOR’s expertise or fundamental policies, finding DOR’s expertise is in tax policy, not relative efficacy of forums or procedural needs. The court, therefore, applied the substitution of judgment standard in assessing the validity of DOR’s interpretation of the statute.
The court noted that the application of this regulation has not been consistent, pointing out that after the regulation was promulgated, SARB, which is an independent entity from DOR, continued to hear taxability appeals from oil and gas property assessments, deciding a taxability appeal regarding TAPS property as recently as 2008. The court said that given the relatively recent conflicting actions of DOR and SARB, DOR’s interpretation is not entitled to the additional deference that it affords longstanding and continuous interpretations.
The court found that DOR’s interpretation of “assessment” in the regulation is not consistent with the statutory provision, whose plain text does not distinguish between appeals involving valuation and appeals involving taxability. The court reviewed both dictionaries and texts in the field of property taxation to ascertain the meaning of “assessment,” which is not defined in the statute and determined that they contemplate the scope of the term as including not just the assigning of value to a piece of property but also the initial identification of that property as eligible for taxation. The court said that by bifurcating the review process for valuation appeals from that for taxability appeals, DOR’s interpretation of the statute changes the standard of review that the superior court affords to the administrative decision below on the issue of taxability. Under DOR’s interpretation, a property owner or municipality appealing a taxability decision by DOR to the superior court does not have a statutory right to a trial de novo, but are limited to an administrative appeal in which the decision to grant a trial de novo is left to the discretion of the superior court judge. The court noted that such discretionary de novo review is rarely warranted and is generally limited to review of due process violations at the agency level. The court said that it is unlikely the legislature would have intended for these serious consequences to arise from a distinction not provided for in the text of the statute. The court said that while the plain text of the statute is silent on the scope of the term "assessment," the text of the overall statutory scheme, the common usage of the term "assessment" in the property taxation context, and the significant consequences of DOR’s interpretation of the statute lead it to conclude that the statute's text indicates that "assessment" encompasses the initial taxability determination. The court further said that it was exceedingly unlikely that the legislature intended to create a bifurcated appeal process without expressly doing so.
The court held that DOR’s interpretation of the statute through its regulation was inconsistent with the statute's text, legislative history, and purpose, rendering the challenged regulation invalid because it has no reasonable basis in the statute and thus falls outside of DOR’s statutory authority. City of Valdez v. Alaska, Alaska Supreme Court, Supreme Court No. S-15840. 4/29/16
Costs of Capital Deductible in Calculating Severance Tax
The Colorado Supreme Court held that the costs of capital associated with the processing and transporting of oil and natural gas are deductible against revenue in calculating severance taxes. The court held that the statute plainly says that all costs associated with transportation, processing, and manufacturing are deductible.
The state statute levies a taxon income derived from the sale of natural gas extracted from Colorado, and permits taxpayers to deduct any transportation, manufacturing and processing costs from revenue in valuing the oil and gas resources for purposes of the tax. The issue in this case is whether this provision permits a deduction for the "cost of capital" associated with natural gas transportation and processing facilities, that is, whether the amount of money that an investor could have earned on a difference investment of similar risk can be deducted. In this case, the cost of capital is the amount of money that the taxpayer’s predecessors could have earned had they invested in other ventures rather than in building transportation and processing facilities. The taxpayer filed amended severance tax returns for tax years 2003 and 2004 seeking to deduct the cost of capital related to its transportation and processing facilities from revenue generated by natural gas sales. The Department of Revenue (DOR) denied the refund and argued that the cost of capital was not a deductible cost because it is not an actual cost and the court of appeals held that the cost of capital is not a deductible cost under the statute. BP Am. Prod. Co. v. Colo. Dep't of Revenue, 2013 COA 147, ¶ 29, __ P.3d __.
The severance tax statute levies a tax on income produced from the sale of nonrenewable natural resources extracted from land in the state. It taxes the value of nonrenewable natural resources, such as oil and natural gas, extracted or severed from real property in the state, with the aim of taxing the value of the resource at the point at which it emerges from beneath the earth’s surface, i.e. the “wellhead value.” Calculating the wellhead value is problematic because the resource is not sold until after it is transported and processed at a market at another location, requiring a taxpayer to look back and calculate the wellhead value after it has been transported, processed and sold. The state’s statute provides a method for doing this using the “netback approach,” which allows extractors to deduct from revenue any transportation, manufacturing and processing costs when valuing the resource. In this case, the bas was transported from the wellhead in the southern part of the state to processing facilities in other states and then sold.
The court looked to the plain meaning of the statute to determine the legislative intent of the provision at issue here. The court noted that it may consider and even defer to an agency’s interpretation of the statute, but it is not bound by the agency’s interpretation and deference is not warranted when the agency’s interpretation is contrary to the statute’s plain language.
The state’s severance tax statute grants a deduction for "any transportation, manufacturing, and processing costs." The court of appeals in holding for DOR held that the statute was ambiguous because the term "costs" is reasonably susceptible to different interpretations, and relied on several prior decision interpreting the words "cost" or "costs" in various statutory and contractual contexts in reaching this conclusion. The court here noted that in each case that the court relied on, however, the words "cost" or "costs" were not modified by the adjective "any," which the court said changes the context of the word “costs.” As a result, the court concluded that those cases were distinguishable because any ambiguity would have been eliminated if the word "costs" had been preceded by the adjective "any," as it is in this case. The court cited Stamp v. Vail Corp., 172 P.3d 437, 447 (Colo. 2007) which held that when used an as adjective in a statute, the word “any” means “all.” The court also held that the noun “costs” is unambiguous in this context. The court concluded that all transportation, manufacturing, and processing costs are deductible under the statute.
The court then turned to the issue of whether the cost of capital is a transportation, manufacturing, or processing cost under the statute. Generally,the cost of capital is the amount of money that an investor could have earned on a different investment of similar risk. In this case, the cost of capital is the amount of money that the taxpayer’s predecessors could have earned had they invested in other ventures rather than in building transportation and processing facilities, and recognizes that the investors had investment choices when they made the investment. The investment in other ventures must be of similar risk and must be calculated over the time period beginning with the initial investment in the new facilities and ending with the first depreciation deduction for the same facilities. The court noted that if the taxpayer’s predecessors had purchased existing facilities to service their wells, then they would have immediately begun to recover the cost of their investment through depreciation deductions and could have invested the proceeds in another investment and earned a return on that investment years before they could begin to recover their investment to build the facilities. The court also noted that this would be true if the predecessors had chosen to pay a third party to transport and process the natural gas because the amounts paid to the third party would be transportation, manufacturing, and processing costs which are deductible under the severance tax statute.
The question in this case is whether the amount that the taxpayer’s predecessors could have earned or recovered from an alternative investment, the cost of capital, is a transportation, manufacturing, and processing cost under the severance tax statute. The court rejected DOR’s argument that the cost of capital is not an actual cost, but, instead, a benefit forgone to pursue a difference opportunity, finding that the plain language of the statute does not support this position. The court said that because the predecessor companies invested in transportation and processing facilities, but have not recovered the cost of capital associated with their investment, the taxpayer is now entitled to deduct that cost given that the statute permits a deduction for "any transportation, manufacturing, and processing costs." The court also noted that other authorities have determined that the cost of capital is a cost, including the property tax and the valuation of oil and gas production for royalty payment purposes.
The court reversed the court of appeals decision and remanded the case with instructions to return the case to the district court for proceedings consistent with the opinion. BP Am. Prod. Co. v. Dep't of Revenue, Colorado Supreme Court, No. 13SC996. 4/25/16
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:
April 29, 2016 Edition
NEWS
Not Too Late to Register for FTA Annual Conference
There is still time to arrange to attend the Annual Conference scheduled for June 12th through 15th in Annapolis, Maryland. Functions include the opening reception on the Naval Academy grounds and an opportunity to tour the Academy Sunday afternoon. The agenda is packed with topics of interest to tax administrators. Check it out on our website, www.taxadmin.org.
U.S. SUPREME COURT UPDATE
Court Splits on Jurisdiction Issue and sets Limitation in Awarding Damages by Nevada Against California
In the continuing litigation in California Franchise Tax Board v. Hyatt, the U.S. Supreme Court, in a decision written by Justice Breyer, held that Nevada may not award a damages amount payable by California to the taxpayer that exceeds what Nevada would be liable for under its own laws, and vacated and remanded the Nevada Supreme Court's latest opinion. The Court affirmed the Nevada courts' jurisdiction over a California state agency in the case. See prior issues of State Tax Highlights for a discussion of this and related Hyatt cases.
The taxpayer claimed that he moved from California to Nevada in 1991, but the Franchise Tax Board of California (FTB) argued that he actually moved in 1992 and assessed taxes, penalties, and interest. A series of Hyatt cases has resulted. In this case, the taxpayer filed suit in Nevada state court, pursuant to the court’s ruling in Nevada v. Hall, 440 U. S. 410, which held that one State can open the doors of its courts to a private citizen's lawsuit against another State without the other State's consent. The current suit argued that Nevada had jurisdiction over California, and sought damages alleging abusive audit and investigation practices by the FTB. The FTB asked the court to overrule Hall and hold that the Nevada courts lacked jurisdiction to hear the lawsuit. The FTB also argued that the Nevada Supreme Court’s decision to award damages to a private citizen in a greater amount than Nevada law would permit a private citizen to obtain in a similar suit against Nevada's own agencies should be reversed.
The court noted that the FTB recognized that, under Hall, the Constitution permits Nevada's courts to assert jurisdiction over California despite California's lack of consent, but had asked the Nevada courts to dismiss the case on other constitutional grounds, pointing out that California law provided state agencies with immunity from lawsuits based upon actions taken during the course of collecting taxes. It argued that the Constitution's Full Faith and Credit Clause required Nevada to apply California's sovereign immunity law to the taxpayer’s case, but the Nevada court rejected this claim, holding that Nevada's courts, as a matter of comity, would immunize California where Nevada law would similarly immunize its own agencies and officials, but they would not immunize California where Nevada law permitted actions against Nevada agencies, say, for acts taken in bad faith or for intentional torts. In a prior appeal to the Supreme Court, the court reviewed that decision and affirmed it. Franchise Tax Bd. of Cal. v. Hyatt, 538 U. S. 488. On remand the case went to trial and a jury found in favor of the taxpayer and awarded him almost $500 million in damages and fees and the FTB filed an appeal. The Nevada Supreme Court rejected the FTB’s argument that the Constitution's Full Faith and Credit Clause required Nevada to limit damages, but it reduced the award to $1 million as compensation for fraud.
The court considered two issues in this matter. The first question was whether to overrule Hall and the second was, if the court did not overrule that decision, whether the Constitution permits Nevada to award Hyatt damages against a California state agency that are greater than those that Nevada would award in a similar suit against its own state agencies. The court came down 4-4 on the issue of the Hall decision, which required it to make a ruling on the second issue.
The court found that the Nevada Supreme Court applied a special rule of law that evinces a “policy of hostility” against California, and, in doing so, violates the Constitution’s requirement that "Full Faith and Credit shall be given in each State to the public Acts, Records and judicial Proceedings of every other State." Nevada had previously permitted Hyatt to sue California in Nevada courts, and Nevada's courts recognized that California's law of complete immunity would prevent any recovery in this case. The Nevada Supreme Court consequently did not apply California law. It applied Nevada law instead and the Supreme Court previously upheld that decision as consistent with the Full Faith and Credit Clause. But the court found in the current case that the Nevada decision embodies a critical departure from its earlier approach because it has not applied the principles of Nevada law ordinarily applicable to suits against Nevada's own agencies. Rather, it has applied a special rule of law applicable only in lawsuits against its sister states. The court said that the special rule allowing damages awards greater than $50,000, is not only opposed to California law, it is also inconsistent with the general principles of Nevada immunity law. The court noted that the Nevada Supreme Court explained its departure from those general principles by describing California's system of controlling its own agencies as failing to provide adequate recourse to Nevada's citizens, but found that what it describe as a conclusory statement cannot justify the application of a special and discriminatory rule. The court said that viewed through a full faith and credit lens, a State that disregards its own ordinary legal principles on this ground is hostile to another State. The court found that Nevada had not offered sufficient policy considerations to justify the application of a special rule of Nevada law that discriminates against its sister States, and the Nevada rule reflects a constitutionally impermissible policy of hostility to the public Acts of a sister state. The court vacated the state court’s judgment and remanded the case for further proceedings not inconsistent with its opinion.
Chief Justice Roberts issued a dissent saying that the Court's decision was contrary to its precedent holding that the Clause does not block a State from applying its own law to redress an injury within its own borders. The dissent says the decision also departs from the text of the Clause, which requires a State to give full faith and credit to another State's laws and in this case the court permitted only partial credit. Franchise Tax Bd. of Calif. v. Hyatt, U.S. Supreme Court, Docket No. 14-1175. 4/19/16
FEDERAL CASES OF INTEREST
No cases to report.
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Bill Pay Services Not Subject to Sales Tax
The Texas Fourteenth Court of Appeals held that bill pay services sold by the taxpayer to banks were excluded from sales tax as nontaxable services. The court said the statute excludes from data processing services providers of professional services who use a computer to facilitate the performance of services.
The taxpayer contracted with several banks to provide bill pay services through these banks' on-line banking services to the banks' customers. The Texas State Comptroller (Comptroller) filed a sales and use tax assessment against the taxpayer for failure to collect the sales tax on its sales of these services to the banks. The taxpayer paid the assessment and filed a claim for refund. The trial court held for the taxpayer, making detailed findings of fact and legal conclusions hat the transactions at issue were “bill pay services” that were not taxable data processing services as defined by the state statute. The Comptroller filed this appeal.
The court cited case law holding that while the Comptroller has been granted exclusive jurisdiction to interpret what taxable services, including data processing services, means for the purposes of the sales and use tax statute, the Comptroller may not interpret this term in a manner contrary to the tax code. The legislature has provided examples of what the term "data processing service" includes and the Comptroller has promulgated a rule to interpret what data processing services include and what they do not include. Information provided by the taxpayer through testimony at the trial and at depositions indicate that the services provided by the taxpayers in these contracts focused on provision of the electronic delivery platform used to facilitate the performance of the bill pay service provided to the bank's customers, the actual bill pay service, and other aspects of the transactions, such as invoices, reports, and customer service that were provided to the banks and the bank's customers. The taxpayer provided the banks with a dedicated connection that was owned and operated by it and the taxpayer monitored and supported the network hardware, software, and mainframe operations. The taxpayer employed thousands of professionals who monitored transactions to prevent fraud and to ensure compliance with banking regulations and also provided professional support directly to the banks' users in cases where payments were not made as instructed. The technology platform through which the bill pay services operated was neither sold nor licensed to the banks. Services to the banks for which taxes were assessed included invoiced charges for monthly infrastructure fees; fees for paper and electronic transactions; processing charges for new subscriber set-ups; processing charges for non-sufficient funds, stop payments, and claims; subscriber fees for active and inactive users; subscriber fees for banking and bill pay; monthly minimum charges; service hosting fees; processing charges for telecommunications minutes and VPN lines; and transaction fees for excess payments and excess sessions.
The court said that the trial court's findings and conclusions properly focused on the "essence of the transaction" at issue, rather than simply the involvement of a computer, to determine the nature of the services the taxpayer provided. The court said that in accord with the Comptroller's rule, the trial court was required to determine whether the taxpayer provides professional services that are facilitated by the use of a computer and does something more than "compiling and producing records of transactions, maintaining information, and entering and retrieving information." The court said a key finding by the trial court that the taxpayer had thousands of skilled and/or certified professional who collaborated in the performance of these professional services centered on bill payment. The court said another key finding is that the delivery platform for the bill pay service is not the service that the taxpayer sells to the financial institutions. The technology and equipment are part of the delivery platform for the service, or inputs that produce the service, but they are not the service.
The court also found that none of the transactions for which the taxpayer was audited and paid taxes fall clearly within the activities enumerated in either the applicable statute or agency rule. The trial court's findings established that, to the extent that the taxpayer provided any of these services taxable under the statute and rule, they were ancillary to the professional bill pay services provided by the taxpayer for the bank's customers. The court said that despite its de novo review of the statute and agency rule at issue here, it nonetheless must defer to the trial court's unchallenged fact-findings regarding the nature of the activities in this case. And these findings established that the taxpayer provides a professional service, facilitated by the use of computers and an electronic commerce system that requires the oversight and management of thousands of certified specialists to achieve the goal of paying the bills of the banks' customers. Hegar v. CheckFree Serv. Corp., Texas Fourteenth Court of Appeals, No. 14-15-00027-CV. 4/19/16
Personal Income Tax Decisions
Return Not Signed by Commissioner Valid
The Minnesota Supreme Court held that returns filed by the commissioner of revenue (Commissioner) on behalf of a taxpayer do not have to be signed by the commissioner in order to be valid. The court also ruled that the tax court had jurisdiction to hear the dispute and did not err in granting the motion for summary judgment filed by the Commissioner.
On May 12, 2014, the Department of Revenue (DOR) notified the taxpayer that their records reflected that he had not filed income tax returns for 2008 through 2010 and requested that he respond by filing the returns or providing documentation why he was no required to file. The notice warned the taxpayer that if he did not respond, DOR would prepare returns on his behalf, pursuant to statutory authority. He responded by stating that federal law does not impose liability for individual income taxes and because he did not consider himself to be a “person” required to file a return under the IRC, he was not a “taxpayer” under state law.
DOR prepared and filed returns for him based on information available regarding his income and mailed him Notices of Commissioner Filed Returns for the years at issue. The notices were signed by DOR’s Assistant Director of the Income Tax and Withholding Division and provided a breakdown of the taxes owed, noted the taxpayer’s right to appeal the amount assessed, and included contact information for the DOR.
The taxpayer requested copies of the original Commissioner filed returns and a DOR representative explained that the return is electronically generated and is not a paper document. The taxpayer filed an appeal, arguing that because the returns did not contain the Commissioner’s signature, they were invalid and unenforceable. He further argued that the Commissioner was, therefore, attempting to extort money from him and violated his due process rights. The Commissioner argued that the taxpayer’s claim lacked a legal basis because no statute or rule requires that commissioner-filed returns be signed and the tax court granted the Commissioner's motion, finding that the returns were validly "made" and "assessed" pursuant to the statute and the lack of a manual signature was of no consequence. The taxpayer filed this appeal.
The court reviewed the tax court’s legal conclusions de novo to determine whether the court had jurisdiction, whether the evidence and the law supported the court’s decision, and whether the court committed any error of law. The Commissioner argued here that the "date of assessment" for commissioner-filed returns is not dependent on the Commissioner's signature, but is set by statute as the date of the return made by the Commissioner. The state statute § 270C.62 defines the "date of assessment" for purposes of the tax collection provisions of Chapter 270C and as applied to commissioner-filed returns, the "'date of assessment' means the date . . . of the return made by the Commissioner." The statute in § 270C.33, which deals more broadly with commissioner assessment procedures, further notes that all orders and decisions respecting any tax, assessment, or other obligation, must be in writing and entered into the records of the commissioner to be valid. The court said that the legislature did not mention a signing requirement in either provision, and the court cannot read such a requirement into the statute.
The court noted that the legislature requires signatures for other types of assessment documents, in contrast to the provisions related to commissioner-filed returns, which the court said indicates that the validity of commissioner-filed returns does not depend on a signature.
Had the legislature intended to require the Commissioner's signature for commissioner-filed returns, it would have done so explicitly just as it did for orders of assessment and property tax assessments. The court held that based on the plain language of the statute, the date of assessment for a commissioner-filed return does not depend on or require the Commissioner's signature. The taxpayer argued that under the rule promulgated by DOR, there is no assessment date without a signature, but the court pointed out that if the rule conflicts with a statute, the statute controls. The court said it recognized that the rule has coexisted alongside the statute, without change, for many years, but said that intervening legislative action had made the rule's signature requirement obsolete.
The taxpayer also argued that because the printouts he received did not contain a signature or any other identifier linking them to the DOR there was no evidence to prove that the Commissioner was involved in the making of the alleged returns and that he, therefore, was deprived of his due process rights. The court rejected this argument, noting that DOR mailed the taxpayer three documents, all dated August 11, 2014, and each titled "Notice of Commissioner Filed Return," informing the taxpayer that because he had failed to file his returns for the years in question, the commissioner-filed returns were prepared on his behalf. The court pointed out that these notices further informed him of the taxes, penalties, and interest owed, and explained, in detail, what a commissioner-filed return is and how to appeal the assessment and each was signed by the Assistant Director of Income Tax and Withholding of the Department. These notices, separate from the printouts he received, were sufficient to provide the taxpayer with notice of his liability, consistent with his due process rights. Berglund v. Comm'r of Revenue, Minnesota Supreme Court, A15-0957. 4/13/16
Corporate Income and Business Tax Decisions
Assessment Not Precluded by Res Judicata
The Michigan Court of Appeals held that a taxpayer's assessment for taxes due under the Single Business Tax Act (SBT) wasn't actually litigated in a prior proceeding. A ruling on the merits, therefore, was not precluded by res judicata or collateral estoppel.
In 2008 the Department of Revenue (DOR) conducted an audit of taxpayer and its two sister companies, all owned by the same individual. The audit concluded that all three companies were Professional Employer Organizations (PEOs) and had been improperly characterizing themselves as Payroll Service Companies (PSCs), requiring that significant compensation be added to each company's tax base. Assessments were issued against each of the three companies. In the present case, DOR issued a final assessment against the taxpayer before any informal conference took place and the taxpayer filed a challenge before the Michigan Tax Tribunal (MTT) which held this case in abeyance pending the outcome of the other two related taxpayers’ motion for summary judgment. The MTT granted judgment in favor of DOR and the related companies filed an appeal. This court ruled that the MTT had erred
In not considering affidavits presented by the companies and remanded the matter to the MTT. On remand, the MTT considered the affidavits of the CPA and of other employees, which set forth factual averments favorable to a conclusion that the Beacon companies and petitioner operated as PSCs. The MTT concluded that, because the DOR had submitted no evidence to contest those affidavits, the affiants' statements governed resolution of the cases, and it granted summary disposition to the Beacon companies, canceling the final assessments that the Department had issued.
The MTT then lifted the order of abeyance, and petitioner's case proceeded forward. The DOR filed a motion seeking permission to take depositions of the affiants who had executed the affidavits upon which the MTT had relied in deciding the Beacon cases. Petitioner filed a response and a motion for summary disposition, arguing, on the basis of res judicata, collateral estoppel, and judicial estoppel, that the DOR was precluded from conducting any further discovery or from mounting a defense in this case and was barred from challenging the credibility of the affiants because it had chosen not to do so in the Beacon cases and had represented that its only argument against those affidavits was the parol evidence rule, an argument that this Court had rejected. DOR argued that the present case concerned a different matter with different parties and different factual issues. The Department presented evidence in the form of filings petitioner had submitted in a federal court case as well as filings with certain state and federal government agencies. In all of these filings, petitioner made statements consistent with it being a PEO as opposed to a PSC. The MTT concluded that res judicata and collateral estoppel precluded the DOR from defending its assessment in this action or from introducing additional evidence challenging the credibility of the affiants.
The MTT ruled that, because the taxpayer and the Beacon companies shared a common owner, petitioner was in privity with the Beacon companies. The MTT further determined that because the material language in petitioner's CSAs was the same as the material language in the Beacon companies' CSAs, with the exception of party names and dates, the same claims and issues were present in this case. On the matter of collateral estoppel, the MTT concluded that the credibility of the affiants could not be challenged in this case because their credibility was an issue of fact that had already been litigated and resolved in the Beacon cases and that mutuality of estoppel existed because petitioner would have been bound had the Beacon cases been decided differently. DOR filed this appeal.
The court cited Sewell v. Clean Cut Mgt, Inc, 463 Mich 569, 575; 621 NW2d 222 (2001) for the proposition that res judicata bars a subsequent action between the same parties when the evidence or essential facts are identical. The doctrine precludes litigation of a second action when the first action was decided on the merits, the matter contested in the second action was or could have been resolved in the first, and both actions involve the same parties or their privies. The court noted the state’s supreme court decision in Banks v. Billups, 351 Mich 628, 635; 88 NW2d 255 (1958), which held that if a party fails in making a full presentation of his case, whereby the judgment has passed against him, he cannot be permitted to make a better showing in a new suit. The court in the current case found that, accordingly, res judicata is potentially applicable, and said that the applicable questions here are whether this action involved the same parties or their privies as the Beacon cases and whether the matter in this action could have been resolved in the Beacon cases. The court found that the taxpayer was not a privy because it was not in a principal/agent, master/servant, or indemnitor/indemnitee relationship with the Beacon companies, nor did the taxpayer acquire an interest in the Beacon judgments through inheritance, succession, or purchase. The fact that the taxpayer and the Beacon companies were commonly owned and controller by the same individual and were functionally interrelated did not create privity.
The court noted that the MTT relied on an opinion issued by the United States Court of Appeals for the Sixth Circuit, which divided the concept of privity into three categories: (1) a successor in interest to a party that was subject to a judgment; (2) a nonparty who actually controlled the original suit in which a judgment was entered; and (3) a nonparty who was adequately represented by a party in the previous litigation, and found that the taxpayer fit into the second category. The court held that even if it assumed privity existed on the basis of nonparty control or on the basis that taxpayer, as a nonparty in the Beacon cases, was adequately represented by the Beacon companies, reversal of the MTT decision was still required because the matter contested in the instant case was not and could not have been decided in the Beacon cases. The court said the procedural posture of this case precluded the DOR from having the taxpayer’s tax liability determined earlier in the Beacon cases, because the MTT had held the instant case in abeyance while deciding the Beacon cases, subsequently lifting the abeyance order so petitioner's case could proceed. Further, the court said that the claims and issues existing between the DOR and the taxpayer did not stem from the same transactions in the Beacon cases.
Collateral estoppel prevents relitigation of issues, and the court noted here that the issue in the Beacon cases was whether the Beacon companies were PEOs or PSCs, not whether the taxpayer was a PEO or PSC. It said that the question of whether the taxpayer was a PEO or PS was not actually determined in the Beacon litigation and, therefore, collateral estoppel did not apply here. The taxpayer also argued the doctrine of judicial estoppel which provides that a party who has successfully and unequivocally asserted a position in a prior proceeding is estopped from asserting an inconsistent position in a subsequent proceeding. The court said that there must be some indication that the court in the prior proceeding accepted the party's position as true, which did not happen in this case because DOR did not present a successful argument in the Beacon cases. The court said that DOR was not advocating an inconsistent position in this case, but simply attempting to bolster its position with additional arguments and evidence.
The court found that granting the taxpayer summary disposition under the statute was improper because there was a genuine issue of material fact in the matter.
The evidence was conflicting regarding whether the taxpayer was a PEO or a PSC. The affidavits of the taxpayer’s owner, CPA, and employees all asserted that the taxpayer was a PSC. However, the DOR introduced evidence suggesting that in past federal court filings and in various other state and federal filings, the taxpayer made statements consistent with it being a PEO. The court said that granting summary disposition was premature because it was granted before discovery was complete. The depositions that DOR had requested could potentially undermine the taxpayer’s claims, with a direct bearing on whether the taxpayer was a PSC or a PEO. The court held that the fact that the DOR was unsuccessful in the litigation brought by the two Beacon companies did not mean that it was precluded from defending the suit brought by the taxpayer to the fullest extent possible. The DOR’s decision not to conduct additional discovery in the Beacon cases did not bar it from conducting fuller discovery in this case or from changing its litigation tactics from those used in the Beacon cases. Better Integrated Sys. Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 325001. 3/23/16
Margin Tax Calculation Decision Reversed
The Texas Supreme Court held that the state's margin tax statutes unambiguously provide that "only the net gain" of sales of investments should be included in the apportionment factor's denominator for the margin tax calculation. The court said and the comptroller improperly required businesses to include net gains and net losses and reversed the decision of the Court of Appeals. See a prior issue of State Tax Highlights for a discussion of the Court of Appeals decision.
The franchise tax is imposed on each taxable entity that does business in Texas or that is chartered or organized in Texas. The tax is calculated by applying a tax rate to the entity's taxable margin, a term defined in the statute. Taxable margin is determined by multiplying a business's total margin by an apportionment factor, the numerator of which consists of receipts from business conducted in the state and the denominator of which consists of receipts from all business anywhere, including business in the state. The figure in dispute in this matter is the denominator of the apportionment factor, or the taxpayer’s gross receipts from its entire business, applicable to the taxpayer for the tax year in question. The statute provides that if an entity sells an investment or capital asset, the gross receipts include only the net gain from the sale. The comptroller adopted a rule requiring businesses to include net gain or a net loss. The taxpayer contends that for the year in question they suffered net losses on their sales of investments and capital assets and the losses should not have been subtracted from their total receipts to obtain their gross receipts in the denominator, effectively reducing their apportionment factor. The Court of Appeals held that the statute was ambiguous and that the rule promulgated by the Comptroller providing that if the combination of net gains and losses results in a net loss, the taxable entity should net the loss against other receipts, is a reasonable construction of the statute and is in accord with the statute's plain language. The taxpayer alleged that the Comptroller misinterpreted the phrase "net gain from the sale" in the code.
The court acknowledged that the Comptroller is charged with administering the franchise tax and has broad discretion to adopt rules for its collection as long as those rules do not conflict with state or federal law. In reviewing the rules of statutory construction the court said its goal in interpreting any statute was to ascertain and give effect to the legislature's intent as expressed by the language of the statute, with the presumption that the legislature chose a statute's language with care, including each word chosen for a purpose while purposely omitting words not chosen. If a statute is unambiguous, the court said it adopts the interpretation supported by its plain language unless such an interpretation would lead to absurd results.
Both parties agreed on how to calculate a “net gain,” citing Calvert v. Electro-Science Inv'rs, Inc., 509 S.W.2d 700 (Tex. Civ. App. - Austin 1974, no writ), which held that net gain requires that gains and losses be offset against one another in order that a net figure is obtained for the calculation of the tax. But the court noted that Electro-Science does not go as far as the Comptroller would like, because it clarified how to calculate net gain, but it did not speak to the statutory treatment of a net loss, which is at issue here. The Comptroller argued
that the court of appeals correctly found the term “net gain” ambiguous, but the court said that the ambiguity the Comptroller suggests is a different one, i.e., whether the term always assumes a gain or does it mean gain or loss after the costs have been considered. The court found that the answer to the question of whether “net gain” can sometimes mean “net loss” is an obvious and easy “no.” The court said that a statutory net gain cannot simultaneously be a net loss, citing the definition of net loss in Black’s Law Dictionary 1088 (10th ed. 2014)
The court concluded that even if "net gain" is ambiguous as the court of appeals decision suggested, the ambiguity is irrelevant to this case. Here, neither party disputes that the taxpayer suffered only a net loss, and the statute requires inclusion of "only the net gain," and under no reading can "net gain" include a net loss. The court concluded that the statute means just what it says, that only the net gain from the sale of investments should be included in the apportionment-factor denominator. It pointed out that while the court generally defers to an agency’s reasonable interpretation of the statute, the Comptroller’s rule is not entitled to the court’s deference because it directly conflicts with the tax code. The court reversed the Court of Appeals judgment and remanded the case to the trial court for further proceedings consistent with its opinion. Hallmark Mktg. Co. LLC v. Hegar, Texas Supreme Court, No. 14-1075. 4/15/16
Property Tax Decisions
Christian Radio Station Is Exempt From Property Tax
The Ohio Supreme Court held that a Christian radio station qualified for a real property tax exemption. The court found that the station’s primary use of the property was for public worship and held that the revenue generated from advertising is used for the religious mission, not to generate a profit.
The taxpayer operates a radio station in the state and, until 2007 the station was operated in offices located in New Albany. In 1991 it was granted an exemption for that property as being used for church purposes. When it related in 2007 to another jurisdiction in the state, a complaint was filed challenging the continued exemption of the taxpayer’s New Albany property. In a final determination issued in 2013, the tax commissioner denied the complaint, similarly reasoning that the property was "being used for church facilities."
In 2008, the taxpayer applied for the same exemption for its new property property that its New Albany property enjoyed. The application stated that a building constructed on the new property contains "production studios used for the origination of certain religious programming, offices, assembly rooms and a chapel." The tax commissioner denied the exemption, finding "no evidence that people assemble to worship together on the subject property" and reasoning that the exemption applies only "where people gather to profess their faith or to observe and participate in religious rituals or ceremonies."
Record established the following facts. The taxpayer has had 501(c)(3) status under the IRC since it was established in1964. According to the taxpayer’s 2008 exemption application, the property at issue here is used to produce radio programming for the purpose of "furthering the gospel of Jesus Christ through Contemporary Christian Music and Preaching and Teaching radio programs." The property is a 2.184-acre parcel improved with a 16,783-square-foot building built in 1998 and diagrams of the building show two floors plus a basement. The basement consists primarily of a meeting room, the first floor contains a chapel and offices for administrative and program staff, and the second floor contains additional offices. The taxpayer’sprimary sources of revenue are funds received from underwriters in exchange for advertising and donations. The chief sales officer testified at the Board of Tax Appeals (BTA) hearing that the sale of advertising is vital to the ministry of the station. The advertising is limited to mentions of the supporting business’ names and telephone numbers and the taxpayer does not accept advertisements that promote alcohol, lotteries, casinos or adult businesses. About 95 percent of the station’s programming consists of Christian music and 5 percent of talk segments that consist of pastoral programming. The chapel on the premises features a collection of Christian books and a minister leads a prayer devotional with the station staff four times a week. The chapel is also used for pastoral counseling and is open to the public for prayer and meditation. The station’s basement meeting room us used regularly by groups and organization with a religious focus and the taxpayer does not charge organization for their use of the chapel or meeting room. The station is also active in community outreach. The BTA acknowledged the case cited by the taxpayer in support of its exemption claim, but distinguished that case as involving a station that was supported fully by donation with advertising or underwriting and that featured preaching and religious teaching on the air. The BTA, therefore, upheld the Commissioner’s denial of the exemption and the taxpayer filed this appeal.
The statute exempts from real-property taxation houses used exclusively for public worship, and the ground attached to them that is not leased or otherwise used with a view to profit.
The court noted that it had previously held that for purposes of this exemption “public worship” means the open and free celebration or observance of the rites of a religious organization. To qualify under the public-worship exemption, the real property must be used in a principal, primary, and essential way to facilitate the public worship. The court cited
Maumee Valley Broadcasting Assn. v. Porterfield, 29 Ohio St.2d 95, 279 N.E.2d863 (1972), a case involving a nonprofit religious corporation that owned land upon which a broadcasting studio and auditorium were located. The court in that case advanced a holistic approach to determine whether an organization qualifies as a church. After that decision the legislature enacted a definition of “church” that embodied the case law, recognizing that in modern society, public worship involves more than formal religious rites and ordinances.
The court said that the fact that Christian music makes up the majority of the broadcasting strengthens, not weakens, the taxpayer’s argument that its purpose is religious. The court, citing the radio devotionals, the chapel services and community outreach, found that the taxpayer had presented evidence demonstrating that it is a corporation that was formed primarily or exclusively for religious purposes and not for the private profit of any person.
The court said that the taxpayer had dedicated all its land and buildings to charity and religion, and the operation of the radio station was not alone sufficient to change the underlying foundation of the corporation.
The court said thatthe tax commissioner's position that a physical assemblage of persons does not engage in worship activity on the taxpayer’s property would not preclude the conclusion that the taxpayer is a church within the meaning of the statute, finding that the statute does not require a congregation or worship activity. Instead, the statute’s concern is whether the organization has a primarily religious purpose and is not for profit. The court found that
BTA's focus on the sale of advertising was without support in the statute, which prohibits exemption for property being used "with a view to profit."
The court said that the taxpayer is a nonprofit corporation that sells on-air advertising to continue its ministry. It was not formed for private profit and its property was not being used to generate a profit, but, instead, the revenue that was generated was for the religious mission of the corporation. The court found that the tax commissioner's failure to consider whether the taxpayer exhibits the essential qualities of a church in determining whether it is a house used exclusively for public worship resulted in an overly narrow construction based on an incorrect legal conclusion.
The court’s chief judge issued a dissent finding that the majority opinion announced a new and overly broad interpretation of the exemption provision. Christian Voice of Cent. Ohio v. Testa, Ohio Supreme Court, No. 2014-1626. 4/14/16
Taxpayer Negated Valuation
The Ohio Supreme Court held that a tax auditor's valuation of property may not serve as the default valuation when the taxpayer negates the evidence at the board of revision. The court held that the Board of Tax Appeals is required to determine a new value if the record permits it to do so.
At issue in this matter is a two-story multi-tenant office building, consisting of three parcels. The property was acquired in 2002 by Theodore Klimczak who later transferred ownership to an LLC, the current owner, while continuing to act as the company's managing member.
For tax year 2012 the county fiscal officer issued an assessment, which was appealed to the Board of Review (BOR). The BOR reduced the value assessed based on a bank appraisal presented by the taxpayer at the hearing. The county Board of Education (BOE) filed an appeal to the BTA which reversed the BOR decision and reinstated the auditor’s valuation, on the basis that the bank appraisal was unsupported by appraiser testimony and the fact that the appraisal's opinion of value was expressed as of June 14, 2011, rather than as of the tax-lien date, January 1, 2012. The taxpayer filed this appeal.
When the taxpayer filed its original appeal to the BOR, Mr. Klimczak, as managing member of the taxpayer, attached documents to the complaint, including his 2011 correspondence with Huntington Bank about refinancing the property, Huntington's request that an appraisal be completed for use in financing and internal collateral and risk analysis, and/or possible use in foreclosure, and a copy of the appraisal report prepared for the bank. Mr. Klimczak testified on behalf of the property owner and explained that the owner had lost money on the property every year since 2002, with the exception of 2012, submitting 2011 and 2012 income-tax records. He also indicated that the taxpayer significantly lowered rental rates for lessees and noted that vacancies were still hard to fill, especially because nearby office rentals were available at a lower rate.
According to Klimczak, approximately 20 percent of the building was vacant and his own business occupied several suites in the building and subsidized the property's losses by paying a higher rental rate for those suites. He testified that the owner still did not have enough money to complete needed repairs, such as a new roof. In light of this the property was refinanced with the bank in 2011 and an appraiser was hired to appraise the property. A copy of the report was introduced by the taxpayer at the hearing but the appraiser did not testify.
The report considered each of the three standard approaches to valuation and concluded that the cost approach was not applicable due to the age of the improvements. He considered four sales, two of which were outside of the county, to arrive at the sales comparison value and under the income approach examined rental data from other area buildings. Ultimately, he reached a value of $1,125,000 as of June 14, 2011, six months before the 2012 tax-lien date at issue in the case.
The court found that the BTA erred in its sweeping rejection of the competency of the evidence on the record to demonstrate the value of the property and in its failure to recognize that the evidence before the BOR negated the validity of the auditor’s valuation, thereby making it improper to revert to the auditor's valuation.
The court cited caselaw that provided in a category of cases in which the evidence presented to the BOR or the BTA contradicts the auditor’s determination in whole or in part, the BTA may not simply revert to the auditor’s determination. Instead, the BTA has a duty to determine whether the record contains sufficient evidence to permit an independent valuation and, if it does, the BTA must perform that valuation. It cited the rule set forth in Bedford Bd. of Edn. v. Cuyahoga Cty. Bd. of Revision, 115 Ohio St.3d 449, 2007-Ohio-5237, 875 N.E.2d 913 that when the BOR has reduced the value of the property based on the owner's evidence, that value has been held to eclipse the auditor's original valuation, and the BTA may not rely on the auditor’s valuation as the default valuation. This has the effect of shifting the burden of proof to the BOE on appeal.
The court further found that the taxpayer’s evidence negated the validity of the auditor’s valuation and furnished a basis for valuing the property. The court agreed with the initial observations of the BTA that the written report was presented without authenticating and supporting testimony, that the appraisal was performed for bank-financing purposes and the “as of” date was six months before the lien date, but noted that the attempt to use the opinion of value expressed in the appraisal report as an opinion of value for a different date does not render the appraisal incompetent as evidence for any purpose at all. The court cited Plain Local Schools Bd. of Edn. v. Franklin Cty. Bd. of Revision, 130 Ohio St.3d 230, 2011-Ohio-3362, 957 N.E.2d 268, in which it specifically determined that there was no plain error in the BTA's consideration of a written bank appraisal despite the absence of testimony by its preparer, based upon "indicia of reliability" in the testimony concerning the appraisal and said the circumstances in the current case parallel those in Plain Local Schools.
The court concluded that under the case law, the appraisal in this case furnished evidence that in conjunction with the testimony was competent, that negated the validity of the auditor's valuation, and that furnished an independent basis for valuing the property. The court said that although the BTA erred in reverting to the auditor's valuation, it correctly perceived that the BOR's determination could not be simply affirmed and adopted and it reversed the decision of the BTA and remanded the matter with instructions that the BTA perform an independent valuation of the property. Copley-Fairlawn City Sch. Dist. Bd. of Ed. v. Summit Cnty. Bd. of Revision, Ohio Supreme Court, No. 2014-0955. 4/12/16
Remote Sales of Other Property Can Be Considered
The Ohio Supreme Court held that an appraiser may use the sale of real property, even if not recent, as a comparable in determining the property's value. It said that the Board of Tax Appeals (BTA) has the discretion to consider remote sales of other properties in its valuation process.
This case involves a dispute over the value of three undeveloped residential lots located near a reservoir in the county. The owners appealed the 2011 year valuations of the properties and introduced testimony and written appraisal report before the Board of Revision (BOR). The BOR adopted the appraiser’s valuation and granted the requested reductions. The county Board of Education (BOE) filed an appeal to the Board of Tax Appeals (BTA) and introduced the testimony and written appraisal of an appraiser hired by the BOE. The report relied heavily on the 2007 sale of a nearby lot, and arrived at higher valuations for the parcels than either the taxpayers’ appraiser or the auditor. The BTA adopted the valuation of BOE’s appraiser and the taxpayers filed this appeal.
The taxpayers’ appraiser described the properties as heavily wooded with rolling topography and opined that the highest and best use of each site was as an acreage home site for a single-family dwelling. He used a sales-comparison approach to determine the value of each lot, but explained that it was difficult to find appropriate comparables because there were no recent lot sales in the immediate area. He noted that a property located between two of the subject lots sold for $775,000 in July 2007, but he did not consider that sale probative because market conditions had changed substantially.
At the BTA proceedings the BOE’sappraiser opined that the highest and best use of the properties was "for residential development" by a single owner, noting that all three lots had all the necessary utilities. He also used the sales-comparison approach, but explained that it was difficult to locate appropriate comparables because the properties were unique in light of their access to the reservoir. Because he believed that the market had remained relatively stable for sales of higher-end residential lots since 2006 in spite of the recession, he looked to older sales to identify comparable properties. At the BTA hearing the owners defended the BOR decision and introduced testimony from their appraiser and additional witnesses.
The court in this appeal noted the BTA's wide discretion in determining the weight to be given to the evidence and the credibility of the witnesses that come before it. Absent a showing of an abuse of discretion, determinations by the BTA will not be reversed by the court. The owners argued that the BTA acted unreasonably and unlawfully when it adopted BOE’s appraiser’s opinions of value, because he improperly relied on the 2007 sale of the a tract as a comparable, his other comparables were temporally remote and not similarly situated to the subject properties, he did not account for new state and local sewer and environmental regulations, and he made material factual errors about the subject properties. The court rejected the taxpayers’ argument that if the tax commissioner by statute cannot rely on sales outside a three-year window for a sales-assessment ratio study, then it would be "illogical" for the BTA to rely on an appraisal report that uses sales older than three years to determine a property's value. The court said it the BTA's duty and authority in an appeal from a board of revision were not subject to this statutory provision, nor do the statutes providing for BTA appeals impose a three-year limitation on the data to be considered. The statute specifically empowers the BTA either to decide an appeal on the existing record or to order the hearing of additional evidence, with no such restriction, and it follows that the BTA has discretion to consider remote sales and that determining their probative value as adjusted by the appraiser lies within the BTA's fact-finding discretion. The court also rejected the taxpayers’ argument that the BOE failed to meet its burden to prove its right to an increase from the value determined by the BOR, finding that the burden of the BOE was to provide competent and probative evidence supporting its request, and nothing in the record affirmatively demonstrated that the BTA’s findings was unreasonable. The taxpayers also argued that the appraisal was not reliable or probative because five of the comparables were “temporally remote”, including one sale in 2009 and three in 2012, and shared nothing in common with the properties at issue here because they were located in developed subdivision with broad amenities and full utilities. The court cited prior caselaw for the proposition that the BTA may consider pre-and post- lien date factors, such as comparable sales, that affect the true value of the taxpayer’s property. It also noted that the BOE’s appraiser testified that he made downward adjustments to the comparables to account for differences between those properties and the subject properties. The court held thatthe BTA reasonably found that the appraisal by BOE’s expert was more probative than taxpayer’s expert, in part because the BOE expert had more thoroughly verified his comparables. Finally, the court held the BTA did not violate the uniform-rule provision in the statute. Bd. of Ed. of the Westerville City Schs. v. Franklin Cnty. Bd. of Revision, Ohio Supreme Court, No. 2014-1036. 4/13/16
Other Taxes and Procedural Issues
Unclaimed Property Statute Constitutional
The Oklahoma Supreme Court dismissed claims that the state's Uniform Unclaimed Property Act was a Ponzi scheme and that the state treasurer violated trust obligations. The court also held that the act does not violate the Oklahoma or U.S. constitutions.
A resident of the state and owner of unclaimed property, which was turned over to the resident after he filed a claim with the State Treasurer, filed suit seeking relief, including damages, declaratory relief, and injunctive relief challenging the constitutionality and administration of the Oklahoma Uniform Unclaimed Property Act. The trial court granted the defendants' motion to dismiss and denied the property owner's motion for summary judgment, and the property owner appealed. Appellant argued that the unclaimed property statute sets up a “public trust” with the State Treasurer as trustee and private parties such as himself as the beneficiaries. He argued that the provisions of the statute that require the transfer of funds not held as reserve in the Unclaimed Property Fund to the state’s General Revenue Fund violate trust obligations, and the statute’s requirement that interest and income accruing in the Unclaimed Property Fund's principal be paid to the general revenue fund violates trust obligations. The appellant also argues that the unclaimed property statute is a “Ponzi Scheme.”
The Uniform Unclaimed Property Act (UUPA) provides a process by which the owners of abandoned property may file a claim to recover their property, or the value of their property if it was sold as authorized by the act. The State Treasurer (Treasurer) is required to consider the claim and if the claim is approved, pay it from the Unclaimed Property Fund. The UUPA contemplates, however, that not all owners of abandoned property will seek to recover it and it, therefore, has provisions for an unclaimed property reserve fund with the remainder of the unclaimed property funds deposited in the general fund of the state.
The appellant argued that the statute created a trust from the unclaimed property fund with the Treasurer as the trustee and the persons claiming any interest in abandoned property as the beneficiaries. The appellant argued that the Treasurer had the duty to take all steps necessary to preserve the principal of monies accruing to the fund and the Treasurer violated that duty.
The court said that regardless of whether the UUPA creates a trust, the language of the UUPA is clear and unambiguous, and its terms control. The duties of the Treasurer, either as a trustee or executive official, are defined by the UUPA and the appellant has not alleged the Treasurer has taken any action contrary to the provisions of the UUPA and there is no merit to appellant’s trust arguments. The court also rejected the appellant’s allegations that the UUPA constitutes a “Ponzi scheme” because of how it handles the reserve to pay claims. The UUPA provides for the maintenance of a reserve fund that might conceivably be insufficient to pay out all established claims and if validly established claims exceed the established reserve, incoming unclaimed property will be held in reserve to pay valid claims until all established claims are paid. The court said that a "Ponzi scheme" is a fraudulent investment scheme and held that the UUPA is not a "Ponzi scheme" within the meaning of that term. The court said that the state is not deceiving new investors in order to pay valid claims, but rather paying those claims with abandoned property it would be taking in anyway, per the terms of the UUPA. The court also rejected the appellant’s claim that transfers from the unclaimed property fund to the state’s general fund created a debt in violation of the state constitution.
The court noted that the transfer of unclaimed property to the general fund pursuant to the UUPA is one way. Claimants' only recourse is to the reserve, itself filled only by the accumulation of abandoned property pursuant to the UUPA. The State has not legally pledged its full faith and credit to pay the owners of abandoned property.
The court also rejected appellant’s assertion that the UUPA effectuates a taking of private property without just compensation in violation of U.S. Constitution, holding that the state is not required to compensate a claimant for the consequences of their own neglect, and this includes interest their property might generate while temporarily in the custody of the State.
The court also rejected the appellant’s due process claim. The court pointed out that the UUPA does not terminate an individual owner's right to recover their abandoned property, even after the statute results in its transfer to the State, and the statute provides a procedural mechanism for owners to seek return of their abandoned property. The UUPA also provides ample notice to potential claimants of the property. Finally, the court rejected the appellant’s equal protection claim, finding that the act’s treatment of abandoned property and its owners rationally furthers a legitimate state interest, and does not operate in an arbitrary manner.
Dani v. Miller, Oklahoma Supreme Court, 2016 OK 35; No. 114482. 3/30/16
Sanitation Tax Funds Cannot Go to General Fund
The Kentucky Court of Appeals reversed a lower court ruling that granted a city mayor's motion to dismiss a challenge to the city's use of sanitation tax funds for general revenue items. The court found that using the money for the benefit of the city for some other purpose was not a valid defense.
The appellant is a taxpayer residing in the city of Audubon Park (City) and filed a civil action in the circuit court against the City's mayor and seven members of the City Council, alleging
that for fiscal years 2007 to fiscal year 2012 the City Council approved annual ordinances setting a sanitation tax for each year for the purpose of paying for sanitation services for the City, including garbage and trash collection, as well as recycling. The appellant alleged that
for each of these fiscal years, the City Council diverted a portion of the tax revenue generated from the Sanitation Tax and placed such funds in the City's general fund and that the Sanitation Tax revenue was expended on items unrelated to sanitation, in violation of the state constitution. The Mayor and the City Council Members moved to dismiss the complaint complaint on the arguing that it did not state a cause of action upon which relief could be granted. They argued that appellant could not satisfy the requisite element of damages because the diverted funds were applied to the legal obligations of the City, and therefore, the City was not actually harmed. The lower court held for the Mayor and City Council and the appellant filed this appeal.
The state constitution provides that when a tax is levied by any local jurisdiction the act shall specify the purpose for the tax and the levied and collected tax may not be devoted to another purpose. The state statute further applies this provision to cities of the home rule class, of which this city is a member and further sets forth that such cities are only permitted to levy taxes by ordinance and that the ordinance must set out the purpose of the tax. The statute also creates a right of action when a city of the home rule class expends tax revenue for a purpose other than that for which the tax was levied or the license was collected.
The court said is undisputed that the City expended the Sanitation Tax revenue on purposes other than those related to sanitation. It is likewise undisputed that the city attorney did not take action within six months. The court agreed with the appellant that the constitution and statute are clear and unambiguous, mandating that cities state the purposes for their taxes in their levying ordinances and prohibit revenue generated under the levying ordinances from being used for any purposes other than those set forth in the ordinances. The court said that it found no indication in the statutory language that the legislature intended to exempt liability if the officials use the funds on other city-related liabilities and concluded that the plain language of the statute suggests that any use of the funds for a purpose other than the purpose specified in the ordinance is prohibited and results in liability. The court also noted that a prior statute that would have permitted the City to transfer excess tax revenues to its general fund was repealed by the legislature in 1980. The court found that the legislature’s enactment of the statutory provision and its repeal of the above-described provision provide clear evidence that its intent was for liability to attach even when funds were used by the City as part of its general funds.
The court rejected the City’s assertion, in reliance on Field v. Stroube, 103 Ky. 114, 44 S.W. 363 (Ky. 1898), that the appellant cannot satisfy the requisite element of damages. The court noted that the statutes at issue were not in existence at the time Field was decided and distinguished the facts of Field from the current case because the tax at issue in Field was levied for a discrete purpose, the construction of a new courthouse. The court said that in this case it is reasonable to conclude that the object to be attained, ongoing waste disposal, has not been finally achieved, nor will it be attained in the reasonable future. If there is an excess after payment of the City's contract for sanitation, the City should use the excess funds for sanitation in the upcoming fiscal year since there is no way to refund a tax that was lawfully levied and collected. The court said thatappellees' interpretation of the statutes at issue would give them an unlimited ability to levy a tax that bears no proportion to the purpose of the tax and use the excess each tax year after tax year for whatever other purposes they deem necessary, and the court said the statutes relied on by appellant were designed to thwart this very practice. If there is extra revenue from the sanitation tax left at the end of the fiscal year, the excess must be used for sanitation in the following fiscal years and if appellants violate the statute, they are jointly liable to the City. Sewell-Scheuermann v. Scalise, Kentucky Court of Appeals, No. 2014-CA-000915-MR. 4/15/16
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:
April 15, 2016 Edition
NEWS
Fraud Update
On April 15, 2016 the IRS released a communication to tax professionals and asked the states to help disseminate this message out to their tax preparation community. The communication warned tax professionals of a new emerging scam. Cybercriminals are obtaining remote control of preparers’ computer systems, completing and filing client tax returns and redirecting refunds to thieves’ accounts. The IRS noted that this scam has the potential to impact the filing of fraudulent returns and is another example of tax professionals being targeted by identity theft criminals. The communication urged all tax preparers to take the following steps:
1. Run a security “deep scan” to search for viruses and malware;
2. Strengthen passwords for both computer access and software access; make sure your password is a minimum of 8 digits (more is better) with a mix of numbers, letters and special characters;
3. Be alert for phishing scams: do not click on links or open attachments from unknown senders.
4. Educate all staff members about the dangers of phishing scams in the form of emails, texts and calls.
5. Review any software that your employees use to remotely access your network and/or your IT support vendor uses to remotely troubleshoot technical problems and support your systems. Remote access software is a potential target for bad actors to gain entry and take control of a machine.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
En Banc Review in DMA Denied
The U. S. Court of Appeals for the Tenth Circuit has denied Direct Marketing Association’s (DMA) petition for an en banc rehearing of its case. The DMA was seeking a review of the court's decision on February 22, 2016 holding that Colorado can require out-of-state online retailers to disclose in-state customers to the state's Department of Revenue. The court in that ruling held that Colorado's notice and reporting requirements don't violate the U.S. Supreme Court's decision in Quill Corp. v. North Dakota. The court's order did not provide a reason for the denial of the rehearing petition. See prior issues of State Tax Highlights for a discussion of this case. Direct Mktg. Ass'n v. Brohl, U.S. Court of Appeals for the Tenth Circuit, 12-1175. 4/1/16
Court Rejects FedEx’s Motion to Dismiss
The U.S. District Court for the Southern District of New York has rejected FedEx's request to dismiss claims by New York State and New York City that it violated a federal anti-racketeering law and the Contraband Cigarette Trafficking Act. The decision also said that FedEx must defend claims it violated its 2006 agreement with the state, later extended nationwide, not to do business with sellers that ship cigarettes to people's homes. Two other claims that related to state public health law were dismissed.
The court rejected FedEx's argument that its alleged dealings with shippers were too far removed from the resulting financial harm claimed by the state and city. The lawsuit here covers FedEx's dealings with 21 shippers, including some associated with Native American tribes and is separate from a lawsuit by the state and city over FedEx's dealings with four other shippers that is ongoing. Both lawsuits accuse FedEx of costing the state between $15 and $43.50 per carton, and the city $15 per carton, in excise taxes through illegal cigarette shipments. City of New York et al v. FedEx Ground Package System Inc, U.S. District Court, Southern District of New York, No. 14-08985. 4/1/16
Unlawful Disclosure Suit Dismissed
The U.S. Court of Appeals for the Ninth Circuit, in an unpublished per curiam opinion, has affirmed a district court's dismissal of an individual's suit against the government for improperly disclosing his return information. The court held that the taxpayer failed to show that the disclosures were not made for tax administration purposes or based on a good-faith interpretation of section 6103 of the Internal Revenue Code. John C. Hom et al. v. United States, U.S. Court of Appeals for the Ninth Circuit, No. 13-17195. 3/24/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Catalogs Shipped to State Exempt From Use Tax
The Missouri Supreme Court held that a taxpayer was qualified for a use tax exemption on catalogs it shipped into the state. The court said that the catalogs were printed and mailed outside the state and the taxpayer did not have power or control over the property once it was in the state.
The taxpayer is a national corporation incorporated in Delaware and headquartered in Florida. It operates several retail stores in the state and in addition to its physical retail locations, it also sells its products through its website. The taxpayer promotes and advertises its products and services to existing and potential customers in the state, in part, by the mailing of unsolicited product catalogs, contracting with a printer to print and mail the catalogs.
The taxpayer purchased paper from a vendor outside the state for the catalogs and delivered it to the printer’s facilities out-of-state, along with addresses where the finished product should be shipped. The printer delivered the finished product to the U.S. Postal Service for shipment.
All of the catalogs relevant to this case were printed at locations and delivered to post offices outside the state. The taxpayer paid the state use tax on the cost of the paper and the printing and in 2012 filed an application for a use tax refund for the full amount paid between 2008 and 2012. The Department of Revenue (DOR) denied the claim and the taxpayer filed an appeal. The Commissioner reversed DOR’s decision and it filed this appeal.
The state use tax statute imposes the tax on the privilege of storing, using or consuming within the state any article of tangible personal property. DOR argued that by causing the catalogs it had printed to be delivered to Missouri residents, the taxpayer "used" those materials in the state and is liable for use tax. The statute defines use as "the exercise of any right or power over tangible personal property incident to the ownership or control of that property. . . . " The court said that the question is whether the taxpayer exercised a right or privilege of ownership or control over the catalogs at the time they entered the state in the United States mail. If so, then it would be using the catalogs in the state and so be liable for the use tax.
The court noted that it had already decided this precise issues in May Dep't. Stores Co. v. Dir. of Revenue, 748 S.W.2d 174, 175 (Mo. banc 1988), when it held that placing catalogs in the mail in another state for delivery to Missouri residents is not "use" of the product in Missouri.
The Court reasoned in that case that by simply giving directions that are executed outside of the state of Missouri, the taxpayer was not storing, using or consuming the catalogs in Missouri and said that there is no legal distinction between the current case and May. DOR cited cases from other jurisdictions supporting the argument that because the taxpayer benefited from delivery of the catalogs to Missouri customers, and because its labels "controlled" where and how the catalogs would be delivered in the state, it should be held to have "used" the catalogs in the state, but the court pointed out that it had specifically rejected this reasoning and the application of these out-of-state cases in its May decision. The court found that May was correct in its holding and said that simply because the taxpayer set events in motion outside the state that eventually caused the catalogs to enter the state does not mean it exercised control over the catalogs in the state. Office Depot Inc. v. Dir. of Revenue, Missouri Supreme Court, No. SC950029. 4/5/16
Use Tax Exemption for Financial Service Hardware and Software Denied
The Missouri Supreme Court held that a company was not entitled to a use tax exemption on hardware and software it sold to MasterCard because its use of the hardware and software did not qualify as manufacturing a product under the exemption statute. The judge said that the production of some data can be manufacturing, but was not the case here.
The state’s Administrative Hearing Commission ruled that the taxpayer was entitled to a use tax refund for its sales of hardware and software to MasterCard International, LLC, for MasterCard's use in processing credit and debit card transactions. MasterCard communicates information between merchants and banks and determines whether customers' purchases should be approved and whether a bank owes money or fees on the transaction and the Commission found that MasterCard's use of the hardware and software qualified as "manufacturing a product" as that term is used in the use tax exemption set out in the statute. The Department of Revenue (DOR) appealed that decision.
The state statute provides an exemption from sales and use tax for equipment and materials used or consumed in the manufacturing, processing, compounding, mining, or producing of any product. The taxpayer argued that when MasterCard transmits approvals and disapprovals of credit card transactions and summarizes the credit card transactions undertaken each day by its customers, MasterCard organizes, manipulates, and communicates data and by doing so, manufactures new products during every transaction.
The court noted that while it has held that the production of intangible products such as computer data may be "manufacturing," it has rejected the idea that every use of a computer to aid a business or transmit information is manufacturing. The court said that such an interpretation of the term "manufacturing" would be at odds with the fundamental principle that exemptions are to be construed narrowly against the taxpayer. The court said that the fact that some intangible products can be manufactured does not mean that all intangibles are manufactured products.
The taxpayer cited Southwestern Bell Tel. Co. v. Dir. of Revenue, 78 S.W. 763 (Mo. banc 2002) ("Bell I") and Bell II and argued that the court should expand the manufacturing exemption to include just the transmission of computer data itself. Those cases, in an attempt to update the definition of "manufacturing" so that it could apply to modern technology, stated that voices transmitted over a telephone are "products" that are "'manufactured' into electronic impulses that can be transmitted and reproduced into an understandable replica." The court rejected this argument finding that this broad interpretation is inconsistent with the well-settled principles that courts are to take the words in a statute in their plain and ordinary sense and that exemptions from taxation are to be narrowly construed against the taxpayer.
The court said that narrowly construing the term "manufacturing" as used in the exemption in question, MasterCard's computers do not "manufacture" a tangible or intangible product. Rather, they receive information, analyze and make determinations based on this information, and relay these determinations to their customers and this type of activity is not "manufacturing" under the statute or under the common lay terminology one uses in speaking of analyzing credit card transactions. The court said that to construe it otherwise, every time a person received an email, made some type of business or mathematical decision, and sent back an email with that decision, the person would be said to be "manufacturing" the data sent and received.
The court held that the taxpayer does not create a product, but, rather, provides equipment that allows merchants to check their customers' credit information while completing and approving a purchase and if the legislature wished to exclude from the use tax all computers used by financial institutions to provide credit information, or all computers used to answer customer queries, it could have easily added language in the statute to do so. The court noted that it has refused, in other recent cases, to expand the term “manufacturing” to the broad limits argued for by the taxpayer. IBM Corp. v. Dir. of Revenue, Missouri Supreme Court, No. SC94999. 4/5/16
Personal Income Tax Decisions
Sexual Harassment Judgment Proceeds Not Subject to City Tax
The Michigan Court of Appeals has ruled that the City of Grand Rapids (City) improperly assessed nonresident city income tax on pay awarded to police officers in a sexual harassment suit. The court said the pay did not constitute compensation for services rendered as an employee or for work done or services performed within the city.
The Tax Tribunal ruled in favor of the petitioners, concluding that they had been improperly charged nonresident city income tax on back pay and front pay awards that the city had been paying petitioners pursuant to federal court judgments and the City filed this appeal.
In a joint lawsuit filed against the city in the United States District Court for the Western District of Michigan, petitioners had alleged that they served as police officers for the city and had been removed from their employment in retaliation for filing a sexual discrimination lawsuit against the city in 2001. In December, 2004, petitioners received a jury verdict in their favor and each petitioner was awarded $223,080 for back pay owed, $1,276,920 in front pay, and $1 million in compensatory damages. On appeal, the compensatory damages were reduced to $350,000. The judgments provided that the front pay was to begin to accumulate as of the date of the judgments, was to be paid bi-weekly at the rates of petitioners' respective job classifications, and was to be paid until the front pay awards were fully satisfied subject to certain set-offs. Under the federal judgments, if either petitioner was reinstated to her former position or a substantially equivalent position, front pay was to cease. The judgments further provided that both petitioners had a duty to mitigate their damages by making reasonable efforts to obtain comparable work. In July 2010, the federal district court entered an order clarifying the judgments. The court observed that the jury verdict was intended to put the petitioners in the same financial position they would have been in if they had continued their employment with the City and stated that petitioners were to accrue holiday and sick pay and were "to be treated in the same manner as other employees." The city chose not to reinstate either petitioner, instead opting to make the front pay awards.
In tax years 2008 through 2012, the city deducted nonresident city income tax from the front pay and back pay awards it paid to each petitioner. It is uncontested that neither petitioner lived within the city limits. The City argued that petitioners were effectively being paid compensation for work performed in the city because the federal district court judgments were intended to place them in the same positions they would have been in but for the results of the federal litigation and had petitioners not been removed from the police force, they would have had to pay nonresident city income tax.
The statute provides that a city may levy, assess, and collect an excise tax on income, and with respect to nonresident individuals the tax shall apply on a salary, wage and other compensation for services rendered as an employee for work done or services performed in the city. The court noted that resolution of this case turns on the construction of the statutory and city ordinance language and said it was a relatively easy and straightforward case.
The court said that assuming that the back pay and front pay awards constituted "compensation" under the ordinance/statute, it was simply not compensation for services rendered as an employee for work done or services performed within the city because the petitioners have not been doing work or performing services as police officers. The court rejected the city’s construction of the language as encompassing compensation for work or services that would have been done or performed but for petitioners' removal from active employment, saying that the court cannot graft such language onto the statute. The city also argued that because petitioners do not dispute that the awards are subject to federal income tax, the awards must also be subject to the city nonresident income tax. The court found that the introductory language in the statute did not expand the types of income subject to tax to all income taxable under the IRC and beyond the income sources specifically listed in the statute. Leclear-Gavin v. City of Grand Rapids, Michigan Court of Appeals, No. 324933. 3/24/16
Corporate Income and Business Tax Decisions
Court Examines Definition of Unitary Business Group
The Michigan Court of Appeals reversed the trial court, finding that indirect ownership for the purpose of a unitary business group means ownership through an intermediary, not constructive ownership. The court said the lower court erred in no relying on the normal rules of statutory construction.
The taxpayer is a Michigan corporation primarily owned by two brothers, Barton and Douglas LaBelle. At no time during the tax periods did either brother own more than 50% of plaintiff's common stock. The Pixie, Inc., (Pixie) is a Michigan corporation and the taxpayer was originally a subsidiary of Pixie. Pixie sold all of its interest in the taxpayer to the LaBelle brothers on January 1, 2008. LaBelle Limited Partnership (LLP) is a Michigan limited partnership. In forming the partnership, each of the LaBelle brothers contributed $50 -- $1 for a 1% general partnership and $49 for a 49% limited partnership. The partnership was later amended to add the brothers' children as limited partners, thereby reducing the brothers' share of the limited partnership. After being sold by Pixie, plaintiff reported its business tax as a separate company.
The Department of Revenue (DOR) conducted an audit of taxpayer for two tax years, and
determined that the taxpayer, Pixie, and LLP should be treated, together, as a "unitary business group" based on the state statute, which defines that term, and the interpretation of that statute provided by DOR’s Revenue Admin Bull 2010-1, Unitary Business Group Control Group Test. Applying the test outlined in the bulletin, DOR concluded that the taxpayer indirectly owns 100% of Pixie and LLP and that Pixie indirectly owns 100% of plaintiff and 90% of LLP. The taxpayer paid the resulting assessment under protest and filed an appeal.
The issue before the court is whether the taxpayer, Pixie and LLP constituted a “unitary business group” which requires one member of the group to directly or indirectly own or control more than 50% of the ownership interests of the other members. The parties agreed that no entity directly owned more than 50% ownership interest of any of the others, and the issue before the court was whether there was sufficient indirect ownership or control to satisfy the statutory definition.
The taxpayer arguedthat the trial court erred in using the federal income tax definition of "constructive" ownership when defining the state’s "indirect" ownership requirement in the statute. While the Michigan Business Tax Act does not define indirect ownership or control, it does provide that "[a] term used in this act and not defined differently shall have the same meaning as when used in comparable context in the laws of the United States relating to federal income taxes in effect for the tax year unless a different meaning is clearly required." MCL 208.1103 (emphasis added). Citing Town & Country Dodge, Inc v Dep't of Treasury, 420 Mich 226, 240; 362 NW2d 618 (1984), the court noted that the Michigan Supreme Court emphasized that when employing federal tax laws to define a statutorily undefined term, the federal context must be comparable to the Michigan context. The trial court noted, "No [federal income tax] provision is directly comparable to § 117 of the MBT." Thus, the court here said that in the absence of a comparable context, the trial court should have resorted to normal rules of statutory construction to determine the meaning of the undefined term.
Instead, the trial court sought out "contextually analogous" provisions, and of the numerous places where indirect ownership or control is considered, the court found most appropriate the provisions relating to international taxation that define a "controlled foreign corporation," specifically 26 USC 957 and 26 USC 958.
The court noted that federal statutes and regulations are careful never to say that indirect ownership means constructive ownership and at times expressly distinguish between the two. Rules of constructive ownership are not broadly applied any time indirect ownership is involved, but only when the federal statute or regulation expressly mandates applying those rules, and rules of constructive ownership are applied in some contexts, but in other contexts only direct and indirect ownership are considered. The court found that, at the point the trial court acknowledged that the federal tax laws do not address a "comparable context," under state law it should have used the ordinary rules of statutory construction.
The court held that, consistent with the definitions and descriptions in dictionaries, the plain and ordinary meaning of indirect ownership in the statute means ownership through anintermediary, not ownership by operation of legal fiction, as the taxpayer argues. Applying the statute to the facts of this case, the court found it clear that no unitary business group exists because none of the involved entities owns, through an intermediary or otherwise, more than 50% of any other entity. Labelle Mgmt. Inc. v. Michigan Dep't of Treasury, Michigan Court of Appeals, No. 324062. 4/1/1
Property Tax Decisions
Property Should Be Valued Based on Use as Headquarters
The Iowa Supreme Court reversed a lower court ruling that assessed a property's value based on its most likely use as a multitenant office building rather than its current use as a single-tenant headquarters building.
The taxpayer completed construction of its corporate headquarters in 2010 in the downtown area of the state’s capitol, an area characterized as a "third-tier" metropolitan statistical area (MSA). The building is comprised of five stories of aboveground office space, and two levels of belowground parking and was described in the trial record as a structure that provides class-A office space with first-class amenities. The taxpayer appealed the county assessor’s valuation of the property for 2011 to the tax appeals board (Board). The Board denied the protest and the taxpayer filed an appeal with the district court. At the trial four appraisals submitted testimony, each providing appraisals based on cost, comparable sales, and income and then reconciling those figures. A key difference in the four calculations was the methodology used. The Board's experts emphasized the current use of the taxpayer’s building as a single-occupant corporate headquarters and this use was the linchpin of their evaluation.
The taxpayer disagreed with this approach, believing that it was very unlikely that their building could be sold on the open market to a single corporate entity for use as a corporate headquarters, basing their position primarily on the realities in the local market in the state capitol. The taxpayer’s experts pointed out they were unaware of any occasion in the local market when a third party corporation purchased an existing building for use as a single-tenant headquarters. The experts further noted the very large size of the structure supported the view that even in the event a corporation was interested in purchasing the building for headquarters use, it was very likely that a substantial balance of the property would be rented out to third-party tenants. For the most part, the lower court agreed with the taxpayer and handed down a decision decreasing the assessed value of the property. The Court of Appeals affirmed the trial court’s decision and the Board filed this appeal.
The court noted that its review of a tax protest is de novo, but its gives deference to the court's assessment of the credibility of witnesses. The court said that a threshold conceptual issue in this case relates to the proper methodology to be employed for tax purposes when a building has substantial, even dramatic, features and improvements that the owner beneficially uses but the value of which might not be objectively demonstrable through past marketplace transactions. The question posited by the court is whether, for property tax purposes, the value of a building with all its fine amenities should be based upon the taxpayer's current use as an owner-occupied headquarters building, even though there may not be a local market for such a property, i.e., whether the proper approach to valuation is one based on "value in use" versus a market-based "value in exchange."
The court pointed out that the current state statute, as amended in 1967, restored the emphasis on valuation to market value, but recognizing that there could be some circumstances where the market value of property could not be readily established and providing for an alternate approach to establishing actual value by considering other factors. The court then turned to a lengthy discussion of case law addressing valuation issues in the state, including cases interpreting special value or use under the current statute and cases involving comparable sales and cases where the value cannot be readily established by market data. Using those cases as backdrop in this case, the court concluded that the value of the building could not be readily established by a comparable-sales analysis and the lower court, therefore, was correct in considering other factors in its effort to establish the value of the property. The court further found that, based on its de novo review of the entire record, on balance the original valuation of the building by the assessor is supported by the record, based on the current use valuation of the building. The court acknowledged that the market for the taxpayer’s property
for use as a single-tenant office building may be limited, but said the fact that the property is currently being successfully used as a single-tenant corporate headquarters cannot go unnoticed. Current use is an indicator that there is demand for such a structure. The decision pointed out that while no specific potential buyer has been identified, the court did not think there had been a showing of no market, but only of no active market. The court adopted the view that under the circumstances, value should be based on the presumed existence of a hypothetical buyer at its current use. Wellmark Inc. v. Polk Cnty. Bd. of Review, Iowa Supreme Court, No. 14-0093. 3/28/16
Paper Mill Assessment Upheld
The Wisconsin Court of Appeals, District IV, held that a paper mill's highest and best use was as an operational pulp and paper mill. The court rejected the taxpayer's claim that the Commissioner also considered property in an adjacent hydroelectric facility in assessing the mill property.
The taxpayer is a pulp and paper manufacturer that acquired the mill property in 2001, and announced closure of the mill in 2008. It continued to operate another nearby paper mill, and moved some of the mill property equipment to the other, still-operating mill. For the years 2009, 2010, and 2011, the Department of Revenue (DOR) assessed the mill property based on a determination that its highest and best use for those years was as an operating pulp and paper mill. The taxpayer appealed DOR’s assessment claiming that after the mill closed in 2008 the highest and best use of the property was for redevelopment. The Commission and the circuit court ruled in DOR’s favor and the taxpayer filed this appeal.
In reviewing the Commission’s ruling, the taxpayer did not challenge the Commission’s findings of fact, but, instead, citing Nestlé USA, Inc. v. DOR, 2011 WI 4, 331 Wis. 2d 256, 795 N.W.2d 46 argued that the Commission misapplied applicable case law and considered irrelevant evidence. According to Nestlé, determining highest and best use involves a four-part test. The contemplated use must be legal, complementary, not highly speculative, and the property must be marketable for the use. The court noted that Nestlé reaffirmed case law stating that an assessment of marketability cannot be based on an "imaginary" buyer or "hypothetical" market for a given use, but the market in question need not be especially extensive or strong. In Nestlé, the court unanimously rejected the taxpayer's argument that the absence of recent comparable sales of powdered infant formula plants barred a finding of marketability for such plants.
The court said that in the present case the commission's determination that the mill property was marketable as an operating pulp and paper mill was based on further findings of fact, including, as pertinent here, a finding that recent comparable sales of paper mills existed in the state. The commission acknowledged that the market was smaller than in past years, but recognized that, under Nestlé, the reduced market did not bar a finding of marketability. The commission also found that, even though the taxpayer had closed the mill in 2008 and moved some equipment to its other mill site, the condition of the mill property was such that it could again have become operational as a pulp and paper mill in the 2009, 2010, and 2011 tax years.
The court rejected the taxpayer’s argument that comparable sales are irrelevant to the highest and best use determination, and are instead relevant only to calculate value after the highest and best use has already been determined, stating that Nestlé implies that comparable sales will often be among the best evidence that a market does exist for a given use. The taxpayer also argued that the Commission erred in considering evidence that its failure to attempt to sell the mill property was motivated by a desire not to sell the property to a competitor. The court rejected this argument saying that this evidence tended to rebut the taxpayer’s claims that there was no market for the property as an operating mill. The court held that in light of the deferential standard of review due the commission’s findings of fact, the finding by the commission was supported by the record and the commission did not err in determining that the highest and best use of the mill property was as an operational pulp and paper mill.
The taxpayer did raise an additional issue relating to whether an adjacent hydroelectric facility added value to the mill property or whether the taxpayer’s tax on the mill property effectively included a tax on a portion of the hydroelectric facility that it does not own. While the court was uncertain regarding the details of this argument it said the taxpayer may have intended to argue that the value of the mill property cannot be increased by the existence of an adjacent facility that it does not own, but noted that the taxpayer provided no factual or legal support for the argument and the taxpayer rejected it. The court additionally rejected the argument because it said it was obvious that a property's value is sometimes positively affected by beneficial features of adjacent property. Domtar A. W. LLC v. Dep't of Revenue, Wisconsin Court of Appeals, District IV, Appeal No. 2015AP1744. 3/24/16
Homestead Credit Denied Based on Husband's Out-of-State Exemption
The Florida Fourth District Court of Appeal held that a taxpayer was not entitled to a homestead property tax exemption because her then-husband received a residency-based exemption for his out-of-state home during the same time period. The court said that the Florida Constitution prohibits a taxpayer from benefiting from an exemption both in and out of state.
The taxpayer brought this suit against the Broward County Property Appraiser after it removed her homestead tax exemption for tax years 1996 through 2005 due to the fact that her then-husband was receiving a residency-based tax exemption for his out-of-state residence during the same time period. On appeal, the taxpayer argued that the pertinent Florida Constitution provision limiting family units to one homestead exemption does not apply when the second exemption is for an out-of-state residence.
The taxpayer and her husband were married in 1944 and remained so until his death in 2007. They comingled their finances throughout the period and jointly owned two properties, one in the state and one in Indiana, until 1986 when the taxpayer transferred her interest in the Indiana property to her husband and her husband transferred his interest in the Florida property to the taxpayer. The Florida property has been the taxpayer’s permanent residence since this time and she received a homestead exemption on her property taxes for this property from 1986 through 2006. Her husband received a residency-based property tax exemption on the Indiana property throughout the same time frame.
The appraiser's action was based on Article VII, Section 6(b) of the Florida Constitution, which provides that "[n]ot more than one exemption shall be allowed any individual or family unit. . . ." The taxpayer’s husband cancelled his Indiana exemption in 2006 and the taxpayer was granted a homestead exemption on the in-state property again in 2007, but because the exemption had been previously cancelled, the appraiser reset the value of the taxpayer’s property to its market value, rather than the lower value under the "Save Our Homes" provision in Article VII, section 4(d) of the Florida Constitution. Taxpayer filed an action seeking a refund of the additional taxes paid for years 2002-2005, seeking a homestead exemption for 2006 and an order requiring the appraiser to revalue the property under the Save Our Homes valuation scheme for years 2007 forward. Taxpayer also sought a declaration that section 196.031(5), Florida Statutes, was unconstitutional.
The court, citing prior case law, said that the law is well settled that a harmonious family unit, even if living apart, cannot claim more than one homestead exemption in the State of Florida.
The taxpayer argued that the Constitution and case law do not apply here and are limited to situations where both residences are in the state. The court cited Wells v. Vallier, 773 So. 2d 1197 (Fla. 2d DCA 2000), a court of appeals decision where the court concluded that the couple was entitled to receive a homestead tax exemption despite the fact that they also received a residency-based property tax credit in the State of New Hampshire, because the couple were permanent residents the state. In 2001, the legislature amended the statute to address the ability of persons to claim homestead credits in multiple states and the legislative history specifically mentions the ruling in Vallier as contradictory to the new statutory language.
The court found that the plain language of the provisions in the Florida Constitution meant that only one homestead exemption was allowed, regardless of location, citing the language’s command that "not more than one exemption shall be allowed any individual or family unit."
The court said that faced with such unambiguous language, it did not need to turn to complex analysis or employ canons of construction. The court said that the opinion in Vallier was not inapposite, finding that the court in that case wasn't focused on Article VII, section 6(b)'s "[n]ot more than one exemption" rule, but, instead, solely dealt with Article VII, section 6(a)'s limitation of exemptions to "the permanent residence" of the party seeking the exemption. It does not appear that there was a section 6(b) issue in that case, as the property owners were merely receiving "a $100 per year residency-based property tax credit" for their "summer home" in New Hampshire. The court also rejected the taxpayer’s argument that the provision unconstitutionally limits the class of persons entitled to a homestead tax exemption, citing case law for the proposition that there is a strong presumption that a statute is constitutionally valid and all reasonable doubts about the statute’s validity must be resolved in favor of constitutionality. Endsley v. Broward Cty., Florida Fourth District Court of Appeal, No. 4D14-3997. 3/23/16
Other Taxes and Procedural Issues
Tax on Small Tobacco Companies Upheld
The Texas Supreme Court held that a per pack tax on small tobacco companies that did not apply to larger companies involved in the state’s settlement agreement did not violate the equal and uniform clause of the state constitution. The court rejected the taxpayers' arguments that the tax applied to one class of identical products. See a prior issue of State Tax Highlights for a discussion of the 2014 decision by the Court of Appeals in this case which held that the fee was unconstitutional.
In 1996, Texas sued four major tobacco companies (Big Tobacco) for antitrust violations, deceptive advertising, and marketing campaigns aimed at children. The suit was settled and Big Tobacco agreed to change the way they advertised and marketed their products and to pay billions of dollars to the state. In 2013, the legislature passed legislation enacting a fee on cigarettes and tobacco products manufactured by companies that did not participate in the 1997 and 1998 settlement (Small Tobacco). The stated purpose of the legislation was to recover health care costs to the state imposed by non-settling manufacturers, prevent non-settling manufacturers from undermining the state's policy of reducing underage smoking, to protect the tobacco settlement agreement and funding, which had been reduced because of the growth of sales of non-settling manufacturer cigarettes and cigarette tobacco products, and to ensure evenhanded treatment of all the manufacturers.
The non-settling manufacturers filed suit for declaratory and injunctive relief arguing that the fee was a tax that violated the Equal and Uniform Clause of the Texas Constitution and the Equal Protection and Due Process clauses of the United States Constitution. The lower court and court of appeals found that the section of the legislation imposing the fee was unconstitutional and enjoined the state from assessing, collecting or enforcing the tax. This appeal resulted.
The court here said that the Equal and Uniform Clause is succinct: "Taxation shall be equal and uniform," a mandate that generally applies only within classes, not between classes. Courts have established a two-pronged framework within which they assess the validity of statutory tax classifications. A challenged statute is entitled to a "strong presumption" of constitutional validity and the Legislature need only have a rational basis in constructing tax classifications. The parties in this matter disputed the formulation and application of the rational-basis standard.
The court of appeals stated that its "focus must be on the subject of the tax, not the entity being taxed," and the court here found that the court kept its word by focusing only on the identical nature of the tobacco products manufactured by settling manufacturers and non-settling manufacturers (NSMs) and the court said that this constricted approach diverged from the court’s settled precedent. The court said it has made clear that, "[a]t least where non-property taxes are concerned, the Equal and Uniform Clause generally only prohibits unequal or multiform taxes that are imposed on members of the same class of taxpayers," an understanding deeply embedded in case law. The court said that the court of appeals' insistence on focusing on the products and not on the entity being taxed is thus at odds with the concerns of the Equal and Uniform Clause. Products do not pay taxes; taxpayers do, and, for that reason, in the non-property context, the nature of the taxpayer necessarily lies at the heart of any Equal and Uniform Clause inquiry. While the differences in taxpayers' products are not wholly irrelevant to this inquiry and those differences may be sufficient to sustain tax classifications, the court said that none of those differences are the sine qua non of rational tax classifications.
The court found that the taxation scheme does not violate the Equal and Uniform Clause, saying that the legislature’s distinction between settling manufacturers and NSMs is rational on at least two grounds. First, the settling manufacturers shoulder a $500-million-per-year burden that NSMs do not bear, and, second, the settling manufacturers function under operating restrictions to which NSMs are not subject. The court found that those distinctions establish sufficient differences in business operations to justify the non-settling-manufacturer and settling-manufacturer tax classifications. The court held that these differences in burdens render these tax classifications rational. It also found that the legislature articulated legitimate purposes for the tax, to recover health care costs to the state imposed by NSMs and to prevent NSMs from undermining the state’s policy to reduce underage smoking by offering tobacco products at substantially lower prices. Finally, the court said the tax classifications were reasonably related to the goals of recovering health care costs and reducing underage smoking. Payments under the Settlement reimburse the state in part for health care costs that flow from settling manufacturers' products, but no similar reimbursement mechanism was in place for NSMs and it was logical for the legislature to recover those costs from NSMs whose products create the same health risks. The court held that the tax classifications do not violate the Equal and Uniform Clause. Hegar v. Texas Small Tobacco Coal., Texas Supreme Court, No. 14-0747. 4/1/16
Club Member Lacks Standing to Challenge Tax
The Arizona Court of Appeals has held that a member of a golf club lacked standing to challenge a privilege tax on the gross income of golf courses. The court said that a customer lacks standing to challenge a tax passed on to him by a business.
The city imposes a two percent privilege tax on the gross income of golf courses and this tax was assessed against the Golf Club at Prescott Lakes, LLC (Club) for membership dues collected by the Club. The Club, in turn, passed the tax on to its members. Appellant is a member of the Club and he filed a petition for administrative review challenging the application of the privilege tax to his membership dues. The municipal tax hearing officer (MTHO) determined that appellant did not have standing to contest the tax because he was not a "taxpayer" as defined by the City Code and he appealed the MTHO's decision to the Superior Court and that court granted the city’s motion to assign the case to the state’s tax court which affirmed the decision of the MTHO.
The court noted that the tax imposed by the city on the privilege of doing business in the jurisdiction is an excise tax assessed against the gross income of the business and may be passed on to its customers, which the club did in this case. The court rejected the appellant’s argument that the superior court erred in granting the City’s motion to assign the case to the tax court, finding that the statute requires the assignment of cases involving the imposition, assessment or collection of a tax to the tax court.
The court then turned to the question of standing and cited the city code which authorizes “a taxpayer” to contest an assessment by filing a petition for administrative review with the tax collector. The city code defines “taxpayer” as “any person liable for any tax under the City Code imposing privilege and excise taxes. The City argued that the appellant did not have standing to challenge the tax because the Club is the taxpayer, not the appellant, and the court agreed. The court said that the legal incidence of the City's two percent privilege tax falls on the Club, not the appellant. He is not the taxpayer as defined by the City Code and, therefore, he lacks standing to challenge the tax. Peters v. City of Prescott, Arizona Court of Appeals, Division One, No. 1 CA-TX 15-0004. 3/29/16
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:
April 1, 2016 Edition
NEWS
A New Top 10 List
On March 21, 2016, the IRS issued a news release drawing attention to identity theft and refund fraud and publicizing its Top 10 Identity Theft Cases in states including Alabama, Florida, Georgia, New Jersey, and Texas. All cases have been finalized and the criminals sentenced to significant jail time. The release can be found at https://www.irs.gov/uac/Newsroom/IRSs-Top-10-Identity-Theft-Prosecutions-Criminal-Investigation-Continues-Efforts-to-Halt-Refund-Fraud.
Some favorites include Eddie Blanchard, a Miami man who got 18 years. His Florida-based co-conspirators traveled to Richmond, Va. to file their fake returns, using an online tax prep program. The scheme unraveled when a Virginia police officer spotted one of the co-conspirators taking stolen personal information from a storage unit. That co-conspirator was arrested, and Blanchard then “convinced him to mislead federal investigators about the identity of his actual co-conspirators, going so far as to facilitate the creation of a fictional accomplice.” Another involved a family of criminals from Georgia who filed some 1,100 fraudulent returns, almost all of them from only two IP addresses, both of which were registered to the ringleader’s home. The ringleader was employed at a regional hospital and used the personal identifying information of five patients to file fraudulent federal income tax returns and the identities of 531 16-year-olds to file returns. The ringleader also used her own cell phone to dial the Automated Efiling PIN request line 114 times — and then she filed her own federal return and claimed a dependent she was not authorized to claim.
U.S. SUPREME COURT UPDATE
Compact Challenge Taxpayer Asks Court for Extra Time to File Cert Petition
On March 16, 2016, the taxpayer in The Proctor & Gamble Manuf. Co. Inc. v. California Franchise Tax Bd. filed an application for a 60-day extension of time to file a petition for a writ of certiorari with the U.S. Supreme Court in a challenge to the California Supreme Court's decision upholding the state's repeal of the elective three-factor apportionment formula in the Multistate Tax Compact. See the January 8, 2016 issue of State Tax Highlights for a discussion of the California Supreme Court’s decision in The Gillette Company vs. Franchise Tax Bd., previously the lead taxpayer in these cases.
FEDERAL CASES OF INTEREST
Taxpayer requests En Banc Rehearing
The Direct Marketing Association has filed a motion for an en banc rehearing of the U.S. Court of Appeals for the Tenth Circuit decision on Colorado's use tax notice and reporting requirements. The motion argues that the law is facially and effectively discriminatory and the court's earlier decision runs afoul of decades of commerce clause jurisprudence.
The motion states thatthe Court’s opinion reaches the untenable conclusion that a state law that imposes burdens solely on out-of-state companies does not discriminate against interstate commerce. DMA argues that the decision “sweeps aside decades of Commerce Clause jurisprudence, exposing interstate commerce to thinly-veiled discrimination and a potential tidal wave of new regulatory requirements that the panel holds are shielded from strict scrutiny by a mere ploy of artful legislative drafting.”
The motion further contends that the full Court of Appeals should address the important constitutional questions presented in this case, arguing that the Colorado act’s notice and reporting provisions would have the potential to burden thousands of retailers with a myriad of conflicting requirements in multiple states, if upheld, and would disclose the personal purchasing information of millions of consumers to government officials. Direct Mktg. Ass'n v. Brohl; U.S. Court of Appeals for the Tenth Circuit, No. 12-1175. 3/22/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
No cases to report.
Personal Income Tax Decisions
Overpayment Credit Cannot Be Applied Until Ascertainable
The Missouri Supreme Court held that a taxpayer's overpayment credit could not be applied to reduce the amount of a subsequent year tax liability or to reduce the amount of the principal amount on which interest was calculated and assessed until the overpayment credit was ascertainable.
On April 15, 2005 the taxpayer requested an extension to file his 2004 income tax return and enclosed a payment of $2,000. He did not file his 2004 return until February 27, 2007 and according to the filed return he owed no tax for that year. He requested that the payment of $2000 be applied to his 2005 income tax liability. On March 31, 2009, he filed both his 2005 and 2006 returns and the Director of Revenue (Director) applied penalties and interest to the tax liabilities on those late filed returns and utilized the $2000 credit to satisfy those liabilities, with the remaining credit carried forward to the 2007 tax year. The taxpayer filed his 2007 return on June 28, 2011 with a balance tax due which he paid with the return. Since the return was filed late, the Director assessed penalty and interest and applied the remaining available credit to those charges, and sent a notice billing the taxpayer for the remaining charges. The taxpayer paid half of those charges and filed an appeal. The court noted that in order to challenge the Director's assessment of tax liability for a given year, the taxpayer must file a timely protest. The taxpayer did not protest the Director’s assessment of interest and additions for tax years 2005 and 2006 and they, therefore, are not part of this case.
The taxpayer argued that the Director incorrectly assessed an “addition to tax” under the statute, five percent per month with a cap of twenty-five percent, on the amount of tax had it been filed timely, because it should have been calculated only on the amount owed after his 2006 overpayment credit was subtracted. The court noted, however, that the existence and amount of the 2006 overpayment credit was not ascertainable until more than five month after the taxpayer’s 2007 return was due to be filed. The statutory provision that imposes the penalty up to twenty-five percent on late filed returns provides that the amount of tax on which this penalty is imposed is reduced by the amount of any part of the tax which is paid on or before the date prescribed for payment of the tax and by the amount of any credit against the tax which may be claimed upon the return. The court said that the plain language of this provision requires the Director to assess an addition to tax whenever there is a failure, not due to reasonable cause, to file a timely return. The taxpayer did not claim to have a reasonable cause for the delay in filing his 2007 return and the court said the Director was correct in assessing the penalty on his 2007 return. The taxpayer argued that the Director should have calculated the penalty after subtracting the overpayment credit from the 2006 return, but the court said he was not entitled to an overpayment credit on April 2008 when his 2007 return was due because on that date the Director did not know whether the taxpayer would have a 2006 overpayment credit, let alone the amount of that credit. The court noted that the taxpayer did not provide any statute, regulation, or case law suggesting that an overpayment from a previous tax year suspends the filing deadline for subsequent returns, especially when the existence or amount of that overpayment was not ascertainable on the filing deadline.
The taxpayer also argued that the Director should have assessed interest only on the amount of taxes he owed for 2007 after his 2006 overpayment credit was subtracted.
The court reviewed the statutory provisions regarding the calculation of interest and found that the Director properly computed the interest on the total amount of tax due from the due tax of the return. The court said that the Director did not know whether the taxpayer would have an overpayment credit from 2006 until March 31, 2009, when he filed his 2006 return. As soon as the taxpayer filed his 2006 return and the Director was able to ascertain the amount of his 2006 overpayment credit, it was applied to reduce the amount the taxpayer owed for 2007, and interest no longer accrued on that amount. The court held that the taxpayer was not entitled to more. Fischer v. Dir. of Revenue, Missouri Supreme Court, No. SC95055. 3/15/16
Corporate Income and Business Tax Decisions
Amendment to Exemption Can Apply Retroactively
The Washington Supreme Court found that the retroactive application of an amendment to a business and occupation (B&O) tax exemption did not violate due process because the amendment was rationally related to the legitimate purpose of preventing devastating revenue losses.
The state’s B&O tax is imposed for the act or privilege of engaging in business activities within the state and applies unless a specific exemption exists. A former statutory provision exempted certain out-of-state sellers from the B&O tax if they made "sales in this state exclusively to or through a direct seller's representative," as defined in the same provision.
The taxpayer is an Illinois-based food reseller that sells products to service companies in the state through its wholly owned subsidiary. The taxpayer qualified for the direct seller's exemption under the former provision from 1997 until 2000, when the Department of Revenue (DOR) narrowed its interpretation of the statute. This new interpretation gave rise to Dot Foods I, the previous tax appeal implicated in the current dispute. In 2009 the court decided Dot Foods I, 166 Wn.2d 920, which held that the DOR’s revised interpretation of the statute was contrary to the statute's plain and unambiguous language. In that case, the court concluded that the taxpayer remained qualified for the B&O tax exemption to the extent its sales continue to qualify for the exemption. The taxpayer continued to pay the full B&O tax during the pendency of its prior tax appeal to avoid penalties and interest and pursuant to the judgment in the case, requested a refund for the taxes paid from January 2005 through August 2009, a time period that extended beyond the tax periods directly at issue in Dot Foods I.
In April 2010, the legislature amended former provision in direct response to the decision in Dot Foods I, narrowing retroactively the scope of the exemption and prospectively repealing the direct seller's exemption. The court said it was undisputed that the taxpayer qualified for the exemption under the former provision, but is ineligible for the exemption under the 2010 amendment. DOR denied the refund application for the periods outside the litigation of Dot Foods I, based on the retroactive application of the amendment. At issue in this case is the taxpayer’s refund for the B&O taxes it paid from May 2006 through December 2007, the interim period beginning immediately after the tax periods at issue in Dot Foods I and ending when the taxpayer’s business practices changed in 2008. In a letter opinion, the trial court granted summary judgment to the DOR on the collateral estoppel and separation of powers issues raised by the taxpayer, but found in favor of the taxpayer on the due process claim.
The court noted that the Supreme Court set forth the due process standard for retroactive tax legislation in United States v. Carlton, 512 U.S. 26, 114 S. Ct. 2018, 129 L. Ed. 2d 22 (1994), establishing that the statute must be “supported by a legitimate legislative purpose furthered by rational means.” The court discussed its recent decision in In re Estate of Hambleton, 181 Wn.2d 802, 335 P.3d 398 (2014), cert. denied, 136 S. Ct. 318 (2015) in which it affirmed a retroactive tax amendment under this rational basis standard. See a prior issue of State Tax Highlights for a detailed discussion of that decision. The court here noted that although the present case involves a different tax scheme, the underlying facts are analogous to those in Hambleton, which is controlling precedent here, and found that the retroactive application of the 2010 amendment does not violate due process protections. The court pointed out that the legislature identified the prevention of large and devastating revenue losses as the primary purpose for narrowing the scope of the exemption in 2010, the same legislative intent that the court recognized as a legitimate purpose in Hambleton. The court also noted that the legislature history of the 2010 amendment concluded that the former provision provided preferential tax treatment for out-of-state businesses over their in-state competitors and created a strong incentive for in-state businesses to move their operations outside Washington.
The court said this was analogous to the legislature's goal of restoring parity between different classes of taxpayers, which it also accepted as a legitimate legislative purpose in Hambleton.
The court rejected the taxpayer’s argument that Carlton requires revenue losses be "'unanticipated"' to meet the rational basis standard, finding that there was no holding in
Carlton to that effect, and the taxpayer provided no case law supporting this contention. The court also rejected the allegation that the legislature had an improper motive of targeting the taxpayer, finding that the fact that the legislature acted in direct response to the court’s decision in Dot Foods I does not constitute targeting a specific taxpayer.
The taxpayer argued that the purported 27-year retroactivity period is irrational on its face. The court noted that a retroactivity period meets the standard set forth in Carlton if it is rationally related to the amendment’s legitimate purpose. The court said that the taxpayer’s contention that a 27-year retroactivity period is per se unconstitutional was belied by the fact that the court upheld a retroactive amendment that occurred 37 years after the statute was originally enacted in W.R. Grace & Co. v. Department of Revenue, 137 Wn.2d 580, 973 P.2d 1011 (1999). The court noted that at issue in this case is whether the amendment, which went into effect on May 1, 2010, applies retroactively to the May 2006 through December 2007 interim tax periods, and, thus, the retroactivity period as applied to the taxpayer is only four years. The court said that in practical terms the 2010 amendment cannot reach back 27 years, because the statute of limitations functionally limits retroactive application of the amendment to four years, a period of retroactivity that the court said was well within the range of retroactivity the court has previously upheld. The court found that the actual retroactive effect of the amendment as applied to the taxpayer was rationally related to the legislature's legitimate, stated purpose of preventing the loss of revenues resulting from the expanded interpretation of the exemption.
The court also rejected the taxpayer’s argument that the May 2006 through December 2007 period is encompassed by the judgment in Dot Foods I, which prevents DOR from assessing B&O taxes against it under the 2010 amendment pursuant to collateral estoppel, holding that collateral estoppel does not apply in this case, citing Christensen v. Grant County Hosp. Dist. No. 1, 152 Wn.2d 299, 307, 96 P.3d 957 (2004) for the proposition that the collateral estoppel doctrine may be applied to preclude only those issues that have actually been litigated and necessarily and finally determined in the earlier proceeding. The court found that both the facts and the applicable law in this case are distinguishable from Dot Foods I. The court said that although Dot Foods I and the present case concern the same taxable activity, different tax periods are involved, and pointed out that the U.S. Supreme Court and federal circuit courts have declined to apply collateral estoppel in federal tax cases involving identical taxable transactions that occur in subsequent taxing periods. Citing Commissioner v. Sunnen, 333 U.S. 591, 598, 68 S. Ct. 715, 92 L. Ed. 898 (1948), the court here said the decision established that determinations about tax liability for one taxing period under then-applicable statutes do not control decisions regarding subsequent taxing periods under amended statutes, and held that collateral estoppel does not apply to subsequent taxing periods that were not previously adjudicated.
Finally, the court rejected the taxpayer’s argument that the legislature violated separation f powers principles in enacting the retroactive provision, finding that the taxpayer cannot point to any evidence that the legislature intended to affect or curtail the judgment in Dot Foods I and noting that the legislature explicitly preserved prior judgments in a section of the legislation. The court said that since the judgment in Dot Foods I does not encompass the interim period at issue, therefore, retroactive application of the amendment to this period does not run afoul of the separation of powers doctrine. The court concluded that it is entirely within the proper function of the legislature to amend laws in response to the court’s decisions and in amending the provision at issue here, the legislature was careful to avoid trespassing on the judicial function by explicitly preserving any final judgments prior to the effective date of the amendment. Dot Foods Inc. v. Dep't of Revenue, Washington Supreme Court, No. 92398-1. 3/18/16
Retroactive Repeal of Multistate Tax Compact Upheld
The Michigan Court of Appeals ruled in a consolidated case of 20 appeals that the Legislature did not violate the compact, due process, commerce, and title-object clauses of the U.S. Constitution by retroactively repealing the Multistate Tax Compact.
These 20 consolidated appeals are part of the ongoing litigation in the state in which corporate taxpayers operating in multiple states made use of the elective three-factor apportionment formula in the Multistate Tax Compact to which the state previously adhered. The state legislature enacted 2014 PA 282, which clarified that its enactment of the Michigan Business Tax Act (MBTA), 2007 PA 36, withdrew the state from the compact and created a single-factor apportionment formula and provided for retroactive application to 2008. The taxpayers here challenge the validity and constitutionality of 2014 PA 282.
The court here noted that it rejected identical arguments in Gillette Commercial Operations North America & Subsidiaries v. Dep't of Treasury, ___ Mich App ___; ___ NW2d ___ (Docket No. 325258 et al, issued September 29, 2015). The plaintiffs' applications for leave to appeal in Gillette are currently pending before the Michigan Supreme Court and the court here held that this appellate proceeding is sufficient to resolve the legal questions presented.
Two of the taxpayers in this matter also requested waivers of the penalty imposed because they made inadequate quarterly tax payments in 2008. The court rejected one because the estimated payments created an excessive shortfall warranting the penalty imposed regardless of the calculation method. The court rejected the other because the taxpayer’s complaint did not fulfill the statutory and rule notice requirements, noting that the complaint sought action from the court, not the defendant, and sought to satisfy the court, not defendant, that the taxpayer's quarterly payments were reasonably calculated, and failed to exhaust the available administrative remedies.
In another issue involving one of the taxpayers, the DOR argued that the lower court lacked jurisdiction to hear the matter because the taxpayer filed the action beyond the 90-day window, the complaint did not allege an actual controversy and the action was a collateral attack which should have been challenged through a direct appeal to the Court of Appeals.
The court said it discerned no error in the Court of Claims considering this action despite that it was filed more than 90 days after defendant's adverse decision and found that there existed an actual controversy to place before the Court of Claims for resolution. Finally, the court held that the collateral attack argument was also unfounded. Harley Davison Motor Co. v. Dep't of Treasury, Michigan Court of Appeals, No. 325498,; 325499,; 325500,; 326130,; 326131,; 326135,; 326862,; 327057,; 327178,; 327217,; 327218,; 327220,; 327222,; 327964,; 327694,; 327995,; 328193,; 328206,; 328317,; 328967. 3/15/16
Trial Court Cannot Make Its Own Motion for Summary Judgment
The Illinois Appellate Court, First District, held that a lower court did not have the authority to make a motion for summary judgment sua sponte in a case to decide whether a corporation had to include the earnings of its wholly owned affiliate. The court remanded the case for the parties to file summary judgment motions or for a trial.
The taxpayer in this matter paid under protest taxes assessed for tax years 2005, 2006 and 2007 by the Department of Revenue (DOR) and filed a complaint in which it prayed for recovery of part of its tax payments. Taxpayer alleged that the DOR had overstated its tax because the DOR improperly included in its tax computation the earnings of a wholly owned affiliate of the taxpayer. The circuit court held a status hearing and entered an order directing the parties to present summary points of the similarities and differences factually between the present matter and Wendy's International, Inc. v. Hamer, 2013 IL App (4th) 110678 providing a deadline for this submission of less than a week after the date of the order. The record did not include any motion to which the order responded, and the order on its face made no reference to any motion of the parties. The taxpayer filed a six-page document listing allegations concerning the wholly owned subsidiary and compared the allegation to the facts in Wendy’s. The court in this matter noted that nothing in the record indicated that the trial court had access to any documents referred to in the summary provided by the taxpayer. DOR filed one page in which it alleged that several factual differences made Wendy's inapplicable to the case against the taxpayer. The circuit court entered a judgment in favor of the taxpayer stating that it found no genuine issue of material fact as to one or more of the major issues and stated that the court’s decision in Wendy’s was controlling.
On appeal, the Department of Revenue (DOR) contended that the circuit court lacked authority t enter judgment in favor of the taxpayer sua sponte, citing Peterson v. Randhava, 313 Ill. App. 3d 1 (2000). The court found that the language of the order indicates that the court acted as though it was deciding a motion for summary judgment. The taxpayer argued that it made an informal motion for summary judgment and the record supports the entry of judgment in its favor, but the court noted that the record included no written or spoken motion for summary judgment. Thus, the court concluded that the record lead to the conclusion that the circuit court made a motion for summary judgment sua sponte, and then, without notice that it intended to proceed under section 2-1005, it entered judgment on its own motion. Citing Peterson, the court held that the statutes and rules did not authorize the circuit court to make a motion on its own to dispose of the case in this summary manner, without the notice required for dispositive motions, and without giving the DOR a full and fair opportunity to create a record in support of its decision to tax the taxpayer on the income of its subsidiary. The court also said that the record on appeal included no evidence admissible at trial in support of the factual assertions on which the taxpayer relies as justification for the circuit court's judgment. The informal memoranda the court requested did not qualify as pleadings, depositions or affidavits and the taxpayer’s memorandum included no evidence admissible in court, consisting solely of allegations without attestation. The court found that even apart from the procedural impropriety, it must reverse the judgment so that the parties can present evidence and create a record that shows a party has presented sufficient evidence to justify the entry of judgment in its favor. Respironics Inc. v. Hamer, Illinois Appellate Court, First District, 2016 IL App (1st) 150471-U; No. 1-15-0471. 3/15/16
Alternative Apportionment Upheld
The Tennessee Supreme Court has ruled that the commissioner of revenue (Commissioner) did not abuse his authority by using a variance to require a telecommunications company to use market-based sourcing to apportion receipts for excise and franchise tax purposes. The court found that the variance comported with the statute, regulations, and statutory purpose of the tax statute. See a previous issue of State Tax Highlights for a discussion of the Court of Appeals decision in this matter.
The taxpayer is a multistate wireless telecommunication and data services provider. The taxpayer contended that it was entitled to apportion their income based upon the state’s standard cost of performance apportionment formulas because the majority of their "earnings producing activities" occurred in a state other than Tennessee. The great majority of the taxpayer’s receipts in the state came from services rather than the sale of tangible personal property, and the taxpayer contended that the greater proportion of its costs associated with such services were incurred in another state. The Commissioner argued that this approach failed to meet the higher goal of fairly representing the business the taxpayer derives from the state, and required the taxpayer compute its apportionment using market-based sourcing and to include "as Tennessee sales" its receipts from service provided to customers with billing addresses in the state. The taxpayer contended that the Commissioner did not have the authority to impose a variance unless unusual fact situations, unique to them, produced an incongruous result unintended by the state’s statute.
The taxpayer owns a 45% partnership interest in a Delaware company that does business throughout the country providing wireless phone services; some of their customers had billing addresses in the state during the period in question. Taxpayer contended that the state statute provides that the partnership’s sales other than sales of tangible personal property are attributable to Tennessee and, therefore, included in the numerator of a taxpayer's sales or receipts factor, if and only if the majority of the taxpayer's earnings producing activity related to the intangible property was performed in the state.
One of the issues raised by the taxpayer in this appeal was whether the Commissioner violated the separation of powers required by the Constitution and the court noted that this issue was not raised at the trial court level and held that the taxpayer had waived consideration of this issue. The court, therefore, considered in this appeal only whether the Commissioner abused his discretion by imposing the variance. The taxpayer also argued in this appealthat the DOR’s own regulations circumscribe the Commissioner's authority to impose a variance, providing that a variance may be imposed only in limited and specific cases, to address incongruous results not intended by the legislature. The taxpayer contended that the variance issued in this case contravenes the legislature's exclusive authority to enact laws and impose taxes, and argued that permitting the variance here would create chaos for taxpayers who rely on the predictability of the tax statutes.
The court noted that it was undisputed that the cost of performance methodology for calculating franchise and excise taxes that the taxpayer proposed is consistent with the methodology set forth in state’s franchise and excise tax statutes. The parties agreed that removal of the taxpayer’s service receipts from the apportionment formula reduced the sales factor in the taxpayer’s apportionment formula from approximately $1.3 billion to approximately $150 million, a decrease of approximately 89%. It was also undisputed that the methodology for calculating franchise and excise taxes chosen by the Commissioner in the variance is consistent with the methodology used by the taxpayer in its original tax returns for the relevant periods here. The court noted that if the Commissioner's variance were upheld, the taxpayer would essentially owe no additional franchise and excise taxes for the relevant periods but also would not be entitled to the refund requested by the taxpayer.
In reviewing the Commissioner’s imposition of the various for an abuse of discretion, the court cited case law in this area and noted that the review would determine whether the factual basis for the decision is properly supported by the record, whether the Commissioner properly identified and applied the most appropriate legal principles applicable to the decision, and whether the Commissioner's decision was within the range of acceptable alternative dispositions. The court noted that the state’s franchise and excise tax statutes, including its apportionment formula and variance provisions, were based on a model law in an attempt to provide some uniformity. The court also noted that the state statutes have long delegated to the Commissioner the power to issue a tax variance and pointed to the model statute that permitted the Commissioner to impose a variance upon a taxpayer if the allocation and apportionment provisions did not fairly represent the extent of a taxpayer’s business activities in the state and authorized the Commissioner to employ, if reasonable, any of four alternative. In 1999 the state legislature enacted changes to the state’s franchise and excise tax structure in order to raise revenues and, as part of this, expanded the Commissioner's authority under the variance statute. The amendments were intended to give the Commissioner more power in fashioning a variance, in order to prevent corporations doing business in the state from shifting income and profits out of the state.
The court said that the threshold inquiry under the variance statute is whether the standard statutory tax apportionment provisions "do not fairly represent the extent of the taxpayer's business activity in this state." If that threshold is met, the court then looks at whether the alternate formula selected by the Commissioner in the variance is "reasonable."
The court rejected the taxpayer’s arguments that its apportionment formula fairly represents its business activity in the state and that the Commissioner overstepped his authority in imposing the variance, citing BellSouth Advert. & Publ'g Corp., 308 S.W.3d 365 in which the court rejected a similar argument. The court in the present case said that the BellSouth Court noted that the legislature, in enacting the variance statute, was aware that the statutory formulas sometimes "just do not work," and so held that the Commissioner's imposition of a variance in such a case was not an abuse of discretion. During the relevant periods in the present case, the court pointed out that the taxpayer’s receipts for telecommunications services for state customers totaled over $1.3 billion, and if the taxpayer were permitted to apply the its method advocated in its refund request, this would drop its sales factor to slightly more than $150 million, thereby excluding some 89% of its total state sales receipts. Thus, billions of dollars in the state’s revenue from in-state customers would become invisible for tax purposes under the standard franchise and excise tax apportionment formula. The court said that it was difficult to imagine a more extreme example of a situation in which application of the statutory apportionment formula does not "fairly represent the extent of the taxpayer's business activity in this state." The court agreed with the taxpayer’s argument that the Commissioner should not be given “unbridled power” in making this variance, but held that the statute provides for adequate standards to guide the agency in making theses decisions and said it was clear that the Commissioner was aware that he needed to meet these standards in exercising his discretion to impose a variance. The court rejected that this discretion is “unfettered,” pointing to the judicial review of the exercise.
The court then turned to the issue of whether the alternate formula that sourced receipts according to the places where the taxpayer’s customers were located and where the cellphone services were provided was reasonable. The Commissioner argued that the methodology was straightforward and conceptually satisfying and was administrable because DOR could verify the state to which receipts from the taxpayer’s cellphone services should be attributed.
The court also noted that it appeared essentially undisputed that, absent the variance, the taxpayer’s state receipts would be "nowhere income," i.e., would not be subject to franchise or excise taxes in any state. The court found that the “reasonable” test had been met. The court also found thatviewing the variance regulation as a whole and in light of the variance statute and the goals of the model statute, the variance imposed on the taxpayer in this case was not inconsistent with the variance regulation.
Having held that the variance comports with the applicable statutes and regulation, the court then determined that the use of the variance was not an abuse of discretion by the Commissioner, finding that it was within the range of acceptable alternatives available to the Commissioner. The court said that application of the statutory apportionment formula would leave the taxpayer reaping millions of dollars in receipts from doing business in in the state while paying no tax for the privilege of doing so. In contrast, the court noted that under the variance the taxpayer would be subject to franchise and excise taxes under an apportionment formula that meets the UDITPA goals of fair apportionment of the business the taxpayer does in the state and taxation of neither more nor less than 100% of the receipts from its state customers. Vodafone Americas Holdings Inc. v. Roberts, Tennessee Supreme Court, No. M2013-00947-SC-R11-CV. 3/23/16
Property Tax Decisions
Partial Exemption Denial on Waste Water Facility Upheld
The Ohio Supreme Court upheld the partial tax exemption on the personal property of a wastewater treatment facility that reflected industrial wastewater. The court also said that the tax commissioner was not required to disclose evidence to the state environmental agency.
The taxpayer is the private owner and operator of a waste-water-treatment plant located in the state that serves numerous communities. The facility also treats wastewater emanating from paper-and cardboard-making operations of several businesses in the area. The facility at issue in the case was previously owned by the Water Conservation Subdistrict and during the period of its public ownership, it enjoyed complete exemption from tax. At issue here is the exemption claim for the treatment of the industrial wastewater generated by its manufacturing customers. The taxpayer sought exemption of the real-estate improvements and all the personal property at the plant and the tax commissioner (Commissioner) granted the exempt-facility certificate for only a percentage of the personal property the commissioner deemed to be exempt, reflecting the amount of inflow that is industrial waste water but not including the amount of residential waste water generated by the communities. The Board of Tax Appeals (BTA) affirmed the Commissioner's disposition and the taxpayer filed this appeal.
The legislature enacted an exemption in 1965 for industrial water pollution control facilities as a measure to encourage the installation of these facilities. The current list of exempt facilities includes air-pollution-control facilities, energy-conversion facilities, noise-pollution-control facilities, solid-waste-energy-conversion facilities, thermal-efficiency-improvement facilities, and industrial-water-pollution-control facilities. Upon obtaining a certificate from the Commissioner, the holder enjoys exemption of the property described in the certificate from real and personal property taxation.
At the Board of Tax Appeals (BTA) hearing, the taxpayer’s former plant manager testified and distinguished the two sources of waste water treated by the plant, the residential waste water, which is essentially sewage from households in the three cities using the plant, and was relatively easy to treat, and the industrial waste water, which according to his testimony contained 94percent of the pollutants treated at the facility. On that basis, therefore, the taxpayer argued that the primary purpose of the plant was to treat the industrial wastewater and justified a 100 percent exemption for all the property at issue here. The Commissioner pointed out that once the application was received, it was referred to the state’s EPA for an opinion, as required by statute, and the opinion divided the property listed in the application into "recommended property" and "non-recommended property," finding that the non-recommended property was not primarily used as an exempt facility. Based on information provided by the taxpayer, the EPA proposed approval of 17 percent of the recommended property. At the BTA hearing, the EPA engineer testified that the 17 percent figure relied on by the EPA and the tax commissioner corresponded to the percentage of the total flow of waste water that was "industrial flow." The taxpayer argued that the percentage of the exemption should correspond to the percentage of contaminants in the industrial inflow, which was higher.
The court noted only some of the effluent treated is “industrial waste,” a requirement of the statutory exemption, and the treatment of industrial and residential waste water means that the property is not used only for the treatment of industrial waste water. The court rejected the taxpayer’s argument that because the treatment facility’s primary purpose is to treat industrial waste, the entire facility is exempt from tax, finding that this assertion is contradicted by both the statute and the case law. The court said the central point is whether the primary purpose test should be applied to the entire plant or to each article of property individually and rejects the taxpayer’s argument for the global application of the test. The court points out the distinction in the statute between “exclusive property” and “auxiliary property,” which the court said requires the Commissioner to look at the functionalities of each article of property in relation to the control of pollution and break out the percentage of use that permits the exemption. In addition, the statute provides that property that serves the business's own benefit, rather than the control of pollution, is not an exempt facility, underscoring the need to look at property piece by piece. The court notes that case law reinforces that the functionality requirement must be applied to each article of property individually.
The court rejected the taxpayer’s argument that the treatment of industrial waste had absolute primacy because the facility was constructed and designed to treat industrial wastewater and the industrial customers are the major contributors. The court said that the assertion did not establish that the principal purpose of building the plant was to serve those customers, and was, in fact, not credible in light of the development of the plant in the 1970s to serve the three communities as well as to process industrial effluent. In addition, from a quantitative standpoint, the court pointed to the evidence that industrial inflow was limited to about 17 percent as refuting the assertion.
The taxpayer also argued that the Commissioner had a duty to transmit documentation it received during the hearing process before the tax agency to the EPA for further evaluation. The court rejected that argument, noting that the documentation was submitted after the original application and noting in the statute requires the Commissioner to submit this supplemental documentation to the EPA and noting that the taxpayer failed to exercise its statutory to demand that the EPA participate at the hearing before the tax department, a demand that would have inevitably exposed the EPA to the new documentation. The court also noted that the testimony of the EPA engineer at the BTA hearing indicated that the EPA's recommendation would not have changed based on the newly submitted documentation, because using pollutant concentration to determine the percentage of the exemption has not been deemed an acceptable approach by the EPA. Veolia Water North Am. Op. Serv. Inc. v. Testa, Ohio Supreme Court, No. 20. 3/2/16
Board of Tax Appeals Erred in Relying on Appraisal
The Ohio Supreme Court held that the Board of Tax Appeals (BTA) erred in relying on an appraisal when potentially material portions of the record were not transmitted on appeal.
The owner of the property at issue here presented an appraisal report based on a comparable-sale analysis and cost analysis, along with the testimony of the appraiser, at the county’s Board of Revision (BOR) in an appeal of the 2009 valuation of the property. BOR rejected the appraisal and retained the valuation submitted by the county’s fiscal officer and the taxpayer filed an appeal to the Board of Tax Appeals (BTA). The BOR certified the record of the proceedings to the BTA, but it failed to include the audio recording of the oral testimony before the BOR. The audio of the hearing was listed on the index of the BOR transcript but was marked “not available.” The BTA reviewed the incomplete record and concluded that the appraisal report constituted the best evidence of the property's value. The county’s Board of Education (BOE) noted this appeal, contending that the BTA acted unreasonably or unlawfully by adopting the appraisal given the absence of the recorded testimony from the record.
The court noted that at the BOR, the BOE presented evidence of its own in the form of printouts from the fiscal officer's website of properties sold in the area, which were summarized on a grid. Twelve of the properties were improved residential properties and the average price of the improved properties was $285.59 per square foot, a figure that, when applied to the living area of the subject property, would yield a sale price of $1,191,767, contrasting with the $330,000 valuation in the appraisal.
The county fiscal officer and the BOR argued that the BTA had a legal duty to avoid adopting the appraisal valuation because the audio recording of the examination and cross-examination of the appraiser was not certified as part of the record, but the court found that this argument was barred as to the county fiscal officer and the BOR, noting that the statute specifically requires the BOR to certify the transcript of the proceedings and provides that the fiscal officer is the secretary of the BOR and is charged with keeping an accurate record of the proceedings of the board. The court said that the fiscal officer and the BOR defaulted on their statutory obligation to supply a record of "all evidence offered" below, yet asked for reversal of the BTA's decision on the grounds that the audio recording that they failed to preserve and transmit as part of the record was necessary to the BTA's consideration and adoption of the appraisal. The court declined to accept the claim saying the county was seeking to take advantage of its neglect of its duty to transmit the audio of the hearing to the BTA.
The BOE also advanced the argument, contending that the BTA could not rely on the written appraisal report, because the audio of hearing was marked as "not available" on the index to the BOR transcript noting the potential significance of the examination and cross-examination of the owner's appraiser in determining the probative value of the appraisal report. The taxpayer argued that the appraisal report contains adjustments to the comparables in the report itself, that it constitutes evidence of value, and that the BTA properly exercised its duty of evaluating and finding value based on the evidence that was in the record before it. The court said that both sides have a legitimate grievance arising from the BOR's failure to perform its statutory duty and said that, under other circumstances, it might be dispositive that the BOE waived hearing before the BTA and did not object to the use of the appraisal to value the property for tax year 2009 and did not exercise its rights as an appellee before the BTA to impugn the written appraisal report. The court concluded, despite the procedural omissions by BOE, that the BTA's reliance on the owner's appraisal, given the absence of potentially material portions of the record, constituted plain error that it can correct on appeal despite a waiver below.
The court said that the reliable and probative character of the owner's appraisal was called into question by the fact that the BOR rejected it based upon a record that was not preserved and made available to the BTA. Moreover, the appraisal opinion of value, $330,000, reflected a reduction of 62 percent from the fiscal officer's original valuation, and the character of the property called for careful scrutiny of an appraisal that advocated so great a reduction. The court concluded that the BTA erred by adopting the appraisal valuation under these circumstances, noting that it had ample statutory authority to address the problems presented in the case and could have ordered the hearing of additional evidence. The court vacated the decision of the BTA and remanded the matter for further proceedings consistent with their opinion, ordering that on remand the BTA shall exercise its statutory authority to develop the record, issue an order supported by reliable and probative evidence, and apply its valuation for tax year 2009 to tax years 2010 and 2011.
The dissent found that the Board of Tax Appeals didn't err in adopting the appraiser's valuation because the appellant failed to object to the appraisal report. Cannata v. Cuyahoga Cnty. Bd. of Revision, Ohio Supreme Court, No. 2014-0957. 3/22/16
Denial of Abatement of Real Estate Taxes Upheld
The Massachusetts Appellate Tax Board held that the taxpayers didn't meet their burden of proving that their property had a lower value than assessed, finding the property's highest and best use was as retail single-family building lots.
For the periods relevant here the taxpayers were the owners of approximately 170 acres of land, composed of an assemblage of various contiguous tracts of land purchased in 2006 and 2007. The tracts include a single-family home with 7.5 acres of land, a tract of 18.5 acres, a home with 11 acres and a non-arm’s-length transfer of more than 122 acres of land. In 2006, a subdivision plan for the subject property was created and endorsed by the local Planning Board totaling 21 single-family house lots that required no further approval. (21-lot ANR plan). Thirteen of the lots in the 21-lot ANR plan contained longer or shared driveways while the remaining 8 lots had greater road frontage and shorter, private driveways.
The developer stated that prior to 2008 he expended a total of more than $400,000 for roadwork and landscaping, engineering fees, and permitting expenses. In 2007, a third party presented an offer to purchase in its entirety the 21-lot ANR subdivision for $8,100,000, which was refused. On June 9, 2008, a new subdivision plan named Hanover Hill for 35 single-family house lots was approved for the subject property and substituted for the 21-lot ANR plan. The new plan required various infrastructure and site improvements and more than $1 million was expended toward these improvements in calendar year 2008, with the remainder performed in 2009. For fiscal year 2009, the taxpayers appealed all of the parcels in the 21-lot ANR subdivision.
The taxpayers timely paid the real estate taxes for all fiscal years at issue without incurring interest and timely filed their applications for abatement for each of the lots or tax parcels contained within the subject property for all fiscal years at issue. For fiscal year 2010, the taxpayers appealed all of the parcels in the 35-lot subdivision except for Lot F that was under agreement and Lot 22. For fiscal year 2011, the appellants appealed all of the parcels in the 35-lot subdivision except for Lots F, 22, and 23, all of which sold in 2009, as well as Lots 14 and 26. For fiscal year 2012, the appellants again appealed all of the parcels in the 35-lot subdivision except for Lots F, 22, and 23, as well as Lots 14 and 26 that sold in 2010.
Based on all of the evidence presented at the hearing, the Appellate Tax Board (Board) found that the appellants failed to prove that the subject property was overvalued for fiscal year 2009, 2010, 2011, or 2012. The Board found that for ad valorem tax purposes, the subject property's highest and best use, as of the relevant valuation assessment dates for the fiscal years at issue, January 1, 2008, January 1, 2009, January 1, 2010, and January 1, 2011, respectively, was as separate retail building lots that were ready to be sold to and utilized by multiple purchasers at retail prices. The Board based its highest-and-best-use determination on numerous factors including: the creation and approval of the 21-lot ANR plan before the valuation and assessment date for fiscal year 2009; the creation and approval of the 35-lot subdivision plan prior to the valuation and assessment date for fiscal year 2010; the completion of the binder roadway for the 35-lot subdivision prior to the valuation and assessment date for fiscal year 2010; and the marketing, availability, and sale of the lots within the subject property at retail prices to others beginning in June, 2009; as well as the assessors' rationale for their highest-and-best-use determination. The Board found that its highest-and-best-use finding for the subject property best met all of the well-settled criteria for determining highest and best use. The Board cited Iantosca v. Assessors of Weymouth, Mass. ATB Findings of Fact and Reports, 2008-929, 947-48 for the proposition that a
“property's highest and best use must be legally permissible, physically possible, financially feasible, and maximally productive."
The Board said that the timing of the subdivisions' creations and approvals, the ANR nature of the 21-lot subdivision, the completion of the binder roadway in December 2008 with respect to the 35-lot subdivision, and the timely marketing of and sale to retail customers of some of the lots within the subject property shows that the its highest and best use was legally permissible. The Board rejected the highest and best use offered by the taxpayer’s real estate valuation expert, finding that his discounted-cash-flow methodology reflected a value based on a different highest and best use, the bulk sale value of the property’s lots and infrastructure to one purchaser. The court found the estimate of the property’s fair cash value for the fiscal ears at issue were not credible. The Board concluded that the lots could not be valued in bulk for ad valorem tax purposes because a bulk sale was not the subject property's highest and best use. The Board found that its highest-and-best-use finding for the subject property met all of the criteria for determining highest and best use and rendered the subject property maximally productive. The Board ruled that the taxpayers failed to prove that the subject property was overvalued for ad valorem tax purposes for any of the fiscal years at issue.
GLW Kids LLC v. Bd. of Assessors of the Town of Carlisle, Massachusetts Appellate Tax Board, X301716-737; F308220; F310968; F315242. 3/23/16
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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