|
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:
February 19, 2016 Edition
NEWS
Hawaii Pay-to-Play Proposal
Pending in the Hawaii legislature this year is a proposal that would require payment of tax, penalties and interest on the first appeal of a tax assessment exceeding $50,000. SB2923, introduced on January 27, 2016 by Senator Kouchi, had its first hearing on February 17, 2016.
The Council On State Taxation in a letter to the Senate committee has noted its opposition to this proposal, saying this "pay-to-play" provision limits taxpayers' access to an independent tax hearing and fair administration.
Oregon Sales Tax Nexus Proposal
A bill that would require some remote sellers to collect sales tax in South Dakota has cleared its first hurdle in the Senate. SB 106 is sponsored by Sen. Deb Peters, a former president of the Streamlined Sales Tax Governing Board. Under the proposal, sellers required to collect the tax would have to have 200 or more in-state transactions a year, with $100,000 or more in sales.
Airbnb to Collect in Alabama
The Alabama Department of Revenue has reached an agreement with Airbnb to collect and remit hotel taxes. Beginning March 1, 2016, Airbnb will collect the state's transient occupancy tax, as well as other local lodgings taxes for its hosts within the state.
U.S. SUPREME COURT UPDATE
Justice Antonin Scalia
March 11, 1936-February 13, 2016
Supreme Court Associate Justice Antonin Scalia died of natural causes on February 13, 2016. He had been appointed to the Court by President Reagan and took his seat on September 26, 1986. Tributes to him were numerous, but of particular note were the comments that his fellow Justices posted on the Supreme Court website, www.supremecourt.gov. Justice Ginsburg, who had also service with him on the D.C. Circuit said, “[I]t was my great good fortune to have known him as working colleague and treasured friend.” Justice Thomas noted, “[I]t is hard to imagine the Court without my friend. I will miss him beyond all measure.”
FEDERAL CASES OF INTEREST
No cases to report.
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Manufacturer's Chemicals Met Criteria for Further Processing Exclusion
A court held that a paperboard products manufacturer was entitled to a refund of sales and use tax for chemicals used in its manufacturing process. The Louisiana Court of Appeal, Second Circuit, found that the materials met the three-pronged test for the state's further processing exclusion.
On July 5, 2011, the taxpayer, a paperboard products manufacturer, filed a claim for refund of sales and use tax on purchases of chemicals it alleged were used for further processing and entitled to the statutory exemption. The claim was denied and the taxpayer requested a hearing that was never scheduled. The taxpayer then filed suit in district court, which held for the taxpayer on the issue of the chemicals but denied that portion of the claim attributable to purchases of repulpable tape and professional services.
The ability for local subdivisions within the state to levy sales and use taxes is governed by the state statute, which, pertinent to this case, provides an exclusion from the definition of sale at retail for the sale of materials for further processing into articles of tangible personal property for sale at retail. The court reviewed prior case law that held raw materials are “further processed” into end products when (1) they become recognizable and identifiable components of the end products, (2) the raw materials are beneficial to the end products, and (3) the raw materials are materials for further processing and are purchased with the purpose of inclusion in the end products. The courts, in formulating this test, rejected the primary purpose test.
The city argued that the lower court was incorrect in finding that conductivity was a benefit achieved by inclusion of the chemicals in the end products and that the chemicals "were purchased for the purpose of achieving" conductivity and additional mass in the end products. The court here noted, however, that although the trial court focused its discussion on the benefits of conductivity and mass, it made a specific factual finding that the chemicals also benefitted the end product for all the reasons suggested -- mass, conductivity, sizing and strength. The city also argued that the taxpayer failed to meet its burden of proof by failing to show that it purchased the chemicals for the purpose of achieving conductivity or additional mass in the end products, but the court said that the pertinent inquiry is whether the chemicals were purchased for the purpose of incorporation or inclusion into the end product, not whether they were purchased for the purpose of achieving some specific benefit in the end product.
The court also cited expert testimony at the lower court proceedings regarding the pulping process used by the taxpayer and the use of the chemicals in that process. One of the witnesses explained that the chemicals are dual- purpose in that they are used for processing and an amount purposefully ends up in the final products as bound soda through the chemical bonding of the sodium and sulfur into the lignin, adding mass to the final product. One of the witnesses testified that the taxpayer, using this chemical process, gets more than 4,000 tons of additional product each year that sells at an average price of $600 per ton. The city argued that the taxpayer could add mass by less expensive means, but the court rejected this saying that it was not persuaded that this point was relevant to whether the chemicals are further processed. The court reviewed the record and found there to be ample evidence in support of the trial court's factual findings that the chemicals at issue are recognizable and identifiable in the end products; that the chemicals are beneficial to the end products with regard to added mass, conductivity, sizing, and strength; and that the taxpayer purchased the chemicals for further processing and with the purpose of inclusion in the end products.
The court then turned to the issue of the sales tax on purchases of repulpable tape. The taxpayer uses repulpable tape, which is cellulose based, to splice or put back together paper that has been cut so that it can go through the winding process. The spliced parts are later cut out before graphics are printed. The cuttings or clippings are recycled as pulp that goes into the manufacturing process. However, the recycled tape does not make it to the process, and the expert witness could not identify the tape in the taxpayer’s end products. The taxpayer could not identify the repulpable tape as a component of the end product, and did not know how much mass the repulpable tape added to the taxpayer’s end products.
The lower court determined that the repulpable tape is recycled by the taxpayer and that the taxpayer failed to present evidence of any benefit achieved by its inclusion in the end product. The court found that while the repulpable tape is fully used by the taxpayer in its manufacturing process, the taxpayer failed to show that the repulpable tape becomes a recognizable and identifiable component in its end products or that it imparts any particular benefits to the end products. The court found that the record shows that the taxpayer purchases the tape for splicing cut pieces of product, not for further processing.
Finally, the court rejected the city’s argument that the lower court erred by failing to apply the "divisible sales approach" so as to refund only taxes paid for that part of the chemicals are further processed, finding that the courts have not applied the divisible sales approach in a matter involving the further processing exclusion, and it declined to do so in this case.
Graphic Packaging Int'l Inc. v. Lewis, Louisiana Court of Appeals, Second Circuit, No. 50,371-CA. 2/3/16
Hotel Booking Services Not Taxable
The Wisconsin Court of Appeals, District IV, held an online hotel booking company's reservation facilitation services were not taxable services. The court said it was unclear under the statute whether "furnishing" encompassed the company's booking activities and the statute did not tax the sale of the service of making a hotel reservation.
The taxpayer is an online travel company (OTC) that contracts with hotels for the right to facilitate reservations for travelers at rates that are determined by the hotels. The taxpayer accesses the inventory databases of the hotels it has contracted with, checks availability for dates when the traveler desires to stay at the hotel, and makes a reservation request to the desired hotel in the traveler's name if a room is available for booking. When a traveler selects an available hotel room, the taxpayer’s website displays the total cost of the room to the traveler, consisting of the net rate the hotel will receive and the markup amount retained by the taxpayer, plus taxes and fees. The traveler pays the taxpayer directly for the room.
During the periods at issue here, sales tax was not collected from travelers on the markup amount.
The Department of Revenue (DOR) asserted that the taxpayer is an "'internet lodging provider'" that provides lodging throughout the state an, therefore, the markup amount retained by it is subject to taxation under the state statute. During the period at issue here, the state statute imposed a tax on the privilege of selling, performing or furnishing certain enumerated services, including the furnishing of rooms or lodging to transients by hotelkeepers, motel operators and other persons furnishing accommodations that are available to the public.
The lower court determined that the taxpayer was not in the business of “furnishing” rooms or lodging within the meaning of the statute and that the taxpayer lacked the essential functions and characteristics of a business which provides lodging accommodations. The lower court pointed out that the taxpayer does not own hotels or motels, does not check people in, or provide them with access to the rooms, and does not provide cleaning, room, or maintenance services. However, the lower court also concluded that, as to the issue of directly furnishing, "furnishing" is capable of being understood to include establishing arranging for, or facilitating reservations, as well as the actual provision of physical accommodations, finding that the language of the statute was ambiguous. It found that when the statute is ambiguous, the ambiguity must be resolved in favor of the taxpayer.
The lower court also concluded that the statute does not impose a sales tax on those selling the service of making reservations on behalf of members of the public. The court in this appeal concluded that the lower court’s interpretation was not contrary to the clear meaning of the statute and that there is not another, more reasonable interpretation of the statutory language.
The court agreed with the lower court that it is not clear from the statute whether "furnishing" encompasses those, who like the taxpayer, facilitate reservation arrangements with hotelkeepers and motel operators and concluded that in light of this ambiguity, the court reasonably interpreted the statute as not imposing a sales tax on the taxpayer. Wisconsin Dep't of Revenue v. Orbitz LLC, Wisconsis Court of Appeals, District IV, Appeal No. 2015AP200. 2/11/16
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Reimbursements From Subsidiary Are Sales for Single Business Tax
The Michigan Court of Appeals held that a worldwide direct marketing corporation that received reimbursements from its subsidiaries for services rendered by shared employees was required to treat those reimbursements as sales for single business tax purposes. The court said the amounts received were consideration for the performance of business activities. The court found that amounts received from a subsidiary for use of the corporation's customer list were royalties and not subject to the single business tax.
The taxpayer is a worldwide direct marketing company that manufactures, markets, and sells a variety of consumer products through Independent Business Owners (IBOs). During the years at issue, taxpayer was also the parent company of numerous subsidiaries, and shared certain employees and their services with its subsidiaries. The shared employees performed human resources, finance, legal services, and accounting tasks for the subsidiaries, which paid a proportionate amount of the shared employees' salary by way of a credit to the taxpayer. The taxpayer described this method of payments by the affiliates for the shared employees as a "cash pooling system." The state Department of Revenue (DOR) audited the taxpayer’s Single Business Tax (SBT) returns from September 1999 to August 2004, and made adjustments that the taxpayer has appealed. The lower court ruled that payment received for the shared services were sales under the SBT, but held that payments received by taxpayer from a subsidiary for its customer list were royalties and were properly deducted from the taxpayer’s tax base. Both the taxpayer and DOR filed an appeal from the lower court’s ruling.
Under the SBT, “sales” is defined to mean gross receipts arising from a transaction or transactions in which gross receipts constitute consideration for enumerated items including the performance of services. After January 1, 2001, sales was defined as the amounts received by the taxpayer as consideration for certain enumerated activities, including the performance of services which constitute business activities. The court noted that under either definition a sale of services required that an amount be received, that the amount constitute consideration and that the consideration be for the performance of services.
The court rejected the taxpayer’s argument that the receipts were merely a bookkeeping entry to record the pass-through payment of employees and did not constitute actual receipts, finding that the amounts at issue were recorded in the taxpayer’s books and represented the actual obligation of the affiliates that had to be satisfied. The court also concluded that the amounts received by the taxpayer were consideration, rejecting the taxpayer’s argument that the amounts received were reimbursement, and not consideration, because there was no profit.
The court held there was consideration because the taxpayer received payment by way of a debit from the affiliate's account in exchange for services provided by the shared employees and found that the fact that the service was provided at cost was not relevant because no definition of consideration requires that the underlying transaction or exchange must result in a profit. Finally, the court held that the reimbursements were for the performance of business activities as defined by the SBT. The taxpayer argued that the services it provided to its affiliates were not business activities because they were not done with the object of gain and were provided at cost. The court said, however, that the services could be a business activity because the affiliates benefited from the shared employee services in that they did not have to hire full-time employees. The court was not persuaded by the taxpayer’s cite of Kaiser Optical Sys, Inc v Dep't of Treasury, 254 Mich App 517; 657 NW2d 813 (2002), for the proposition that a parent company's shared employees performing accounting services for an affiliate are the business activities of the affiliate, not the parent. The court also rejected the taxpayer’s assertion that the services it provided to its affiliates do not constitute business activities because they do not represent the taxpayer’s primary business, noting that the statute does not requires a sale of services constitute the taxpayer’s main line of business.
Under the SBT, a taxpayer can deduct royalties from its tax base, but the term royalties is not defined in the statute. After a review of state case law regarding what constituted royalties in areas including the sale of oil and gas rights, the court concluded that the payments in this case were royalties because they were based on a percentage of gross sales and were facilitated by use of the licensed property. The dissent said the services performed by the shared employees were not business activities and thus payments received for the services were not sales. The dissent also argued that the payments received for the use of the customer service list were not royalties because the subsidiary's payments were not based upon sales generated from use of the list. Alticor Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 323350. 2/9/16
Addback Safe Harbor Exception Does Not Apply
The Virginia Circuit Court, City of Richmond, held that a taxpayer did not qualify for the safe harbor addback exception for royalties it paid to an affiliate for intangibles. Although the royalty payments were included in the affiliates taxable income in other states, the royalty payments were not actually taxed, a requirement under the statutory exception.
The taxpayer argued that the royalties that it paid to an out of state affiliate fell within the safe harbor provision of the state’s add back statute, but the state’s Department of Taxation (Department) argued that the plain language of the statute requires the taxpayer to add back portions of its intangible expenses that were not actually taxed in other jurisdictions. The court rejected the taxpayer’s argument, holding that the plain language of the statute states that the exemption applies when intangible expenses paid to related members are "subject to a tax based on or measured by net income or capital imposed by . . . another state." Va. Code § 58.1-402(B)(8)(a)(1) (emphasis added). The court said that to fall within the safe harbor exception, the intangible expenses paid to a related member must not only be subject to a tax in another state, but that tax must actually be imposed and noted that this reading of the statute is also consistent with the legislature’s intent in enacting the add back statute and its exceptions to close a corporate tax loophole and ensure that income attributable to the state is taxed. Kohl's Dep't Stores Inc. v. Virginia Dep't of Taxation, Virginia Circuit Court, City of Richmond, Released 2/10/16; Case No.: CL12-1774. 2/3/16
Property Tax Decisions
University's Property Exempt From Ad Valorem Tax
The Arkansas Supreme Court held that state property is immune from ad valorem taxation. The court then ruled that the University of Arkansas is an instrumentality of the state and found property owned by the university exempt from a county's ad valorem taxes.
In 2011, 2012, and 2013 the Board of Trustees of the University of Arkansas (University) submitted applications to the county assessor seeking immunity from taxation. These applications were denied and the University filed an appeal to the Washington County Board of Equalization (BOE), which affirmed the assessor’s decision. The circuit court held for the University and this appeal resulted.
The state constitution grants the authority to tax and provides that the state legislature may delegate the taxing authority to municipal corporations within the state to provide for their maintenance and wellbeing. The state constitution also provides for the taxation of property and specifies that certain property shall be exempt from taxation. The county argued that
The constitution does not grant immunity from ad valorum taxes to the state or its instrumentalities. Instead, the county relies on Arkansas Teacher Retirement System v. Short, 2011 Ark. 263, at 10, 381 S.W.3d 834, 840 for its argument that the constitution employs a use analysis and all public property shall be taxed, and exempted only if it is used exclusively for public purposes. The University contended that it is simply immune from taxation and is not "subject to" taxation, and therefore, an analysis regarding exemption is not necessary.
The court noted that the plain language of the constitution provides that real and tangible personal property are subject to taxation, but also notes that the constitution lacks language articulating that property owned by the state is “subject to” taxation. The court said that based on the plain language of the constitution, the constitution does not state that sovereign property is subject to ad valorem taxation. The court pointed out its long-standing precedent addressing the issue of when public property is exempt from taxation, School District of Ft. Smith v. Howe, 62 Ark. 481, 37 S.W. 717 (1896). That decision stated the provision in the constitution that is at issue here, defining what public property is exempt from taxation does not refer to property owned by the state, because the presumption is that the state does not intend to tax its own property. The provision, instead, refers to property owned by the public corporations, or organizations of the state, such as counties, cities, towns, and school districts.
The court said that in reviewing the specific facts and circumstances in this particular case, based on the state constitution constitution and long-standing precedent, the property owned by the state is immune from ad valorem taxation. It then turned to the issue ofwhether the University is the state in this situation and entitled to immunity from taxation. The court cited Texas v. Arkansas, 346 U.S. 368, 370 (1953), which addressed a contract issue, and the United States Supreme Court held that the University of Arkansas is an official state instrumentality. The court said its holdings have been consistent with those of the United States Supreme Court's that the University is an instrumentality of the State and acting as the State. Accordingly, the court held that the University is an instrumentality of the State of Arkansas and the property at issue in this case is immune from ad valorem taxation. Washington Cnty. v. Bd. of Trs. of Univ. of Arkansas, Arkansas Supreme Court, 2016 Ark. 34; No. CV-15-357. 2/4/16
Valuation Remanded for Ruling on Special-Purpose Doctrine
The Ohio Supreme Court remanded a valuation dispute to the Board of Tax Appeals (BTA) to determine whether the special-purpose doctrine applies in the case before the BTA can accept or reject the county's appraisal evidence.
The property at issue consists of six parcels, five actual tracts of land plus a tax increment financing (TIF) parcel, totaling 16.22 acres, improved with a 142,446-square-foot building constructed in 2002. At issue is the tax year 2010 valuation of the property by the county, appealed by the taxpayer, a large, big box retailer. At the hearing before the BTA, taxpayer’s appraisal performed by a third party reconciled an income approach with a sales-comparison approach. The county’s appraiser, another third-party company, also reconciled an income approach with a sales comparison approach, but yielded a higher appraisal value. The BTA adopted the county’s appraisal and the taxpayer filed this appeal.
The court here noted that the differences in the two appraisals stemmed in significant part from competing assumptions. The taxpayer’s appraiser testified that she was valuing the property as if the taxpayer were to leave the property in connection with a sale. The county's appraiser testified that her assumptions were the exact opposite, and when asked who would be the most likely occupant of the property if it were not owner occupied on January 1, 2010, she indicated that the taxpayer would be. The comparables reflected these approaches with one placing reliance on big box store rent comparable from remote parts of the state, making adjustments for market conditions and location, size, and age of the building. The other selected retail store comparables from across the state with square footage varying from 62,000 o 129,000. Three were subject to a lease and three were owner occupied. No adjustments were made to the leased-fee sales to account for the fact that the subject was owner-occupied as of the lien date.
The taxpayer in its argument emphasized the board's "inconsistent and discriminatory" application of the property-valuation statute, along with the board's abuse of discretion in accepting the very type of appraisal it rejected in Rite Aid, BTA No. 2011-1760, 2014 WL 2708165. The court noted that in its decision of the county's appeal in the Rite Aid case, it discussed the significance of its decision in Meijer Stores and the special-purpose doctrine. In that case it affirmed the BTA's decision on the grounds that the special-purpose doctrine had not been shown to be applicable to the subject property, with the result that the BTA's adoption of the property owner's appraisal was neither unreasonable nor unlawful. In the present case, the court said that BTA went in the opposite direction from its determination in Rite Aid by adopting the appraisal prepared for the county. The court further noted that absent a showing of an abuse of discretion, the court will not reverse the BTA’s determination regarding the credibility of witnesses and the weight to be given their testimony. But the court said in this case that the BTA committed legal error in its reliance on Meijer Stores in conjunction with its own decision in Target Corp., BTA No. 2008-M-1088, 2011 WL 6917517.
The court said that the BTA's Target decision is contrary to part of its holding in Rite Aid of Ohio, Inc. v. Washington Cty. Bd. of Revision, ____ Ohio St.3d ____, 2016-Ohio-371 ____ N.E.3d ____, which the court issued on the day of this decision. In Rite Aid, the court discussed the general rule that leased comparables will typically need to be adjusted in determining the value of a subject property that is itself unencumbered by such a lease.
The court found that the absence of any finding by BTA concerning the special-purpose doctrine is an error making it necessary to vacate the decision and remand for further proceedings. The court said that if the BTA determines that the special purpose doctrine applies, the taxpayer may be treated differently than Rite Aid. Lowe's Home Centers Inc. v. Washington Cnty. Bd. of Revision, Ohio Supreme Court, 2016-Ohio-372; No. 2014-0843. 2/4/16
Use of Special Purpose Doctrine in Property Valuation Case Rejected
The Ohio Supreme Court held that a comparable sale property encumbered with a lease should be adjusted when used in the valuation of property not subject to a lease. The court found that the special purpose doctrine did not apply in the case and rejected the board's application of a use valuation.
At issue here is the tax-year-2010 valuation of parcels totaling 1.13 acres that together constitute a major retailer drugstore and its parking lot. In the 2010 reappraisal year, the County Auditor determined a value of approximately $3,319,000 for the store and the taxpayer filed an appeal. On appeal at the Board of Tax Appeals (BTA), the taxpayer and the county presented competing appraisals. The BTA adopted the taxpayer’s appraisal, and the county appealed.
The county argued that the court’s decision in Meijer Stores Ltd. Partnership v. Franklin Cty. Bd. of Revision, 122 Ohio St.3d 447, 2009-Ohio-3479, 912 N.E.2d 560, required the use of the kind of comparables that the county's appraiser relied upon. The taxpayer’s attorney presented a summary of information developed by an appraisal company showing sale comparables and rent comparables in the geographic region. The attorney stated that the contractor was not able to find any drugstore sales in the area considered. At the hearing before the Board of Tax Appeals (BTA), both parties submitted appraisal reports and both found the cost approach inapplicable, primarily because the building was already ten years old as of the lien date. The county’s appraiser also stated that she did not have sufficient data to compute the obsolescence deduction in light of the economic recession. Both appraisers looked at comparables, but the county’s appraiser looked only at drugstores for their comparables across the state whereas the taxpayer’s appraiser did not restrict the comparables to drugstores but looked at comparable properties both for sale and lease in the general geographic area. The taxpayer’s appraiser also testified before the BTA that nothing about the subject parcel and building made it a special-purpose facility usable only for a retail drugstore and that if it were sold, it would likely go on the market for general retail purposes. He also distinguished between the leased-fee market and the market for owner-occupied properties like the subject property. Both appraisers also used an income-approach valuation and reconciled the sales comparison to the income to determine a final valuation. The BTA found the taxpayer’s appraisers valuation more persuasive and held for the taxpayer.
The court here said that as a general rule, the sale prices of leased-fee properties should be adjusted when used to determine the value of an un-leased property because the lease affects the sale price and value of the property. In addition, the general rule in the state is that the exchange value is the rule and the use valuation is a limited exception to the rule.
The court cited Dinner Bell Meats, Inc. v. Cuyahoga Cty. Bd. of Revision, 12 Ohio St.3d 270, 466 N.E.2d 909 (1984) which discussed a permissible example of use valuation if the property was a “special purpose” in nature. In that case the court acknowledged the general principle that the “special purpose exception” is applied to a building in good condition being used currently and for the foreseeable future for the unique purpose for which it was built.
Finally, the court held that the special purpose doctrine was not shown to be applicable in this case.
The court said that one crucial element in determining the value of property in the overall market lies in the concept of "highest and best use." According to the International Association of Assessing Officers ("IAAO"), highest and best use "is that use which will generate the highest net return to the property over a reasonable period of time." The court said that highest and best use of the improvements to the land will usually be expressed in terms of the general type of use to be made of such property, and in this case a "retail store" might be the highest and best use. Since the property at issue is currently in that use, the court said that the appraisal report might say: "continued use as a retail store" which is the essence what both appraisal reports said in this case. By contrast, the court said, in the special-purpose situation one would expect to see: "continued use by the current occupant in its ongoing business." The court found that there was no evidentiary basis upon which to apply the special-purpose doctrine and engage in use valuation here and did not find a legal reason for reversing the BTA's decision. Rite Aid of Ohio Inc. v. Washington Cnty. Bd. of Revision, Ohio Supreme Court, No. 2014-0828. 2/4/16
Other Taxes and Procedural Issues
Illegal Tax Shelter Claims Not Timely Filed
The Illinois Appellate Court, First District, held that a taxpayer's claims for fraud, breach of fiduciary duty, and civil conspiracy filed in connection with an illegitimate tax shelter strategy were barred by the state’s statutes of limitations.
In January 2014, the plaintiff filed a complaint against the defendants alleging fraud, civil conspiracy, and breach of fiduciary duty, arising from the defendants’ promotion of an illegitimate tax shelter in which the plaintiff invested. The lower court ruled for the defendants on the basis that the complaint’s claims were time-barred, and the plaintiff filed this appeal.
The taxpayer/plaintiff is a former president and COO of a computer software company. In 2000 he exercised stock options in that company, realizing $250 million in ordinary income and he contacted his longtime accounting firm to obtain advice on how to manage and account for the income. That firm helped clients minimize taxes on income by creating structured investment strategies with a third party bank, including one known as Partnership Option Portfolio Securities (POPS). The taxpayer was advised that POPS utilized trades and warrant investments that carried a reasonable probability of profit, but would more than likely result in losses that could be deducted from his income for tax purposes. The firm provided the taxpayer with an opinion letter from an attorney in a Washington D.C. law firm indicating that POPS met legal standards to produce tax benefits and could withstand a challenge by the federal government and advised the taxpayer that the letter would protect him in the event of an IRS investigation. Based on this advise, in October 2000 the taxpayer decided to participate in the POPS shelter. The taxpayer then filed a 2000 tax return prepared by his accounting firm claiming over $249 million in losses from the POPS transactions, avoiding paying taxes on $250 million in income at a 35% rate, resulting in $87.5 million in tax savings. Although he lost his initial $18 million POPS investment, he realized, at least temporarily, a net gain of $69.5 million. Defendants had, however, had misrepresented many elements of the POPS strategy, including the fact that the law firm providing the guidance letter was not acting independently, but was working with the accounting firm and the bank to promote POPS. In addition, the taxpayer’s guarantee of the loan it made in the investment was riskless, because the bank retained sufficient collateral in the event of default on the loan.
The POPS shelter had come under scrutiny by the IRS at the time the taxpayer elected to participate, a fact that the accounting firm knew. In January 2002, the IRS announced an amnesty program for taxpayers who admitted involvement in shelters akin to POPS, and the accounting firm provided the taxpayer with information about the program, but allegedly downplayed its significance and represented to the taxpayer that the POPS shelter was not among those the IRS found to be illegal. The taxpayer did not participate in the amnesty program.
In May 2002 the government initiated an action against the accounting firm as part of an investigation into whether it had promoted illegal tax shelters and as part of this action, a court ordered the firm to notify its clients of the investigation and give them an opportunity to intervene. The taxpayer took advantage of this opportunity in June 2004 and sought to block the disclosure of opinion letters and correspondence he received from the firm offering tax advice. In the ensuing years, several individuals involved in promoting the illegal shelter pled guilty to criminal charges, including the attorney who authored the opinion letter and the accounting firm employee who had advised the taxpayer on the investment. In 2005 the IRS notified the taxpayer that it was auditing the 2000 tax return of the company in which he had invested and in 2013 it issued a notice of deficiency against the taxpayer disallowing the losses he had claimed on his 2000 return, and assessing interest and penalty on the tax liability. He paid the liability in December of that year and filed this action on January 3, 2014.
The lower court dismissed the taxpayer’s complaint as untimely and he filed this appeal.
This court began by setting forth the statute of limitations applicable to the taxpayer’s claims, noting that claims against the bank were required to be brought within 5 years after the cause of actin accrued. Action against the accounting firm are subject to a two year statute of limitations, beginning from the time the taxpayer "knew or should reasonably have known" of the firm’s acts or omissions in performing professional services. The court noted that the statutes differ not only in their length, but also in their start dates, and, therefore, the court was required to determine when the taxpayer’s claims “accrued” and when he was put on notice of his injury.
Citing a prior state supreme court decision, the taxpayer argued that his claims accrued on January 31, 2013, with the IRS's issuance of the notice of deficiency, and prior to that time there was no cause of action for him to discover, making the date of accrual concurrent with the date of notice of his injury. The court rejected the taxpayer’s argument that the cited case set forth a bright-line rule that any cause of action by a taxpayer suing as a result of a deficiency notice accrues when the taxpayer receives the notice of deficiency, pointing out that the court in that case did not consider when plaintiffs' cause of action accrued, but when it was discovered. As a result, the court turned to a fact-specific analysis of the taxpayer’s claims to determine both the date of accrual and the date of discovery.
The court noted that the taxpayer’s claims, with regard to the date of accrual, are all premised on the same general allegations that defendants knowingly misrepresented the legitimacy of the POPS shelter, which induced him to pay substantial fees and resulted in tax penalties and disallowance of tax deductions. The court said that there was no dispute that these knowing misrepresentations of fact and breaches of duty occurred in 2000, when defendants worked to convince the taxpayer to invest in POPS. The court also said that a part of Lane's injury also occurred at this time, when he invested $18 million to participate in POPS only to later learn the investment constituted a total loss. The court said that while the taxpayer’s tax-related injuries did not occur until years later, he was not required to know the full extent of his injury before the statute of limitations was triggered. Thus, the court found that the taxpayer’s causes of action accrued in 2000 or 2001 when he learned that his $18 million investment was lost.
The court then turned to the issue of when the taxpayer should have known this loss was wrongfully caused. The court noted that ordinarily the trier of fact is in the best position to determine when a plaintiff knew or should have known of his injury and its wrongful cause. When the facts are undisputed, however, the court may decide this question as a matter of law. While the firm concealed the taxpayer’s injury by informing him in 2002 that the IRS amnesty program for illegal shelters did not apply to POPS, the court said that events occurring after this act of concealment were sufficient to put the taxpayer on notice of his injury and its wrongful cause, including his participation in the litigation that then made him aware of the contents of a firm memorandum in 2004 which indicated that POPS was an IRS deemed illegal shelter. The court also noted that in 2005 the taxpayer learned that the company in which he had invested was being audited by the IRS, and in 2008 the attorney who had prepared the letter to the taxpayer on the legality of POPS pled guilty t defrauding the IRS by authoring false opinion letters. The court said that all these factors were sufficient to put the taxpayer on notice that his $18 million loss was wrongfully caused, and, by September 2008, he was under an obligation to inquire further to determine whether an actionable wrong was committed. As a consequence, the court found that the taxpayer’s January 2014 complaint was filed beyond both the five-year statute of limitation applicable to the bank and the two-year statute applicable to the accounting firm. Lane v. Deutsche Bank AG, Illinois Appellate Court, First District, No. 1-14-2968. 1/29/16
State Entitled to Portion of Lottery Proceeds for Back Taxes
The Wisconsin Court of Appeals, District IV, held that an individual's sale of the income stream from lottery proceeds constituted a prohibited assignment. The Department of Revenue (DOR) was holding the proceeds for the taxpayer’s back taxes liability and the court found that DOR was not equitably estopped from denying an insurance company's claim for a refund of those proceeds.
The taxpayer won the state’s “Megabucks” lottery in 1994 and opted for 25 annual payments, commencing in September 1994. In response to a lawsuit filed by his ex-wife, the taxpayer created a trust to receive the prize payments and the state lottery agreed to pay the taxpayer’s future payments to the trust. In 1997 the taxpayer sold the income stream he would have received from the trust for a lump sum payment from an insurance company and for approximately three years, DOR paid the annual prize money to the trust and the trust, in turn, paid the prize money to the insurance company. In 2001, DOR withheld a portion of the annual prize money to satisfy back taxes owed by the taxpayer and the insurance company filed a claim with DOR seeking a refund of those monies. DOR denied the claim and the insurance company filed an appeal. The issue in this matter was whether the taxpayer’s sale to the insurance company of the income stream he would have received from the Trust constitutes an assignment in violation of the state statute and, therefore, whether DOR is equitably estopped from objecting to the assignment.
The court found that thesale of the income stream to the insurance company violated WIS. STAT. § 565.30(6), which provides, in pertinent part, that the right of any person to a lottery prize may not be assigned. All parties agreed that the circuit court order creating the trust and ordering that the prize money be paid each year to the trust was valid, but the court found that the statute prohibits the assignment of lottery winnings to a third party, except under the limited circumstances specified in the statute. The use of a trust as a vehicle for assigning a lottery prize to a third party is not one of the limited exceptions in the statute. The insurance company argued that the statutory prohibition does not apply here because once the prize was assigned to the trust, the prize money that the Lottery paid into the trust converted to a beneficial trust interest that the taxpayer was free to sell under the common law principle that trust interests are freely alienable. The court held that the taxpayer’s sale of his income stream to the insurance company would defeat the legislature’s broad prohibition in the statute against assignment.
The insurance company alsocontended that DOR is estopped from denying the validity of the taxpayer’s assignment of the prize money to the trust because DOR co-authored, approved, and honored the Polk County judgment requiring the taxpayer to assign the prize to the trust.
The court agreed with DOR’s argument that the insurance company could not have relied on DOR’s actions because the evidence shows that DOR never indicated its approval of the taxpayer’s sale to the insurance company or otherwise indicated that the taxpayer had the right to assign his right to proceeds from the trust. The insurance company, however, argued that it was reasonable for it to think that the creation of the trust would render the taxpayer’s income stream from the trust freely alienable and asserts that it would not have purchased the income stream from the trust had DOR not agreed to the creation of the trust.
The court points out that the insurance company does not argue that DOR indicated its approval of this separate action, and, further, does not point to any evidence that DOR misled the insurance company regarding DOR's opinion of the propriety of the taxpayer’s sale of the income stream from the trust. The court said it would have been unreasonable for the insurance company to rely on DOR's role in the creation of the trust as indicating DOR's approval of the propriety of the taxpayer selling his income stream. In fact, the court pointed out that the record indicates that the insurance company relied on outside and in-house counsel, not DOR, in deciding to purchase the income stream. Great-West Life & Annuity Ins. Co. v. Dep't of Revenue, Wisconsin Court of Appeals, 2013AP2605; 2013AP2765. 1/28/16
Taxpayer's Refund Case for Dogs Sold by DOR Dismissed
The Indiana Supreme Court dismissed a taxpayer's complaint seeking a refund related to dogs the state Department of Revenue (DOR) seized and sold pursuant to jeopardy tax assessments. The court said that the tort claims contained in the refund petition should be litigated in the taxpayer's civil court case and, until the property assessment amount is determined, a refund case is not appropriate.
The taxpayer filed this tax appeal against DOR, seeking a tax refund relating to dogs the seized and sold by DOR pursuant to jeopardy tax assessments that were later declared void. Garwood v. Indiana Dep't of State Revenue, 953 N.E.2d 682 (Ind. Tax Ct. 2011). The Tax Court denied DOR’s motion for summary judgment in this matter and DOR filed an appeal. The court hear oral argument in the matter and DOR argued that the taxpayer’s tax appeal, currently pending before DOR, alleges tort claims that should be decided in the civil action the taxpayer has filed in the state circuit court.
The taxpayer’s counsel agreed during that hearing that the tort claims arising from the sale of the dogs should be decided in the circuit court case and the court said that both counsels' statements bind their clients. The court found that the taxpayer’s entitlement to a refund and the amount of any refund could be resolved until a decision is reached on the amount of taxes, if any, that the taxpayer owes, and that issue remains pending before the Department of Revenue. The court vacated the Tax Court’s order, dismissed the tax appeal without prejudice, and ordered that the tort claims case should proceed in circuit court. Garwood v. Indiana Dep't of State Revenue, Indiana Supreme Court, Supreme Court Case No. 82S10-1505-TA-330. 2/8/16
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]. |
|
STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
February 5, 2016 Edition
NEWS
Challenge to Chicago's Rental Car Tax Update
The Illinois Supreme Court has agreed to hear The Hertz Corp. v. City of Chicago, a challenge to the constitutionality of Chicago's personal property tax on rental car leases outside the city.
Rental car companies challenged a Chicago administrative ruling that applied an 8 percent personal property tax on rental car leases occurring within three miles of the city's border if the car was used primarily within the city. See the October 2, 2015 issue of State Tax Highlights for a more detailed summary of the appeals court decision.
FTA Annual Conference
FTA’s Annual Conference will be held this year June 12 through 15 in Annapolis, Maryland. We are busy preparing the agenda for the conference and, as usual, there will be breakout sessions on Monday and Tuesday afternoons discussing issues of interest in the legal arena. If you have a topic you want us to include in the agenda, or if you are volunteering to participant on a panel, please communicate that interest to me. Please mark your calendars for this event and I hope to see you for an informative, enjoyable few days in Maryland’s capital.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
TIA Bars Alabama Income Tax Challenge
The U.S. Eleventh Circuit Court of Appeals held that the Tax Injunction Act (TIA) barred a federal district court from hearing an Alabama individual income tax case because that state’s administrative process provided the taxpayer with sufficient and timely relief.
On August 25, 2014, the taxpayer filed a pro se amended complaint against the state Department of Revenue (DOR), two DOR employees, David Baxley and Eddie Crumbley, in their individual and official capacities, and other "Unknown Agents" of DOR, also in their individual and official capacities (collectively the "defendants"). The complaint alleged seven federal claims and three state claims arising from the DOR’s assessment and collection of the taxpayer’s 2010 and 2011 state income tax liability.
The complaint alleged that the taxpayer attended college in Alabama, but has lived and worked in Tennessee since 2007. On July 2, 2014, the taxpayer’s mother received a notice from DOR at her Alabama home that stated the taxpayer owed $1,707 in Alabama state income taxes for the years 2010 and 2011. On July 10, 2014, the taxpayer called DOR to discuss the letter sent to her mother's home and a DOR agent instructed the taxpayer to provide documentary proof of her Tennessee residency. The next day, the taxpayer submitted to DOR her vehicle registration, her Nashville Electric Service seven-year billing history, a current water bill, and a lease from a former apartment. The taxpayer alleged that DOR blatantly ignored her submissions and filed a tax lien. She stated that other than the letter sent to her mother's house, she received no notice from the DOR that it would place a tax lien on her credit report. The taxpayer repeatedly called the DOR to ask why it imposed a tax lien, and eventually Defendant David Baxley, a DOR agent, called the taxpayer and informed her that the DOR had initiated a collections action against her because she still had an Alabama driver's license. Mr. Baxley also told her that the DOR sent her a notice before imposing the tax lien, though the notice was mailed to one of her prior Tennessee addresses. The taxpayer later contacted Defendant Eddie Crumbley, the Director of Operations for the DOR’s Criminal Division, who refused to investigate the situation further. The court here stated that the agents' actions were related to a separate lawsuit filed by the taxpayer’s fiancé, Samuel Robinson, in the Middle District of Tennessee against Tennessee officials.
The taxpayer filed her complaint alleging a violation of her procedural and substantive due process right, as well as an allegation of fraud and intentional infliction of emotional distress.
The defendants filed a motion to dismiss the complaint for lack of subject matter jurisdiction and for failure to state a claim, arguing, among other things, that the Tax Injunction Act (TIA), 28 U.S.C. § 1341, and principles of comity barred the district court from exercising subject matter jurisdiction because the relief the taxpayer requested would enjoin, suspend, or restrain the state's ability to assess taxes and the taxpayer had an adequate state remedy.
The district court a report and recommendation of a magistrate judge and dismissed the complaint filed by the taxpayer for lack of subject matter jurisdiction.
The court here pointed out that under the TIA district courts are prohibited from "enjoin[ing], suspend[ing] or restrain[ing] the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State." 28 U.S.C. § 1341. The TIA limits jurisdiction and was intended to prevent taxpayers from using federal courts to raise questions of state or federal law relating to the validity of particular taxes if the relief requested by the plaintiff would enjoin, suspend, or restrain a state tax assessment, and if the state affords the plaintiff a plain, speedy, and efficient remedy.
The court said that the taxpayer’s request in this caseplainly constitutes relief that would enjoin, suspend, or restrain a tax assessment and, therefore, meets the first requirement of the TIA bar. Citing precedent, the court said that the TIA also bars claims for damages because a monetary award against the state or its tax administrators would have the same detrimental effect on the state as equitable relief, and would dampen state tax collectors. The court said it has explicitly relied on both the TIA and comity to conclude that a district court lacked subject matter jurisdiction in a state-tax dispute requesting damages and declaratory relief.
The court noted that at the time of the taxpayer’s Alabama tax assessment, state law provided that a taxpayer had the right to appeal a final assessment to either the Administrative Law Division or to the state's circuit courts within 30 days of the final assessment date, and the court, therefore, found that the statute provides a plain, speedy, and efficient remedy within the meaning of the TIA. In addition, under the state statute, taxpayers may petition for a refund of taxes paid to the state and may appeal the denial of such petitions and raise federal constitutional challenges to state taxes in the state courts.
The court held that the district court did not err in dismissing the taxpayer’s complaint for lack of subject matter jurisdiction under Rule 12(b)(1), finding that granting the taxpayer’s relief would have required the district court to interfere with the state’s tax system, which would contravene the principle underlying both the TIA and comity that federal courts generally should avoid interfering with state taxation schemes. Citing case law, the court rejected the taxpayer’s argument that a state remedy must be presently available and not expired. Kelly v. Dep't of Revenue, U.S. Court of Appeals for the Eleventh Circuit, No. 15-12124. 1/15/16
State May Not Deny Tax Breaks for Religious Theme Park
The U.S. District Court for the Eastern District of Kentucky ruled that the state could not deny a sales tax rebate for the construction of a religious theme park. The court found that providing the incentives would not violate the establishment or equal protection clauses of the U.S. Constitution andthat the park met the neutral criteria for the incentives.
The project at issue in this matter is a replica of Noah’s ark that has been constructed as part of an investment to produce a tourist attraction in the state. The state Tourism Cabinet initially approved tax incentives for the project, but reversed that decision when presented with concern that the project was going to “advance religion,” citing that providing the incentives would be contrary to the First Amendment protection from the state establishment of religion. The issue before the court was whether the tax incentives could be denied for Establishment Clause reasons if the tourist attraction otherwise met the criteria for the incentives. The state statute provides an incentive program for qualifying tourism attractions in order to advance the public purposes of relieving unemployment by preserving and creating jobs and by preserving and creating sources of tax revenues for the support of public services.
Since the statutory provisions have been enacted, the state approved over $1 billion in new tourism investments for a wide variety of attractions, but the taxpayer in this matter is the only applicant with a religious affiliation, engaged in distributing publications, and also providing museums, facilities, and exhibitions related to the Bible.
In 2011 the taxpayer began plans for a theme park centered on a full-scale replica of Noah’s Ark designed to expand taxpayer’s ministry mission of proclaiming biblical authority.
The initial concept included a variety of exhibits such as an extensive petting zoo and aviary with live shows, a pre-Flood town with retail and entertainment, a children's play area, a replica of the Tower of Babel, geology and Biblical history exhibits with special effects, a first-century village, and several restaurants and food carts as well as retail outlets and kiosks. In December, 2010, after meetings, a legal memorandum addressing concerns about separation of church and state, and a press conference with the Governor announcing the planned project, the Kentucky Tourism Development Finance Authority (KTDFA) gave preliminary approval of the taxpayer’s first application and entered into the first Memorandum of Agreement (MOA) with it, reflecting the Commonwealth's intent to provide tax incentives subject to satisfying the KTDA's requirements.
On May 19, 2011, the KTDFA granted final approval for the Ark Project to receive the KTDA's tax incentives and entered into a Tourism Development Agreement (TDA) with the taxpayer, which stated that the Ark project was eligible to receive incentives of up to 25% of approved costs incurred through May 19, 2014, and affirmed that without that assistance "the Company would not engage in the Project." The TDA also contained a provision that required the taxpayer to waive its right to exercise religious preferences in hiring for the Ark project -- a provision not included in agreements with other participants in the program. After obtaining final approval for the project, the taxpayer exercised its option to purchase land in the state and prepared the offerings for private investors. According to the taxpayer, however, the economic downturn resulted in the investor subscription process taking longer than anticipated, and it had to reduce its budget for the project and change its focus to funding an initial phase and then complete the project under a phased development plan.
Because of changes, the project could not be completed by May 2014 as originally anticipated, and state officials advised the taxpayer that a new application was required which was submitted on March 28, 2014. That application was virtually identical to the first one, except for specifying that the project would be completed in several phases. The purpose and religious nature of the Ark Project remained the same. After a number of meetings to discuss the religious nature of the project and its suitability for state tax incentives, on July 29, 2014, the Ark project received preliminary approval for the KTDA incentives and an MOU was completed. The second MOA did not contain any requirements or agreements concerning hiring practices other than an agreement that the taxpayer would comply with all applicable state and federal laws and regulations, as previously agreed.
Subsequently, the taxpayer posted employment positions for various jobs related to the Ark project, which included a requirement that applicants agree with the organization’s statement of faith. The state, in response to a complaint received protesting the taxpayer’s participation in the incentive program and objecting to the job posting, advised the taxpayer that it did not believe that the taxpayer was complying with all state and federal laws in its hiring practices and that the state would not be moving forward with the promised tax incentives. While the taxpayer continued to proceed with construction of the first phase, it contended that the state’s denial of the incentives impacted the projected cash flow, budgeting, and planning of the remaining phases, and filed a motion for a preliminary injunction, arguing that the rejection of their application violates their Constitutional rights under the First and Fourteenth Amendments. The state filed a motion to dismiss on the grounds that allowing the taxpayer’s participation in the program violates the prohibition against establishing a religion under both the federal and state constitutions.
To qualify for the tax incentives at issue here, the proposed project must fall into one of several listed categories and meet the requirements for that category. The court noted that the parties do not appear to dispute that the proposed project at issue falls into the category of "a tourism attraction project." The project also met the remaining requirements for the incentive regarding the cost, minimum days of planned operation and percentage of expected visitors from out-of-state. The court cited the federal rules of civil procedure regarding a court’s review of a motion for preliminary injunction and said that a court must consider (1) whether there is a likelihood of success on the merits of the plaintiff's claim; (2) whether the plaintiff will suffer irreparable harm if the injunction is not granted; (3) whether others would be harmed by granting the injunction; and (4) whether the public good is served by issuing the injunction. The court, however, cited Jones v. Caruso, 569 F.3d 258, 265-66 (6th Cir. 2009) (quoting Connection Distrib. Co. v. Reno, 154 F.3d 281, 288 (6th Cir.1998)) for the proposition that when a party seeks a preliminary injunction on the basis of a potential violation of the First Amendment, the likelihood of success on the merits will often be the determining factor
The court said that because the taxpayer argues the Commonwealth's actions violate the Free Exercise Clause while the Commonwealth defends its actions by arguing that to do otherwise would violate the Establishment Clause, the instant dispute encompasses the interplay between the First and Fourteen Amendments and the question before the court was whether in this case interaction between church and state actually creates an impermissible establishment of religion. The court cited ACLU of Kentucky, 591 F.3d at 844 (quoting McCreary County, 545 U.S. at 860) in analyzing the purpose of the government action at issue, that "[t]he defining principle of Establishment Clause jurisprudence is that the First Amendment mandates government neutrality between religion and religion, and between religion and nonreligion." The court said that government neutrality is an objective of the Establishment Clause and a sensible standard for applying it. The court reiterated the stated purpose of the state’s incentive program here and found that the purpose is plainly secular and there is no language in the act itself or in the application requirements addressing religious affiliations or excluding groups based on religion. Further, the listed criteria described above required for qualifying projects to receive the incentive, are entirely secular, such as eligible costs, days of the year the project will be open, and the percentage of out-of-state visitors it is likely to attract; and such requirements do not address the content, subject matter, or religious affiliation of any of the projects. Accordingly, the court found that the Act has a secular purpose and meets the first prong of neutrality. In addition, the state’s concern that allowing the taxpayer to participate in the incentive program would violate the Establishment Clause because of the taxpayer’s religious purpose misunderstands the concept of neutrality. The court said it is the government's purpose that must be secular, and therefore the KTDA must be neutrally applied to all applicants regardless of religious affiliation. If a particular religious group receives more favorable treatment than a secular group, or if a secular group receives more favorable treatment than religious groups because they are secular, the court said such treatment would violate the Establishment Clause. The court saidthat because the KTDA is neutral, has a secular purpose, and does not grant preferential treatment to anyone based on religion, allowing the taxpayer to participate along with the secular applicants cannot be viewed as acting with the predominant purpose of advancing religion. The court also found that as long as the taxpayer is treated equally along with secular recipients, any religious indoctrination or speech that takes place at the Ark Park will not be attributed to the Commonwealth. Here, the court said, allowing the taxpayer to participate in the KTDA program does not compel or coerce anyone to participate in any religious ceremony. The court also found that the state did not demonstrate how allowing the taxpayer to participate in the tourism program constitutes impermissible government entanglement with religion. Finally, the court said that the relationship between the state and the taxpayer simply allows the taxpayer to participate in the program on the same footing as all other applicants and applies the criteria in a neutral, even-handed way. There is no resulting relationship that is any different from the state’s relationship with the secular applicants. On the other hand, however, if the state examines each applicant's message and viewpoint to determine if they are religious, and if so, how religious, and then uses that information to approve or deny their application, the government will involve itself in an impermissible form of entanglement.
The court said that excluding the taxpayer from the program because of its religious beliefs violates the First Amendment principle of neutrality and leads to improper government entanglement with religion because it requires state officials to critique and scrutinize applicants' beliefs and adds an unwritten requirement to the KTDA that participants be secular or at least not "too religious."
The taxpayer claimed that the state’s exclusion of the taxpayer from the program because of its religious views and message violates the Free Exercise Clause of the Constitution, specifically by interfering with their rights to free speech and free association. The court said that when a plaintiff claims that the government has violated his rights under the Free Exercise Clause, the state may justify a limitation on religious liberty by showing that it is essential to accomplish an overriding governmental interest. In this case, the state admitted that it denied the taxpayer’s application because of its religious beliefs, evangelical message, and desire to hire those who agree with its religious views. The court said that action was essentially employing the taxing power to inhibit the dissemination of particular religious views, which is unconstitutional because it discourages the taxpayer’s First Amendment rights of religious expression. Because of their religious activity, the taxpayer is being denied an equal share of the benefits and privileges enjoyed by the other applicants. In addition, the court found that the state had not shown a compelling state interest justifying such infringement.
The court said that the goals of the tax incentive program would best be met by allowing the taxpayer’s participation in the program, as demonstrated by the report done by the outside consultant, which concluded that the project met the definition of a tourist attraction as defined in the state statute, that it would create hundreds of jobs in the surrounding area, and that it should have a large positive net economic impact on the state even after subtracting out the expected rebates. Therefore, the court found that the state’s pressure for the taxpayer to give up its religious beliefs, purpose, or practice in order to receive a government benefit and gain acceptance into a government program impermissibly burdens the taxpayer’s free exercise of religion. The court found that not only has the taxpayer stated a plausible claim for a violation of its free exercise rights, but also that the taxpayer is likely to succeed on the merits of that claim.
The court next addressed the issue of whether the state’s actions violate the taxpayer’s freedom of speech through unconstitutional viewpoint discrimination.
The court said that in this case the state clearly targeted the taxpayer’s religious views and excluded it from participation in a government program because of its religious message and rejected the state’s argument that viewpoint discrimination is not at issue because the KTDA did not create a forum for speech. The court said that to say that no forum is involved in this case or that the state did not intend to create a forum through the KTDA, and therefore is free to discriminate against various applicants based on their message, overlooks the nature of the freedom the First Amendment is designed to protect. The court also rejected the state’s argument that the taxpayer’s claims should be dismissed because permitting the taxpayer’s participation in the program would violate the state constitution barring government preferences to religious institutions and requiring that state tax funds be used for public purposes, finding that these provisions were inapplicable to this case. The court said that the KTDA does not levy or collect any taxes but instead provides a potential rebate of sales taxes to qualified participants and the money that constitutes the actual amount of the rebate will not have been "levied or collected" for a specific purpose other than to provide the economic incentives under the Act. The stated aim of the KTDA is to promote tourism as a means of relieving unemployment and increasing revenue, which are public purposes in the sense that the state as a whole will receive a benefit from the program regardless of allowing the taxpayer to participate. Ark Encounter LLC v. Parkinson, U.S. District Court for the Eastern District of Kentucky, Civ. No: 15-13-GFVT. 1/25/16
IRS Claim Has Priority in Bankruptcy
The Fourth Circuit held that a law firm that represented a debtor wasn't entitled to subordinate the IRS's secured tax claim to its unsecured claim for administrative expenses. The court found that the bankruptcy court properly applied the bankruptcy law in effect at the time it reached its decision.
On February 3, 2010, the Debtor filed a voluntary petition under Chapter 11 of the Bankruptcy Code, governing reorganizations of debtors' estates, and the bankruptcy court approved an attorney to serve as the Debtor's counsel. In July 2011, the IRS filed a claim against the estate for approximately $1 million, most of which was secured by the Debtor’s property interest. The bankruptcy court entered five orders over the pendency of the case approving compensation to the attorney for legal services, totaling more than $200,000, as actual and necessary expenses of preserving the Debtor’s estate. These represented an unsecured claim for administrative expenses against the estate. The Bankruptcy Code establishes a hierarchy of unsecured creditors like the attorney here. The Debtor failed to prove that he could effectuate a final plan of reorganization and on November 17, 2011 the bankruptcy case converted to Chapter 7, which governs liquidations and the court appointed a Chapter 7 trustee. The Trustee accumulated $702,630.25 for distribution to the estate's creditors. He estimated that total Chapter 7 administrative expenses would amount to $278,921.42, leaving the Debtor's estate with $423,708.83 to satisfy the IRS's secured tax claim of nearly $1 million and the attorney’s unsecured Chapter 11 administrative expense claim of roughly $200,000.
The issue here was whether the attorney could subordinate the IRS's claim in order to receive payment of his fee and the court said that the issue was governed by 11 U.S.C. § 724(b)(2).
The court noted the general rule in bankruptcy that secured claims are satisfied from the collateral securing those claims prior to any distributions to unsecured claims and under that general rule, the IRS's claim in this case would be paid first and nothing would be left for payment on the attorney’s unsecured claim for administrative expenses incurred during the Chapter 11 proceeding. There is a limited exception to this rule under Chapter 7 liquidations in Section 724(b)(2) of the Bankruptcy Code, which permits certain unsecured creditors to step into the shoes of secured tax creditors, and, thus, the issue became whether the attorney’s claim here came within the exception in that provision.
The court discussed the history of the provision, stating that until 2005 § 724(b)(2) provided all holders of administrative expense claims, like the one here, with the right to subordinate secured tax creditors in Chapter 7 liquidations. That provision was criticized for creating an incentive for debtors and their representatives to incur administrative expenses even when there was no potential for a reorganization, which was a detriment to secured ta creditors. In 2005 Congress amended the section to exclude claims for the expenses incurred during prior Chapter 11 proceedings. Due to a drafting error, however, the exclusion of Chapter 11 expenses inserted into § 724(b)(2) did not apply to the administrative expenses that were its target, but instead to a new set of claims enumerated under § 507(a)(1). This was the status of the provision when the Debtor filed his initial Chapter 11 petition in February of 2010.
In December 2010, while the Debtor's case remained in Chapter 11, Congress corrected its error with the Bankruptcy Technical Corrections Act of 2010 and clarified that Chapter 11 administrative expense claimants do not hold subordination rights under § 724(b)(2). In November 2011, the Debtor's bankruptcy case converted from Chapter 11 to Chapter 7, implicating § 724(b)(2) for the first time.
Now in a Chapter 7 proceeding, Stubbs could invoke § 724(b)(2)'s exception to the general rule that unsecured claims like its own take a back seat to secured claims like the IRS's -- but only if its claim to Chapter 11 administrative expenses was covered by the governing version of § 724(b)(2). The Trustee argued that the corrected version of § 724(b)(2) then in effect controlled, and that under that provision, there is no question but that the attorney’s unsecured claim to Chapter 11 administrative expenses is excluded. The attorney argued that regardless of Congress’ intent, the plain language of the prior version of § 724(b)(2) did entitle it to subordinate the IRS's secured tax claim, and application of the new and corrected version of § 724(b)(2) would have an impermissible retroactive effect, cutting off its right to recover for Chapter 11 administrative expenses incurred before Congress fixed its drafting error.
The court noted that a general rule of interpreting statutes like this one is to apply the law in effect at the time it renders its decision. An exception to this rule is that because retroactively is disfavored, a court should not apply the law currently in effect if it would have a retroactive effect on conduct predating the law’s enactment, absent clear congressional intent favoring that result. The court agreed with the lower courts’ conclusion that this was the ordinary case, in which the law in effect at the time of decision applied, saying that this rule had the advantage of being clear and easy to administer which was especially important in the bankruptcy context where Chapter 7 trustees have a fiduciary duty to make already-complex calculations in an expeditious manner. The court rejected the attorney’s argument that it would be unjust to apply the amended version of the provision retroactively to disallow payment on its unsecured claim, finding that before the 2010 enactment, the section at issue had no application to be Debtor’s case at all. By the time the case converted to Chapter 7 in November 2011, implicating § 724(b)(2) for the first time, the version of § 724(b)(2) had been superseded already by the corrected version. The court said it recognized that § 724(b)(2) is being applied in this case to the incurrence and approval of legal fees in the Chapter 11 proceeding that predates the provision's enactment, but said that by itself does not trigger presumption against retroactivity.
The court said that while the attorney may have expected that if the Debtor's Chapter 11 bankruptcy case at some point converted to Chapter 7, the attorney would acquire a right to subordinate the IRS's secured claim under § 724(b)(2). But the court noted that such an inchoate expectation is not the kind of vested right that, if frustrated, gives rise to retroactivity concerns. The court held that the bankruptcy court properly applied the version of § 724(b)(2) in effect when it rendered its decision, and under that provision, it was clear that the attorney was not entitled to subordinate the IRS's secured tax claim in favor of its unsecured claim to Chapter 11 administrative expenses. Stubbs & Perdue PA v. James B. Angell et al., U.S. Court of Appeals for the Fourth Circuit, No. 15-1316. 1/26/16
Assessments Against Former NFL Team Owner Upheld
The Ninth Circuit reversed a district court holding and upheld IRS tax assessments against the late Allen Davis (Taxpayer), the former owner of the Oakland Raiders, and his wife. The court found the assessments were timely and determined that the IRS's breach of a closing agreement with the partnership through which the taxpayer owned the team did not invalidate the assessments.
In 2011 the taxpayer and his wife filed a complaint against the United States seeking refund of income taxes paid, arguing that the Internal Revenue Service (IRS) assessed the taxes beyond the statute of limitations and breached a Closing Agreement between the IRS and the
partnership that formally owned the Raiders. The district court held that the breach of contract invalidated the assessments held in favor of the taxpayers. The IRS filed an appeal. Mr. Davis had the largest interest in the Oakland Raiders, a California limited partnership (Partnership), which owned and operated the professional football team, and he was also the president of A.D. Football, Inc., the sole general partner and tax matters partner (TMP) of the Partnership.
The Partnership and the IRS, involved in long-running Tax Court litigation, reached a settlement in 2005 over tax years 1988 through 1994. The Closing Agreement, which concluded the litigation, was signed by Davis, as President of the TMP. Under the Agreement, the IRS was required to make "computational adjustments" to determine the effect of the settlement on each partner's tax liability. Paragraph Q of the Closing Agreement gave the partners procedural rights related to those computations, including the provision that each partner would be permitted at least 90 days to review and comment of the adjustment proposed by the IRS as part of the implementation of the settlement prior to the IRS issuing assessments for those amounts.
The Closing Agreement was implemented for tax years 1990, 1991, and 1992, and on June 6, 2006, the Tax Court approved and entered the stipulated decisions. The IRS did not distribute its calculations of each partner's computational adjustments until June 2007. The taxpayer responded, but by the time the IRS sent revised calculations on August 27, 2007, it had no time to wait 60 days for Davis to review these calculations, as provided in the Closing Agreement, because the statute of limitations to make assessments was about to expire. On September 4, 2007, the IRS issued assessments against the taxpayer for 1990, 1992 and 1995 and applied a portion of refunds otherwise due to him for earlier years to satisfy those assessments. The IRS admits that it breached Paragraph Q of the Closing Agreement by making the September 2007 assessments without giving the taxpayer a second opportunity to review its calculations. The issue here is whether that breach of contract invalidates the subsequent assessments.
The court said that closing agreements are contracts, governed by federal common law. Damages are always the default remedy for breach of contract. The taxpayer, however, did not seek damages, but, instead, argued that any assessments made in breach of the contract are invalid. The taxpayer relied primarily on I.R.C. § 7121(b)(2), which provides that closing agreements are "final and conclusive," noting that the Tax Court incorporated the Closing Agreement into its decision, making it enforceable as a court order. The court said, however, that the "final and conclusive" nature of closing agreements simply means that they settle an existing dispute with finality, and may not be modified or disregarded "except upon a showing of fraud or malfeasance, or misrepresentation of a material fact," I.R.C. § 7121(b).
The court noted that the fact that a contract is "final" does not dictate the remedy for its breach and pointed out that the taxpayer offered no support for the proposition that, because a settlement with the IRS is "final" and court-approved, the remedy for any breach is to free the taxpayer from his pre-existing obligation to pay taxes. The court said that if this were the case, the IRS would be reluctant to enter into a closing agreement for fear that a minor error could have major consequences. The court noted that the taxpayer’s obligation to pay taxes validly and accurately assessed comes from the Internal Revenue Code, not the Closing Agreement, which only specified the treatment of certain Partnership income as inputs to the calculation of his taxes and the IRS's failure to perform its contract with the Partnership cannot relieve Davis of his statutory obligation to pay taxes. Nothing in the Closing Agreement provided that any taxes assessed on the partners pursuant to statute would be rendered invalid if the government failed to perform. Although the breach denied the taxpayer an opportunity to comment on the amounts of the assessments before they were made, it did not prevent him from challenging the assessed amounts in an administrative refund claim or a refund action. Had he done so, the court pointed out, he might have sought consequential damages resulting from his having to challenge the assessments in a more expensive manner than that provided for by Paragraph Q.
Because the court found that the lower court erred in holding that the breach of the Closing Agreement invalidated the assessments, it then addressed an issue that the lower court did not, i.e., whether the assessments were untimely. Under general principles of partnership law, a partnership is not liable as an entity for income taxes because income is allocated among the partners. In 1982,Congress enacted the Tax Equity and Fiscal Responsibility Act (TEFRA), which provided for the resolution of partnership tax disputes at the partnership level. That act requires each partnership to designate a TMP with primary responsibility over tax disputes.
Although TEFRA generally provides that the tax treatment of partnership items will be determined at the partnership level, the IRS still can enter into settlement agreements with individual partners.
If the IRS "enters into a settlement agreement with the partner" under I.R.C. § 6231(b)(1)(c), a one-year statute of limitation is triggered. If the IRS does not enter "into a settlement agreement with the partner," then the one-year statute of limitations under I.R.C. § 6229(d) begins to run when the tax court decision becomes final, which occurred here 90 days after the tax court entered the decision documents. The taxpayer argued that the Tax Court approved decision documents approved on June 6, 2006 were each a settlement agreement with the partner so that a one-year statute of limitations was triggered on that date. The taxpayer, therefore, argued that the September 4, 2007 assessments were not timely.
The court held, however, that under the plain language of I.R.C. § 6231(b)(1)(C), the IRS does not "enter into a settlement agreement with the partner" when it enters into a settlement agreement with the TMP and the individual partner is bound merely by operation of the tax court's decision to which the partner is a party. Therefore, the assessments made on September 4, 2007 were timely, as they occurred within one year after the Tax Court decision became final. Allen Davis et ux. v. United States, U.S. Court of Appeals for the Ninth Circuit, No. 13-16458. 1/25/16
Collection Actions Caused Debtors Emotional Distress
A U.S. bankruptcy court found that the IRS repeatedly violated the bankruptcy stay, sending the debtor couple notices of intent to levy their assets while their bankruptcy case was pending. The court awarded the couple damages for emotional distress.
The taxpayer is a retired Oregon State Police trooper and his wife is employed in the business office of a hospital. Their petition for relief under Chapter 13 of the Bankruptcy Code was filed on November 5, 2012. The bankruptcy case was apparently a difficult one and a plan of reorganization was finally confirmed on September 3, 2014. The automatic stay under 11 U.S.C. § 362(a) became effective when the petition was filed, and remained in effect and the taxpayers have made required plan payments since the case was commenced. The Internal Revenue Service was scheduled as a creditor at the time the case was commenced, and filed a proof of claim, in the amount of $9,301, on November 13, 2012. During the course of the case, while the automatic stay was in effect, the IRS delivered directly to the taxpayers four notices, each of which demanded payment, and advised of imminent enforcement action if the payment was not made promptly. On each occasion the taxpayers brought the notice to the attention of their attorney who assured them that the collection efforts were unlawful, and on December 2, 2013, and again on February 10, 2014, wrote to the IRS advising that the taxpayers were in bankruptcy, and asking that the IRS cease all collection activity.
The court noted that both of the taxpayers were adversely affected by the notices. The stresses naturally inherent in a complex bankruptcy case were exacerbated by the perceived threat of additional collection actions by the IRS. They were especially concerned with the threat to levy on the husband’s Social Security income, because loss of a substantial portion of their income would render their plan of reorganization unfeasible. The Internal RevenueCode § 362(a)(1) provides that a petition for relief in a bankruptcy proceeding operates as a stay of all proceedings against the debtor. Section § 362(k) provides that an individual injured by a willful violation of the stay shall recover actual damages, including costs and attorneys fees, as well as punitive damages in appropriate circumstances. In this case, the United States concedes that the actions of the IRS, described above, constituted violations of the automatic stay, but asserts that it is immune from claims for damages for emotional distress.
Code § 106 provides for a waiver of sovereign immunity in these cases, but the government argued that the waiver of sovereign immunity contained in § 106 does not explicitly provide for an award of damages based on emotional distress. The court said that applying this rationale, however, would “swallow up” the waiver of immunity altogether, noting that in drafting the section, Congress explicitly excluded punitive damages, but no other variety. It follows that a governmental unit is subject to liability for any type of damages otherwise authorized by the Code.
The court noted that Dawson v. Washington Mutual Bank (In re Dawson), 390 F.2d 1139, 1148 (9th Cir. 2004) established for the first time in the circuit that emotional distress damages are compensable under § 362(k). In that case the court established criteria for ascertaining when such damages are allowable in an attempt to limit frivolous claims. The individual must suffer significant harm, clearly establish the significant harm, and demonstrate a causal connection between the harm and the violation of the automatic stay.
The court here said that the injuries described by the taxpayers at trial, particularly the wife’s migraine headaches, were clearly established as neither trivial nor insubstantial, and are compensable under the Dawson standards.
The court found that the evidence here sufficiently demonstrated that the "inherent" tension and stress of the taxpayers’ bankruptcy was exacerbated by the stay violation. The case was progressing well, and a plan was finally confirmed shortly before the fourth notice was sent. The wife testified that she suffered from migraines attributable to the notices.
The court found that the evidence presented in the case was clear and convincing that the harm and causation be was clearly established. The court found that the evidence established that each of the taxpayers, suffered harm, and that, of the two, the wife’s was more intense. Considering all the circumstances, the court awarded the wife damages of $3,000 and damages of $1,000 to the husband. Jonathan Eldon Hunsaker et ux. v. United States, United States Bankruptcy Court for the District of Oregon, No. 14-06218. 1/13/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Petition for Review Denied in California Sales and Use Tax Case
On January 20, 2016 the California Supreme Court denied the Board of Equalization’s (BOE) Petition for Review in the Lucent Technologies, Inc. and AT&T Corp. v. State Board of Equalization (Lucent) sales and use tax case. The petition was filed as a result of the Court of Appeal’s decision on October 8, 2015 in favor of the taxpayers, AT&T Corp. and Lucent Technologies. That decision held that certain charges for software were not subject to the sales and use tax, finding that the decision in Nortel Networks Inc. v. State Board of Equalization (2011) 191 Cal.App.4th 1259 (Nortel) determined the issues in this case. See the October 16, 2015 issue of State Tax Highlights for a more detailed discussion of the Court of Appeals decision.
The State has said that it could owe refunds to almost 900 technology companies with claims held in abeyance as a result of the Supreme Court’s ruling in the case.
Dance Classes Sales Subject to Tax
The Missouri Supreme Court held that a dance studio was liable for sales tax on the price of its dance classes finding that the amusement and recreational activities at the studio were more than a de minimis portion of its business activities.
The dance studio charges fees for dance classes that instruct participants, ranging from young children to adults, on various styles of dance. The court documents showed that the studio’s website described the place as "A Dance studio focused on performance quality in a fun and family friendly atmosphere." The exhibits also showed that the promotional materials, while noting the skill and technique involved in some classes, also emphasize the fun and enjoyment of its classes. At the hearing before the Commission, the studio’s founder and sole shareholder admitted that participants "get recreation" from the dance classes and that it is her hope and belief that participants have fun while learning dance at her studio. Prior to being audited, the taxpayer did not file any sales tax returns, relying on a 2008 Missouri Department of Revenue (DOR) letter ruling addressed to a different business that stated that the fees charged by that business for dance lessons were not subject to sales tax. DOR audited the taxpayer and determined that it was subject to sales tax on dance lesson fees. Taxpayer filed an appeal and the Commission ruled the dance fees were taxable under § 144.020.1(2) as fees to a place of amusement, entertainment, or recreation.
The statute imposes a sales tax on the amount paid for admission and seating accommodations, or fees paid to, or in any place of amusement, entertainment or recreation, games and athletic events. The words amusement, entertainment, and recreation are not defined in the statute and the court, therefore, looked to their plain and ordinary meaning.
The court noted that the common thread in all three definitions in the dictionary is that of diversion and found, therefore that a “place of amusement, entertainment or recreation” is a place that provides diversion. The taxpayer argued that the studio is not a place of amusement, entertainment, or recreation because the purpose of the studio is to teach students how to dance, not to amuse, entertain or provide recreation to students. Case law had previously set out a de minimis test for the application of this provision, meaning that if the amusement or recreational activities of the taxpayer comprise more than a de minimis portion of the business activities of the studio, it is considered a place of amusement or recreational activities.
The case law identified three factors to consider in making the de minimis determination: (1) the manner in which the place holds itself out to the public; (2) the amount of revenue generated by amusement or recreational activities at the place; and (3) the pervasiveness of the amusement or recreational activities at the place. Here, the court noted that the studio’s website and promotional materials have consistently emphasized the fun and enjoyment that participants will experience when taking its dance classes, meaning that it has held itself out to the public as a place providing diversion.
The court also found that the taxpayer’s dance classes are activities of a dual nature, providing diversion along with instruction. In comparing the dance classes to the studio’s other business activities, including costume and other retail sales, the numbers before the Commission reflected that fees for dance classes accounted for nearly two-thirds of the taxpayer’s combined gross income for the relevant years of 2010 and 2011, and the court found that the amusement and recreational activities of the taxpayer passed the de minimis test. A dissent said the studio was not a place of recreation under the sales tax law and that the amusement activities do not comprise more than a de minimis part of its business activities.
Miss Dianna's Sch. of Dance Inc. v. Director of Revenue, Missouri Supreme Court, No. SC95102. 1/12/16
Sales Tax Initiative for Education Constitutional
The Oklahoma Supreme Court held that an initiative that would amend the state constitution and implement a 1-cent sales tax to fund higher education did not violate the one general subject rule. The court held that although the initiative had various provisions, its general purpose was to supplement education funding.
On October 21, 2015, the respondents (Proponents) filed Initiative Petition No. 403 with the Oklahoma Secretary of State, seeking to amend the Oklahoma Constitution by adding a new Article 13-C. That article would create the Oklahoma Education Improvement Fund, designed to provide for the improvement of public education in the state through an additional one-cent sales and use tax that would be used to fund a pay raise for teachers and distributed to schools for certain educational purposes. On November 12, 2015, the petitioners (Opponents) filed an Application to Assume Original Jurisdiction in this Court, arguing that the petition is unconstitutional because it violates the one general subject rule of Art. 24, § 1 of the Oklahoma Constitution.
People have the power of the initiative and the court is vested with the original jurisdiction to evaluate and determine the sufficiency of the proposed initiative petitions. But the court said that it will not declare a ballot initiative invalid except where there is a clear or manifest showing of unconstitutionality and pointed out that the Opponents bear the burden of demonstrating that the proposed initiative clearly and manifestly violates the state Constitution. Citing prior cases decided by the court on the subject of the one general subject rule, the Court reiterated that when the proposed constitutional amendment is by a new article the test for gauging multiplicity of subjects is whether the changes proposed are all germane to a singular common subject and purpose or are essentially unrelated to one another.
In the case before the court, the proposed Article 13-C consists of seven sections. The subject of the proposed amendment is the Oklahoma Education Improvement Fund and the court found that each section of the proposed amendment was reasonably interrelated and interdependent, forming an interlocking package deemed necessary by the initiatives' drafters to assure effective public education improvement funding. Proponents drafted the petition with each component being necessary to the accomplishment of one general design. The court found that the proposed initiative petition clearly constitutes a single scheme to be presented to voters, and each section is germane to creating and implementing the Oklahoma Education Improvement Fund.
The court noted that the purpose of the one general subject rule is to prevent imposition upon or deceit of the public by the presentation of a proposal which is misleading or the effect of which is concealed or not readily understandable, to afford the voters free of choice, and to prevent the combining of unrelated proposals in order to secure approval by appealing to different groups. The court rejected the opponents’ argument that the proposal is misleading because voters will think they are voting for teacher pay raises, when in fact, they are voting to significantly change the state's fiscal structure to give the Board of Equalization (BOE) control over their local Representative and Senators deciding on education appropriations, saying that it ignored the powers already conferred to the BOE in the state constitution.
The court said that BOE already examines the General Revenue Fund and each Special Revenue Fund and certifies to the Legislature the amounts available for appropriation in the upcoming fiscal year, and audits the Lottery Education Fund in the same way it would audit the Education Improvement Fund.
The court also rejected the argument of the Opponents that including funding for higher education and common education in the same proposal constitutes logrolling because each is established in separate articles of the constitution, finding that the proposal in this case does not amount to logrolling and constitutes a single scheme to be presented to voters. The court held that the initiative was legally sufficient for submission to the people of the state. The dissent said the one general subject rule was violated and that voters who wished to increase teacher salaries were forced to vote on other unrelated issues in the initiative.
OCPA Impact Inc. v. Sheehan, Oklahoma Supreme Court, Case No. 114425. 1/12/16
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Court Rejects Challenges to Retroactive Repeal of Compact
The Michigan Court of Appeals has rejected consolidated challenges to retroactive legislation that repealed the Multistate Tax Compact and its three-factor apportionment formula. The court explained that it rejected identical arguments in Gillette Commercial Operations N. Am. & Subsidiaries v. Dep't of Treasury holding that the compact was not a binding interstate compact and the legislation did not violate due process or Michigan's laws on retroactivity. See the October 16, 2015 issue of State Tax Highlights for a more detailed discussion of the Gillette decision.
The 16 Plaintiffs in this case presented multiple state and federal constitutional challenges to the retroactive amendment to the statute, which the court said were identical in all relevant respects to the arguments raised by the plaintiffs in Gillette. In Gillette the court held that the Compact was not a binding agreement on the state but was merely an advisory agreement, and the legislation’s removal of Michigan from membership in the Compact was not prohibited, and no violation of the Contract Clauses of either the federal or state Constitutions occurred. The court in that case also held that the retroactive repeal of the Compact did not violate the Due Process Clause of either the state or federal constitution. The court found that the challenges of the 16 plaintiffs were devoid of merit. Sapa Extrusions Inc. v. Dep't of Treasury, Michigan Court of Appeals, Nos. 326414; 326415; 326512; 326513; 326585; 326586; 326732; 326733; 326818; 326819; 327360; 327725; 327880; 327962; 32. 1/21/16
Property Tax Decisions
YMCA Qualifies for Religious Exemption
The Colorado Court of Appeals, Division I, held the YMCA was entitled to a religious purpose property tax exemption. The court said the property did not only have to be used for religious purposes to qualify for the exemption. The character of the property's owner should also be considered.
In December 2003, the YMCA, a nonprofit organization, applied for religious purposes and charitable use property tax exemptions for two properties, the Snow Mountain Ranch (Ranch) and Estes Park Center (Center). The Ranch consists of 40 cabins, 12 vacation homes, and 61 campsites located on 2187 acres of land. The Center consists of 179 cabins, 25 vacation homes, and 451 lodge rooms located on 860 acres of land. Each of the properties has a chapel, conference facilities, dining halls, a swimming pool, a laundromat, and maintenance and administration buildings. The properties offer a variety of recreational activities, including hiking, fishing, biking, horseback riding, cross-country skiing, tennis, roller skating, ropes courses, and fitness rooms. The properties also offer special activities and family programs such as Bible study, worship services, arts and crafts, story time at the library, and games. The YMCA provides guests with a schedule of activities, but it does not require guests to participate in any of the activities or religious services.
The state property tax administrator (Administrator) determined that the properties were being used exclusively for religious purposes and granted a religious purposes exemption. The counties’ Boards of Commissioners (Commissioners) appealed the Administrator's determination to the Board, contending that the YMCA's use of the properties was not sufficiently religious to entitle it to the exemption. The Board conducted a hearing and concluded that the properties were not used exclusively for religious purposes, noting that the properties were open to the general public regardless of faith, the properties were marketed without reference to religion, and many guests did not participate in any "overtly Christian" activities. The Board also found that the YMCA operated public school programs that were devoid of religious content, and that the YMCA had accepted bond funds which could not be used for "pervasively sectarian purposes." The Board upheld an exemption for the properties' chapels and the religious activities center at the Ranch, finding that these areas were used for religious purposes, but otherwise reversed the grant of an exemption. The YMCA appealed and a division of this court reversed, concluding that the Board failed to apply the proper legal standard. The YMCA I division concluded that the Board had failed to consider the YMCA's use of its property in light of its religious mission and purposes. Instead, it concluded that the Board had looked at the use of the property independent of the YMCA's stated mission and purposes and, without considering the presumptive effect of the organization's declared purposes, had deemed the uses of the property insufficiently religious to qualify for the exemption. The court remanded to the Board to apply the correct legal standard.
On remand, the Board concluded that the YMCA was sincere in its stated mission and purposes, even though, as the Counties argued, the YMCA's promotional literature did not contain "overtly Christian" references. The Board then considered the actual use of the property for which the exemption was sought and concluded that the use of the property was in furtherance of the organization's purposes. The Board determined that the YMCA's religious mission and purposes, based on sincerely-held religious beliefs, were broad enough that each of the uses challenged by the Counties furthered the organization's religious purposes and that the property was not being used for private gain or corporate profit.
The Board concluded that the YMCA was entitled to the religious purposes exemption and the counties filed this appeal, arguing that the critical question was whether the use of the property was inherently or objectively religious. For example the counties argued that hiking is not a religious activity, regardless of whether a person hikes on property owned by the YMCA or on property owned by a luxury resort. Therefore, the fact that the hiking trails are on property owned by the YMCA, an organization with a religious mission and purposes, should not factor into the analysis. The counties also argued that the statutory provision that construes the religious property tax exemption broadly is unconstitutional.
Initially, the court noted that a division of this court may review another division's ruling in the same case if there is the possibility that the previous decision is no longer sound because of changed conditions or law, or legal or factual error, or if the prior decision would result in manifest injustice. In light of the counties’ argument that the prior ruling was legal error, the court chose to review the merits of the counties’ arguments.
The court noted that the statutory scheme required that the applicant for the exemption provide a declaration of its religious mission and religious purposes and the uses of the property that are in furtherance of such mission and purposes and activities of a religious organization that are in furtherance of its religious purposes constitute religious worship. The court said that the issue was whether the property was used for activities that further the organization's religious purposes. The court cited Maurer v. Young Life, 779 P.2nd 1317 (Colo. 1989), in which the state supreme court explained that, although courts look to the use to which the property is put, the character of the property owner is relevant to illuminate the purposes for which the property is used. The court in that case further said that by considering the character of the property owner as a religious organization, the fact finder could reasonably conclude that even nonreligious activities furthered the property owner's religious purposes.
The court agreed with the YMCA I division that the use of the property must be considered in light of the property owner's religious mission and purposes and found that the Board applied the proper standard and concluded that the YMCA's use of its properties furthered its religious mission and purposes. The court rejected the counties’ argument that the Board was not bound by the presumption that the stated uses were actually in furtherance of the YMCA's religious purposes, concluding that, consistent with the structure of the statute, the presumption applies throughout the application process, including at any stage of review. In this case, the court said, the property owner, having provided a declaration of its religious mission and purposes, is entitled to a presumption that its property is used in furtherance of that mission and those purposes. The reviewing body must ensure that the presumption is given effect unless it is rebutted and the court said that the counties made no argument that the presumption was rebutted. Nothing in the statutory language would permit a reviewing body to disregard the statutory presumption. Finally, the court rejected the counties’ constitutional argument, finding no violation of the separation of powers doctrine. Grand Cnty. Bd. of Comm'rs v. Colorado Prop. Tax Administrator, Colorado Court of Appeals, 2016 COA 02; Colorado Court of Appeals No. 14CA1767. 1/14/16
Board Lacked Authority to Hear Tax Challenge
The Nebraska Supreme Court held that a county board of equalization properly dismissed a property valuation protest when the taxpayer failed to include a reason for the requested change, as required by statute. The court found that the Nebraska Tax Equalization and Review Commission (Commission) lacked statutory authority to consider the merits of the valuation.
The state statute requires that a taxpayer's property valuation protest must contain or have attached a statement of the reason or reasons why the requested change should be made. The statute further provides that if the taxpayer does not comply with this requirement, the protest “shall” be dismissed by the county board of equalization. The taxpayer filed a property valuation form, listing the assessed and requested valuation amounts but leaving blank the section for reasons for the requested change.
The court said that there was no dispute that the taxpayer did not include a reason in the space on the form for that purpose, nor did it attach a statement setting forth the reason for its requested change. The taxpayer claimed that it complied with the statutory requirement, because its protest contained a reason for the appeal, i.e., that the property was overvalued, as indicated by the protested valuation figure and the requested valuation figure. The court said that under the rules of statutory interpretation, the statute provision at issue here plainly requires a reason why the requested change should be made and the taxpayer failed to provide one. A requested change is not synonymous with a reason why the requested change should be made. The court rejected the taxpayer's argument that a reason for the protest was apparent from the face of the protest form, finding that different figures could result for a multitude of reasons. The court said that a county board of equalization should not have to guess the basis for a taxpayer's property valuation protest, and the statutory requirement exists to frame the issue for a hearing before a county board of equalization.
The court also rejected the taxpayer’s assertion that the doctrine of substantial compliance should apply, finding that the taxpayer in this matter did not comply with the statutory requirement to any degree. The court found that because the taxpayer's protest did not include a reason for the requested change, the Board did not have authority to do anything other than dismiss the protest. The lower court dismissed the taxpayer's appeal from the Board decision for lack of jurisdiction and the court concluded that it correctly declined to reach the merits of the appeal regarding the property's value. Vill. at North Platte v. Lincoln Cnty. Bd. of Equalization, Nebraska Supreme Court, 292 Neb. 533; No. S-15-508. 1/15/16
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]. |
|
|
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:
January 22, 2016 Edition
NEWS
FTA’s NEW Website
We are moving all legal information that was on the FTA’s TaxExchange over to the new site attaxadmin.org. A direct link to the legal information is www.taxadmin.org/legal. All back issues ofState Tax Highlights as well as the searchable database are in the process of being moved to this new site.To obtain an id/password for this section if you do not already have one, send an email to[email protected]. Tip of the Month: at the log-in page, check the box [Keep me logged in] to always have access to allthe information. Note, availability of menu items and certain pages will change based on your logged-instatus. Michigan Issues Guidance on Impact of Computer Software Decision
On January 6, 2016 the Michigan Department of Treasury issued a notice providing taxpayers with guidance on the impact of Auto-Owners Insurance Company v. Department of Treasury, a case that determined which types of prewritten computer software were subject to use tax. See the November 13, 2015 issue of State Tax Highlights for a more detailed discussion of the court’s decision. The notice set forth the issues in the case and the court’s determination. It also provided advised taxpayers that the decision in the case would be applied to all open tax years. A Taxpayer seeking a refund of taxes paid for a product falling within the Auto-Owners opinion should file a written refund request with the Department within the statute of limitations.
Legislators override veto of Online Travel Company Bill
On January 21, 2016, the Maryland General Assembly voted to override the Governor’s veto of a bill that requires online travel companies (OTCs) to remit the 6 percent sales tax based on the total amount they charge customers rather than on the amount they pay to hotels. Under SB 190 passed during the 2015 Session of the General Assembly, OTCs are subject to the state sales tax as an "accommodations intermediary," defined in the bill as a person that facilitates and collects the cost of sales of lodging but doesn't provide the lodging. For such an intermediary, the bill provides that the taxable price of a sale includes the full pretax amount charged to a buyer by the seller.
U.S. SUPREME COURT UPDATE
Cert Denied
Sierra Pac. Power Co. v. Nevada Dep't of Revenue, U.S. Supreme Court Docket No. 15-25. Petition for Certiorari denied on 1/11/16. In December 2014 the Nevada Supreme Court ruled that the state's use tax on coal purchased out of state but used in Nevada violated the dormant commerce clause because coal mined in the state was exempt, but refused to authorize refunds to the taxpayer here finding that it did not suffer any real harm because coal was not mined in the state. The taxpayer asked the U.S. Supreme Court to rule that by not providing a refund under a taxing schemethat has been deemed unconstitutional, the state has failed to provide the meaningful relief required under McKesson Corp. v. Div. of Alcoholic Beverages.
FEDERAL CASES OF INTEREST
Tax Evader's Sentence Vacated
The U.S. Court of Appeals for the Fifth Circuit vacated the sentence of an individual who was convicted of tax evasion for failing to pay taxes on money he earned through government contracts and remanded the matter to the district court for resentencing. The decision found that the lower court improperly imposed employment restrictions, improperly ordered restitution, and improperly adjusted the offense level.
The taxpayer contracted to make and sell airplane parts to the United States Government (Government). He then hid the income created by these sales from the IRS, funneling his income through two corporate entities, WET Publishing (WET) and Middle Creek Construction (MCC). The owners of WET and MCC authorized the taxpayer to enter into government contracts on their behalf. The airplane parts were sold pursuant to contracts between these entities and the government, and the profits from the sales then went to the entities. The taxpayer split split the profits from the contracts with the owners of the two companies. The taxpayer believed he was a "sovereign citizen" not subject to federal law and, therefore, believed that the Internal Revenue Code did not require him to pay taxes. The government indicted the taxpayer on five counts of tax evasion, and a jury convicted him on all counts. In determining the taxpayer’s sentence, the district court first calculated his sentencing range under the Guidelines and imposed a prison sentence, restitution and three years of supervised probation. The court also imposed an employment restriction on his
supervised release, prohibiting him from entering into contracts with the Government.
Taxpayer appealed that decision.
The court found that the lower court had the discretion to order the sentence in its decision. The court noted that the taxpayer argued and the government conceded that the lower court improperly ordered restitution as part of the taxpayer’s tax evasion sentence. The court has previously held that restitution cannot be imposed as part of a tax evasion sentence. The district court can order restitution as a condition of supervised release, but it may do so only if the defendant admits the amount of the tax liability or the government establishes the amount of the tax liability at trial. The court vacated that part of the sentence and remanded the matter to permit the district court to consider whether to impose restitution as a condition of supervised release.
Taxpayer also argued that the district court lacked authority to prohibit him from contracting with the government as a condition of his supervised release, asserting that this occupational restriction was neither reasonably related to tax evasion nor necessary to protect the public.
The court said that a district court has discretion to impose conditions on supervised release, but it must be reasonable related to the nature and circumstances of the offense, the need to afford adequate deterrence, the need to protect the public from future crimes, and the need to provide treatment to a defendant. If required, the condition must be imposed to the minimum extent possible. The court found that restricting the taxpayer from entering into government contracts does not meet any of the above criteria and the court vacated the district court’s order as it pertained to the employment restriction.
The taxpayer also argued that the district court's sentence was not reasonable, asserting that the court did not adequately explain its reasons for its sentence and did not properly calculate the taxpayer’s Guidelines range. The court noted that if a court issues a non-guidelines sentence, as the district court did here when it issued a sentence to run consecutively instead of concurrently, it needed to provide a more detailed explanation of its reasoning. The court found that the reasons given by the court adequately explained the basis for the taxpayer’s sentence. The court did find, however, that the district court had improperly calculated the sentence under the Guidelines and found that this error was not harmless, necessitating a remand for resentencing. United States v. Daniel Isaiah Thody, U.S. Court of Appeals for the Fifth Circuit, No. 14-50904. 1/8/16
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Test Vehicles Subject to Use Tax Under Old Law
The Michigan Court of Appeals held that a car manufacturer’s test vehicles were not exempt from use tax under the pre-1999 use tax law. The court determined the vehicles' manufacturer's license plates permitted the vehicles to be used on public highways. The court also found the court of claims properly awarded the taxpayer attorney fees for time spent on the claims regarding parts provided for extended service which were resolved by an earlier court decision, but not for time spent on an amended complaint.
TheDepartment of Revenue (DOR) conducted a tax audit of the taxpayer for the period of July 1, 1993 through November 30, 2001. During part of the audit period, the Use Tax Act (UTA) provided a use tax exemption for property used or consumed in industrial processing, but specifically provided that this exemption did not extend to vehicles licensed and titled for use on public highways. In 1999, the UTA was amended to provide an exception to that provision for vehicles bearing a manufacturer’s plate.
The lower court concluded that the taxpayer’s test vehicles that were titled and driven under manufacturer’s license plates were not licensed for use on public highways and, therefore, were exempt from use tax and DOR filed this appeal. The court in this appeal noted that before the 1999 amendment the UTA did not define the word “licensed” and the court then looked to the plain and ordinary meaning of the word. It determined that the taxpayer’s test vehicles were “licensed” because they were driven under manufacturer's license plates that authorized their use on public highways.
The court rejected the taxpayer’s argument that manufacturer's license plates did not license its test vehicles for use on public highways, but rather licensed the taxpayer to test the vehicles, finding that a manufacturer's license plate is a physical representation that a vehicle is authorized to operate on public highways and when it is affixed to a test vehicle, the vehicle becomes licensed for use on public highways pursuant to the statutory provision. The court also rejected the taxpayer’s argument that its test vehicles were not licensed for use on public highways because it could not lawfully sell, lease, or lend a test vehicle to a third party or use a test vehicle for any purpose other than testing, stating that the mere fact that the taxpayer could not sell or lease the vehicles, or use them for purposes other than testing, does not mean that the vehicles were not licensed for use. The taxpayer also argued that the court should retroactively apply the 1999 amendment, but the court noted that statutory amendments are only applied prospectively unless the legislature expressly or impliedly identifies its intention to give the amendment retroactive application and it declined to retroactively apply the 1999 amendment of the UTA.
This case also involved challenges by DOR of four separate awards of attorney fees and costs and the court reviewed the trial court’s actions for an abuse of discretion. The first case involved the lower court’s conclusion that DOR’s defense of its assessment of use tax for automotive parts was frivolous. DOR argued that the lower court did not make sufficient factual findings to justify its determination that the DOR’s defense was frivolous. The court found that although the lower court’s explanation occurred in relation to a separate motion, a finding that is brief, definite, and pertinent is sufficient, and the court's statement in this matter was adequate to facilitate appellate review. The court further found that DOR’s defense was frivolous, lacking any factual or legal support. Similarly, the court rejected DOR’s arguments in the remaining three awards of attorney fees.
Finally, on the issue of when interest began to accrue on the refund claim for vehicles included after the 1999 amendment, the court said that evidence supports that the taxpayer paid the taxes at issue, petitioned or claimed a refund, and then filed the claim, and, therefore, the 45-day waiting period before interest began to accrue started after the taxpayer sent its January 28, 1999 letters. Ford Motor Co. v. Dep't of Treasury, Michigan Court of Appeals, No. 322673. 12/15/15
Charging Sales Tax for Exempt Portion of Sale Violated Consumer Fraud Act
The Illinois Court of Appeals, First District, held that the taxpayer violated the Consumer Fraud Act by charging sales tax on the full price of digital-to-analog converter boxes because portions of the boxes were federally subsidized and exempt. The court reversed an award for attorney fees and remanded for further proceedings on that issue.
In 2009 the plaintiff filed a complaint alleging, among other things, that the taxpayer wrongfully collected sales tax on the entire sale price of digital-to-analog television converter boxes (converter boxes), despite the fact that a portion of the retail price of the devices was subsidized by federally-funded coupons which are exempt from the state sales tax. The matter proceeded on plaintiff's class-action claims until October 27, 2011, when he withdrew his motion for class certification, and the matter was transferred to the municipal department of the circuit court for further proceedings on his individual Consumer Fraud Act claim. On July 16, 2013, the circuit court issued a 17-page written order containing its findings of fact and conclusions of law and entering a judgment in favor of the plaintiff in the amount of $3.10. On July 31, 2013, the plaintiff filed a fee petition seeking $252,402.08 in attorney fees and costs. The circuit court conducted a hearing on the plaintiff's fee petition and on October 6, 2014, entered an order awarding the plaintiff attorney fees in the amount of $157,813.53. The taxpayer filed this appeal.
Section 10a(a) of the Consumer Fraud Act (Act) authorizes a private right of action for any person who suffers actual damage as a result of a violation of the Act. A person filing such a claim must prove (1) a deceptive act or practice by the defendant; (2) the defendant’s intent that the plaintiff rely on the deception; (3) the occurrence of the deception in the course of conduct involving trade or commerce; and (4) actual damages to the plaintiff proximately caused by the deception.
The undisputed facts are that a federally funded program, initiated in 2008, provided households coupons that could be used as a credit of up to $40 for the purchase of eligible converter boxes enabling analog boxes to receive digital signals. The retailer would then be reimbursed by the federal government for the lesser of $40 or the purchase price of the converter box. The state Department of Revenue (DOR) issued an information bulletin in July 2008 informing all Illinois retailers that these coupons were exempt from state sales tax and that retailers were only to charge sales tax on the net sale price of a converter box after the value of the coupon was applied to reduce the retail price of the device. The record established that the taxpayer learned of the information bulletin in July of 2008.
In April 2009, the plaintiff applied for, and thereafter received, two coupons and subsequently used them to purchase a qualifying converter from the taxpayer, whose sales associate calculated the sales tax upon the full retail price before deducting the value of the coupons. The miscalculation resulted in the plaintiff being overcharged $3.10 in sales tax.
The plaintiff stated that, at the time that he purchased the converter box, he did not know that sales tax should not have been charged on the $40 value of the coupon which he tendered. According to the plaintiff, had he known that taxpayer charged him too much for sales tax on the transaction, he would not have paid it.
The taxpayer argued that the plaintiff was not deceived when its sales associate represented that he owed $24.64 on the transaction, pointing out that the allegations in the plaintiff's original complaint are virtually identical to those in a complaint filed previously by a third party. The taxpayer referred to the plaintiff as a "professional class action plaintiff" who has filed 23 class action complaints in the past eight years, using the same attorneys that represented him in this action, implying that the plaintiff was not deceived by any misrepresentation made by the taxpayer’s sales associate, but, instead, made the purchase so that he could file the instant action. The court said that the facts relied upon by the taxpayer could certainly support the inference that the plaintiff was not deceived by the representations of the sales associate as to the net amount that he owed and that he was well aware at the time that he purchased the converter box that sales tax should not have been assessed on the $40 value of the coupon which he tendered, but found that the findings of the circuit court rested upon the credibility of the plaintiff’s testimony and the court deferred to the court’s findings unless they are against the manifest weight of the evidence.
The court also rejected the taxpayer’s argument that the circuit court erred in holding that its collection of excess sales tax from the plaintiff is a de jure deceptive practice violation of the Act, noting that the taxpayer was aware that sales tax should not be charged on the value of the coupon but did not institute an automated system at its stores to exempt the value of the coupons from the calculation of the sales tax. The court said that an examination of the record reveals that the circuit court's findings were amply supported by the evidence of record and the court, therefore, concluded that the plaintiff proved each element of his Consumer Fraud Act claim.
The taxpayer also appealed the award of attorney fees arguing that the circuit court erred in awarding the fees without determining their reasonableness, awarding them for unreasonable services and based upon hourly rates supported by insufficient evidence as to their reasonableness, and admitting the attorneys’ computerized time sheets into evidence in the absence of the underlying time sheets. The court said that the propriety of the fee award rests initially upon the admissibility of the July 31, 2013, billing statement, as there is no other evidence of record from which a fee award could be calculated. The circuit court found that the plaintiff failed to produce his attorneys' original time sheets, and the partner testified that those time sheets had been purposefully discarded. The plaintiff argues that the itemized billing statement of July 31, 2013, was properly admitted into evidence pursuant to the business record exception to the hearsay rule and the court said that the resolution of this issue rests on the distinction between computer-generated records and a printout of computer-stored data. Computer-generated records are the spontaneously created tangible results of the internal electrical and mechanical operations of a computer itself and which are not dependent upon the observations and reporting of a human declarant. In contrast, computer-stored records consist of information placed into a computer by an out-of-court declarant. The court noted that when computer-stored records sought to be admitted are the product of human input taken from information contained in original documents, the original documents must be presented in court or made available to the opposing party, and the party seeking admission of a record of that consumer-stored data must be able to provide testimony of a competent witness who has seen the original documents and can testify to the facts contained therein. When the original documents have been destroyed by the party offering secondary evidence of their content, the secondary evidence is not admissible unless, by showing that the destruction of the original documents was accidental or was done in good faith and without any intention to prevent their use as evidence, the party offering the secondary evidence repels every inference of fraudulent design in the destruction of the original documents.
In this case, the billing statement of July 31, 2013, upon which the plaintiff's fee petition is based, is the product of human input of data derived from original time sheets into a computer program known as Time Slips. The billing statement is nothing more than a tangible printout of that computer-stored data, consisting of approximately 518 entries and the court found that admitting the documents into evidence was an abuse of discretion. The absence of the original time sheets deprived the taxpayer of an opportunity to test the reliability and accuracy of the billing statement. The court found that absent the July 31, 2013, billing statement, there was no evidence in the record from which a reasonable fee could be calculated and reversed the awarded fee and remanded the matter with directions to grant the plaintiff an opportunity to prove reasonable fees to which he is entitled through admissible evidence.
Aliano v. Sears Roebuck and Co., Illinois Court of Appeals, No. 1-14-3367. 12/30/15
Casino Does Not Owe Use Tax on Lottery Machines
The Kansas Court of Appeals held that a casino does not owe use tax on electronic gaming machines used to play the Kansas lottery. The court found that the casino, as a lottery gaming facility manager, purchased the machines on behalf of the state lottery and does not own or have independent control over the machines.
The taxpayer paid use tax on the purchase for the state lottery of electronic gaming machines (EGMs) from out of state vendors for use at a casino and resort in the state. Each EGM sales agreement identified the taxpayer as a purchasing agent and the Kansas Lottery as the owner of the EGMs purchased. After paying the tax under protest, the taxpayer applied to the state Department of Revenue (DOR) for a refund, which was denied and the taxpayer filed a timely appealed to the Board of Tax Appeals (BOTA). The BOTA granted the taxpayer’s refund and the DOR filed this appeal. In 1986, the state Constitution was amended to allow limited exceptions for certain bingo games, horse and dog racing, and state-owned and operated lotteries. Following the constitutional amendment, the Lottery Act was passed in 1987, establishing the Kansas Lottery, a state-owned and operated independent state agency tasked with the overall management and operation of the state lottery. In 2007, the Lottery Act was amended, allowing for the establishment of state-owned and operated lottery facilities. The statute allows the state to contract and delegate the management of the lottery gaming facility, but places ultimate ownership and operational control of the lottery game equipment with the Kansas Lottery.
The taxpayer derives the right to manage the casino through the statute and the management contract it entered into with the Kansas Lottery, which provides the taxpayer little or no control over the EGMs. The court noted that the taxpayer is under stringent supervision by the Kansas Lottery. All revenue received is paid daily to the Kansas Lottery, and the taxpayer’s 73% of the revenue share is then returned to it on a monthly basis.
The contract provided that the taxpayer has no authority to own, purchase or lease any Lottery Facility Games, except on behalf of the State of Kansas and through the Kansas Lottery. The Executive Director of the Lottery, in consultation with the taxpayer selected the games to be offered for play at the facility and determined the prizes to be awarded for the play of the games. The management contract explicitly stated, "[t]he Kansas Lottery will be the licensee, owner and possessor of the right to use all control software and logic chips required to operate the games available on the Lottery Facility Games at the Lottery Gaming Facility."
In addition, the Executive Director of the Kansas Lottery was entitled to appoint one or more on-site personnel, reporting directly to him, to oversee the lottery gaming facilities and enforce gaming rules and policies. A number of regulations were promulgated expressing the right to control various aspects of the gaming facilities. The court found that is was readily apparent from the record that the management contract confirms the Kansas Lottery owned the EGMs used by the taxpayer in managing the casino, and the taxpayer provided the Kansas Lottery with 100% of the gross gambling proceeds on a daily basis. Under the management contract and the statute, the taxpayer has no authority to purchase or lease any lottery facility games except on behalf of the Kansas Lottery.
The court noted that not only do the purchase agreements very clearly demonstrate that the taxpayer purchased the EGMs on behalf of the Kansas Lottery, the statute is only constitutional if the Kansas Lottery has ultimate ownership and control over the EGMs.
The DOR argued that prior case law is factually distinguishable because the taxpayer was not reimbursed for the purchase price of the machines. The court said that while this was technically accurate, under the management contract in this case, 100% of the revenues from the gaming facility are paid to the Kansas Lottery on a daily basis and the Kansas Lottery then transfers back 73% of the revenue to the taxpayer on a monthly basis as payment for managing the facility, resulting in the reimbursement of the purchase price over a period of time.
Finally, the court rejected DOR’s comparison of the taxpayer’s use of the EGMs to the lease of a vehicle in which the lessee does not hold title but pays sales tax on the lease payment, finding that the EGMs are not leased from the Kansas Lottery and with a car lease you have some independent control of the vehicle which the taxpayer does not have with the EGMs.
The court found that the Kansas Lottery had the ultimate control over the machines and the taxpayer was not liable for the use tax. Matter of the Appeal of BHCMC LLC, Kansas Court of Appeals, No. 112,911. 12/31/15
Use Tax on Company's Vehicles Constitutional
The Massachusetts Supreme Judicial Court held that an unapportioned use tax on a freight company's interstate fleet of vehicles met the Complete Auto test and did not violate the dormant commerce clause.
The taxpayer is a Massachusetts S corporation that operates a freight business with terminals in Massachusetts and New Jersey. The taxpayer is licensed by the Interstate Commerce Commission as an interstate carrier to operate a fleet of tractors and trailers and carries and delivers goods throughout the eastern United States. Throughout the tax periods at issue, the taxpayer maintained its corporate headquarters in the state, as well as four warehouses and a combined maintenance facility and terminal location, which it used for repairing and storing vehicles in its fleet. Regency also operated five warehouses and two combined maintenance facility and terminal locations out of state and performed thirty-five per cent of the maintenance and repair work on its fleet at its in state locations and thirty-five per cent of the work at its out of state locations, with the remainder being performed by third parties. All vehicles in the taxpayer’s fleet entered into the state at some point during the tax periods at issue. During these same periods Regency employed between sixty-three and eighty-three percent of its workforce in the state. The taxpayer purchased the vehicles in its fleet from vendors in in several other states and accepted delivery and possession outside the state. The vehicles were registered out of state. The taxpayer did not pay sales or use tax to any jurisdiction on its purchases of the vehicles because one state in which it made purchases does not impose a sales tax and the remaining states provide an exemption for vehicles engaged in interstate commerce. Massachusetts does not have this exemption and in 2010 issued a use tax assessment on the full purchase price of each tractor and trailer in the taxpayer’s fleet.
The taxpayer filed a timely appealed to the Appellate Tax Board (Board).
The taxpayer argued before the Board that the Commonwealth's imposition of a use tax on vehicles engaged in interstate commerce violated the commerce clause of the United States Constitution and the equal protection clauses of the United States and Massachusetts Constitutions. The taxpayer also argued that its reliance on a letter ruling issued by the Department of Revenue (DOR) under prior law constituted reasonable cause for the commissioner to abate the penalties assessed for failure to file returns and pay the tax.
The Board rejected the commerce clause and equal protection arguments, but found reasonable cause for abating the penalty charges. On appeal, the taxpayer challenges only the Board's determination that the motor vehicle use tax does not violate the commerce clause.
The state statute creates a rebuttable presumption that property brought into the Commonwealth by the purchaser within six months of purchase was purchased for storage, use, or other consumption in the state. The statute provides an exemption from the tax is a corresponding sales tax of equal value has been paid to another jurisdiction. The taxpayer does not dispute that it used and stored its tractors and trailers in the state during the tax periods at issue and does it dispute that it did not pay sales or use tax to any other state on the purchase of the vehicles.
The court’s review of commerce clause challenges to state taxes focused on the practical effect of a challenged tax and noted that a state tax will be sustained under the commerce clause if it meets the test articulated by the Supreme Court in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 281 (1977). That test requires that the tax is applied to an activity with a substantial nexus with the taxing state, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State. In examining whether this case met the fair apportionment test, the court looked at both the internal and external consistency and found that the imposition of the tax here was both internally and externally consistent, rejecting the taxpayer’s argument that it subjected it to potential multiple taxation and finding that the taxpayer’s tax liability reasonably reflects the in-state activity being taxed. The court rejected the taxpayer’s argument that the tax was not reasonably apportioned to reflect the in-state activity which it contended was the use of the state’s roads, finding that the taxpayer’s activities in the state were not limited only to its use of the state’s roads. The court cited Oklahoma Tax Comm'n v. Jefferson Lines, Inc., 514 U.S. 175, 186 (1995) (Jefferson Lines, Inc.) in which the U.S. Supreme Court rejected the argument that a tax must be apportioned to satisfy the external consistency requirement.
The court also rejected the taxpayer’s argument that the use tax was discriminatory because when divided by the miles actually driven in the state, the tax was significantly higher for the taxpayer than for intrastate companies, again finding that the imposition of the tax was not based solely on the use of the roads within the state. The court said that the taxpayer was seeking to use the commerce clause as an escape from any taxation at all which the constitution does not permit. The court also concluded that given the nature and extent of the taxpayer’s activities in the state, and the benefits it receives consonant with its presence here, the tax is fairly related to the taxpayer’s activities in the state. Regency Transportation Inc. v. Comm'r of Revenue, Massachusetts Supreme Court, SJC-11873. 1/6/16
Rental Company’s Waiver Fee Not Subject to Sales Tax
The Utah Supreme Court held that a taxpayer’s optional liability fee was not subject to sales and use tax. The fee allowed its customers to increase their payments to the store in order to avoid liability for enumerated damages to the property and the court found that the fee did not affect the possession, use, or operation of the rental property.
The taxpayer leases and sells a variety of consumer goods, ranging from smartphones and televisions to couches and washing machines. The taxpayer’s rental agreement contains a provision allowing customers to accept or decline participation in an optional liability waiver program. Customers participating in the liability waiver program pay an extra fee, calculated as 7.5 percent of the rental payment, each pay period and, in return, customers are not required to reimburse the taxpayer for any loss if the product is damaged or destroyed due to lightning, fire, smoke, windstorm, theft, or flood. The liability waiver fee does not entitle customers to repairs or replacement items and participation in the liability waiver program does not affect the amount owed for the rental payments. On the customers' receipts, the taxpayer separately itemizes the amount paid for the rental payment and the amount paid for the liability waiver fee, and customers may cancel the liability waiver payment at any time without any effect on the rental or the rental payment. The taxpayer also offers an early purchase program enabling the customer to make a lump-sum payment ahead of schedule, and this option does not require payment of the liability waiver fee. The taxpayer charged sales tax on the rental payment but not on the liability waiver fee and the State Tax Commission (Commission) assessed the taxpayer imposing the sales tax on the liability waiver fees. Taxpayer filed an appeal.
The state statute imposes the sales tax on amounts paid or charged for leases or rentals of tangible personal property. The court found that the liability waiver fee was not an amount “paid for” the lease or rental because it did not affect the possession, use, or operation of the rental property. It looked to the plain and ordinary meaning of these words and noted that the Oxford English Dictionary definition indicates that it is not enough for the payment to merely concern a good or service, but, instead, it must go to the purpose or aim of the transaction.
The court concluded that the essence of the transaction is the exchange of money for the right to possess, use, or operate the product that is the subject of the rental. It found that the liability waiver fee did not have any effect on the customer's possession, use, or operation of the property, but simply secures the taxpayer’s promise to waive any claims it would otherwise have against the customer if damage or destruction occurred. The court rejected the Commission’s argument that other states tax liability waivers or similar fees, noting that those states have statutes with language much broader than Utah’s statute. The plain language of the statute here does not tax amounts derived from the rental of tangible personal property and it does not include services for which tangible personal property is leased. The court also determined that the Commission's regulation was not consistent with the authorizing statute, finding that the administrative regulation impermissibly broadens the language of the statute.
Rent-A-Center Inc. v. State Tax Comm'n, Utah Supreme Court, No. 20140129; 2016 UT 1. 1/5/16
Personal Income Tax Decisions
Use of Alternative Fuel Credit for Truck Purchase Upheld
The Louisiana Court of Appeal, First Circuit, held that a couple were entitled to an tax credit on their income tax return for the purchase of a flex fuel vehicle (FFV) because the Department of Revenue’s (DOR) regulation excluding FFVs from the credit did not take effect until after the vehicle was purchased.
In November 2011, the taxpayers purchased a 2011 Ford F-150 pickup truck, known as a Flex Fuel Vehicle ("FFV"), capable of running on either gasoline or a mixture of gasoline and ethanol commonly referred to as E85. The taxpayers learned of the tax credit applicable to vehicles operating on alternative fuels and filed an amended tax return seeking a credit for the purchase of the truck. DOR denied the credit and the taxpayers filed an appeal with the Board of Tax Appeals (BTA), which ruled in favor of the taxpayers. DOR filed an appeal with the district court which affirmed the BTA’s ruling and this appeal was taken.
A law firm in the state representing clients with similar tax credit claims pending before the BTA filed a motion for leave to file an amicus curiae brief, but the court found that the firm’s motion did not meet the basic requirement of stating specific reasons why the amicus brief would be helpful to or aid the court in deciding the appeal, instead, offering general "experience as a friend of the court" without any indication regarding their aid or any suggestion that counsel and the parties in the case would not present all relevant legal arguments on appeal. The court denied the motion of the law firm to file the amicus brief.
The alternative fuel tax credit statute was enacted in 1991 and amended over the years. The version at issue here is the one effective for 2011 when the taxpayers made their purchase.
The court noted the intent of the alternative fuel tax credit statute was clearly written at the beginning of the statute: "to provide an incentive to persons . . . to invest in qualified clean-burning motor vehicle fuel property[,]" and "any person" who purchases such property "shall be allowed a credit against income tax liability." See La. R.S. 47:6035(A). The court quoted the statute’s definition of "qualified clean-burning motor vehicle fuel property[,]" as "equipment necessary for a motor vehicle to operate on analternative fuel and shall not include equipment necessary for operation of a motor vehicle ongasoline or diesel."
DOR initially interpreted the alternative fuel tax credit statute to include the purchase of FFVs that can be operated on both gasoline and a mixture of gasoline and ethanol, known as E85. In response to a rapid increase in the number of tax return filings claiming the alternative fuel tax credit, DOR issued a declaration of emergency rule on April 30, 2012, "to clarify the existing statute." Attached to the declaration was a list of approved vehicles, including FFVs that operate on E85 fuel, similar to the one purchased by the taxpayers. According to the record, the emergency rule was voided on June 14, 2012, for procedural reasons, prompting the DOR to announce that it would only honor and allow alternative fuel tax credit claims that had been postmarked on or before June 14, 2012, and the taxpayer’s tax credit claim was filed on June 16, 2012, two days past the announced deadline.
Before DOR formally denied the taxpayer’s credit, it promulgated a regulation which provided that if the vehicle had the capability of being propelled by petroleum gasoline or petroleum diesel, the vehicle must have a separate fuel storage and delivery system for the alternative fuel, capable of using only the alternative fuel, limiting the vehicles eligible for the credit. In 2013 the legislature amended the statute expressly disallowing the alternative fuels tax credit for FFVs that are designed to run on alternative fuel and gasoline or diesel if the FFV has only a single fuel storage and delivery system and retains the capability to be propelled by gasoline or diesel. The court recognized that the 2013 statutory amendment was obviously intended to eliminate purchases of FFVs like the taxpayer’s FFV from eligibility for the tax credit, it noted that the change in the law was not effective until January 1, 2014.
The court said that the DOR relied on a regulation that was inconsistent with the pertinent version of the alternative fuel tax credit statute, which did not contain any exclusion for FFVs or require separate, or different, or additional equipment for operation only alternative fuels, as opposed to gasoline and said that an administrative agency's construction of its own regulation cannot be given effect where it is contrary to or inconsistent with the legislative intent of the applicable statute.
The court held that until taxable years beginning January 1, 2014, purchases of FFVs such as the one purchased by the taxpayers were eligible for the alternative fuel tax credit and found that the taxpayers submitted sufficient evidence of their 2011 purchase of a qualified vehicle that contained equipment necessary to operate on an alternative fuel. The court found that the BTA ruling in favor of the taxpayers was legally correct and agreed with the district court's judgment affirming the BTA's decision. Barfield v. Bolotte, Louisiana Court of Appeal, No. 2015 CA 0847. 12/23/15
Corporate Income and Business Tax Decisions
Court Declines to Rule on Jurisdictional Grounds
The Louisiana Court of Appeal, First Circuit, held that it could not hear a corporate and franchise tax case because the trial court's decision lacked the requisite decretal language to render the judgment appealable.
The taxpayers were assessed by the state Department of Revenue (DOR) for corporate income tax and franchise taxes, paid the assessments under protest and filed claims for refund. DOR argued that the taxpayers funneled all taxable net capital profits to a purported parent company located in another state to avoid the state’s franchise tax. The taxpayer argued that the audit was erroneous, in part, because the DOR auditors misapplied costs and values to taxable income based on a misunderstanding of the cash management system employed by the taxpayers’ entities, which included an out-of-state parent company and subsidiaries operating in the state. The district court granted a partial summary judgment in favor of the taxpayers on the issue of "liability" only, and certified that judgment as final for purposes of appeal. DOR appealed that judgment and asserted there were genuine issues of material fact as to whether or not it committed errors in applying state law and assessing the taxes at issue.
Prior to oral argument in this case, the court examined the record and noted the potential jurisdictional defect in the judgment. It issued an interim order to the parties, notifying them to come to oral arguments prepared to argue whether the November 24, 2015 judgment was a valid final judgment due to the lack of decretal language. At oral argument, without conceding that the judgment lacked decretal language, the parties suggested that the court could nonetheless review the matter under its supervisory jurisdiction, by converting the otherwise timely filed appeal to a writ. The parties also asked the court for leave to file a supplemental memorandum addressing the issues, which the court granted. The taxpayers maintain that they raised six issues at the district court, and in their motion for partial summary judgment, they raised all the issues so that a ruling on the motion would conclude all of the liability issues in the matter. They argue that the only issue remaining is a determination of the amount of money that should be refunded, which requires only a simple mathematical calculation, and the judgment in their favor is, therefore, an appealable judgment.
Citing prior case law, the court said that it is well settled that a final judgment must be precise, definite, and certain and must also contain decretal language. Conley v. Plantation Management Company, L.L.C., 2012-1510 (La. App. 1 Cir. 5/6/13), 117 So.3d 542, 546-47, writ denied, 2013-1300 (La. 9/20/13), 123 So.3d 178. Generally, the judgment must name the party for whom the ruling is ordered, the party against whom the ruling is made and the relief that is granted or denied, which must be determinable from the judgment without reference to an extrinsic source. The court said in this matter that although the district court granted the taxpayers’ motion for partial summary judgment on the issue of liability and certified the partial judgment as final, it lacked the requisite decretal language to render it a final appealable judgment. Specifically, the court noted, the judgment did not specify the particular basis for the imposition of the liability and it did not delineate what that relief entails. It also does not order the payment of money, even if in an amount to be later determined. The court noted that the judgment did not specify which of the errors alleged by the taxpayers were made the DOR or how those errors resulted in an erroneous imposition of the taxes. The court found that the lack of precise and certain decretal language specifying the individual and specific bases for the district court's ruling on liability particularly in light of the many components by which the assessments were alleged to be erroneous rendered it impossible for the court to discern the propriety of the district court's ruling.
The court also pointed out that a review of the jurisprudence reveals that the vast majority of the cases in which the appellate courts exercise the discretion to convert an appeal to an application for supervisory writs involve matters where the court lacks jurisdiction because the appeal is of an interlocutory judgment, and not when the non-finality of the judgment is the defect, the court, therefore, declined to exercise discretion to convert the appeal to an application for supervisory writs. Boyd Louisiana Racing Inc. v. Bridges, Louisiana Court of Appeals, Nos. 2015 CA 0393; 2015 CA 0394; 2015 CA 0395. 12/23/15
Property Tax Decisions
Welfare Property Tax Exemption Upheld for Community Center
The California Court of Appeal, Second Appellate District, upheld a welfare property tax exemption for a Jewish community center after finding the State Board of Equalization's (BOE) interpretation of the statute erroneous. The court said that the statute did not require both the owner and operator of the property to file claims and the refund claim was not untimely.
The taxpayer is a 501(c)(3) organization under the Internal Revenue Code and is a state nonprofit public benefit corporation. It owns the property at issue in this matter and the property is operated as a community center. The taxpayer in 2004 leased the property to a third party, which is also a state nonprofit public benefit corporation, and the property continued to be operated as a community center.
During 2005, the lessor initiated the process of applying for an OCC but did not submit the required documents. The County issued tax bills to the taxpayer, which it did not pay and in July, 2008, the taxpayer sold the property and paid the outstanding taxes, penalties and interest. In 2012, the taxpayer obtained an OCC retroactive to 2006 and filed tax refund claims based on the exemption in the statute for property that is owned and used for charitable purposes. In filing the claims for refund, the taxpayer did not check the box indicating that the property “is used for the actual operation of the exempt activity." The county assessor denied these claims solely on the basis that the lessee did not have an OCC, basing this decision on an advisory rule in the Assessor's Handbook (Handbook) in which the BOE interpreted the pertinent statutory provision and advised assessors that both an owner and operator of a property must file claims for welfare exemptions, and that any organization seeking a welfare exemption must file a claim for an OCC. The trial court ruled in favor of the taxpayer and the county appealed.
The court said that the dispositive issue was whether the lessee was required to have an OCC and the county urged the court to defer to BOE’s interpretation and the handbook on the requirements of tax exemptions. Regarding rules of statutory interpretation, the court noted that courts owe no deference to an interpretation that is clearly erroneous, citing Kelly v. Methodist Hospital of So. California (2000) 22 Cal.4th 1108, 1118. The Legislature enacted the statutory provision at issue here to establish the property tax exemption, known as the welfare exemption, for specified charitable entities, and the court noted that for the exemption to apply, the owner and operator need not be the same entity. The provision sets forth various preconditions for the exemption, including that the property must be used for "the actual operation of the exempt activity," which must not "exceed an amount of property reasonably necessary to the accomplishment of the exempt purpose." (§ 214, subd. (a)(3).) The assessor cannot approve ax exemption claim until the claimant has been issued a valid OCC. Tax refunds are available even if a claim for a welfare exemption was not timely filed.
BOE is required to prescribe forms and procedures necessary to administer any property tax exemption and also issues instructions to assessors designed to promote uniformity in the assessment of property. In 2004, the BOE published section 267 of the Handbook regarding, among other things, the welfare exemption which provides in pertinent part that the property will not be exempt unless the owner and the operator meet the specific requirements of exemption provision and each must qualify and file a claim for exemption.
The court also said that even if any of these statutes could be construed as ambiguous, they are still not amenable to BOE’s interpretation. While an owner of private property has a taxable interest, a tenant does not have a taxable possessory interest in the lease of that private property. Thus, with or without a lease, an operator does not have a taxable possessory interest, and only the owner is subject to property tax. The court said that to interpret the statutory scheme as suggested in the Handbook would result in the absurdity of requiring an operator to go through the time and expense of seeking a welfare exemption it does not need. In rejecting the BOE’s interpretation, the court adhered to the principle that a court construing an ambiguous statute must avoid, if it can, an interpretation that would lead to absurd consequences.
The court also rejected the county’s argument that a third party operator must file a claim for and obtain an OCC before an owner will qualify for the exemption and cited the statutory provisions that require the claimant seeking the exemption to file for an OCC. The county also argued that the taxpayer waived its exemption claims because it did not file them in a timely manner, and because it did not check the box on the claim forms indicating that the property "is" used for the actual operation of the exempt activity, but the court also rejected these claims, finding that the trial court presumed that the only issue for it to review was the county assessor's reason for denying the taxpayer’s tax refund claims, i.e., the lessor did not have an OCC. To prevail, the county was required to demonstrate that the trial court's presumption was error, and the court said the county did not meet its burden of proof.
The court noted that the timeliness argument was raised for the first time on appeal, and it was not analyzed in the opening brief, so it is forfeited. Jewish Cmty. Ctrs. Dev. Corp. v. Cnty. of Los Angeles, California Court of Appeals, B261022. 1/5/16
Other Taxes and Procedural Issues
Tax Board Not Entitled to Deference in Inheritance Tax Dispute
The Kentucky Supreme Court held that the Board of Tax Appeals (BTA) was not entitled to deference for its interpretations of tax statutes because it is not tasked with administering the statutes. The court also held that an estate could not take a deduction for inheritance taxes paid by the estate on behalf of beneficiaries of a will.
Decedent died on January 23, 2007 and the bulk of her estate consisted of a transfer-on-death (or TOD) securities account with Smith Barney Investments with a total value of $1,733,417. Such accounts pass outside of probate, with ownership passing directly to the named beneficiaries on the death of the owner. The property in this account, however, remains subject to inheritance taxes as if part of the estate, unless the beneficiary is exempt by statute. This account was transferred to the decedent’s stepdaughter and her nephew, with each taking 50%. The remainder of her property, valued at $240,522, was subject to a will, with the nephew appointed administrator of the estate. The properly deductible costs of administering the will totaled $25,687.03, leaving $214,834.97 in property to be distributed. She made various specific bequests of money and property, real and personal, to individuals and churches, with the remainder as the residuary estate, half of which was to be left to three named individuals and the other half to pass through intestacy to her heirs at law. The decedent intended her estate to pass "tax free" to the beneficiaries, with their inheritance taxes paid instead out of the residuary estate.
The Estate prepared a state inheritance and estate tax return. The return reflects the transfers on death to two of the named beneficiaries, which were taxable events to the extent not exempted by nature of their relationship to the decedent. The transfer to the third was tax exempt because of the relationship to the decedent. The return also reflects the specific bequests in the will, though the specific cash amounts listed are less than their face value in the will, apparently because the Estate believed, based on its view that the tax-exoneration clause should be given effect before the specific bequests, that there would be insufficient cash after payment of costs and taxes to cover the full bequests. The return does not show a residuary estate to pass after payment of taxes because, according to the Estate's calculations, the entire residue will be consumed by costs and taxes. The Estate included the costs of taxes as a debt of the decedent, which reduced the property available in calculating the distributive shares of beneficiaries.
The Department of Revenue conducted an audit of the return and filed an assessment, which was appealed by the Estate. The state Board of Tax Appeals (BTA) reversed the assessment, concluding that the inheritance taxes were properly deducted as a "cost of administration" under the statute because the decedents will "so directed." DOR filed an appeal to the circuit court, which reversed the decision of the BTA, concluding that the Estate could not deduct the taxes as a cost of administering the estate or debt of the decedent, notwithstanding the language in the will. The court also concluded that the will's direction that inheritance taxes be paid out of the residuary estate created additional gifts or "bequests of tax," which are also subject to the inheritance tax. The Court of Appeals affirmed, and this appeal resulted.
Because there were no facts in dispute and the case involves only questions of law, the standard of review is de novo. The Estate argues, however, that the BTA’s interpretation of the statutes in question is entitled to deference under Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). The court noted, however, that the case said that deference to decisions of state administrative agencies is only afforded is the statute is silent or ambiguous with respect to the specific issue addressed. The court said that the statute here is neither silent nor ambiguous. The court also pointed out that deference is given only to an administrative agency’s interpretation of a statute that it administers and the statutes at issue here are not administered by the BTA, whose limited purpose is to determine appeals of tax rulings. These rulings are subject to judicial review and a reviewing court can reverse such a decision if the BTA’s decision is in violation of a statute. The statutes in question are administered by the DOR and, the court said, if any deference is to be given, it is to the DOR’s formal interpretation of a statute that it administers.
The court said that the inheritance taxes to be paid out of the estate could not be deducted from the gross estate as costs, thereby reducing the value of the distributive shares, the primary effect of which would be on the amount of the residuary estate subject to tax. The court said that the state statute controls what may be deducted from the value of the gross estate, and inheritance taxes are not included in the enumerated listing in the statute because the tax is not a debt which has accrued and remains unpaid at death and it not a tax accrued and unpaid, and finally, are not the type of cost of administration contemplated by the deduction statute.
The court next addressed the question of whether a bequest of tax under a tax-exoneration clause is itself a taxable transfer of estate property and the court found that it clearly was.
Ordinarily, inheritance taxes are paid out of the shares received by the beneficiaries or out of their own funds if their gifts consist of specific property, unless the will of the decedent directs otherwise as was done in this case. The court pointed out that when a will directs payment of the inheritance taxes as directed here, the beneficiary also receives the benefit of the tax paid by the estate, even though it does not pass through his or her hands. Because the beneficiary receives the benefit of the tax paid on his or her behalf, the tax paid is itself a taxable transfer of property and is part of the overall bequest. The full value of a bequest is taxable, unless the beneficiary is exempt from tax. The court pointed out that to hold that the property used to pay a bequest of tax is not to be taxed would be to allow part of the full cash value of the estate to avoid taxation, which could potentially be a considerable portion of the estate. The court said that a sub-question of whether a bequest of tax is itself taxable is whether this is a one-time tax calculated on only the initial bequest of tax or an infinite series of tax calculations. In this case, the DOR calculated the tax on the bequested tax for the specific bequests beyond the one step and the documents submitted by the DOR showing how the calculation is to be done show more than one level of tax on tax. The court held that the full cash value of the estate must be accounted for to avoid part of the estate passing tax-free, and allowing only one level of tax on a bequest of tax fails to do this. Instead, the court said the tax must be calculated ad infinitum, but said that this does not mean the tax is limitless, with each "tax on the tax" paid on a beneficiary's behalf growing smaller with each new level.
The court said that DOR acted correctly in denying the inheritance-tax deduction from the gross estate and in calculating a bequest of tax on each specific bequest to the great-nieces and the cemetery, but made other errors in adjusting the return to reflect a gift of the residuary estate. The bequest of tax takes precedence over distribution of any residue, even if it consumes the residue and deprives the residuary beneficiaries of any gift under the residuary clause. The court noted that DOR’s adjustments to the tax return of the distributive shares of the residuary beneficiaries ignored how the will directed the estate to be distributed, and were done incorrectly, but this resulted in an under-calculation of the tax owed. While the amount of additional tax assessed by the DOR did not represent all of the tax owed and was not calculated by the correct method, it was properly assessed because it was owed. Because DOR did not ask for additional taxes that might be owed, the court said it could not make that award. Estate of Mildred L. McVey v. Dep't of Revenue, Kentucky Supreme Court, 2014-SC-000013-DG. 12/17/15
Contingency Fees in Credit Application Assistance Reg Struck Down
The California Superior Court, County of Sacramento, held that a regulation barring tax practitioners from assisting companies in their applications for tax credits on a contingency fee basis exceeded the agency's statutory authority. The court found that the regulation was inconsistent with the statute's goal of encouraging applications for the credit.
In 2013, legislation was enacted establishing a new tax incentive policy known as the "California Competes Tax Credit" program, the purpose of which was to reform and refocus state tax incentives on attracting and retaining jobs in economically distressed areas of the state. The legislature stated that the program will allow businesses to publicly apply for tax credits allowed on the basis of job creation and retention standards. The California Competes Tax Credit Committee (Committee) determines the overall amount of tax credits available for a fiscal year and the California Governor's Office of Business and Economic Development (GO-Biz) is the agency responsible for allocating the credits to taxpayers. The statute provides for the allocation of the credit to taxpayers based on eleven enumerated factors.
GO-Biz adopted regulations to implement the program, including California Code of Regulations, title 10, section 8030, governing the application process for tax credit allocation (Regulation). The Regulation requires applicants for tax credits to provide certain information on the application form, including the name of any "consultant" providing services related to the credit application, the consultant's fee structure and cost of services, and whether payment to the consultant is influenced by whether a credit is awarded.
The Regulation establishes a two-phase review process for credit applications. Phase I of the process is an automated phase in which the amount of tax credit requested, aggregate employee compensation, and aggregate investment provided on the application form is evaluated to determine a "cost-benefit" rate of return. The applicants with the best cost-benefit ratio move forward to Phase II which involves a qualitative evaluation of the applicants, based on eight factors, including the one at issue here that provides that GO-Biz shall evaluate any other information requested in the application, including the reasonableness of the fee arrangement between the applicant and any consultant, attorney, tax practitioner or any other third party that prepared or submitted the application, or provided any services related to the credit. The regulation further states that any contingent fee arrangement must result in a fee that is less than or equal to the product of the number of hours of service provided to the applicant and a reasonable hourly rate for such services.
The petitioner is a global tax advisory and site selection firm, based in Dallas, Texas, but authorized to do business in the state and derives substantial income representing state taxpayers with respect to income tax claims. It assists clients to identify locations for their businesses, analyzing a variety of factors including any applicable tax incentives and aids its clients in pursuing tax incentives. Clients have the option of paying the petitioner on either an hourly or contingency basis and most elect a contingent fee arrangement. Petitioner’s agreements are typically multi-year agreements and are not directed at specific tax credits or incentives in particular locations. The court noted that because the services petitioner provides to its clients are interconnected, span multiple years and locations, and encompass a variety of different tax credits and incentives, including national, state, regional, and municipal, the fees charged by it cannot be isolated on a "per credit" basis. On behalf of its clients, petitioner has submitted applications for the California Competes Tax Credit and GO-Biz has rejected at least one application in which the petitioner served as an advisor.
The court point out that an administrative agency is not limited to the exact provisions of a statute in adopting regulations to enforce its mandate and the legislature may confer upon an administrative agency the power to "fill up the details" of a statutory scheme, citing Knudsen Creamery Co. v. Brock (1951) 37 Cal.2d 485, 492. However, the court noted that an administrative agency may not substitute its judgment for that of the legislature and there is no agency discretion to promulgate a regulation that is inconsistent with the governing statute.
The court cited Samantha C. v. State Dept. of Developmental Services (2010) 185 Cal.App.4th 1462, 1482 for the proposition that the issue is not whether the regulation is wise or sensible, but whether the regulation is reasonably related to a statutory objective.
The petitioner argued that the Regulation exceeds the scope of authority conferred on the agency, is not reasonably necessary to effectuate the purpose of the statute, and is impermissibly vague and says that the Regulation impairs the its ability and that of other site selection/tax advisers to serve clients potentially seeking the California Competes tax credit.
GO-Biz argued that the petitioner lacks standing to challenge the Regulation, and that, even if it has standing, the Regulation is valid. The court held that the petitioner had standing to challenge the Regulation, both because it is beneficially interested in the validity of the Regulation, and because it falls within the "public interest" exception to the standing requirement.
The petitioner argued that because the amount of consultant fees paid by tax credit applicants is not one of the qualifying factors in the statute, the Regulation impermissibly alters the substantive requirements that applicants must meet to qualify for a tax credit. GO-Biz asserted that the challenged Regulation falls within the scope of the eleventh qualifying factor, which authorizes GO-Biz to consider the "extent to which the anticipated benefit to the state exceeds the projected benefit to the taxpayer from the tax credit." GO-Biz contends that regulating consultant fees furthers this purpose by ensuring tax credits are used for job creation and are not unnecessarily diverted to "unreasonable" consultant fees. The court rejected this argument, pointing out that the program offers a tax credit, a offset against a tax liability.
The court said it was not aware of any tax credit programs dictating how the credit itself must be used, pointing out that a credit is not an expenditure of public funds. It said that the fact that a tax credit reduces a taxpayer's liability, and thereby frees up funds that otherwise would be paid to the state as taxes, does not give the state the right to control how the tax "savings" are used. The court further stated that reducing consultant fees does not directly "benefit" the state. The court rejected GO-Biz’s argument that fees paid to a consultant are taxpayer funds that otherwise could be used to increase the taxpayer's investment in the proposed project, finding that the language of the statute does not support such a broad interpretation. The court noted that the statute requires GO-Biz to "negotiate" with the taxpayer the "terms and conditions" of a proposed written agreement, supporting an interpretation that GO-Biz may, through negotiation, attempt to secure a better deal for the State, but it does not empower GO-Biz to reject a proposal merely because GO-Biz finds a consultant's cost of services to be too high. The court said that excluding an applicant because it pays "too much" for consultants is equivalent to excluding an applicant because it pays "too much" rent, pays "too much" interest on loans, or pays "too much" for office supplies. Finally, the court said that even if the statute is construed as allowing GO-Biz to consider whether consultant fee arrangements are reasonable, the court finds the Regulation's de facto ban on contingent fee arrangements to be arbitrary and capricious and not reasonably necessary to carry out the purpose of the statute.
The court also rejected GO-Biz’s argument that the Regulation does not prohibit contingent fee arrangements, but merely limits them to a reasonable hourly rate, finding that limiting contingent fee arrangements to a "reasonable hourly rate" is a de facto ban on contingent fee arrangements. It noted that if the legislature had intended to ban contingent fee arrangements for outside consultants, it easily could have prohibited them in the language of the statute and it did not do so. Ryan U.S. Tax Serv. LLC v. California, California Superior Court, Case Number: 34-2014-00167988. 1/7/16
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].
|
|
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:
January 8, 2016 Edition
NEWS
New Deputy at MTC
The Multistate Tax Commission has announced that Marshall C. Stranburg, currently the executive director of the Florida Department of Revenue, will assume the position of deputy executive director of the MTC effective April 1, 2016. The deputy’s position became vacant when Gregory S. Matson became the executive director, succeeding Joe Huddleston. Marshall Stranburg has a couple of decades of experience in state and local taxes and has participated in various MTC committees and projects for over 20 years. Welcome!
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
.
State Can Collect Nonprofit Donor Information
The U.S. Court of Appeals for the Ninth Circuit vacated preliminary injunctions that prevented the state of California from demanding that two nonprofits provide their IRS Form 990 Schedules B, which disclose names and contributions of certain donors. The court held that the state should not be enjoined from collecting the data, but could be enjoined from publicly disclosing Schedule B information.
The Petitioners, two nonprofit organizations, filed suit against the state’s Attorney General (AG) challenging the AG’s collection of the Internal Revenue Service (IRS)
Form 990 Schedule B, which contains identifying information for the organizations’ major donors. They argued the nonpublic disclosure requirement is unconstitutional as applied to them because it impermissibly burdens First Amendment rights to free speech and association by deterring individuals from financially supporting them. The district court entered preliminary injunctions preventing the AG from demanding the Schedule B forms pending a trial on the merits and the AG filed this appeal.
The state’s Charitable Purposes Act requires the AG to maintain a registry of Charitable Trusts and authorizes the AG to obtain whatever information needed to establish and maintain the registry. An organization must maintain membership in the registry to solicit tax-deductible gifts from the state’s residents and as a condition of membership the AG requires each organization to submit annually the complete IRS Form 990 Schedule B, which lists the names and addresses of persons who have given $5,000 or more to the organization during the preceding year.
The AG argued that these forms are used solely to assist in enforcing charitable organization laws and ensuring that charities in the Registry are not engaging in unfair business practices.
The court noted that the AG’s longstanding policy of treating Schedule B forms as confidential, as well as the proposed regulation formalizing that policy, confirm that the state has no interest in public disclosure of the information contained therein. The court stated that it was bound by their holding in Center for Competitive Politics, 784 F.3d at 1317, that the Attorney General's nonpublic Schedule B disclosure regime is facially constitutional.
In that decision the court rejected the facial challenge to the disclosure requirement because the plaintiff failed to show it placed an actual burden on First Amendment rights, but the court left open the possibility that a future litigant might show reasonable probability that would warrant relief. The plaintiffs are organizations engaged in advocacy some may consider controversial and argued they have made a showing that warrants relief. They contended disclosure to the state will infringe First Amendment rights by deterring donors from associating with and financially supporting them, and therefore that the AG should be enjoined from collecting their Schedule B forms, even for nonpublic use in enforcing the law.
The petitioners also argued that notwithstanding the AG’s voluntary policy against disclosing Schedule B forms to the public, the AG may change the policy or be compelled to release the forms under California law, and that the resulting public disclosure will lead to harassment of their donors by members of the public, chilling protected conduct.
The court found that neither plaintiff had shown anything more than broad allegations or subjective fears that confidential disclosure to the Attorney General will chill participation or result in harassment of its donors by the state or the public. The court held that the district court abused its discretion by enjoining the AG from demanding the plaintiffs' Schedule B forms given the absence of evidence showing confidential disclosure would cause actual harm. It stated that to the extent the district court found actual chilling or a reasonable probability of harassment from confidential disclosure to the Attorney General, those findings were clearly erroneous. With regard to the potential public disclosure of the information on the IRS forms, the court noted that the petitioners raised serious questions as to whether Schedule B forms collected by the state could be available for public inspection under California law, notwithstanding the AG’s good faith policy to the contrary. While it noted that it was not convinced the evidence offered by either petitioner sufficiently established that public disclosure would result in First Amendment harm, the court declined to hold that the district court abused its discretion to the extent it preliminarily enjoined public disclosure pending trial. The court said that it serves the interests of the state by allowing it to resist efforts to compel public disclosure pending formal adoption of a regulation to accomplish the petitioners’ and the state's shared objective of preventing disclosure to the public. It said that because a preliminary injunction would further the state's public policy as well as allay the concerns of the plaintiffs, there was no harm in allowing that aspect of the injunction that serves to prevent public disclosure to remain in effect on a temporary basis. Americans for Prosperity Foundation et al. v. Kamala D. Harris, U.S. Court of Appeals for the Ninth Circuit, No. 15-55446. 12/29/15
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Airplane Use Tax Case Remanded
The Texas Court of Appeals, Third District, remanded an airplane use tax dispute back to the trial court to determine whether the sale of the airplane fell under the occasional sale exemption. The court also directed the lower court to decide whether the taxpayer’s sales tax report was fraudulent or filed with an intent to evade taxes making the statute of limitations provision inapplicable.
The taxpayer purchased an aircraft in April 2003 and neither the taxpayer or the vendor paid any tax on the transaction. More than four years later, in October 2007, the Comptroller of Public Accounts (Comptroller) alleged that he had failed to pay the applicable taxes for the transaction and issued an assessment. The taxpayer challenged the assessment, which was affirmed by the Comptroller. During a hearing for reconsideration the taxpayer argued that the sale of the airplane was exempt from taxation as an occasional sale and that the assessment was barred because it was imposed beyond the four-year statute of limitations. The administrative law judge held for the Comptroller finding that the taxpayer did not meet his burden for proving that the sale qualified as an occasional sale and that the exception to the statute of limitations applied because no return had been file. The taxpayer paid the assessment under protest and filed suit in the district court. The district court granted the Comptroller’s motion for summary judgment and this appeal resulted.
The state statute provides a general four-year statute of limitations for assessing taxes, beginning from the day after the last day on which a payment is required by the provision imposing the tax. This general provision does not apply when no tax report has been filed.
The taxpayer argued that the exception applies only when no report is filed and that if a report is filed, regardless of who filed it, the exception cannot apply. In this case the facts showed that the vendor from whom the taxpayer purchased the aircraft did file a return for the period in question. The court noted that the occasional-sale exception found in the statute provides that the limitations period does not apply and the Comptroller may assess a tax imposed by at any time if no report for the tax has been filed. The Comptroller recognized that the vendor filed a tax return, but contended that the sales-tax report filed by the vendor could not have satisfied the obligation because the transaction was subject to use tax and not sales tax, and the taxpayer was obligated to pay use tax for his acquisition of the airplane because the sale occurred outside of the state and because the taxpayer transported the plane into the state for use. The Comptroller pointed to Rule 3.330 which explains that the statute of limitations does not apply if “the taxpayer fails to file a” return and argued that because the taxpayer did not file a use-tax report, the statute of limitations did not apply. The taxpayer argued that the rule impermissibly broadened the statutory language from “No report for the tax has been filed” to “the taxpayer fails to file a” return.
The court noted that the statutory provision does not expressly state that the filing of a tax report pertaining to the time in which a taxable transaction occurs will prohibit the limitations exception from being applied to an individual who did not file a report and who would otherwise owe taxes because of the transaction and it looked to the other exceptions and language in the tax code for assistance. The court said that in light of those provisions, it seemed reasonable to conclude that the legislature did not intend for the statute of limitations to bar recovery when a report is filed by someone other than the person who allegedly owes the taxes at issue, particularly in the circumstances present in this case where the filed report does not accurately reflect that a taxable transaction occurred. The court also said that in light of the focus that the legislature placed on the obligation of taxpayers to file tax reports and on ensuring the accuracy of a filed report, the no-report exception is properly construed as meaning that the statute of limitations does not apply and the comptroller may assess a tax imposed by this title at any time if the taxpayer does not file a tax report and the Comptroller’s interpretation was reasonable and consistent with the statute.
The court then addressed whether the evidence presented by the parties established that there were no genuine issues of material fact regarding whether the taxpayer was obligated to file a tax report. The statute requires that a person who acquires a taxable item subject to the use tax shall file a use tax report if the person did not pay the tax to the retailer. The Comptroller argued that the transaction occurred out of state and the taxpayer argued that the sale took place in state, subjecting it to the sales tax and making the retailer obligated to file the report.
The court concluded that there was a genuine issue of material fact regarding whether the transaction occurred in Texas or in Alabama and, therefore, whether the taxpayer was obligated to file a use-tax report concerning his purchase of the aircraft. The Comptroller argued that even if the sale took place in the state, the statute of limitations does not apply where the taxpayer files a false or fraudulent report with intent to evade the tax, which the Comptroller urges is the case for the retailer here. The court said it did not need to determine whether this applied here because the Comptroller had failed to carry the burden of establishing that there were no genuine issues of material fact regarding the applicability of the fraud exception, noting that no evidence was presented regarding the retailer’s intent when it filed the report at issue.
The taxpayer also argued that a statutory exemption for occasional sales applied and he was not obligated to pay taxes even if the statute of limitations was tolled. The statute provides that “occasional sale” means the sale of the entire operating assets of a business and the taxpayer argued that the evidence conclusively established that the airplane was the only operating asset of the retailer. The Comptroller argued that the plane was not a qualifying operating asset, citing one of its promulgated rules. The court concluded that there is a fact issue regarding whether the sale of the aircraft qualified as an occasional sale. The fact issues regarding whether the statute of limitations bars the tax assessment at issue and regarding whether the occasional-sales exemption applies resulted in the court’s reversal of the district court's judgment granting summary judgment in favor of the Comptroller on those issues. The matter was remand for further proceedings consistent with this opinion.
Brown v. Hegar, Texas Court of Appeals, Third District, No. 03-14-00492-CV. 12/3/15
MRI Repair Services Subject to Sales Tax
The Louisiana Court of Appeal, First Circuit, found that a company that sold and repaired magnetic resonance imaging (MRI) systems was subject to sales tax from its repair services. It determined that the MRIs that were installed at various medical facilities were not component parts of medical facilities.
The taxpayer sells and leases MRIs to various medical facilities in the state and enters into contracts to service and repair the MRIs that are installed in the medical facilities. The state statute levies a sales tax on sales of services, including the repairs of tangible personal property, including the repair of electrical and mechanical appliances and equipment. At issue here is whether the MRIs are classified as movable or immovable property, i.e., whether the MRIs that the taxpayer services and repairs are component parts of the medical facility in which they are installed.
The court described at length the legislative history of the statutory provisions dealing with movable or immovable property and case law pertinent to those provisions. It also noted that in 2002 the Department of Revenue (DOR) issued Revenue Ruling No. 02-003 (RR 02-003) in which it determined that MRIs house in specifically designed imaging rooms that were wired into the hospital electrical system would meet the requirements of the statute regarding immovable property because they were electrical or other installation and because they could not be removed from the hospital without substantial damage to both the unit and the hospital.
As such, sales tax would not be collectible by the sellers, lessor, and repair dealers on sales and leases of or on repair services rendered to the MRIs. In 2003, DOR issued Private Letter Ruling 03-005 (PLR 03-005) in which the DOR determined that various imaging equipment installed at a medical facility, including MRIs, met the requirements of electrical installations because the installed equipment was hard wired into the medical center's electrical systems and met the test in the statute because the hospital or equipment would be damaged if the imaging equipment were removed. The statute was amended several times after the issuance of the RR and PLR, including in 2008 and 2009. According to the record, prior to 2004, the taxpayer collected sales taxes from its customers on repairs it made to MRIs. In October 2004, it ceased collecting sales taxes on repair services it performed for its customers because a customer, who had a contention with paying the taxes, provided the taxpayer with RR 02-003 and PLR 03-005, described above.
The taxpayer argued here that it did not owe the taxes because the MRIs were immovable, and thus, any repairs to them were not taxable. It further asserted that the DOR had accepted a payment of $103,692.88 made as part of a proposed settlement, and therefore, should be estopped from contesting the remainder of the assessment. The taxpayer also argued that it should not be penalized for its failure to collect the taxes since its failure to do so was the result of its reliance on certain pronouncements of the DOR which stated that no taxes were due on repair services to MRIs.
The doctrine of detrimental reliance, codified in state law, is designed to prevent injustice by barring a party from taking a position contrary to his prior acts, admissions, representations, or silence. To establish detrimental reliance, a party must prove three elements by a preponderance of the evidence: (1) a representation by conduct or word; (2) justifiable reliance; and (3) a change in position to one's detriment because of the reliance. Because estoppels are not favored in law, a party must prove all of the essential elements to succeed.
The taxpayer argued that detrimental reliance should be applied in this case because the law with regard to component parts, particularly during the audit period, was ambiguous given court decisions and the legislative response to them.
The court rejected the taxpayer’s contention that there was unequivocal advice from an unusually authoritative source upon which it could have reasonably relied, noting that between the time of RR 02-003 and PLR 03-005 and the beginning of the audit period, the state supreme court issued a decision relating to this issue, the legislative amended the statute in response to the decision, and DOR issued Tax Topics describing the impact of those changes. The court also pointed out that during the audit period, the legislature amended the pertinent provision of the statute two more times and stated that although the applicable law may have been uncertain, during the time period of the audit, neither RR 02-003, nor PLR 03-005 could have been considered "unequivocal" advice from the DOR. The court said that it was not the taxpayer that requested either PLR 03-005 or PLR 06-010, and, as such, the guidance contained in PLR 03-005 and PLR 06-010 was not applicable to the taxpayer and cannot be considered unequivocal advice from the DOR. Moreover, in PLR 06-010, the DOR determined that the MRIs at issue were tangible personal property, and therefore, subject to taxation. Hitachi Medical Systems America Inc. v. Bridges, Louisiana Court of Appeals, 2015 CA 0658. 12/9/15
Apartment Lessor Owes Sales Tax on Rental Income
The Alaska Supreme Court held that rental income an apartment operator and lessor received for his lease of residential units was subject to sales tax. The court rejected the taxpayer's argument that he had a standing contract with the city exempting him from licensing and sales tax requirements, find that the city never explicitly agreed to the terms.
The taxpayer owns and leases property in the city and a city ordinance required the taxpayer to collect and remit a 6% sales tax, which he failed to do. The city also sought payment of the taxpayer’s delinquent property taxes and utility bills. In addition, the taxpayer had not obtained an annual business license or certificate of authority to conduct business and collect sales taxes after 2007 and the city demanded that he rectify those matters immediately. When he failed to provide an adequate response, the city sent him an estimated assessment, including interest and penalties. Under city ordinance this estimate was final unless the taxpayer documented a lesser liability within 30 days. Instead of providing the requested information, the taxpayer mailed a series of letters challenging the city's authority to collect taxes and require credentials for running a business and defined silence by the city or a rejection not complying with his specific terms as assent by the city. His rejection terms sometimes were creative, including a demand that the city "fulfill" rejection by delivering gold coins to a California address. Ultimately, his estimated assessment became final and the city filed a property lien and then filed suit to foreclose, determine the proper penalties, and obtain injunctive relief during the litigation. In response, the taxpayer admitted his sales tax liability, partially denied liability for his failure to obtain a business license or a certificate for collecting sales tax, acknowledged liability for some unpaid utilities, and agreed to comply with all city ordinances if the court granted a stay to allow him time to negotiate a settlement.
After the lower court entered its memorandum decision finding for the city, the taxpayer moved to compel an acknowledgment that he had satisfied his obligation by tendering a "Security Agreement" as payment for his liability on all claims, obligations, and taxes owed to the city, arguing that the city had forfeited its right to recover against him by failing to agree to the terms in this agreement within 30 days. The superior court denied the taxpayer’s motion. The court later granted full reasonable attorney's fees to the city and entered both a total judgment for nearly $300,000 against the taxpayer and a judgment of foreclosure against his property.
On appeal, the taxpayer contended that the lower court erred by refusing to find his purported contract letters, sent both prior to and after the trial, legally binding on the city, and claimed that he satisfied both his discovery and financial obligations to the city through "offers" conveyed in these letters. He claimed the city had accepted by not responding to or by failing to properly reject the specified terms. The court found that the record and the law are clear that no reasonable person could have understood the city's silence to be an assent, and the city did not intend its silence to be an assent. The court noted that the taxpayer provided no authority that an offeror may unilaterally create conditions for rejecting an offer which, if not met according to the offeror's express terms, would transform the offeree's action into an acceptance. The court said that the taxpayer’s arguments were frivolous. He argued that he had no duty to collect and remit sales taxes during the time periods when he did not hold a certificate of authority to do so, but the court said that failing to comply with the requirement to obtain a certificate to collect and remit sales tax did not eliminate the taxpayer’s duty to comply with the city's sales tax ordinances. Bingham v. City of Dillingham, Alaska Supreme Court, Supreme Court No. S-15706. 12/9/15
Cement Company Engaged in Industrial Processing Activity
The Michigan Court of Appeals held that a custom acid and cement services provider was engaged in an industrial processing activity for use tax exemption purposes finding that the cement used was not permanently affixed to real estate. The court remanded the case to reduce the refund by the percentage of materials used to plug wells, which it said were not exempt.
The taxpayer provides custom acid and cement, as well as pumping services, to oil and gas well companies throughout the state. It purchases items of tangible personal property, including two types of cement, fly ash, gel, chloride, sugar, water, acid, inhibitors, water, clay stabilizers, antisludging agents, xylene, and methanol, which it then uses to make specialty cements and acids that it transports to and uses in wells. The specialty cement constitutes 50-60% of the price on the taxpayer’s customer invoices. The Department of Revenue (DOR) audited the taxpayer and determined that the industrial processing exemption did not apply to its cement pumping service or the tanks and vehicles the taxpayer uses to store and haul cement and acid. Taxpayer paid the amounts under protest and filed suit in the Court of Claims, arguing that it was eligible for the statutory industrial processing exemption as an industrial processor and as an entity that performed work on behalf of industrial processors. The trial court held for the taxpayer.
The state’s Use Tax Act provides several exemptions from use tax, including the industrial processing exemption, which provides that property sold to an industrial processor for use in industrial processing is exempt from use tax. Industrial processing is defined as 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 or for use in the manufacturing of a product to be ultimately sold at retail. Industrial processing excludes storing raw materials and maintenance of nonprocessing equipment. An industrial processor includes a person who uses tangible personal property to perform an industrial processing activity for or on behalf of an industrial processor, whether or not the person is an industrial processor.
The DOR argues in this appeal that the taxpayer is not engaged in an industrial processing activity and instead provides services for improving real property. The court disagreed with this argument, finding that the taxpayer purchases cement ingredients, as well as other chemicals, to manufacture specialty cement that is custom-blended to meet the needs of each specific customer. These custom-blended cement sales constitute 50-60% of the end cost to its customers. The taxpayer also hauls the cement to the customers' properties and pumps the cement to their desired locations. In essence, the court said, the taxpayer takes objects of tangible personal property, including cement mix and chemical compounds, and processes those compounds into a finished custom cement product for retail sale. It engages in the same transformation and delivery of acid through use of its acid mixers and pumpers. The court concluded that the lower court did not err when it determined that the taxpayer is engaged in an industrial processing activity under the statute. In addition, the court said that because the DOR premised its argument regarding taxpayer’s vehicles on its assertion that the cement is not exempt, the court also rejected that argument. The court also found that the custom cement, pumps, and mixers were ultimately used in industrial processing by an industrial processor.
The court also rejected DOR’s argument that the taxpayer’s products were not exempt because the cement was permanently affixed and becoming a structural part of real estate and, therefore, not entitled to the industrial processing exemption. The court said that to fall within this exception to the exemption, the property must be both permanently affixed to the real property and become a structural part of the real estate. In this case, the court said that the cement was actually annexed to the real estate, but the property owner did not necessarily intend the drilling cement to make the property a permanent accession to the realty. Oil and gas processing takes an extended period of time, and the products must be extracted where they exist -- they cannot be extracted in a facility. Finally, the purpose of the cement around the well is not to improve the land or make it more valuable. It is to assist in the safe production of oil and natural gas. The court concluded that the cement, absent the eventual cement plugs, is not permanently affixed to the real estate. The court also noted that DOR presented no evidence that the cement becomes a structural part of the real estate in this case.
The lower court determined that plugging inactive wells after production had ceased was not an industrial processing activity, but it concluded that this did not affect the amount of the taxpayer’s refund. DOR argued that the lower court should have determined what percentage of the taxpayer’s business was attributable to plugging the finished wells and the court agreed. It said that there was a factual dispute and remanded the matter to resolve the factual issue.
Cent. Michigan Cementing Serv. LLC v. Dep't of Treasury, Michigan Court of Appeals, No. 323405. 12/8/15
Personal Income Tax Decisions
Security Concerns Not Valid Reason to Waive Fee
The Massachusetts Appeals Court held, in a summary decision, that an individual who filed extension forms and estimated tax payments by mail was not entitled to an abatement of a fee assessed for his failure to file electronically. The taxpayer was aware of the requirement to file electronically, and the court rejected his professed concerns of privacy and security as irrelevant because all returns are stored electronically regardless of how they are submitted and noted that the taxpayer had previously submitted electronic payments.
The Appellate Tax Board (Board) granted an abatement of the penalty the Commissioner of Revenue (Commissioner) had imposed on the taxpayer for failure to file a request for an extension and make payment electronically in compliance with the agency’s requirements. The Commissioner filed an appeal. It was undisputed that the taxpayer annually filed requests to extend the due date of his personal income tax return, accompanied by an estimated tax payment as required. Technical information release 04-30 issued by the Commissioner in 2004 requires the estimate to be filed electronically if the amount equals or exceeds $5,000. The taxpayer did not comply for tax year 2005, filing the extension form by mail and making an estimated payment of $5,000 by check. The Commissioner advised the taxpayer of the requirements to file electronically and warned that a penalty would be imposed in the future if he failed to comply. He failed to comply in tax year 2006 and again in 2010 and the penalty was imposed both years. The taxpayer testified at the Board hearing that he had a profound distrust of online data security and as a result, conducted most of his personal and professional financial transactions offline. The board ruled that this constituted "reasonable cause" within the statute that governs penalties for tax filings and abated the penalties.
The court noted that the question of what constitutes "reasonable cause" is a question law and said that the taxpayer failed to establish a basis for his refusal to comply with the statute both before the commissioner and on appeal. The court noted that it was not disputed that the taxpayer was aware of the electronic payment requirement, and it was also clear that he was able to comply with the requirement, as evinced by his compliance during tax year 2007. On this record the court found that Commissioner was not required to consider as reasonable the taxpayer's professed concerns regarding privacy, which were irrelevant because as paper filings are scanned electronically, or the security concerns which were ignored by the taxpayer himself in 2007. Haar v. Comm'r of Revenue, Massachusetts Court of Appeals, 14-P-1725. 12/21/15
Corporate Income and Business Tax Decisions
Refund Limitation Period Begins Date Taxes Filed
The Commonwealth Court of Pennsylvania held that, based on statutory language, the three-year limitation for the filing of a franchise tax return began to run on the day the taxpayer actually filed its tax return, not on the date the tax was due.
The taxpayer is a calendar-year taxpayer that conducted business for the year ending December 31, 2007 and was subject to Franchise Tax. During the 2007 tax year, the taxpayer remitted quarterly estimated payments to its 2007 franchise tax account and a credit overpayment was also carried forward for the taxpayer’s 2007 tax year. Without having sought an extension, the taxpayer filed its Corporate Tax Report on September 19, 2008, reporting a total tax liability comprised of the franchise tax and corporate income tax. That filing resulted in an overpayment that the taxpayer elected to have transferred to its 2008 tax year. On September 16, 2011, the taxpayer filed a petition for refund of the franchise tax. The Appeals Board dismissed the petition as untimely because it was not filed within three years of April 15, 2008, the due date of the return for tax year 2007.
The taxpayer argued that since the tax to be paid was not known until its annual report was filed, its September 19, 2008 annual report filing established its tax liability and its actual payment of the tax. Thus, that date started the running of the three-year statute of limitations and the September 16, 2011 petition was timely filed within the three years. In deciding the issue, the court said that it needed to interpret the undefined phrase "actual payment of the tax" in Section 3003.1(a) of the Tax Reform Code. Based upon definitions found in dictionaries, the court said that common and approved usage of the phrase "actual payment" means the delivering of money in the acceptance and performance of an obligation, rather than the mere depositing of money on account for potential future use.
The court said that the Tax Reform Code supports such a conclusion, providing that a corporate net income/franchise taxpayer is required to make its "final" tax payment with its annual report. The court found that the legislature made it clear that a corporation's tax liability is not established until the corporation's annual report is filed. Thus, although April 15th is the date upon which taxes are due without interest and/or penalty, the code expressly affords corporate taxpayers the opportunity to make their final tax payments with their annual reports, which are filed after their tax liabilities are known, albeit subject to interest and, perhaps, penalties. The court held that "actual payment of the tax" cannot occur until the annual report is filed. Mission Funding Alpha v. Commonwealth, Pennsylvania Commonwealth Court, No. 313 F.R. 2012. 12/10/15
Multistate Tax Compact Is Not Binding
The California Supreme Court, in a unanimous decision, held that the Multistate Tax Compact constitutes state law and is not a binding reciprocal agreement. The court held that the state legislature had the unilateral authority to eliminate the compact's election provision and did so in 1993 when it adopted a new apportionment formula.
In 1974, the state legislature passed former section 38006 and California joined the Multistate Tax Compact (Compact), which contained an equally weighted three-factor apportionment formula election provision for determining corporate income tax liability. This resulted in no change to the apportionment formula because existing state law at that time used this three-factor formula. In 1993 the state legislature amended the state tax code to provide for a different apportionment formula and mandated that it shall apply notwithstanding the Compact’s apportionment formula. Under this new formula in-state sales were double weighted, amounting to one half of the calculation, rather than one-third under the Compact.
The 1993 legislation did not withdraw the state as a member state or otherwise modify the Compact's election provision or apportionment formula set out in former article III, section 38006.
Taxpayers here paid the state’s corporate income tax calculated under the new formula and subsequently filed a claim for refund arguing that the Compact gave then the right to choose between the UDIPTA formula contained in the Compact and the new legislative formula. The Franchise Tax Board (FTB) denied the claims and they filed an appeal. The trial court sustained the FTB’s action holding that the state legislature could eliminate the election provision in the Compact. The state Court of Appeals reversed the trial court’s decision find that the legislature could not unilaterally repudiate mandatory terms of the Compact.
The FTB contends in this appeal that the new apportionment formula should control, arguing that when member states entered the Compact their intent was to allow them to change their state laws to establish alternate mandatory apportionment formulas. The taxpayers argue that while the legislature has the authority to enact an alternate formula, the Compact explicitly permits an election among the formulas and the legislature is compelled to allow it.
The court noted that the taxpayers recognized that the Compact does not have the force of federal law, as it was never ratified by Congress as required under the compact clause. Instead, the court looked to whether the Compact was a binding contract among its members.
The court cited Northeast Bancorp v. Board of Governors, FRS (1985) 472 U.S. 159 (Northeast Bancorp) which set forth the several indicia of a binding interstate compact: (1) whether the Compact created reciprocal obligations among member states, (2) whether its effectiveness depends on the conduct of other members, (3) whether any provision prohibits unilateral member action, and (4) whether a joint organization or body has been established to regulate the members. The court looked at the application of each of these factors to the facts in this case and determined that they weighed against a finding that the Compact was a binding contract. The court found thatnothing in the language of former section 38006, the circumstances of its enactment, the subsequent conduct of other members states, or the position taken by the Multistate Tax Commission, indicate that the legislature intended to be bound by the taxpayer election provision in the Compact.
The taxpayers also argued that the legislature's amendment was invalid because it violated the reenactment rule in the state constitution, which provides, in pertinent part, that a section of a statute may not be amended unless the section is reenacted as amended. The purpose of this provision is to ensure that legislators are aware of the provisions in proposed legislation and the public can be made aware of changes in the law. The court noted that, generally, the reenactment rule does not apply to statutes that act to amend others only by implication.
The court pointed out that the 1993 amendment replaced the equal-weighted UDITPA apportionment formula with a different formula double counting the sales factor and the amendment expressly referenced the Compact, stating that it applied notwithstanding Section 38006. The court found that reference to the Compact was strong evidence that the legislature acted with the Compact in mind and concluded that the amendment did not violate the reenactment rule.
Finally, the court found that the legislature intended to eliminate the Compact’s election provision when it enacted the 1993 legislation, citing what it called the unambiguous language of the statute that explicitly provided that all business income shall be apportioned to this state by using the formula set forth in the legislation, notwithstanding the language in Section 38006 of the Compact. The court held that there was no credible argument that the legislature intended to retain the Compact's election provision. The Gillette Co. v. Franchise Tax Board, California Supreme Court, S206587. 12/31/15
Property Tax Decisions
Non-Retroactive Law Does Not Apply to Pending Case
The Arizona Court of Appeals, Division One, held that an amendment to a property tax that is not retroactive cannot be applied to a case that was pending at the time of its enactment. The court found that the amendment could not be used to interpret the prior statute because the amendment changed the law.
The taxpayers operate electric generation facilities that use renewable energy equipment. They received a rebate, or reimbursement, in the form of an investment tax credit or cash grants in lieu of tax credits of a percentage of the amount they spent to build their facilities.
For the 2014 tax year the taxpayers reported the cost of their facilities as the cost to build the facilities less the amounts they received as federal tax credits/grants. The Department of Revenue (DOR) added the amount of the federal tax incentives back into the amount the taxpayers reported before applying the valuation formula. Taxpayers filed an appeal to the State Board of Equalization (Board), which upheld DOR’s valuations. While the taxpayer’s appeals of the Board’s decision was pending in the superior court legislation became effective that impacted the valuation of the properties. The amendment to the statute was not retroactive and had no specified effective date and, thus, became effective on July 24, 2014. Taxpayers moved for summary judgment on June 6, 2014, arguing that under the 2008 version of the statute the Department improperly valued their renewable energy equipment by adding back the amounts of cash grants and tax credits to the cost Taxpayers reported. The motion mentioned the amendment to the statute and attempted to use the amended version to interpret the 2008 version. DOR argued thatthe plain language of the 2008 statute supported the its valuation and contended that the 2014 amendment did not apply because the law existing at the time of the valuation year, the 2008 statute, was the law applicable to the taxpayers' valuation appeals. The superior court entered a judgment in favor of the DOR and the taxpayers filed this appeal.
Taxpayers argue the 2014 amendment applies to their tax appeals because the amendment became effective before the taxes in question were assessed, citing Waddell v. 38th St. P'ship, 173 Ariz. 137 (Tax. 1992), to conclude that until a tax has been assessed, any change in law can be applied to that tax year. The court found that the taxpayers' reliance on Waddell was misplaced because in Waddell thelegislature was clear that the amended statute at issue was retroactive to the beginning of a prior tax year. In this case the amendment was not retroactive and the statute provides that the valuation date for property valued by DOR is January 1 of the year preceding the year in which the taxes are levied. Therefore, the valuation method to be utilized by DOR was statutorily mandated to be the method in place on January 1, 2013 unless the legislature specifically provided otherwise.
The taxpayer also argued that the 2014 amendment construed and clarified the applicable 2008 version of the statute. The court noted that there is a general presumption that a statutory amendment changes the existing law rather than clarifies it, but this presumption can be rebutted where amendments enacted shortly after the original version clarify ambiguities in the earlier version. The court said that the 2014 amendments may not be used to construe the 2008 version of the statute because it represents a change in the law, not a clarification, noting that fourteen years elapsed between enactment of the original version and the 2014 amendment. Additionally, the court found that the operative language of the statute, including the 2008 version, did not significantly change between 2000 and the 2014 amendment. The court concluded that the plain language of the statute is clear and unambiguous and declined to insert a different definition of cost where the legislature expressly declined to do so.
The court pointed out that the federal tax incentives providing qualifying facilities with a one-time tax credit or cash grant in the amount of 30% of the renewably energy project's cost were not in effect when the legislature adopted the original version of statutory provision at issue in 2000. The federal tax credits and cash grants the taxpayers obtained in this case were enacted in 2009 as part of the American Recovery and Reinvestment Act. Accordingly, the court said there was no basis to infer the legislature intended to include these federal credits or cash grants, enacted in 2009, as part of the "depreciated cost of equipment" in the prior version of the statute. The court rejected the taxpayers’ argument that adding tax credits or cash grants back to the cost of the equipment contravenes the purpose of the act, finding that this purpose is accomplished without providing rebates for purchasing equipment in the amount of the subject federal tax credits and grants. The court declined to address the taxpayers’ argument that failing to interpret the 2014 amendment as a clarification of earlier versions violates the "Uniformity Clause" of the state Constitution, finding that the claim was clearly speculative. Siete Solar LLC v. Dep't of Revenue, Arizona Court of Appeals, No. 1 CA-CV 15-0126. 12/10/15
Property Tax Challenge Dismissed for Failure to Timely File
The Florida Fourth District Court of Appeal held that a trial court lacked jurisdiction to hear a property owner's claim. The taxpayer argued that the assessor exceeded the statutory cap on annual increases in the assessed value of a homestead, but the court found that the taxpayer had failed to timely file the challenge with the court.
In 1992 voters in the state passed the Save Our Homes (SOH) Amendment, which capped annual increases in the assessed value of a homestead to three percent of the assessment for the prior year or the percent change in the Consumer Price Index, whichever is lower. In 2008, voters approved a separate constitutional amendment that permits a homeowner to transfer the benefit accrued under the SOH Amendment to a new homestead established within two years of abandonment of the prior homestead. The amount of the SOH benefit that can be transferred depends on the value of the new homestead, but the benefit is capped at a maximum of $500,000. Of note for this case, if the just value and assessed value of the former homestead were the same when it was abandoned, there no SOH benefit could be transferred. The SOH benefit depends on the difference between the just value and the assessed value in the year that the homeowner abandons the former homestead and the amendment uses the former homestead's just value as of January 1 of the year in which the homestead is abandoned.
The taxpayer in this matter sold her homestead in January 2012 and for 2012 the just value and assessed value of that homestead were identical. The taxpayer applied for and obtained a homestead exemption for her new home and sought to transfer an SOH benefit to it, but was notified that there was zero portability value because the just value and assessed value for the former homestead were the same for that year. She filed an appeal to circuit court. Taxpayer sold her former homestead in 2012 for $5.1 million, but for the 2012 tax year, the county appraiser assessed a just value of only $2,325,295. The taxpayer argued that her 2012 just value was too low and she was entitled to the maximum $500,000 portability benefit toward the assessed value of her new homestead. The county argued that the action should be dismissed because it was time barred by the statute and she lacked standing to challenge the 2012 assessment of her former property. The lower court denied this motion and this appeal resulted.
The record reflects that the taxpayer did not file an administrative challenge to the 2012 assessment with the value adjustment board and the 2012 assessment was certified for collection on October 10, 2012. The 60-day time for filing a circuit court action challenging an assessment, therefore, expired on or about December 10, 2012. The taxpayer filed her declaratory judgment complaint on October 24, 2013. While this action was timely-filed within 60 days of the 2013 assessment of her new homestead, it was filed well outside the time for challenging the 2012 assessment. The court noted that the state supreme court has strictly construed the state’s jurisdictional statute and bars untimely challenges. In addition, the court pointed out that the statute providing for the transfer of an SOH benefit expressly prohibits any retroactive adjustment of a prior assessment. The court said that the taxpayer’s challenge in this matter is actually to the 2012 assessment and the jurisdiction time limit in the statute cannot be circumvented by including a challenge to a prior year’s assessment in a challenge to the current year’s assessment. The taxpayer’s action seeks to create an SOH benefit after the fact where none existed at the time the former homestead was abandoned, contrary to the purpose of the amendment allowing portability of an SOH benefit and contrary to the strong public policy reflected in the statutory provision requiring finality in tax assessments. The court noted that although the circuit court generally has jurisdiction to consider a declaratory judgment action, it said the action in this case would necessarily involve an untimely and barred challenge or adjustment to the 2012 assessment of the former homestead. The court concluded that the lower court lacked jurisdiction as a matter of law to grant the relief requested in the taxpayer’s action. Nikolits v. Neff, Florida Fourth District Court of Appeal, No. 4D15-2423. 12/9/15
Other Taxes and Procedural Issues
Taxicab Drivers Employees for Unemployment Tax
The Oregon Supreme Court held that a taxicab company owed unemployment insurance taxes on taxicab drivers' wages. The court found that the company had an employer/employee relationship with the drivers because the drivers provided services for the company for remuneration. The court said that the drivers were not independent contractors because they had no separate place of business and only the company could hire drivers.
The state statute provides that an employer must pay unemployment insurance taxes on wages paid for services performed. If the employer can establish that an individual is an independent contractor, as that term is defined in the statute, the employer is not liable for taxes on wages paid to that individual. In the current matter, the state Employment Department (Department) issued an assessment notice to the taxpayer for unemployment insurance taxes on the earning of certain taxicab drivers affiliated with the taxpayer. The taxpayer argued, instead, that it was obligated to perform services for the drivers and the drivers paid the taxpayer for the services received.
Facts presented on the record before the Administrative Law Judge (ALJ) included that to lawfully drive a taxicab within the city, a driver must obtain a taxicab company permit or be associated with a permitted company. While none of the drivers here had a permit, the taxpayer was issued a permit that required it to be capable of fulfilling requests for service from any location within the city, 24/7. To fulfill its service obligations, the taxpayer contracted with individual taxicab drivers, who were required to sign "Driver Agreements" in order to be included on the taxpayer’s list of approved drivers. Those agreements set forth the requirements for each driver, the various vehicle arrangements, and the weekly payment from each driver for the driver agreement fee and vehicle fee. The court accepted the taxpayer’s contention that the drivers provided services for their passengers, but did not accept the argument that the drivers provided those services alone. It pointed out that the relevant statutes do not require that services provided by a putative employee be provided for the exclusive benefit of an employer, and many employees provide services that benefit both the recipients of the services and those who employ them.
The taxpayer further argued that the drivers here were different, however, because they drove only when they chose to do so and not out of any legal obligation to it. While the "Driver Agreements" did not explicitly require the drivers to provide driving services for the taxpayer, the court said that the agreements were premised on an assumption that the drivers would do so. The taxicabs that the drivers operated, whether driver-owned or leased, were marked with the taxpayer’s colors and name, and all drivers, including those who owned their own vehicles, were required to pay substantial fees which were due whether or not the drivers performed any driving services during that period. Therefore, the court said that the drivers could not fulfill their financial obligations to the taxpayer without driving for it for a significant number of hours and the reality of the parties' agreement, therefore, was that the drivers would "perform" driving "services" for the taxpayer within the meaning of the statute.
The court rejected the taxpayers argument that its arrangement with its drivers was a provider/purchaser relationship, distinguishing the facts in the matter from the facts in precedent cited by the taxpayer, Golden Shear Barber Shop v. Morgan, 258 Or 105, 481 P2d 624 (1971). The court said that while the taxpayer here provided certain administrative services and the driver paid fees for those services, the exchange of services for fees was not the only way in which the parties benefitted from their contractual relationship. The "Driver Agreements" enabled the taxpayer to fulfill its obligations to the city and other public entities, and they enabled the drivers to drive taxicabs within the city. In addition, the court noted that the taxpayer did not submit evidence that the fees charged bore a direct relationship to the value of the services actually used by each driver. Finally, the court rejected the taxpayer’s argument that because the passengers, and not the taxpayer, paid the drivers for their services, the drivers did not provide services for the taxpayer for remuneration, noting that the relevant statute does not impose that requirement and the court has declined to read that requirement into the statute. The court concluded that the ALJ did not commit legal error in concluding that the taxpayer employed the drivers.
The taxpayer argued that even if it had an employment relationship with the drivers, they were independent contractors and it was not liable for the unemployment insurance taxes.
The state statute defines the term independent contractor and provides four criteria in making that determination. The ALJ concluded that the taxpayer’s drivers were not independent contractors because the taxpayer failed to demonstrate three of the four criteria: that the drivers were free from the taxpayer’s direction and control, that the drivers were customarily engaged in an independently established business, that the drivers were responsible for obtaining other licenses or certificates necessary to provide the services. The court here noted that the Court of Appeals affirmed the decision, but focused solely on the taxpayer’s failure to demonstrate the requirement that the drivers were customarily engaged in an independently established business. The statute provides that a person is engaged in an independently established business if any three of five requirements set forth are met.
The court here focused on whether the uncontested facts demonstrated that the drivers maintained business locations separate from the taxpayer and had the authority to hire and fire other persons to provide or assist in providing the services. The court rejected the taxpayer’s argument that the drivers maintained separate business locations because the operator’s work location was their vehicle, finding that the taxpayer’s business was located not only at its administrative offices, but also in the field, where its taxicabs were operating. Thus, the court said that even if the drivers' businesses were located in their taxicabs, those vehicles were not separate from the business or work location of the taxpayer. Finally, the court said that the question of whether the drivers had authority to hire other persons to "provide or to assist in providing" the driving services that the drivers provided to the taxpayer was directly addressed by a provision of the "Driver Agreements" that precluded persons other than approved drivers who had themselves entered into "Driver Agreements" from driving vehicles on the taxpayers approved vehicle list. The court said that the authority to hire individuals to perform services other than driving services was not the kind of authority to which the statutory definition applies. Broadway Cab LLC v. Emp't Dep't, Oregon Supreme Court, SC S062715. 12/10/15
Lower Court Overstepped Authority in Unemployment Tax Case
The South Carolina Supreme Court reversed a court of appeals decision which had reversed an Administrative Law Court’s (ALC) determination that a limited liability company's workers were employees for unemployment tax purposes. The court found that if the appeals court had applied the correct standard of review, it would have been constrained to affirm the administrative law court's ruling.
The court noted that judicial appellate review of the ALC's decision is confined to the record, and the appellate court may reverse the ALC's decision if it finds it to be clearly erroneous in view of the reliable, probative, and substantial evidence on the whole record.
The court said that in determining whether the ALC's decision meets this evidentiary standard, an appellate court "need only find, considering the record as a whole, evidence from which reasonable minds could reach the same conclusion that the ALC reached," citing ESA Servs., LLC v. S.C. Dep't of Revenue, 392 S.C. 11, 24, 707 S.E.2d 431, 438 (Ct. App. 2011).
It held that had the Court of Appeals applied the proper standard of review, it would have been constrained to affirm the ALC's order and reversed the Court of Appeals decision.
Rest Assured LLC v. Dep't of Emp't and Workforce, South Carolina Supreme Court, Memorandum Opinion No. 2015-MO-072; Appellate Case No. 2014-002233. 12/9/15
Tax Credit Scheme Does Not Violate Dormant Commerce Clause
The Utah Supreme Court held that a sales tax credit for cable companies that paid franchise fees for the use of local infrastructure did not violate the dormant commerce clause. The court said that there was no commerce clause violation because whether a cable TV or satellite TV provider qualified for the credit was not based on the company's geographic location. The court also said the credit survived rational basis scrutiny under the uniform operation of laws clause.
In the state pay-tv programming is delivered by cable and satellite providers. Cable
providers employ a network of wires run underground or on utility poles and this necessary infrastructure requires substantial in the local economy. And subjects them to franchise fees for the use of public rights-of-way. Satellite providers, on the other hand, avoid many of these infrastructure costs by delivering TV programming directly to subscribers. Under the satellite TV business model, satellite providers pay expenses associated with building, launching, and maintaining orbital satellites, and, as a result, are not subject to franchise taxes.
Further, under the Telecommunications Act of 1996, satellite providers are exempted from taxes or fees imposed by any local taxing jurisdiction, but not those imposed by a state.
In 2004 the state legislature enacted a 6.25 percent excise sales tax for all pay-TV service and in 2008 adopted a tax credit against the sales tax for up to 50 percent of the franchise fees paid by pay-TV providers to counties and municipalities within the state. This provision also required the service providers to pass the value of this tax credit through to its customers, resulting in lower subscription costs. Because satellite providers pay no local franchise fees, they are ineligible for the tax credit. Thus, while both cable and satellite subscribers pay the same excise sales tax, cable providers alone pay franchise fees and thus qualify for the tax credit.
Two satellite providers challenged the tax credit and filed this complaint, alleging that the credit violates the Commerce and Equal Protection Clauses of the U.S. Constitution.
They alleged that the tax credit violates the dormant Commerce Clause by facially granting a preference based on geographic ties to the site, imposing a discriminatory effect on interstate commerce, and being motivated by an intent to discriminate against satellite providers who do not have an extensive local footprint. And they averred that the tax credit violates the Equal Protection Clause of the U.S. Constitution and the Uniform Operation of Laws Clause of the Utah Constitution because it advances no valid state interest.
In addressing the dormant commerce clause issue the court noted that the U.S. Supreme Court has articulated two levels of dormant Commerce Clause scrutiny. First is a "strict" level of scrutiny triggered by laws that directly discriminate against interstate commerce and the second is a law whose effect on interstate commerce is merely “incidental” and triggers a balancing test. A law subject to strict scrutiny survives only it is serves a legitimate local purpose that could not be served by nondiscriminatory means. With the “incidental” level, the balancing test under Pike v. Bruce Church, Inc., 397 U.S. 137, 142 (1970) invalidates state laws affecting interstate commerce only if the law's burdens on commerce outweigh its "putative local benefits," a bar that is relatively low. The petitioners in this matter argued that the sales tax credit fails strict scrutiny because the statute makes it clear that the tax credit is available only to those service providers that perform a specific economic activity in the state and the credit is dependent on the payment of franchise fees “within the state.” The satellite providers claimed a discriminatory effect in the tax credit's impact of shifting the competitive balance in the pay-TV market in a way that benefits local economic interests at the expense of non-local interests. The satellite providers also alleged a discriminatory purpose, asserting that the cable providers drafted the tax credit provision and urged the state to distinguish between cable and satellite TV on the basis that cable provides substantially more economic benefits to the state and its residents than satellite TV. They argued that because the legislature adopted this provision essentially as drafted by the cable providers, the legislature adopted the discriminatory purpose of the statute.
The court found that the satellite providers failed to identify an element of discrimination in the sales tax credit that triggered strict scrutiny under the line of dormant commerce cases at issue. The court noted that the cases in which the Supreme Court has invoked strict dormant commerce scrutiny have involved favoritism for entities or business operations within a particular state, and attendant discrimination against entities or business operations outside the state. The court said that the Supreme Court has emphasized that the dormant Commerce Clause is not implicated by mere discrimination based on "differences between the nature of [two] businesses," and not on the "location of their activities." Amerada Hess Corp. v. Dir., Div. of Taxation, 490 U.S. 66, 78 (1989). The court pointed out that the Supreme Court has never held that the dormant Commerce Clause is concerned with discrimination based on the relative local "footprint" associated with a particular business activity.
The court cited Exxon Corp. v. Governor of Md., 437 U.S. 117 (1978); Minnesota v. Clover Leaf Creamery Co., 449 U.S. 456 (1981); Amerada Hess, 490 U.S. at 66¶ 29 for the proposition that the Supreme Court has affirmed the prerogative of state and local governments to treat different business models differently. The court in this matter rejected the taxpayers’ argument that a footnote in Lewis v. BT Inv. Managers, Inc., 447 U.S. 27, 42 n.9 (1980) meant that discrimination based on differences in the relative economic footprint of competing business models is sufficient to trigger dormant commerce strict scrutiny, finding instead that the reference to “discrimination based on the extent of local operations” was not a freewheeling expansion of the strict dormant commerce scrutiny. The court found that the satellite providers failed to state a claim under the dormant Commerce Clause and said specifically that the tax credit does not discriminate in favor of companies or activities with a unique geographic connection to the state. It said that the larger economic footprint that the cable companies have does not make them “in-state” businesses under the Commerce Clause, nor are satellite companies “out-of-state” businesses in the context of the discussion. The court, therefore, disposed of the case at this threshold level without delving into more detailed analysis of the satellite providers' theories of dormant commerce discrimination.
The court said that the franchise fee sales tax credit may marginally change the market structure of the pay-TV market in the state by weakening the satellite providers relative to their cable competitors and that may cause some business to shift from one interstate supplier to another. But, the court said, that is insufficient to trigger strict dormant commerce scrutiny.
The tax credit provides no benefits to business entities based in Utah at the expense of those that are not. Instead, it discriminates solely on the basis of a difference in business models.
The state constitution requires that all laws of a general nature have uniform operation and the taxpayers argued that the sales tax credit violated this provision. The court found that the satellite providers’ claim failed the standard rational basis test. DIRECTV v. State Tax Comm'n, Utah Supreme Court, No. 20130742. 12/14/15
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected]. |
|
