State Tax Highlights

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].

The full archive of State Tax Highlights is available below.  To read the most recent issue, click here.

 


 

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:
 
December 11, 2015 Edition

NEWS

 
Cert Filed in Michigan Compact/ Retroactive Law Cases
 
The Michigan Supreme Court is being asked by taxpayers involved in the Multistate Tax Compact apportionment litigation to review analysis by the court of appeals in a series of cases over the past decade upholding retroactive tax laws enacted after court decisions have gone against the state. Gillette Commercial Operations N. Am. & Subsidiaries v. Dep't of Treasury is appealing the court of appeals' September 29 opinion rejecting the constitutional arguments made by taxpayers in 50 consolidated cases challenging the state's retroactive repeal of the compact in 2014 to avoid paying $1.1 billion in refunds to out-of-state businesses after the supreme court held in International Business Machines Corp. v. Dep't of Treasury that the compact election was available to taxpayers for years 2008 through 2010.  See prior issues of State Tax Highlights for a discussion of IBM and Gillette.
 
Airbnb Update
 
Airbnb recently announced that it would begin collecting and remitting state hotel taxes on behalf of its hosts in Illinois.  It originally piloted a state program in Chicago that it expects to generate $2.5 million in revenue for the city by February 2016 according to the announcement issued by the company.
 
Happy Holidays!
 
State Tax Highlights is taking a Holiday.  The next issue of STH would normally be issued on December 25th, but we will be busy opening presents and drinking eggnog so please don’t open your office emails on that day expecting to be regaled with exciting court decisions.  The next issue will come out on January 8, 2016 and will catch you up on all the newsworthy events.   Happy New Year to all of you!
 
 
 
 

U.S. SUPREME COURT UPDATE

 
Cert Denied
 
Chabot v. United States, U.S. Supreme Court Docket No. 15-503.  Petition for certiorari denied on November 30, 2015.  Issue:  U.S. Court of Appeals for the Third Circuit decision
that upheld the enforcement of IRS summonses for their foreign bank account records.  The taxpayers had asserted their Fifth Amendment privilege against self-incrimination in response to the summonses.  The Circuit Court ruled that the required records exception to the Fifth Amendment privilege applied.
 
Cert Filed
 
Sierra Pac. Power Co. v. Nevada Dep't of Revenue, U.S. Supreme Court Docket No. 15-25.  Petition for Certiorari filed 7/2/15.  Issue:  Did the Nevada Supreme Court err in denying NV Energy a refund of millions in taxes paid under a lawful tax with an exemption that facially discriminates in violation of the dormant Commerce Clause.  The exemption had never been used and the taxpayer admitted that it had suffered no competitive disadvantage.
 
 

FEDERAL CASES OF INTEREST

 
No cases to report.
 

DECISION HIGHLIGHTS

 
Sales and Use Tax Decisions

Railroad Repair Company Must Source Sales to South Dakota
 
The South Dakota Supreme Court held that a railcar repair services provider did not owe use tax on parts it purchased and used in its repair business.  In a consolidated matter, it also held that sales of its services provided to an out-of-state company were sourced to South Dakota because the both the services were provided and the product received in the state.
 
The taxpayer is in the business of servicing railcars for various customers.  Taxpayer’s owner also owns and operates two companies that own and lease railcars to third parties.  The taxpayer services railcars for these two companies and incorporates parts and materials from its inventory.  Taxpayer did not pay use tax on these materials and parts in reliance on written advise by the Department of Revenue (DOR) issued in 1996 that parts and materials used in its modification of railcars were not subject to tax.  DOR noted that this advice letter had been overridden by the court’s decision in Butler Machinery Co. v. South Dakota Department of Revenue, 2002 S.D. 134, 653 N.W.2d 757 and filed an assessment for use tax.  Taxpayer noted an appeal.  Prior to an administrative hearing in this matter, the taxpayer filed suit in federal court seeking a declaration that state’s assessment of use tax violated the 4-R Act. While this suit was dismissed, the court here noted that the taxpayer argued during the federal litigation that it repairs railcars and DOR posited that the taxpayer should, therefore, be estopped from asserting that it modifies those railcars.  Taxpayer also services railcars for other companies, many of whom are located out of state and these transactions were not included in the subject assessment because the taxpayer had been paying the state tax on its service of these railcars.  In 2008 DOR, at the request of the taxpayer, issued written advice on the taxation of its service based on the statute’s sourcing rules.  DOR issued the ruling advising the taxpayer that its services would be sourced to the location where the railcars are delivered by common carrier, but qualified that advice with the statement that it did not apply
to railcars owned or leased by the common carrier railroad or its affiliates.  As a result of this advice, the taxpayer discontinued paying the state’s sales tax on certain transactions and submitted refund claims.  DOR denied the claims related to the servicing of Burlington Northern railcars contending that Burlington took possession of the cars in state since they provided the transportation for the delivery out of state for their own railcars.  The lower court abated the assessment and DOR filed this appeal.
 
The court rejected DOR’s argument that the taxpayer failed to submit evidence in a timely manner and it, therefore, should not have been considered.  The court found that DOR did not
Submit a notice of review of this issue at the circuit court level and, therefore, waived the issue on appeal.  The court also disagreed that the taxpayer was judicially estopped from
asserting that it modifies railcars of the two related companies because judicial estoppel requires that a party's prior inconsistent assertion be judicially adopted and the federal court did not accept the taxpayer’s position and did not hold for the taxpayer in the federal suit.
 
DOR also argued the taxpayer cannot meet its burden to demonstrate that the certificate of assessment contained a mistake of fact or error of law under the statute, saying that the record before the hearing examiner supported the hearing examiner's finding of fact that the taxpayer performed repairs, and the circuit court clearly erred when it entered an independent fact finding that the taxpayer modifies railcars.  The court found that they could not determine from a review of the hearing examiner’s proposed decision whether the hearing examiner made a specific finding that the taxpayers makes repairs versus modifications and, in fact held that the real issue is whether the hearing examiner correctly held that the taxpayer could no longer rely on the 1996 advice letter in light of the subsequent Butler Machinery Co. decision
 
The court said that Butler Machinery Co. did not create a bright-line rule that all parts and materials used for any lease purposes are subject to taxation, but, instead, the case was decided on the nature of the transaction between Butler and its customers. The court said that Butler's lease-agreement relationship with its customers is not akin to the relationship between the taxpayer and its related companies, the hearing examiner erred when it interpreted Butler Machinery Co. to overrule the Department's 1996 Advice Letter to the taxpayer. The court found that the taxpayer’s service to these companies’ railcars was not subject to taxation.
 
With regard to the sourcing of service issue, the state statute provides that a retailer shall source sales and services to the location where the tangible personal property is service is received.  The court said that it was undisputed that the taxpayer provided its repair service to Burlington Northern railcars at the taxpayer’s business location in the state and Burlington Northern took physical possession of its railcars at the taxpayer’s business location in the state.  Thus, the court said, pursuant to the statute the sale is sourced in the state, the business location of the taxpayer.
 
The taxpayer argued that it is immaterial that Burlington Northern took physical possession of the railcars in the state because the taxpayer provided a repair service, not tangible personal property, which puts into play the alternate definition of “receive” in the statute, i.e., “making first use of services.”  The taxpayer argued that Burlington Northern could not make "first use" of the taxpayer’s repair service until Burlington Northern delivered the railcar to the destination listed on the waybill or bill of lading, which was a location outside the state. The taxpayer also argued that federal law prohibits Burlington Northern from putting the railcar to use until it is inspected for safety, which happens at a location outside the state.  The court rejected this argument finding that the plain language of the regulation did not support the taxpayer’s argument, saying that the rule uses the word “or” and provides alternate meanings.  The court found that it could not be disputed that Burlington Northern took possession of the serviced railcar at the taxpayer’s location in the state.  Midwest Railcar Repair Inc. v. Dep't of Revenue, South Dakota Supreme Court, 2015 S.D. 92; 27265.  11/24/15
 
 
Personal Income Tax Decisions
 
No cases to report
 
 
Corporate Income and Business Tax Decisions
 
Communication Equipment and Services Are Taxable
 
The Pennsylvania Supreme Court, Middle District, held that Verizon's phone installation, directory assistance services, and non-recurring charges for installation or line changes are subject to the state's gross receipts tax.  The court said that under Pennsylvania precedent the term "telephone messages transmitted" in the statute has been applied broadly.
 
At issue in this case is the taxability under the state gross receipts tax of the taxpayer’s gross receipts from the installation of private phone lines, the provision of directory assistance services and certain non-recurring charges levied on customers for the installation and repair of telephone lines.
 
The state gross receipts tax was originally enacted in 1866 and applied only to the gross annual receipts of railroad, canal and transportation companies incorporated in the state which did not pay income tax.  Through the years the scope of the tax was broadened and now includes the gross receipts of all telephone companies doing business in the state and was imposed on receipts received from telephone messages transmitted in interstate commerce, where such messages originate or terminate in this State and the charges for such messages are billed to a service address in this State.  Excluded from these gross receipts are sales of telecommunications services to interconnect with providers of mobile telecommunications services.
 
Taxpayer is a telecommunications provider operating in the state and DOR filed a gross receipts assessment against it for failure to include certain charges in it gross receipts return for tax year 2004.  The taxpayer filed an appeal arguing that the charges included did not constitute gross receipts from telephone messages pursuant to the statute. The lower court, in reaching its determination, examined two single judge decisions from the Dauphin County Court of Common Pleas, Commonwealth v. Bell Telephone Company, 12 Pa. D. & C. 617 (Dauphin County 1929) ("Bell I"), Commonwealth v. Bell Telephone Company, 14 Pa. D. & C. 675 (Dauphin County 1930) ("Bell II"), and a prior decision from this court, Commonwealth v. Bell Telephone Company, 34 A.2d 531 (Pa. 1943) ("Bell III") which, respectively, interpreted and applied the relevant language of the gross receipts tax as it existed in 1889, 1925 and 1941.  In Bell III the court was asked to interpret, for the first time, the meaning of "telephone messages transmitted," the phrase introduced in the 1929 statute.
In the current appeal the taxpayer argued that the court’s Bell III decision was erroneous and the court should not adhere to the doctrine of stare decisis. Instead, it urged the court to reconsider that decision and refuse to apply its holding to resolve the question of whether revenue it derives from the services and equipment at issue in the appeal is subject to the gross receipts tax, contending that the court should reinterpret the words (telephone messages transmitted” in light of their plain meaning.
 
The taxpayer argued that the plain meaning of "telephone messages transmitted" limits the application of the gross receipts tax to only completed phone calls which take place entirely within the state, and, thus, the tax should be assessed only on a per-message basis, saying this interpretation is supported by the fact that, when the legislature extended the tax in 2003, it specified a required origin and billing address for interstate telephone messages in order to make them taxable.  It further argued that, when the legislature has intended that a tax be calculated on telecommunications services other than on a per-message basis, it has plainly said so in the taxing statute.  DOR argued that the lower court correctly looked to the court’s decision in Bell III as governing the question of whether the equipment and services at issue in this appeal were subject to the gross receipts tax.  DOR argued that, because the legislature did not alter this controlling statutory language after the decision in Bell III, even though it amended the gross receipts tax statute repeatedly since the time of that decision, this establishes that the court’s interpretation is in accord with the legislature’s intent as to the proper meaning of this phrase, noting that the legislature is free to correct any error that it perceives in the court’s interpretation of its intentions. DOR also argued that the 2003 amendments to the statute had any effect on the court’s interpretation in Bell III since those amendments merely expanded the scope of the tax to include interstate commerce, but did not change the operative language, "telephone messages transmitted,” which remained the same.
 
The court said that its interpretation of “telephone messages transmitted” in Bell III is long-standing, and has not been altered by any subsequent decision of the court, and the court noted that in the over 70 years which have passed since that decision, the legislature amended the gross receipts tax statute containing this language 28 times, but it did not at any time change the language specifying the method of imposing the tax on telephone companies such as the taxpayer.  The court pointed to a fundamental tenet of statutory interpretation, that whenever the court has interpreted the language of a statute, and the legislature subsequently amends or reenacts that statute without changing that language, it must be presumed that the legislature intends that the court's interpretation become part of the subsequent legislative enactment.
 
The court cited its language in Bell III that "telephone messages transmitted" includes any item of equipment, and any service, which renders the transmission of telephone messages more effective, or makes telephone communication more satisfactory.  The court rejected the taxpayer’s argument that Bell III should be overruled, finding that the rule of stare decisis compels the court's close adherence to its prior decisions construing statutory language.
The court then turned to the question whether the monies the taxpayer takes in from its customers for the specific equipment and services at issue are taxable under the Bell III standard.  The court noted that Bell III made clear that the question of whether a telephone company's revenues from charges to its customers for providing lines are subject to taxation does not depend on how the telephone company chooses to bill its customers for the lines.
The court said the private lines at issue here are exclusively for the use of the customers who purchase them, and they allow those customers to directly, securely, and continuously transmit telephone messages between specific endpoints, with enhanced telephone communications capabilities beyond those afforded by the public telephone network, rendering the process of telephone communication more effective and satisfactory for its customers. With regard to the fixed directory assistance fee, the court concluded that receipts the taxpayer took in from the sales of its directory assistance service were subject to the gross receipts tax because the service makes the process of telephone communication more satisfactory to the customers who pay fees to the taxpayer to use them.
 
The court agreed with the Commonwealth’s argument that the lower court erred in determining that the charges for installation and line charges were not subject to the tax, again relying on the decision in Bell III.  The court agreed that when a customer pays the taxpayer a one-time fee for its installation of telephone lines, this makes his or her ability to transmit telephone messages more effective, since, absent those lines, the making and receiving of telephone calls is impossible. Likewise, when a customer pays for repair service for telephone lines, this also has the result of making telephone service more effective, since the customer would not pay for such repairs unless he or she was experiencing difficulty transmitting messages through the telephone lines. The court also concluded that payments made by customers for moves of and changes to telephone lines and services also meet the requirements for taxability under Bell III. If a customer chooses to pay for a move of his or her telephone line, or pays to change his or her telephone service, the customer is doing so because the current location of the line, or the nature of his or her current service, is displeasing. Movement of the customer's lines, or alteration of the customer's phone service to better suit the customer's needs and wishes, makes the customer's use of the telephone service more satisfactory, much like the installation of a telephone line in the first instance.  Verizon Pa. Inc. v. Commonwealth, Pennsylvania Supreme Court, No. 70 MAP 2013; No. 74 MAP 2013.  11/18/15
 
Financial Services Group, Ski Resort Not Unitary Group
 
The Vermont Supreme Court, in a case of first impression in the state on combined unitary reporting, held that a financial services provider was not in a unitary group with a ski resort that was a wholly owned subsidiary.  The court found that there was no centralized management, functional integration, or economies of scale between the companies.
 
The taxpayer is a multinational corporation, owning approximately 700 subsidiary corporations worldwide, with operating segments of general insurance, life insurance and retirement services, financial services, and asset management.  The ski resort is wholly owned by the taxpayer, and has its principal place of business in the state. While it is primarily a ski resort, it also offers year-round accommodations and summer attractions.
At issue is taxpayer’s corporate income tax for the 2006 tax year, the first year for which the state required unitary combined reporting.  When the 2006 return was initially filed the taxpayer included the ski resort in its unitary operations, but in 2009 filed an amended return in which it removed the resort and claimed a refund.  The amended return was denied by the Department of Revenue (DOR) and the taxpayer filed an appeal. The issue here is whether the ski resort is part of a functionally integrated enterprise with the taxpayer such that an apportioned share of the income earned by the taxpayer’s unitary group out of state may be taxed by Vermont.
 
The unitary-business principle provides that a state may impose an apportioned tax on income from a multistate business if the business's operations in the taxing state have a sufficient nexus to the unitary operations outside of the state.  The state adopted unitary combined reporting and the statute and regulations reflect the unitary-business approach.  DOR’s regulations define a unitary business as "one or more related business organizations doing business both within and without the State where there is a unity of ownership, operation and use. . . . [or] interdependence in their functions." Code of Vt. Rules 10-060-040, Unitary Combined Reporting (Reg. § 1.5862(D)), § 6(a).  The regulations provide factors to consider in determining whether an interdependence of functions exists, and further state that the regulations adopt the decisional law of the U.S. Supreme Court.  The court here said that DOR’s regulations follow the factors identified by the Supreme Court and list several circumstances as indicators that there is an interdependence of functions, including operations are in the same line of business, entities have a vertically structured business, strong centralized management, goods or services are exchanged at non-arm's-length prices, cost-savings results from joint or shared activities, and exercise of control.  In this appeal, the court cited a U.S. Supreme Court decision in finding that the taxpayer has the burden of producing clear and cogent evidence that its business is not unitary.  The court concluded that some of the findings the Commissioner of Revenue relied upon in determining that the ski resort was part of the taxpayer’s unitary group were not supported by the evidence in the case.
 
The court found that, although the taxpayer had sole ownership and the ability to direct the resort’s operations because of its power of appointment to the resort’s board and its exclusive role providing financing, the resort was a distinct business operation. The court said that evidence linking the economic realities between the business enterprise in Vermont and the taxpayer’s operations outside the state were lacking and there was no interdependence of functions or use amounting to an exchange of value accruing to the taxpayer across state lines. The court found that the taxpayer met its burden of demonstrating that the resort was not unitary with the rest of its operations given that there were no economies of scale realized by the entities' operations, the resort’s business was not functionally integrated with the taxpayer’s business, and the taxpayer did not actually direct the resort’s policy or operations.
 
DOR also argued that unitary operations should be assumed here because the taxpayer included the resort in its unitary combined reporting returns for tax year 2006 for each of the fifteen states that use unitary combined reporting for corporate tax purposes, contending that in light of this the taxpayer has admitted that its operations are unitary with the resort.  The court distinguished cases cited by DOR in support of this argument, noting that in each of those cases the fact that the entity was included in other states’ reporting as part of the unitary group was not determinative, but an additional factor showing a unity of operations.
The court acknowledged that an entity's representations in other states can be a factor, but said it cannot create a unitary operation where it does not otherwise exist.  The court found that the taxpayer met its burden of demonstrating that the resort was a discrete entity and not part of the taxpayer’s unitary group. AIG Ins. Mgt. Servs. Inc. v Dep't of Taxes, Vermont Supreme Court, No. 2014-312.
 
 
 
 
 
Court Rejects State's Use of Throw-Out Rule
 
The Superior Court of New Jersey, Appellate Division, found that it was improper for the state to apply the throw-out rule to an intangible holding company's receipts that were constitutionally subject to taxes in other states, even though the receipts were not actually taxed.
 
At issue here is the application of the “Throw-Out Rule,” codified in the state statute, for tax years 2002 through 2004.  This rule relates to the allocation factor used by the Department of Revenue (DOR) for purposes of determining what portion of the income of a corporation, having regular places of business inside and outside of the state, is subject to taxation under the state’s corporation tax statute.  Without application of this rule the sales portion of the formula is calculated by dividing the taxpayer's state receipts by total receipts of the corporate taxpayer. The effect of throwing out receipts from the denominator is that the sales fraction always increases, causing the apportionment formula and the taxpayer's tax liability for state  tax to increase.
 
In the present matter, the taxpayer is a wholly-owned subsidiary of a corporation organized in Delaware and it owned, managed and licensed certain intellectual property, and received royalty payments, from the parent for its use.  It had no offices, employees or bank accounts in the state.  DOR assessed the taxpayer for tax years 1999 through 2004, a period for which the taxpayer admitted that no state tax returns had been filed.  The assessment applied the Throw-Out Rule and removed substantial receipts from the denominator in computing the tax due.  The taxpayer appealed arguing that the removed receipts had no connection to the state and that it was subject to taxation on its business activities in other states.  During the appeal of the assessment, the state enacted a tax amnesty program and the taxpayer filed returns for the years at issue here and entered into a stipulation of partial settlement of the assessment.  This stipulation limited the issues to amounts in the assessment arising from the application of the Throw-Out Rule and any interest and penalties due on those amounts.  In its motion for summary judgment the taxpayer stated that the taxpayer has no physical presence or employees outside of North Carolina and detailed the states for which it filed tax returns for 2002 through 2004.  The statement further provided that under the licensing agreement, the parent paid royalties to taxpayer for the use of its intangible property based on the parent’s sales in all fifty states, the District of Columbia and other possessions of the United States.
DOR stated, in response, that the assertions regarding payment of taxes in other states was unsupported by actual tax returns and that a copy of the licensing agreement was not included in the motion record.  The lower court concluded the motion record was adequate, the Throw-Out Rule did not apply and granted the taxpayer’s partial summary judgment. The court also ordered the DOR to audit the taxpayer’s filed returns to determine whether any additional tax payments were due.  The court noted another case that ruled on the constitutionality of the Throw-Out Rule specifically and said that the rule operates constitutionally when the category of receipts that may be thrown out are not taxed by another state because the taxpayer does not have the requisite constitutional contacts with the state or because of congressional action.  That decision further said that the rule does not operate in a situation where the receipts are not taxed in another state because that states chooses not to impose an income tax.  The court said that under Lanco the state has the authority to tax a trademark holding company with no physical presence in the state but where the taxpayer has the requisite contacts with a state to authorize taxation, receipts from that state cannot be removed from the denominator of the receipts fraction under the Throw-Out Rule. The court agreed with the lower court’s ruling that whether or not the other states actually collected a tax from the taxpayer does not control the inquiry, but, rather, it is the ability to tax, not actual taxation, which determines if the Throw-Out Rule applies.  Lorillard Licensing Co. LLC v. Div. of Taxation, Superior Court of New Jersey, Appellate Division, Docket No. A-2033-13T1.  12/4/15
 
 
Property Tax Decisions
 
Casino's Valuation Properly Based on Purchase Price
 
The Kansas Court of Appeals held that the Court of Tax Appeals did not err in valuing a casino based on the purchase price the casino's parent company paid for the land.  It rejected the taxpayer's agricultural land comparable sales argument and the county's argument that additional costs should have been considered.
 
The taxpayer is contesting the appraised value of a 195.5-acre tract of land in the state used for casino operations. The taxpayer’s parent company was awarded the management contract by the state for one of the legislatively mandated state casinos on October 19, 2010 and it exercised its option for two tracts of adjoining agricultural property comprising the subject property on March 2 and 3, 2011. The Court of Tax Appeals (COTA) appraised the value of the land at the actual price the taxpayer’s parent company paid for the land and the taxpayer argued that the land should have been valued based on the sales of agricultural property in the surrounding area.  The county cross-appealed, arguing COTA erred in declining to include various additional costs as part of its valuation. The taxpayer argued that COTA improperly valued the property because the land would never be worth $86,605 per acre without the management contract, essentially asserting that it paid an inflated price for the property due to the unique circumstances of the management contract.  According to the taxpayer, the value attributable to the management contract should be subtracted from the property value for the purposes of ad valorem taxation.
 
The taxpayer and the county agreed that the cost approach was the appropriate method for valuing the property, and the central tenet of this approach is the principle of substitution.  An informed buyer will pay no more for a property than the cost to acquire a similar site and construct improvements of like desirability and utility.  An appraiser estimates market value under the cost approach by (1) estimating the value of the land, (2) estimating the replacement cost of the improvements, (3) subtracting depreciation as necessary, and (4) adding the land and improvement values together.  The taxpayer in this appeal challenges only the land value component of this analysis.  Under state law, real property is appraised at its fair market value, which is based on the property “highest and best use.”  Highest and best use analysis is performed assuming the property is vacant and four criteria are used in making this determination:   (1) physical possibility; (2) legal permissibility; (3) financial feasibility; and (4) maximum productivity. The parties did not dispute that operating a casino on the property was physically possible, financially feasible, and maximally productive, and the court said that the critical issue was whether it would have been legally permissible to operate a casino on the property assuming the property were vacant.  The court rejected the taxpayer’s argument that it must remove the value of the management contract from the land value, finding that operating a casino on the property would be legal is the land were vacant because on the valuation date the taxpayer held the management contract for the south central gaming zone, one of four zones in the state, meaning it was the only entity legally capable of operating a casino on that date.  It said in the highest and best use analysis, all actual market facts must stay the same, only the property at issue is assumed to be vacant.
 
With the highest and best use of the property established as a casino, COTA ultimately determined the land value of the property and determined under this unique situation that the actual sales price for the property was the best evidence of its fair market value.  The court found that this determination complied with state law.  The court also rejected the taxpayer’s argument that COTA erred in failing to exclude value attributable to the management contract erred in including the option payment on tract as part of the value of the property, did not err in its determination that the taxpayer did not purchase the property under undue compulsion, and did not err when it determined the property contained no excess land.
 
In its cross-appeal, the county argued COTA undervalued the property, asserting that it should have included certain costs in the value.  The court disagree, finding that the lower court correctly concluded that the taxpayer’s marquee sign was personal property, the rental of trailers, the money spent in organizational, administrative and legal costs, and the financing costs were not soft costs subject to taxation.  Matter of the Equalization Appeal of Kansas Star Casino LLC, Kansas Court of Appeals, No. 111,650.  11/20/15
 
Exemption for Non-Profit Housing Company Upheld
 
The Texas Court of Appeals, Fourteenth District, held that a non-profit, single room occupancy facility that provided housing for low-income individuals was entitled to a charitable property tax exemption.  The court found that the totality of the taxpayer's programs and services were provided at no cost.
 
The taxpayer is a subsidiary of a state non-profit corporation exempt from federal income taxation under section 501(c)(3) of the Internal Revenue Code, and organized exclusively for charitable and educational purposes. The property at issue is an apartment building classified as a single room occupancy facility. All residents of the property are low-income individuals, most of whom are homeless, disabled, or have special needs. In order to qualify for housing, an applicant must demonstrate that his or her annual gross income does not exceed the limits set by the Department of Housing and Urban Development and demonstrate sufficient income to pay rent. In addition to significantly reduced, or free, rent, residents are provided assistance with securing employment, managing finances, education assistance, social programs, nutritional information, health screenings and counseling.  The county appraisal district denied the taxpayer’s application for exemption from the property tax for years 2008 through 2011 and the taxpayer filed an appeal.  The lower court granted the county’s motion for summary judgment and this appeal followed.
 
The court noted that the standard of review when both parties move for summary judgment, requires the court to review the summary-judgment evidence presented by both sides to determine the questions presented, and render the judgment the trial court should have rendered.  The taxpayer argued that it was entitled to an exemption from the property tax pursuant to the statute that provides an exemption, in pertinent part, for a charitable organization organized exclusively for providing support or relief to the impoverished, or victims of natural disaster without regard to the beneficiaries' ability to pay. The county did not contest that the taxpayer provided support to the impoverished, but contended that it did not provide those services without regard to the beneficiaries’ ability to pay.  The court found that a review of the types of residents served by the taxpayer, as well as their gross annual income required the conclusion that the taxpayer established it serves the impoverished.  The record also reflected that the rents charged are substantially below-market rental rates due to large contributions which eliminated debt for the construction and operation of the apartments and do not fund all of the resident services provided. As a result, taxpayer operates at a loss on an annual basis and its expenses are subsidized. The court said that when taken as a whole for the tax years at issue here, i.e. below-market rent, costs of resident services programs and debt-free construction, 65-75% of the taxpayer’s costs are charitable.
 
The court rejected the county’s argument that a requirement that tenants have incomes greater than 1.5 times the rental amount equates to the taxpayer’s consideration of the tenants’ "ability to pay," which runs contrary to the statutory provision, finding that the ultimate consideration should turn on the totality of the services provided at or below cost by the taxpayer.  The court said that the facts demonstrate that the taxpayer provides housing and other services to low-income individuals, and concluded that ensuring that tenants have a minimum income does not change the fact that the taxpayer provides support to the impoverished "without regard to the beneficiaries' ability to pay."  The taxpayer also argued that under a plain reading of the statute, the words "without regard to the beneficiaries' ability to pay” modifies only “victims of natural disaster” and not “impoverished,” and pointed to another portion of the exemption section that provided the exemption for a charitable organization where it is “providing support without regard to the beneficiaries’ ability to pay to (a) elderly persons,…(b) the handicapped…”  The court rejected the county’s argument that the words “without regard to the beneficiaries’ ability to pay” also modifies “impoverished,” finding that had the legislature intended this result, it could have written the section as it did in the provision relating to the elderly and handicapped.  The court concluded that the taxpayer is entitled to the exemption from the property tax.  NHH-Canal St. Apts. Inc. v Harris Cty. Appraisal Dist., Texas Court of Appeals, No. 14-14-00251-CV.  11/19/15
 
Court Dismisses Principal Residence Exemption Claim
 
The Michigan Court of Appeals held that the lower court properly dismissed a taxpayer's claim for a principal residence exemption.  The taxpayer failed to present evidence of non-receipt of the notice of hearing and failed to pay the filing fees when filing the motion for reconsideration before the lower court.
 
At issue is the taxpayer’s request for a principal residence exemption (PRE) that was initially denied and the taxpayer filed an appeal. The matter was set for hearing on June 5, 2014, and the certified record indicates that a notice of hearing was sent to the taxpayer on April 14, 2014. When the taxpayer did not appear at the hearing, the lower court entered an order of dismissal.  Although the taxpayer filed a signed motion for reconsideration of the order of dismissal arguing that he had not received the scheduling notice, he did not pay the filing fee for his motion and did not request a waiver of suspension of fees.  As a result, the lower court took no action on the motion and he filed this appeal.
 
The court here said that under these circumstances, it consider the issue unpreserved, and unpreserved issues are reviewed for plain error affecting substantial rights.  The court noted that the certified record indicated that the April 14, 2014, notice of hearing was mailed or e-mailed to petitioner on that date, and cited Goodyear Tire & Rubber Co v. City of Roseville, 468 Mich 947; 664 NW2d 751 (2003), which said that while a presumption arises that a letter with a proper address and postage will, when placed in the mail, be delivered by the postal service, this presumption can be rebutted with evidence that the letter was not received. It is then a question of fact regarding whether the letter was received.  The taxpayer in this case attempted to present his evidence of non-receipt, his signed motion for reconsideration, without paying the proper filing fee. Accordingly, the lower court said no evidence was properly presented to the tribunal regarding non-receipt.  The taxpayer argued that he was deprived of due process because the lower court would not grant a waiver of the fees, but the court here noted that there was nothing in the record that established that a request for waiver was ever made by the taxpayer with regard to the petition at issue.  An affidavit to waive court fees was filed in conjunction with a separate petition relating to a property appraisal, but not in this matter.  Bouis v. City of Lansing, Michigan Court of Appeals, No. 322465.  11/17/15
 
Assessment Grossly Excessive and Discriminatory
 
The Missouri Court of Appeals, Eastern District affirmed a lower court decision that there was sufficient evidence to support a tax commission finding that an auditor's assessment of bank's real property was discriminatory.  The court found that the assessment was so grossly excessive as to be inconsistent with an honest exercise of judgment.
 
 In 2007, the taxpayer received a Change of Assessment Notice for its property regarding for tax year 2007, increasing its valuation and the taxpayer filed an appeal.  The County Board of Equalization (BOE) heard the matter and issued a determination reducing the assessment.  Taxpayer filed an appeal of BOE’s decision with the state tax commission, appealing only the assessment ratio of 32% applied by the Assessor to determine the assessed valuation.
 
One of the bases upon which a taxpayer may appeal a state BOE decision to the STC is discrimination and, upon showing discrimination, a taxpayer has the right to have his assessment reduced to the percentage of that value at which others are taxed.  To accomplish this, the complaining taxpayer must prove the true, or FMV, value of the property as of the taxing date and show an intentional plan of discrimination by the Assessor resulting in an assessment at a greater percentage of value than other property within the same class and the same taxing district.   In the absence of such an intentional plan, the taxpayer must show that the level of assessment is so grossly excessive as to be inconsistent with an honest exercise of judgment.  The state Supreme Court has previously held that the proper method in analyzing discrimination compares the median level of assessment for similarly situated properties to the actual level of assessment imposed on the property at issue.  
 
The county argued that the hearing officer improperly calculated the level of assessment for the property, which lead to an erroneous conclusion of discrimination.  In addition, the county assessor argued that the hearing officer and STC erred in finding discrimination because the disparity between the level of assessment and the median level of assessment for commercial properties in the area was a de minimis error and no so grossly excessive to constitute discrimination.  The court here found that the STC properly determined that the property in question was assessed at 42% of FMV, comparing the tax assessed at the original assessed value and 32% rate to the reduced FMV determined by the hearing officer at the average 29.4 rate for properties in the same area.  In analyzing whether discrimination occurred, the Hearing Officer compared the two assessed value figures, the assessed value originally calculated by the Assessor in 2007 using both the original FMV determination and the original statutory assessment ratio; and the assessed value calculated by the hearing officer using the revised FMV and the average assessment ratio figures. Based on the difference between the two assessed values, the hearing officer calculated that the assessor assessed the property at 42% of its FMV. The hearing officer then compared the two levels of assessment, 29.4% and 42%, respectively, and concluded that the disparity between the two represented more than a de minimus error on the part of the assessor.  The court said that comparing the 32% level of assessment urged by the assessor to the 29.4% median level of assessment for commercial properties in the county results in a disparity between the respective levels of assessment of only 8%, which the assessor claims is de minimus.  The court rejected the assessor’s position saying it was not persuaded that the assessor accurately calculated the valuation differential and that the proposed method of calculation was contrary to well-established legal precedent.  The court noted thatboth parties agreed that neither state courts nor the STC has established a "bright-line" test to identify what constitutes a grossly excessive assessment as opposed to a mere de minimus error in judgment.  The court found that competent and substantial evidence in the record clearly showed that the assessor's assessment of the property, as compared to the median level of assessment for commercial properties in the county in 2007, constituted a disparity so grossly excessive as to be inconsistent with an honest exercise of judgment by the assessor. The court noted that the assessed value determined by the assessor was 43% greater than what the assessed value should have been, and held that such a disparity is so grossly excessive as to be inconsistent with an honest exercise of judgment.  Finally, the court found that STC's findings that the taxpayer was entitled to present the BOE decision as evidence of the FMV of the property for purposes of discrimination and that the BOE valuation evidence could serve as persuasive evidence were lawful and supported by competent and substantial evidence, and, further, that the Hearing Officer and STC acted well within their sound discretion in concluding that the BOE determination was competent and persuasive evidence of the FMV of the property. Zimmerman v. Mid-America Fin. Corp., Missouri Court of Appeals, No. ED102716.  11/24/15
 
Court Upholds Application of Penalties
 
The California Court of Appeal, Second Appellate District denied a taxpayer's request for cancellation of tax penalties totaling approximately $1.6 million citing the statute that provides a taxpayer may not be delinquent as to any tax period in excess of four years in order to seek relief for penalties accrued.
 
The taxpayer acquired title to the properties at issue here in 2011 by foreclosure and had sold some of the parcels of the Property to Kaiser Foundation Health Plan, Inc. (Kaiser), but retained liability for the delinquent taxes and associated penalties on the sold parcels through the date of sale.  In a letter dated June 5, 2012, the taxpayer through counsel sent to the county treasurer and tax collector a request for cancellation of penalties on the 26 parcels for which tax was delinquent beginning in the 2005-2006 tax year.  The taxpayer argued that under § 4985.2(a) cancellation of the penalties was mandatory, notwithstanding use of the permissive “may” where the statutory criteria are satisfied and argued that good cause existed requiring cancellation of the penalties because the taxpayer was composed largely of lenders who were defrauded when they invested in the development of real estate in Los Angeles and their victimization was part of a larger, billion-dollar scheme of fraud by the lender's agent.
By checks dated July 31, 2012, the taxpayer paid the delinquent taxes on the parcels sold to Kaiser, but not on the parcels that were not sold to Kaiser.
 
The taxpayer argued that the trial court erred in its ruling because it should have provided the taxpayer with an opportunity to respond before it considered an issue not raised in the summary judgment motion.  The court said, however, that the record showed that the taxpayer paid the taxes after its letter requesting cancellation of the penalties and the taxpayer did not dispute that fact.  Thus, the court rejected this procedural argument and found, that the taxpayer could not have shown a triable fact issue had this point been raised by the moving party.   The court found that under the plain language of the statute that the tax collector can cancel penalties for reasonable cause and circumstances beyond the taxpayer’s control, if the principal payment of the tax due is made no later than June 30 of the fourth fiscal year following the fiscal year in which the tax became delinquent.  The court noted that prior to the current provision, there was no authority to cancel penalties under equitable circumstances and the current provision added the required findings about the taxpayer and the timeliness of the payment of the delinquent taxes.  Marlton Recovery Partners LLC v. Cty. of Los Angeles, California Court of Appeals, B257400.  11/20/15
 
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:
 
November 27, 2015 Edition
 
 

NEWS

Wynne Update
 
On November 13, 2015, a taxpayer, Michael J. Holzheid, filed a class action complaint in the Maryland Circuit Court for Baltimore City against the Comptroller of Maryland.  The suit alleges that a reduction in the state's tax refund interest rate, which was enacted by the legislature in 2014 and applied retroactively and only to refunds resulting from the Supreme Court’s decision in Wynne, violates the 14th Amendment of the U.S. Constitution resulting in the unlawful taking of a vested property interest for public use, without due process or just compensation.
 
The taxpayer’s complaint argues that by retroactively imposing a reduced interest rate on the Wynne refund that he was entitled to for the 2009 tax year, the interest amount would be reduced from approximately $297.66 to $165.74, resulting in a loss for Mr. Holzheid of $131.92 when the Wynne refund is ultimately issued.
 
 

U.S. SUPREME COURT UPDATE 

No cases to report.
 

FEDERAL CASES OF INTEREST

Documents Are Privileged, Work Product
 
The Second Circuit vacated a lower court decision that refused to quash a summons issued to a taxpayer’s attorney in an IRS investigation of the taxpayer and his companies.  The court held that that attorney-client privilege was not waived when documents were shared with a bank consortium that funded a stock acquisition.  The court found that the parties shared a common legal interest in the tax treatment of a refinancing and corporate restructuring and work product protection applied.
 
 
 
The taxpayer’s company is an automotive and industrial parts supplier incorporated in Germany.  The taxpayer, a resident of Dallas, Texas, is an 80% owner of the ultimate parent of the company. This appeal arises from an attempt by the company to acquire a minority interest in a German company, Continental AG, through a tender offer for its stock. Because German law prohibits tender offers that seek less than all of a company's shares, a partial offer can be accomplished only by setting an offering price estimated to result in the acquisition of the desired number of shares, and this is the course followed by the company with regard to Continental AG.  To finance the offer, the company executed an eleven billion Euro loan agreement with a consortium of banks.  The offer was made in the months before the stock market collapse and during the acceptance period the shares of stock fell dramatically.  German law prohibited the company from withdrawing its tender offer and more shareholders than expected accepted the offer, combining to threaten the company’s solvency and ability to meet its payment obligations to the consortium.  The result was an urgent need to restructure and refinance the acquisition debt.  The company retained two companies to advise on the federal tax implications of the transaction and possible future litigation with the IRS.
 
As anticipated by the company, the IRS began an audit that led to the issuance of the summons at issue in this appeal. The summons sought "all documents created by Ernst & Young, including but not limited to legal opinions, analysis and appraisals, that were provided to parties outside [appellants], that relate to [the restructuring]." Appellants produced several thousand documents in response to the information document request from the IRS but sought to quash the demand for legal opinions.  The lower court denied the petition to quash, holding
the appellants had waived their attorney-client privilege by sharing the withheld documents with the Consortium and holding that the documents were not protected under the work-product doctrine.
 
On appeal, the court noted that the IRS summons seeks only those documents prepared by EY "that were provided to parties outside the Schaeffler Group” and because there was no evidence that any of the documents were disclosed beyond the Consortium, the court said it needed to determine the effect of disclosure to the Consortium.  Citing United States v. Mejia, 655 F.3d 126, 132 (2d Cir. 2011), the court said a party that shares otherwise privileged communications with an outsider is deemed to waive the privilege by disabling itself from claiming that the communications were intended to be confidential and that the purpose of the communications must be solely for the obtaining or providing of legal advice.  The court noted that communications that are made for purposes of evaluating the commercial wisdom of various options as well as in getting or giving legal advice are not protected.  The court cited the “common interest rule” where multiple clients share a common interest about a legal matter even if they are not parties in ongoing litigation.  The rule serves to protect the confidentiality of communications from one party to the attorney for another party where a joint defense effort or strategy has been decided.  The court found that the Consortium's common interest with appellants was of a sufficient legal character to prevent a waiver by the sharing of the communications between the parties.
The court said that once the tender offer was made, the relationship between the parties was altered. Because the tender offer could not be withdrawn under German law, the Consortium and the company were, respectively, locked into the loan and to the offering price. As a result of the oversubscription, the Schaeffler Group faced a threat of insolvency that would in turn cause a default on the Consortium's eleven billion Euros loan. The Group and the Consortium could avoid this mutual financial disaster by cooperating in securing a particular tax treatment of a refinancing and restructuring. Securing that treatment would likely involve a legal encounter with the IRS. Both appellants and the Consortium, therefore, had a strong common interest in the outcome of that legal encounter.
 
The court said the nature and viability of the refinancing and restructuring had a commercial component and tax law component and the documents in question were all directed to the tax issues, a legal problem albeit with commercial consequences.  The court said that the fact that eleven-billion Euros of sunken investment and any additional sums advanced in the refinancing were at stake does not render those legal issues "commercial," and sharing communications relating to those legal issues is not a waiver of the privilege.  The court pointed out that there was no case law in any circuit that compelled the court to hold that the Consortium's interest in appellants' obtaining favorable tax treatment for the refinancing and restructuring transaction is not a sufficient common legal interest.  It held that a financial interest of a party, no matter how large, does not preclude a court from finding a legal interest shared with another party where the legal aspects materially affect the financial interests.
 
The lower court acknowledged that the EY Tax Memo was prepared at a time when appellants believed litigation was highly probably and contained analyses of the strengths, weaknesses, and likely outcomes of potential legal arguments, but the court found that appellants would have sought and received advice created in essentially similar form even if they had not anticipated litigation. On this ground, the court denied work-product protection.
The court here said that neither professional standards, tax laws, nor IRS regulations required that appellants' tax advisors provide the kind of highly detailed, litigation-focused analysis and advice included in the EY Tax Memo. The court said that the standards relied upon by the lower court all target concerns over the "audit lottery," in which aggressive tax advisers might recommend risky tax positions solely because the particular clients were statistically unlikely ever to be audited.  The court said that the implication of the lower court holding that tax analyses and opinions created to assist in large, complex transactions with uncertain tax consequences can never have work-product protection from IRS subpoenas is contrary to case law that explicitly embraces the dual-purpose doctrine.  The court found the memo protected by the work-product doctrine. The court vacated the judgment of the district court and remanded the matter for such further proceedings as may be necessary to determine whether any remaining documents are protected by the attorney-client privilege or work-product doctrine.  Georg F.W. Schaeffler et al. v. United States, U.S. Court of Appeals for the Second Circuit, No. 14-1965-cv.  11/10/15
 
 
 
Court Permits Enforcement of IRS Summonses
 
In the IRS’s transfer pricing audit of Microsoft Corp. (Company) for the 2004-2006 tax years, a U.S. District Court has granted the motion for enforcement of the IRS summons, finding that the company has failed to meet its burden of proof to show that enforcement would result in abuse of the process.
 
The IRS audit, which has been ongoing since 2007, focuses on two cost-sharing arrangements that the Company entered into with its affiliates in Puerto Rico and Asia during the years in question.  The court records show that through October 2014, the IRS examination team conducted fact gathering by issuing over 200 information documents requests (IDRs) to the Company and conducting informal interviews with its employees. In furtherance of its investigation, the IRS issued a designated summons to the Company on October 30, 2014, pursuant to 26 U.S.C. §§ 7602 and 6503(j).
 
The Company’s arguments against enforcement concern the IRS's engagement of the law firm Quinn Emanuel Urquhart & Sullivan, LLP (Quinn), as a private contractor to assist in the IRS's examination of Microsoft's 2004 to 2006 tax years. In May of 2014, The IRS awarded Quinn a contract for "Professional Expert Witness" services, agreeing to pay the firm $2,185,500 for its work investigating the Americas cost sharing arrangement.  The Company asserts that this contract represented the first time that the IRS had engaged private civil litigators in a U.S. income tax audit.  On June 9, 2014, the Treasury Department and the IRS issued, without notice and comment, a temporary regulation providing for third-party contractors like Quinn to participate in the summons process.  The regulation provided that third-party contractors may receive books, papers, records, or other data summoned by the IRS and take testimony of a person who the IRS has summoned as a witness to provide testimony under oath.
 
According to the IRS, Quinn did not begin its performance under the contract until July 15, 2014, over one month after the issuance of the temporary regulation and Quinn representatives subsequently attended Company employee interviews held by the IRS during the weeks of September 22 and October 6, 2014, with their direct participation limited to asking follow-up questions.  The IRS conceded that Quinn reviewed documents and transcripts of the interviews and completed an independent assessment of the positions taken by the IRS and the Company with respect to the Americas cost sharing arrangement.
In order to obtain the court's enforcement of a summons, the IRS must make an initial showing of "good faith" by establishing its compliance with the certain factors set forth in United States v. Powell, 379 U.S. 48, 57-58 (1964) and the court had previously determined   the IRS made this prima facie showing in this case.  Once the IRS makes this initial showing, the burden shifts to the taxpayer to demonstrate that enforcement of summons would result in an abuse of the court's process.  Although the court noted that there is no definitive list of activities that can constitute an abuse of the court's process, Powell offers the examples of summons issued "to harass the taxpayer or to put pressure on him to settle a collateral dispute, or for any other purpose reflecting on the good faith of the particular investigation."
 
The IRS argues that these summonses are being issued to do what Congress authorized it to do, i.e., make an accurate determination of the Company’s tax liability.  The IRS further argued that these summonses are needed to support those numbers with a record that will withstand challenges from the Company.  The court rejected the Company’s arguments of the IRS' bad faith or improper purpose, which included that the IRS deceived the Company into extending the statute of limitations, that enforcing the summonses would allow Quinn contractors to take testimony contrary to 26 U.S.C. § 7602, that enforcing the summons would allow Quinn to impermissibly conduct tax examination functions, and that the hiring of Quinn shows that the IRS was or is improperly preparing for tax court rather than conducting an audit.  The Court found that the Company presented insufficient facts and legal authority to connect its statute of limitations extension claim to the kind of improper purpose or bad faith required to prevent the enforcement of these summonses.
 
The court found that the Company’s characterization of the role of Quinn greatly exceeds what is evident in the record and that it has no factual basis for the assertion that Quinn was or would be engaging in taxation or conducting the audit. Rather, the court said the facts indicate that Quinn will be gathering limited information for the IRS under the direct supervision of the IRS.  The court further found that the record does not contain any direct evidence that the summonses were issued to circumvent the discovery procedures of tax court or that they were issued by or at the behest of Quinn.  The court found that while there was significant evidence that Quinn was hired for its expertise in litigation, there was uncontroverted testimony that these summonses were issued to help the IRS get to the right number in the audit.  The court concluded that the taxpayer had entirely failed to meet its burden of proof necessary to prevent the enforcement of these summonses.  United States v. Microsoft Corp. et al., U.S. District Court for the Western District of Washington, No. 2:15-cv-00102.  11/20/15
 
Tax Evasion, Failure to File Convictions Affirmed
 
In an unpublished per curiam opinion, the Eleventh Circuit affirmed an individual's convictions for tax evasion and failing to file a return.  The court found that the district court didn't abuse its discretion in its evidentiary rulings and didn't err in the jury instructions.
 
The court reviewed the lower court’s decision for abuse of discretion and noted that the harmless error standard is applied to erroneous evidentiary rulings.  An error is harmless unless it had a substantial influence on the case's outcome or leaves a grave doubt as to whether the error affected the outcome.   Jury instructions properly are reviewed by the court de novo to determine whether the given instructions misstated the law or misled the jury to the prejudice of the objecting party.  The court said that it was unpersuaded by the taxpayer’s claim that the lower court abused its discretion in excluding certain testimony and exhibits that allegedly supported the taxpayer’s good-faith belief that she had no duty to pay income taxes or file returns.   The court said that even if the lower court erred by excluding this evidence, that error would have been harmless because the court permitted the taxpayer to testify, in great detail, about her beliefs on income taxes, based on specific cases that she had read.  The court also admitted a seven-page statement of her beliefs into evidence. The court also noted that the taxpayer chose to testify at trial, so any statements that the jury disbelieved could be considered as substantive evidence of her guilt, especially when the element to be proven was willfulness.
 
The court found that because the jury did not believe the taxpayer’s testimony, the admission of the exhibits at issue and of her testimony about the substance of several of those exhibits would not have had a substantial influence on the case's outcome. Accordingly, the error, if any, was harmless. The court also rejected the taxpayer’s argument that the lower court erred when it instructed the jury on reasonable doubt by equating reasonable doubt to proof that jurors would rely on in the most important of their own affairs, citing cases where the court has upheld similar jury instructions.  The court found that the lower court did not misstate the law or mislead the jury to the prejudice of the taxpayer by giving the Eleventh Circuit Pattern Jury Instruction, in which proof beyond a reasonable doubt was equated to that which a juror would be willing to rely and act upon without hesitation in their important affairs.  United States v. Nova A. Montgomery, U.S. Court of Appeals for the Eleventh Circuit, No. 15-10370.  11/5/15
 
 
 
DECISION HIGHLIGHTS
 
Sales and Use Tax Decisions
 
Aircraft Lease Was a Bona Fide Purchase for the Resale Exemption
 
The Tennessee Court of Appeals held that an aircraft purchased by a Delaware limited liability company that was leased to an in-state company with the same owner qualified for the sale for resale exemption.  The court found the lease was a bona fide purchase under the statute and not a tax avoidance scheme, and rejected the Department of Revenue's (DOR) economic substance claim.
 
In January 2004, Robert Klee and Charles Ingram founded Hometown Quotes, LLC (Hometown), an insurance shopping portal that provided insurance price quotes to consumers and sold consumer information to insurance carriers. They each had a 50% ownership interest in the company and shared equal control of all business decisions.  Eventually, Mr. Klee, who took flying lessons, decided to purchase an aircraft to assist in business travel and for use in personal travel.  After his partner made it clear he would not approve the purchase by the business, Klee worked with a consulting firm to make the purchase.  Acting on the advice of the consultants, he formed a Delaware limited liability company, Niuklee, LCC (Niuklee) where he was the 98% owner and chairman and his spouse was the remaining owner, and the purpose of the LLC was to purchase and hold title to the aircraft and to lease it to Hometown and Klee.  Niuklee purchased an aircraft and entered into lease agreements with Hometown and Klee and in December 2008, traded that aircraft for another from the same company and provided the seller with a blanket certificate of resale to claim the exclusion from the sales tax.  After completing its purchase, Niuklee entered into new lease agreements with Hometown and Klee. Under the terms of its lease with Hometown, Niuklee agreed to lease the aircraft to Hometown for business use at a rate of $80 per flight hour, and Hometown agreed to be responsible for all operating costs of the aircraft. Under the terms of its lease with Klee, Niuklee agreed to lease the aircraft to Klee for noncommercial transportation at a rate of $183 per flight hour, less the cost of fuel. Niuklee did not lease the plane to any parties other than Hometown and Klee.
 
In early 2009, Hometown's business declined and so did its need to use the plane. As a result, Niuklee struggled financially, and Klee, his partner in Hometown, and Hometown frequently transferred money into its bank accounts to cover its expenses. According to its flight logs, Hometown and Klee began using the aircraft in December 2008. Niuklee's annual rental calculations reflect that between 2009 and 2011, Niuklee leased the aircraft to Hometown for approximately 377 flight hours and to Klee for approximately 15. During that three-year period, Niuklee collected and remitted $2,286 to the Department in sales tax on its income from the leases.  In March 2012, Niuklee sold the aircraft for approximately $485,000.
 
On June 9, 2010, DOR issued a notice of assessment seeking payment of $28,080, plus interest, from Niuklee for its failure to pay use tax in the state. The company argued that the sale-for-resale exemption applied and that it was therefore not required to pay use tax on the cost of the aircraft.  DOR upheld its tax assessment based on the finding of its auditor that Niuklee and Hometown were owned and operated by the same persons. DOR concluded that the lease transactions between the two entities were part of a scheme to avoid paying sales and use taxes on the purchase price of the airplane.  The company appealed this decision asserting that it purchased the aircraft with the intent to resell, and following a trial the lower court held for the taxpayer.
 
The state statute defines retail sale as any sale for any purpose other than for resale, with the intention to avoid multiple taxation of the same property as it passes from producer to wholesaler to distributor to retailer.  In 2008 the state legislature amended the statute to include the definition of “resale” as a “subsequent, bona fide sale of the property, services
or taxable item by the purchaser." Tenn. Code Ann. § 67-6-102(75)(A).  At the heart of the dispute in this case is the “bona fide sale” language in that definition.  On appeal, DOR argued that Niuklee’s agreements to lease the airplane to Hometown and Klee do not meet the “bona fide sale” requirement of the sale for resale requirement because one of the primary objects of the leases was to avoid tax liability and the leases were not objectively reasonable because they had no business purpose or economic substance.  DOR argued that the company existed solely as a vehicle for Klee and his business to use the aircraft without paying taxes on its acquisition.  DOR said that the trial court should have disregarded its separate legal status.
The taxpayer argued that Klee's consideration of tax consequences is immaterial to the question of whether the leases were bona fide because the decision to form Niuklee to purchase and lease the aircraft was commercially reasonable and otherwise motivated by legitimate business concerns. The taxpayer cited the Tennessee Supreme Court's statement in CAO Holdings, Inc. v. Trost, 333 S.W.3d 73 (Tenn. 2010) that "the courts should heed Judge Learned Hand's observation that ‚[a]ny one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes.'"
 
The court turned to the rules of statutory construction and found that the meaning of the phrase "bona fide sale" was clear and did not require construction. The court said that the term "bona fide," taken literally, means "in good faith, and a "bona fide sale" of tangible personal property consists of the lease or rental of the property in good faith and for valuable consideration.  The court found that the evidence demonstrated that Klee's decision to form Niuklee to purchase and lease the aircraft served a legitimate business purpose other than tax avoidance. Because Klee’s partner in Hometown indicated that he would not grant the approval for purchase by the company, Klee's remaining options were to either purchase the aircraft himself or purchase the aircraft through a separate entity.  Klee testified at the lower court that he was disinclined to purchase the aircraft himself because of concerns about subjecting his wife, a physician, to personal liability, and subjecting himself to liability, and the court here found that the formation of Niuklee provided protection to the spouse because, as a general rule, members of a limited liability company have no personal liability for the debts or obligations of the company.  The court also found that his decision to limit his personal liability was a logical one.  The court said that while Klee admittedly considered the tax consequences of forming Niuklee to purchase and lease the aircraft, the record supports the trial court's finding that his decision to do so served a legitimate business purpose other than tax avoidance.  The court also found that Niuklee's leasing of the aircraft to Hometown and Klee was supported by valuable consideration.
 
The trial court held that the DOR failed to rebut the taxpayer’s expert witness’ testimony as to the reasonableness of the rates charged for the aircraft because its expert used data compiled from suburban Chicago rather than Tennessee and from 2014 rather than 2008 when the leases were entered. The court concluded that because the evidence demonstrated that the leases served a legitimate business purpose and were made for valuable consideration, they satisfied the statute’s definition of bona fide sales.  DOR also argued that the transaction did not satisfy the economic substance doctrine commonly employed by federal courts to disregard, for tax purposes, transaction that comply with the literal terms of the tax code but which lack economic reality.  DOR contended that the leases were not bona fide because Klee never intended to operate Niuklee as a profitable enterprise. The court here rejected DOR’s assertion that the legislature’s addition of bona fide sales language requires it to apply the economic substance doctrine here, finding that the sale for resale exemption's bona fide sale language clearly contemplates an examination of the resale transaction itself, not of the parties engaging in the transaction.  Niuklee LLC v. Dep't of Revenue, Tennessee Court of Appeals, No. M2014-01644-COA-R3-CV.  11/9/15
 
 
 
Personal Income Tax Decisions
 
No cases to report.
 
 
Corporate Income and Business Tax Decisions
 
Credit Application Order Under MBT Clarified
 
The Michigan Court of Appeals held that carryforward and brownfield rehabilitation credits created under the Single Business Tax Act (BTA) but used under the Michigan Business Tax Act (MBT) were credits for MBT purposes.  As such, the credits had to be applied to offset tax after the investment and compensation credits were applied.
 
At issue in this matter was the order in which certain carryforward credits were applied by the Department of Treasury (Treasury) when calculating the taxpayer’s BTA liability.  There are four types of credits at issue, the unused carryforward credit described in § 401 of the BTA, the "brownfield rehabilitation credit" referred to in § 437 of the BTA, the "compensation credit" set forth in § 403(2) of the BTA, and the "investment tax credit" provided for by § 403(3) of the BTA.   The unused carryforward credit and brownfield rehabilitation credit were available under the SBTA and they were carried forward into the BTA. The other credits were created by the BTA.  The BTA statute provides that notwithstanding any other provision in this act, the credits provided in this section (i.e., the compensation credit and investment tax credits) shall be taken before any other credit under this act." (emphasis added)  Despite this language, Treasury developed a form that required taxpayers to take carryforward credits and brownfield rehabilitation credits before taking compensation credits and investment credits. In the current matter, however, the taxpayer did not follow the ordering of the form and it claimed its compensation credits and carryforward credits first and Treasury issued a notice reducing the taxpayer’s claimed refund.
 
The lower court reversed Treasury’s decision, concluding that the statute created a “super” priority for compensation credits and investment tax credits, requiring that they be taken first before all credits that originated under the BTA.  On appeal, the issue was one of statutory interpretation.  Both parties to this matter recognized that compensation credits and investment tax credits must be taken before other credits under the BTA, but they disagreed with regard to what constitutes a credit under the BTA.  Treasury argued that credits under the BTA consist only of credits created by the BTA, meaning that the phrase does not include the brownfield rehabilitation credits and the carryforward credits that originated under the SBTA. The taxpayer argued that the brownfield rehabilitation credits and carryforward credits are credits provided for under the BTA and thus, under the plain language of the statute, the compensation credits and investment tax credits must be taken before the brownfield rehabilitation and carryforward credits.
 
 
The statute at issue is MCL 208.1403(1), which provides, in pertinent part, that notwithstanding any other provision of the act, the credits provided in the section shall be taken before any other credit under the act.  The court found that it was clear that “any other credit under this act” referred to any credit described in a section of the BTA other than the one discussed above.  For a credit to be “under the BTA, the court said that it must be within the group or designation of the BTA and the court concluded that the brownfield rehabilitation credits and carryforward credits constitute other credits under the BTA.
The court said it is clear that these credits are also subject to the ordering provision found in the statute.
 
The court noted that it was true that these credits originated under the SBTA, the SBTA has been repealed and these credits were then governed solely by the BTA.  The court rejected Treasury’s argument that its interpretation of MCL 208.1403(1) should prevail because the Treasury was delegated the discretionary authority to administer the BTA, including the authority to prescribe forms for use in effectuating the BTA, finding that although Treasury has authority to prescribe forms under the BTA, its designation in those forms of the order in which credits should be taken is not subject to rational-basis review because the Legislature expressly set the order of credits in the BTA and did not grant such discretion to the treasury department. The court said that, ultimately, while the treasury department's interpretation of the BTA is entitled to respectful consideration, it is simply not persuasive because it does not comport with the plain language of the statute. Ashley Capital LLC v. Dep't of Treasury, Michigan Court of Appeals, No. 322386.  11/10/15
 
 
Reduction of NOLs Allowed After Statute of Limitations Expired
 
The Oregon Supreme Court held that the Department of Revenue could question the validity of taxpayers' net operating loss deductions incurred in 2004 and carried forward for use in tax year 2006.  The court found that the statute of limitations applies to assessments and notices of deficiencies but not to the reduction of taxpayers' losses.
 
For the 2006 tax year, the taxpayers claimed a deduction based on a net operating loss carryover from their 2004 tax return. The Department of Revenue (DOR) rejected the deduction, contending that taxpayers did not actually have a net operating loss in 2004 that could be applied against their 2006 taxes. The lower court held that DOR could not challenge the 2004 deductions that resulted in the net operating loss carryover because the statute of limitations had run on the 2004 tax year.
 
Both the Internal Revenue Code (IRC) and the Oregon state statute provide that a net operating loss (NOL), when a taxpayer has more deductions that gross income for a given year, can be used to offset taxable income in other taxable years, either by being carried forward to a future tax year or carried back to an earlier year.  The net operating loss carryover allows the taxpayer with irregular income to carry a loss from one year to another year that was profitable, assisting in allowing a taxpayer to average out irregular income for tax purposes over time.  In the present case, the taxpayers claimed a number of business deduction on their 2004 tax return which resulted in a net operating loss.  In 2009 DOR commenced an audit of the taxpayers’ 2006 return, culminating in a notice of deficiency for unpaid taxes, and it is undisputed that the notice was issued before the statute of limitations had run on the 2006 return, but was issued after the 2004 tax year was closed by limitations.  The lower court found for DOR in many areas of the assessment, disallowing many of the claimed deductions because the taxpayers had not adequately documented them.  The lower court, however, ruled against DOR on the issue of the 2004 net operating loss applied to the taxpayers’ 2006 return, finding that the three-year statute of limitations prohibited DOR from contesting any aspect of the 2004 tax return.  DOR had argued that the taxpayers were not entitled to apply the 2004 NOL to their 2006 liability because they had claimed almost $10,000 in deductions in 2004 that they could not substantiate and, therefore would not have had a NOL for that year to be carried over to 2006.  The lower court held that the statute of limitations prohibited DOR from contesting any aspect of the 2004 return.
 
The court held that to challenge the accuracy of the loss that the taxpayers claimed in 2004 as it bears on taxpayers' 2006 tax liability was not to seek to recover a deficiency or to issue a notice of deficiency for the 2004 tax year and said that it is not plausible that the legislature intended to foreclose the DOR from acting after a particular period when the legislature gave DOR no authority to act within that period.  The court said that by attempting to carry over their 2004 net operating loss to apply against their 2006 tax liability, taxpayers put the validity of their 2004 net operating loss at issue. Because DOR was not trying to assess additional taxes due for 2004, the statute of limitations did not apply. The court remanded the matter to the Tax Court to consider the evidence.  Hillenga v. Dep't of Revenue, Oregon Supreme Court, SC S062603.  11/13/15
 
 
Property Tax Decisions
 
No cases to report.
 
Other Taxes and Procedural Issues
 
Town's Fire Protection Charge a Fee, Not a Tax
 
The Wisconsin Court of Appeals determined that a town's annual fire protection fee imposed on all property owned in the town was a fee and not a tax because the primary purpose of the charge is to cover the expense of providing fire protection services within its geographic boundaries.
 
A town in the state imposes an annual charge on all property owners within the town for the cost of fire protection, including Clark County as the owner of a medical center within the town.  The town filed for declaratory relief to compel the county to pay the fee and the lower court granted summary judgment in its favor.  The county argued that the charge under the ordinance is a tax rather than a fee and the county is exempt from general taxes.  Even if the charge is a fee, the county argued, the statute only authorizes fees for fire protection services actually provided to a property owner.  It is undisputed that the town is required by statute to provide fire protection to properties located within it geographic boundaries.  The town joined with other municipalities to form a fire district to provide fire protection to the municipalities including the town. The fire district does not levy property taxes to fund its operations, and is, instead, primarily funded by the individual municipalities in the fire district. Each municipality contributes an equal share towards the cost of operating the fire district and the funding of its capital needs.  Prior to 2014, the Town funded its annual contribution to the fire district by means of a general tax levy. Properties that were exempt from local taxation did not pay towards the cost of fire protection provided by the fire district.  In September 2013, the town board enacted Ordinance No. 091113, which imposes an annual charge on properties located within the Town for the provision of fire protection according to a written schedule. The written schedule provides a formula for calculating a property's "domestic user equivalent" (DUE) units based upon the property's square footage and its nature of use.
 
The town conceded that if the charge under its ordinance is a tax then, under the state statute, the county is exempt from paying the charge.  Citing City of River Falls v. St. Bridget's Catholic Church of River Falls, 182 Wis. 2d 436, 441-42, 513 N.W.2d 673 (Ct. App. 1994), the court noted the primary purpose of a tax is to obtain revenue for the government, while the primary purpose of a fee is to cover the expense of providing a service or of regulation and supervision of certain activities.  The facts in this matter indicate that expenses and capital needs of the fire district are primarily funded by contributions from each of the municipalities. In 2014, the Town's annual contribution was $24,500. The annual contribution is divided by the total number of DUE units in the funding system to then allocate the cost amongst the property owners.    Money collected from the property owners under this system does not exceed what is put into the fire district.  The court concluded that the town demonstrated that the primary purpose of the charge was to cover the expense of providing the service of fire protection to the properties within its geographic boundaries and, therefore, the charge is a fee rather than a tax.  The court also held that the town has authority to charge a fee to cover the expense of providing fire protection under the state statute.  The court said the statute is unambiguous as applied here. The town must provide fire protection to itself, and the legislature specifically defines how a town is to provide fire protection, including by joining with another municipality to establish a joint fire department.
 
The court concluded that the charge in this matter is a fee and not a tax and that the state statute authorizes the town to charge property owners a fee, set according to a written schedule established by the town board, for the cost of fire protection provided to their property, and the town provided fire protection to the county's property.  Town of Hoard v. Clark Cty., Wisconsin Court of Appeals, Appeal No. 2015AP678.  11/12/15
 
 
 
 
City Bag Fee Not a Tax Violating Taxpayer's Bill of Rights
 
The Colorado Court of Appeals held that a waste reduction fee imposed by a city in the state requiring grocers to collect a fee for disposable paper bags provided to customers, is not a tax in violation the state's Taxpayer's Bill of Rights because the city intended to use the revenue to fund services related to trash and waste reduction.
 
In 2011 the city adopted an ordinance that prohibited grocers from providing customers with disposable plastic bags and required grocers to charge customers a fee of 20 cents for each disposable paper bag provided.  Grocers were permitted to retain a percentage of each fee, reduced after the first year, to provide educational material, train staff and improve infrastructure to implement the fee.  Remaining fee are remitted to the city and are deposited into a special “Waste Reduction and Recycling Account,” proceeds of which are used for specific projects related to waste reduction.  The fees may not be used to supplant funds appropriated as part of an approved annual budget, nor do any fees revert to the general fund.
 
The Colorado Union of Taxpayers Foundation (Foundation) is a nonprofit organization formed to "educate the public as to the dangers of excessive taxation, regulation, and government spending." In August 2012, the Foundation filed suit alleging that the enactment of the ordinance without first obtaining voter approval violated the Taxpayer Bill of Rights (TABOR).  The lower court ruled in favor of the city, finding that the Foundation did not establish that the ordinance violated TABOR beyond a reasonable doubt.  On appeal, the Foundation argued that the district court erred in applying the beyond a reasonable doubt standard in this case and argued that the court erred when it ruled that the ordinance created a fee, rather than a tax, and was, therefore, not subject to TABOR.
 
 TABOR limits the state's ability to levy new taxes or create new debts by requiring voter approval of any new tax, tax rate increase, or tax policy change that could cause a net tax revenue gain to any district.  The court noted that the purpose of a tax is to raise revenue to defray the general expenses of government, but a fee is a charge imposed on persons or property for the purpose of defraying the cost of a particular governmental service.  The court pointed out that the primary purpose of the ordinance was to reduce waste and the top priority for the use of funds collected from the waste reduction fee was to provide reusable bags to both residents and visitors. The waste reduction fee provided a direct benefit to those paying the charge by making reusable bags available to them and the payors of the waste reduction fee each received a disposable paper bag for their use.  The ordinance also expressed an intent that the waste reduction fees remitted to the city be used for several other functions reducing the cost to the city of litter cleanup and waste disposal, including education regarding trash and waste management, the funding of programs and the presentation of community events regarding trash and waste management, and outreach through the use of a website to educate the public about these topics.  The court concluded that the city intended the charge to finance a particular class of services related to the reduction of trash and waste and to fund education about those matters.
 
The court noted that, to date, the cost of the services to be funded by the fee has exceeded the amount of fees collected, and there have been no surplus revenues. Thus, the court concluded that the waste reduction fee is raised solely for the purposes outlined in the ordinance and not to defray the costs of general city or state expenses.  The court also determined that the primary purpose of the waste reduction fee was to finance or defray the cost of services to those who are required to pay the charge, rejecting the Foundation’s argument ha o be considered a fee, a service must be utilized only by those who pay a charge or by all those who must pay the charge.  The court said that the fact that a payor of the waste reduction fee may choose not to take advantage of the reusable carryout bags or the education, community outreach, or other trash and waste reduction efforts that the charge funds does not bar its consideration as a fee.The court concluded that the waste reduction fee is a fee and not a tax, that TABOR does not apply to it, and that the Foundation failed to overcome the presumption of validity attached to the ordinance.  Colorado Union of Taxpayers Found. v. City of Aspen, Colorado Court of Appeals, 2015 COA 162; No. 14CA1869.  11/4/15
 
 
False Claims Act Case Dismissed for Ethical Violations
 
A New York Supreme Court judge dismissed a false claims act suit against an investment management company because the former management company attorney bringing the suit disclosed and relied on confidential information he obtained while employed by the company.
 
The relator, David Danon brought this action, alleging that the defendants submitted false claims under New York State Finance Law §§ 187-194 (False Claims Act or FCA),  avoiding the payment of taxes due to federal and state taxing authorities. Mr. Danon stated that he brought this action based on information that he obtained through his employment as in-house counsel at the investment management company as well as his knowledge of federal and New York tax law. The complaint filed by Mr. Danon alleges, among other things, that the company’s formative documents establish illegal tax avoidance, and that it has operated as an illegal tax shelter for 40 years. The complaint further alleged that New York, as well as other states, has been unable to discover the company’s violations of their true income or controlled-party transaction statutes, because it knowingly failed to file required tax returns in New York and other states for decades, and even when it filed returns, it did so on a false and fraudulent basis.  The complaint contained nine causes of action for the violation of various sections of the False Claims Act and also alleged that the company retaliated against Danon by discharging him, and harming his career and ability to obtain employment.
As remedies, Danon, on behalf of himself and New York State, seeks a judgment equal to three times the amount of damages sustained, plus a civil penalty for each act in violation of the False Claims Act, with interest, including the cost to the state for its expenses related to this action. The state opted not to proceed with this action.
 
Mr. Danon is a former employee of the company and is admitted to practice law in New York and Pennsylvania.   He stated that, through his work, he became aware of the company’s alleged wrongdoing, and that he made repeated, but unsuccessful, efforts to end the illegal practices, because they would likely cause substantial injury to the company.   He began assembling whistleblower documentation and ultimately provided them to governmental agencies, including the IRS, the New York Attorney General’s office and the SEC.  He filed this action in May 2013 and was terminated from his employment shortly thereafter.  He retained the whistleblower documents, but indicated that he destroyed any that he deemed unnecessary to substantiate the company’s fraud.  The company argued, among other things, that the lawsuit should be dismissed based on violations of the attorney ethics rules, and that Danon and his counsel should be disqualified from the action because Danon violated his duty of loyalty and confidentiality to the company.
 
The court noted that as a private individual Danon had the right to bring a qui tarn action, and there was no absolute bar to an attorney acting as a relator in a qui tarn action against a former client.  The primary issue on the motion before the court was whether, under the circumstances here, the complaint should be dismissed based on Danon's alleged violation of several ethical rules by bringing this action against the company while employed by it as an attorney, and by supporting his claims against defendants through the use of confidential information that he obtained through that employment.  In support of its argument, the company relied on Rules 1.6, 1.7, and 1.9, pertaining to attorney conduct (22 NYCRR 1200.0) and the court found that the confidentiality provisions of Rule 1.6 and 1.9(c) are central to, and dispositive of, the determination of the issues raised in this motion.  Rule 1.6 provides that a lawyer shall not knowingly reveal confidential information or use that information to the disadvantage of a client or for the advantage of the lawyer unless the client gives informed consent, is impliedly authorized to advance the best interests of the client and is reasonable or customary in the professional community, or, finally, the disclosure of the information is otherwise permitted by the rule.
 
The court cited U.S. v. Quest Diagnostics Inc. (734 F3d 154 [2d Cir 2013]  in which the Second Circuit affirmed the District Court's dismissal of a qui tarn action because the plaintiff entity included an attorney who previously worked for the defendant entity, and relied upon confidential information obtained through that employment.  The company argued that the circumstances in this matter are more offensive to the ethics rules that those in Quest, because the relator there previously worked for the defendant and Danon brought this action while still in company’s employ. The company further argued that Danon appropriated and disclosed confidential information, even though the relevant government agencies could have resolved any alleged improper tax issues without use of that confidential information.
 
The court noted that Mr. Danon’s complaint stated that the action was based on direct information obtained through his employment at defendant’s company as well as his knowledge of federal and New York tax law and the court said that this is reflected in the complaint allegations which are based on information he would not have been privy to, but for his employment status with the company.  The court points out that Mr. Danon's primary argument is that the "crime-fraud" exception permits him to pursue this qui tarn action. Under the exception contained in Rule 1.6 (b)(2), "[a] lawyer may reveal or use confidential information to the extent that the lawyer reasonably believes necessary... to prevent the client from committing a crime."  The court again cited Quest for the proposition that this exception to confidentiality is strictly construed and is applied only when a client is planning to commit a crime in the future or continuing an ongoing criminal scheme and disclosure under this exception is limited to information necessary to prevent the crime.
 
The court said that even assuming arguendo that Danon reasonably believed the company intended to commit a crime based on the alleged tax violations, here, as in Quest, it cannot be said that bringing this qui tarn action through revealing company’s confidential material was reasonably necessary to prevent the it from committing such a crime.  The court noted that Danon had alternate means of preventing the alleged tax violations and, in fact, exercised them approximately three months before bringing this action by providing certain internal Vanguard documents to the IRS, SEC and the New York State Attorney General.  The court also said the extent of the disclosure of the company’s confidential information was broader than reasonably necessary to stop the alleged tax violations and Danon did not attempt to justify the inclusion of this information as necessary to prevent alleged tax violations in the future.  Accordingly, the court found that the qui tarn action must be dismissed based on the violations of Rule 1.6 and Rule 1.9(c).  In light of its holding here, the court determined that it did not need to reach the company’s other arguments.
 
With regard to the wrongful termination complaint, Danon commenced this action in May 2013, and acknowledged that the company informed him in January 2013, that his employment would be terminated.  The court said that neither the complaint, nor the additional submissions, contain any allegations that the company knew in January 2013 that Danon was involved in protected conduct.  The company continued to employ Danon as its attorney until June 2013, and during those months he continued to have unfettered access to the company’s confidential information.
 
The court found that the absence of a date that Danon expressed his concerns as to the company’s tax practices, the lack of restriction to confidential information after he was notified of his termination in January 2013, and the fact that the concerns expressed by Danon were a critical part of his job responsibilities, the retaliation claim failed. The court held that Mr. Danon may not proceed with, nor profit from, any disclosure of confidential information to bring this qui tarn action in violation of New York State attorney ethics rules, nor may Danon or his counsel proceed with any subsequent related qui tarn action.  New York ex rel David Danon v. Vanguard Group Inc., Supreme Court of New York for the County of New York, No. 100711/13.  11/13/15
 
 
 
 
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].
 
STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
November 13, 2015 Edition

NEWS

Airbnb Community Compact
On November 11, 2015, Airbnb released what it captioned as a “Community Compact” in which it pledged to work with local governments on an individual basis to ensure efficient and proper collection of tourist and hotel taxes.  The full text of the compact can be found on the members only legal page of the FTA website,www.taxadmin.org.


 

U.S. SUPREME COURT UPDATE

Cert Denied

DIRECTV Inc. v. Roberts, U.S. Supreme Court Docket No. 14-1524. Petition for Certiorari was denied on November 2, 2015. The Supreme Court declined to review the Tennessee Court of Appeals’ decision that a sales tax exemption for a portion of a cable company’s monthly charge that was not available to satellite company customers, was not a violation of the dormant commerce clause or the equal protection clause of the federal Constitution. The Tennessee court held that the two industries were not substantially similar for tax discrimination purposes. See the March 20, 2015 issue of State Tax Highlights for a more detailed discussion of the Court of Appeals decision.

DIRECTV v. Dep’t of Revenue, U.S. Supreme Court Docket No. 14-1499. Petition for Certiorari was denied on November 2, 2015. The Court declined to review the decision of the Massachusetts Supreme Judicial Court that an excise tax imposed only on satellite television providers did not violate the dormant commerce clause of the U.S. Constitution because cable companies and satellite television providers are not similarly situated for tax comparison purposes. See the March 6, 2015 issue of State Tax Highlights for a more detailed discussion of the Massachusetts decision.

Cleveland Bd of Review v. Hillenmeyer, U.S. Supreme Court Docket No. 15-435. Petition for Certiorari was denied on November 9, 2015. The Court declined to review the decision of the Ohio Supreme Court that the city’s practice of using the games-played method to allocate professional athletes' income from games played in the city was unconstitutional. In the same petition the Board of Review asked the court to review the Ohio Supreme Court decision in Saturday v. Cleveland Bd of Review that held that the city’s effort to tax a professional athlete affiliated with an out-of-state team for income from a game played in the city while he was absent because of injury amounted to unconstitutional extraterritorial taxation. See the May15, 2015 issue of State Tax Highlights for a more detailed discussion of Hillenmeyer case and click here for the Saturday case.

  

FEDERAL CASES OF INTEREST

  
U.S. Sixth Circuit Reverses District Court Following State Court’s Guidance

The U.S. Court of Appeals for the Sixth Circuit reversed a district court decision on whether a lessee may deduct severance taxes before remitting royalty payments to a natural gas producer, as a result of certifying a question of a state law to the Kentucky Supreme Court.

The state levies a severance tax on the gross value of natural resources that are extracted or processed within the state. The issue before the court was whether the taxpayer, a natural gas processor, could deduct the amount of the severance tax is paid, under the state’s “at-the-well” rule, on natural gas extracted under a lease with a third party when it calculated the royalties owned to the third party. An extractor of natural gas incurs post-production costs prior to the sale of the gas at a site apart from the well and because these costs increase the value of the gas at the time it is sold, they are deducted from the final sales price before the calculation of the royalties due to the lessor. The taxpayer here also deducted from the price the amount of the severance tax paid, a practice that was upheld by the lower court.

The court had certified this question of state law to the Kentucky Supreme Court which held that the producer severing and/or processing the natural gas is the entity solely responsible for the payment of the severance tax. That court noted that “severing” is defined as the physical removal of the natural resource from the earth or waters of the state and “processing” including breaking, crushing, cleaning, drying, sizing, or loading or unloading for any purpose. The Kentucky Supreme Court observed that the taxpayer was the only party to the lease engaged in severing and processing the gas. In light of the decision of the Kentucky Supreme Court, the U.S. Court of Appeals reversed the lower court’s ruling and remanded the matter for further proceedings consistent with their decision. Appalachian Land Co. v. EQT Prod. Co., U.S. Court of Appeals for the Sixth Circuit, No. 12-5589. 10/27/15
   

IRS Program Would Hurt CPAs
The U.S. Court of Appeals for the District of Columbia Circuit reversed a district court decision that dismissed a suit filed by the American Institute of Certified Public Accountants (AICPA), a professional association, for lack of standing. The court found that AICPA suit, which challenged the IRS's voluntary annual filing season program for unenrolled tax return preparers, adequately alleged that its members would suffer harm from the program due to an increase in competition.

Under the IRS's filing season program unenrolled return preparers were permitted to take required courses and fulfill other prerequisites to have their names listed in the IRS's federal return preparer directory. AICPA filed this suit, arguing that the IRS exceeded their statutory authority in establishing this program. The suit also alleged that the IRS failed to comply with notice and comment procedures in adopting the program. The lower court dismissed the case, holding that AICPA would suffer no harm from the program, and, therefore, lacked standing. The court described the tax return preparer market as consisting of certified public accountants (CPAs), lawyers, "enrolled agents" and unenrolled preparers. It noted that CPAs and attorneys are subject to state professional licensing regimes, and enrolled agents are licensed by the IRS and subject to various IRS requirements including taking continuing education courses and passing an exam. These three groups are also subject to IRS Circular 230, which includes rules and disciplinary procedures for practice before the IRS.

Unenrolled preparers account for approximately 60% of all tax return preparers. Like all tax return preparers, unenrolled preparers must obtain a "Preparer Tax Identification Number" (PTIN) and list that number on every return they sign, but they have no obligation to take courses or pass an exam.

In 2011, the IRS issued the Registered Tax Return Preparer Rule (Rule), which would have required unenrolled preparers to become registered tax return preparers, complete fifteen hours of continuing education annually, and pass a written examination in order to continue assisting clients with their tax returns. Three unenrolled preparers challenged the IRS’s action arguing that it exceed their statutory authority to regulate the practice of persons before it. The court agreed and permanently enjoined the IRS from enforcing the rule, but later modified its order to clarify that the IRS could choose to retain the testing centers and staff because some preparers might wish to voluntarily take the continuing education and examination, believing that these credentials might distinguish them from other preparers. The Court of Appeals affirmed the district court’s decision, but did not address the retention of these training centers. IRS subsequently adopted the program at issue in this case, the "Annual Filing Season Program," which is designed to encourage tax return preparers who are not attorneys, certified public accountants or enrolled agents to complete continuing education courses to increase their knowledge of the federal tax law.

AICPA alleged in its complaint that it had standing to bring the suit because the Program harms its members by confusing consumers and causing competitive harm, by imposing regulatory burdens on unenrolled preparers that some of the AICPA’s members employ, and by increasing the regulatory burden on AICPA’s members. The IRS sought dismissal of the suit on standing grounds, arguing that the Program caused no harm because it was entirely voluntary, and contending that each of AICPA’s theories of standing was fatally flawed. The lower court granted the IRS’s motion to dismiss, and AICPA filed this appeal.

The court said that AIPCA’s members will face intensified competition as a result of the IRS program, because participating unenrolled preparers will gain a credential and a listing in the government directory and this will dilute the value of a CPA's credential in the market for tax-return-preparer services and permit unenrolled preparers to more effectively compete with and take business away from presumably higher-priced CPAs. And the court said that although AIPCA offered no evidence that the competitive harm had yet occurred, case law precedent imposes no such requirement. The court rejected the argument put forth by the IRS that the Program would help unenrolled preparers compete only with other unaffiliated unenrolled preparers who decline to participate, rather than with the CPAs and CPA firms that comprise AICPA’s membership. Finally, the court rejected the IRS’s claim that AIPCA’s grievance does not arguably fall within the zone of interests protected or regulated by the statutory provision it invokes because the IRS never presented this argument at the lower court level. American Institute of Certified Public Accountants v. IRS et al., U.S. Court of Appeals for the District of Columbia Circuit, No. 14-5309. 10/30/15

 

DECISION HIGHLIGHTS

Sales and Use Tax Decisions

Prewritten Software Contracts Are Not Taxable
The Michigan Court of Appeals held that an insurance company's contracts for the use of prewritten computer software were not subject to use tax finding that the majority of the transactions did not involve prewritten software. The court said that even if software was delivered, the tangible personal property was incidental to services the taxpayer received.

Taxpayer is a Michigan corporation that provides insurance services and is represented by over 35,000 independent agents in 26 states. The taxpayer entered into a variety of contracts from 2006 to 2010 that used complex computing arrangements between the corporation and the third-party providers. One category of contracts was insurance industry specific contracts and in each instance the third party provided a service to the taxpayer using its specific software and the taxpayer did not download software to its systems. The second category was for technology and communication to provide videoconferencing services, webinar services, and online meeting services and to provide remote access so that an employee can work on his home computer as if he were sitting at his desk at work. The taxpayer also contracted with online internet research websites to conduct legal research by using the third party’s online database service. The taxpayer also contracted with a third party for payment processing services and the company’s software was loaded onto the taxpayer’s computers and was used to scan images of checks and stubs to validate data and compare amounts. The taxpayer also contracted for support and maintenance of the scanners, training, and customer support. According to the taxpayer, the transaction that was taxed was solely for software maintenance and support. The taxpayer also contracted with several companies with regard to software it had already purchased, and argued that all the transactions that were taxed involved support and maintenance of existing software. Finally, the taxpayer also entered into several contracts with marketing and advertising companies, to review the taxpayer’s marketing prices and provide ideas related to branding.

In this matter the taxpayer sought a refund of the use tax assessment paid under protest, asserting that the items included were not prewritten computer software and that, pursuant to the decision in Catalina Mktg Sales Corp v. Dep't of Treasury, 470 Mich 13; 678 NW2d 619 (2004), any software involved in the transactions was incidental to the services the products provided. The lower court granted the taxpayer’s motion for summary disposition, finding that the transactions were not subject to use tax since the software involved in the case was not "delivered by any means" because any software remained on the third party’s server and what was transferred to the taxpayer was information that had been processed through the third-party’s software and infrastructure. The lower court held that the taxpayer had no control over the underlying software used by the third-party companies to complete the necessary tasks and, instead, was only able to input data in order to control outcomes. The court also said that even if the software was delivered to the taxpayer, its use was merely incidental to the services provided and would not subject the overall transactions to the use tax.

The state’s use tax is levied for the privilege of using, storing or consuming tangible personal property in the state. Use if defined in the statute as the exercise of a right or power over tangible personal property and the court has previously held that the key feature in determining whether a party exercised a right or power over tangible personal property is whether the party had some level of control over the tangible personal property. The court noted that the transactions at issue in this case were taxable under the use tax if the taxpayer exercised control over a set of coded instructions that was conveyed or handed over by any means and was not designed and developed by the author or other creator to the specifications of a specific purchaser.

The court of appeals noted that the lower court incorrectly determined that all software remained on a third-party server, pointing out that with one of the vendors a desktop agent was installed on each computer and another vendor used software that runs locally on the taxpayer’s computers. In addition, the court said that the lower court applied a narrow definition of the term "deliver," saying that the phrase "delivered by any means" indicates that the legislature was aware that software could be purchased at a store and delivered by a number of means, including electronically. The appellate court did say, however, that the lower court the correctly determined that the mere transfer of information and data that was processed using the software of the third-party businesses does not constitute delivery by any means of prewritten computer software. In that situation, no prewritten computer software is delivered, and only data resulting from third-party use of software is delivered. The court here said that the majority of the transactions in this case were not taxable under the use tax act because they did not involve the delivery of prewritten computer software by any means. Finally, the court found that the support and maintenance transactions were not subject to taxation since they involved the provision of services, rather than the delivery by any means of prewritten computer software. The court then looked at the transactions where the taxpayer received prewritten computer software delivered to it including software to provide access to the web conferencing support center which was downloaded to a couple of computers and aided the taxpayer in fixing problems with the web-conferencing system and software to provide remote access to taxpayer’s systems. The court found, however, that although plaintiff exercised a right or power over tangible personal property, the transfer of tangible personal property was incidental to the rendering of professional services, citing the “incidental to service” test that looks objectively at the entire transaction to determine whether the transaction is principally a transfer of tangible personal property or a provision of a service, and, thus the transactions were not subject to the tax. Auto-Owners Ins. Co. v. Dep't of Treasury, Michigan Court of Appeals, No. 321505. 10/27/15

 

Personal Income Tax Decisions

No cases to report.

  
Corporate Income and Business Tax Decisions

Royalty Payments Not Subject to Single Business Tax
The Michigan Court of Appeals affirmed a lower court decision that royalty payments received for the licensing of intellectual property were not includable in a corporation's tax base for the state’s single business tax purposes. The court said the licensing agreements did not include the transfer of software.

During the period 1999 and 2004, the taxpayer developed intellectual property for use in its sales processes. According to the taxpayer, the intellectual property included trademarks, confidential business information, domain names, patents, copyrighted materials, trade dress, know-how, and trade secrets. The intellectual property was licensed by the taxpayer’s predecessor in interest to Quixtar Canada in 1999, and in 2006, the taxpayer licensed the property to Quixtar Investments. The patents and patent applications covered under the agreements were listed on Schedule B of the license agreements. Pursuant to the license agreements, the taxpayer received royalty payments, but did not include those royalty payments in its calculation of taxes owed under the Single Business Tax (SBT), which has since been repealed. The SBT was a type of value added tax imposed on the privilege of conducting business in the state and the base line for calculating a business's SBT was to determine the business's tax base which consisted of the business's federal taxable income plus or minus a number of modifications. The SBT statute provided that a business could deduct from its tax base all royalties included in its federal taxable income, except for royalties received for application software, which was defined in the statute, or operating software pursuant to a license agreement. At the lower court level, the taxpayer submitted affidavits from expert witnesses to demonstrate that the licensing agreements did not include software. The lower court agreed with the taxpayer, finding that the plain language of the licensing agreements revealed that they lacked any reference to software and the intent was that the royalty payments were to be made for the use of trademarks, patents and the like.

The appeals court noted in its de novo review that, when interpreting a contract, the court must determine the intent of the parties by examining the language of the contract. If the contractual language is unambiguous, the court must enforce the contract as written. The Department of Revenue (DOR) argued that there is ambiguity in the contract because certain undefined terms could encompass computer software. The evidence presented by DOR consists solely of a statement by a taxpayer employee that some of the royalties received under the agreement were for software and an alleged statement from the director of North America tax for the taxpayer’s parent company, that it was software. The court took note of the affidavits provided by the taxpayer from a patent attorney and an expert in software licensing in support of its argument. The court concluded, after a review of all the evidence, that the extrinsic evidence did not support DOR’s argument that the contract language at issue here was susceptible to more than one interpretation. As a result, the court said that there was no latent ambiguity in the contract and the trial court did not err in concluding that the contract was unambiguous. The court found that the license agreements lacked any reference to licenses of software and there was no language in either agreement that provides any basis to treat the royalties at issue as derived from the licensing of software. Alticor Invs. Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 322000. 10/27/15
  

Construction Company Subject to Contractor Excise Tax
The South Dakota Supreme Court held that a construction company's at-risk services were subject to state contractor excise taxes. The court found that, pursuant to the plain language of the statute, the taxpayer’s at-risk contract was managed for enumerated construction services provided under the statute.

The taxpayer is a South Dakota corporation engaged in multiple construction-related services for both private and public entities. At issue here is whether its construction management at-risk services provided to public and non-profit entities are subject to a contractor's excise tax under SDCL 10-46A-1. An excise tax is imposed under the statute upon the gross receipts of all prime contractors engaged in realty improvement contracts. It is undisputed that the taxpayer did not remit excise tax on the gross receipts it received from its construction management at-risk services provided to public and non-profit entities.

The taxpayer stated that a construction management at-risk service involves a contract with a public entity where the construction manager agrees to provide a completed project for the public entity at a specified cost and by a specified date, removing the risk, uncertainty and burden of managing construction projects from city or county officials and transferring it to an expert in the construction field. The Department of Revenue (DOR) determined that the taxpayer’s actions in the performance of its construction management at-risk contracts were more that of a prime contractor than that of a construction manager and issued the assessment at issue here.

Taxpayer asserted that it merely acted as a pass-through for the public entities' funds when it paid the subcontractors for work completed and claimed that although it paid the contractor's excise tax due on the projects, it did so as part of its construction management at-risk services to the public entities. It argued that rather than acting as a prime contractor, it provided management and inspection services to ensure the timely and efficient delivery of public projects. The taxpayer presented testimony at the hearing that the construction manager purchases no materials and performs no actual construction work on the project. The testimony asserted that the prime contractors receive the bids, provide the realty improvement, and engage in the actual construction service contracts. In contrast, the construction manager supervises and manages the various prime contractors, schedules work, and ensures satisfactory completion of the project at a specified cost and by a specified date.

The state statute at issue here defines a prime contractor as "a person entering into a realty improvement contract or a contract for construction services as enumerated in division c of the Standard Industrial Classification Manual, 1987[.]" While the statute does not define "realty improvement contract" DOR argued that the taxpayer entered into a contract for realty improvement because it agreed to provide the public entity a completed building, an improvement to realty. DOR also argued that an excise tax is imposed because the taxpayer entered into a contract for construction services listed in the SIC Manual (division c).


The taxpayer argued that there is an ambiguity whether the statute applies because the state’s excise tax regime was enacted prior to the creation of the construction manager at risk entity. The taxpayer also argued that the definition of "prime contractor" is ambiguous because it is unclear whether the phrase "as enumerated in division c of the [SIC] Manual" applies to both a person entering into a realty improvement contract and a contract for construction services. In light of these alleged ambiguities and the general rule that statutes imposing tax are construed liberally in favor of the taxpayer, the taxpayer argued that the lower court correctly determined that its construction management at-risk services were not subject to excise tax.

After a review of the statute, the court found no ambiguity. An excise tax under the state statute applies if a construction manager is a prime contractor engaged in a realty improvement contract, or if a construction management at-risk contract is for construction services enumerated in the SIC Manual (division c) and cited AT&T Corporation v. South Dakota Department of Revenue, 2002 S.D. 25, ¶ 8, 640 N.W.2d 752 in support of this finding.

The court said that the excise tax applies not just to prime contractors engaged in realty improvement contracts, but also to those who contract for construction services as enumerated in division c of the Standard Industrial Classification Manual. The court then turned to the question of whether taxpayer’s construction management at-risk services fall under the SIC Manual (division c). In reviewing the scope of the taxpayer’s services, the court said it was undisputed that, as the construction manager, taxpayer did not assume the role of a traditional general contractor. It did not perform actual construction work on the project but instead managed the construction project on a contract or fee basis. However, the court noted that the SIC Manual (division c) contemplates an activity where all of the actual construction work is subcontracted to others and the contractor may or may not have workers on their payroll. The court said that the pivotal inquiry, therefore, is whether the taxpayer assumed all responsibility for the entire construction project, and, from a review of the record, the taxpayer assumed all responsibility for the entire construction project as part of its construction management at-risk services. Therefore, the court said that although the taxpayer did not perform actual construction on the project, its construction management at-risk contract was "for construction services as enumerated in division c of the Standard Industrial Classification Manual" and it was, therefore, properly subject to excise tax. Taxpayer also argued that it could not be subject to the tax because under the statute it would be illegal for them to act as the prime contractor on a project when it also acts in the role of an architect. The taxpayer also points to several attorney general opinions in which the construction management at-risk construction method was examined and the Attorney General opined that a construction manager is prohibited from performing actual construction work as a contractor when also acting as an architect. The court rejected these arguments pointing out that the statute cited by the taxpayer regulates the rights and actions of parties related to the procurement of public contracts, not whether a certain service is subject to taxation, and notes that simply because the taxpayer cannot be a contractor and an architect under that provision does not mean that the DOR cannot impose excise tax on the taxpayer’s construction management at-risk services. The court found that the taxpayer in its capacity as a construction manager, entered into a contract with a public entity to guarantee a satisfactorily completed public improvement project by a specific date for a specific cost and this service is subject to excise tax under SDCL 10-46A-1. Puetz Corp. v. Dep't of Revenue, South Dakota Supreme Court, 2015 S.D. 82; No. 27282. 11/4/15

  

Property Tax Decisions

Environmental Remediation Costs Considered in Property Valuation
The Pennsylvania Supreme Court held that a school district could consider a hypothetical use of a taxpayer’s manufacturing plant in determining its fair market value. The court also said, however, that it had to consider environmental remediation costs associated with an earlier settlement from when the property was used for weapons manufacturing.

This case involves a 229.24-acre parcel of commercial/industrial property situated in the township and currently owned by the taxpayer. Approximately 110 acres of the parcel contain buildings and other improvements, and the remaining 119 acres are considered "excess" land. From 1941 until 1964 the U.S. Navy and, later, a private firm, with whom the taxpayer merged in 1969, used the parcel to operate a weapons manufacturing plant. In the course of that business numerous contaminants, as well as unexploded military ordnance, were buried in the subsurface strata. This use resulted in significant environmental damage to the property and military contracting was phased out in the 1980s. The taxpayer subsequently repurposed a portion of the site to operate a motorcycle manufacturing plant, which continues in operation today. In 1995 the taxpayer executed a settlement agreement with the United States and its agencies under which the parties agreed to share in the costs of the parcel’s remediation. Currently the remediation has not been completed and the taxpayer is participating the program of the United States Environmental Protection Agency (EPA) that permits owners of contaminated land to avoid federal environmental liability by complying with state remediation law. As a result, the taxpayer’s conduct regarding this parcel is governed by the Pennsylvania Land Recycling and Environmental Remediation Standards Act. This act permits property owners to avoid state environmental liability by satisfying certain conditions until the remediation is complete.

The county assessor notified the taxpayer of its intent to increase the assessed value of the property at issue and the taxpayer filed an appeal. At the trial court level the local school board (Board) intervened. At the trial both parties presented testimony by expert witnesses. The lower court found in favor of the District, concluding that the testimony of the Board’s expert witness was more credible. Ultimately, the taxpayer took this appeal. The court held that while hypothetical ways in which a property could be used by potential buyers are properly considered by an expert in evaluating what a willing buyer would pay for a property, the Commonwealth Court erred in concluding that the District's expert valued the subject property as already subdivided. The court also concluded that the potential effect of an agreement concerning possible environmental remediation liability and ongoing environmental restrictions and maintenance is a relevant factor that must be taken into account when determining the fair market value of property, and agreed that the Commonwealth Court properly concluded that these agreements were not accounted for by the trial court. The court reversed the Commonwealth Court’s rejection of the trial court’s reliance on the environmental stigma in its valuation of the property, finding that the environmental stigma may be relevant to determining fair market value of real estate for tax purposes in appropriate circumstances, and finding that the trial court properly relied upon the District’s expert's opinion regarding a 5% environmental stigma devaluation for the property.

The court’s holding affirmed in part and reversed in part the decision of the Commonwealth Court and remanded the matter for proceeding consistent with the opinion. Harley-Davidson Motor Co. v. Springettsbury Twp., Pennsylvania Supreme Court, No. 82 MAP 2014. 9/29/15

 

Other Taxes and Procedural Issues

Emergency Service Is a Constitutional Fee
The Kentucky Supreme Court found that a county fee used to fund local 911 emergency telephone services was a constitutional and statutorily valid exercise of the county’s authority.  The court held that the fee, levied on occupied residential and commercial properties, was neither a tax nor a user fee and the 911 service is a benefit for all citizens.

The emergency 911 service in the county in question has historically been funded by imposing a monthly subscriber fee per landline telephone.  As the number of landline phones is decrease, supplanted by wireless telephones and other technologies, the landline subscriber fee has become an inadequate funding mechanism.  In 2013 the county adopted an ordinance replacing the landline subscriber charge with an annual service fee levied on each occupied individual residential and commercial unit within the county.  This suit was filed by the
Greater Cincinnati/Northern Kentucky Apartment Association (Association) alleging that the ordinance was an unconstitutional and invalid exercise of the county's authority.

At the appellate level the Association did not raise the constitutional arguments and the only issue before the court was whether the ordinance was a statutorily valid exercise of the county’s authority.  The state statute provides in pertinent part that a county may obtain the funds necessary to establish and operate a 911 emergency telephone service through the levy of any special tax, license, or fee not in conflict with the Constitution and statutes of the state.

The Association argued that the fee imposed under the ordinance constituted an impermissible user fee in violation of a provision of the state statute that defines a user fee as a fee on the user of a public service for a service not also available from a nongovernmental provider.  The Association argued that the fee is invalid because it is not based on actual use of the benefit received and argued that it is, instead, an unauthorized flat-rate tax.

The court said that there was no need to harmonize the two statutes at issue here because the statute defining user fee is entirely inapplicable to the present issue, the argument of the Association being premised on the erroneous assumption that the term fee must mean user fee.  The court also noted that these two statutory provisions appear in entirely different Chapters of the state statute and contain no references or citations to each other.

The court said that the provision that expressly authorized the use of fees to fund 911 emergency telephone services demonstrates the legislature’s specific intent to permit local governments to fund 911 telephone services through the imposition of fees. It said that it is also clear that nothing in that provision required that the fee be based on use.

The court said that the ordinance’s fee is levied upon occupied properties, which it said are a logical and practical object of the fee revenue.  The court said that common sense dictates that the county residents spend a significant amount of their time at residential and commercial properties located within the county and it follows that demand for the 911 service derives significantly from residents' occupation and use of those properties, and the 911 service is a benefit for all citizens. The court found that to assess payment upon only those citizens actually telephoning 911 has never been the policy of the counties or the state, noting that even the landline fee would offend the Association’s restrictive interpretation of the statute.

The court clarified that the nexus required to sustain a fee imposed under the pertinent statutory provision does not need to be direct; rather, the court said, a fee that bears a reasonable relationship to the benefit received is sufficient. The court held that the fee imposed by the county to fund what it termed an indispensable service was a constitutional and statutorily valid exercise of its authority.  A dissenting opinion found that the service fee in the case was really a tax on real property ownership in violation of the state constitution because it is not assessed on an ad valorem basis.  Greater Cincinnati/N. Ky. Apartment Ass'n Inc. v. Campbell Cnty. Fiscal Court, Kentucky Supreme Court, 2014-SC-00383-TG.  10/29/15
  

License Suspension Upheld for Purchasing Cigarettes Without Tax Stamps
The Illinois Appellate Court has ruled that Chicago did not abuse its discretion in revoking a registered tobacco dealer's license for purchasing cigarettes without a tax stamp.  The court found that the one-act, one-crime rule does not apply to municipal order proceedings.

The taxpayer is a licensed tobacco dealer in Chicago, Illinois.  Chicago's Department of Administrative Hearings and its Department of Business Affairs and Consumer Protection (collectively, Department) found that the taxpayer violated tobacco related provisions of the Chicago Municipal Code (Code), including purchasing or receiving 1,127 packs of cigarettes that did not bear an unmutilated tax stamp affixed or cancelled indicating payment of the proper cigarette tax to Chicago and purchased or received 1,107 packs of cigarettes in a package not bearing an unmutilated tax stamp affixed or cancelled indicating payment of the proper cigarette tax to Cook County.  Taxpayer also was charged with failure to provide records of cigarette transaction for inspection, and engaging in an act of concealment. The lower court denied the taxpayer’s petition for writ ofcertiorari, and affirmed the findings of the department and this appeal followed.

The taxpayer argued that under the one-act, one-crime rule it could not be convicted for both 
section 3-42-020(d) of the Code for nonpayment of Chicago cigarette taxes and section 3-42-025 of the Code for the nonpayment of Cook County cigarette taxes.  The Department argued that the taxpayer was found liable for two separate actions: nonpayment of the Chicago cigarette tax and nonpayment of the Cook County cigarette tax. Taxpayer also argued that the Department abused its discretion when it revoked the taxpayer’s license as a sanction for its tobacco related violations.  

Testimony at the hearing commissioner level indicated that a revenue investigator visited the taxpayer’s place of business as a result of a complaint that the taxpayer was selling unstamped cigarettes out of the rear room of its store.  The investigator testified that he identified himself to the employee behind the cash register who, after the investigator’s request, provided the appropriate licenses for the business.  The investigator checked the rear of the store and found 1,127 unstamped packs of cigarettes in an 18-inch gap in the wall. Out of those 1,127 packs of cigarettes, 20 only had a county tax stamp affixed to its packaging while the remaining 1,107 packs of cigarettes lacked the single tax stamp that serves as a joint tax stamp for both Cook County and Chicago.  The employee did not comply with the investigator’s request to see the licensee’s transaction book.  The taxpayer offered no testimony or other evidence at the hearing. In aggravation, the department presented a 2007 Chicago stamp tax violation that resulted in a $1,000 fine, a 2009 violation for illegally posting a tobacco advertisement that resulted in a $200 fine, and a 2011 violation for selling tobacco products or accessories to a minor which resulted in a $500 fine and the taxpayer did not present any evidence in mitigation, but argued that its prior infractions were too remote in time and factually irrelevant to be considered in aggravation.

The court in this matter noted that while the taxpayer improperly sought a writ of certiorari as opposed to seeking review pursuant to the Administrative Review Law, it would review the petition according to the Administrative Review Law because the standards of review were essentially the same.

With regard to the applicability of the one-act, one-crime rule to the facts of this case, the court held that the one-act, one-crime rule does not apply to municipal ordinance violations such as the ones at issue here. The court said that the one-act, one-crime rule prevents criminal defendants from being convicted of multiple offenses based on the same physical act, but that state courts have considered prosecutions in which a fine is sought for the violation of a municipal ordinance as a civil proceeding, albeit quasi-criminal in nature.

The court also noted that the hearing commissioner specifically found that the proceedings were civil, not criminal, and the record did not give any indication that the hearing commissioner applied the criminal standard of proof. The taxpayer also argued that the penalty of revoking its license was unduly harsh, arbitrary, and an abuse of discretion because it was based on improper convictions under the one-act, one-crime rule, because the revenue inspector did not conduct a proper investigation and did not obtain evidence of a knowing violation and because the hearing officer improperly considered prior tax ordinance violations as a factor in aggravation.  The taxpayer argued that the prior infractions were unrelated, remote, and irrelevant.

The court noted that, as previously discussed, the taxpayer’s offenses were not barred by the one-act, one-crime rule.  The court also pointed out that the taxpayer did not raise the issue that the inspector did not conduct a proper investigation at the administrative hearing and, therefore, cannot be raised on administrative review.  The remaining argument challenging the legitimacy of its sanction because that the hearing officer should not have considered evidence of prior infractions offered in aggravation was the final issue before the court.

The court said that, after reviewing the record of the taxpayer’s actions in this case, it could not say that revocation of plaintiff's license was arbitrary and capricious, or overly harsh in view of the mitigating circumstances.  It noted that the taxpayer was found in violation of not paying either the city or county taxes for over 1,000 packs of cigarettes and attempted to conceal the cigarettes in the back room and found that, even without considering taxpayer’s prior infractions, the agency did not abuse its discretion when it revoked The taxpayer’s license.  But the court rejected the taxpayer’s argument that its prior infractions were too remote in time or irrelevant to its current violations, noting that all of the taxpayer’s prior violations were tobacco-related and occurred within five years of the current violations.  Smoke N Stuff v. City of Chicago, Illinois Court of Appeals, 2015 IL App (1st) 140936; Docket No. 1-14-0936.  8/24/15 (decision released 11/6/15)


 

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].

 
STATE TAX HIGHLIGHTS
A summary of developments in litigation.
Published biweekly by the Federation of Tax Administrators
October 30, 2015 Edition

NEWS

Iowa Responds to Wynne Decision
In response to the U.S. Supreme Court’s decision in Comptroller v. Wynne, U.S. Supreme Court, Docket No. 13-485, the Iowa Department of Revenue has announced that Iowa's out-of-state tax credit calculated on Form IA 130 must be applied prior to other nonrefundable Iowa tax credits and before calculation of any school district surtax or EMS surtax. Taxpayers must file amended tax returns (IA 1040X) for each applicable year in order to claim a refund. The previous process in Iowa was to calculate the surtax prior to applying the out-of-state tax credit, resulting in the state’s out-of-state tax credit only being applied to state income tax liability, a practice that the U.S. Supreme Court said in Wynne could lead to double taxation. More detailed information can be found on the DOR’s website where FAQs have been published.
  

Class Action Suit Filed Against Hawaii
The Tax Foundation of Hawaii, a Hawaii non-profit corporation, has filed a class action complaint alleging the state used funds from a county surcharge for the state's general use fund. The suit alleged the amount retained by the state, in excess of a hundred million dollars, amounted to an illegal and discriminatory excise tax. The surcharge has been imposed on Honolulu taxpayers since 2007 for the purpose of funding the city’s mass transit rail project.

The suit seeks to have the court issue an injunction or mandamus to compel the State to follow the law and end the unlawful reallocation of monies to the state’s general fund. The original legislation provided that the Department of Revenue (DOR) could recoup the costs of administering the legislation each year, and the suit alleges that 10 percent of the gross amount received is deduction for costs of administration and the remainder distributed to Honolulu. The suit alleges that this percentage is deducted each year without ever determining the costs incurred by the state in assessing, collecting and disposing of the county surcharge, and grossly exceed the costs incurred by the state. The suit contends that the state's diversion of tax proceeds in excess of its actual costs of administration injures the Plaintiff and the class it represents by increasing the gross amount of excise tax that must be collected in order to cover the cost of the Honolulu rail project and by exposing the Plaintiff and the class it represents to an illegal tax burden.


 

U.S. SUPREME COURT UPDATE

No cases to report.

  

FEDERAL CASES OF INTEREST

  
Preparer's Tax Fraud Conviction Affirmed
The Fifth Circuit, in an unpublished per curiam opinion, affirmed a return preparer's conviction for aiding and assisting in the preparation of false and fraudulent income tax returns, determining that the evidence was more than sufficient to support the conviction.

The preparer filed this appeal challenging the sufficiency of the evidence supporting his convictions, contending that none of the employees of Action E-File Services testified that he trained or encouraged anyone to commit tax fraud or that they observed him commit the crimes alleged in the counts of conviction. He also alleged that the testimony of taxpayers for whom he prepared returns was insufficient to show that he willingly violated federal tax laws. He also contended that their testimony was not credible since the government agreed not to prosecute them. The preparer also asserted that the jury's decision was not rational because the evidence on the counts of conviction was materially indistinguishable from the counts on which he was acquitted.

The court cited United States v. McDowell, 498 F.3d 308, 312 (5th Cir. 2007) for the proposition that evidence is sufficient to support a conviction "if a reasonable trier of fact could conclude . . . the elements of the offense were established beyond a reasonable doubt, viewing the evidence in the light most favorable to the verdict and drawing all reasonable inferences from the evidence to support the verdict." The court found that the evidence in this matter was more than sufficient to support the preparer’s convictions. He presented himself as a professional tax preparer, and his name appeared as the preparer on the tax returns at issue. He listed numerous deductions or credits even though the taxpayers testified that they did not incur the expenses, did not discuss the expenses with the taxpayer, and did not provide the taxpayer with the figures or documentation to support the expenses. The court said that the false information was material because the taxpayers received tax refunds. The court found that a rational jury could infer from this evidence that the preparer acted willfully to aid or assist in the preparation and presentation of false or fraudulent tax returns. While the preparer asserted that he acted in good faith, the court noted that he did not identify any specific evidence in support of this assertion. The court also found that the preparer had not shown that the testimony of the taxpayers was incredible on its face. Finally, the court did not consider the jury's rejection of certain counts in determining whether the evidence is sufficient to support Perez's convictions. United States v. Mickey Joe Perez, U.S. Court of Appeals for the Fifth Circuit, No. 15-10026. 10/14/15

 

DECISION HIGHLIGHTS

Sales and Use Tax Decisions

ISP's Dial-Up Services Are Exempt from Sales and Use Tax
The Commonwealth Court of Pennsylvania held that an Internet service provider's (ISP) sales of dial-up routing services to other ISPs were exempt as sales of Internet access services. The court said the taxpayer's facility was a point of presence where Internet connection begins.

The taxpayer in an international Internet Service Provider (ISP) operating a Tier 1 network. It sells various services, including a service that provides the infrastructure for ISPs desiring to outsource the remote access to their network or the internet. DOR assessed the taxpayer for failure to collect the sales and use tax on its sale of the service to retail ISPs. The only portion of that assessment at issue in this matter is the sale of the service to AOL. The taxpayer argued that this service sold to AOL constitutes internet access and is, therefore, exempt from the state’s sales and use tax under both the state statute and the federal Internet Tax Freedom Act (ITFA). DOR, relying on America Online, Inc. v. Commonwealth, 932 A.2d 332 (Pa. Cmwlth. 2007) (AOL/Sprint), aff'd, 963 A.2d 903 (Pa. 2008), argued that the service sold to AOL is a basic telecommunications service and is, therefore, subject to tax. The state statute provides that the tax is imposed on sales of tangible personal property, which includes interstate telecommunication service originating or termination in the Commonwealth and charged to a service address in the Commonwealth.

The court rejected DOR’s argument, pointing out the fundamental and material technological differences between the services provided by Sprint in the case cited by DOR and the services provided by the taxpayer in the present matter. The court noted that the taxpayer’s facility, as the point at which the end-user connects with the network access point and network access servers, is a Point of Presence (PoP), in other words an access point, location or facility that connects to and helps other devices establish a connection with the internet. Because the facility is a PoP, the court said that it is where the end-user's connection to the internet begins and the service, therefore, constitutes internet access. The court rejected DOR’s argument that the service was not internet access because it always delivered AOL's end-users to www.aol.com first, finding that delivering an end-user to www.aol.com as a homepage is no different than delivering an end-user to www.msn.com or www.google.com and noted that a skilled end-user could hack the AOL software and direct that a different homepage be used.

Internet access is an enhanced telecommunications service, and is, therefore, excluded from the definition of telecommunications services subject to the tax. The court found that the Taxpayer’s service is exempt from tax as internet access under the state code. Level 3 Commc'ns LLC v. Commonwealth, Commonwealth Court of Pennsylvania, No. 166 F.R. 2007. 10/15/15
  

Chicago's Claims Against Other Municipalities for Use Tax Revenue Dismissed
The Circuit Court of Cook County, Chancery Division, dismissed the suit brought by the City of Chicago and the Village of Skokie against other Illinois cities and private companies seeking to collect tax revenue because it should have been sourced to Chicago. The court said that the other cities' misconduct had ceased and that the non-governmental defendants should be sued as third-party defendants.

Illinois' method of taxing sales involves two complementary statutes, the Retailers' Occupation Tax Act (ROTA) and the Use Tax Act (UTA). The purpose of the use tax is to prevent avoidance of ROTA by people making out-of-State purchases, and to protect Illinois merchants against such diversion of business to retailers outside Illinois. The use tax is complementary to the ROT and expressly provides that it does not apply to out-of-state transactions that would be exempt under the ROT if the sale had occurred in the state.

Since the ROT and use tax are levied at the same base rate, 6.25%, this arrangement tries to assure that each transaction involving the sale for use of personal property to an Illinois purchaser is taxed the same amount regardless of where the purchase occurs. Of the 6.25%, 5.0% is allocated to the state and the remaining 1.25% is distributed geographically, based on where the taxed sale took place. Each municipality is entitled to a 1.0% local share of the statewide ROT for sales that took place in the municipality and each county where the sale took place is allocated a 0.25% share. The formula for distributing the remaining 1.25% of use tax collections is different, since by definition the use tax sale did not take place within the state. The remaining 1.25% of use tax revenue is deposited in the State and Local Sales Tax Reform Fund, and distributed pursuant to a formula with 20% going to Chicago. In addition to the ROT, some municipalities and municipal entities impose a local sales tax as well, including Chicago where sales are subject to an overall tax rate of 9.25% and Skokie where sales are subject to a 9.0% sales tax.

The Chicago Plaintiffs claim that certain entities improperly reported use tax as ROT tax by fictitiously brokering transactions through an entity purportedly located in Kankakee that has no local sales tax or Channahon that imposes a 1% local tax. The Chicago Plaintiffs contend that Kankakee or Channahon partnered with Brokers who arranged for services, such as credit checks, within the municipalities' respective city limits, on behalf of the out-of-state internet retailers, converting what would otherwise have been an out-of-state use tax sale into an in-state ROT sale. As a result, the municipalities received the 1% ROT local share from the state, rather than the smaller percentage of the local use tax. The plaintiffs contend that to provide an incentive to the retailers to participate in this arrangement, they agreed to share with the brokers for the deal the 1% ROT local share generated from the sales. The brokers then entered into agreements with the internet retailers, where the brokers would accept purchase orders by Illinois residents on behalf of the retailers, and the retailers would report the sales as taking place in Kankakee and/or Channahon for tax purposes, sharing in a portion of the rebate they received from the municipalities. Plaintiffs contend that little or no meaningful sales activity took place at the offices maintained by the Brokers. While the Brokers may have performed credit checks at the offices in the state municipalities, the plaintiffs argue that all significant sales activities, including the acceptance of customer orders, took place outside the state.

The defendants argued that the plaintiffs should not be permitted to amend their complaint. The court said that the decision whether to grant leave to amend a complaint lies within the sound discretion of the trial court, noting that while leave is to be granted liberally, the right is neither absolute nor unlimited. The court concluded in this matter that the plaintiffs had not pleaded, and could not plead, cognizable claims against the Internet Retailers, the Operating Companies, or the Brokers, finding that the amended complaint was far too general and conclusory in its factual allegations, and failed to plead factually adequate causes of action against those defendants. The court determined that this deficiency might be incurable, concluding that the plaintiffs cannot plead viable claims against the defendants. The court said that it is not disputed that the use-tax-related conduct charged against them has ceased. It is also not disputed that the Internet Retailers and the Operating Companies paid the taxes they owed. The plaintiff’s claims against them are not for unpaid taxes, but for paying the correct amounts under the wrong label. The court said that the rebates do not alter this conclusion, saying that to the extent the taxpayers and the Brokers got rebates from the municipalities, that is for them to sort out if and when DOR decides to adjust the municipalities' share of tax revenues. The court said that the rebates were not paid by, and are not owed to, the plaintiffs and would not be a proper measure of damages owed the plaintiffs.

With regard to the non-municipal defendants, the court agreed that there is no controversy in the complaint because the conduct the plaintiffs complained of ended a year ago. The purpose of declaratory judgment is to permit the court to address a controversy one step sooner than normal, after a dispute has arisen, and the court said that purpose is not served here. The court pointed out that the plaintiffs are attempting to judicially pre-empt DOR's authority to audit tax payments, and to re-distribute amounts collected, while bypassing the agency which has both the authority and the expertise to do that job. The court said that state precedent shows that the correct path to challenge such distributions is to challenge a final decision issued by DOR and noted that municipalities do not have the power to enforce tax collection or distribute taxes.

The court also noted the difficulties which would attend a judicial attempt to fashion an effective remedy in this case, saying it would seem a waste of effort and resources for the court to attempt to do such a redistribution and then order DOR to carry it out, questioning whether DOR, a non-party here, could be compelled to accept the court's calculations.

The court said that the legislature authorized sales tax mis-sourcing suits, where the remedy can be calculated and effectuated without resort to DOR's expertise, but it did not authorize use tax suits. Chicago v. Kankakee, Circuit Court for Cook County, Chancery Division 11 CH 29745. 10/9/15

  
Taxpayer Failed to File Timely Appeal
The Missouri Supreme Court upheld the administrative hearing commission’s rejection of a restaurant's sales tax appeal for lack of jurisdiction. The court said that the taxpayer failed to timely appeal the assessment and the commission's interpretation of the statutes' time requirements for filing the appeal did not violate due process.

In July 2014 the taxpayer received estimated assessments from the state Department of Revenue (DOR) for unpaid sales and use tax, notifying the taxpayer that final assessment notices would be delivered via certified mail after the audit was reviewed and processed. The record reflects that, on September 5, 2014, the DOR sent 34 final assessment notices by certified mail to the taxpayer’s address, each of which advised the taxpayer that these notices represented final decisions of the Director of Revenue and appeals must be taken within 60 days after the date the decision was mailed or the date it was delivered whichever date is earlier. The notice provided an address to which the appeal should be sent. The taxpayer could request an informal review of the assessments by the Director of Revenue but this review would not extend or affect the 60-day appeal period, which in this case was November 4, 2014. The taxpayer claims it never received these final assessment notices. 
On October 9, taxpayer’s counsel emailed an auditor at DOR, indicating an intent to dispute the estimated assessments and expressing concern over a possible approaching deadline to do so. Counsel requested an extension of the deadline. The auditor responding by sending counsel the Missouri Taxpayer Bill of Rights which contained information about appeals and the time limitations. Taxpayer claims that the following day its counsel had a telephone call with another DOR employee and was informed that the 60-day appeal period did not run if the taxpayer had not received the notices.

The taxpayer claims it then requested an informal review on October 24 and that, after not hearing back, its counsel called DOR on November 12 and was told the taxpayer’s filing was missing and to "quickly file with [the Commission]." The taxpayer’s appeal was finally filed with the Commission on November 19, over two weeks past the deadline. The Commission granted DOR’s motion for a summary decision on the basis that the appeal was not timely and the taxpayer filed this appeal. The taxpayer argued that it missed the deadline to file an appeal with the Commission because it never received the final assessment notices and, therefore, had no notice of the right of appeal and the corresponding deadline. The taxpayer contends that the Commission's interpretation of the statute is unfair to taxpayers and violates the due process clauses of the Missouri and United States Constitutions. The court rejected the taxpayer’s argument that, because one provision requires the director to provide notice of the right of appeal, the legislature intended to make the taxpayer's actual knowledge of the right of appeal a pre-condition to the imposition of the 60-day filing deadline. The court said that the Commission’s application of the law involved no statutory interpretation because the provisions do not contain language that the taxpayer must actually receive the decision or have actual knowledge of the right of appeal for the time limitation to run.

The court also said that the fact that the sections provide for the time limitations to start without the taxpayer actually receiving notice of the director's decision does not raise a due process concern because due process does not require actual notice before the government takes action. Because due process does not require actual notice, there is no constitutional prohibition with the statute starting the time limitations without requiring the taxpayer to receive actual notice. The court said the issue is whether notice sent pursuant to these sections was reasonably calculated to give notice and an opportunity to respond in this particular case.

In this case, the final assessment notices were sent via certified mail to the taxpayer’s last known address, the notices were not returned, there is no evidence that the notices were sent to the wrong address, and the final assessment notices were addressed the same as the estimated assessments that the taxpayer admittedly received less than two months prior. Therefore, the court found that there was no due process violation.

The taxpayer also argued that the doctrine of equitable estoppel applied here to excuse its late filing because a DOR agent told taxpayer’s counsel, incorrectly, that the 60-day period to appeal did not begin to run until the taxpayer received the final assessment notices, DOR lost the taxpayer's October 24 filing, and a DOR employee gave the taxpayer’s counsel the wrong fax number for the Commission. The court, citing a number of cases on this issue, said that even if a DOR agent erroneously told taxpayer's counsel that the 60-day period for appeal did not start until the taxpayer received the final assessment notices, this would simply be a case of bad advice based on a government agent's misunderstanding of the law, which does not amount to affirmative misconduct. But the court also noted that taxpayer’s argument is undermined by the undisputed evidence that, in response to its email inquiry on October 9, DOR provided the taxpayer with the "Missouri Taxpayer Bill of Rights," which correctly stated the law regarding the right of appeal and time limitations. Moreover, the court said, as the right of appeal and its time limitations were stated clearly and unambiguously in the statute, knowledge of such is imputed to the taxpayer, making estoppel inappropriate.

The court found that the Commission did not err and did not base its entire decision on the assumption that the taxpayer received the final notices, noting that in its findings of fact the Commission did not find that the taxpayer received the notices and such a finding was not necessary for its decision. Instead, the Commission found that the notices were mailed to the taxpayer’s address of record on that date. The court also dismissed the taxpayer’s argument that it’s complaint dated October 24, 2014 addressed to DOR constituted an appeal, finding it indisputably was not an appeal to the Commission, as it was addressed to, and intended for, the DOR. An appeal, distinguishable from a request for informal review, could only be sent to the Commission. New Garden Rest. Inc. v. Dir. of Revenue, Missouri Supreme Court, No. SC94897. 10/13/15
  

False Claims Suit Allowed to Proceed
The New York Court of Appeals upheld a lower court decision allowing a false claims act case to proceed against Sprint Nextel Corp., holding that the tax statute the company was alleged to have purposely violated was not ambiguous. The court said that the attorney general had a valid cause of action against the company under the false claims act (FCA).

Congress enacted the Mobile Telecommunications Sourcing Act (MTSA) establishing a uniform "sourcing" rule for state taxation of mobile telecommunications services, providing that the only state that may impose a tax is the state of the customer's "place of primary use,” either a residential or primary business address, as selected by the customer. The state legislature responded to the MTSA in 2002 by enacting multiple amendments to the state sales tax law that clarified and amended the state's treatment of mobile telecommunications services, implementing a new set of rules applicable to voice services sold through flat-rate plans. The FCA provides for enforcement by both the AG, in civil enforcement actions, and private plaintiffs on behalf of the government, in qui tam civil actions, and provides the AG with the right to intervene and file a superceding complaint in a qui tam action. The FCA provides for the imposition of treble damages and civil penalties against violators. The FCA applies to any person who knowingly makes a false record or statement material to an obligation to pay money or property to the government. The statute provides that a defendant acts "knowingly" when the defendant has actual knowledge of a statement's truth or falsity or acts in deliberate ignorance or reckless disregard of its truth or falsity. In 2010 the legislature amended the FCA to cover claims made under the tax law in certain circumstances, to provide an additional enforcement tool for the state and deter the submission of false tax claims and providing additional funds for the revenue of the state.

The taxpayer is a wireless telecommunications service provider that doing business in the state and selling wireless plans that include a certain number of minutes of talk time for a fixed monthly charge. After the state tax law amendments were enacted in 2002, the taxpayer paid sales tax on all of its receipts from its flat-rate plans. In 2005, however, the taxpayer began a nationwide program of unbundling charges within these flat-rate monthly plans, specifically unbundling the portion of the fixed monthly charge that it attributed to intrastate mobile voice services and it did not collect taxes on the portion of the monthly charge that it attributed to interstate and international calls. For the tax years at issue, the percentage of the fixed monthly charge on which the taxpayer collected sales tax ranged from 71.5% to 83.6%, but it did not separately state on customers' bills the charges for interstate and international voice services included in the flat-rate plan.

On March 31, 2011, Empire State Ventures, LLC, filed suit against the taxpayer under the state’s FCA, and on April 19, 2012, the AG filed a superceding complaint, which converted the action into a civil enforcement action by the AG. The Ag’s complaint alleges that the statute requires the payment of sales tax on the full amount of fixed periodic charges for wireless voice services sold by companies like the taxpayer’s. The complaint argues that the statute permits wireless providers to treat certain components of a bundled charge for mobile telecommunications services separately for sales tax purposes, as long as the charges are not for voice services. The complaint states that the taxpayer violated the law by failing to collect sales tax on the portion of its flat-rate charge that was attributable to interstate and international voice services. The complaint also alleges that taxpayer’s decision to unbundle its plans was driven by a desire to gain an advantage over its competitors by reducing the amount of sales tax charged. The AG argued that the percentages of the flat-rate charges that the taxpayer allocated to interstate and international calls were completely arbitrary. The AG, in support of its arguments, cited a Tax Department guidance memorandum, published before the 2002 amendments became effective, which states that the sales tax is to be applied in the manner that the AG now advocates. The AG pointed out that the taxpayer adhered to this guidance until July 2005, when it changed its tax practices, and did not seek a tax refund for the 2002 - 2005 tax years in which it paid those taxes. The AG further alleges that the taxpayer also disregarded the statements of a Tax Department field auditor and enforcement official advising it in 2009 and 2011, respectively, that its sales tax practice was illegal.

The court here said that the plain language of the statute subjects to tax all "voice services" that are sold for a fixed periodic charge and it is uncontested that the services at issue meet that requirement. Further, the court noted that the statute allows for the separate accounting of bundled services that are non-taxable, if the provider can provide "an objective, reasonable and verifiable standard for identifying each of the components of the charge," but specifically applies only if it is "not a voice service" (Tax Law § 1111[l] [2]). The court rejected the taxpayer’s argument that such an interpretation of the state tax law is preempted by the MTSA, finding that because the state statute imposes a tax on the entire amount of the fixed monthly charge for voice services, there is no exemption for any interstate and international component that would even trigger section MTSA 123(b)'s exception. It further noted that no provision of the MTSA prohibits the taxation of interstate and international mobile calls.

With regard to the cause of action under the FCA, the taxpayer asserts that there is a reasonable interpretation of the tax law that does not subject bundled interstate and international calls to sales tax and, thus, there can be no knowingly false record or statement, and no valid FCA claim. The court dismissed that argument, finding that even assuming there could be such a reasonable interpretation of what the court termed “this unambiguous statute,” it cannot shield a defendant from liability if the defendant did not in fact act on that interpretation, a this complaint alleges. The court stated that the AG would have to prove the allegations of fraud, that the taxpayer knew the AG's interpretation of the statute was proper, and that it did not actually rely on a reasonable interpretation of the statute in good faith. But, the court found that the AG had stated a cause of action for a false claim, given the complaint's allegations about the agency guidance and industry compliance with the AG's position, the taxpayer’s payment of the proper amount of sales tax for several years, and its undisclosed change in its practice. On a motion to dismiss, the court said it accepts facts as alleged in the complaint as true and provides the plaintiff with the benefit of favorable inference. The court denied the motion to dismiss saying the AG is entitled to discovery, and there are factual issues that need to be fleshed out in further proceedings. The court also held that retroactive application of the FCA is not barred by the Ex Post Facto Clause of the United States Constitution. One justice filed a dissent on the grounds that the tax law is an ambiguous statute and the ambiguity must be resolved in favor of the taxpayer. State v. Spring Nextel Corp., New York Court of Appeals, No. 127. 10/20/15
  

TV Station Not High Tech Company
A television station does not constitute a "qualified high technology company" for tax preference purposes under a District of Columbia Court of Appeals decision that found that the legislative history indicated that tax preferences were designed to draw high tech developers and not to reward users of technology.

The taxpayer is a television station in the District of Columbia wholly owned and operated by NBC Universal Media LLC and was assessed a sales and use tax deficiency by the District's Office of Tax and Revenue (OTR), on the ground that it was not a Qualified High Technology Company (QHTC) as defined by the D.C. Code. It was, therefore, not eligible for the tax preference the District grants to such companies.

In its reply brief, the taxpayer argues that it meets the definition of a QHTC because it generates its receipts from information and communication technologies by using these technologies, equipment and to create and transmit the television programming from which it derives most of its revenue through on-air advertising. OTR argued that the language in the statute required a much closer nexus between the activities listed and a QHTC's revenues than purchase and use of high technology equipment and systems. OTR argued that, under the taxpayer’s interpretation, any company otherwise meeting the definition would gain preferred tax treatment by investing heavily in information and communication technologies that it in turn uses to market its products or services. It was OTR’s position that the QHTC tax preferences instead were enacted to incentivize companies engaged in the development and marketing of high technology systems and applications to locate in the District of Columbia, rather than provide a boon to companies that purchase the technology to generate revenues from other sources.

The court said that the language itself of the code section supported, though not unqualifiedly, OTR’s understanding. It said that although the broad reference to "[i]nformation and communication technologies . . . that involve advanced computer software and hardware [etc.]" could be read to include purchaser-users as well as developers or makers of those technologies, other enumerated activities point instead to the originating, enabling or supporting of high-technology use. The court’s opinion also said that the statutory language alone did not answer the question before it and, therefore, turned to the legislative history of the provision. The committee report that accompanied the legislation, Bill 13-752, the "New E-Conomy Transformation Act of 2000," stated that the legislation was designed to increase revenues by promoting the entry and expansion of "the 'new' high technology economy" in the District, which the report said was associated with activity in Northern Virginia and surrounding suburbs.

This statement of purpose, the court observed, contained no hint that the D.C. Council saw advantage in providing tax exemptions to companies that merely use technology in their business, as well as to "New E-Conomy" companies engaged in developing and producing such technologies. In the accompanying revenue analysis for the bill, the District estimated how many high technology companies would benefit from the incentive and used data based on a definition of high-technology businesses, admittedly evolving, that included 45 SIC codes used by the federal government, and this grouping did not include the SIC code for television broadcasting stations or for radio, television and publishers’ advertising representatives. The court stated that it was likely that the District Council was willing to grant latitude to OTR in interpreting the definition of QHTC as the industry’s understanding of high technology evolved, and held that the lower court’s conclusion that the taxpayer’s operation did not come within the meaning of QHTC activity was reasonable. NBC Subsidiary WRC-TV LLC v. Office of Tax and Revenue, District of Columbia Court of Appeals, No. 14-AA-174. 10/22/15

 

Personal Income Tax Decisions

Payments to Retired Partner Not Deductible Retirement Income
Payments made by a law firm to a retired partner did not qualify as deductible retirement or pension income in a recent opinion by the Michigan Court of Appeals because the plan was unqualified and the payments did not come from a pension trust.

The taxpayer was a partner with a Wisconsin law firm before retiring in 2005. Pursuant to the partnership agreement, a partner would continue to participate in the earnings of the partnership after retirement, if the partner met certain eligibility requirements, and the benefit, which was guaranteed for the remainder of the retired partner’s life, was characterized as a retirement benefit. The record reflects that it is undisputed that the benefit is an unqualified pension plan under federal law. The taxpayer met the partnership's eligibility criteria and began receiving payments after his retirement. The taxpayer and his spouse did not initially deduct these payments from income for purposes of calculating taxable income under the state law, but in 2011, filed amended state returns for the 2007, 2008, and 2009 tax years, claiming that they were entitled to deduct the retirement benefits paid by the firm for those tax years. The Department of Revenue (DOR) denied the request for a refund in June 2012.

The state statute provides that a taxpayer other than a corporation, estate, or trust has a taxable income equal to his or her adjusted gross income as defined by the internal revenue code (IRC). The statute further provides that a taxpayer may deduct from his or her taxable income certain retirement or pension benefits included the adjusted gross income, and these retirement or pension benefits are defined in the statute to mean certain qualifying distributions from retirement and pension plans. In dispute here is whether the distributions at issue meet the criteria stated in the statute, which provides that a qualifying distribution includes distributions from "retirement and pension plans" that do not constitute a qualified plan under the internal revenue code.

The court noted that the legislature provided that distributions from plans maintained by governmental entities and by a church or convention or association of churches may be deducted without regard to the source of the distributions. In contrast, however, the legislature stated that distributions from "[a]ll other unqualified plans" may be deducted under MCL 206.30(1)(f)(iv), but only to the extent that the unqualified plans "prescribe eligibility for retirement and predetermine contributions and benefits if the distributions are made from a pension trust." The court said, therefore, that in order for a distribution from an "unqualified pension" plan other than those maintained by governmental entities and by a church or convention of association of churches to be eligible for deduction under the state statute, the distribution must be made from a pension trust.

The taxpayers argue, on the other hand, that distributions could qualify for deduction under that provision if they are from either (1) a plan that prescribes eligibility for retirement, or (2) from a pension trust, so long as the contributions and benefits are predetermined. The court rejected this interpretation, finding that the taxpayer’s application of the last antecedent rule results in a strained construction that requires the reader to infer that the legislature intended to allow a deduction for distributions from "[a]ll other qualified plans that prescribe eligibility for retirement" without regard to whether the distributions came from a pension trust and then intended to allow a deduction for distributions from "[a]ll other unqualified plans" that "predetermine contributions and benefits," but only if the distributions from those plans were "made from a pension trust." The court said that the problem with the taxpayer’s construction of the statute is that nearly every pension plan, including those offered by governments and churches, prescribes eligibility for enrollment, and an interpretation that included a deduction for a pension plan simply because it prescribes eligibility for enrollment would render the provisions of MCL 206.30(8)(b)(i) and (b)(ii) surplusage. The court said that when read as a whole, the taxpayer’s construction of the statute is not plausible. Because it is undisputed that the distributions at issue were not from a pension trust, the court held that they were not entitled to deduct those distributions from their gross income. Feldkamp v. Dep't of Treasury, Michigan Court of Appeals, No. 321735. 10/20/15
Payments to Retired Partner Not Deductible Retirement Income

Payments made by a law firm to a retired partner did not qualify as deductible retirement or pension income in a recent opinion by the Michigan Court of Appeals because the plan was unqualified and the payments did not come from a pension trust.

The taxpayer was a partner with a Wisconsin law firm before retiring in 2005. Pursuant to the partnership agreement, a partner would continue to participate in the earnings of the partnership after retirement, if the partner met certain eligibility requirements, and the benefit, which was guaranteed for the remainder of the retired partner’s life, was characterized as a retirement benefit. The record reflects that it is undisputed that the benefit is an unqualified pension plan under federal law. The taxpayer met the partnership's eligibility criteria and began receiving payments after his retirement. The taxpayer and his spouse did not initially deduct these payments from income for purposes of calculating taxable income under the state law, but in 2011, filed amended state returns for the 2007, 2008, and 2009 tax years, claiming that they were entitled to deduct the retirement benefits paid by the firm for those tax years. The Department of Revenue (DOR) denied the request for a refund in June 2012.

The state statute provides that a taxpayer other than a corporation, estate, or trust has a taxable income equal to his or her adjusted gross income as defined by the internal revenue code (IRC). The statute further provides that a taxpayer may deduct from his or her taxable income certain retirement or pension benefits included the adjusted gross income, and these retirement or pension benefits are defined in the statute to mean certain qualifying distributions from retirement and pension plans. In dispute here is whether the distributions at issue meet the criteria stated in the statute, which provides that a qualifying distribution includes distributions from "retirement and pension plans" that do not constitute a qualified plan under the internal revenue code.

The court noted that the legislature provided that distributions from plans maintained by governmental entities and by a church or convention or association of churches may be deducted without regard to the source of the distributions. In contrast, however, the legislature stated that distributions from "[a]ll other unqualified plans" may be deducted under MCL 206.30(1)(f)(iv), but only to the extent that the unqualified plans "prescribe eligibility for retirement and predetermine contributions and benefits if the distributions are made from a pension trust." The court said, therefore, that in order for a distribution from an "unqualified pension" plan other than those maintained by governmental entities and by a church or convention of association of churches to be eligible for deduction under the state statute, the distribution must be made from a pension trust.

The taxpayers argue, on the other hand, that distributions could qualify for deduction under that provision if they are from either (1) a plan that prescribes eligibility for retirement, or (2) from a pension trust, so long as the contributions and benefits are predetermined. The court rejected this interpretation, finding that the taxpayer’s application of the last antecedent rule results in a strained construction that requires the reader to infer that the legislature intended to allow a deduction for distributions from "[a]ll other qualified plans that prescribe eligibility for retirement" without regard to whether the distributions came from a pension trust and then intended to allow a deduction for distributions from "[a]ll other unqualified plans" that "predetermine contributions and benefits," but only if the distributions from those plans were "made from a pension trust." The court said that the problem with the taxpayer’s construction of the statute is that nearly every pension plan, including those offered by governments and churches, prescribes eligibility for enrollment, and an interpretation that included a deduction for a pension plan simply because it prescribes eligibility for enrollment would render the provisions of MCL 206.30(8)(b)(i) and (b)(ii) surplusage. The court said that when read as a whole, the taxpayer’s construction of the statute is not plausible. Because it is undisputed that the distributions at issue were not from a pension trust, the court held that they were not entitled to deduct those distributions from their gross income. Feldkamp v. Dep't of Treasury, Michigan Court of Appeals, No. 321735. 10/20/15

  
Corporate Income and Business Tax Decisions

No cases to report.

  

Property Tax Decisions

Homestead Exemption Occupancy Timing Rules Clarified
The Ohio Court of Appeals held that a taxpayer was entitled to a homestead exemption, finding that the county board's requirement that the taxpayer occupy the residence on January 1 of the taxable year in order to be eligible for the exemption was an unreasonable interpretation.

The taxpayer purchased the subject property in August, 2012 and in January 2014 filed an application for a homestead exemption for the tax year 2013. The application provided that the taxpayer certify, under penalty of perjury, that, among other things, he occupied the property as his principal place of residence on January 1 of the year for which he was requesting the exemption. The taxpayer’s application was denied because the new income threshold limits effective for tax year 2014 were applied and his income exceeded the new threshold. Taxpayer appealed arguing that he qualified because he turned 65 years of age during the tax year and his income was not subject to the threshold requirement. The Board of Review (BOR) denied his appeal contending that his income was in excess of the 2014 threshold. The trial court affirmed BOR’s decision on the basis that the taxpayer did not own the property on January 1 of 2013, and this appeal resulted.

In 1971, the legislature provided tax relief to residential property owned and occupied by persons 65 and over, in the form of a credit against real property taxes. This homestead credit was tied to the income of the owner-occupants of the property and was originally available only because of the age of the owner-occupants. It was later amended to include in the exemption permanently and totally disabled homeowners, certain surviving spouses who did not independently qualify for the reduction, mobile and manufactured homes, and units in a housing cooperative. In 2007, the legislature amended the credit provision, eliminating the income test as a restriction, with the result that the homestead exemption provided tax relief on $25,000 of a property's value whenever the owner-occupants satisfied the age or disability criteria. In 2013, the legislature amended the homestead exemption, beginning in tax year 2014, by limiting future homestead exemptions to applicants whose income did not exceed $30,000.00. In that same 2013 legislation the legislature included a provision that individuals who turned 65 years of age in 2013 would be eligible for the credit if they filed a "late application," a process set forth in the statute. That statutory provision provides that if the information within the late application is correct, the auditor shall determine the amount of the reduction in taxes to which the applicant would have been entitled for the preceding tax year had the applicant's application been timely filed and approved in that year.

The court looked to the legislative intent of these provisions to interpret the relevant statute. The taxpayer contended that the legislature did not intend to reject an otherwise qualifying applicant from receiving the homestead exemption simply because the applicant purchased a new home and argued that when the legislature amended the homestead exemption statutes, it did not specifically require that the applicant must own the property on January 1 of the tax lien year. Citing Dugan v. Franklin Cty. Bd. of Revision, 10th Dist. Franklin No. 14AP-351, 2014-Ohio-4491, discretionary appeal not allowed, 142 Ohio St.3d 1411, 2015-Ohio-1099, BOR argued that the taxpayer is not entitled to the exemption because he did not own and occupy the residence on January 1, 2013. The court rejected BOR’s argument, finding that Dugan was distinguishable from the current matter because the taxpayers did not occupy the homestead at the time of their application and because the applicable statute relied on by the court in Dugan was a prior versions. The court said in this case that the taxpayer occupied the homestead at the time of his application and noted, in particular, that the legislature had modified the requirements for the approval or denial of the exemption by deleting any reference to the January 1 tax lien date. The court also said that had the legislature intended to carve out an exception to the late application process for applicants who moved during the tax year 2013, it would have done so. The court found, therefore, that an interpretation of the statute that requires the applicant to occupy the residence as of January 1, 2013, for the tax year 2013 homestead exemption is inappropriate and the county’s denial of the taxpayer’s application was unreasonable. Devan v. Cuyahoga Cnty. Bd. of Revision, Ohio Court of Appeals, No. 102945. 10.15.15
  

BTA Has Jurisdiction to Hear Property Valuation Dispute
The Ohio Supreme Court held that the Board of Tax Appeals (BTA) had jurisdiction to hear a real property valuation challenge that was originally filed in a state trial court by the taxpayer's receiver and then rejected by a board of review. The court reasoned that once the school appealed a ruling to the BTA, the taxpayer had no option but to appeal to the BTA as well. The court then remanded the matter to the board of review to vacate its dismissal and determine the property's value according to the trial court's order.

This case involves a real property valuation complaint for tax year 2008 filed by the taxpayer’s court-appointed receiver. The taxpayer is the former owner of the property at issue. The county Board of Revision (BOR) substantially reduced the valuation, but the taxpayer and the current property owners filed an appeal in the county Court of Common Pleas, which remanded the cause to the BOR. On remand, the BOR dismissed the complaint on the grounds that the complainant lacked standing. Subsequently, appellee Columbus City Schools Board of Education (Board) and then the taxpayer perfected appeals from the BOR's dismissal order to the Board of Tax Appeals (BTA). The BTA dismissed the appeals on the grounds that because the first appeal had been filed in the common pleas court, the BTA lacked jurisdiction to entertain an appeal from the BOR's dismissal order on remand.

The property at issue is a 16.592-acre site improved with a high-rise hotel and a water park. 
It was assessed for the year in question at more than $24 million with most of the value attributable to the buildings on the property. The taxpayer presented evidence at the BOR hearing that the property sold in 2010 for $5.5 million.

In the earlier proceeding, the common pleas court considered a motion filed by the school board that argued that the complaint had been invalid because the receiver lacked written authority to file the complaint at the time it was filed. The common pleas court stated that it disagreed with the contention that the receiver, which had been appointed after foreclosure proceedings were initiated, lacked written authority as required by the receivership order, and therefore had no standing to file the BOR complaint. The common pleas court also granted a motion to remand filed by the BOR and the auditor on the basis that the auditor's delegate failed to actually recuse himself from the vote after having indicating he would do so.

In the present matter, the Board, in support of its motion to dismiss, contends that taxpayer’s appeal failed to vest jurisdiction in the court because the taxpayer failed to serve the subsequent owners as appellees. The court cited case law to find that the service requirement is mandatory and jurisdictional and failure to comply requires dismissal of the appeal. However, the court said the record before the BTA revealed that counsel for the taxpayer also appeared on behalf of the subsequent owners, a factor not at issue in the cases cited by the Board. The court said that Ohio courts have held that when two parties in a case are represented by the same counsel, one party's having received notice or knowledge in the case imputes constructive notice or knowledge to the other and the court concluded that the principle in those cases extends to this matter and denied the Board’s motion to dismiss.

The BTA ruling dismissing the taxpayer’s appeal relied on prior case law suggesting that when there is concurrent jurisdiction, once one has exercised jurisdiction over a matter, the other cannot interfere with that tribunal’s authority. In this case the court of common pleas had previously exercised jurisdiction and, therefore, the subsequent appeal must also be heard before that court. The court here, however, noted that the subsequent appeal rule did not apply here. The statute gives an owner of property two options for appeal, but gives a board of education only one option. Once the Board had appealed the BOR's dismissal order to the BTA, the statute left the taxpayer no option but to pursue its own appeal to the BTA rather than to the common pleas court. The court found that because the school board filed an appeal of the second BOR decision with the BTA, the BTA possessed sole jurisdiction over appeals from the second BOR decision. When the common pleas court remanded the case to the BOR, it did not retain jurisdiction. As a result, the parties started over, with the proviso that the proceedings had to be conducted consistently with the orders issued by the common pleas court during the pendency of the first appeal. The court held that BOR lacked the authority to dismiss the case for lack of standing after the common pleas court ruled that there was standing. The court found that circumstances of the case were disturbing with respect to the BOR's disregard of its duty to abide by the orders issued by a reviewing court, stating that the law-of-the-case doctrine dispositively applies in this matter. Here, the law of the case at issue is the common pleas court's decision on whether the complainant had standing and, consequently, whether the BOR had jurisdiction. As the "inferior court," the BOR was bound by the standing decision of the common pleas court, and it lacked authority to act contrary to it. The court remanded the cause to the BOR with instructions that it determine the value of the property in accordance with the common pleas court's remand order. Columbus City Schools Bd. of Educ. v. Franklin Cnty. Bd. of Revision, Ohio Supreme Court, No. 2013-0514. 10/20/15

 

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
October 16, 2015 Edition

NEWS

Airbnb Update
Airbnb Inc. will begin collecting and remitting all lodging-related taxes, both state and local, in Washington state as of October 15. In addition, city officials in Jersey City, New Jersey announced that Airbnb Inc. agreed October 12 to collect and remit the 6 percent hotel tax imposed by the city. Airbnb already collects and remits hotel and tourist taxes in the District of Columbia, San Francisco, San Diego, Chicago, Philadelphia, Portland, Oregon, and Malibu, California. It also collects hotel and tourist taxes statewide in North Carolina, Oregon, and Rhode Island. 
  

Texas Tax on Small Tobacco Companies Update
On October 9, 2015, the Texas Supreme Court agreed to review the Court of Appeals decision in October 9 to review Hegar v. Texas Small Tobacco Coal, the case brought by the Texas Small Tobacco Coalition to protest a 55-cent-per-pack cigarette tax that has been levied on small cigarette manufacturers since 2013.

In 2013 the state legislature enacted the tax imposed on the sale of cigarettes and cigarette tobacco products manufactured by certain companies not signatories to the 1998 tobacco lawsuit settlement. Soon thereafter, the Coalition filed this suit against the state claiming the tax was unconstitutional because the tax imposed on small tobacco and the payments made by the participating manufacturers and the big tobacco companies are not equal and uniform. The state argued that the tax generates millions annually and advances important policies.

The court has set the case for oral arguments on December 8, 2015.


 

U.S. SUPREME COURT UPDATE

Cert Granted

Nebraska v. Parker, U.S. Supreme Court Docket No. 14-1406. Petition for Certiorari granted on October 1, 2015. Issue: Whether a 10 percent alcoholic beverage excise tax imposed by a Nebraska Indian tribe on top of state taxes already required to be collected is permitted. A group of retailers in the village of Pender, filed suit in federal district court challenging the imposition of the tax by the Omaha Tribe claiming that their location in the village is outside the tribe's taxing jurisdiction.

First Marblehead Corp. v. Massachusetts Comm'r of Revenue, U.S. Supreme Court Docket 14-1422. On October 13, 2015, the Petition for Certiorari was granted, the decision vacated and remanded for further consideration in light of the Court's decision in Comptroller of Treasury of Maryland v. Wynne. Issue: the state's method of sourcing taxpayer’s income from securitized loans for purposes of its property apportionment factor. See prior issue of State Tax Highlights for a more detailed discussion of the Massachusetts Supreme Judicial Court’s decision. [see summary of state decision]
  

Cert Filed

Hillenmeyer v. Cleveland Board of Review, U.S. Supreme Court Docket No. 15-435. On October 6, 2015 the City of Cleveland filed a petition for certiorari. Issue: Whether the city could use the games-played method for allocation of income for apportioning a professional athlete’s income for imposition of the city’s income tax. The Ohio Supreme Court struck down the city’s use of this method, holding that it violated due process because it did not reasonably associate the compensation taxed with the work performed in the city and finding that the city should, instead, use the duty-days method of allocation. [see summary of state decision]
  

Cert Denied

Commr. of Revenue of Minn. v. Nelson, U.S. Supreme Court Docket No. 15-62. On October 5, 2015 the Supreme Court declined to review a California Court of Appeals case in which the court denied a taxpayer’s motion to vacate a California judgment that was based on a Minnesota judgment. The Minnesota proceeding had found the taxpayer liable personally for unpaid taxed owned by companies that he controlled. Because due process had been afforded the taxpayer in Minnesota, California was required to accord the full faith and credit to the Minnesota judgment.

Schulze v. County of Erie, U.S. Supreme Court Docket No. 14-1399. On October 5, 2015 the Supreme Court declined to review the Pennsylvania Supreme Court’s denied of a petition to set aside a tax sale. A lower court had found that the taxpayer failed to follow the county’ rule when filing his motion to enjoin the tax sale and this error prevented the motion from being heard until after the sale. The court, therefore, dismissed the motion as moot.

John B. Corr, et al. v. Metropolitan Washington Airports Authority, U.S. Supreme Court Docket No. 13-1559. On October 5, 2015, the Supreme Court declined to hear an appeal from the Fourth Circuit in a case arguing that the tolls charged for passage on the Dulles Toll Road are taxes rather than user fees under the Virginia statute. The Fourth Circuit held that the tolls were user fees because the toll road users pay the tolls in exchange for a particularized benefit not shared by the general public, drivers are not compelled by government to pay the tolls or accept the benefits of the project facilities, and the tolls are collected solely to fund the project that also includes the Metrorail expansion, not to raise general revenues.

Hambleton v. Washington Dep't of Revenue, U.S. Supreme Court Docket No. 14-1436. On October 13, 2015 the Supreme Court declined to hear a challenge to Washington's retroactive change to its gift and estate tax laws. See prior issue of State Tax Highlights for a discussion of the Washington Supreme Court decision in this matter.

  

FEDERAL CASES OF INTEREST

  
Municipalities Again Denied Federal Class Status in OTC Suit
On September 28 the U.S. District Court for the Northern District of Illinois has, for the second time, denied class certification to 154 municipalities bringing suit against online travel companies (OTCs) for unpaid hotel accommodation taxes.

The first class petition was rejected by the court because the proposed class’s ordinances were too varied and numerous, and the municipalities filed a second motion for class certification in July seeking to remedy that problem by dividing the municipalities into five subclasses that reflected the different statutory schemes localities use to impose tax on hotels. The court found, however, that there was still not sufficient justification to certify a class in the case, because common questions would not predominate over questions of individual municipal code provisions. The court said that the plaintiffs failed to establish that, in each of the subclasses, the ordinances set materially identical legal standards, noting that it would, in all likelihood, be required to interpret each municipal ordinance at issue because many of them had been amended during the period at issue in the case and do not have materially identical legal standards across the subclasses. The court noted that more than half of the ordinances do not define what an owner or operator is and the court would have to interpret each ordinance to determine the definition and establish that the ordinances are sufficiently similar to constitute a class. The court concluded that this issue and others undermined the possibility that managing this matter as a class action would be superior to individual proceedings. Vill. of Bedford Park v. Expedia Inc., U.S. District Court for the Northern District of Illinois, Case No. 1:13-cv-05633. 9/28/15

 

DECISION HIGHLIGHTS

Sales and Use Tax Decisions

True Object Test a Question of Fact
The South Carolina Court of Appeals held that a portable toilet company was subject to sales tax on its proceeds finding that the true object of its sales was the rental of tangible personal property, not the service of removing and disposing of human waste.

The taxpayer operates a portable toilet company in the state. The taxpayer did not have a sales tax license and had never collected the tax from customers. The state Department of Revenue (DOR) assessed the taxpayer for sales tax on the gross proceeds from it portable toilet business. The taxpayer argued that the true object of the business was the service of removal and disposal of human waste and, therefore, was not subject to the sales and use tax.

The lower court found that the true object sought by the customer was the use of the portable toilets and other tangible personal property. The court here said that the dispute was not primarily a question of statutory interpretation. Both parties agreed that if the transactions at issue are a rental or lease of tangible personal property, the sales and use tax applied, and if the transactions are a service, the sales and use tax does not apply. The court said the issue presented is a question of fact, whether the customer’s purpose for entering the transaction was to procure a good or a service. It is subject to the substantial evidence standard of review, that is, whether the evidence, taken as a whole, would allow reasonable minds to reach the conclusion that the administrative agency reached. The court found that there was substantial evidence supporting the lower court’s finding that the true object of the transactions was the rental or lease of the portable toilets. It cited the fact that the taxpayer’s website stated that she was in the business of renting portable toilets and said that in 1969 the company became the first portable toilet rental business in the state. It also noted that the taxpayer’s service agreements with customers states that the customer requests “delivery and use of portable toilets.” The court also found evidence the customer is paying for the use of the taxpayer’s personal property for a limited amount of time, an arrangement essential to a lease or rental. The court reviewed the evidence for transactions involving special events for which the taxpayer charges a higher fee and found that one could reasonably infer from the higher costs depending on the type of special event toilet that the customer is paying a premium for extra amenities provided with the toilet. Consequently, this is evidence the customer is interested in the use of the toilet, rather than the removal of human waste.

After reviewing the record as a whole, the court found that there was substantial evidence supporting the lower court’s order. Boggero v. Dep't of Revenue, South Carolina Court of Appeals, Appellate Case No. 2014-000214. 9/30/15
  

Use Tax on Golf Course Irrigation System Upheld
The Ohio Court of Appeals, Ninth District, held that a taxpayer owed use tax for construction and installation of an irrigation system on a golf course. The court found that the system did not have a distinct purpose separate from the business of the golf course and was installed with the primary intent of benefitting the business.

In 2003, the taxpayer decided to build a new golf course in the state and hired a general construction company and a company to construct and install an irrigation system. At issue here is the use tax imposed on amounts paid to install the irrigation system. The taxpayer, on appeal, argued that the monies paid for the installation of the irrigation system are not subject to the tax because the irrigation system should be considered real property for tax purposes because it has become affixed to the land. The facts in the case were not in dispute.

The court cited a recent state Supreme Court decision that addressed the distinction between business fixtures and fixtures on real property in Metamora Elevator Co. v. Fulton Cty. Bd. of Revision, Slip Opinion No. 2015-Ohio-2807 and noted that the distinction is significant because business fixtures are classified as personal property and are not subsumed within the real property tax assessment. The state statute defines "fixture" on real property as "an item of tangible personal property that has become permanently attached or affixed to the land or to a building, structure, or improvement, and that primarily benefits the realty and not the business, if any, conducted by the occupant on the premises." R.C. 5701.02(C). A "business fixture" is defined by R.C. 5701.03(B) as "an item of tangible personal property that has become permanently attached or affixed to the land * * * and that primarily benefits the business conducted by the occupant on the premises and not the realty."

The court said that the Supreme Court in the Metamora decision recognized it is apparent that the legislature expressed its intent that fixtures are real property and that business fixtures are personal property. The lower court determined that the irrigation system did not constitute real property finding that the specialized system was designed and installed to address the unique needs associated with the business of the golf course. The lower court also found that the taxpayer separately purchased the irrigation pipes and materials, supporting the court’s determination that the contract with the irrigation contractor could not be construed as a construction contract. The taxpayer relied on a lower court decision, Inverness Club v. Wilkens, BTA No. 2004-R-338, 2007 WL 1453730 (May 11, 2007), which the taxpayer argued stands for the proposition that a golf course irrigation system is not a business fixture as defined by R.C. 5701.03(B), but instead is a fixture that has become affixed to the land, and is considered realty and non-taxable. The court here, however, distinguishes Inverness from the current case, finding that Inverness dealt with modernizing an existing golf course with the intent to improve playability, improve drainage and change the difficulty level.

This required extensive renovations and the question was whether the reconstruction equated to landscaping and lawn care services or construction. The court in this matter said that the taxpayer’s reliance on Inverness in support of his statutory and constitutional arguments is misguided because the lower court’s decision in Inverness made no conclusions with regard to whether the irrigation system constituted a business fixture.

The court found in the present matter that review of the evidence before the lower court further supported the conclusion that its decision was reasonable and lawful. While removing the irrigation system would cause injury to the land, the court drew the distinction between the damage caused by the removal of an irrigation system and undoing permanent fabrication and construction to the property as was discussed in Inverness. Though removing an irrigation system would result in temporary damage, such damage could be repaired and the court said that it was apparent from the record that the installation of the irrigation system was separate from the construction of the golf course, with the primary intent of benefitting the business. In addition the record reflected that golf course irrigation systems are specialized and sophisticated irrigation systems and are not akin to residential sprinkler systems, and the taxpayer had not identified an independent use of the irrigation system distinct from the golf course business. Hoffman Prop. Ltd. P'ship v. Testa, Ohio Court of Appeals, Ninth District, 2015-Ohio-3931; C.A. No. 14CA0041-M. 9/28/15

Intangibles in Telecom Contracts Not Taxable
The California Court of Appeal, Second District, held that sales tax was erroneously assessed on a telecommunications manufacturer's sales of equipment and software to telephone companies, finding that intangible portions of the contracts, like software, are not taxable.

The taxpayer is a manufacturer of sophisticated telecommunications equipment and sells the equipment to a number of different telephone companies who use it to provide telephone and Internet services to their customers. In the transactions at issue here, the companies paid for (1) the equipment, (2) written instructions on how to use the equipment, (3) a copy of the computer software that makes the equipment work, and (4) the right to copy that software onto the equipment's hard drive and thereafter to use the software to operate the equipment.

The court cited Nortel Networks Inc. v. State Board of Equalization (2011) 191 Cal.App.4th 1259, which held that an almost identical transaction satisfied the requirements of California's technology transfer agreement statutes and, as a result, the manufacturer was responsible for paying sales taxes only on the tangible portions of the transaction (the equipment and instructions), but not the intangible portions (the software and rights to copy and use it). The court rejected the state’s argument that this matter could be distinguished from Nortel because the software was transferred on magnetic tapes and compact discs rather than over the Internet, finding that this method of transfer does not turn the software itself or the rights to use it into tangible personal property subject to the sales tax.

The court also found that a "technology transfer agreement" within the meaning of the pertinent statutory provisions, which exempts from the sales tax the intangible portions of a transaction involving both tangible and intangible property, can exist when the only intangible right transferred is the right to copy software onto tangible equipment, and such an agreement can exist as long as the grantee of copyright or patent rights under the agreement thereafter copies or incorporates a copy of the copyrighted work into its product or uses the patented process, and any of these acts is enough to render the resulting product or process "subject to" the copyright or patent interest. The court also found that the lower court did not abuse its discretion in awarding the manufacturer reasonable litigation costs in light of the State Board of Equalization’s opposition to the taxpayer’s position that was supported by Nortel and other binding decisions and statutory law. Lucent Tech. Inc. v. State Bd. of Equalization, California Court of Appeals, Second Appellate Division, B257808. 10/8/15

 

Personal Income Tax Decisions

DOR Has to Follow Its Own Regulations
The Kansas Court of Appeals held that the Court of Tax Appeals (COTA) failed to consider the Department of Revenue (DOR) regulations in determining whether a taxpayer was domiciled in the state for individual income tax purposes. The court dismissed the taxpayer’s constitutional arguments and remanded the case for further proceedings.

This case concerns the disputed tax-residency status of the taxpayer for tax years 2005 and 2006. The taxpayers argued here that COTA erroneously ignored or disregarded almost all regulations adopted by DOR regarding tax-residency status. The taxpayers also challenged the constitutionality of DOR’s 2006 amendment to its regulation, arguing that it lacked any ascertainable standard, was unconstitutionally vague, and violated due process. The taxpayer and DOR were previously before the court on a petition for declaratory judgment challenging the constitutionality of the regulation on domicile and the court held that the trial court properly determined that it lacked subject matter jurisdiction over the taxpayer’s declaratory judgment action.

The court in this matter said that the ultimate question before it was whether COTA furnished adequate support or reasons for its failure to apply DOR’s regulations that listed objective criteria to be used in determining a taxpayer's tax-residency status in determining the taxpayer’s tax-residency status for the tax years 2005 and 2006. The court noted that in making its decision, COTA expressly admitted that it was "ignoring all presumptions contained in the current regulation." COTA's reason for ignoring the regulation was that "[t]he current regulation restates and incorporates existing common-law principles and evidentiary standards." COTA chose to rely instead on state statutory law and case law.

The taxpayers maintain that they were deprived of due process when COTA decided to rely on a common-law approach as opposed to applying DOR’s published regulations, arguing that the regulations were the only notice that taxpayers had of the factors that would be used to determine domicile. DOR contended that the taxpayers incorrectly argued that the regulations are separate and different than the common law, arguing, instead, that the regulations are a detailed reflection of existing statutory and case law and that COTA essentially applied the regulations.

The court said that the DOR Secretary promulgated the regulations as a means of evaluating taxpayers' tax-residency claims and once a regulation has been adopted, neither the Secretary nor his or her subordinates are free to ignore the regulation. It said that COTA is not free to ignore regulations that DOR has adopted. The court noted that it is well established that COTA must give adequate reasons for its decisions. In its order in this matter, COTA focused exclusively on state statutory law and case law, including the Restatement (Second) of Conflict of Laws, concerning the taxpayer’s tax-residency status.

The court said that COTA ignored the regulations and essentially reasoned that the regulations are meaningless because they are simply a reflection of existing statutory and case law. The court noted, however, that DOR is ordered to adopt rules and regulations for the administration of the state Income Tax Act, and said that because the regulations have the force and effect of law it is disingenuous to say that the regulations are meaningless and should be completely ignored. The taxpayers cited Tew v. Topeka Police & Fire Civ. Serv. Comm'n, 237 Kan. 96, 697 P.2d 1279 (1985) for the proposition that, in the application of administrative rules and regulations, when an agency fails to follow the rules which it has promulgated, its order is unlawful, and COTA was not free to ignore the previously cited regulations which DOR adopted. The court found that the failure to apply the applicable regulations was a prime example of an erroneous application of the law and a clear and express failure to follow prescribed procedure and vacated the decision. It remanded the case to COTA for readjudication consistent with the opinion, instructing COTA to consider the regulations along with controlling statutory law and case law in determining the taxpayer’s tax-residency status for the years in question. The court declined to address the taxpayer’s constitutional challenge because of the remand for further findings in accordance with the applicable regulations. One justice filed a dissent finding that COTA correctly applied state law in this matter. In re Bicknell, Kansas Court of Appeals, No 111,202. 9/25/15

  
Corporate Income and Business Tax Decisions

LLC Withholding Tax Challenge Dismissed on Jurisdictional Grounds
The Indiana Court of Appeals held that a trial court did not have jurisdiction to hear a limited liability company's challenge to withholding taxes. Because the case involved a challenge to an assessment, the court said it should have originated in the tax court.

Companies doing business with the state Department of Revenue (DOR) utilize two different unique identification numbers, their federal tax identification number (FEIN) and the state tax identification number (TID) assigned to them after they register with DOR. The taxpayer is an LLC organized in the state and in May 2011 it filed electronically a form with DOR with its FEIN number indicating its location in the state and the fact that it had begun withholding taxes from a state resident or employee, obligating it to begin collecting and remitting the state’s withholding tax. When the taxpayer did not comply with these requirements DOR issued proposed assessments for the third and fourth quarter of 2011. Subsequently, a warrant for collection of tax was issued for the taxpayer. The taxpayer subsequently filed zero due returns for the quarters in question and the assessments were cancelled by DOR. When returns were not filed for 2012 and 2013 assessments were issued by DOR. The assessments were converted to judgment and collection efforts were initiated, including a levy on the taxpayer’s bank account. The taxpayer filed a complaint for injunctive relief and damages, requesting the release of the levy that was done on July 21, 2014. Following a hearing, the trial court denied the request for a temporary restraining order and injunction, concluding that the request for injunctive relief was moot. The court did, however, evaluate the taxpayer’s request in accord with the standards applicable to Indiana Trial Rule 65 and concluded that the requests for injunctive relief failed on the merits and the taxpayer filed an appeal from that determination.

The standard of review in this matter required a determination of whether the trial court's findings supported its judgment and the court will reverse only when the trial court's judgment is clearly erroneous. Taxpayers argued that its had established all of the requisite elements to obtain injunctive relief, but the relief sought was resolution of the assessment and collection of the tax assessed against it because the taxpayer claims it is not owed. DOR argued that under either scenario the jurisdiction over such claims was with the state Tax Court and not the state superior court. The court here noted that the state code clearly provides that the tax court has exclusive jurisdiction over any case that arises under the tax laws of the state and that is an initial appeal of a final determination made by DOR with respect to a listed tax.

The court held that the claim in this matter clearly involved a challenge to a collection of a tax or assessment and was within the exclusive jurisdiction of the Tax Court. The court noted that when an unpaid tax assessment is reduced to judgment, a circuit or superior court acquires jurisdiction for the limited purpose of enforcing the judgment, but said that the taxpayer asked the Superior Court for relief in excess of that limited power. Troyan v. Dep't of Revenue, Indiana Court of Appeals, Court of Appeals Case No. 49A02-1411-PL-794. 9/30/15
  

Court Upholds Constitutionality of Repeal of Multistate Tax Compact
On September 30, the Michigan Court of Appeals affirmed the Court of Claims’ finding for the state’s Department of Revenue (DOR) in 50 consolidated cases challenging the state's retroactive repeal of the Multistate Tax Compact and the use of its three-factor formula for apportionment of income.

These cases involved a number of state and federal constitutional challenges to 2014 PA 282, which the legislature enacted to retroactively rescind Michigan's membership in the Multistate Tax Compact, in reaction to the state Supreme Court’s decision in Int'l Business Machines Corp v. Dep't of Treasury, 496 Mich 642; 852 NW2d 865 (2014). That action by the legislature then precluded foreign corporations from utilizing a three-factor apportionment formula previously available under the Compact until 2011 when the legislature expressly repealed the Compact’s apportionment formula. The lower court rejected each of those arguments and this appeal followed.

Between 2011 and 2015 these multi-state taxpayers all filed suit in the Court of Claims seeking refunds due under the Compact that had been refused by DOR on the ground that the only apportionment method available was that established by the MBT. Most of the cases were filed prior to the Supreme Court's resolution of IBM, and the trial court held them in abeyance pending that decision. Quickly after the decision in IBM, which has previously been reported in State Tax Highlights, the state legislature enacted 2014PA 282 amending the Michigan Business Tax Act (MBT) and expressly repealing the Compact, effective January 1, 2008. It was the intent of the legislature that the repeal of the Compact expressed the original intent of the legislature to eliminate the election provision in the Compact when it provided in 2007 an apportionment factor in the Michigan business tax act

The court’s review of the lower court decision entering summary judgment in favor of DOR was de novo. The taxpayer in this case argued that the 2014 legislative action violated the Contract Clauses of the state and federal constitutions. The court noted that the presumption in cases like this one is that the presumption is that the statute is constitutional and the presumption is especially strong with tax legislation. The court said that in order to determine whether a contract clause’s prohibition should be accommodated, the Supreme Court has developed a three-prong test, the first part of which is whether the change in state law has operated as a substantial impairment of a contractual relationship. In the case here, the court found that there was not a contractual relationship because the Compact was not a binding contract under Michigan law. The court concluded that the Compact contained no features of a binding interstate compact and, therefore, was not a compact enforceable under the Contract Clause. The court also said that because the Compact is not binding, either as a contract or a compact, it is subject to Michigan law concerning the interpretation of statutes. The court also held that the retroactive repeal of the Compact did not violate the Due Process Clauses of either the state or federal constitutions or Michigan's rules regarding retrospective legislation.

The court noted that the federal courts and our state courts have uniformly held that the retroactive modification of tax statutes does not offend due process considerations so long as there is a legitimate legislative purpose that is furthered by a rational means. The court reviewed the case law in this area and held that the retroactive impact of 2014 PA 282 did not violate the due process clauses of either the state or federal constitutions because the plaintiffs had no vested right in the tax laws or in the continuance of any tax laws and did not have a vested interest protected by the due process clause in the continuation of the Compact's apportionment provision. The court also found that case law supports the proposition that the state legislature had a legitimate purpose for giving retroactive effect to 2014 PA 282, stating that it is legitimate legislative action to both correct a perceived misinterpretation of a statute, and eliminate a significant revenue loss resulting from that misinterpretation. The retroactive application of 2014 PA 282 was likewise a rational means to further these legitimate purposes.

The taxpayers also argued that retroactive application of 2014 PA 282 violates the Separation of Powers Clause of the Michigan Constitution. The court said that there is little doubt that the state legislature lacks authority to reverse a judicial decision or to repeal a final judgment, but it does have the authority, if not the obligation, to amend a statute that it believes has been misconstrued by the judiciary and this power to amend includes the power to retroactively correct the judiciary's misinterpretation of legislation. The court found that although 2014 PA 282 may have rendered moot the effect of the judicial interpretation in IBM, this action did not overturn the court's judgment and did not violate the separation of powers doctrine.

The court rejected the taxpayers’ argument that the retroactive legislation violated the Commerce Clause of the U.S. Constitution by discriminating against interstate commerce, holding that 2014 PA 282 does not discriminate against or unduly burden interstate commerce. It does not reflect an explicit discriminatory design, does not have a discriminatory purpose, and does not have a discriminatory effect. The court also concluded that the taxpayers were not denied the right to petition the government under the First Amendment of the federal Constitution or the Michigan provision, stating that the First Amendment right to advocate does not guarantee that the speech will persuade or that the advocacy will be effective. The court also rejected the taxpayers’ argument that there was a change of the original bill's purpose, that it violated the Five-Day Rule and that there was a violation of the Distinct-Statement Clause. Finally, while the court noted that summary disposition is premature if it is granted before discovery on a disputed issue is complete, it said that summary disposition is appropriate if there is no fair chance that further discovery will result in factual support for the party opposing the motion and found in this matter that discovery on this issue did not stand a fair chance of providing support for plaintiffs' position.

Gillette Commercial Operations N. Am. & Subsidiaries v. Dep't of Treasury, Michigan Court of Appeals, Nos. 325258; 325475; 325476; 325477; 325478; 325479; 325480; 325481; 325482; 325483; 325484; 325485; 325486; 325487; 325488; 325489; 325490; 325491; 325492; 325505; 325506; 325507; 325508; 325509; 325510; 325511; 325515; 325516; 325517; 325518; 325520; 325522; 325523; 325525; 325526; 325528; 325529; 325532; 325533; 325534; 325535; 325541; 325972; 325974; 326039; 326075; 326080; 326110; 326123; 326136. 9/29/15

  

Property Tax Decisions

Partial Hospital Tax Exemption on Personal Property Upheld
The Wisconsin Court of Appeals, District IV, held that some hospital personal property was tax exempt under the nonprofit hospital exemption because the taxpayer met its burden of proof to show that the area in question were not doctors' offices. The court found that the area was used to expand hospital space to provide for the sick.

The taxpayer, a non-profit corporation, owns and operates St. Mary's Hospital and sought a refund for property taxes levied by the City of Fitchburg against all of its personal property that was located in a renal center and a sleep center owned and operated by it in Fitchburg during the 2009, 2010, and 2011 tax years. The lower court ruled that some of taxpayer’s personal property in these two centers was exempt under the state’s non-profit hospital exemption and that the taxpayer was entitled to a refund for that property. The lower court ordered the taxpayer to itemized the items of personal property that were not entitled to the exemption, along with their estimated value, and permitted the City to contest the assigned value.

The undisputed facts are that the taxpayer leases two buildings in the City for the renal center and the sleep center and then subleases a portion of each, one to a physician group practice and the other to a health system. The taxpayer owns personal property that it keeps in the centers, including dialysis machines, furniture, computers, and other electronics. The taxpayer filed an asset list in July 2014, itemizing the personal property that it conceded was not exempt from taxation. It indicated one value for each piece of personal property that it conceded is not exempt from taxation, but did not provide separate values for each tax year. The city objected, arguing that the list was incomplete, and the taxpayer in August filed an amended list complying with the city’s objections.

The City filed this appeal, arguing that the non-profit hospital exemption does not apply here because the renal center and the sleep center are both used as a doctor’s office and, therefore, the personal properly located in those areas is taxable. The city also argued that the taxpayer’s initial claim for exemption was for all the personal property in each center and the taxpayer is now precluded from converting that request to a partial exemption.

The court reviewed three state cases providing guidance in considering whether property is used as part of a doctor's office and said that the determination of whether property is used as a doctor's office ultimately turns on the facts of each case. The court said that facts support a conclusion that the renal center is not used as a doctor's office. It is a freestanding medical facility and patients at the renal center receive bills from the renal center, which shares a common billing system with the hospital, separately from bills from their physicians. The services provided in the renal center were at one point provided at the hospital. The building that houses the renal center has approximately 28,000 square feet of space. SSM sub-leases a small portion of that space, approximately 641 square feet of exclusive space and 500 square feet of shared space, to the physician group practice MARS. The MARS physicians do not have offices within the renal center. The entrance to the renal center is separate from the entrance to the MARS group practice. MARS physicians do not perform consults with patients in the renal center, and some of the MARS patients do not receive treatment at the renal center. The renal center accepts patients from any physician with admitting privileges at the hospital. The court said the renal center is not exclusively used by patients seen by MARS physicians. The court noted that the city conceded that the establishment of the renal center in Fitchburg was part of an effort to free up space at the hospital and that the establishment of the renal center was part of an effort to provide treatment services in a more efficient and effective manner. The court found that the city’s facts favoring a conclusion that the center is used as a doctor’s office are not significant and found that, considering all of the relevant undisputed facts in light of the case law above, the taxpayer met its burden of establishing that the renal center is not a doctor's office under the statutory provision.

The sleep center is also housed in a freestanding facility. Patients of the sleep center also receive bills through the billing system at the hospital, and like the renal center, the sleep center was originally housed in the hospital. The taxpayer leases approximately twenty percent of that building to Dean Health Systems. Although the sleep center and the Dean Health Systems space share one entrance and share a waiting room, they have different receptionists and separate entrances coming off from the waiting room. The court noted that the city did not point to any evidence contradicting the lower court's conclusion that physicians don’t do a lot in the sleep center and that the sleep center is run primarily by and for the hospital. The court concluded, after considering all of the relevant undisputed facts in light of the case law, that the taxpayer met its burden of establishing that the sleep center is not a doctor's office.

Finally, the court rejected the city’s argument that the circuit court erred in denying it summary judgment because the taxpayer initially sought tax exemption for all personal property in each of the two centers and cannot subsequently convert the request into a partial exemption in the midst of litigation, saying that the City failed to explain why that failure should bar the taxpayer from being entitled to a refund for taxes levied against property that is tax-exempt. SSM Health Care of Wisconsin Inc. v. City of Fitchburg, Wisconsin Court of Appeals, Appeal No. 2015AP429. 9/24/15

 

Other Taxes and Procedural Issues

No cases to report.


 

The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected].

 
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