State Tax Highlights

Circuit Court Rules in New York v. United Parcel Service Inc Case

The U.S. Court of Appeals for the Second Circuit in New York v. United Parcel Service Inc. reduced a penalty award against UPS for knowingly shipping untaxed cigarettes from Native American reservations throughout New York state and New York City. The court still upheld nearly $100 million in penalties and taxes. The November 7, 2019 decision affirmed a trial court determination that UPS was liable for violations of the Prevent All Cigarette Trafficking (PACT) Act, the Contraband Cigarette Trafficking Act (CCTA), and state law, doubling the charge for unpaid state and local taxes from $9.4 million to $18.8 million. The court, however, concluded that the lower court’s penalty award was excessive and vacated close to $160 million of the almost $250 million in penalties the lower court had imposed. The state and New York City filed this suit against UPS in 2015, contending that the company knowingly shipped untaxed cigarettes from contraband cigarette enterprises on Native American reservations. They argued that this scheme cost the state and the city tens of millions of dollars in tax revenue. The state also alleged that this action by UPS violated
a 2005 settlement in which the company agreed to comply with state law and its own internal policy prohibiting the shipment of cigarettes to consumers which the company made in exchange for the state not bringing a civil suit for the company’s alleged violations of state law.

U.S. SUPREME COURT UPDATE

Cert Denied

Staples Inc. v. Comptroller of the Treasury of Maryland, U.S. Supreme Court Docket No. 19-119. Petition denied November 4, 2019. The Court refused to review Maryland’s taxation of an out-of-state business based on royalty payments made by an in-state related company. See the FTA’s legal database for a discussion of the decision of the Maryland Court of Special Appeals.
Petition Filed

Donald J. Trump v. Cyrus R. Vance Jr. et al. Petition filed November 14, 2019. President Trump has asked the Supreme Court to review a decision by the U.S. Court of Appeals for the Second Circuit that found that presidential immunity doesn’t apply in the suit to enjoin enforcement of a grand jury subpoena issued by the New York County district attorney to the president’s accounting firm for his financial records and tax returns. The president’s legal team argues that a sitting president cannot be subjected to criminal proceedings, even though the subpoena he is fighting is meant for his accounting firm.

FEDERAL CASES OF INTEREST

Suit Seeking Damages for Tax Collection Dismissed

The U.S. District Court for the Southern District of Ohio, Eastern Division dismissed an individual’s suit against IRS employees and the state tax commissioner (Commissioner) that sought damages for their attempts to collect taxes from her. The court adopted, over objections by the taxpayer, the magistrate judge’s report and recommendation, agreeing with the magistrate that the taxpayer failed to state a claim on which relief can be granted.

The taxpayer filed this action arguing that she "is one of the [s]overeign people who hold all political power according to Art. I, Sec. 2 of the Ohio [C]onstitution." She alleged that the IRS and the Commissioner demanded she pay unauthorized taxes on her labor and threatened to levy her labor for not paying the unauthorized taxes and these actions deprived her of her right to property, equal protection off the laws, and the pursuit of happiness. She also alleged the defendants abused their discretion, exceeded their authority, and acted outside of their official duties and that their actions caused her harm and damages through mental and physical suffering. She requested general and punitive damages and that the defendants be removed from their jobs.

The Magistrate Judge issued a Report and Recommendation, which recommended dismissing the action for failure to state a claim upon which relief may be granted and the taxpayer filed objections to the Report. The federal code provides jurisdiction to a district court if a party objects to a magistrate’s Report and Recommendation and the court may accept, reject, or modify, in whole or in part, the findings or recommendations made by the magistrate. The federal in forma pauperis statute is designed to ensure indigent litigants have meaningful access to the federal courts, but recognizing that a litigant whose costs are assumed by the public lacks economic incentive to refrain from filing frivolous, malicious, or repetitive lawsuits, Congress included a provision authorizing federal courts to dismiss certain claims which they determine are frivolous or malicious sua sponte. These complaints must also satisfy Federal Rule of Civil Procedure 8(a), requiring a "short and plain statement of the claim showing that the pleader is entitled to relief." Under case law, a claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.

The taxpayer’s first objection was her contention that she had not failed to provide a short and plain statement of the claim showing she is entitled to relief. The court noted that the Supreme Court has stated that a claim that a citizen’s status as a "sovereign citizen" relieves them of their obligation to pay taxes is "completely without merit and patently frivolous." Courts have found no merit in claims where petitioners assert the state or federal government has no jurisdiction over them because they are a "sovereign citizen." The court agreed with the Magistrate Judge that based on the caselaw the taxpayer’s claim that the attempted collection of taxes, and levy on her labor for nonpayment of taxes, violated her rights as one of the sovereign people who hold all political power is without merit and frivolous. The court, therefore, agreed with the Magistrate Judge that the taxpayer did not state a claim upon which relief may be granted and that her claim is frivolous.

The taxpayer also contended that she had never claimed to be a member of the "sovereign-citizen movement" but only claims to be one of the sovereign people of this country. The U.S. Court of Appeals for the Sixth Circuit described the sovereign citizen movement as a highly disperse, antigovernment movement, with tax protesting or tax defiance a logical consequence of the movement’s beliefs. Sovereign citizens believe that the U. S. Government, including the IRS, is a fraud and that they, the sovereign citizens, retain an individual common law identity exempting them from the authority of those fraudulent government institutions. The court noted that the Report and Recommendation does not assert that the taxpayer is involved in any particular movement but only that "Plaintiff’s Complaint appears to be asserting some form of ‘sovereign citizen’ claim" and the court found that statement correctly characterized the taxpayer’s claim. Patricia K. Davis v. Jeff McClain et al., U.S. District Court for the Southern District of Ohio, Eastern Division, No. 2:19-cv-03466. 11/8/19

D.C. Circuit Remands FOIA Case Against IRS

The U.S. Court of Appeals for the D.C. Circuit reversed a district court's grant of summary judgment to the Internal Revenue Service (IRS) IRS in a public interest law firm’s Freedom of Information Act (FOIA) suit seeking records from the IRS’s Asset Forfeiture Tracking and Retrieval System (AFTRAK). The court found that there was a genuine factual dispute regarding whether a report provided by the IRS contains all the requested records. The court also took issue with the IRS’s claim that AFTRAK is not a database. The court also vacated the district court’s holding that Exemption 7(A) applied to entire rows of the report it provided in response to the FOIA request without showing that non-exempt information could not be segregated. The court remanded the case to the district court for further proceedings.

The Institute for Justice, a non-profit, public interest law firm, filed a FOIA request seeking information kept by the IRS about asset forfeitures. The IRS’s own manual repeatedly refers to the Asset Forfeiture Tracking and Retrieval System (AFTRAK) as the “database” in which the agency compiles information about asset forfeitures and the Institute
submitted a FOIA request for “all records contained in” the AFTRAK database. The IRS's response was that the Institute's FOIA request failed from the start because AFTRAK is not a database and therefore its contents do not qualify as records under the FOIA. The IRS said that AFTRAK is a web-based application that aggregates information from various other sources within the IRS into a single user interface. According to the IRS, this distinction renders the Institute's request not just imprecise, but unintelligible.

After the Institute filed suit, the IRS created what it described as the “most comprehensive standard report from the AFTRAK system, the Open/Closed Asset Report,” and saved
the Report in PDF format, heavily redacted it, and provided it to the Institute. The Institute was unhappy with that result and filed a cross-motion for summary judgment. The district court awarded summary judgment in large part in favor of the IRS, reasoning that there was no need to resolve the technical question of whether AFTRAK was or was not a database, because the IRS generated a comprehensive report that revealed every possible data point on seized assets in the AFTRAK system during the relevant timeframe.

The court reversed the district court and remanded the case for further proceedings. It concluded that whether the Open/Closed Report covered all records “contained in” AFTRAK was itself a material, genuinely disputed question of fact, and the answer in turn depends on other disputed and material facts. It also determined that whether AFTRAK was correctly classified as a database, a matter on which the IRS's Manual and other official documents contradict its legal denial here, appeared to be an intermediate fact with potential consequences for resolving the parties' claims. These disputes, the court found, precluded summary judgment. Institute for Justice v. IRS, U.S. Court of Appeals for the District of Columbia Circuit, No. 18-5316. 11/1/19

DECISION HIGHLIGHTS

Sales and Use Tax Decisions

Software Purchases Refund Denied

The Pennsylvania Commonwealth Court ruled that a regulation providing that a seller-installer of security equipment to be installed in a financial institution is liable for the sales tax was superseded by a change in the law. This decision affirmed the court’s previous decision that a financial institution was properly denied a refund of sales tax it paid on purchases of computer software and related services under the statute.

The taxpayer, a commercial bank, filed exceptions to the court’s three-judge panel opinion and order in Victory Bank v. Commonwealth of Pennsylvania, 190 A.3d 782 (Pa. Cmwlth. 2018) (Victory Bank I), dated July 17, 2018 in which the court denied the taxpayer’s petition for refund because it was required to pay sales tax on its purchase of computer hardware, canned computer software, and related services. The taxpayer purchased the disputed items from three sellers and used all of the computer software and hardware for its protection or convenience in conducting financial transactions and it paid state sales tax on these purchases
The taxpayer initially filed a petition with the Department of Revenue's Board of Appeals (BOA) seeking a refund of sales tax paid on these purchases. The BOA denied the taxpayer’s request and the Board affirmed. The taxpayer filed an appeal to this court, arguing that its
purchases of computer software components, as well as related services, were excluded from tax pursuant to the DOR’s Financial Institution Security Equipment Regulation (FISE regulation), because the sellers or their designees installed the computer hardware and the bank used the computer and software for its protection or convenience in conducting financial transactions. The court originally concluded that it was undisputed that the taxpayer met the definition of a “financial institution” and that its computer system met the definition of “security equipment” under the FISE regulation. It determined, however, that statutory changes had superseded the definition of “construction contract” in the regulation.

The court said that it noted that when DOR first promulgated the FISE regulation there was no statutory definition of the term “construction contract,” so that if equipment was installed within the definitions under the regulation it amounted to a “construction contract” and the obligation to pay sales tax fell on the contractor/installer rather than the purchasing institution. When the Tax Code was amended by the legislature in 2002, the definition of “construction contract” was changed and the court said in its original decision that it clearly departed from the one found in the FISE regulation. The court further observed that a statute is law and trumps an administrative agency’s regulations. The court determined that the FISE regulation presented a conflict with the statutory definition and it was irrelevant that the FISE regulation had not been amended or repealed. because the Commonwealth was merely interpreting a self-executing act of the General Assembly. The court concluded that the taxpayer could not rely upon the FISE regulation to argue that the seller of the computer system, instead of it, owed the sales tax. The taxpayer filed exceptions to the court’s original decision.

The taxpayer alleged that under the CDL, the Commonwealth was precluded from seeking a judicial decision invalidating the FISE regulation and, accordingly, the court’s panel decision erred in concluding that the definition of “construction contract” in the regulation was superseded by statute. The Commonwealth argued, conversely, that the CDL did not preclude it from seeking application of a recently enacted and implemented statutory definition in defense of a request for a tax refund. The court reviewed the relevant administrative procedure and found that this case was readily distinguishable from prior court decisions because in the current case changes to the Tax Code rendered the FISE regulation inconsistent with the underlying statute.

The court found, first and foremost, that the amendment of the Tax Code resulted in the language of the FISE regulation being inconsistent with the statutory language. Under the FISE regulation, a “construction contract” includes the installation of security equipment by a financial institution. Once the Tax Code was amended in 2002, “construction contract” was defined in section 201 of the Tax Code as “[a] written or oral contract or agreement for the construction, reconstruction, remodeling, renovation or repair of real estate or a real estate structure. The court reaffirmed its decision on this issue that the statutory definition of “construction contract” clearly departs from the one found in the FISE regulation. The amendment of section 201 of the Tax Code resulted in the FISE regulation being in conflict with the underlying statute; and the court noted that under the law the statute takes precedence over the regulation without regard to whether DOR followed the procedure mandated by the CDL. Victory Bank v. Pennsylvania, Pennsylvania Commonwealth Court, No. 236 F.R. 2014. 10/16/19

Industrial Production Tax Exemption Ruling

The Minnesota Tax Court granted a motion for summary judgment filed by a company that uses a burn-off oven to remove accumulated powder coating from customers' personal property manufacturing equipment. The court found that the natural gas and electricity used by the taxpayer to operate the oven qualifies for the state’s industrial production sales tax exemption.

The Commissioner of Revenue (Commissioner) previously granted the taxpayer’s request for a capital equipment sales tax exemption for its burn-off oven, which it uses exclusively to clean accumulated powder coating from hooks, racks, and fixtures that its customers use to produce or manufacture tangible personal property to be sold at retail. In this matter the taxpayer sought an exemption and consequent refund of sales tax it paid for natural gas and electricity it used to operate the oven, arguing that the natural gas and electricity are exempt from sales tax because its cleaning of its customers' production equipment is a necessary component of the customers' industrial production. The Commissioner denied the taxpayer’s refund claim based on statutory language which provides in pertinent part that industrial production does not include painting, cleaning ,repairing or similar processing of property
except as part of the original manufacturing process. The taxpayer filed this appeal.

The state imposes a tax on the gross receipts from retail sales, with numerous business-related exemptions, including an exemption for materials used to produce tangible personal property.
That exemption is for materials stored, used or consumed in industrial production of tangible personal property intended to be sold ultimately at retail, are exempt, whether or not the item so used becomes an ingredient or constituent part of the property produced. The legislature provided a non-exclusive list of qualifying materials including chemicals and fuels, electricity, gas, and steam used or consumed in the production process. The facts here show that the taxpayer’s customers manufacture or produce tangible personal property to be sold at retail. As part of their production processes, those customers use metal hooks, racks, and fixtures to support parts, such as lawn mower decks, that must be sprayed with a non-liquid paint, also known as powder coating. The hooks, racks, and fixtures are production equipment. When powder coating accumulates on the equipment, which occurs after one or two uses, it can no longer conduct electricity and, consequently, cannot be reused in the production process without first being cleaned. The taxpayer operates a bum-off oven that removes the accumulated coating, allowing its customers to reuse the cleaned equipment in their production processes. The taxpayer’s use of its burn-off oven to remove accumulated coating from its customers' production equipment qualified the oven for the capital equipment exemption. At issue here is the sales tax refund claim for natural gas and electricity the taxpayer used to run its burn-off oven.

The taxpayer argued that the natural gas and electricity it used to operate the bum-off oven were exempt under the industrial production exemption. It pointed to the fact that the Commissioner’s prior determination that the burn-off oven itself was entitled to the capital equipment exemption meant that the oven constitutes an "essential" part of its customers' manufacturing or production processes and was necessarily part of “industrial production and the natural gas and electricity used to run the oven must be exempt from the tax. The Commissioner argued, on the other hand, that the equipment cleaning does not qualify as industrial production and is not part of the original manufacturing process. The Commissioner argued that the taxpayer cleans the equipment involved in the manufacturing process and the electricity and gas consumed in this process do not constitute materials consumed in industrial production.

The court said that to be non-taxable under the industrial production exemption, materials including natural gas and electricity must be "stored, used, or consumed in industrial production of tangible personal property intended to be sold ultimately at retail, and set forth a broad non-exclusive list of activities that qualify as “industrial production.” The statute then excludes from “industrial production” the painting, cleaning, repairing or similar processing of property except as part of the original manufacturing process. The court concluded that this post-production processing exclusion had no application to the facts presented. The court said that the provision consistently distinguished between tangible personal property created during industrial production, on the one hand, and productive machinery, tools, and equipment, on the other. The court said that because the statutory provision consistently distinguished between "property" on the one hand, and "machinery" and "equipment" on the other, it concluded that the post-production processing exclusion, which pertains exclusively to property, has no application to the cleaning of production equipment. The court said the taxpayer cleans production equipment that its customers use to produce tangible personal property to be sold at retail. After one or two uses, the taxpayer’s customers cannot reuse this equipment in the production process without first cleaning it. Accordingly, the court determined, the post-production processing exclusion in the provision, which deals with "property" rather than with machinery and equipment, was not applicable here. Inthermo Inc. v. Comm'r of Revenue, Minnesota Tax Court, Docket No. 9143-R. 9/10/19

Buyer of Marina Liable for Tax

The New York Supreme Court, Appellate Division, found that a company that purchased a marina and boat shop was liable for sales tax on all of the real property and assets acquired in the transaction.

In an asset purchase agreement, the plaintiffs sold the Gaines Marina & Gaines Marina Boat Shop and Storage Yard, located in the Town of Champlain, Clinton County, to the defendants.
The sale included, among other things, all real property and assets, tangible and intangible, used in connection with the marina. After the sale closed, the defendants registered the vehicles that they had acquired in the sale and paid the associated sales tax. The defendant
CMS Marina, LLC notified the Department of Taxation and Finance (T&F) of the sale and T&F subsequently notified the defendant that it was liable for the payment of $248,000 in sales tax on the tangible personal property it had purchased. The defendants appealed and the amount owed was subsequently reduced to $91,422. The defendants sought to recoup the sales tax owed on the assets acquired in the sale from the plaintiffs and the plaintiffs commenced this declaratory judgment action seeking a ruling that defendants, not them, were liable for the payment of the sales tax assessed by T&F. The court denied defendants' motion and granted plaintiffs' motion, declaring that plaintiffs were not responsible for payment of the disputed sales tax and the defendants filed this appeal. The defendants argued that the plaintiffs agreed in the asset purchase agreement to assume responsibility for the payment of sales tax due on any tangible personal property purchased or acquired and that the lower court erred in concluding otherwise.

The court, citing case law, said that courts must construe written agreements in accord with the parties' intent, and the best indicator of intent is what the parties say in their agreement
The relevant portion of the asset purchase agreement provided that certain liabilities shall remain the sole responsibility of the sellers. including certain liabilities for taxes. The court determined that the sections of the agreement when read together with the definitions do not provide for the plaintiffs’ assumption of liability for the payment of sales tax due on the acquired personal property — a liability that is statutorily imposed on defendants, as the purchasers. The court determined that the language of the agreement referred to any tax liabilities already imposed by law upon plaintiffs, as the sellers, and stated that any such liabilities will be retained. The court found that the plain language of the agreement did not evince an intent to shift liability for the payment of sales tax due on the acquired personal property to the plaintiffs. Gains Marina & Servs. Inc. v. CMS Marine Storage LLC, New York Supreme Court, Supreme Court, 2019 NY Slip Op 07825. 10/31/19

Personal Income Tax Decisions

Father Not Entitled to Exemptions for Children

The Minnesota Tax Court held that a father was not entitled to exemptions for his dependent children. The court found that the taxpayer and the children did not have the same principal place of abode for more than half of the year.

The taxpayer is the father of two children, a son who is now six years old and a daughter who is now four years old. For 2016 and 2017 state income tax purposes, the taxpayer treated both his son and his daughter as qualifying children and, on that basis, claimed dependent exemptions, Working Family Credits, a Dependent Care Credit, and Head of Household filing status. For both 2016 and 2017, the daughter’s mother also claimed her as a qualifying child and for 2017 the son’s grandmother claimed him as a qualifying child. For 2016, the Commissioner of Revenue (Commissioner) determined that the taxpayer could claim the son as a qualifying child, but not the daughter. For 2017, the Commissioner determined that the taxpayer could not claim either child as a qualifying child. As a result, the Commissioner recalculated the taxpayer’s state tax liability, which reduced his claimed refund for each tax year. The taxpayer filed this appeal.

The evidence at trial centered on whether the children had "the same principal place of abode" as the taxpayer for more than half of 2016 and 20 I 7, and on whether any other person had a superior right to claim them as qualifying children. The facts show that the son lived primarily with the taxpayer in 2016. In 2017, the son lived with him until January 17th . The grandmother testified that the son began living with her in late January 2017 and lived with her for the remainder of that year and testified that the son did not have any overnights with the taxpayer during that time. The taxpayer testified that he lived with the daughter and her mother in 2016 until September or October, when he left the home because of a no-contact order. He acknowledged that the daughter continued to live with her mother for the balance of that year. The taxpayer testified that the daughter spent every night of 2017 with her mother, but also testified that he lived with them, spending every night of the year with them.
Evidence submitted by the Commissioner suggested otherwise, including a petition the taxpayer filed in the district court on February 4, 2017, to establish custody and parenting time with the daughter. In the petition, the taxpayer listed his address and the daughter’s mother's address as the same, but he also wrote that the child currently lived with her mother, rather than with both the other parent and himself. As a result, the district court filed numerous orders indicating that the daughter did not spend every night of 2017 with her father. In addition, when the grandmother testified about changes to the son’s residence and care during 2017, she said testified that the taxpayer was living with his own mother during early 2017.

The court said that the resolution of this case turned on whether the son and the daughter were qualifying children of the taxpayer in 2016 and 2017, as that term is defined in the state’s statute. A "qualifying child" is a child of the taxpayer or a descendant of such a child who has the same principal place of abode as the taxpayer for more than one-half of the taxable year. If more than one parent can claim a child as a qualifying child, then only the parent with whom the child resided for the longest period of time during the taxable year is allowed to claim that child.

During 2016, the daughter resided with both of her parents until September or October, when the taxpayer left the residence. After the taxpayer left, the daughter continued to live there, spending each night with her mother. The curt determined that although the daughter resided with the taxpayer for more than half of 2016, she resided for the longest period of time with her mother, who also claimed her as a qualifying child, and the taxpayer therefore could not claim her for 2016. For 2017, mother again claimed the daughter and there is no dispute that the child spent each night with her mother. The court said that if the taxpayer spent even one night away from the daughter in 2017, he would not be eligible to claim her as a qualifying child, and noted that the record strongly weighed against the taxpayer’s assertion that he spent every night of 2017 with the daughter and her mother. The court found that he failed to meet his burden of proof and was unable to claim the daughter for 2017.

With regard to the son, the taxpayer’s primary argument was that he should be able to claim him in 2017 because the grandmother was not granted legal custody of the son until August of that year and had not adopted him. The court noted that legal custody did not determine whether a child qualified for income tax purposes, but rather the controlling criterion was whether the child had "the same principal place of abode as the taxpayer for more than one-half of such taxable year." For 2017, the son did not reside with the taxpayer for more than half of the year, living instead with the grandmother beginning in late January and continued to live with her throughout the rest of the year. The court concluded that the taxpayer could not claim the son as a qualifying child for 2017.

To claim a child under the state’s Working Family Credit, the child must be a "qualifying child" under the federal Earned Income Tax Credit (EITC). The court said that since the daughter was not a qualifying child of the taxpayer for 2016 and 2017, and the son was not a qualifying child of the taxpayer for 2017, the Commissioner correctly limited his Working Family Credit. The "Head of Household" filing status has three requirements in the state: ( 1) the claimant must be unmarried on the last day of the tax year; (2) the claimant must pay more than half the cost of maintaining the household during the tax year; and (3) a qualifying person must live with the claimant for more than half the year. The court determined that because neither the son nor the daughter was a qualifying child of the taxpayer for 2017, he was not entitled to Head of Household filing status. Cermak v. Comm'r of Revenue, Minnesota Tax Court, Docket No. 9261-R. 10/16/19

Corporate Income and Business Tax Decisions

Court Sides with Microsoft in Calculation of Franchise Tax

The Wisconsin Court of Appeals affirmed a lower court’s decision that royalties a taxpayer received from licensing its software to original equipment manufacturers (OEMs) that are not located in the state but whose products are used in the state should not be included in the calculation of the taxpayer’s franchise tax liability for the 2006-2009 tax years.

The taxpayer is engaged in the business of developing, distributing, and licensing computer software. OEMs are businesses like Dell and Hewlett Packard that manufacture or assemble computers, which incorporate the taxpayer’s software. During the tax years in dispute, the taxpayer entered into software copyright license agreements with OEMs, most of which were not based in the state. This matter does not concern payments from OEMs based in the state.
Under the license agreements, the OEMs paid royalties to the taxpayer, in exchange for which the taxpayer granted non-exclusive rights to the OEMs to install its software on computers and to distribute its software that was installed on the computers and grant sublicenses for end-users to use the software. OEMs sold the computers with the installed software to consumers directly or through retailers. The court referred to the consumers as “end-users.”
At issue in this case is end use of the taxpayer’s software that occurred in Wisconsin, not end use that occurred outside the state. Computers sold by the OEMs with the taxpayer’s software installed came with End-User Licensing Agreements (Agreements), in which end-users
agreed to be bound by the terms of the end-user agreements, the terms of which were dictated by the taxpayer. The DOR does not contend that the taxpayer was a party to the end-user agreements. The taxpayer took the position that the software license royalties it received from OEMs should not be considered in calculating its state franchise tax for tax years 2006 to 2009. The DOR conducted an audit and determined that the taxpayer was required to include the royalties that it received from OEMs in its state franchise tax calculations and assessed the taxpayer addition franchise tax for the years at issue. The taxpayer filed an appeal to the Commission for review of the additional assessed tax and following a trial, the Commission reversed the additional franchise tax assessed by the DOR against the taxpayer. DOR filled an appeal to the circuit court which affirmed the Commission's decision. The DOR filed this appeal.

This court said the appeal concerned issues of statutory interpretation, which begins with the statute's text. The court said it gives the text its common, ordinary and accepted meaning, except that it gives technical or specially defined words their technical or special definitions. If the meaning of the statute is clear from its plain language, the court will not look beyond that language to ascertain its meaning. The state imposed for the tax years at issue here a franchise tax on a corporation based on the corporation's income derived from, or attributable to, sources within the state. When a corporation is engaged in business within the state and at least one other state, Wisconsin has adopted an apportionment method for determining the portion of the corporation's income that is subject to the state’s franchise tax. During the tax years at issue, that apportionment formula included a percentage of the taxpayer’s sales, referred to as the “sales factor” and the dispute here centers on the sales factor portion of the apportionment formula.

The provision that the Commission applied in its decision concerned sales of intangibles and provided that sales are in the state and should therefore be included in the numerator of the sales factor if the income-producing activity is performed in this state and the Commission determined that the OEMs' royalties to the taxpayer should not be included in the numerator of the sales factor because those royalties were not income-producing activities in Wisconsin.
The DOR argued that the Commission erred in failing to apply a statutory exception to § 71.25(9)(d), under which franchise taxation of computer software occurs if a “licensee” uses the software in Wisconsin. The court said the question in this appeal, therefore, was whether the Wisconsin end-users of the taxpayer’s software in computers sold by the OEMs were “licensees” as that term is used in the statute. The court determined that the end-users were not the “licensees” of the taxpayer as a matter of law and were not the end-users when viewing the transactions as a whole, noting the Commission's factual findings that the end-users did not purchase software and software licenses from the taxpayer and were not the customers of the taxpayer. As a consequence, the Commission found that there was no “direct relationship” between the taxpayer and the end-users, and the court said those findings inevitably lead to the conclusion that there was no license between the taxpayer and the end-users.

The court also rejected DOR’s argument that OEMs acted as agents of the taxpayer for the limited purpose of granting sublicenses of the taxpayer’s computer software to end-users, and, therefore, the licenses are, in effect, between the taxpayer and the end-users. The court concluded that the Commission’s findings provided substantial evidence that OEMs were not the taxpayer’s agents. The court noted that DOR neither disputed the Commission’s factual findings nor pointed the court to evidence in the record sufficient to overcome the Commission's factual findings supporting its determination that OEMs did not act as an agent, solely for the taxpayer’s benefit, when selling their computer systems containing taxpayer’s software.

Finally, the court rejected DOR’s argument that the statutory provision “depends entirely on 'use’” and contended that the only relevant factor is where the software is used and the location of OEMs. DOR argued that to the extent that end-users used the software in Wisconsin pursuant to sublicenses from OEMs, royalties to the taxpayer from OEMs for the software licenses should be considered in calculating the taxpayer’s Wisconsin franchise tax liability. The court found that DOR's exclusive focus on the use of the software ignored the statutory requirement that there must be a “licensee” that uses the software in this state for the statutory provision to apply. The court concluded that royalties paid by OEMs to the taxpayer were not subject to the Wisconsin franchise tax because the end-users were not licensees of the taxpayer. Wisconsin Dep't of Revenue v. Microsoft Corp., Wisconsin Court of Appeals, Appeal No. 2018AP2024; Cir. Ct. No. 2017CV2214. 10/31/19

Property Tax Decisions

Exclusion of Evidence an Abuse of Discretion

The Virginia Supreme Court held that the trial court's exclusion of evidence from the taxpayer's expert, who was temporarily licensed in Virginia to complete the appraisal offered in the case, was an abuse of discretion. The court also found, however, that the trial court did not err in ruling that the taxpayer failed to overcome the presumption of the personal property assessment's correctness.

The taxpayer owns a marine container terminal in the City of Portsmouth fronting the Elizabeth River, consisting of 610 acres including a wharf, buildings, eight “ship-to-shore” (STS) cranes, and other improvements. The record shows that when container ships dock at the wharf, the STS cranes unload shipping containers onto a large container yard. Surrounding the container yard is a system of 30 remotely operated rail-mounted gantry cranes. These gantries straddle the container yard, moving along the rails to pick up and place containers onto waiting trucks. The terminal also uses four rubber-tire gantry cranes for this task. The rubber-tire gantries differ from the rail-mounted gantries in that they are diesel-powered rather than electric, require an onboard driver to operate, and have tires permitting them to move freely around the yard. For taxation purposes, the taxpayer’s real property includes the land, buildings and improvements on the land, the wharf, and the eight STS cranes which are considered fixtures, and the city assessed them at more than $361 million for the 2015-2016 tax year. The rail-mounted gantries and rubber-tire gantries are considered personal property for tax purposes and the city assessed those items separately.

The taxpayer believed the assessments for its real and personal property were above fair market value and filed separate applications to correct the 2015–16 real estate and personal property assessments. The city denied that the assessments exceeded fair market value and filed a counterclaim to the real property application contending that the fair market value was actually several hundred thousand dollars more than the assessment. The trial court consolidated the two cases for trial.

At trial, the taxpayer offered expert testimony to support its position that the actual fair market value of the real property was $197,217,000, relying on a taxation consultant and real estate appraiser with experience evaluating complex industrial properties, to establish the value of the land, buildings, improvements, and wharf. The expert held an active New York real estate appraisal license for all times relevant to this appeal. His work with the taxpayer began in 2015, when he reviewed the city's assessments, visited the property, and arrived at a preliminary valuation of the real estate in the hopes of settling the matter informally. When litigation became inevitable, the expert obtained a temporary Virginia license active from January 28, 2016 to January 27, 2017 and conducted a formal appraisal of the property's value. The expert acknowledged that he based his formal appraisal on the initial valuation he developed in 2015 but testified that once he obtained Virginia licensure, he updated his findings to comply with the Uniform Standards of Professional Appraisal Practice (USPAP) and other requirements for formal appraisals. He completed his appraisal report in October 2016. The city objected to the expert’s testimony and expert qualification because he lacked Virginia licensure at the time of trial, but the trial court overruled the objection.

The expert relied on a combination of the cost and sales-comparison methods to appraise the property and appraised the total fair market value of all real property other than the STS cranes at $163,017,000. The taxpayer used a broker specializing in buying and selling container-handling equipment used by marine ports, to testify regarding the value of the STS cranes and other port equipment. The trial court qualified him as an expert in the field of valuing specialized marine terminal equipment, including STS cranes, rail-mounted gantries, and rubber-tire gantries. He acknowledged that he was unfamiliar with the standards of appraising in the United States, because he was not from the U.S. and said that he used a “customer-centric approach” that incorporated elements of the sales-comparison method in valuing the taxpayer’s property and factored in the transportation costs in the overall valuation of the crane because transporting an STS crane is a risky and expensive proposition, sometimes costing more than the value of the crane itself.

The taxpayer also challenged its assessment of its personal property, primarily contesting the value of the rail-mounted and rubber-tire gantries. The city used a standard formula of fifty percent of original cost to assess the personal property and the taxpayer maintained that this default approach resulted in overvaluation. The taxpayer’s personal property valuation expert, testifying as to the value of both types of gantries, determined that there was little, if any, domestic market for the rail-mounted gantries, so he discounted their valuation by the transportation and technological refitting costs necessary for them to become operational in a foreign market. He determined that there was a domestic market for the rubber-tire gantries and thus no corresponding need to discount for transportation-related expenses. The city’s expert on personal property valuation specialized in machinery and equipment valuations. The trial court qualified him as an expert based on his “vast knowledge of different items of equipment,” noting that his inexperience with marine terminal equipment went only to the weight of his opinion. He relied on the cost approach for valuing the rail-mounted gantries and both a cost and sales-comparison approach for the rubber-tire gantries.

The trial court entered a final order dismissing both of the taxpayer’s applications as well as the city's counterclaim. The trial court dismissed the taxpayer’s real estate case, reversing its prior decision to qualify the taxpayer’ appraiser as an expert. Despite finding him eminently qualified to testify, the court said it was an abuse of its power to recognize him as an expert in real estate values in Virginia and permit his testimony because his appraisal work was unlicensed and he was again unlicensed at the time he gave his testimony. The court also rejected the taxpayer’s appraiser’s opinion on the personal property's value, largely because he included transportation-related costs in his appraisals, noting that costs of removal are not part of Virginia's definition of fair market value and their inclusion rendered his testimony “flawed.” The taxpayer filed this appeal.

The state statute provides that it is unlawful to engage in the appraisal of real estate or real property for compensation or valuable consideration in the Commonwealth without first obtaining a real estate appraiser's license and sets forth various categories of exemption from the requirement. The court noted that a 1995 amendment to the statute provided that a trial court may qualify a person as an expert witness to testify regarding the value of real estate without regard to his or her Virginia licensure status. The court said that the amendment did not, however, render licensure status irrelevant and it remains an important consideration in assessing a prospective expert's qualifications. The court said that the amendment stands only for the proposition that a trial court cannot refuse to qualify an otherwise appropriate expert solely for the lack of an active Virginia license at trial.

The court pointed out that the trial court acknowledged that the taxpayer’s expert’s “history of licensure in the State of New York and twice temporarily in Virginia, along with his previous designation as an appraiser by the American Society of Appraisers, was adequate evidence of his expertise enabling him to formulate a knowledgeable opinion as to real estate values.”
Despite the trial court’s belief that the expert was qualified to testify as an expert and that it had the power to qualify him, it refused to do so because it found that his “appraisal work was unlicensed and he was again unlicensed at the time he gave his testimony,” and the court here found this was error. The court noted that the expert completed his final appraisal report in October 2016, within the period of his active licensure and his testimony addressed only the appraisal for which he was licensed. The court concluded there could be no reasonable concern that permitting his testimony would condone or promote an unlawful activity even though he lacked a Virginia license at trial.

The court then addressed the taxpayer’s appeal of the personal property assessments. The court pointed out that there is a presumption in favor of the correctness of a tax assessment and the burden is upon the property owner who questions it to show that the value fixed by the assessing authority is excessive. The court said it is not enough for the taxpayer to prove that the assessment is flawed but has the burden to show that the assessment exceeds fair market value. The court looked to it recent decision in Western Refining Yorktown, Inc. v. County of York, 292 Va. 804 (2016) as particularly instructive because the taxpayer there, like this taxpayer, contested assessments of highly specialized personalty with limited marketability. At issue in Western Refining was the valuation of machinery and tools used in an oil refinery. In that case, under the presumption of correctness and the deferential standard of review, the court found the refinery's evidence did not prove that the county overvalued its equipment, and in reaching that conclusion, the court identified several reasons why the refinery failed to rebut the presumption of correctness. The court ultimately concluded that the evidence before the circuit court established a possible range of values for the refinery's machinery and tools and that, in light of the presumption of correctness, the refinery had not proven that the county overvalued its equipment. The analysis in Western Refinery guided the court in the current case. The court first recognized that although the city's fifty-percent-of-original-cost methodology created a higher actual tax rate than that in Western Refining, it remained an approach expressly authorized by the General Assembly. The presumption of correctness meant that the city's fifty-percent-of-original-cost methodology was prima facie appropriate even if the assessor is unable to come forward with evidence to prove its correctness. The court said, however, the City not only came forward with evidence of the assessment's correctness in the form of its independent appraisal, it also presented evidence that the taxpayer’s appraisal of the gantries was flawed. The court said that although the expertise of the taxpayer’s appraiser was undisputed, the expert acknowledged that his appraisal methodology did not comply with the ordinary principles of valuation used in Virginia.

Whereas the refinery's expert in Western Refining simply made mistakes in his application of the otherwise appropriate sales-comparison, income, and cost approaches, Verheijen testified that he was unfamiliar with these methods and instead used a “customer-centric approach” that incorporated some characteristics of the sales-comparison method. The court said that the taxpayer was asking it to recognize a novel and significant cost factor relating to transportation of personalty because the only feasible markets for its personal property are abroad. The court concluded that the trial court reasonably determined that the taxpayer’s evidence of transportation costs was too speculative to be considered and it did not err in declining to adjust the personal property assessment. Virginia Int'l Gateway v. Portsmouth, Virginia Supreme Court, Record No. 180810. 10/31/19

Motion to Supplement Appraisal Materials Granted

The New York Supreme Court, Appellate Division, affirmed a lower court's decision granting an electric energy provider's motion to supplement its appraisal materials. At issue in the matter were tax assessments on three of the taxpayer’s hydroelectric generating facilities.

The taxpayer filed three separate proceedings against the Town of Moreau Assessor (Assessor) challenging the 2014, 2015 and 2016 tax assessments on three of its hydroelectric generating facilities located in the Town of Moreau, seeking a reduction of more than $105 million for each year for each plant. The proceedings were subsequently consolidated. In March 2018, the court ordered that the expert appraisals for the three tax years be simultaneously exchanged on April 6, 2018. On that day, the taxpayer served the Assessor, via counsel for the Town, and the court a copy of the appraisal reports prepared by Michael Green, an expert with Filsinger Energy Partners. The report consisted of a total of nine appraisal reports with addenda including three reports related to each hydroelectric facility for each tax year. The addenda to these reports included a Work Papers' CD-ROM that consisted of electronic copies of the expert's work files. In May 2018, the taxpayer’s counsel was provided with additional work papers, specifically an EXCEL worksheet and some graphics for each of the appraisal reports that were not included with the expert appraisal and the taxpayer subsequently served an electronic copy of these files on the Assessor and the court. The Town subsequently sent a letter to the court opposing the taxpayer’s submission of the supplemental EXCEL file. The taxpayer asserted that the supplemental EXCEL file was not adding to or amending the Filsinger reports. The Town requested that the court reject the taxpayer’s request to submit the supplemental files and further requested that the taxpayer file a formal motion seeking permission to supplement the Filsinger reports. The taxpayer moved to, among other things, supplement the Filsinger reports with the supplemental EXCEL file. The Assessor argued that the taxpayer failed to demonstrate good cause for its failure to file the supplemental EXCEL file and that filing the supplemental EXCEL file would cause the Town prejudice. In October 2018, a hearing was held on the issue, after which the court granted the taxpayer’s motion to submit the supplemental EXCEL file. The Town filed this appeal.

Pursuant to New York Code, Rules and Regulations (NYCRR), the court may, upon the showing of good cause, extend the time for exchanging reports, or allow an amended or supplemental report to be served. The court said that although good cause shown is not specifically defined in NYCRR generally the court may exercise its discretion to determine whether a party has shown good cause by considering all the relevant circumstances. The court concluded that under the facts presented in the matter, the Supreme Court properly exercised its discretion in granting the taxpayer’s motion to supplement the work papers with the supplemental EXCEL file. The worksheets contained in the supplemental EXCEL file were merely graphic illustrations showing how capacity prices used in the income approach were forecast and did not result in a single change to the Filsinger reports, nor did they impair the Town's ability to prepare to cross-examine the taxpayer’s expert witness. The court noted that the initial request to supplement was made approximately a month after the appraisal exchange and immediately upon the taxpayer’s counsel being notified by the appraiser that one of his colleagues who worked with him on his report had some additional material that should be within the work file. The court rejected the Town’s argument that it was unduly
prejudiced by the granting of the taxpayer’ motion, noting that the taxpayer’s initial request
to supplement was made approximately one year prior to trial, providing the Town with ample time to review the supplemental EXCEL file, which did not change any information contained in the Filsinger reports. Erie Boulevard Hydropower LP v. Town of Moreau Assessor, New York Supreme Court, Appellate Division, 2019 NY Slip Op 07826. 10/31/19

Entity Ineligible for Exemption

The Arkansas Court of Appeals affirmed the denial of a public use/public ownership exemption from ad valorem tax to a recreational improvement district. It found that the taxpayer's recreational use facilities were not exclusively used for public purposes because the taxpayer provided preferential access to residents of the subdivision and leased out portions of the clubhouse to a third-party vendor operating for profit.

The taxpayer is a statutorily created, quasi-governmental entity in the state. It encompasses a residential neighborhood and 156 acres of recreational facilities, which include a golf course, tennis courts, a swimming pool, and two buildings. The taxpayer purchased the recreational facilities in 2011 from the individual who originally created the improvement district and developed the neighborhood. The golf course, the swimming pool, and all other facilities on the property are open to the public and have been since before they were purchased by the improvement district. There are fees for the use of these facilities. There are assessments of $540 per year for each lot in the neighborhood and payment of these assessments entitles the resident to a reduced fee membership in the facilities, compared to nonresidents. Portions of the clubhouse are leased to a third-party vendor that provides restaurant services, manages the bar, and occasionally operates the cash register in order to take payment from golfers. The third-party vendor operates the restaurant for profit. Since the purchase of the recreational facilities by the District, ad valorem taxes have not been paid to the county. The prior owner made the District commissioners aware of this in 2015, and the District commissioners then filed a request to be declared exempt from ad valorem taxation as a result of the public-ownership/public-use exemption. The lower court denied the exemption and this appeal was filed.

The court noted that a party seeking a tax exemption has the burden of proving its claim for tax-exempt status beyond a reasonable doubt and tax exemptions are strictly construed against the exemption. Therefore, the term “exclusively” must be strictly construed and to make that determination it is generally necessary to look to the primary use to which the property is put and not to the secondary use. Under the state constitution public property used exclusively for public purposes shall be exempt from taxation. The state code provides that public property that is being used exclusively for public purposes, with or without fee for such use, shall be exempt from taxation. There court said there was no dispute that the property in question was owned by a statutorily created improvement district and that the District is considered a quasi-governmental entity. In addition, no one disputed that recreational-use facilities can qualify for tax-exempt status. The court said the only issue in this appeal was whether the circuit court erred in finding that the taxpayer did not prove beyond a reasonable doubt that its recreational-use facilities were used exclusively for public purposes. The circuit court based its finding on three key facts. First, the petition documents used in establishing the creation of the improvement district state that the District was formed “to serve the inhabitants of the district” and “[t]o contract for the right of the district's property owners. . . .” The court also considered the fact that persons outside the improvement district pay $99 per month for a membership in the golf course while property owners within the district pay $59 per month for a membership. Residents of the subdivision within the district pay the district $540 annually, which is used to reduce the bonded indebtedness of the District and this fee is paid by all residents, regardless of whether they use the recreational facilities, and it is explicitly for the purpose of paying off the District's bonded indebtedness. The court found no error in the court's interpretation that these annual fees are separate from what residents and nonresidents pay to use the taxpayer’s recreational facilities. The court concluded that these facts support the conclusion that the taxpayer, while open to everyone, provides preferential access to the residents of the subdivision located within the improvement district because residents pay a lower monthly fee.

The lower court also found that portions of the clubhouse are leased out to a third-party vendor who provides restaurant services, manages the bar, and occasionally operates the cash register, and that the third-party vendor operates with a view toward profit. The court concluded that given prior case law and the burden of proof in this case, there was no reversible error in the court's finding that the district was not operated exclusively for public purposes. Silver Springs Prop. Owners' Recreational Improvement Dist. No. 30 of Haskell, Arkansas v. Arey, Arkansas Court of Appeals, 2019 Ark. App. 520; No. 63CV-16-932. 11/6/19

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:
http://www.taxadmin.org

November 1, 2019 Edition

NEWS

No news to report.

U.S. SUPREME COURT UPDATE

Cert Denied

Diamond v. United States, U.S. Supreme Court Docket No. 19-334. Petition denied October 21, 2019. The Court declined to review a decision by the U.S. Court of Appeals for the Ninth Circuit dismissing a suit seeking tax refunds and damages for unauthorized disclosure. The Ninth Circuit found that dismissal was proper because the taxpayer had previously litigated those claims, and it affirmed the denial of his request for a change of venue.

Lange v. Commissioner, U.S. Supreme Court Docket No. 19-366. Petition denied October 21, 2019. The court declined to review a decision by the U.S. Court of Appeals for the Fifth Circuit which affirmed a Tax Court decision holding the taxpayer liable for frivolous return penalties and imposing frivolous argument penalties against him.

FEDERAL CASES OF INTEREST

Spouse Denied Relief

The U.S. Tax Court held that an individual was not entitled to innocent spouse relief for unreported income that was attributable to her husband’s Chinese business dealings. The court found that the wife had reason to know of the understatements that she benefited from and that she failed to show she’s entitled to equitable relief.

The taxpayers met in Japan and married in 1991. Their daughters were born in 1991 and 1993 in Japan. At all relevant times petitioners were married and living in the same household. They filed joint federal tax returns for tax years 2005-17. They resided in Minnesota when they timely filed their petition. The husband, who was born in China, moved to the U.S. in 2001 and the wife and their daughters moved to the U.S. in 2004 or 2005.

During the years at issue the husband worked for the Tile Shop, LLC (Tile Shop), a publicly traded company that provides home tile and decor through retail locations throughout the U.S. While working for the Tile Shop, he traveled extensively to China and other countries to source materials. In December 2013 the Tile Shop discovered that the taxpayer had not disclosed a conflict of interest related to his own business interests in China and subsequently terminated his employment. The taxpayers maintained joint and separate bank accounts and the facts showed that he deposited at least a portion of his earnings from the Tile Shop and his Chinese connections into their joint account. The taxpayer husband handled the family's financial matters and the wife took care of the family home and made household purchases.
The wife used her separate bank account, their joint checking account, and joint credit cards to pay for household expenses and family needs. She had access to but did not review all the bank statements that she received, and she had difficulty understanding details of financial documents because of the language barrier. According to bank statements the taxpayers spent approximately $445,000 on family expenses during the years in issue. For example, in November 2012 they purchased a new vehicle for $41,000 and paid for it with a check drawn from their joint checking account and in 2012 paid off the mortgage on the house they had purchased in 2007. The husband prepared the taxpayers joint tax returns for the years at issue and the wife signed each. Before trial the parties filed a joint stipulation of settled issues, agreeing that the taxpayers had unreported income of $424,015, $384,882, and $687,206 for 2011-13, respectively, attributable to the husband’s Chinese business dealings, and that they are liable for section 6662(a) accuracy-related penalties for the years in issue.

After making the election to file joint federal income tax returns, each spouse is jointly and severally liable for the entire tax due for that taxable year. Section 6015 provides a requesting spouse with three alternatives for relief from joint and several liability. To be entitled to relief under section 6015(b)(1) the requesting spouse must satisfy all of the following requirements: (A) a joint return has been made for the taxable year; (B) on such return there is an understatement of tax attributable to erroneous items of the nonrequesting spouse; (C) the requesting spouse did not know and had no reason to know of the understatement when the return was signed; (D) taking into account all the facts and circumstances, it is inequitable to hold the requesting spouse liable for that year's deficiency in tax attributable to such understatement; and (E) the requesting spouse timely elects relief under the section.
The IRS argued that the wife did not meet the requirements of subsection (C) and (D) because she should have known that their joint Federal tax returns understated her husband's income. Case law has said that a requesting spouse has a duty of inquiry with respect to the Federal tax return filed and the factors to consider in making this determination is the requesting spouse's level of education, the requesting spouse's involvement in the family's business and financial affairs, the presence of expenditures that appear lavish or unusual when compared to the family's past levels of income, standard of living, and spending patterns, and the culpable spouse's evasiveness and deceit concerning the couple's finances. The court found the wife had a duty to inquire given the amount of her husband's wages in contrast to their spending. The court said that even though the wife testified that she had difficulty understanding financial documents and speaking English, she had her own bank account, certificates of deposit, and authority to write checks for their joint account. She further testified that she was capable of understanding bank statements when she opened them.
During 2012 the wife was aware that petitioner husband had paid fully the balance of their mortgage, within five years of petitioners' purchasing their home. If she had reviewed the bank statements, she would have known that income in addition to her husband's wages was being deposited and that their spending exceeded his wages. The court said that although the taxpayers testified that the wife was frugal in her spending habits, a reasonable person in similar circumstances would have inquired how they could afford their yearly household expenses, and when the wife signed their joint Federal tax return for 2011, she had reason to know that her husband had understated his income. The court determined that the wife had knowledge of the unreported income when she signed the 2013 Federal tax return and the 2012 amended Federal tax return and said that section 6015 did not protect a spouse who turns a blind eye to facts readily available to her. The court concluded that the wife was not entitled to relief under section 6015(b) since she had reason to know of the understatements.
The court also said that even if it had concluded that the wife did not have knowledge or reason to know, she would not be eligible for relief because she did not meet the requirements of section 6015(b)(1)(D). After looking at the facts and circumstances, the court concluded that it would not be inequitable to deny the wife relief. A requesting spouse may still be eligible for equitable relief under section 6015(f) if, taking into account all of the facts and circumstances, it would be inequitable to hold the requesting spouse liable for the unpaid tax or deficiency. The court pointed to its consideration of the factors for equitable relief under section 6015(b)(1)(D) and held that for the same reasons in its determination there, the wife was not entitled to relief pursuant to section 6015(f). Fumitake Nishi et ux. v. Commissioner, U.S. Tax Court, No. 6936-17; T.C. Memo. 2019-143. 10/23/19

DECISION HIGHLIGHTS

Sales and Use Tax Decisions

LLC’s Purchase of Assets Subject to Tax

The Wyoming Supreme Court has held that a limited liability company's purchase of 28 percent of the assets of a company was subject to sales tax. The court found that the taxpayer did not qualify for the exemption for purchases of 80 percent or more of a company's Wyoming assets.

The taxpayer purchased assets valued at $1,150,000 from the seller, an HVAC services business, but did not purchase any of the seller's cash, checking and savings accounts, accounts receivable, promissory notes, “or other amounts owing to Seller” for work done prior to the closing. The parties agreed that the taxpayer purchased 28% of the seller's “assets” and “intangible value.” The Department of Revenue (DOR) determined the transaction was not exempt from sales tax because the taxpayer did not purchase at least 80% of the total value of the seller's assets, which included cash and accounts receivable. The taxpayer appealed to the Wyoming Board of Equalization (BOE), arguing that it made no sense to transfer cash and accounts receivable in a business purchase. The BOE affirmed the DOR’s determination, and the district court certified the case to the supreme court. DOR argued that the statutory exemption only applied where at least 80% of the value of all of the assets of the business entity which are located in this state are purchased and because the taxpayer had only purchased 28% of the seller's assets, DOR concluded the transaction was a “sale” subject to taxation. The taxpayer argued that the sales tax should only apply to retail sales of tangible personal property and that cash and receivables should not be considered in evaluating the applicability of sales tax or the 80% value exemption. The taxpayer argued the 80% sale exemption should be interpreted to apply to the transaction at issue because there was no logical reason to require buyers to purchase cash. It asserted the exemption was meaningless if interpreted literally, rendering it ambiguous and a better interpretation of the statute would exempt non-retail sales of substantially all of a seller's tangible assets when the buyer intends to continue to operate a business with those assets. It contended DOR’s interpretation introduced unnecessary and harmful distortions to transactions because it needlessly required buyers to purchase cash. DOR argued he language of the statute was unambiguous and the taxpayer’s policy arguments about what words it prefers in the statute should be disregarded because they did not change the language the legislature actually enacted.

The court said that while the taxpayer might be making a credible policy argument, the court’s role was not to determine whether the legislature's chosen policy was the best one. Instead, the court’s role was to give effect to the one it chose and to give effect to the legislature's intent. The best evidence of the legislature's intent is the plain and ordinary meaning of the words used in the statute. The court found that the statutory provision at issue
plainly stated that only purchases of “all or not less than eighty percent (80%) of the value of all of the assets which are located in this state” are excluded from the definition of sale and, thus, exempt from sales tax. The taxpayer did not dispute that cash and accounts qualify as assets or that it did not purchase 80% of the value of all of the seller's assets. The court rejected the taxpayer’s argument that the section should be interpreted to require only a purchase of 80% of a seller's tangible personal property, rather than 80% of its total Wyoming assets, noting that the provision does not differentiate between tangible and intangible assets.
The court said that the taxpayer’s argument ignored that courts are not free to legislate, and it was not the court's prerogative to usurp the power of the legislature by deciding what should have been said. The court said that any perceived defect in the tax code must be taken up with the legislature. Delcon Partners LLC v. Dep't of Revenue, Wyoming Supreme Court, No. S-19-0078. 10/21/19

Bakery's Baking Racks Exempt from Use Tax

The New Jersey Tax Court held that a bakery's purchases of mobile baking racks are exempt from use tax. It found that the racks qualify for the machinery, apparatus, or equipment exemption.

The taxpayer, a New Jersey S corporation, owns and operates a production plant in the state where it makes and sells at wholesale and retail almost 250 varieties of baked products such as bread, sandwich breads, rolls and other specialty items, totaling 600,000 pieces each day. This plant measures about 110,000 square feet and is open 363 days a year and 90% of the taxpayer’s more than 400 employees work at that facility. The production process of a baked item involves several steps and phases, from preparing the dough, to shaping, proofing, refrigerating or de-activating, re-activating, and finally baking it. Each process is a required step in the production of a quality baked product and is performed in a continual cycle or loop.

The taxpayer uses a variety of equipment in the production process, several of which are undisputed as being machinery, apparatus or equipment (MAE), including the industrial mixer, the cutter which cuts the dough into pieces, and the conveyor systems which transport bread boards from one stage of the production to another, the prepared dough into the oven loaders, and the baked products into the packaging area. At issue in this matter are the racks.
The production process involves a mix of mechanical and manual steps and this is true with the racks. Each rack, with bread boards loaded with dough pieces are manually wheeled by an employee to different areas of the plant for various processes depending on the type of the product being produced. In all cases, the dough pieces are moved via the racks to another area of the plant for the proofing process. The proofer is a large heat-and-humidity controlled enclosed space with a door, and the racks hold the prepared and processed dough within the proofer box. Without the correct size and spacing within the racks, the dough's ability to breathe and rise are negatively impacted, and the dough could lump together or overflow.
After proofing, the Racks with the risen dough pieces are moved into the refrigeration unit for staging and refrigeration serves as the retardation process so that the rise of the dough slows down. The racks themselves do not have any sensors, timers, or flashers to indicate the adequacy of the rise of the dough, or the dough's readiness for removal to the next stage of production either from the proofer rooms or the cooler rooms. They do not contain any heating elements to provide the temperature and humidity to commence and continue the dough's rising nor do they contain any cooling elements which provide the temperature to slow down the chemical process. The cooled items on the racks are then moved to the next stage, which is re-activation, and after this, the racks are wheeled to the next staging area where the bread boards are manually removed and loaded onto another conveyor belt which separates the prepared dough into one assembly line for baking. An employee manually removes the bread boards for cleaning and re-stacking on the racks and the cleaned bread boards are then wheeled into another area for re-use in the next production loop. The racks are used from the time the dough is formed and until it is sent into the ovens, in a continual loop. They are free-standing and have four heavy duty swivel casters on them making them easy to turn. During the audit period, the taxpayer had about 200 Racks, all custom made and purchased from a third-party vendor located in California.

The Division of Taxation (Taxation) audited the taxpayer and assessed use tax on the purchase of the racks, based on a sampling of invoices from 2011 to 2013. The audit report concluded that the racks were taxable as “fixed assets,” and that they were not exempt as “production equipment” since they were not designed to be used, in manufacturing, converting, processing, fabricating, assembling, or refining tangible personal property.
The taxpayer protested the assessment, contending the racks were exempt production equipment. The conferee determined that the equipment used was exclusively for preparing, fermenting and baking a variety of breads to a finished product, but concluded that the racks were not exempt from tax since they were not to be used directly in the refining of a finished product and were not “complex devices.” The taxpayer filed this appeal.

The statutory provision at issue exempts from the sales tax the sale of MAE for use or consumption directly and primarily in the production of tangible personal property by manufacturing, processing, assembling or refining. The exemption is not lost if the end product is not sold to a final consumer, but is used to produce other tangible personal property, but the exemption does not apply if the purchase is for a “use” that is “incidental to the activities described” in the statute. The court said it was undisputed that the bakery products were being made by the taxpayer through a “manufacturing” process. The court also found that the racks were being actively “used” for, and during, the baking production process. The issue before the court was whether the racks were being used “directly and primarily in the production of” the bakery items. The taxpayer argued that they were an indispensable part of its production process, adapted to, and used in every step of the five-phase production. Taxation contended that the racks were not directly involved in making bakery products but were simply used in the manual transportation and storage of the dough.
The terms “directly and primarily” were defined and interpreted by Taxation's regulations in a restrictive manner. Under the plain meaning of the terms in the statute and based on the credible evidence presented, the court was satisfied that the racks were used to “sustain” the taxpayer’s production process, thus, were used directly in the production process.
The court noted that the racks were custom designed to fit the exacting specifications of the taxpayer as to height and size, without which the chemical process which the dough undergoes could not be actively managed and controlled. The racks provided and facilitated the requisite airflow and spacing and prevented potential rust leaks or condensation drips on the dough, supporting the chemical process which the dough was undergoing in the proofer and the cooler rooms. Without this, the court said, the very product being produced would be jeopardized. The court said the racks are continually in use, and used in all phases of the production process, commencing from when the dough is formed until the activated, fermented, expanded and retarded dough is ready-to-bake and conveyed onto the oven loader.

The court rejected Taxation’s argument that since the racks had no timers, sensors, flashers, or signals which would alert an employee that the dough was ready to be removed and transported to the next stage of production, they cannot directly be part of the production process. The court said that there was no evidence provided to show that the proofers or the coolers were all set up with the timers, flashers, and the like and there was no dispute that these units qualified for exemption as directly used in the production process. The court also disagreed with Taxation that the racks were not being “primarily” used in the production process simply because they were also being used to stack the cleaned and empty bread boards during certain times of the day, finding that this did not transform the racks into merely passive storage devices, not used “primarily” in production phases of the bakery items.

The next issue was whether the racks are MAE, a term not defined in the statute. Regulations, however, provide that MAE means any complex, mechanical, electrical or electronic device, mechanism or instrument that is adapted to the accomplishment of a production process. The court found that the racks fit within the plain meaning of both an “apparatus” and “equipment.” The court does not find that the racks were incidentally used in the taxpayer’s production process. Even if the word “complex” was somehow controlling for a MAE to qualify for exemption, here, the court found that the racks would qualify. They were custom-made to the taxpayer’s exacting specifications and were not simply an “off the rack” product sold wholesale. The court said that limiting the exemption only to conveyor systems but not to the racks which not only perform the identical transportation function but are also directly and primarily used in production of the bakery items, actively and continually throughout the production process, unduly and unreasonably restricts the MAE exemption. Liscio's Italian Bakery Inc. v. Dir., Div. of Taxation, New Jersey Tax Court, Docket No. 009658-2017. 9/30/19

Casual Sale Exemption Case Partially Vacated

The Ohio Court of Appeals, Ninth District, concluded that the Board of Tax Appeals (BTA) incorrectly found that a road construction company owner's newly acquired business operated solely as a leasing business. The court concluded the BTA incorrectly held that the casual sale exemption cannot apply unless the seller used the item within the audit period.

The taxpayer is a road construction company that does most of its work for the state Department of Transportation (DOT). Taxpayer’s DOT contracts usually required it to provide and install traffic maintenance equipment during the project. The equipment can include concrete barrier walls, temporary traffic lights, signs, and message boards. A company that provided maintenance services and equipment to the taxpayer went out of business and the taxpayer’s owner and his wife formed a new company, which did business as K&H Excavating, LLC (K&H), to acquire the equipment and personnel of the closing business. After K&H formed, it provided the same equipment and maintenance services to the taxpayer as the former company. The Commissioner audited the taxpayer and assessed a use tax on the traffic maintenance equipment that the taxpayer provided while performing DOT contracts. He also assessed tax on the employment services that K&H provided to the taxpayer and on the equipment that K&H rented to the taxpayer. The taxpayer filed an appeal and after a hearing the Commissioner issued a final determination that denied the taxpayer’s objections to the tax assessment. The taxpayer appealed to the BTA, which determined that the taxpayer did not have to pay use tax on the traffic maintenance equipment it installed while performing DOT contracts because it was effectively leasing the equipment to DOT during the construction projects. It also determined that the taxpayer did not have to pay tax on the employment services that K&H provided to it because K&H was part of the same affiliated group as the taxpayer. It did, however, determine that the taxpayer had to pay tax on the equipment it leased from K&H because the leases did not qualify as casual sales. Both parties filed this appeal.

The court rejected the Commissioner’s initial argument that the court did not have jurisdiction over the appeals, asserting that they belonged in the Tenth District Court of Appeals, concluding that it had jurisdiction of the appeals under Section 5717.04 because the taxpayer is a corporation and it has its principal place of business in one of the counties within this District. The Commissioner next argued that the BTA incorrectly determined that the taxpayer did not owe tax for the traffic maintenance equipment it supplied under its contracts with DOT. The Commissioner contended that the taxpayer owed use tax for the equipment because it used it in performance of a construction contract. The BTA found that the. taxpayer did not use the traffic maintenance equipment while working on DOT contracts, but instead rented the equipment to DOT to allow DOT to maintain traffic during the taxpayer’s work.
The Board found that DOT dictated the amount and type of traffic maintenance equipment required for a project and controlled its placement and use during the project and found that, although the taxpayer’s workers benefitted from the placement of the equipment, the equipment was not necessary to their paving work. The court noted that testimony was that the taxpayer could ensure the safety of its workers just as well by working on smaller sections of the road and using barrels instead of the concrete barriers required by DOT. The BTA also concluded that the taxpayer did not owe sales tax on its initial purchase of the traffic maintenance equipment because that purchase qualified as a sale for resale. The court concluded that the BTA’s finding that DOT had possession of the traffic maintenance equipment while the taxpayer was performing its contracts was supported by reliable and probative evidence and was not against the weight of the evidence.

The Commissioner's also argued that the BTA incorrectly concluded that the taxpayer did not have to pay tax on the employment services that K&H provided to it because K&H was an affiliated entity. The statute provides that employment services are generally included in the definition of sale, but an exception is a transaction between members of an affiliated group.
The statute defines an affiliated group as two or more persons related in such a way that one person owns or controls the business operation of another member of the group. In the case of corporations with stock, one corporation owns or controls another if it owns more than fifty per cent of the other corporation's common stock with voting rights. The BTA found that the taxpayer and K&H were part of an affiliated group because they were both controlled by the owner of the taxpayer and the BTA concluded that the employment services that K&H provided to the taxpayer were not taxable. The Commissioner argued in the appeal that the taxpayer and K&H cannot be affiliated because they did not have common ownership, noting that although Mr. Karvounides owned all of the taxpayer, he only owned 45% of K&H while his wife owned the remainder. The BTA found credible Mr. Karvounides's testimony that he controlled the operations of both the taxpayer and K&H, even though his wife was the majority owner of K&H. The court here found that the language in Section 5739.01(B)(3)(e) regarding ownership or control of one corporation over another was not applicable because K&H is a limited liability company, not a corporation. The court concluded that the BTA’s determination that Mr. Karvounides, the taxpayer, and K&H were part of an affiliated group was supported by reliable and probative evidence and that the BTA correctly determined that the employment services K&H provided to the taxpayer were exempt from taxation.

The taxpayer argued that the BTA incorrectly concluded that the casual sale exemption did not apply to the equipment it rented from K&H. That provision says that a casual sale means a sale of an item of tangible personal property that was obtained by the person making the sale for the person's own use and was previously subject to any state's taxing jurisdiction on its sale or use. The BTA found that, because the only business that K&H conducted was to lease equipment, the leases cannot be said to have been casual.

The taxpayer argued that the Board incorrectly concluded that the casual sale exemption cannot apply to a lease. The BTA found that the only business that K&H conducted during the audit period was leasing equipment. Although that is true, the court said that the definition of casual sale does not contain any time limits. Instead, the sold item must only have been obtained by the person making the sale for the person's own use and was previously subject to any state's taxing jurisdiction on its sale or use. The court concluded that the BTA’s finding that the taxpayer retained K&H as a separate entity and operated it solely as a leasing business was not supported by reliable and probative evidence because it overlooks Mr. Karvounides's testimony that K&H initially performed excavating work with the equipment, and it specifically found him credible as to his other testimony. The court concluded that the BTA incorrectly found that K&H operated solely as a leasing business and incorrectly held that the casual sale exemption could not apply unless the seller used the item within the audit period.
Karvo Paving Co. v. Testa, Ohio Court of Appeals, Ninth Judicial District, 2019-Ohio-3974. 9/30/19

Personal Income Tax Decisions

Business Expense Deductions Allowed

The Oregon Tax Court held that a married couple was entitled to additional business expense deductions on their 2012 individual income tax return. The court allowed deduction for advertising, permits, and equipment purchased for the taxpayers' general contracting business, but disallowed additional deductions for fuel and services.

The taxpayer operated a general contractor business, which worked with manufactured homes “from the ground up,” overseeing projects from permitting through the final home. In 2012, the business had three or four employees. The business had two bank accounts, one into which all business payments were deposited and from which business expenses were paid, and one used for federal and state employee payroll payments. On their 2012 Amended Schedule C, filed after the audit had commenced, the taxpayers claimed expenses totaling $253,173. Following the audit, the Division of Taxation (Taxation) allowed $177,870 in business expenses. The taxpayers filed an appeal and their conference officer allowed an additional $1,661 for payroll, bringing the total expenses allowed to $179,530. The taxpayers filed this appeal.

During the trial, Taxation’s auditor testified that the taxpayers’ source documents revealed a total discrepancy of approximately $50,000 between the source documents and the original return and after receiving additional notes from the taxpayers, she reviewed the receipts and bank statements again, allowing some additional expenses. During trial, the parties identified areas of agreement and focused their testimony on areas of disagreement: fuel, equipment, and services. The state income tax statute is modeled after the federal statute and in general, terms have the same meaning as used in the Internal Revenue Code (IRC), unless a different meaning is clearly required, or the term is specifically defined in the state statute. The court said that on the issue of trade or business expenses, the state law makes no adjustments to the rules under the IRC and therefore, federal law governs the analysis. IRC section 162(a) allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Plaintiffs ask the court to increase their deduction for fuel expenses by $2,274.14, which they maintain is reflected in their bank statements. The auditor allowed fuel expenses of $7,608.83 based on receipts provided by the taxpayers, less charges for personal items. In support of their request to increase the amount of fuel expenses allowed, taxpayers provided bank statements, but no receipts and the court noted that the problem with relying solely on bank statement is that debits at gas stations reflect mixed personal and business use purchases. Although the court said it was permitted to estimate expenses, the estimate must have a reasonably evidentiary basis and the court found no basis here to increase the taxpayer’s deduction for fuel expenses. The court also found it was unclear which expenditures the taxpayers claimed as services beyond what Taxation allowed, either under the services category or under another category such as supplies, and the court determined no further deduction was supported by the evidence. The court found that the taxpayers should be allowed an additional equipment expense of $78 based on the United Rentals invoice dated October 27, 2012. Morrison v. Dep't of Revenue, Oregon Tax Court, No. TC-MD 190060N. 10/14/19

EITC Granted

The New Jersey Tax Court held that an individual was entitled to an earned income tax credit (EITC). The court found that the taxpayer had income for the 2016 tax year and that she provided credible proof of the income received from her babysitting business.

The taxpayer reported her status on her 2016 federal tax return as head-of-household and claimed her three youngest children as dependents for purposes of personal exemptions. She reported $10,080 as income from babysitting and the Internal Revenue Service (IRS) granted her a federal Earned Income Credit (EIC) in the amount of $4219. She timely filed her 2016 state return with the filing status head-of-household and three dependents. She reported net profits from a babysitting business in the amount of $10,080 and claimed an EITC of $1477.
On May 15, 2017, the Division of Taxation's (Taxation) taxpayer accounting branch requested a Form 1099-MISC, bank statements, or a business license to determine the taxpayer's eligibility to claim the EITC. The taxpayer produced a copy of her Social Security card and a copy of a Federal Account Transcript showing 2016 EIC of $4219. She also provided a statement saying that she had a babysitting business and named three clients. On June 2, 2017, Taxation denied her EITC claim on the grounds that she failed to provide sufficient documentation to substantiate her claim of EITC eligibility. The taxpayer then sent Taxation additional documentation and Taxation sent her a final denial letter on the grounds that she had not submitted sufficient proof of business income. The taxpayer filed a timely appeal and a conference was held during which the taxpayer argued that she had provided documents to Taxation multiple times, but that Taxation was not “releasing” the money due to her. She argued that if the IRS had granted her the EIC, New Jersey could not deny her the EITC. The Conferee instructed the taxpayer to provide additional documents to substantiate her income, including a comprehensive statement by taxpayer detailing the nature of her business, bank statements, invoices, receipts, or other such documents that would support her claim of income, and notarized statements from her clients clearly stating the services they paid for and the amounts that they paid. The taxpayer forwarded a statement from providing the names of three clients, Ruth Ogunsaju, Shenell Samll, and Jazzmyn Byrd, and stating that each client paid her $300 on a monthly basis for babysitting. She provided twelve months of handwritten receipts for each of Ogunsaju and Samll; and notarized statements from Ogunsaju and Samll affirming that the taxpayer provided babysitting care for their respective children. Based on a review of information available to it, Taxation identified “discrepancies” as to the number of children Ogunsaju had in 2016 and its Final Determination upheld the denial of the EITC on the ground that the taxpayer failed to provide sufficient documentation to substantiate her source of income. The taxpayer filed this appeal.

The state provides an EITC to resident individuals under the its Earned Income Tax Credit program. To qualify for the state program the individual must claim and be allowed the federal EIC for the same taxable year. The court said, however, that despite the taxpayer's contention, Taxation was not required to grant her the EITC solely because the IRS did so. Taxation may find that a taxpayer failed to qualify regardless of whether the IRS challenges the taxpayer's EIC claim and the burden is on the taxpayer to prove entitlement to the EITC.
It was undisputed that the taxpayer was a New Jersey resident in 2016, had qualifying children, and Taxation accepted her filing as head-of-household. The court said that Taxation's rationale in denying the taxpayer's EITC claim was her inability to verify her income source. She contended that she did have income and complied with Taxation's requests for proof, but Taxation argued that it could not verify her income because she failed to provide bank statements despite repeated requests. The taxpayer testified at trial that she had no bank statements to provide and the court noted that neither the statute nor the regulation conditions EITC eligibility on the production of bank statements or the need to maintain a bank account. Instead, the taxpayer provided the three forms of documentation requested by Taxation: her comprehensive statement detailing the nature of her business, transaction receipts for payments received, and signed and notarized statements from her clients.

The taxpayer admitted that she prepared the receipts only after Taxation asked her for them, but the court noted that the fact that the receipts were not prepared by the taxpayer and signed by her clients contemporaneously with the transactions does not affect the reliable nature of the documents. However, the court found that effective cross-examination raised a question about the authenticity of the client's signatures and for that reason, the court said it would not assign weight to the documents. The taxpayer also submitted notarized statements from two of her clients, Samll and Ogunsaju. In her statement, dated April 17, 2018, Shenell Samll specified that she paid $300 per month as compensation for taxpayer providing babysitting care for her two children. Taxation raised on cross-examination the inconsistencies in the spelling of Samll's name. The court noted that on the one-page statement alone, Samll's name is spelled three different ways — “Shanail Small,” “Shenell Samll,” and “Shenell Sample.” The signature reads “Shenell Sample.” The court pointed out that the inconsistencies went unexplained at trial and the court found that these inconsistencies rendered the statement unreliable. Taxpayer provided the signed affirmation of Ruth Ogunsaju, also dated April 17, 2018. Ogunsaju stated that Taxpayer provided babysitting care for her 4 children for which she paid taxpayer a total of $300 per month. Ogunsaju's affirmation provides the ages of the four children as: four months, three years, six years, and eight years. Taxation discounted the evidence because of a discrepancy in the description of the services provided Ogunsaju. In her first statement, the taxpayer claimed she babysat for Ogunsaju's three children, but in her second statement she listed four children. In addition, Taxation discounted Ogunsaju's statement because their records indicated that Ogunsaju had filed her 2016 return claiming just one dependent.

At trial, Taxpayer clarified how many children she babysat, testifying that in 2016 she babysat three children for Ogunsaju, and that the fourth child was born sometime later. The court found her explanation for the discrepancy in her statements to be reasonable. As to the number of dependents Ogunsaju reported in her tax returns, the court noted that a taxpayer can have more children than “dependents,” as that term is defined in the state statute. The court said it was entirely possible that Ogunsaju's other children did not qualify as her dependents under the statute. While the number of children the taxpayer babysat for in 2016 might be in dispute, the court accepted that she baby sat for the family at that time.
This court found the taxpayer credible in her testimony that she provided babysitting services during 2016 and was paid for her services. The court concluded that while cross-examination did reveal that the taxpayer kept poor records and made some mistakes in her correspondence with Taxation, the documents she produced, namely both Ogunsaju's and Taxpayer's statements, provided credible proof of the taxpayer's 2016 source of income. The Court found that the taxpayer had income during tax year 2016, which entitled her to the EITC for 2016. Byrd v. Dir., Div. of Taxation, New Jersey Tax Court, Docket No. 011136-2018. 10/10/19

Corporate Income and Business Tax Decisions

No cases to report.

Property Tax Decisions

Valuation Affirmed

The Minnesota Supreme Court affirmed the decision of the state’s Tax Court, which dismissed Walmart Real Estate Business Trust's (Trust) challenges to property valuations in two of the state’s towns for tax year 2017. The Tax Court had concluded that the Trust was subject to the property tax mandatory-disclosure provision and had failed to satisfy it.

To trigger the mandatory-disclosure provision, the property at issue must be “income-producing,” and the Trust argued that its properties were not income-producing for three reasons. First, the Trust asserted that “vestibule businesses” on its properties do not make those properties income-producing. The Trust argued that the vestibule businesses are part of Walmart's business enterprise, are not subject to market-based leases that would indicate property value and are irrelevant to the income approach to property valuation. Second, the Trust argues that it does not receive anything from the vestibule businesses as the properties' owner and further argued it did not “admit” that the disclosure statute applies simply by attempting to comply with it. The County asserted that the Trust's properties are income-producing because the properties generate income from third-party entities who occupy space on the properties.

The court noted that it resolved a similar tax appeal last term in Wal-Mart Real Estate Business Trust v. County of Anoka, 931 N.W.2d 382 (Minn. 2019) in which it held that the
Trust's Anoka properties were income-producing and were thus subject to the mandatory-disclosure provision and, further, that the Trust had failed to satisfy the provision's requirements. The court ordered supplemental briefing in the current matter to address whether County of Anoka controlled the disposition in this consolidated appeal. The County's brief asserts that County of Anoka was controlling in all aspects and the Trust's brief asserted that the case was distinguishable based on the more comprehensive disclosures in this case and affidavits that clarify the relationship between the vestibule businesses and Walmart, Inc.
After reviewing the submissions by the parties, the court concluded that County of Anoka was directly on point in all relevant respects and controlled the disposition of the consolidated cases. The court, therefore, affirmed the decision of the tax court. Wal-Mart Real Estate Bus. Trust v. Cnty. of Washington, Minnesota Supreme Court, A19-0419; A19-0424. 10/22/19

Parcels Should Not Be Treated as Single Economic Unit

The New Jersey Tax Court held that parcels consisting of multiple parking lots, an office building, and a parking garage should not be treated as a single economic unit for property tax purposes. The court found that the parcels did not share a unity of use or unity of ownership.

The facts show that the taxpayer, a New Jersey corporation, owned parcels designated by the court as the “EGDC Parcels,” and parcels designated by the court as the “HPI Parcels.” The taxpayer sold the HPI Parcels until August 1995 when it sold them to HPI-Linque Partners One, L.P. (HPI). The HPI Parcels have changed ownership since 1995. The EGDC Parcels consist of parking lots each measuring 5.72 and 5.27 acres respectively. The former lies within Rutherford's Office, Research, Development (ORD) zone, and the latter in the Rutherford's A (light industrial) zone. The HPI Parcels are located in the ORD zone and comprise an office building, parking garage and a parking lot and are separate and contiguous to the EGDC parcels, located in between the two EDGC lots. As part of the August 25, 1995 sales transaction, EGDC entered into a Reciprocal Easement Agreement (Agreement) with HPI in which each entity reserved unto itself, its successors and assigns, the unrestricted and free right to the uninterrupted enjoyment of its Parcels.

EGDC filed an appeal contesting the assessments on the EGDC parcels for tax years 2012 through 2017. In 2017, Rutherford filed a motion for partial summary judgment asserting that the EGDC Parcels and the HPI Parcels “should be valued as a single economic unit as a matter of law based upon the vested rights between the parcels and the actual operation of the properties in question.” Rutherford acknowledged that the EGDC Parcels and HPI Parcels were under separate ownership but alleged that the “rights and actual operation of the subject parcels are intertwined and connected” because the EGDC parcels “operate as points of ingress, egress, and parking lots for” the HPI Parcels. The taxpayer opposed Rutherford's motion and argued that there was no unity of ownership nor unity of use between the EGDC Parcels and the HPI Parcels, highlighting that the parcels are operated separately and independently from each other and emphasized that EGDC does not operate, manage or have any control over the HPI Parcels.

The court found that genuine issues of material fact were not in dispute, and therefore, it could decide whether the EGDC Parcels should be valued as a single economic unit with the HPI Parcels through summary judgment. The court said that in New Jersey, the single economic unit doctrine has become an essential tool for appraising properties at their highest and best use. In order for the doctrine to apply to a combination of noncontiguous parcels, there must be a unity of use and a unity of ownership. Case law has said that unity of use is determined based on whether the parcels are functionally integrated, that each is reasonably necessary to the use and enjoyment of the other. Courts also looks to see whether there is a connection or relation of adaption, convenience and actual use between the parcels. In one prior case, the court determined that four lots owned by a defendant, one of which was not contiguous to the others, had to be valued as a single economic unit as they were operated together, would be sold together as one parcel of land, and would be developed together for one use.

Rutherford relied in the current case on the parcels' reciprocal rights of ingress and egress, as well as EGDC's affirmative duty to maintain a minimum of 2261 parking spaces, to contend that the EGDC Parcels are “reasonably necessary” to the use and enjoyment of the HPI parcels. However, after analyzing the agreement between the parties, the court found that the affirmative duty to maintain parking spaces during construction is not unique to the EGDC Parcels because the agreement provided that during construction, EGDC has the option of providing off-site parking. The court also determined that the purported use relationship was further eroded by the fact that either owner had the right under the agreement to permanently close its parcel for ingress and egress. Rutherford also provided a proposed future site plan that contemplated the construction of a hotel and office building on the EGDC Parcels and the proposed plan showed that EGDC planned to exercise its right to permanently close off some of the parking spaces on its parcels and provide temporary parking elsewhere for new construction. The proposed plan provided by Rutherford did not show any dependence by either party on the other's parcels beyond the agreement to provide parking spaces during construction. The court found that Rutherford had not established that the EGDC Parcels and HPI Parcels operated together, will be developed together, or are currently, or in the future, going to be used for a unifying purpose. The court, therefore, concluded that the EGDC Parcels and HPI Parcels were not functionally integrated to rise to the level of a unity of use.

The court further found that even if it were satisfied that a unity of use existed between the EGDC Parcels and HPI Parcels, the second crucial component of the single economic unit analysis was missing here. Easements do not convey an actual ownership interest, but simply entitle the holder of the easement to make some use of the other's property. The court said it was undisputed that EGDC had not held legal title to the HPI Parcels since 1995. In prior cases, the court has extended the concept of unity ownership to encompass the concept of beneficial ownership in addition to actual ownership by title, but this concept has been curtailed in several circumstances. In the current matter, Rutherford has acknowledged that the EGDC Parcels and HPI Parcels have been under separate ownership since 1995, and as such, it has not established that there is a unity of actual ownership by title. The court looked at whether beneficial ownership arose by virtue of the agreement between the parties. The court found that Rutherford had not established, and the record did not show, any beneficial ownership interest granted by the agreement. There was no evidence that EGDC managed or exercised any degree of control over the HPI Parcels, or that the owners of the HPI Parcels managed or exercised any degree of control over the EGDC Parcels. Rutherford pointed to the agreement that outlined affirmative duties for EGDC to maintain parking spaces during any construction. The court noted, however, that the agreement grants either owner the independent right to permanently close any area or all of their respective parcel without the other's approval. The court found that unity of ownership had not been established based on the evidence presented. EGDC C/O AM Resurg Mgmt v. Rutherford Borough, New Jersey Tax Court, Docket No. 004521-2012; Docket No. 002730-2013; Docket No. 002112-2014; Docket No. 003453-2015; Docket No. 003586-2016; Docket No. 003546-2017. 10/16/19

Other Taxes and Procedural Issues

Petition for Slot Machine Taxes Credit Denied

The Pennsylvania Commonwealth Court held that a racetrack and casino operator’s petition seeking a credit for allegedly overpaid slot machine taxes was not timely filed with the Department of Revenue (DOR). The court found that the three-year statute of repose under section 3003.1(a) of the state's Tax Reform Code of 1971 applies to petitions seeking either a refund or credit.

The court previously ruled on this matter and held that the taxpayer’s petition for refund was untimely. The taxpayer asked the court for reconsideration and the court agreed to review the question of whether Board of Finance and Revenue (F&R) erred in applying the three-year statute of repose in the state to the taxpayer's petition. The court requested supplemental briefs from the parties, limited to the question of whether, as a matter of statutory construction, the three-year statute of repose in Section 3003.1(a) of the Code applies to the taxpayer's petition for refund in this case, which sought only a credit against future tax liability. To make the determination regarding the taxpayer’s petition for refund in the nature of an adjustment/credit, the court said it was guided by the Statutory Construction Act of 1972, which provides that the object of all interpretation and construction of statutes is to ascertain and effectuate the intention of the General Assembly and the court said the clearest indication of legislative intent is generally the plain language of the statute. The court said the question was whether the reference to a petition for “refund or credit” in the first sentence of Section 3003.1(a) of the Code but a subsequent reference only to a “petition for refund” in the statute of repose language should be interpreted to mean that the statute of repose applies only when a party is petitioning for a refund of taxes and not for a credit.

The court noted that the first sentence of Section 3003.1(a) of the Code authorizes a taxpayer to petition the DOR for either a refund or credit with respect to any tax that the DOR collects and the second sentence provides the statute of repose, which requires that “a petition for refund” must be submitted to DOR within three years of the actual payment of the tax. The court said that at first blush, the use of the word refund in isolation suggests that the statute of repose does not apply when the taxpayer petitions for a credit, but determined that such a construction of the statute of repose provision would be contrary to the legislature’s intent.
The court said the question was whether a “petition for refund,” as that phrase is used in Section 3003.1 of the Code, was the filing by which a taxpayer may seek either a refund or a credit from DOR and the court concluded that it was and said that the subsection following the statute of repose in Section 3003.1 of the Code resolved the question. This subsection relates to refunds or credits following DOR’s issuance of an audit report and the court said that while the subsection did not apply here, the statutory language added context to its interpretation of the statute of repose. That subsection authorizes refunds and credits and treats a “petition for refund” as the filing by which a taxpayer seeks either. The court also noted that Section 3003.1(a) of the Code applies broadly to requests for refunds or credits of all taxes that DOR collects and said that the language of that provision clearly expressed the legislature’s intent that a timely filed petition for refund under Section 3003.1(a) of the Code is the vehicle by which a taxpayer must seek a refund or credit for overpaid state sales tax. In light this, the court concluded that it could not interpret the phrase “petition for refund” in Section 3003.1(a) of the Code narrowly to exclude petitions that seek a credit rather than a refund of overpaid taxes without contradicting the intent of the legislature. Greenwood Gaming & Entm't Inc. v. Pennsylvania, Pennsylvania Commonwealth Court, No. 609 F.R. 2015. 9/30/19

Mailbox Rule Case Remanded

The Michigan Court of Appeals held that affidavits establishing that a tax return was executed in the usual course of business are enough under the mailbox rule to create a presumption that the returns were mailed and received by the Department of Treasury (Treasury). The court remanded the case to the state’s Court of Claims after finding that evidence produced by both the taxpayer and Treasury created a question of fact regarding when the return was filed.

The taxpayer is a Michigan corporation engaged in financial and investment services and is a member of a unitary business group (UBG). All seven affiliates of the UBG elected to be treated as “S” Corporations for purposes of federal income taxation. The issue in this case is when the taxpayer filed its 2009 Michigan Business Tax (MBT) return because the date that the return was filed determines whether credits claimed on the taxpayer’s MBT return were valid, and whether Treasury could issue an assessment for tax deficiency. The taxpayer claimed it mailed the return to Treasury on November 15, 2010, and, therefore, Treasury’s July 2016 assessment was untimely and barred by the statute which provides a four-year limitations period for filing assessments. Treasury claimed that it did not receive the taxpayer’s 2009 MBT return until after it notified the taxpayer that a tax return for 2009 was not filed and argued that the taxpayer was not entitled to the credits claimed because the tax return was filed after the expiration of the limitations period for filing an original return. The taxpayer argued that under the mailbox rule, it had submitted sufficient documentary evidence to create a rebuttable presumption that because it had placed the return in the mail on November 15, 2010, it had been received by Treasury and therefore timely filed.

The taxpayer relied on two affidavits attached to its complaint, the first from its tax professional and the second from its corporate controller and vice president of accounting,
The tax professional’s affidavit stated that he printed the taxpayer’s 2009 MBT return on November 3, 2010, and in accordance with his usual practice, he would have delivered it to the taxpayer within “one or two days of that date” either personally or via “electronic mail.” He attached to his affidavit a print out of his “client status histories,” showing the work history of the files for the disputed return. The printout was consistent with the facts in his affidavit. The second affidavit stated that the corporate controller and VP had supervised the
preparation of, reviewed, and was responsible for, the filing of all tax returns” for the taxpayer since 1999 and averred that it was his usual business practice that upon receiving the return from the tax professional, the return would be signed by either himself or by the taxpayer’s CEO. The affidavit said that all tax returns “were reviewed, signed and mailed at or near the time of their receipt from” the tax professional. The Court of Claims concluded that the taxpayer failed to submit sufficient, non-speculative evidence that the 2009 MBT return was submitted for mailing in November 2010, finding that the lack of proof was whether the return made it to the mailroom in the first instance. As a result, the taxpayer’s ordinary mailing practices, and the presumption created by the mailbox rule, did not become relevant. The taxpayer filed this appeal.

The court rejected the taxpayer’s argument that although the four-year limitations provision only mentions “a refund,” the Court of Claims erred by reading into the statute a provision that treats a claim for a credit in excess of taxes due as “a claim for a refund,” noting that statutory language should be read in harmony with the entire legislative scheme. The court, however, concluded that the loer court erred in granting summary disposition in favor of Treasury where a material question of fact remained regarding when the taxpayer first filed its 2009 MBT return. The taxpayer argued that under the mailbox rule, because it mailed its 2009 MBT return in accordance with its business customs and habits on or about November 15, 2010, it is entitled to the presumption that Treasury received the return. The court noted that if the timeline presented by the taxpayer were accurate, Treasury would have had until November 15, 2014 to issue an assessment for tax delinquency and it followed that the assessment issued by Treasury in July 2016 barring the taxpayer from claiming any credits on its 2009 MBT return was untimely, as it is also subject to the four-year statute of limitations.

The mailbox rule provides that the mailing of a notice properly addressed and postpaid raises a presumption that the notice was received by the person to whom it was directed and has been expanded by case law so that a letter mailed in due course of business is presumed to have been received. The court said that in Good v Detroit Automobile Inter-Insurance Exchange, 67 Mich App 270, 276; 241 NW2d 71 (1976), it concluded that “upon proper evidence of business custom and habit of a commercial house as to addressing and mailing, the mere execution of [a] letter in the usual course of business rebuttably presumes subsequent receipt by the addressee.,” and the court in that case considered what evidence of a private business or custom was necessary to prove the mailing of a letter. That case adopted the view that evidence of a business custom or usage was sufficient to establish the fact of mailing without further testimony by an employee of compliance with the custom.

The court concluded that in the current case all the taxpayer needed to prove to establish a presumption under the mailbox rule was that the tax return was executed in the usual course of business. The tax profession averred that he printed the taxpayer’s return on November 8, 2010, and that his usual course of business was to send the return to taxpayer within one or two days. The VP averred that once he received the returns, he would facilitate their signature, and would then “place the signed returns in a sealed envelope properly addressed to the appropriate taxing authority and then place the envelope with the taxpayer’s mail department.” The court found that, under Good, this evidence was sufficient to entitle the taxpayer to the presumption that it mailed its 2009 MBT return in November 2014. However, the court pointed out, the presumption that the taxpayer mailed its 2009 MBT return in November 2014 is rebuttable, with evidence that the return was not received. Treasury submitted its own affidavit, in which it averred that the taxpayer’s 2009 MBT return was not found in its database. In fact, Treasury received the taxpayer’s 2009 MBT return for the first time in 2014. Accordingly, the court found that Treasury’s affidavit created a question of fact that precluded summary disposition for either party and the lower court erred in granting summary judgment to Treasury. Federated Fin. Corp. of Am. Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 344181; LC No. 16-000257-MT. 10/17/19

Casino's Complimentary Event Tickets Tax-Exempt

The Pennsylvania Commonwealth Court has held that a racetrack and casino operator is allowed to deduct the costs of complimentary event tickets that it gives to gamblers from its gross table and slot revenues prior to paying tax. The court reversed the Board of Finance and Revenue's (Revenue) denial of the company's tax refund request.

The taxpayer operates a casino and distributes complimentary event tickets to patrons as a result of their table game and slot machine play. The Commonwealth’s Race Horse Development and Gaming Act (Act) defines “Gross table game revenue” as cash or cash equivalents received in the playing of a table game minus the actual cost paid by the certificate holder for any personal property distributed to a player as a result of playing a table game, not including travel expenses, food, refreshments, lodging or services. For taxing purposes, the Commonwealth included the costs of those complimentary event tickets in the taxpayer’s gross table game revenue and gross terminal game revenue. The taxpayer contended it was entitled to deduct the costs of event tickets from its gross table and slot revenues, and thus avoid paying taxes on the ticket costs. The court said the dispute here hinged on whether the event tickets the taxpayer provided to patrons were “services” under the Act. If they were “services,” their cost was included in the taxpayer gross table and slot revenues for tax purposes and, if not, the cost is deductible by from the taxpayer’s gross table and slot revenues. The Commonwealth argued an event ticket merely confers a right of admittance, and it is the event experience for which the taxpayer pays and which its patrons receive, asserting that event performances are clearly “services.” The taxpayer argued that neither the tickets nor the event admittances they conferred were “services” within the meaning of the Act and that the meaning of “services” was ambiguous as applied to event tickets.

The court reviewed the rules of statutory construction. The Act did not define what constitutes a “service,” but the court said that pertinent authority suggested a ticket conferring a right of admission to an event is intangible personal property, and as such, neither a good nor a service. In Yocca v. Pittsburgh Steelers Sports, Inc., 854 A.2d 425 (Pa. 2004) (Yocca II), the court found that the licenses which entitled the purchaser to a future agreement to buy a season tickets for a specified seat were the equivalent to option agreements to keep open the purchasers' rights to enter subsequent agreements to buy season tickets and, as such, the licenses might conceivably be “services” under the Unfair Trade Practices and Consumer Protection Law (UTPCPL). The dissent in that case agreed with the trial court and argued that the licenses were intangible property rights, and as such, were neither goods nor services.
On appeal to the Commonwealth’s Supreme Court, the matter was decided on the issue of whether the plaintiffs had stated a UTPCPL claim, but the court did observe that it was clear that the law was not completely settled as to whether the license constituted either a good or a service.

The court noted that the Commonwealth conceded that the event tickets at issue represented and conferred “intangible rights” and pointed out that an event ticket is a “general intangible” under Article Nine of the Uniform Commercial Code (UCC). The court also noted that nothing in the UCC definition includes a “service” in the definition of a “general intangible.”
Citing federal provisions, the Commonwealth also argued the events themselves are services, but the court said the cited federal provisions were not tax laws and that federal definition of “services” in a non-tax context should carry over into state law. Even assuming events constitute services, the court pointed out that the taxpayer was not the service provider. The performers provide the service at an event and the ticket merely conveys the right of attendance. The court did admit that it was logical to argue that the legislature may have intended to except only patrons' winnings from gross table and slot revenues but concluded that it could have done so expressly. To the extent it was unclear under the current language of the Act whether event tickets constitute “services” included in gross table and slot revenues, the court found that the term “services” is ambiguous. Because ambiguities in taxing statutes are construed in favor of the taxpayer, the court found that the taxpayer was entitled to the deductions it sought for the comps it distributed to patrons in the form of event tickets. Greenwood Gaming & Entm't Inc. v. Pennsylvania, Pennsylvania Commonwealth Court, No. 531 F.R. 2017. 10/16/19

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].