NEWS
Direct Marketing Association v. Brohl update
As previously reported, the U. S. Supreme Court ruled on March 3, 2015 that the suit brought by the Direct Marketing Association against the Colorado Department of Revenue to enjoin enforcement of the Colorado enacted legislation requiring non-collecting retailers to notify any Colorado customer of the State’s sales and use tax requirement and to report tax-related information to those customers and the Colorado Department of Revenue was not barred by the Tax Injunction Act. The court remanded the matter and the U.S. Court of Appeals for the Tenth Circuit has now ordered the parties to brief the court on the commerce clause claims, whether the case should be dismissed under the comity doctrine, and any other pertinent issues.
Tax Day
The Wall Street Journal celebrated April 15th with an article highlighting a number of individuals in the country who collect memorabilia related to paying taxes, state and federal forms, old tax manuals, posters and tax stamps. The article noted that many of these collectors work or have worked in tax-related professions and are drawn to the history of tax collection. Collectors look to places like flea markets and eBay for their finds. The writer pointed out that eBay had a completed 1946 tax return listed for $14.99.
Many long-term employees in the state tax agencies have been their agency’s unofficial historians, collecting memorabilia of tax amnesty programs, old law books, pictures, tax bulletins and forms. You can find the full text of the article at http://www.msn.com/en-us/money/taxes/these-tax-collectors-say-few-understand-their-passion/ar-AAb0j8v
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
No cases to report.
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Court Remands City's Challenge Against Equalization Board
The California Court of Appeal, First Appellate District, held that the trial court must determine where title passed for all of the Internet sales transactions in order to determine whether the State Board of Equalization (SBE) should impose a local sales tax instead of a use tax for a city on an Internet retailer's sales.
The city of Brisbane filed a local tax inquiry contending that SBE was improperly imposing a local use tax instead of a local sales tax on transactions involving an Internet retailer of goods that had its corporate headquarters in Brisbane. SBE responded that it imposes a state sales tax only when a California business participates in the sale and title to the property under the California Uniform Commercial Code (CUCC) passes to the customer in California, and because the state and local sales tax law is the same, this interpretation applies to the transactions at issue here. SBE asserted that the sales at issue did not meet either requirement for imposing a sales tax as title transferred to the consumer outside of California, and employees located in Brisbane did not participate in the sale. Whether SBE administers a local sales or use tax has significant consequences for cities and counties because all local sales tax revenue is distributed to the city where the sale was consummated, but local use tax revenue is distributed to the county which then distributes the revenue to its cities out of a countywide pool.
At the time of the challenge at the trial court level, there were two other cases pending that challenged SBE's determination that state and local sales and use tax laws were the same. Prior to the appeal in this case, the court ruled on the other two and held that SBE's interpretation of the statutes was correct and that it properly imposed the sales tax only when a California business participated in the transaction and title to the goods passed in California.
While the principal issue raised in this case is identical to the other two cases, the court found that this case involves a factual dispute that did not exist in those cases because the parties here do not agree that title for all of the sales passed to the customer outside of California.
The lower court made no findings on this issue because it ruled that title was irrelevant in the decision. The court reversed the lower court ruling, but remanded the matter to the trial court to make the necessary findings regarding where title passed for all of the transactions at issue and issue a new judgment consistent with the court’s opinion. City of Brisbane v. California State Bd. of Equalization, California Court of Appeals, A137185. 3/25/15
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Company Must Exhaust Administrative Remedies Before Challenging Tax Credit Denial
The Iowa Supreme Court held that the denial by the state’s Department of Economic Development (IDED) of taxpayer’s film tax credits was considered "other agency actions," and the taxpayer must exhaust its administrative remedies before filing an action for breach of contract in court. The court also held that the administrative process used to process film tax credit claims did not violate either the state or federal due process clause.
In January 2009 IDED entered into a contract with the taxpayer for tax credits under the Film, Television, and Video Project Promotion Program that included a description of the project, the terms and conditions for the credit and the repayment provisions if the taxpayer failed to complete its obligations under the contract, all provisions required under the statute for the program. The contract also provided that IDED “shall have the authority to reasonably assess whether the Recipient has complied with the terms of this Contract. Any IDED determinations with respect to compliance with the provisions of this Contract and the Funding Agreements shall be deemed to be final determinations pursuant to Section 17A of the Code of Iowa (2005).” The court noted that IDED did not promulgate any rules dealing with the procedures for claiming a credit, for IDED to verify a credit, or for a party to contest a decision concerning a credit within the agency.
After completion of the project, the taxpayer submitted its request for the tax credits, along with supporting materials. After submitting additional documentation, the taxpayer was granted a portion of its request, but the remainder of the credit was denied by IDED and the department issued its final determination on the tax credits on February 22, 2012. The taxpayer brought an action in district court to collect the credits it argued the state owed them, but the district court dismissed the petition on the grounds that the court did not have the authority to hear the case because the taxpayers had failed to exhaust their administrative remedies.
Chapter 17A of the Code classifies three types of agency action, rulemaking, contested cases, or other agency action. The dispute in this appeal is whether the IDED's refusal to honor all the tax credits claimed by the taxpayer qualifies as other agency action. The court reviewed prior case law on the definition of “other agency action” and noted that if the action or inaction of the agency in question bears a discernible relationship to the statutory mandate of the agency as evidenced by express or implied statutory authorization, a party must first present the claim to the agency for other agency action before the party can proceed to district court. In the present case, the court found that the review of the tax credits by IDED was “other agency action” that required the taxpayer to seek judicial review under chapter 17A of the state code, pointing out that the legislature mandated IDED to verify the eligibility of the credit. The court found that the duty to verify and issue the credits bears a discernible relationship to the statutory mandate of the IDED as evidenced by the express statutory authorization. The court also noted that the legislature had not devised a separate remedial statutory scheme to process a claim for film tax credits. Therefore, the district court did not have the authority to hear this case because the taxpayer failed to exhaust its administrative remedies.
The court rejected the taxpayer’s argument that they were denied due process because there were no administrative rules in place to process claims which IDED wrongly decided. They claim they did not receive a full and fair hearing on the merits of the case. The court found the informal procedure did not offend the due process guaranteed under the State and Federal Constitutions because it correctly balanced the interests set forth in Mathews v. Eldridge, 424 U.S. 319, 335, 96 S. Ct. 893, 903, 47 L. Ed. 2d 18, 33 (1976), noting that just because another procedure may seem fairer or wiser, does not mean the procedure provided violates due process. Ghost Player LLC v. Iowa, Iowa Supreme Court, No. 14-0339. 2/27/15
Property Tax Decisions
Quarry Scale on Property Not Assessable
The Iowa Court of Appeals held a taxpayer proved that a quarry scale used to weigh mining products on property the taxpayer leased was nontaxable equipment or machinery attached to a taxable concrete structure or improvement on which it rested rather than an assessable improvement constructed on the land.
The taxpayer leases land in the state on which it built and operated a quarry scale to weigh mining products. The city assessed the leased property and attributed a portion of the leased value to the scale. The taxpayer argued that the lower court erred when it placed the burden of proof on it to show that the scale was exempt, but the court, after reviewing the state statute, found that the burden is on the party asserting the invalidity of the agency action, i.e., the taxpayer in this matter.
All real property in the state is subject to annual property tax and for the purposes of this tax is defined to include buildings, structures, or improvements on the land, and buildings, structures, equipment, machinery, or improvements attached to buildings, structures, or improvements on the land. The statute further provides a definition of “attached,” and the taxpayer asserts that the scale is not “attached” because it falls within an exception set forth in the statute for property that would ordinarily be removed when the owner of the property moves to another location.
Testimony in this matter indicated that the scale has a 20-year useful life, costs approximately $52,000 new, and is installed by reusing existing piers. Expert testimony characterized moving the scale as a simple process and noted that there is a market for used scales. There was also testimony that the taxpayer had never abandoned or left a scale behind when relocating or closing an operation and that the usual and customary practice in the quarry industry was for the scale and all its component parts to be removed during the reclamation process. The county assessor, however, testified that in his experience scales like the one in this matter generally stay on site.
The court disagreed with the lower court’s characterization of the scale and the concrete base on which it rests as together forming the taxable property and found, instead, that they were separate for the purpose of taxation. The base on which the scale is built includes the concrete piers, the approach ramps, and the washout areas. The court said these underpinnings together form a base where the scale rests and are either an improvement or a structure constructed in or on the land. The court viewed the scale as a piece of mining equipment that can be taken apart and freely bought and sold between mining operations. It reversed the lower court’s finding that the scale itself was an improvement rather than equipment attached to an improvement or structure. The court remanded the case for a determination of whether the exception under section 427A.1(3) applies to the scale in this case. Wendling Quarries Inc. v. Prop. Assessment Appeal Bd. of Iowa, Iowa Court of Appeals, No. 14-0626. 2/25/15
Trust's Property Tax Exemption Appeal Barred by Statute of Limitations
The New York Supreme Court, Appellate Division, held that the Supreme Court should have rejected an unincorporated charitable trust's petition contesting the denial of its tax-exempt status because the trust did not timely appeal the denial. The trust brought the action more than a year after the county concluded foreclosure proceedings.
Plaintiffs are an unincorporated charitable trust that was established in the 1970s to hold land for the purpose of creating a community for Native Americans who wished to practice a lifestyle in accordance with their ancestral traditions and to educate the public about their culture. The trust acquired, by lease or deed, a number of parcels in the Town of Altona, and in 2003 the Town determined that most of the parcels held by the trust were taxable and began to send property tax bills. When the plaintiffs did not pay the taxes on these parcels over a period of some years, the county filed a petition for foreclosure, which was ultimately granted, and the county subsequently gained title by tax deed to 14 of the trust’s 17 parcels in the town. Plaintiffs admit that they had notice of these proceedings, the last of which concluded in March 2011, but chose not to defend themselves against any of them. In November 2012 the plaintiffs filed an action for declaratory and injunctive relief.
The state property tax statute provides that a taxpayer aggrieved by an assessment can challenge the assessment within thirty days after the final completion and filing of the assessment roll containing the assessment. If the taxpayer alleges the assessment is void because of the methodology of the assessment or because the taxing authority lacks jurisdiction to assess the property, the property owner can bring an action pursuant to article 78 of the code or file a declaratory judgment action, but these provisions are subject to a four-month statute of limitations.
The court rejected the plaintiffs' argument that, because the property is allegedly mandatorily exempt from taxes, the assessment is illegal and void and may be challenged at any time.
Plaintiffs conceded that they had notice of the town's determination regarding the taxable status of the parcels, and filed a grievance to administratively challenge the tax bills when the property was first listed as not tax exempt. They failed to appeal when the town denied the grievance and did not file any further actions until they commenced this action more than a year after the final foreclosure proceeding was concluded. The court held that while an action for declaratory judgment was a proper method, the statute of limitations barred the plaintiffs' challenges to their tax assessments.
The court also rejected the plaintiffs’ argument that, regardless of the statute of limitations, the assessments were invalid because the town failed to provide notice to the Attorney General regarding a change in the tax-exempt status of the property. The count found that the plaintiffs could have raised this argument in the tax foreclosure proceedings, for which they were on notice but failed to appear, and the doctrine of collateral estoppel bars plaintiffs from litigating the issue now. Plaintiffs also argued that notice to the Attorney General is a condition precedent to initiating a tax foreclosure proceeding, but the court found after reviewing the statute that it does not require that the Attorney General be given notice of a foreclosure proceeding, only of a change in tax-exempt status. Turtle Island Trust v. Cnty. of Clinton, New York Supreme Court, Appellate Division, 519007. 2/26/15
Military Retained Ownership of Property Under Public-Private Partnership
The Florida Court of Appeal, Third District held that property under a public-private partnership between the U.S. Navy and a private developer in order to update military housing is exempt from ad valorem taxes because the Navy retained equitable and beneficial ownership of the properties.
The properties at issue are five military housing complexes serving the Naval Air Station at Key West. In 1996, Congress enacted the Military Housing Privatization Initiative, codified at 10 U.S.C. sections 2878 et seq., which authorized "public/private ventures" to facilitate the upgrading of United States Military housing through private lending and redevelopment. In 2007, the Navy partnered with a third party (BBC) to enhance various naval housing developments in the southeast United States, including the military housing at the Naval Air Station at Key West. The Navy and BBC then took a series of steps to effectuate the private/public venture. The Navy and BBC created the Southeast Housing, LLC (Southeast), a for-profit corporation whose income is subject to federal income taxes, that was to lease the land, to assume title to the improvements, and to demolish, reconstruct, maintain, and operate the housing units. Southeast was also empowered to issue debt in the form of taxable revenue bonds. In accordance with their partnership, BBC and the Navy contributed capital to Southeast. The Navy also granted Southeast a fifty-year ground lease of the land under the buildings for the nominal payment of ten dollars, but limits the use of the properties to housing. Finally, the Navy and BBC entered into an operating agreement to govern Southeast, under which BBC serves as the managing member, with "sole and absolute" discretion regarding tax matters.
Construction must conform to the Navy's plans, specifications, and design/build agreements, which are expressly incorporated by reference into the operating agreement, with any changes to those plans subject to approval by the Navy. The Navy is entitled to appoint its own Resident Officer in Charge of Construction to inspect construction, review plans, analyze construction reports, and examine government permits to ensure compliance with the plans, quality standards, and laws. BBC was also empowered to rent the housing units, but the Navy retained substantial rights regarding rental. As an example, although BBC can charge non-military renters fair market value, the rents charged to the individuals referred by the Navy's Housing Service Center are tied to a sailor's basic housing allowance, not fair market value. Under certain circumstances, the Navy can remove BBC from the venture; under no circumstances can BBC remove the Navy. Finally, the operating agreement reflects that the Navy keeps substantial control of the income from the properties.
Initially, in 2007 the county property appraiser found that the property was a federally owned facility and, therefore, exempt under state law. In 2012 the appraiser changed the designation and issued tax notices on each of the properties for tax years 2008 through 2011. Subsequently, tax years 2012 and 2013 were added to this suit. The court noted that the property of the United States is immune from state taxation and, thus, the dispositive issue in this matter is whether the United States owns the subject improvements. Citing two prior cases, Leon County Educational Facilities Authority v. Hartsfield, 698 So. 2d 526, 528-29 (Fla. 1997) and First Union National Bank of Florida v. Ford, 636 So. 2d 523 (Fla. 5th DCA 1993), the lower court held that while Southeast was the titular owner of the property, true equitable ownership was held by the U S Navy,
The court pointed out that where legal title to property is held by one party but other significant rights concerning the property are held by another party, the determination of who possesses equitable or beneficial ownership turns on the allocation between the parties of the property rights associated with the real estate. The court found that although title to the improvements rests with Southeast, the use of the improvements is essentially limited to military housing, serving the interests of the Navy. In addition, the Navy retained a large element of control over the construction, repair, and maintenance of the buildings, important property rights normally held by the owner. The Navy also essentially controls the rental of the housing units, an important property right of the sort associated with ownership. Through security requirements that the Navy can impose and change at will, the Navy controls Southeast’s access to the improvements. At the same time, the Navy retains the right to access the properties and even enter individual housing units. The court also noted that the Navy supervises the operations of the improvements during the entire term of the lease and benefits from the revenues and receives a large share of the profits. The court also found that the return of the improvements to the Navy in good order, after the expiration of the lease, is a factor that heavily favors Navy ownership. The court also found that title to the property was transferred not to establish fee ownership in Southeast, but to issue private bonds and to create a technicality that will allow the Navy and Southeast to circumvent a restriction in federal law and noted that the concept of equitable ownership exists because paper title is sometimes transferred for reasons other than the conveyance of ownership. The court held that the allocation of the underlying property rights between the Navy, BBC, and Southeast indicated that the Navy holds equitable ownership of the improvements. Finally, the court rejected the appraiser’s argument that the United States had consented to taxation of the properties and improvements, finding that the provisions of the agreement cited by the appraiser were too equivocal to constitute consent to taxation. Russell v. Southeast Hous. LLC, Florida Court of Appeal, No. 3D14-746. 3/11/15
Principal Residence Exemption Denied Based on Lack of Water Service
The Michigan Court of Appeals found a principal residence exemption was properly denied an individual because water had been shut off at the residence years earlier. The court found that the taxpayer was unable to otherwise prove her claim that she lived at the residence.
Taxpayer owns property in the state and filed an application for exemption claiming that she had lived at that property since 2001. The county initially granted the application, but subsequently denied the application for 2012, finding that she did not occupy the property. The Tax Tribunal found that water usage is considered a reliable and reasonable indicator for determining occupancy of a residence and noted that water records for the property showed that the minimum chargeable amount of water was never exceeded from January 2008 through June 2012. Petitioner’s explanation that she conserves water and uses alternative water sources was found to be unpersuasive. The tribunal also found that petitioner failed to submit utility bills or other reliable evidence to support her contention that she had occupied the subject property as her principal residence.
The court noted that a petitioner must establish entitlement to a statutory exemption by a preponderance of the evidence. The statute provides that a principal residence is exempt from the tax levied by a local school district and defines principal residence as the one place where an owner of the property has his or her trued, fixed, and permanent home to which the owner intends to return under another principal residence is established. The court found that the taxpayer failed to provide competent, material, and substantial the property as her one true, fixed, and permanent home for the period at issue here. The court noted that the taxpayer here had extremely little water usage at the property and no proof of an alternative water source or a reasonable explanation about the lack of water usage.
The county also presented evidence that the taxpayer only registered to vote in the city in which the property was located on July 6, 2011, and the registration showed her as having moved to the city from an address in another town, pertinent because the taxpayer had previously claimed to have lived in the subject property during the period she was registered to vote in another township. The court determined none of petitioner's remaining evidence proved by a preponderance of the evidence that she actually occupied the property at issue here as her one true, fixed, and permanent home for the period at issue as required to receive the exemption. It found that the Tax Tribunal’s decision was based on competent, material, and substantial record evidence. Spranger v. City of Warren, Michigan Court of Appeals, No. 31927. 3/12/15
Court Rejects Purchase Price of Property for True Cash Value Determination
The Michigan Court of Appeals held that the 2013 true cash value of the taxpayer's residence was not the 2012 purchase price of the property, finding that it was not an accurate depiction of the property's value. It found that the lower court’s evaluation was supported by competent, material, and substantial evidence.
The taxpayer purchased the subject residential property on December 19, 2012, for a purchase price of $99,799. Maple Street runs alongside a canal leading to Lake St. Clair. For 2013, the city assessed the true cash value (TCV) of the property at $180,000.
The court noted that the review of the Tax Tribunal’s decisions is limited and the tribunal's factual findings are final if they are supported by competent, material, and substantial evidence on the whole record. Three methods of valuation, the cost-less-depreciation approach, the capitalization-of-income approach, and the market approach, are generally acceptable and it is the tribunal’s duty to determine which approach provides the most accurate valuation in a particular circumstance.
The taxpayer argued that the 2012 purchase price of the property reflects its true cash value because the property was purchased in an arm's length transaction, but the court noted that the state’s highest court has found that the sale price of a particular property is not conclusive of the value of that property. In this case the tribunal found that the rapid drop in price for the listed property from July 2012 to November 2012 was not an accurate reflection of its true cash value and, rather, indicated that the seller preferred to sell the property as soon as possible, and lowered the price accordingly. The tribunal also found that the condition of the canal on which the property was situated varied from year to year. The tribunal determined that the county’s nine properties provided a better overall comparison, and that the values were adjusted to reflect differences between taxpayer’s property and the comparable properties.
The court found that under the substantial evidence standard, the county’s analysis of the other canal-side properties, as adjusted by the tribunal, provided more than a scintilla of evidence supporting the tribunal's finding that the TCV of taxpayer’s property was $160,000. The court rejected the taxpayer’s argument that his comparable properties were more similar to his property than the county’s comparables, and therefore were entitled to greater weight in the tribunal's review, finding that the tribunal's evaluation is supported by competent, material, and substantial evidence. Beydoun v. City of St. Clair Shores, Michigan Court of Appeals, No. 319664. 3/17/15
Other Taxes and Procedural Issues
Telecommunications Tax Violates State Constitution
The Kentucky Court of Appeals modified an earlier decision holding the telecommunications tax, enacted in 2005, violates the state constitution. The tax imposed a state-level tax while forbidding local franchise fees that are expressly permitted in sections 163 and 164 of the state's constitution.
In 2005 the state enacted the Telecommunications Tax, effective January 1, 2006, altering the taxation of telecommunication companies and services at both the state and local levels. It imposed statewide tax on multichannel video programming services (MVP) and on gross revenues received by all providers of MVP services and communication services. It also barred local governments from taxing cable television franchises. Prior to enactment of this legislation, local governments collected franchise fees from telecommunications companies and cable providers pursuant to the state Constitution Sections 163 and 164.
The court noted that the power and authority to grant franchises and charge fees are attributes of the sovereign state and remain vested in the state except to the extent that such power has been constitutionally or statutorily delegated to local governments. It also pointed out that case law has consistently interpreted Section 163 of the Kentucky Constitution as a delegation to local government of the right to grant utility franchises within its boundaries.
The court noted that while Section 163 has been viewed as a delegation of the authority to grant a utility franchise to local government, Section 164 has been interpreted as a limit upon that delegated authority, mandating that local a government may only grant a utility franchise for twenty years and only after a competitive bidding process. Through enactment of Section 164, the drafters of the Constitution envisioned that local governments would receive valuable consideration in exchange for the granting of the utility franchises. The court said that the state’s case law has also recognized the retained authority of the state to regulate by legislative enactment a utility franchise granted by local government, but pointed out that this tax is unique because it seeks to impose state taxes at the expense of franchise fees historically imposed and collected by the localities.
The court held that legislative fiat may not abrogate the localities’ constitutionality delegated prerogative to grant a franchise and collect franchise fees. The Telecommunications Tax effectively frustrated the ability of local governments to collect franchise taxes, which the court said could only be accomplished through constitutional amendment. It ruled that the Telecommunications Tax was unconstitutionally void. City of Florence v. Flanery, Kentucky Court of Appeals, No. 2013-CA-001112-MR. 11/7/14, modified 3/13/15
Sewer Infrastructure Update Fee Is an Impermissible Tax
The Idaho Supreme Court held that a capitalization fee imposed on a city's residents to make infrastructure updates to the regional sewer system was an impermissible tax because the fee exceeded the actual cost of the service being rendered and the municipal legislative body did not vote on a tax increase.
The City in this case provides sewer service to the residents living in the City and to some persons living outside the City and to effectuate this, entered into a joint powers agreement with the regional sewer board, which operates a regional wastewater treatment plant serving the City and two other local entities. Pursuant to that agreement, the City collects sewage from its customers and delivers it to the treatment plant. The City is responsible for the construction, maintenance, and operation of its collection system, which includes various components, such as trunk lines, sewer mains, interceptors, and lift stations that collect sewage for transport to the treatment facility.
The City charges each customer it serves a bi-monthly fee, which covers a proportionate share of the operation and maintenance of the City's sewer collection system and of the operation and maintenance costs associated with the regional wastewater treatment facility. The city also charges a one-time "sewer capitalization fee", imposed when a building permit is issued, for each new structure and for any addition to an existing commercial structure that will result in an increase in the volume of sewage generated. This fee has two components, one represents the amount charged to the city by the sewer board for each connection to the city’s sewer system and the second is a fee retained by the city to fund capital improvements to the sewer system. As a result of recommendations made to the city for a capital improvement plan to replace existing infrastructure and accommodate future population growth, the city significantly increased their portion of the capitalization fee effective June 7, 2007.
A contractors’ group filed suit claiming the fee was unconstitutional but the lower court held that the increased fee was authorized by a provision of the state code, which permits a taxing district to impose fees for services that would otherwise be funded by property tax as long as those fees are reasonably related to, but not exceeding, the actual cost of the service being rendered. In this appeal, the issue was whether there was evidence supporting a finding that the increased fee was the actual cost of the service being rendered as of June 7, 2007.
The court found that the additional fee was not to provide sewer service to a house connected to the City sewer system after June 6, 2007, but to accumulate a fund to provide a sewer system to extend to areas to be acquired by the City in the future. The court also rejected the City’s arguments that other sections of the state code permitted them to set this fee, again finding that the fee did not represent the actual cost of the service being provided and citing a case that held a connection fee charged to connect to a city's sewer and water system could exceed the actual cost of physically connecting to the system.
The court said is nothing in the record of this case showing that the fee was based upon the value of that portion of the existing City sewer system that the new user will be utilizing. The fee was based upon the estimated cost of the construction necessary to extend sewer service throughout the city area of impact so that it could be used by those who could be connecting to the enlarged system at some time in the future.
The court said that the portion of the fee at issue was not based upon the sewer service rendered to the new user who connects to the City's sewer system. It was based upon the estimated cost of new construction needed to extend that system to future users in other areas, including areas outside the City in its area of impact, in order to meet public needs. The court noted that although the sections of the code that the City argued did permit a fee for services provided, including sewage removal, the provision does not state that the fee charged to one used can be based on the cost of extending the service to future users. The court said that a city's power to spend money does not include the power to impose any tax or fee that is necessary to raise the money it desires to spend. N. Idaho Bldg. Contractors Ass'n v. City of Hayden, Idaho Supreme Court, 2015 Opinion No. 19; Docket No. 41316-2013. 2/26/15
Dismissal of Qui Tam Suit Upheld
The Illinois Appellate Court, First District held a lower court properly limited discovery for a law firm bringing a qui tam action to a deposition of only a company’s official responsible for state tax compliance. The court also said the firm did not have a right to payment from the state of a portion of that company’s sales tax proceeds paid after the start of the suit.
The taxpayer (QVC) had previously been audited by the state for sales and use tax to determine whether it had complied with an agreement reached with the state in 1995 to collect tax on all sales shipped to customers in the state after that date. The records QVC provided showed that they were not collecting tax on the shipping and handling charges. At the conclusion of that audit the state notified QVC that its returns were in order. In 2009, the Illinois Supreme Court decided, in Kean v. Wal-Mart Stores, Inc., 235 Ill. 2d 351 (2009), that purchasers who use items in Illinois purchased from sellers outside of Illinois, under specified conditions applicable to many purchases made over the internet, must pay use taxes on shipping and handling charges paid for delivery of the merchandise. Soon after the law firm filed suit, QVC started collecting and remitting use taxes to the state on shipping and handling charges. QVC moved to dismiss the lawsuit and the state intervened in the action. The firm opposed the motion to dismiss and filed a motion for leave to discover all communications between the State and QVC after August 2011 concerning use tax collection and the State's decision to dismiss the qui tam case. The firm subsequently filed a petition for an award of a relator's share of amounts QVC paid to the State.
Citing prior case law, the court explained that the State has primary responsibility for conducting the qui tam action, and the State has authority under the False Claims Act to dismiss the case over the relator's objection. When the state does dismiss the action, it is presumed that it is acting in good faith and, barring glaring evidence of fraud or bad faith by the state, it is the state's prerogative to decide which case to pursue, not the court's. If the State settles a qui tam action, the False Claims Act empowers the court to determine whether the proposed settlement is fair, adequate, and reasonable under all the circumstances.
The court concluded that the State did not act in bad faith when it decided that it would not penalize QVC for acting in accord with the procedures the State approved 6 years earlier when it completed its audit and approved QVC's explicit practice of not charging use tax on shipping and handling charges. It ruled that the law firm did not met its burden of presenting glaring evidence the State acted in bad faith when it moved to dismiss the qui tam action against QVC, and the evidence in the record indicates that further discovery would not prove the State acted in bad faith.
The firm argued that even if the lower court properly dismissed its complaint, it was entitled to fee for help in producing income for the state under the False Claims Act. In making that determination, the court looked to the provision that set forth the amounts to be paid when the state received proceeds of the action and found that since the court dismissed the firm’s claims in their entirety, it did not qualify as a prevailing party and was, therefore, the payments QVC started to make after the firm filed the lawsuit do not count as proceeds of the lawsuit. The court noted that the firm’s original complaint sought damages including use tax, penalty and interest that QVC had not paid to the state and pointed out that the state recovered no interest or penalty or use tax on prior sales’ delivery charges. The court said it could not construe the payment QVC voluntarily started to make on sales after the filing of this lawsuit as part of the proceeds of this lawsuit. Illinois ex rel. Schad Diamond and Shedden PC v. QVC Inc., Illinois Appellate Court, 2015 IL App (1st) 132999; No. 1-13-2999. 3/31/15
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected].
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NEWS
April Fools Day
Well, did we all survive April 1 without falling prey to a friend or coworker hoping to prank us? How many New England fans gasped when they saw Tom Brady’s picture in a full body cast? Or how about that grocery store chain that is revolutionizing the supermarket shopping experience by introducing "trampoline inspired bouncy aisles" to help you the height impaired customers reach the top shelves. Or Italian officials plans to raise money by turning the Leaning Tower of Pisa into a luxury hotel?
In case you missed it, two of our colleagues contributed to the fun of the day with articles on tax humor (though some would call that an oxymoron). Frank Shafroth, the director of the Center for State and Local Leadership at George Mason University, wrote a column in the April 1st edition of State Tax Today about proposals introduced in Congress that would authorize recreational use of marijuana and permit states to increase state revenue by taxing those sales. Here’s the link if you haven’t already read it.
In that same issue of State Tax Today, Billy Hamilton, former Texas Deputy Comptroller and now a consultant, wrote about the Hollywood producer Rufus T. Firefly and his upcoming movie about the California tax code. Here’s the link.
Enjoy! Next stop, April 15th and we’ll see if anyone can find any humor in that.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
No cases to report.
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Use of Deferred Trade-In Credits to Reduce Price for Sales Tax Purposes Permitted
The Louisiana Court of Appeals, held that a videogame retailer properly charged and collected sales tax when it reduced the sales price subject to the tax by "trade-in" credits maintained on customer stored value cards. The court found that sales price reductions for trade-ins are not required to be immediately applied but can be applied at a future date.
The taxpayer is a retailer that sells new and used video game hardware, software, and accessories to retail customers. As part of its regular course of business, the taxpayer also accepts used games from its customers if it determines that the game is in a resalable or refurbishable condition and the customer can choose to receive cash for the video game or trade-in the video game and immediately apply the trade-in amount toward the purchase of another video game. The customer can also receive the determined trade-in amount for the video game on a stored value card to be used by the customer at one of the taxpayer’s locations at a later date. The stored value card resembles a credit card with a unique number and is obtained by a customer for free when he/she subscribes to Game Informer magazine. Taxpayer has collected sales tax on the sales price of a game purchased using this stored value card, minus the trade-in amount on the card.
The court discussed the rules for determining when a motion for summary judgment is granted and the burden of proof rules for such motions. The court also noted that the fundamental question in all cases of statutory interpretation is legislative intent and the ascertainment of the reason or reasons that prompted the legislature to enact the law. When a law is clear and unambiguous and its application does not lead to absurd consequences, the law shall be applied as written and no further interpretation is necessary. It is a recognized rule of statutory construction that the court must give the words of a law their generally prevailing meaning.
The state statute at issue here imposes the sales tax on the sales price of an item. Sales price is a defined term and specifically excludes the market value of any article traded in. The statute does not, however, define trade in or set forth any time frame within which the trade in must occur. The court noted that "trade in" is commonly defined as "merchandise [that is] accepted as partial payment for a new purchase." Merriam-Webster's New College Dictionary 1195 (3rd ed. 2008). The taxpayer had established a system for accepting items from a customer, determining the trade in value and placing that value on the customer’s card for later use in purchasing items from the taxpayer. The court said that keeping in mind that the term “trade in” must be liberally construed in favor of the taxpayer and against the Department of Revenue, the taxpayer’s unique system of using the value added cards as partial payment toward a future purchase by the customer comes within the generally prevailing meaning of “trade in” for purposes of the sales tax statute. The court also found that the plain language of the trade in provision in the statute does not restrict the timing of the trade in nor does it suggest that a trade in must occur simultaneously with the sale. Gamestop Inc. v. St. Mary Parish Sales and Use Tax Dep't, Louisiana Court of Appeals, 2014 CA 0878. 3/19/15
Court Dismisses Store’s Claims Against Comptroller's Audit Methods
The Texas Court of Appeals, Third District, withdrew a prior opinion and held a convenience store operator's claims should have been dismissed for lack of jurisdiction. The store operator had argued that the comptroller's audit methods were unauthorized and conducted ultra vires and that the statute permitting estimation was unconstitutional
The Comptroller of Public Accounts (Comptroller) performed an audit on the taxpayer who operated a convenience store and determined that the taxpayer had underreported its sales of alcohol and tobacco products. The amount of the deficit was determined using what was referred to as H.B. 11 data, the legislation enacted in 2007 that authorized the Comptroller to request wholesalers and distributors of tobacco products to file reports detailing their sales to stores and listing the stores by name. The taxpayer did not file a timely appeal of the assessment and the Comptroller then filed suit to recover these taxes determined by the audit. The taxpayer filed various counterclaims against the Comptroller arguing that the manner in which the amount of taxes due was calculated was under the terms of an unauthorized rule, that many of the actions that the Comptroller engaged in while conducting the audits were ultra vires, and that the provision of the tax code authorizing audits by sampling and projecting was unconstitutional.
The court noted that sovereign immunity protects the state, its agencies, and its officials from lawsuits unless the legislature expressly gives its consent to the suit. Texas Natural Res. Conservation Comm'n v. IT-Davy, 74 S.W.3d 849, 853 (Tex. 2002). Absent the State's consent to suit, a trial court lacks subject-matter jurisdiction. Citing Texas Logos, L.P. v. Texas Dept. of Transp., 241 S.W.3d 105, 118 (Tex. App. - Austin 2007, no pet.) the court also pointed out that sovereign immunity not only bars suits for money damages but also protects the State against suits to "control state action." Taxpayer argued that the state’s Administrative Procedure Act and the Uniform Declaratory Judgments Act provide limited waivers of immunity, as well as the doctrine of ultra vires, and confer jurisdiction on the district court over its counterclaims to the assessment. The court rejected these arguments, concluding that they were preempted by provisions in the tax code that the state’s courts have previously held provide exclusive remedies for relief from the assessed taxes. Since the taxpayer did not comply with these mandatory requirements by engaging in an administrative redetermination proceeding or meet any of the statutory requirements for a refund claim or protest suit, the district court had no jurisdiction over any of the taxpayer’s counterclaims. Sanadco Inc. v. Comptroller of Public Accounts, Texas Court of Appeals, Third District, No. 03-11-00462-CV. 3/25/15
Company's Purchases of Giveaway Items Are Taxable
The Michigan Court of Appeals found that an event management company owed sales tax on its purchases of giveaway items provided to clients to award to convention guests. The court found the items were purchased for resale because they were provided as part of the company's services and thus were part of mixed transactions subject to tax.
The taxpayer is an event management service company that, among other things, designs, organizes, executes, and manages special events and meetings for a Fortune 500 clientele. The taxpayer works closely with a client to help the client choose the various components of an event and draws up an agreement that reflects those choices and identifies its obligations. It contracts for hotel accommodations, transportation, food and beverages, activities, and entertainment and, if the client so directs, it also procures tangible personal property for use as gifts and giveaways to event attendees. Record evidence showed that vendors often shipped the items to the taxpayer at its headquarters in the state. The taxpayer stated that it retained the merchandise to inspect it for quality and quantity, consolidated it with other items, and then shipped everything to the event venue. Third-party vendors billed the taxpayer for the items, and it invoiced its clients the cost of the items, generally without markup. Taxpayer claimed a sales tax exemption when it purchased these items because, it reasoned, the purchase was for resale to its clients.
The state statute provides that every person in the state is subject to a use tax for the privilege of using, storing or consuming tangible personal property. A person who purchases tangible personal property for resale is exempt from paying the use tax as long as the person does, in fact, resell the property. The taxpayer argued that the lower court should have found that each separately stated sale of program gifts and giveaways was a separate transaction constituting a taxable sale at retail to plaintiff's customers, and thus exempt. The court rejected this argument finding that the taxpayer does not sell, and clients cannot purchase from it, the tangible personal property at issue apart from the taxpayer’s event management services. Its clients can opt out of giving room gifts to its attendees, but they cannot purchase, rent, or lease gifts and giveaways from the taxpayer apart from engaging its services.
The court rejected the taxpayer’s argument that it serves as a purchasing agent for its clients and thus is not liable for use tax, noting that whether an agency relationship has been created is ordinarily a question of fact that a party may resolve by direct or by circumstantial evidence. The court said that the taxpayer did not present evidence sufficient to create a genuine issue of material fact that an agency relationship existed between it and any of its clients. Its blanket purchase order clearly stated that "nothing in the contract makes either party the agent or legal representative of the other for any purpose whatsoever." The court also noted that the state presented indisputable evidence in the form of the testimony of the taxpayer’s controller that the taxpayer held itself out to third-party vendors as a buyer purchasing tangible personal property for resale. The taxpayer procured the tangible personal property requested by the client for itself for use in partial fulfillment of its obligation to design, arrange, execute, and manage a particular event for the client.
The court agreed with the state that the incidental-to-services test was applicable in this case because the taxpayer provided a single transaction, namely a group event or program, to its clients, finding that the taxpayer’s scope of work agreement actually represents a single transaction -- the design, arrangement, execution, and management of a special event. Thus, where plaintiff's event management services are comprised of the sale of both services and goods, they are mixed transactions subject to the incidental-to-services test. Morley Cos. Inc. v. Dep't of Treasury, Michigan Court of Appeals, No. 318624. 3/24/15
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
OTCs Subject to General Excise Tax, Exempt From Transient Accommodations Tax
The Hawaii Supreme Court held online travel companies selling hotel rooms in the state are liable for general excise taxes (GET) on their portion of income derived from selling hotel accommodations. The court also held that but hotels, not online travel companies, are liable to remit the state's transient accommodations tax (TAT).
In 2011 and 2012 the Director of the Department of Revenue (DOR) filed assessments against online travel companies (OTC). These cases were consolidated in the present matter. The OTCs operate websites where transients can research their destinations, compare travel options, and make reservations with third-party travel suppliers. The OTCs do not own any hotels. A hotel grants the OTC the right to sell occupancy of a hotel room to a transient, and the OTC contracts with the transient for a specific room accommodation. The hotel contractually delegates to the OTC numerous "day-to-day" responsibilities the hotel would otherwise perform itself, including the marketing, pricing, tax collecting, payment processing, legal contracting, accounting, and customer service functions. The OTC-hotel contract establishes the rate the hotel will charge the OTC for a room (net rate). An OTC independently sets the price the transient is charged for the room based on the net rate under the OTC-hotel contract, plus a markup and a service fee set by the OTC. Tax is collected on the net fee. The OTC controls the relationship with the transient from the time the transient logs on to the OTC's website until the transient checks in at the hotel. Once the transient accepts the OTC's contract terms, the OTC processes the credit card transaction as the merchant of record. In the invoice to the transient, the OTC combines the taxes and service fees into a single line item called "taxes and fees." The hotel invoices the OTC for the hotel stay, typically after the transient has checked out. Pursuant to the hotel's invoice, the OTC pays the hotel the net rate and the tax (TAT and GET) that has been collected from the transient on the net rate.
The state imposes the GET on the gross income derived from the sale of services or rental income resulting from all services activities that occur within the state. At the summary judgment hearing, the tax court found that the GET applied to gross income resulting from these transaction and granted the state’s motion for summary judgment as to the assessment of that tax. The OTCs argue that the GET only applies to revenue generating activities within the state that refers to the physical, geographical location where the particular activity that generates income is performed and their activities do not occur in the state. The OTCs cited Ramsay Travel, Inc. v. Kondo, 53 Haw. 419, 495 P.2d 1172 (1972), in which the court upheld the imposition of the GET on travel agencies because their business activity was conducted exclusively within the state and the agencies were physically in the state. In further support of their argument, the OTCs cited DOR regulations and tax information releases (TIRs).
The court found that it was clear that the taxable event is the receipt of income by the OTCs under agreements with transients to provide accommodations in the state’s hotel rooms. The OTCs gain and economically benefit from the transactions at issue. The court said that just as transients are the state’s consumers when they purchase hotel rooms directly from a hotel, they remain the state’s consumers when they purchase a state hotel room from an OTC.
The court noted that the OTCs are not passive sellers of services to the state’s consumers, actively soliciting customers for these hotel rooms and actively solicit hotels to contractually provide the right to sell on their website the right of occupancy of hotel rooms. The court also said it was clear that the OTCs constructively benefit through the transients' use and benefit from state services -- including use of the roads and access to police, fire, and lifeguard protection services. The court found that there were sufficient business and other activities in the state to impose the GET on the gross income resulting from the transactions at issue here.
The court did find, however, that the GET provision regarding apportionment did apply to these transactions, resulting in the division of income subject to the tax between hotel operators and a "travel agency and tour packager."
The TAT is imposed on the gross rentals or gross rental proceeds derived from furnishing transient accommodations and is payable by operators. The statute defines an "operator" as "any person operating a transient accommodation, whether as owner or proprietor or as lessee, sublessee, mortgagee in possession, licensee, or otherwise, or engaging or continuing in any service business which involves the actual furnishing of transient accommodation." HRS § 237D-1. The court said it was clear that the OTCs did not come within the first definition of operator and it then examined whether they came within “or engaging or continuing in any service business which involved the actual furnishing of transient accommodations.” The court concluded that OTCs were engaged in a service business that involved furnishing transient accommodations. The court, however, focused on the requirement that the business involve the “actual” furnishing of transient accommodations and found that that term was ambiguous in the context of the definition of operator. After a lengthy review of the legislative history of the TAT and its amendments, the court concluded that, taken together, the amendments indicate that the TAT is a tax to be paid by the transient based only on the cost attributed to the hotel room that is allocated to the operator. That is, the TAT was to be based on a room rate paid by the transient and allocated to the operator, less any amount distributed to a travel agency or tour packager, and excluding any GET or TAT.
The court pointed out that the TAT Apportioning Provision defines the tax amount as "only the respective portion allocated or distributed to the operator, and no more." HRS § 237D-1 (emphasis added). The court concluded that the TAT Apportioning Provision takes the gross amount paid by a transient and divides it into two portions: one assessable under the TAT, and one that is not. As a result, whereas the GET Apportioning Provision holds both parties liable for the GET, the TAT Apportioning Provision provides that only the operator is liable for the TAT. The parties did not dispute that the hotels owe the TAT on their Gross Rental Proceeds that derive from furnishing the transient accommodations in these transactions. Thus, if the meaning of "actual" within the definition of "operator" encompasses the OTCs, then the TAT would be assessed twice: first, against the OTCs based on the room rate plus the mark-up and service charges, and second, against the hotel on the net rate collected for the room.
The court noted that the primary justification for the TAT was to enable the visitor to pay to the state their "fair share" of the costs incurred by the county for providing infrastructure and services. Since the TAT was designed to charge the visitor through the assessment against the cost of the hotel room, to more than double the TAT assessment would be contrary to the intent of the legislature that correlated the tax to the hotel room use.
The court concluded that, based on the continuing intent of the legislature to tax visitors for their use of county infrastructure and services by assessing the cost of transient accommodations that is allocated to the operator, to utilize the hotels as the vehicle for collecting that tax, and to minimize the impact of the TAT on the hotel and visitor industry, only a single taxable event as to the TAT occurs when a transient accommodation is furnished to a visitor. It follows then, that a single operator is associated with the furnishing of transient accommodations. Therefore, the OTCs are not operators and the TAT is not applicable to the OTCs in these transactions. Matter of Travelocity.com LP v. Dir. of Taxation, Hawaii Supreme Court, SCAP-13-0002896. 3/17/15
Property Tax Decisions
Electric Co-op's Income Capitalization Valuation Method Rejected
The Arizona Court of Appeals affirmed the valuation of a nonprofit electric cooperative's taxable property. The court rejected the valuation evidence based on the income capitalization method that the cooperation presented because it said that method is not permitted for nonprofit utility cooperatives.
The taxpayer is a nonprofit electric utility cooperative that distributes electric power to approximately 51,000 customers in rural areas of the southern part of the state. It has taxable property consisting of overhead lines, transmission lines, power poles, substations, and miscellaneous tools and equipment (the Property). The taxpayer challenged the Department of Revenue’s (DOR) valuation of their property for tax years 2010 through 2013.
State law requires DOR to value electric transmission and distribution property owned by for-profit corporations according to a statutory formula, based on original plant in service cost, less depreciation, with some exceptions. The statute excludes property owned by member-owned nonprofit electric distribution cooperatives from that statutory valuation formula, and, for the tax years at issue, no statutory formula existed. In the absence of a statutory formula, the statute provides that DOR is required to value the property of a nonprofit electric distribution cooperative by applying "standard appraisal methods and techniques." The appeal then involves the question of what constitutes "standard appraisal methods and techniques" as applied to the valuation of a nonprofit electric distribution cooperative.
The court acknowledged that state law establishes a presumption that the state or county's valuation of property is lawful and correct and a taxpayer challenging the valuation of property has the burden of proving, by competent evidence, that the state or county's valuation is excessive. The taxpayer retained an expert appraiser to formulate an opinion of the market value of the property and the taxpayer argued that the appraiser’s report utilized standard appraisal methods and techniques, and therefore is competent evidence that rebuts the statutory presumption of correctness. DOR argued, however, that the report did not constitute competent evidence sufficient to overcome the statutory presumption because the appraiser relied on an income approach in valuing the property, which state law prohibits. The court noted that the appraiser arrived at his opinion of value by using both the income approach and the cost approach, but the result gave greater weight to the income approach.
The court noted that the state supreme court has previously issued three opinions addressing the valuation of nonprofit electric cooperatives. Those opinions held that using the income approach to calculate full cash value of property owned by a cooperative utility was fundamentally wrong because those entities are non-profit corporations, and set its rates with the deliberate intention of not making a profit. The court affirmed the lower court's grant of summary judgment determining that the taxpayer failed to overcome the statutory presumption of correctness. The court also rejected the taxpayer’s argument that the methodology utilized by DOR in valuing the property is an invalid rule, finding that DOR was required to use standard appraisal methods and techniques, choosing among commonly accepted valuation methods. Since the late 1980s the Department valued the property of nonprofit electric distribution cooperatives by applying a combination of the cost and market approaches to value and the court noted the taxpayer had admitted that DOR applied “some type of” standard appraisal method and technique in this case. The court concluded that because the taxpayer presented evidence of valuation not permitted by state law, it failed to rebut the statutory presumption of correctness. Sulphur Springs Valley Electric Coop. Inc. v. Dep't of Revenue, Arizona Court of Appeals, No. 1 CA-TX 14-0002. 2/24/15
Decision Denying Property Tax Exemption Reversed
The Michigan Court of Appeals reversed a lower court decision and held that a taxpayer was able to claim the principal residence exemption on her property for 2009-2012 because she provided sufficient evidence that the property was her principal place of residence. The court found that the lower court’s decision was not supported by competent, material, and substantial evidence.
The court noted that its ability to review the lower court’s decision was only permitted in the case of fraud, error of law or the adoption of wrong principles and the appellant had the burden of proof in this appeal. State law provides an exemption from the tax levied by a school district for a principal residence that is defined as “the 1 place where an owner of the property has his or her true, fixed, and permanent home to which, whenever absent, he or she intends to return". The taxpayer and her husband bought the property at issue here in March 2006 and in April 2008, petitioner filed a Homeowner's Principal Residence Exemption (PRE) Affidavit stating that this property became her principal residence in February 2008. She stated that she lives at this property and visits her husband at their Illinois home on some weekends.
The court found that the taxpayer presented ample evidence that this property is her true, fixed, and permanent home, including utility bills demonstrating at least two years of consistent usage at the property during the years at issue. She also submitted her individual Michigan income tax returns for each year at issue. Taxpayer's business is incorporated in Michigan, and all relevant business documentation lists this address as her address. Taxpayer's vehicle is titled and registered in Michigan at this address and insured in compliance with the state's no-fault act. Taxpayer possesses a Michigan driver's license, which lists the subject address and is registered to vote in Michigan at this address. The court also found that the record contained no evidence in support of the town's position.
The township stated that the reason for denial of a PRE was that taxpayer also owns property in Illinois and that a PRE, or its Illinois equivalent, was being received on both the Illinois and Michigan properties. The court stated that owning property in another state does nothing to deprive an individual of a Michigan PRE and pointed out that the Court had previously ruled, consistent with the applicable statutes, that a married party who files a separate income tax return may obtain a PRE on his or her principal residence even if his or her spouse obtains a similar exemption in another state on another property. Accordingly, the court ruled that the lower court’s decision was not based on substantial evidence, particularly in light of the voluminous evidence submitted by the taxpayer, and, therefore, constituted an "error of law" under the state constitutional provision. Nass v. Twp. of Saugatuck, Michigan Court of Appeals, No. 318437. 2/24/15
Business Inventory Exemption Lost When Land Transferred
The Idaho Supreme Court denied a company's business inventory property tax exemption, finding the statute only granted an exemption to the land developer making site improvements and when the land was transferred out of the company itself and into the company owner's name temporarily, the exemption was lost. The court also held that a 2013 amendment to the statute at issue had no effect on the meaning of the statute as it existed in 2012.
The taxpayer, a land developing business, acquired forty-one parcels of real property located in seven different real estate developments in the state. In 2008, the taxpayer made site improvements to the property by installing utilities, roads, sidewalks, and curbs. At the time the improvements were made, taxpayer had a sole shareholder. In December of 2008, taxpayer was reorganized to an LLC and in the process the parcels of land were transferred from the original corporation to the sole shareholder and then from the shareholder to the LLC. The sole shareholder of the corporation became the managing member of the LLC.
In February of 2010, the LLC was dissolved and a new development company was formed with the managing member the sole shareholder. In a similar manner to the 2008 reorganization the parcels were transferred from the LLC to the managing member and then to the new development company. In 2012, the taxpayer timely filed a site improvement tax exemption application for the parcels with the county assessor for the 2012 tax year which was denied by the county assessor on the basis that the development company did not qualify for the exemption because it was not the developer who installed the site improvements.
This case was purely a question of law regarding interpretation and application of Idaho Code section 63-602W(4) that was amended in 2012 to provide that certain site improvements shall be exempt from property taxation, retroactive to January 1, 2012, on property held by the land developer. In 2013 the statute was amended to provide that the exemption for the site improvements would continue under certain conditions even when the ownership was transferred. The lower court concluded that the exemption only applied to the land developer that made the site improvements and because the site improvements were undertaken by the original corporate entity before the current development company acquired title to the land, the development company was not exempt.
The court noted that under the plain language of the statute, site improvements are exempt when held by the person or entity that made the improvements. It was undisputed that the construction company made the site improvements to the parcels in and around 2008. The subsequent development company did not develop the real estate and is, therefore, not entitled to the tax exemption. The court rejected the development company’s argument that title was never conveyed from the land developer because the sole shareholder of the construction company was also the sole shareholder of the development company, finding that the construction company was not the same legal entity as the development company and the shareholder in her personal capacity is separate from the legal entities. The court also found that the amendment in 2013 has no effect on the meaning of the statute as it existed in 2012, rejecting the taxpayer’s argument that the amendment served to clarify the legislature’s earlier intent. The court also awarded attorneys’ fees to the state’s Board of Equalization. Jayo Dev. Inc v. ADA Cnty. Bd. of Equalization, Idaho Supreme Court, Docket No. 41668. 2/26/15
Surviving Spouse Can Carry Over Homestead Exemption
The Florida District Court of Appeal, Fourth District, held that a widow could keep a homestead exemption originally obtained by her spouse for a property later held by both spouses as tenants by the entireties.
The facts of this case were not in dispute. The husband applied for and received a homestead exemption for the house he owned in his name in 1985 and soon thereafter married the woman who is the subject of this appeal. From that time, the couple resided at the house as their primary residence for the remainder of their marriage. On February 24, 2000, the husband conveyed the house via warranty deed to himself and his wife, as tenants by the entireties. After this conveyance, the spouse did not apply for her own homestead exemption. The couple received property tax bills in both their names, consistent with the entireties ownership, and continued to receive the homestead exemption. The husband died in April 2006 and his widow continued to occupy the house as her primary residence. She did not apply for a homestead exemption in her name after her spouse’s death, nor did she notify the Property Appraiser (Appraiser) of his demise.
From 2007 through 2011, the Appraiser continued to apply the homestead exemption's tax benefits and the "Save Our Homes" assessment cap to the home and sent notices of proposed taxes addressed to both the husband and wife. In 2012 the Appraiser learned of the husband’s death and the county subsequently placed a lien on the home for taxes, penalty and interest the county argued should have been paid on the property in the years since the husband’s death because of what the county argued was an erroneous exemption for those years. The taxpayer argued her husband's death did not constitute a change of ownership of the home that triggered the requirement to reassess the property at just value. The county contended that the widow waived the homestead exemption benefits from 2007 through 2011 by failing to file a homestead application in her name.
The homestead property tax credit in the state provides financial relief for owners of property who qualify for homestead status. For real property to qualify for a homestead exemption, an applicant must make three showings: (1) that the real property is owned by a "natural person"; (2) that the owner has "made, or intend[s] to make the real property his or her permanent residence or that of his family"; and (3) that "the property . . . meet[s] the size and contiguity requirements of article X, section 4(a)(1) of the Florida Constitution." Aronson v. Aronson, 81 So. 3d 515, 518 n.2 (Fla. 3d DCA 2012) (citing Cutler v. Cutler, 994 So. 2d 341, 344 (Fla. 3d DCA 2008)). Once the homestead exemption is granted, the homeowner is not required to submit a renewal application each year unless there has been change affecting the property's homestead status. Section 196.011(9)(a), Florida Statutes (2011), provides that the refilling of an application for the homestead credit shall be required when any property granted an exemption is sold or otherwise disposed of, when the ownership changes in any manner, when the applicant for homestead exemption ceases to use the property as his or her homestead, or when the status of the owner changes so as to change the exempt status of the property.
The court held there was no change of ownership that triggered the need for a new application. The court said that while the homestead provision fails to define the term “ownership change”, the “Save Our Homes” amendment, which must be read in pari material, expressly provides that there is no change in ownership when there is a transfer of homestead property to one spouse upon the death of the other. The court also noted that § 193.155(8), Fla. Stat. (2011) specifically provided that both husband and wife who owned and permanently resided on a previous homestead would each be considered to have received the homestead credit even though only one of them filed for the exemption. The court also said that the notion that there was not a change of ownership or use in this case that triggered the requirement of a new homestead application is strengthened by the characteristics of the tenancy by entireties form of ownership which was utilized here. The court found that because the widow owned no more or less of the property after her husband died, and because entireties law viewed them as one owner, neither the ownership of the property nor the widow’s use of it "changed" within the meaning of the homestead statute. The rule created by reading the Constitution and applicable statutes together is that where a husband and wife occupy a homestead and where one of the spouses properly applied for and obtained a homestead exemption, the death of one spouse will not destroy the homestead exemption of the other so long as the survivor continues to use the homestead as his or her permanent residence. Kelly v. Spain, Florida Court of Appeal, No. 4D14-510. 2/25/15
Other Taxes and Procedural Issues
Tax and Bond Plan for Professional Football Stadium Upheld
The Georgia Supreme Court held that a development authority did not violate the state constitution when it extended a 7 percent occupancy tax through 2050. The tax was originally used to construct a professional football stadium and was extended in order to fund a new, successor stadium facility. The court also rejected challenges to the bond program used to fund the project.
This case involves approximately $200 millions in municipal bonds to be issued for the purpose of funding a portion of the cost of developing, constructing, and operating a new stadium facility in downtown Atlanta (NSP) for the Atlanta Falcons professional football team. The NSP is a successor facility to the Georgia Dome, and the owner will be the Congress Center Authority, which also owns the Georgia Dome. Petitioners (hereinafter collectively "Cottrell") moved to intervene in the proceedings to file objections to the bond validation, contending, among other things, that a provision of the state statute, which allows for an extended time period in which a county or municipality may levy a hotel/motel tax for purposes of funding a "successor facility" to an existing "multipurpose domed stadium facility," was an unconstitutional special law. Generally, hotel/motel taxes can only be levied at a rate of three percent or less. The statute provides an exception allowing counties and municipalities to levy a seven percent tax if a designated portion of the collected tax is used to fund a multipurpose domed stadium facility. Taxes imposed under that provision were required to have a stated expiration date not later than December 31, 2020. However, in 2010 the legislature amended that provision and added a new subsection, which allowed taxing jurisdictions that had previously levied a tax under the original provision to extend the stated expiration date to December 31, 2050, so long as the same portion of the proceeds that had been used to fund the original multipurpose domed facility was expended to fund a successor facility during the extended period.
The court rejected the petitioners’ argument that the 2010 amendment is an unconstitutional "special law" that violates the Uniformity Clause of the Georgia Constitution. The court, citing prior case law, said that if a law operates alike on all who come within the scope of its provisions, constitutional uniformity is secured. It noted that uniformity does not mean universality. The court had previously determined that the exception to the three percent cap on the hotel/motel tax rate was a proper general law in that it applied uniformly to any county or municipality that decided to levy the increased tax. The court said that the 2010 amendment authorizing the extension of time for the increased tax rate was also a constitutional general law exception to the cap on the motel/hotel tax. It said that was of no consequence that the amendment happens to impact only the New Stadium Project at this time, as the other counties and municipalities covered under the original provision could have collected a seven percent hotel/motel tax for purposes of funding their own multipurpose domed stadium facilities had every opportunity to do so. The court rejected the argument that the legislature is now forbidden from enacting legislation that affects the class of taxing entities covered under the original provision simply because only one taxing entity chose to take advantage of implementing a seven percent hotel/motel tax for purposes of funding a multipurpose domed stadium facility over twenty years ago.
Petitioners also argued that the Hotel/Motel Tax Funding Agreement between the City and Invest Atlanta is illegal, and, by extension, unconstitutional, because the statute requires that tax proceeds collected to fund the successor stadium facility shall be expended only through a contract with the certifying state authority, and the City's contract with Invest Atlanta is not a contract with the certifying state authority. The court pointed out, however, that more than one contractual agreement existed to control the manner in which the NSP Tax Proceeds are ultimately expended by the Congress Center Authority to fund the NSP and the funding agreement worked in conjunction with the Bond Proceeds Funding and Development Agreement to ensure that the tax proceeds are expended in a manner consistent with the requirements of the 2010 amendment. The court held that there is no requirement that Invest Atlanta own the NSP nor is there a requirement that Invest Atlanta actually construct the NSP in order to properly issue revenue bonds for the purpose of financing the project.
The court also rejected the petitioner’s argument that the City resolution, which extended the existing Hotel/Motel tax to fund a portion of the construction and maintenance costs of the NSP, is illegal because it was passed before the stadium authority provided the city with the certification required by the statute. The court pointed out that the statute does not require that the city’s resolution must be passed after the certification is received. The statute simply provides that both the resolution must be passed and the certification given before the city continues to levy and collect the tax after the 2020 termination date. Cottrell v. Atlanta Dev. Auth., Georgia Supreme Court, S14A1874. 3/16/15
City's Utility Surcharge Is an Illegal Tax
The California Court of Appeal, Second Appellate District found that a city’s 1 percent surcharge imposed on an electric utility and passed along to customers was an illegal tax and not a franchise fee. The court found that the surcharge was not functionally different from a utility user tax and the city did not seek voter approval of the tax.
The California Constitution, as amended by Proposition 218, prohibits local governments from imposing new or increased taxes without first obtaining voter consent. Petitioners here are an individual and a hotel that incurred a one percent surcharge on their electricity bills (1% surcharge) collected by Southern California Edison (SCE) and remitted to the city, which did not seek voter approval of the 1% surcharge.
For some time the taxpayer’s franchise agreement with the city and subsequent extensions of that agreement required the taxpayer to pay a 1 percent franchise fee on its gross annual receipts for electricity sold within the city. In negotiating a new agreement the city proposed the imposition of an additional 1 percent fee and it was agreed that this increase was contingent on the Public Utilities Commission (PUC) authorizing the additional one percent to be treated as a surcharge. Following the PUC's approval of the 1% surcharge, the taxpayer began billing and collecting it from the city's electricity users and remitting the revenues to the city. The 1% surcharge was never submitted to or approved by city voters.
The sole issue before the court was whether the 1% surcharge is a tax subject to Proposition 218's voter approval requirement or a franchise fee that may be imposed by the city without voter consent. The court pointed out that although Proposition 218 prohibits local government from imposing taxes without voter approval, it does not define taxes. The definition of "franchise fee", however, has been constant for nearly a century. A franchise fee is a "charge which the holder of the franchise undertakes to pay as part of the consideration for the privilege of using the avenues and highways occupied by the public utility." (Tulare County v. City of Dinuba (1922) 188 Cal. 664, 670; accord, City of Santa Cruz v. Pacific Gas & Elec. Co. (2000) 82 Cal.App.4th 1167, 1171.)
In prior case law the California Supreme Court adopted a “primary purpose” test for determining whether a regulatory fee was a tax and the court here applied that same test to distinguish between a franchise fee and a tax. If revenue is the primary purpose, the imposition is a tax. The court looked first to the franchise agreement itself and pointed out that the agreement treats the 1 percent surcharge differently that the 1 percent franchise fee.
The 1% franchise fee resembles a traditional franchise fee. Its purpose is to compensate the city for allowing the taxpayer a right of way to purvey electricity. The purpose of the 1% surcharge was to raise franchise fee revenues for use by the City Council for general city governmental purposes. The court pointed out that the franchise agreement became effective, and the taxpayer had the privilege of using the city's property, regardless of whether or not the PUC authorized the taxpayer to impose the 1% surcharge. The only benefit to the taxpayer from acting as the city's agent in collecting the 1% surcharge was to know with certainty how long the franchise would last. The court noted that a utility user tax, unlike franchise fees and other local government fees and taxes, is not incorporated into the utility's rate structure and is not subsidized by the utility's customers outside the city. Instead, it is purely a tax that is passed along to its customers, with the utility acting as a tax collector for the city.
After reviewing the agreement, the court found that the 1% surcharge bears all the hallmarks of a utility user tax and that its primary purpose was for the city to raise revenue from electricity users for general spending purposes rather than for the taxpayer to obtain the right of way to provide electricity. The court found that it constituted a tax under Proposition 218 and was subject to approval by the voters.
The court rejected the city’s argument that the 1% surcharge is a traditional franchise fee simply because its collection from the taxpayers and remittance to the city is one of the taxpayer’s obligations under the franchise agreement, reiterating that the reason a traditional franchise fee is not a tax is because its primary purpose is consideration for the right of way, rather than simply to raise revenue. Jacks v. City of Santa Barbara, California Court of Appeals, 2nd Civil No. B253474. 2/26/15
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected].
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NEWS
Update on New York’s suit against FedEx
On March 9, 2015 U.S. District Judge Edgardo Ramos in Manhattan denied FedEx's motion to dismiss claims it violated an anti-racketeering law and the Contraband Cigarette Trafficking Act. He did, however, grant the company’s bid to dismiss claims it violated a state public health law and created a public nuisance. The lawsuit filed by New York City and New York State has accused FedEx of illegally delivering cigarettes to individual residences from 2005 to 2012, depriving both governments of excise taxes. A lawsuit was also filed last month against United Parcel Service Inc. with similar complaints.
Combating Fraudulently Filed Returns
In light of the recent issues this filing season with fraudulently efiled income tax returns, the Senate Finance Committee conducted a hearing on March 12th to discuss increased fraud experienced on both the state and federal level. Indiana commissioner Mike Alley and Utah Tax Commission Chairman John Valentine testified before the Committee about their states’ recent experiences with filing fraud; their written comments are on http://www.taxadmin.org. Both called for better collaboration and information sharing between the states, the IRS and the software vendors. Commissioner Alley pointed out that the FTA has created a fraud working group comprising multiple states that have developed taxpayer identification standards and monitoring mechanisms to ensure that uniform data can be shared with the intent to establish uniform measures that the software industry would apply consistently.
IRS Commissioner, John Koskinen, announced on March 19th that the IRS has set up three working groups with major tax return preparation software developers, tax return preparation companies, and state tax authorities on stolen identity refund fraud (SIRF) issues that will make recommendations for increased security and fraud prevention to the IRS commissioner this summer.
Report on Multistate Tax Commission’s Amicus Briefs
Helen Hecht, MTC’s general counsel and former general counsel for FTA, has produced a report on MTC’s role as amicus curiae. In the past year the Multistate Tax Commission has filed 10 amicus briefs on behalf of individual states, a signification increase from the more typical number of three to five filed per year.
The report discusses the MTC's litigation-consulting role and the circumstances under which the MTC files an amicus brief. It provides a summary of the recent briefs filed by the MTC, all of which can be found on the Commission’s website. Helen also provides some thoughts over the growing use of amicus briefs and what such a brief should say. Here’s a link to the report.
U.S. SUPREME COURT UPDATE
No cases to report.
FEDERAL CASES OF INTEREST
Challenge to Delaware Unclaimed Property Audit Methodology Permitted
The U.S. District Court for the District of Delaware held a challenge to Delaware's use of estimation in unclaimed property audits may proceed in federal court. The court dismissed a charge that federal common law preempts use of estimation but sustained arguments that the estimation methodology violates the due process and ex post facto clauses.
Plaintiff, a manufacturer and nationwide supplier of corrugated packaging, is a corporation organized under the laws of Delaware, with a principal place of business in another state. Plaintiff filed a complaint on May 21, 2014 challenging the use of a statistical model by the Department of Finance of the State of Delaware to estimate the petitioner’s obligations under Delaware's Abandoned and Unclaimed Property Law. Plaintiff also asked for a preliminary injunction against the state from enforcing the assessment issued and from continuing to examine its records for potentially abandoned property. The state’s Secretary of Finance administers Delaware’s unclaimed property statute.
States have laws that govern the disposition of unclaimed property, often referred to as "escheat laws." The stated purpose of Delaware's Escheat Act is to provide for the "care and custody . . . of all abandoned property paid to the State Escheator" until the property is reclaimed by the true owner. 12 Del. C. § 1144(a). A company is required to attempt to return the abandoned property to the owner before turning the property over to the State as part of its annual reporting requirement, but once the State takes custody, the company is no longer liable to the property owner, and the State will attempt to reunite the owner with the property. In 2010 Senate Bill 272 amended the state’s unclaimed property statute to permit the state to estimate the liability for unclaimed property where the records of the holder for the periods subject to the examination are insufficient to permit the preparation of a report. The legislative history for that senate bill shows that the legislature found that the use of estimation techniques is an accepted and routine practice used by both holders of property and the state’s unclaimed property administrator when records are inadequate.
The state initiated an audit with plaintiff for the period beginning in 1983. Because plaintiff was unable to produce records prior to 2003 the state used an estimation method to extrapolate the amount of unclaimed property due to the state for the years prior to 2003. Plaintiff contends that, to the extent that the Escheat Act authorizes estimation of unclaimed debts, it violates and is preempted by federal common law established in Texas v. New Jersey, 379 U.S. 674 (1965), and subsequent cases collectively referred to as "the Texas Cases".
Plaintiff argued that the Supreme Court's holding in Delaware v. NewYork, 507 U.S. 490, 499-500 (1993), the most recent of the Texas Cases, limited the State's authority to collect unclaimed property to situations where a precise debtor-creditor relationship is shown. Plaintiff argued that in that case the Court declined to use a statistical methodology instead of debtor's records to locate the last known addresses of creditors.
The court found, however, that, consistent with the stated purpose of the priority scheme in Delaware to "resolve disputes among States," the Texas Cases apply to disputes among States, not to disputes between private parties and States. It noted that although relevant case law on the topic of escheat law is sparse, such a finding is in accord with a number of state court opinions addressing the applicability of the Texas Cases. The court also stated that finding that the Supreme Court's holding in Delaware preempts the State's valid exercise of regulatory power over abandoned property would be contrary to the well-established principle that federal courts may not ordinarily displace state law. See Erie Railroad Co. v. Tompkins, 304 U.S. 64, 78 (1938). The court, therefore, granted defendants' motion to dismiss count I of the complaint alleging violation of and preemption by federal common law.
Plaintiff also alleged a violation of due process, arguing that the use of estimates to calculate the debt results in two or more States claiming the same property as expressly prohibited by the Texas Cases. The court found that if the allegations as claimed are true, the disputed money may indeed violate the Supreme Court's prohibition against more than one State escheating a given item of property and, the court denied state’s motion to dismiss count II of the complaint alleging a violation of substantive due process under the Fourteenth Amendment.
The plaintiff also argues that the state has violated Article I, § 10, of the United States Constitution that prohibits the States from passing any "ex post facto Law” by imposing a retroactive penalty for lack of record keeping. The court said that civil legislation violates the Ex Post Fact Clause "[i]f the intention of the legislature was to impose punishment." Smith v. Doe, 538 U.S. 84, 92 (2003). However, if "the intention was to enact a regulatory scheme that is civil and nonpunitive, [the court] must further examine whether the statutory scheme is punitive either in purpose or effect as to negate [the State's] intention to deem it civil.'" Id. (quoting Kansas v. Hendricks, 521 U.S. 346, 361 (1997)). The court noted that case law has said that only the clearest proof will suffice to override legislative intent and transform what has been denominated a civil remedy into a criminal penalty.
The state argues that the 2010 legislation is not retroactive because the use of estimates to evaluate debt is a longstanding practice in Delaware. Plaintiff argued that any use of estimates occurred outside of Delaware and, in those States, estimation was a penalty for inadequate record keeping. Additionally, the plaintiff alleged that the State Escheator admitted that "standard retention policies" are 7 to 10 years. The court found that although the 2010 amendment was retroactively applied in accordance with the intent of the General Assembly, questions of fact remain as to whether the legislation merely codified a pre-existing practice and, as a consequence, fails to trigger Ex Post Facto review. The court noted that in addition to being applied retroactively, legislation that violates the Ex Post Facto Clause must also be punitive in nature. The court pointed out that the Delaware General Assembly eliminated the document retention requirement and avoided characterizing the estimation provision as a penalty, but in doing this, set the stage for a violation of substantive due process. If the amendment is not a penalty provision, the court posited, it likely violates plaintiff's rights to substantive due process. If, on the other hand, it is a penalty provision, its retroactive application likely violates the Ex Post Facto Clause. The court held that plaintiff's pleading withstands defendants' motion to dismiss count Ill of the complaint alleging an unlawful Ex Post Fact Law and issues of fact remain regarding whether using estimates to calculate liability was a change of practice, or merely codification of a pre-existing practice.
The court also found that plaintiff has provided sufficient facts to support the position that it has a legitimate property interest in the estimated debt because the estimate may not be traceable to bona fide creditors. If Delaware does not have the authority to escheat the property in question, then the seizure of such property without just compensation would be a violation of the Takings Clause. Plaintiff alleged that the estimation methodology affects economic production, and consequently, interstate commerce in other states outside of Delaware. The court was unwilling to dispense with the Commerce Clause claim at this stage of the litigation, as a more complete factual record would aid the court in making a determination of its merit. Temple-Inland Inc. v. Cook, U S District Court for the District of Delaware, Civ. No. 14-654-SLR. 3/11/15
Challenge to California's Unclaimed Property Law Properly Dismissed
The U.S. Court of Appeals for the 9th Circuit has affirmed the district court's dismissal, for failure to state a claim, of a putative class action brought by abandoned property owners challenging the constitutionality of California's Unclaimed Property Law (UPL). The suit claimed that the procedures used both before unclaimed property is transferred to the state Controller and after it is transferred violate the appellants' due process rights. The owners and argued that the pre-escheat notice provided by the Controller is constitutionally inadequate because the Controller does not attempt to locate property owners using the data sources required by the state statute. They also argued that the Controller's notice process is inadequate because the state uses third parties companies to perform the notice who have an alleged conflict of interest because they receive a portion of the escheated property's value. The suit also alleges that there is not an adequate remedy when the Controller denies a claim for the escheated property, in violation of due process. The court rejected the appellants' argument that the Controller's failure to use the additional data available violated their constitutional rights because the statutory provision referenced by the plaintiffs related only to post-escheatment procedures. The court also found the argument related to the use of third party companies to provide notices to owners was not supported by law or fact. Finally, the court found that the complaint regarding the lack of adequate procedures for protesting denial of a claim for property was not ripe for challenge. Taylor, et al. v. Yee, et al., U.S. Court of Appeals for the Ninth Circuit, Dkt No. 12-17828. 3/11/15
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Commerce Clause Challenge Over Sales Tax on Satellite Television Service Rejected
The Tennessee Court of Appeals rejected arguments that the state's sales tax discriminates against satellite television providers by allowing an exemption for subscription fees billed to cable customers, finding satellite and cable providers are not similarly situated for purposes of the commerce clause.
Taxpayers provide direct-to-home satellite television service, competing for subscribers with cable providers. While satellite and cable providers are similar in a number of respects, the manner in which they assemble and deliver programming to customers is very different, resulting in differing infrastructure requirements. Cable providers have large investments to build, service, and maintain their in-state distribution system of headend buildings and miles of cable. They also employ over 4,000 Tennessee residents, many in connection with the assembly and distribution of programming. The satellite providers, on the other hand, either directly or through affiliates, lease space in the state to provide office support for installation technicians and storage of installation-related equipment. They also lease space in Tennessee for the collection of local television signals for rebroadcast to their subscribers. They have substantially fewer employees in the state than the cable providers.
Historically the state has taxed cable and satellite services differently. In 1984, the Legislature enacted legislation that imposed an amusement tax on cable television subscription charges in excess of charges made for the basic or lowest rate charged. In 1994 the Department of Revenue (DOR), having determined that satellite TV services were not subject to sales or use tax, began taxing these services as a telecommunications service, without an exemption for any part of the charge. In 1999, the legislature changed the tax treatment of these services, subjecting them to the state’s sales tax and creating a three-tiered taxing structure for cable television services, with an exemption for the first $15 billed each month and a lower rate for charges between $15 and $27.50, and a single-tiered taxing structure for satellite services.
The satellite companies argued that the sales tax on satellite television services violated the Commerce Clause and the Equal Protection Clause of the United States Constitution, as well as the equal protection guarantee of the Tennessee Constitution. The Commissioner argued that the differential treatment results from differences in the nature of the two businesses and that there was a rational, non-discriminatory basis for the differential tax treatment. The court reviewed the dormant commerce clause history and discussed cases decided elsewhere in the country. It noted that a tax discriminates against interstate commerce when it "tax[es] a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State." Armco Inc. v. Hardesty, 467 U.S. 638, 642 (1984). Taxpayers claim that the sales tax on satellite television services discriminates both purposefully and, as found by the trial court, in practical effect.
The court noted that because taxes may discriminate by intent or in practical effect as well as facially, distinctions other than location or geography may conceal discrimination against interstate commerce. In addition, the fact that the parties benefitting from a tax are themselves interstate companies does not shield the tax from negative Commerce Clause review. The court did point out that what negative Commerce Clause precedent does not explain is how state legislatures are to weigh variances in investment in order to avoid favoritism, noting the satellite providers argument that the state’s tax scheme favors the pay-TV providers that incur infrastructure investment in the state. The court reviewed the legislative history of the 1999 legislation in the state and noted that while the legislative objective of the legislation may be uncertain, the objective of the cable industry was clear for maintaining the exemption for cable services. The court said, however, that it could not assume that the legislature embraced the cable industry’s argument when it enacted the 1999 legislation.
The court said that a threshold question here was whether satellite providers and cable providers are “substantially similar entities,” making any disparate treatment discriminatory.
The court began by stating it was clear that satellite and cable providers are competitors for the same customers, but noted that even where the entities are competitors, it does not necessarily follow that the entities are similarly situated. It pointed out that cable providers are heavily regulated by the federal government while satellite providers are minimally regulated and found that the difference in regulatory treatment and the resulting benefits inuring to cable customers mean that satellite providers and cable providers are not substantially similar entities for purposes of the Commerce Clause. Therefore, the disparate tax treatment of satellite providers and cable providers does not constitute discrimination. DIRECTV Inc. v. Roberts, Tennessee Court of Appeals, No. M2013-01673-COA-R3-CV. 2/27/15
Metal Processor's Liquid Oxygen Is an Exempt Industrial Supply
The Kentucky Court of Appeals found that a metal processing company's liquid oxygen used in torches to cut metal is exempt from tax as an industrial supply. It also held that its purchases of hammer pins are taxable because the pins are replacement parts, not industrial tools.
The taxpayer operates a metal processing business located in the state. Part of its operation involves the cutting of metal so that it can be placed into a furnace and melted, and to accomplish this, the taxpayer uses torches which require a mixture of liquid oxygen and acetylene to create temperatures hot enough to cut the metal. The taxpayer also utilizes several machines, including those that require pins that hold a hammer in place on a rotor which turns to break up large pieces of metal. These hammer pins have a useful life of between two weeks and one month.
The state statute provides an exemption from the sales tax for tangible personal property used in manufacturing and provides that tangible personal property includes certain supplies such as lubricating and compounding oils and chemicals. The statute also specifically provides that sale at retail and use do not include the sale or use or other consumption of energy or energy-producing fuels used in the course of manufacturing with certain limitations. DOR argued that liquid oxygen, as used by the taxpayer, was properly classified as energy or an energy producing fuel and, therefore, taxable. The taxpayer argued that the Department of Revenue (DOR) had considered liquid oxygen an exempt "supply," and not an "energy producing fuel," for decades prior to its denial of the taxpayer’s refund request.
The doctrine of contemporaneous construction states that where an administrative agency has the responsibility of interpreting a statute that is in some manner ambiguous, the agency is restricted to any long-standing construction of the provisions of the statute it has made previously. The court noted that, like any rule of statutory construction, it need not resort to the doctrine in the absence of an ambiguity. The court said that the threshold question was whether the statute’s use of the term "energy and energy producing fuels," was ambiguous as applied to the liquid oxygen used in the taxpayer’s acetylene torches and the court agreed that it was ambiguous. The court found that as it was used by taxpayer in cutting of various metals, liquid oxygen does not fit squarely within the definitions of a "fuel" and "energy" in the statute. The liquid oxygen, as used, does not compare to coal, gasoline, or oil; and it did not, by itself, "provide light or heat." The court said that since the usual, ordinary and everyday meaning of the terms were not easily derived, the court had to resort to other sources to determine its application and it held that the lower court properly applied the doctrine of contemporaneous construction. The record showed that on at least two prior occasions DOR expressly held that liquid oxygen and acetylene when used for welding or cutting function in manufacturing are industrial supplies and exempt from taxation. The court found that DOR had established a four-decade long pattern of exemption of liquid oxygen as a "supply."
The state’s statute also exempts from taxation the sale, storage, and use of other tangible personal property used in manufacturing or industrial processing, if the property has a useful life of less than one (1) year. Included in the property entitled to this exemption are industrial tools, but the statute also specifically provides that repair, replacement or spare parts are not exempt from the tax. The taxpayer argued that its hammer pins were industrial tools meeting the criteria for the exemption. DOR contended that the hammer pins were simply repair, replacement or space parts, subject to the tax. The court agreed that the hammer pins came within the definition of repair, replacement or spare parts as those used to maintain, restore, mend or repair equipment and were not entitled to the exemption. The court said the record supported the assertion that contact between the hammer pins and the metal being processed was merely incidental and that the hammer, not the pins holding it to the rotor, directly contacted the processed metal, leading to the reasonable conclusion that hammer pins are not hand tools. Dep't of Revenue v. Progress Metal Reclamation Co., Kentucky Court of Appeals, Nos. 2013-CA-00175-MR; 2013-CA-001776-MR. 3/13/15
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
Newspaper Publisher Is Manufacturer
The Arizona Court of Appeals held that newspaper publishing is a manufacturing process and that software directly used in designing and laying out a newspaper is integral to the manufacturing of the newspaper. The proceeds from the sale of the software license agreement and maintenance agreements is, therefore, exempt from the state transaction privilege tax as machinery or equipment used in manufacturing.
The taxpayer develops and sells software that performs all layout, formatting and typesetting functions necessary to produce printed editions of a newspaper. In 1997, the taxpayer sold a third party a 99-year license to use its software to produce the printed Arizona Republic. The parties also entered into software maintenance agreements where the taxpayer agreed to provide the software with new software updates and releases, as well as support and software troubleshooting. Taxpayer argued that the income from the agreements is deductible under the state statute which exempts gross proceeds realized from the sale of machinery or equipment used directly in manufacturing. The Department of Revenue (DOR) argued that newspaper publishing is not manufacturing, but even if it were, the software is not used directly in the manufacturing process.
The state’s transaction privilege tax is a tax on the gross receipts of the seller’s business activities, imposed on the privilege or right to engage in an occupation or business in the state. The statute provides a number of statutory exemptions to this tax including the one at issue here. The court noted that the term "manufacturing" is not defined in that provision of the statute and looked to apply the ordinary meaning of the term. It cited definitions of that term in established and widely used dictionaries, including the Oxford dictionary that defines “manufacture” to make something on a large scale using machinery. The court looked to the lower court record and found that the third party uses printing presses and other machinery daily to produce large numbers of printed newspapers. During the audit period, it was producing approximately 3,450,000 copies of the Arizona Republic a week and used approximately 4,387,835 pounds of newsprint, 65,568 pounds of ink, 63 rolls of strapping, and 54 rolls of packaging per week. The court found that raw materials are used and printed newspapers are the result of the manufacturing process.
In support of the definitions in the dictionary, the court also referenced the state’s Administrative Code, which defined "manufacturing" as "the performance as a business of an integrated series of operations which place tangible personal property in a form, composition, or character different from that in which it was acquired and transforms it into a different product with a distinctive name, character, or use." A.A.C. R15-5-120. The regulations also defined "publisher" as "one who manufactures and distributes a publication from a point within this state." A.A.C. R15-5-1303(A). The court also pointed to a letter that DOR had sent to the third party in 1984 in response to their inquiry. The letter advised that items of machinery and equipment, including computer systems and parts directly related to the production process would be exempt from taxation if used directly in the printing operation of the newspaper. The court noted that the letter has never been rescinded, and, as a result, constitutes an acknowledgement that printed newspaper production is "manufacturing." The court then turned to the issue of whether the software was used directly in manufacturing and cited prior case law in which the state’s supreme court stated that a court should examine the nature of the item and its role in the operations and found that the closer the nexus between the item and the process of converting raw materials into finished products, the more likely the item will be exempt. That court also said that throughout a court’s analysis, it should bear in mind that the goal of the exemption was promoting economic development and that goal should not be frustrated by too narrow an application of the exemption.
In the present case, the court found that the software was essential and necessary to the completion of the finished printed newspaper. It performed the layout, formatting, and typesetting functions necessary to create the printed newspaper pages and assigned a naming convention that controls the flow of each page through the production and printing process.
The court found that the software, including the updates and releases, was integral to the manufacturing of the paper and was deductible under the exemption. The court also awarded reasonable attorneys’ fees and costs to the taxpayer in this matter. CCI Europe Inc. v. Arizona Dep't of Revenue, Arizona Court of Appeals, No. 1 CA-TX 13-0002. 3/12/15
Property Tax Decisions
Recession Is Not a Circumstance Beyond Taxpayer's Control for Waiving Tax Liability
The California Court of Appeal held that the owner of a shopping center is not entitled to a waiver of its predecessors' penalties on its tax liability. The taxpayer had argued that the economic recession of 2008 was a circumstance beyond the previous owners' control that would allow the tax collector to cancel the penalties.
The shopping center owner purchased the property in March 2013 from five limited liability companies that owned the property as tenants in common (TICs). The relationship of the prior owners was governed by a tenancy in common agreement, which provided that each TIC was responsible for a pro rata share of the operating costs, including property taxes. If the income from the property was insufficient to cover operating costs as happened during the recession beginning in 2008, the managing TIC was responsible for calling for capital from each TIC. The TICs were unable to meet the financial obligations of the property and were unable to pay the property taxes beginning in 2010. When petitioner purchased the property, assuming the liability for unpaid property taxes, taxes assessed for fiscal years 2010-2011, 2011-2012, and 2012-2013 were unpaid and delinquent, totaling more than $550,000, with penalties totaling $142,000 of that amount.
The statute provides that a penalty resulting from failure to make a timely property tax payment may be canceled by the tax collector if the failure "is due to reasonable cause and circumstances beyond the taxpayer's control, and occurred notwithstanding the exercise of ordinary care in the absence of willful neglect, provided the principal payment for the proper amount of the tax due is made no later than June 30 of the fourth fiscal year following the fiscal year in which the tax became delinquent." (§ 4985.2, subd. (a).) The taxpayer contends its predecessors' failure to timely pay the property taxes was due to reasonable cause and circumstances beyond the predecessors' control because it was caused by an unforeseen economic recession which resulted in the property failing to generate sufficient income to enable the owners to pay the taxes. Petitioner asserted the previous owners' exercised ordinary care in attempting to keep the shopping center fully leased and producing income, and the non-payment of the tax was not the result of any willful neglect.
The court reviewed prior case law interpreting “reasonable cause” and “circumstances beyond the taxpayer’s control” and noted that whether a taxpayer's inability to pay its taxes when due because of a recession constitutes grounds for cancellation of delinquency penalties under section 4985.2 appears to be a question of first impression. The court held that, based on limited legislative history and common sense, the statute primarily contemplates circumstances that interfere with a taxpayer’s ability to make the payment of the tax by the due date, and was not intended to apply to a taxpayer's general financial situation that might make it difficult to pay the tax when due.
The court said “[w]e do not construe the term ‘circumstances beyond the taxpayer's control’ to include the failure of commercial property to generate sufficient income to cover all of its operating expenses, regardless of the cause.” The court opined that the provision was not intended to permit every commercial property owner adversely affected by an economic downturn or recession to postpone payment of its property taxes indefinitely, without payment of a delinquency penalty. The court also noted that while the recession may have been beyond the taxpayer's control, it was not the recession that directly caused the former owners' failure to pay the taxes on time. The agreement entered into by the five limited liability companies provided that if the income was insufficient to pay the taxes, each TIC would pay a pro rata share of the costs. However, because the owners were single asset entities and the high vacancy rates persisted, they lacked the financial ability to contribute the necessary capital. Thus, it was the previous owners' ownership structure that caused them to be unable to afford to pay the taxes on the property, a matter within their control. Ashlan Park Center LLC v. Crow, California Court of Appeal, F069221. 2/2/15
Tax Foreclosure Sale Upheld Despite Failure to Notify Occupants
The Michigan Court of Appeals upheld a property tax foreclosure and sale because although the county failed to notify the lessees of the property that foreclosure was imminent. The court found that the property owners were notified and the General Property Tax Act's notice requirements are stricter than due process requirements, so strict compliance is not required.
The property at issue is a single parcel, jointly owned by the taxpayers, with two separate lessee businesses operating on the premises. Each business operates under a different address; the salon operates at 2920 W. Grand Blvd., while the insurance agency uses the address 2922 W. Grand Blvd. On June 14, 2011, the county Treasurer filed a petition for foreclosure for the nonpayment of property taxes. Taxpayers, as owners of the property, were served notice of the proceedings by certified mail, first class mail, publication, as well as personal service. On Sunday, November 27, 2011, an agent of the county Treasurer visited the property. Because the businesses were closed at that time, the agent was unable to meet with any occupant of the parcel and the agent posted a copy of the foreclosure petition and the notices for the show cause hearing and judicial hearing on the door of the salon.
The taxpayers argue that the County Treasurer's failure to mail notice to and personally serve an occupant of the parcel constituted a violation of due process and the county should be required to cancel its sale of the parcel. The court reviewed the statutory provisions and noted that the language reflects a clear effort to limit the jurisdiction of courts so that judgments of foreclosure may not be modified other than through the limited procedures provided in the property tax act, and that the only possible remedy for such a property owner would be an action for monetary damages based on a claim that the property owner did not receive any notice. The Court further noted, however, that prior case law had said in cases where the foreclosing entity fails to provide constitutionally adequate notice, depriving the property owner of due process, the portion of the property tax act limiting the circuit court's jurisdiction to modify judgments of foreclosure is unconstitutional and unenforceable.
It is undisputed that the owner-taxpayers received constitutionally and statutorily sufficient notice of the tax foreclosure proceedings, but they argue that the foreclosure proceedings were improper because the occupants of the parcel, and specifically the insurance agency, were deprived of adequate notice, citing a provision that requires the governmental unit engaged in the foreclosure proceeding to mail notice to the occupant of the property. There was no evidence that the occupants of the property were mailed a notice as required by the statute. The facts show that a personal visit was made to the property by the county treasurer, it was on a Sunday and the occupants were not on the premises. The Treasurer argued that the leases were not recorded and the lessees were, therefore, not entitled to the same notice as the owners. The court found that although the lease was not recorded, the interest in the property was identifiable through other sources and the insurance company was entitled to receive notice by mail. The court also noted that the visit was made to the address listed in the court documents for the foreclosure proceeding and the statute provides that the “a” person occupying the property be served, not all occupants. The court found that even though the visit was done on a Sunday when it was not likely that the occupant would be personally served, the notice was posted on the premises and the county Treasurer made notice by publication.
Citing provisions of the statute providing that when a property owner has been properly serviced with a notice of the foreclosure hearing and fails to redeem the property, the owner shall not assert that the notice was insufficient because some other owner of a property interest was not also served, the court concluded that despite any violations of the statute in this matter, the lower court properly denied the taxpayer’s motion to set aside the judgment of foreclosure. Wayne Cnty. Treasurer v. Karris, Michigan Court of Appeals, No. 316400. 2/3/15
Court Denies Retroactive Assessment of Gas Leasehold
The Colorado Court of Appeals determined that a county assessor improperly imposed a retroactive value increase on a gas leasehold because the undervaluation that occurred in this case was not premised on a willfully false or misleading statement, the only statutory reason for a retroactive value increase.
The taxpayer extracts and processes carbon dioxide located in deposits in the state, and then transports it through the Cortez Pipeline to the Permian Basin in West Texas, where the taxpayer uses the carbon dioxide in enhanced oil recovery. In April 2008, the taxpayer submitted six operator statements, one for each tax district, detailing its production in the county for 2007. These statements showed a decrease in valuation of carbon dioxide from the previous tax year. The county conducted an audit and issued an assessment that the taxpayer paid and, subsequently, filed a petition for refund. The lower court ruled that because the property tax administrator exercised its authority under the statute to develop guidelines for auditing oil and gas leaseholds for property tax purposes, including changing the valuation of the oil and gas leasehold, issuing special notices of valuation, and issuing a tax bill, the assessor had the statutory authority to retroactively assess taxes.
The state statute provides that oil and gas leaseholds are valued by county assessors based on the "selling price of the oil or gas sold from each wellhead during the preceding calendar year." § 39-7-102(1)(a), C.R.S. 2014. Every oil or gas leasehold operator or owner is required to file an annual statement and provide information including the selling price at the wellhead of all oil or gas sold. The assessor's valuation is determined by the information provided in the annual statement. Any false statement willfully and knowingly made in the annual statement is subject to a second-degree perjury charge and retroactive assessment of additional property taxes. The court held that because no one argued in this case that the annual statements filed by the taxpayer contained willfully false and misleading information, the court must construe and apply the statutory language as written and may not judicially legislate. It concluded there is no statutory authority for the retroactive tax assessed by the county in this case. Kinder Morgan CO2 Co. v. Montezuma Cnty. Bd. of Comm'rs., Colorado Court of Appeals, No. 13CA2187. 1/29/15
Nonprofit Qualifies for Benevolent Organization Exemption
The Wisconsin Court of Appeals held that a nonprofit taxpayer qualified for a benevolent organization property tax exemption, finding that the issue was not already litigated in an earlier case. It said that the city was incorrect in arguing that, in addition to satisfying the statutory requirements, the taxpayer had to prove a "benevolence test."
The taxpayer is a charitable nonprofit organization and a state nonstock corporation duly organized and existing under the laws of the state. In 2000, taxpayer acquired property in the City of Madison to develop, construct, and operate a retirement community for the aged. The taxpayer’s Articles of Incorporation state that one of its purposes is "[t]o develop and operate senior housing and to provide necessary services to allow individuals 55 years old and older to live independently." In 2010, the property contained 108 residential independent living units. Since the development of the property, the taxpayer has not made a profit from its operations. The lower court found that the taxpayer is a benevolent association and, therefore, the property is exempt under WIS. STAT. § 70.11(4d).
In 2009 the state legislature enacted an exemption from general property taxes for benevolent retirement homes for the aged, with specific requirements that must be met for the exemption.
At dispute here is whether the taxpayer met one of those requirements, that is, whether it is a benevolent association. The court rejected the City’s argued that the taxpayer is barred from arguing that it is a benevolent association because the issue was previously litigated and decided against the taxpayer in the circuit court for the 2002-03 tax years, and the taxpayer did not appeal that decision. The court said that the circuit court did not address the requirement whether the taxpayer was a benevolent association in that case, but instead, focused on whether the record demonstrated that the taxpayer used the property exclusively for benevolent purposes. The court also rejected the City's argument that there is a stand-alone "benevolence test" and distinguished the cases cited by the City to support its argument that the taxpayer is not a benevolent association. Attic Angel Prairie Point Inc. v. City of Madison, Wisconsin Court of Appeals, Appeal No. 2012AP2095. 3/5/15
Other Taxes and Procedural Issues
County Tax Levy Does Not Apply Statewide
The Indiana Court of Appeals reversed a lower court decision and held that a tax warrant issued by a county does not become valid statewide until a judgment has been issued. A third-party plaintiff in the case, therefore, had priority over the Department of Revenue (DOR) to receive a taxpayer's proceeds earned from the Indiana Horse Racing Commission.
The facts in the case show that DOR filed four warrants in 2000 for unpaid income taxes owed by Dale Dodson. In 2010 DOR renewed the warrants, extending them for another 10 years. In 2010, the Petitioner filed a UCC Financing Statement with the state Secretary of State, asserting an interest in any breeder's award proceeds owed to Dodson by the Indiana Horse Racing Commission. In 2010 and 2011, the DOR levied against two separate breeder's awards in the amounts of $7,400 and $4,100, respectively. The funds were payable to Dodson but were intercepted and withheld by the State Auditor prior to deposit in Dodson's bank account and were used to satisfy Dodson's outstanding tax liabilities. Petitioner sent several letters to DOR claiming a right to the breeder's award funds and demanding that the funds be paid to him. DOR refused his demands for payment and Petitioner ultimately filed this complaint.
The dispute turns on who had priority in the breeder's award proceeds and whether the DOR had authority to levy the proceeds in the manner it did. Where a debtor owes to multiple creditors, the creditor who first perfects its interest in the debtor's property has the right to collect on that property first. DOR contended that because its liens were established first, it had a superior interest in the breeder's award proceeds and properly exercised its authority to levy on the proceeds pursuant to Indiana Code § 6-8.1-8-8. DOR argued that state law does not limit its ability to levy on property to satisfy judgment liens by county.
The court found that although Indiana Code section 6-8.1-8-8 does not specifically reference a county-based limit on the DOR’s collection methods, Indiana Code chapter 6-8.1-8 provides numerous indications that DOR’s tax warrant liens are effective county-by-county, citing, in particular Ind. Code § 6-8.1-8-2(e) that once a judgment on a tax warrant has been entered that judgment "creates a lien in favor of the state that attaches to all the person's interest in any: (1) chose in action in the county; and (2) real or personal property in the county. . . ." The court also points out that the statute contemplates that warrants may be filed in multiple counties and if DOR files in multiple counties the statute specifies that DOR is not required to issue more than one demand notice.
The court concluded that because the judgment resulting from DOR’s tax warrant filed in one county only creates a lien on property in that county, and because the DOR did not take measures to establish a lien on property located in any other county, DOR’s ability to levy on Dodson's property was limited to that county. DOR did not dispute that the funds were located outside of the county in which the warrant was filed at the time they were seized. Consequently, the court concluded that DOR did not have authority to levy on the breeder's award proceeds and that it is not entitled to summary judgment. The court also found that the Petitioner filed a valid UCC Financing Statement that perfected his interest in the breeder's awards and was, therefore, entitled to collect the breeder's award proceeds. Etzler v. Indiana Dep't of Revenue, Indiana Court of Appeals, Court of Appeals Cause No. 50A04-1406-PL-285. 3/3/15
Taxpayer's Suit Properly Dismissed for Lack of Jurisdiction
The Louisiana Court of Appeal, First Circuit, found that a taxpayer's suit against the Department of Revenue (DOR) for alleged improper seizure of funds was properly dismissed for lack of subject matter jurisdiction because the taxpayer's claims were based on events that occurred after the assessments became final and collectible.
In March 2009, the DOR seized more than $50,000.00 from the taxpayer’s bank account pursuant to a warrant for distraint to satisfy tax assessments that had become final and collectible. In January 2011, the taxpayer instituted suit against DOR, alleging that its president/counsel met with DOR employees and presented proof of the DOR’s error in making the tax assessments and seizing the funds and that on three separate occasions, DOR employees agreed that an error had been made and promised to return the funds.
The lower court held for DOR noting that the taxpayer had not filed a timely appeal of the assessment.
The court found that all of the causes of action alleged by the taxpayer to have been erroneously dismissed by the trial court are premised upon events that occurred after the tax assessments became final and collectible pursuant to Section 47:1565 of the state statute. That section provides, in pertinent part, that if a taxpayer does not file an appeal within 60 days, the assessment shall be final and collectible by distraint and sale. Citing MCI Telecommunications Corp. v. Kennedy, 04-0458 (La. App. 1 Cir. 3/24/05), 899 So. 2d 674, 680-81, the court opined that if a taxpayer fails to timely appeal an assessment or make payment under protest, the taxpayer has no right of action to challenge the assessment and the trial court lacks subject matter jurisdiction to review the assessment. The court further noted that Section 47:1565C provides, in cases involving alleged errors in tax assessments that are final, relief lies solely within the discretion of DOR’s secretary to determine whether an error of fact or error of law was made. That provision is clear that the courts do not have any jurisdiction to review those decisions by the secretary. The court determined that the taxpayer did not appeal its assessment within the statutory time period and the court lacked subject matter jurisdiction over the taxpayer’s cause of action. Shields & Shields APLC v. Louisiana, Louisiana Court of Appeal, No. 2014 CA 0693. 3/4/15
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected].
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NEWS
This Week at the Supreme Court
The news this week is that the Supreme Court issued decisions in two of the three tax cases heard last fall. See below for the write-ups on the two decisions. Just a reminder, though, of FantasySCOTUS’ predictions: 8-1 in favor of Direct Marketing and 5-4 in favor of affirming Circuit’s decision in Alabama v. CSX.
The Affordable Care Act was also before the Court this week. Oral arguments in King v. Burwell, Sup. Ct. Dkt. 14-114 (2014), were heard on March 4, 2015. The question the court addressed is whether the IRS may make premium tax credits available to all eligible individuals who purchase health insurance through exchanges or whether the subsidies are limited to coverage purchased through an exchange established by a state under section 1311 of the ACA. Fantasy SCOTUS is predicting today that the lower court’s decision will be affirmed 6-3.
U.S. SUPREME COURT UPDATE
Certiorari denied
SHAC, LLC v, Nevada Dep’t of Revenue, U S Supreme Court Docket No. 14-727.
Issue: whether a tax broadly levied on live entertainment, but "gerrymandered" to target a specific group of disfavored taxpayers, is a facial violation of the First Amendment. See discussion of Déjà Vu Showgirls of Las Vegas, LLC v. Department of Taxation in the October 3, 2014 issue of State Tax Highlights for more detailed information.
Opinion Issued
Direct Marketing Ass'n v. Brohl, U S Supreme Court Docket No. 13-1032.
On March 3, 2015 the U S Supreme Court reversed the Tenth Circuit decision and unanimously held that the federal Tax Injunction Act does not bar a suit to enjoin enforcement of Colorado's sales and use tax reporting statute.
Facts: Colorado’s sales and use tax statute requires residents who purchase tangible personal property from a retailer who does not collect sales tax to remit the use tax on that purchase directly to the state. To enhance what is typically low compliance with the use tax requirement especially as the percentage of purchases from remote sellers has increased with the use of the internet, the state enacted legislation requiring non-collecting retailers whose gross sales in the state exceed $100,000, to notify purchasers of this requirement to pay the use tax and to file annual reports with the Department of Revenue (DOR) providing information on purchases by the state’s residents. A trade association of retailers, many of which sell to Colorado residents but do not collect taxes, sued DOR alleging that the state’s law violates the United States and Colorado Constitutions.
Issue: Whether the Tax Injunction Act (TIA) is a bar to the petitioner’s suit in federal court. The TIA provides that federal district courts "shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State," 28 U. S. C. § 1341.
Holding: Petitioner’s suit is not barred by the TIA. The court found that the terms “assessment,” “levy” and “collection” do not encompass the state’s enforcement of its notice and reporting requirements and the relief sought by the petitioner would, therefore, not fall within the constraints of the TIA. The court characterized the requirements under the state’s law as information gathering which it said has long been a phase of tax administration occurring before assessment, levy and collection. It rejected the state’s argument that the notice and reporting requirements were part of the assessment and collection process, which the court said is triggered after the state has received returns and made a deficiency determination, finding that these requirements precede the actions of assessment, levy and collection. The court pointed out that the notice given to the state’s consumers, for example, would inform them of their use tax liability and prompt them to keep a record of taxable purchases to be reported to the state at some future point. The annual summary that the retailers are required to send to consumers under the legislation serves to provide them with a reminder of that use tax liability and the specific information they need to fill out their use tax returns. And the report the retailers are required to file with DOR facilitates audits by DOR to determine tax deficiencies. The opinion noted that the state still needs to take further action to assess a taxpayer's use tax liability and to collect payment from a taxpayer after each of these notices or reports is filed. The court acknowledged that while enforcement of the state’s notice and reporting requirements may assist the state in increasing the collection of the use tax due, the petitioner’s suit does not restrain the collection of the use tax simply because it may make that collection more difficult for the state. The court rejected the broad interpretation of the word “restrain” used by the Tenth Circuit in the context of the TIA in favor of a narrower meaning used in equity which includes only those actions that stop acts of assessment, levy, or collection. It pointed out that, as used in the TIA, “restrain” acts on assessment, levy and collection, not the broader term “taxation” and to give it that broader reading would render the terms “assessment, levy and collection” surplusage, a result the court tries to avoid.
The Court did not decide whether this matter might be barred under the comity doctrine, noting that the state did not raise this argument before either of the lower courts. The court said it would leave it to the Tenth Circuit to decide on remand whether the comity argument remained available to the state.
Of Note: Justice Kennedy issued a concurrence opinion, that should be of special interest to state tax administrators, in which he pointed out “a serious, continuing injustice faced by Colorado and many other states” as a result of the court’s holdings in National Bellas Hess, Inc. v. Department of Revenue of Ill.,386 U. S. 753 (1967) and Quill Corp. v. North Dakota, 504 U. S. 298, 311 (1992). He said that in Quill, the Court should have taken the opportunity to reevaluate Bellas Hess not only in light of Complete Auto but also in view of the dramatic technological and social changes that had taken place in the economy. He said there is “a powerful case to be made that a retailer doing extensive business within a State has a sufficiently ‘substantial nexus’ to justify imposing some minor tax-collection duty, even if that business is done through mail or the Internet.” He noted that the case has grown stronger and more urgent over the years as sales through mail order and now the internet have burgeoned, noting the difficulty that states have in collecting many of the taxes due on these purchases.
He pointed out the far-reaching systemic and structural changes in the economy brought on by the internet and noted that although online businesses may not have a physical presence in a state, the internet has in many ways brought the average citizen closer to major retailers, making these retailers “present” in a state without that presence meeting the physical presence test. He concluded by saying, “The instant case does not raise this issue in a manner appropriate for the Court to address it. It does provide, however, the means to note the importance of reconsidering doubtful authority. The legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess.”
Justice Ginsburg also wrote a concurrence that Justice Breyer joined, making two observations: First this suit did not challenge the petitioner’s own or anyone else’s tax liability or tax collection responsibilities which would result in a different question posed to the Court than the one before it. Second, the Justice pointed out that the decision in this case is consistent with prior decisions, noting that even a suit that somewhat inhibits assessment, levy and collection does not come within the scope of the TIA. Justice Sotomayer joined in the first observation.
Alabama Department of Revenue v. CSX Transportation, Inc., U S Supreme Court Docket No. 13-553.
On March 4, 2015, the Supreme Court reversed the Eleventh Circuit Court of Appeals decision in this case holding that while the appropriate comparison class for determining discrimination against railroads under the Railroad Revitalization and Regulation Reform Act of 1976 (4-R Act), 49 U. S. C. § 11501(b)(4), is a railroad's competitors, courts must consider the overall tax burden in making that determination. The court remanded the case to the Eleventh Circuit to make the determination of whether the fuel excise tax is roughly equivalent to the sales tax on diesel fuel to justify the exemption from the sales tax for motor carriers.
Facts: Alabama imposes sales and use taxes on railroads when they purchase or consume diesel fuel. Trucking transport companies (motor carriers) are exempt from the sales tax but pay an alternative fuel excise tax on diesel fuel. Companies that transport goods interstate through navigable waters (water carriers) are exempt from both the sales tax on diesel fuel and the excise tax. In CSX Transp. v. Ala. Dept. of Revenue, 562 U. S. 277, 287 (CSX I), the Supreme Court held that a tax discriminates under the 4-R Act when it treats groups that are similarly situated differently without sufficient justification for the different treatment. On remand, the District Court ruled for Alabama, but, on appeal, the Eleventh Circuit reversed and held that CSX established discrimination by showing that the state taxed railroads differently that their competitors and rejected the state’s argument that imposing a fuel excise tax on motor carriers, but not railroads justified the different treatment.
Issue: Does the state's asymmetrical tax treatment discriminate against a rail carrier in violation of the Railroad Revitalization and Regulation Reform Act of 1976 (4-R Act), 49 U. S. C. § 11501(b)(4).
Holding: In a 7-2 decision written by Justice Scalia, the Court found that CSX’s competitors are an appropriate comparison class for its subsection (b)(4) claim. The decision rejected Alabama’s argument that the only appropriate comparison class for a subsection (b)(4) claim is all general commercial and industrial taxpayers. The Court said that while all general and commercial taxpayers may be an appropriate comparison class, it is not the only one. The Court noted that the context of the statute confirms that the comparison class for subsection (b)(4) is not limited as Alabama suggests. Scalia points out that the 4-R Act is an "asymmetrical statute," with subsections (b)(1) to (b)(3) containing three specific prohibitions directed towards property taxes, each of which requires comparison of railroad property to commercial and industrial property in the same assessment jurisdiction. Under subsection (b)(4) the comparison class is to be determined based on the theory of discrimination alleged in the claim—in this case that the railroad has a tax disadvantage compared to its transportation industry competitors. The Court concluded that the Eleventh Circuit properly concluded that, in light of CSX’s complaint and the parties' stipulation, a comparison class of competitors consisting of motor carriers and water carriers was appropriate, and differential treatment vis-à-vis that class would constitute discrimination.
The Court then turned to the issue of whether Alabama’s tax structure discriminated against CSX. The opinion rejected CSX’s argument that because the 4R provision forbids imposing another tax that discriminates against a rail carrier, the appropriate inquiry is whether the challenged tax discriminates, not whether the tax code as a whole does so. The Court noted that a state's tax discriminates only where the state cannot sufficiently justify differences in treatment between similarly situated taxpayers, such as CSX, motor carriers and water carriers. The Court said that an alternative, roughly equivalent tax is one possible justification that renders a tax disparity nondiscriminatory, citing Gregg Dyeing Co. v. Query, 286 U. S. 472, 479-480 (1932). The Court held that the Eleventh Circuit erred in refusing to consider whether Alabama could justify its decision to exempt motor carriers from its sales and use taxes and, instead, subject them to a fuel-excise tax and instructed the court, on remand, to consider whether Alabama's fuel-excise tax is the rough equivalent of Alabama's sales tax as applied to diesel fuel, and therefore justifies the motor carrier sales tax exemption. The Court noted that while the state cannot offer a similar defense with respect to its water carrier exemption, the Eleventh Circuit should also examine whether any of the state's alternative rationales justify that exemption.
Dissenting opinion: Justices Thomas and Ginsberg joined in a dissent.
The dissent found that the statutory structure of the 4-R Act provision supports the conclusion that a tax discriminates against a rail carrier within the meaning of subsection (b)(4) if it singles out railroads for unfavorable treatment as compared to the general class of commercial and industrial taxpayers. The dissent also found that the state’s tax scheme cannot be said to discriminate against a rail carrier, because the tax is not directed at rail carriers, their property, their activity, or goods uniquely consumed by them. It is instead a generally applicable sales tax. The dissent noted that the only relevant good exempted from the tax is diesel on which the motor fuel tax has been paid, and no provision of law prevents rail carriers from buying such diesel. The dissent concludes by noting that the majority's interpretation prolongs Alabama's burden of litigating a baseless claim of discrimination that should have been dismissed long ago.
FEDERAL CASES OF INTEREST
Individual State Income Tax Liability Not Dischargeable in Bankruptcy
The United States Court of Appeals for the First Circuit held that state income tax returns filed late and never paid are not dischargeable taxes in bankruptcy because a 2005 amendment to the bankruptcy code allowing the discharge of debts requires that taxpayers follow the state's return filing requirements.
The four taxpayers in this matter were Massachusetts residents and all failed to timely file their state income tax returns for multiple years in a row and failed to pay their taxes to Massachusetts for these years. Eventually, each taxpayer filed his late tax returns, but still failed to pay all taxes, interest, and penalties that were due. More than two years later, each filed for Chapter 7 bankruptcy. The taxpayers argued that their obligation to pay the taxes on those late-filed returns was dischargeable in bankruptcy. The Massachusetts Department of Revenue (DOR) argued that since the returns were not timely filed, the unpaid taxes for those years fit within an exception to discharge under 11 U.S.C. § 523(a)(1)(B)(i). The lower courts were split on the issue before the court.
Pursuant to the Bankruptcy Code, a taxpayer in a Chapter 7 bankruptcy proceeding
is discharged from his debts, with certain exceptions. The exception applicable in this matter provides that a tax is not dischargeable if the debtor failed to file a return, or if he filed the return late and within two years of his bankruptcy petition. In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"), making numerous revisions to the bankruptcy law, including a definition of a “return.” Section 523(a)(*) provides:
- For purposes of this subsection, the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.
The question presented in this case is whether a Massachusetts tax return filed after the due date for such returns is a "return" as defined in section 523(a)(*) so that the tax due under that return remains dischargeable? The court found that for a document to be a "return," it must satisfy the requirements of applicable non-bankruptcy law, including applicable filing requirements, and the court further found that the language of the Massachusetts statute is clear that timely filing is a filing requirement in the state. The court noted that both the Fifth Circuit and the Tenth Circuit have reached this same conclusion, albeit construing other jurisdictions’ applicable filing deadlines. The court rejected the taxpayers’ argument that the paragraph’s language is not quite as clear, finding that as a matter of plain language, a Massachusetts law setting the date when a tax return is required to be filed is a filing requirement.
The taxpayers also argue that the language of the bankruptcy code that includes the two-year provision clearly implies that there can be a return that is filed two years after the date on which the return was due and, therefore, the language on the 2005 amendment cannot be read as excluding that possibility. The court acknowledges that and points out that the 2005 amendment carves out an exception from the general rule, that is, a return prepared pursuant to IRC Section 6020(a) or a similar state or local law. The fact that section 6020(a) may only apply in a small minority of cases, the fact that a late filed section 6020(a) return can still qualify as a "return" for section 523(a) purposes means that the two-year provision still has a role to play if the paragraph's plain meaning controls.
There was a dissent filed in this matter, arguing, in part, that it was absurd to believe that Congress would permit a discharge of taxes under a section 6020(a) return prepared years after the due date, but not permit it for a Massachusetts return filed even one day late. The court argued, in opposition to the dissent, that section 6020(a) is a tool for the IRS invoked solely at its discretion when it decides obtaining help from the late filing taxpayer is to the I.R.S.'s advantage and that this tool offered in such infrequent cases does not mean that it was absurd for Congress not to extend this carrot categorically to large numbers of other late filers. The court also rejected the taxpayers’ argument that the consequences of finding all late filed return in the state are not subject to discharge in bankruptcy is draconian and absurd, stating that while that result may be unfavorable toward delinquent taxpayers, it is not draconian.
The dissent found that the majority ignored the mandates of statutory construction, years of lines of case law upon which debtors had been relying, and the clearly stated policy reasons for Congress's imposing these statutory provisions in the first place. In re Fahey, U S Court of Appeals for the First Circuit, No. 14-1328. 2/18/15
Injunction Against Tax Return Preparer Issued
A U.S. district court issued an order defining the scope of a permanent injunction against a professional tax return preparer previously issued by the court. The court found that based on his behavior it was appropriate to issue a broad injunction prohibiting him from preparing federal returns or assisting in the preparation of those returns.
On October 23, 2013, the Government filed its Complaint for Permanent Injunction and Other Equitable Relief ("Complaint") to enjoin the Defendant, a paid professional federal tax return preparer, from preparing taxes. The Complaint sought injunctions pursuant to 26 U.S.C. § 7407 ("Count I") and 26 U.S.C. § 7402 ("Count II") for taking unrealistic and unsustainable positions on customers' tax returns, willfully understating taxes due, and recklessly and intentionally disregarding tax rules and regulations. The Government sought a permanent injunction prohibiting the Defendant from acting as a federal tax return preparer and assisting in preparing fraudulent tax returns. On November 30, 2014, the Court found that Defendant knowingly and repeatedly violated the tax code, and granted summary judgment for the Government as to both counts. The Court found that a permanent injunction was necessary to prevent recurrence of the Defendant’s fraudulent practices but reserved ruling on the scope of the permanent injunction, including whether the Defendant should be prohibited from preparing taxes entirely, until he had a final opportunity to more fully argue his position on this issue.
The court noted that the Ninth Circuit has not clearly articulated a standard or test that a district court should apply in determining whether a lifetime injunction against all tax preparation is proper. The court pointed out a number of factors that courts have used in making this determination, including (1) a defendant's willingness or refusal to acknowledge wrongdoing; (2) compliance with the law following a warning or notification by the IRS that the conduct is unlawful; (3) the percentage of fraudulent tax returns filed; (4) the amount of money fraudulently requested and the amount actually released; (5) the number of discrete fraudulent practices; (6) the longevity of the fraudulent scheme; and (7) the defendant's degree of scienter, or intent or knowledge of wrongdoing.
The court found that the Defendant, even after his second supplemental memorandum in this matter, had not clearly admitted his fraudulent practices and had not clearly promised to desist from all fraudulent practices with future filings. Further, he failed to comply with the law following a warning or notification by the IRS that the conduct was unlawful. The court also found that the percentage of fraudulent returns filed by the Defendant for the years in question was high and the total loss in revenue for the government was significant. While the Defendant argued that there was no evidence of fraudulent practices before 2007, the court found that five years of fraudulent activity was still significant. Finally, the court found that the Defendant knowingly and repeatedly violated the tax code.
The court noted that the Defendant, during this period after the initial order, had not offered any facts that counterbalanced the factors in favor of the government’s position that would lead the court to lessen the severity of the remedy. The Defendant had simply argued that his family budget required him to continue working, but provided no details to substantiate this argument. The court found that all of the factors weighed in favor of the Government’s position, and the Defendant did not offer any reasons why the broad injunction would be unfair. The court, therefore, granted the requested for permanent injunction from preparing or assisting in preparing any federal tax returns. In addition, the court ordered that the Defendant prepare a list that identifies by name, social security number, address, email address, telephone number, and tax period(s) all persons for whom he prepared federal tax returns or claims for refund since January 1, 2008. United States v. James A. Ericson, U S District Court for the District of Hawaii, No. 1:13-cv-00551. 2/20/15
DECISION HIGHLIGHTS
Sales and Use Tax Decisions
Aircraft Lease to Common Carrier Qualifies for Use Tax Exemption
The Missouri Supreme Court held that a taxpayer was entitled to a use tax refund for its purchase and subsequent lease of an aircraft because the lessee was a common carrier and the lease constituted a sale qualifying for the resale exemption.
The taxpayer purchased an aircraft in Kansas and immediately lease it to a third party who then moved the aircraft to Missouri basing it in Kansas City for use in the third party’s air carrier operations. The taxpayer argues that it’s purchase qualified for the resale exemption provided in the statute pursuant to the exemption to common carriers and claims the lower court erred in excluding three documents which it claimed were relevant to the determination of whether the third party lessee was a common carrier. In a review of the record, the court noted that the lower court found that the third party was a common carrier, but that the taxpayer was not entitled to the refund of tax paid under protest because the lease was not a sale for purposes of the resale exemption.
The aircraft is an item subject to the state’s sales tax as tangible personal property. The statute defines sale to include any transaction “whether called leases…notwithstanding that the title or possession of the property is retained for security.” Section 144.605(7). The court cited prior case law that was on point and found that the lease by taxpayer to the third party constituted a sales for sales tax purposes because the right of the aircraft's use was fully transferred to the third party, who in turn, provided air courier service for valuable consideration. The court also pointed out that the Director conceded at oral argument that for purposes of the appeal the record supported the determination that the third party was a common carrier. The court ruled that the taxpayer had shown clear and unequivocal proof that it qualified for the exemption. Five Delta Alpha LLC v. Dir. of Revenue, Missouri Supreme Court, No. SC94224. 2/24/15
Office Rental Not a Taxable Service for Sales Tax Purposes
The Missouri Supreme Court ruled that a gym did not owe sales tax on rental fees collected from a personal training company because the gym did not take an affirmative act, and therefore did not provide a taxable service at retail.
The taxpayer is a fitness facility; in return for a fee, it offered members various services, such as the use of fitness classes, weights and exercise machines. It did not directly offer personal training services, but rented space in its facility to a personal training business that employed personal trainers and used the taxpayer’s facility to provide these services to taxpayer’s members. The personal trainers were not permitted to use taxpayer's facilities for personal use pursuant to the lease agreement.
The issue here is whether the monthly rental fees were taxable under section 144.020.1 that provides for a sales tax for the privilege of selling tangible personal property or rendering a taxable service at retail in the state. It provides for various rates of taxation, including a four percent tax on "fees paid to, or in any place of . . . recreation." The Department of Revenue (DOR) argued that the rental fees were subject to sales tax because the statute applies to all fees paid to a place of recreation. The taxpayer contended that the fees were only rent for the office space and limited use of the fitness equipment when conducting personal training sessions. DOR argued that the rental fee involved much more than the simple rental of office space because the company also received the opportunity to market and sell personal training services to the taxpayer’s members and access to its facilities to hold personal training sessions.
The court pointed out that the statute only applies when a taxpayer sells tangible personal property or renders a taxable service at retail. Since the taxpayer did not sell tangible personal property, the issue is whether the rental fees were for rendering a taxable service. The court looked to the plain and ordinary meaning of “rendering a taxable service” and found that “to render” in the dictionary is “to do” a service for another. The court found that the taxpayer did not do anything for the lessee as an affirmative act, but instead was passive regarding the lessee’s interaction with the taxpayer’s members. Without performing an affirmative act, the court said that the taxpayer did not render any taxable service at retail and was not liable for the sales tax on the monthly charges. Tatson LLC v. Dir. of Revenue, Missouri Supreme Court, No. SC94260. 2/24/15
Personal Income Tax Decisions
No cases to report.
Corporate Income and Business Tax Decisions
No cases to report.
Property Tax Decisions
No cases to report.
Other Taxes and Procedural Issues
Nursing Bed Charge Upheld as Tax
The Illinois Supreme Court held that a tax on licensed beds in the state’s nursing homes did not violate the state constitution's uniformity clause because the tax did not fund a single expense. The court said a tax may be imposed on a class even though the class enjoys no benefit from the tax when there is a reasonable relationship to the object of the legislation.
The taxpayer, a 501(c)(10) organization under the Internal Revenue Code, owns, operates and maintains a nursing home in the State. The nursing home is licensed by the state Department of Public Health and has also been granted a permit to enter into life care contracts under the state’s Life Care Facilities Act . In May 2002, the Department of Public Aid (Department) directed the taxpayer to pay the "Nursing Home License Fee" established in section 5E-10 of the Code (the bed fee) which provides, in pertinent part, that every nursing home provides shall pay each quarter a fee in the amount of $1.50 for each licensed nursing bed day in the quarter.
According to the taxpayer, admission to the nursing home is limited to members of the taxpayer, who either pay the nursing home a monthly fee or, alternatively, surrender all of their present and future assets to the nursing home in exchange for lifetime care. The nursing home does not apply for or accept any government funding or subsidies, including Medicaid reimbursement, and its residents are required to relinquish the receipt of any government aid, including Medicaid, prior to entering the facility. The taxpayer alleged, therefore, that collection of the bed fee was unconstitutional as applied to it because the principle purpose of the bed fee is to fund Medicaid-related expenditures that are neither precipitated by nor paid to the nursing home. The state argued that the purpose of the bed fee is not simply to fund Medicaid-related expenditures since the Department is required to deposit all collected bed fees into the Long-Term Care Provider Fund which is used for a variety of purposes, only one of which is the reimbursement of Medicaid-related expenditures and many of which either benefit or are precipitated by the operation of nursing homes generally, including the nursing home operated by the taxpayer.
The lower court ruled in favor of the taxpayer, holding that the sole purpose of the bed fee is to provide reimbursement for Medicaid, a purpose that bears no reasonable relationship to the taxpayer. Under the state constitution’s uniformity clause, with any law classifying non-property taxes or fees, the classes must be based on a real and substantial difference between the people tax and non-taxes and they must bear some reasonable relationship to the object of the legislation or to public policy. Arangold Corp., 204 Ill. 2d at 153. The taxpayer is arguing in this matter that there is a real and substantial difference within the class of those who are taxed, nursing homes that participate in the Medicaid program and those that do not. The court’s inquiry in this matter was limited to whether the taxing classification bore a reasonable relationship to the object of the legislation or public policy.
The court disagreed with the lower court’s finding that the sole purpose of the bed fee was the funding of Medicaid, finding, instead, that though Medicaid reimbursement was certainly one of the purposes of the bed fee, it was clear that the bed fee served many additional purposes that were wholly unrelated to the Medicaid program. The bed fees are required to be deposited into the Long-Term Care Provider Fund and the statute enumerates seven distinct purposes for which disbursements from the fund may be made, including, in addition to Medicaid reimbursement, paying the administrative expenses of the Department and its agents, the enforcement of the state’s nursing home standards, support of a nursing home ombudsman program, the expansion of home and community-based services, and the funding of the state’s General Obligation Bond Retirement and Interest Fund. In rejecting the argument advanced by both the lower court and the taxpayer that a taxpayer cannot be made to pay a tax for which he receives no direct, reciprocal, and proportionate benefit, the court noted that it has never required perfect reciprocity between the payment of a tax and the receipt of a benefit from that tax. It cited prior case law holding that the court has "repeatedly held that a tax may be imposed upon a class even though the class enjoys no benefit from the tax." Empress Casino, 231 Ill. 2d at 71-72.
The court held that the taxing classification at issue in this case, every nursing home, bears some reasonable relationship to the object of the legislation or to public policy. As the court noted earlier, the object of the bed fee was not simply Medicaid reimbursement, but to fund a number of areas relating to nursing homes and related services. The court found that there was a reasonable relationship between collecting the bed fee from every nursing home, including the taxpayer’s facility and the state’s need to fund these various obligations. The court pointed out that every nursing home, including the taxpayer’s, is licensed and operates under various permits issued by the state’s Department of Public Health, which receives a substantial amount annually from the Long-Term Care Provider Fund. It also noted that every nursing home, including the taxpayer’s, benefits from operating within a regulated industry, the enforcement and oversight of which is paid for in part by the Long-Term Care Provider Fund. Finally, the court said that everyone who lives or does business in the state, including taxpayer’s nursing home, benefits from and has an interest in ensuring that the state’s bond obligations remain adequately funded.
The court did take the opportunity to opine that the fact that the fee is constitutional does not necessarily mean that it is wise, outlining the compelling picture of both the noble charitable work performed by the taxpayer and the substantial financial burden it experiences as a result of the bed fee. The court suggested that the legislature reexamine the bed fee statute to determine whether the inclusion of facilities such as the taxpayer’s is necessary and essential as a matter of public policy. Grand Chapter, Order of the E. Star of the State of Illinois v. Topinka, Illinois Supreme Court, 2015 IL 117083; Docket No. 117083. 1/23/15
Utility Company PILOT Program Is Tax Subject to Voter Approval
The California Court of Appeal for the Third District held a municipally owned utility company's payment in lieu of tax (PILOT) to the city is a tax and that the city must secure a two-thirds voter approval before transferring the funds; the case was remanded for an evidentiary hearing on whether the PILOT exceeds reasonable costs of providing electricity.
In 1978 voters in the state adopted Proposition 13 that requires, among other things, that any special taxes for cities, counties, and special districts be approved by two-thirds of voters.
Proposition 218, adopted in 1996 further required that new taxes imposed by a local government be subject to two-thirds vote by the electorate. Proposition 26, adopted in 2010, added a broad definition of tax to include any levy, charge, or exaction of any kind imposed by a local government, with seven enumerated exceptions to that definition. One of these exceptions, and the subject of this matter, provides that tax does not include "[a] charge imposed for a specific government service or product provided directly to the payor that is not provided to those not charged, and which does not exceed the reasonable costs to the local government of providing the service or product." (Art. XIII C, § 1, subd. (e)(2)). The local government has the burden of proving by a preponderance of the evidence that a levy or charge is not a tax and that the amount is no more than necessary to cover the reasonable costs of the governmental activity.
At issue here is the practice by the City of Redding (Redding) since 1988 of making an annual budget transfer from the Redding Electrical Utility (Utility) to city's general fund. The Utility is municipally owned and is not subject to a one percent ad valorem tax imposed on privately owned utilities in California. The amount transferred between the Utility's funds and the Redding general fund is designed to be equivalent to the ad valorem tax the Utility would have to pay if privately owned. The city describes the annual transfer as a payment in lieu of taxes (PILOT). The PILOT is not set by ordinance, but is part of the Redding biennial budget. Plaintiffs argue that the PILOT constitutes a tax requiring approval by two-thirds of voters. The city argues that it is not a tax and, alternatively, that it is grandfathered-in because the PILOT precedes the adoption of Proposition 26.
The court concluded that the PILOT constituted a tax under Proposition 26, which was intended to address taxes disguised as fees, and the city must secure two-thirds voter approval unless it proves the amount collected is necessary to cover the reasonable costs to the city to provide electric service. It rejected the city’s argument that the PILOT is grandfathered-in by preceding Proposition 26's adoption, finding that the PILOT is subject to annual discretionary reauthorization by the city council and did not escape the purview of Proposition 26 because it is a long-standing practice. The court remanded the matter to the lower court to determine whether the PILOT exceeds reasonable costs to provide electric service. Citizens For Fair REU Rates v. City of Redding, California Court of Appeal, C071906. 1/20/15
Partnership's Profit Distributions Are Subject to Payroll Expense Taxes
The California Court of Appeal held that San Francisco's Proposition Q, which amended the payroll expense tax, does not violate the California constitution or the state's revenue code because the company's profit distributions to equity partners are "compensation for services" subject to the payroll expense tax base.
The taxpayer is a limited liability partnership seeking a refund of that portion of the Payroll Expense Tax that it paid on the profits distributed to its equity partners. The voters approved the Payroll Expense Tax Ordinance in 1970 and it is payable by every person engaging in business within the city, levied upon that portion of the payroll expense attributable to the city. Proposition Q amended the ordinance in 2008 to clarify that specify that the tax applies to compensation paid to shareholders of professional corporations, members of limited liability companies, and owners of partnerships for their services and to specify how that compensation is determined.
The taxpayer argued that the ordinance cannot be read to tax any portion of the partnership's profit distributions paid to equity partners because none of those distributions constitute "compensation for services." According to taxpayer, equity partners receive either guaranteed payments for services in the form of salary-like payments, which taxpayer concedes are part of the payroll expense tax base, and/or a portion of the partnership's profit distributions.
Plaintiff then argues the partnership's profit distributions do not include "compensation for services" because as a general rule an equity partner is not entitled to "compensation for services", and profit distributions are not treated as "compensation for services" under federal and state tax laws and regulations for the purpose of an equity partner's individual income tax liability. The court rejected this argument finding that Proposition Q is not concerned with an equity partner's individual income tax liability for profit distributions, but, instead, more broadly seeks to tax "compensation for services" reflected in the calculation of the partnership's profit distributions.
For purposes of the payroll expense tax base at issue here, the partnership's profit distributions are viewed at the partnership level and necessarily require a calculation of its gross income. The court noted that one of the major sources of a partnership’s gross income is compensation for services, including fees received for client services. The court concluded that some portion of the taxpayer’s profit distributions do include an equity partner's "compensation for services," as that term is used in Proposition Q, and that portion is to be included in the calculation of the payroll expense tax base.
The court rejected the taxpayer’s argument that Proposition Q violates due process if it is read to tax any portion of the profit distributions paid to equity partners. The court saw no merit to taxpayer’s argument that Proposition Q is unconstitutionally vague on its face because it does not define "compensation for services" or "return on capital investment" citing common understanding of those terms. The court also rejected the taxpayer’s argument that Proposition Q is an invalid income tax in violation of section 17041.5 of the California Revenue and Taxation Code. Coblentz, Patch, Duffy & Bass LLP v. City and Cnty. of San Francisco, California Court of Appeal, A135509. 1/9/15
Satellite TV Company's Excise Tax Challenge Rejected
The Massachusetts Supreme Judicial Court has rejected a satellite TV company’s argument that the state's excise tax discriminated against satellite TV companies that are largely out-of-state, compared with cable companies, which have large local operations, concluding the two are not similarly situated for tax comparison purposes.
Plaintiffs are satellite TV companies, subject to the state’s five percent excise tax on video programming delivered by direct broadcast satellite. They contended that the tax discriminates against interstate commerce, both in its effect and in its purpose, by disfavoring them as compared with those companies that provide video programming via cable. The satellite and cable companies that operate in the state are all incorporated and headquartered in other states. The satellite companies argue, however, that the cable companies represent in-state interests because their in-state commercial operations are substantially greater than those of the satellite companies.
The court concluded that the lower court ruling of summary judgment for the Department of Revenue (DOR) was warranted. It pointed out that cable companies and the satellite companies are subject to similar tax obligations, which differ primarily in the ways in which they are collected and calculated, but found that the differences are grounded in important characteristics of the cable and satellite companies' respective methods of operation, and in the different regulatory regimes to which they are subject. The court found that the satellite companies raised no genuine issue as to the facts material to their claim of discrimination against interstate commerce. DirecTV LLC v. Dep't of Revenue, Massachusetts Supreme Judicial Court, SJC-11658. 2/18/15
The State Tax Highlights is a publication of the Federation of Tax Administrators for its members. If you have any comments on this publication, please send them to Linda Tanton at [email protected].
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