State Tax Highlights
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STATE TAX HIGHLIGHTS
A summary of developments in litigation.

Published biweekly by the Federation of Tax Administrators
Also available at the FTA Member website at:
http://www.taxadmin.org

December 13, 2019 Edition


NEWS


Georgetown University Law Center Partners with MTC

April 1, 2020 is the deadline to qualify for the tuition discount now available through the MTC for state and local tax government lawyers and qualified tax professionals (“government employees”) applying for Fall 2020 admission to the Georgetown University Law Center’s Tax online distance education programs. Membership in MTC is not a precondition of enrollment. For details concerning eligibility, among other things, see https:// http://www.mtc.gov/The-Commission/News/Georgetown-University-Law-Center-Partners-with-MTC.

Court Rejects Appeal in Interest Dividends Case

The California Supreme Court will not review an appellate court decision upholding the taxation of dividends from a regulated investment company (RIC) that received interest income from holdings of government bonds. This decision lets stand the decision of the California Court of Appeal, Second District, that the taxation of the dividends did not violate the state constitution’s provision exempting interest on bonds issued by the state or a local government in the state. See the FTA’s legal database for a discussion of that decision.

Under the state’s statute a RIC may pay exempt interest dividends to its shareholders if at least 50 percent of the value of its total assets at the close of each quarter of its tax year consists of obligations that the interest from which is exempt. The taxpayers owned shares in a RIC that received 12.41 percent of its interest income from holdings in California municipal bonds and received dividends derived from interest from their investments in the RIC during the 2010 tax year. They protested an assessment arguing that the statute conflicted with Article XIII, section 26(b), of the state constitution by taxing interest income on government bonds. The FTB contended that the bond interest lost the exemption when it was distributed to the taxpayers as a dividend of the RIC.

 

U.S. SUPREME COURT UPDATE

No cases to report.

FEDERAL CASES OF INTEREST

Railroad Fuel Tax Suit Concludes

The United States District Court for the Northern District of Alabama, Southern Division, issued an order in CSX Transportation Inc. v. Alabama Department of Revenue holding that the state must exempt CSX from the fuel tax purchased while engaged in interstate commerce, as long as it exempts water carriers from the tax. See the FTA’s legal database for a discussion of the prior decisions in this matter.

The U.S. Court of Appeals for the Eleventh Circuit remanded this matter to the district court with instructions to enter declaratory and injunctive relief in favor of CSX Transportation, Inc. (CSX) consistent with its opinion in CSX Transportation, Inc. v. Alabama Department of Revenue, 888 F.3d 1163 and 891 F.3d 927 (11th Cir. 2018). In accordance with those opinions, the district court declared that, as long as the State of Alabama retains the sales and use tax exemption in the statute for diesel fuel used by water carriers engaged in foreign or international commerce or in interstate commerce, the Railroad Revitalization and Regulatory Reform Act of 1976 (4R Act) forbids it from imposing on CSX the sales and use tax under the state statute on diesel fuel purchased or used by CSX while “engaged in foreign or international commerce or in interstate commerce.” The court order further enjoined the state DOR from assessing, levying, or collecting from CSX sales and use taxes on diesel fuel purchased or used by CSX while engaged in foreign or international commerce or in interstate commerce. The court also noted that it had been informed that, in order to avoid further litigation, CSX and the DOR had entered into an agreement to resolve what portion of diesel fuel used by CSX should be deemed as affecting only intrastate commerce and therefore subject to taxation without violating this injunction. CSX Transp. Inc. v. Alabama Dep't of Revenue, U.S. District Court for the Northern District of Alabama, Southern Division, Case No.: 2:08-cv-00655-AKK. 12/9/19

Tobacco Company Violated PACT Act

The United States Court of Appeals for the Second Circuit has found a tobacco company that shipped untaxed cigarettes from a Native American reservation in Washington to several reservations in New York violated the Prevent All Cigarette Trafficking Act (PACT Act) by selling tobacco in interstate commerce. This decision affirmed a lower court's decision which barred the company from making any more similar shipments. The decision also permitted the state to ask for civil penalties and damages.

The taxpayer shipped unstamped and untaxed cigarettes from the Yakama Indian Reservation in Washington State to certain Indian reservations in the State of New York and New York filed this action to enjoin the taxpayer from making these shipments, arguing that they violate state and federal law. The action also requested additional relief including civil penalties and damages. The U.S. District Court for the Eastern District of New York granted partial summary judgment for the State and the taxpayer filed this appeal, contending that the state’s enforcement violates the dormant Commerce Clause and the injunction amounted to state regulation of commerce between Indian nations in violation of federal Indian protections. The State cross‐appealed from the district court's dismissal on summary judgment of its claims under two federal statutes, the PACT and the Contraband Cigarette Trafficking Act (CCTA).
The State argued that the taxpayer’s cigarette shipments were “interstate commerce” as defined by the PACT Act, and that the taxpayer did not enjoy the CCTA's exemption for “an Indian in Indian country.”

The New York State Department of Taxation and Finance (Department) uses a “stamping” system to pre-collect certain state and local cigarette taxes. State law requires that all cigarettes “possessed” for sale in the state bear a stamp evidencing payment of the applicable taxes, and that all cigarettes delivered into the state be sent initially to state‐licensed stamping agents, who purchase tax stamps, affix them to cigarette packages, and pass on the taxes to consumers by incorporating the stamps' value into cigarette resale prices. The taxpayer is a manufacturer and seller of cigarettes, organized under the laws of the Yakama Nation, with its principal place of business on the Yakama reservation, situated within the boundaries of Washington State. In 2012 and 2013, state investigators purchased unstamped cartons of the taxpayer’s cigarettes from smoke shops on the Poospatuck Indian Reservation in Mastic, New York and in 2013 from a smoke shop on the Cayuga Nation reservation in Union Springs, New York. In December 2012, state troopers seized 140 cases of unstamped cigarettes from the taxpayer from a truck in Clinton County, New York, which was enroute to the Ganienkeh Nation in Altona, New York. The State alleged that the taxpayer unlawfully delivered millions of unstamped cigarettes into New York since 2010 and asserted claims under various provisions of state law.

The taxpayer argued that the State violated the dormant Commerce Clause by enforcing its tax laws only against non‐New York Indian cigarette manufacturers, thus unconstitutionally discriminating against out‐of‐state Indian cigarette manufacturers. The court noted that the taxpayer did not contend that New York's tax statutes are discriminatory on their face and said there was no decision of the Court standing for the proposition that discriminatory enforcement of a nondiscriminatory state law violates the dormant Commerce Clause. The court said that the lack of universal enforcement did not bespeak discrimination. The taxpayer cited decisions in two other circuits, but the court concluded that they did not support the taxpayer’s arguments and determined that the taxpayer failed to establish a violation of the dormant Commerce Clause.

The court also dismissed the taxpayer’s argument that the State's claim was barred by res judicata by virtue of prior state administrative proceedings, resulting from an assessment that was issued against the taxpayer for unstamped cigarettes. The district court ruled that a state investigator's purchase of unstamped King Mountain cigarettes in November 2012 arose out of a different underlying factual transaction than the December 3rd Inspection, namely, the purchase of unstamped cigarettes at a smoke shop on the Poospatuck Reservation in Suffolk County rather than the search and seizure of a truck of unstamped cigarettes in Clinton County. The lower court ruled that because a common carrier was used to transport the cigarettes to Indian reservations and Indian‐owned businesses in New York, the taxpayer did not “possess” unstamped cigarettes in the State of New York and therefore did not violate the statute, but did find that the taxpayer violated the statute by admittedly failing to sell its cigarettes directly to a licensed stamping agent. The taxpayer argued that the statutory requirement to sell cigarettes to licensed stamping agents applies only to “wholesalers,” not manufacturers such as the taxpayer. which is a “wholesale dealer.” The court said that even if it accepted, arguendo, that a distinction between a “wholesaler” and a “wholesale dealer” was decisive under the applicable statutes, the taxpayer’s admissions establish that it violated the implementing regulations of the statute. The court noted that the taxpayer had conceded that it is a wholesale dealer under the statute, that it is not a licensed stamping agent, and that it sold unstamped cigarettes directly to Indian tribes and companies owned by tribe members, actions clearly in violation of the implementing regulations which require that all cigarettes sold by agents and wholesale dealers to Indian nations or tribes or reservation cigarette sellers located on Indian reservations must bear a tax stamp.

The taxpayer argued on appeal that the relevant New York statutes violate the Indian Commerce Clause and the Yakama Treaty of 1859, and are thus preempted by federal law.
The Indian Commerce Clause grants the United States Congress the power to regulate commerce with the Indian tribes and the taxpayer contended that this power belongs exclusively to Congress, and that the district court's ruling impermissibly allows New York to burden Indian‐nation‐to‐Indian‐nation trade. Prior decisions in this area have held that the legal incidence of New York's tax falls on non‐Indian consumers, and, therefore, whatever its economic impact, the tax is not categorically barred by the Indian Commerce Clause. Prior decisions have also concluded that New York's stamping regime does not place an undue burden on tribal retailers. The court acknowledged that the Yakama Nation Treaty of 1855 preserves the Yakama people's right to travel all public highways but found that right is not at issue in this case because the taxpayer did not transport cigarettes within New York, but instead utilized a common carrier.

The lower court determined that all the relevant King Mountain cigarette sales were made from King Mountain's location on the Yakama reservation to Indian reservations within the boundaries of New York. The State argued that the district court erred by ruling that the PACT Act's definition of “interstate commerce” excludes sales that begin and end on Indian reservations located within the borders of different states and the court agreed. The court concluded that the district court's view that the terms “Indian country” and “State” in the PACT Act are mutually exclusive was inconsistent with the statute's definition of “State” as “each of the several States of the United States, the District of Columbia, the Commonwealth of Puerto Rico, or any territory or possession of the United States,” and noted that as a general rule, this definition includes Indian reservations within the States. The court agreed with the State that Congress's decision to separately define “Indian country” and “State” in the PACT Act evidences Congressional intent to expand the traditional understanding of “interstate commerce” rather than narrow it. New York v. King Mountain Tobacco Co. et al., U.S. Court of Appeals for the Second Circuit, No. 17-3198(L); No. 17-3222(XAP). 11/7/19

DOR Can’t File Involuntary Bankruptcy for Taxpayer with Disputed Debt

The United States Court of Appeals for the Ninth Circuit held that the Montana Department of Revenue (DOR) could not use the portion of an assessment that the taxpayer did not dispute to qualify as a petitioning creditor and file involuntary bankruptcy proceedings against the taxpayer. The court affirmed the lower courts’ decisions that the DOR lacked standing to commence the proceedings.

The taxpayer is the co-founder of the private ski resort Yellowstone Mountain Club. DOR commenced an audit of the taxpayer for tax years 2002 through 2006 and in 2009 issued a notice of deficiency assessing tax, interest and penalties, including tax assessed on a disallowed deduction the taxpayer claimed for the environmental penalty payment made by a pass-through entity in the 2004 tax year in the amount of approximately $200,000. The taxpayer worked with DOR in an informal review process during which he conceded the environmental penalty payment, but disputed the remaining audit issues, and provided additional information and materials to DOR. In light of the additional information provided, DOR adjusted its original audit assessment. The taxpayer filed an appeal to the State Tax Appeals Board (Board), disputing all audit issues with the exception of the environmental penalty payment. While the taxpayer’s appeal was pending before the Board DOR, along with two other entities, initiated involuntary bankruptcy proceedings against the taxpayer, each asserting claims for unpaid taxes and penalties and interest. DOR’s claim consisted of the taxes, penalties, and interest purportedly flowing from the audit issue of the environmental penalty payment. The other entities subsequently entered into settlement agreements with the taxpayer and withdrew as petitioning creditors. The taxpayer moved to dismiss the bankruptcy proceedings on the ground that the petitioning creditors' claims were the subject of bona fide disputes.

Following a hearing, the bankruptcy court entered an order granting the taxpayer’s motion to dismiss. The bankruptcy court acknowledged that no party contested that the petitioning creditors collectively held unsecured claims exceeding the statutory minimum amount to initiate an involuntary bankruptcy or that their claims were non-contingent. Thus, the only issues before the court were whether the taxpayer had more than eleven creditors on the petition date, necessitating three qualified petitioning creditors and whether the petitioning creditors' claims were subject to bona fide disputes as to liability or amount. The bankruptcy court evaluated the petitioning creditors' standing. The court looked to DOR, Idaho, California, and Yellowstone's claims and determined that Idaho and California's claims were subject to bona fide disputes as to liability or amount. Thus, at least two of the four petitioning creditors lacked standing. The court then looked at DOR's claim and noted that DOR contended that it had over $50 million in claims against the taxpayer, and at the time most of those claims were disputed. The court said that DOR had not shown that it was authorized to create a separate liability for the environmental penalty or if authorized that it took the proper steps to create that separate liability. The taxpayer’s remaining liability for the 2004 tax year was disputed, and thus, DOR's claim was the subject of a bona fide dispute. The bankruptcy court granted summary judgment in favor of the taxpayer. DOR filed an appeal to the district court, and the district court affirmed the bankruptcy court's grant of summary judgment. DOR filed this appeal.

The federal statute provides that to commence involuntary bankruptcy proceedings against a debtor, a creditor must be a holder of a claim that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount. The court said the issue here was whether DOR's claim for the 2004 tax year was subject to a bona fide dispute as to amount notwithstanding the taxpayer’s concession that the deduction for the environmental penalty was improper. The bankruptcy statute was amended in 1984 addressing the risk of creditors using bankruptcy to force debtors into paying legitimately disputed debts as an alternative to resolving the disputed claims through other means. The amendment, however, did not define the phrase “bona fide dispute.” In 2005 the statute was amended to clarify that a creditor’s
claim must not be the subject of a bona fide dispute “as to liability or amount.” Following the 2005 amendment, courts have been evenly split on whether a dispute as to any portion of a claim means there is a bona fide dispute as to the amount of the claim. The court agreed with other circuits' adherence to the statute's plain meaning and held that a creditor whose claim is the subject of a bona fide dispute as to amount lacks standing to serve as a petitioning creditor even if a portion of the claim amount is undisputed. The court said that although a portion of DOR's claim was undisputed on the petition date, the vast majority of its claim remained disputed. As a result, DOR's claim was the subject of a bona fide dispute as to amount. Montana Dep't of Revenue v. Blixseth, U.S. Court of Appeals for the Ninth Circuit, No.18-15064. 11/26/19


DECISION HIGHLIGHTS

Sales and Use Tax Decisions

Company not Entitled to Sale-for-Resale Exemption

The Texas Court of Appeals denied a taxpayer’s refund claim for sales tax paid on its purchases of coin-operated gaming equipment concluding that the company did not "transfer" its coin-operated gaming equipment to customers who pay to play or ride the machines at its restaurants. The court found that the taxpayer did not qualify for the state's sale-for-resale exemption.

The taxpayer owns and operates restaurants in the state which provide food, beverages and entertainment, including coin-operated machines. Between March 2007 and April 2013, the taxpayer purchased and paid sales taxes on coin-operated game equipment and component parts for use in its restaurants in the state and subsequently filed refund claims with the Comptroller. arguing that its purchases of coin-operated machines and component parts are exempt from the imposition of the sales tax under the Tax Code's “sale for resale” exemption.
The Comptroller denied the refund claims and the taxpayer filed an appeal in the county district court. The court found for the Comptroller and the taxpayer filed this appeal.

The court said there was no dispute that the coin-operated machines were tangible personal property typically subject to sales tax unless otherwise specifically exempt in the statute.
The statute provides that the sale for resale of a taxable items is exempt from the tax. “Sale for resale” includes, in pertinent part, the acquisition of property for the purpose of reselling it in the normal course of business or for the purpose of transferring it as an integral part of a taxable service. The taxpayer argued that reading the provisions regarding “sale for resale” and “sale or purchase” together it was entitled to the sale-for-resale exemption because it “transfers” the coin-operated machines to its customers as an integral part of its amusement service. Citing case law, the court said that in the context of the statute’s sale-for-resale exemption, it has determined “transfer” means to make over or negotiate the possession or control of property for a consideration. The court found that, based on the record before it, the taxpayer’s patrons had neither “control” nor “possession” over the coin-operated gaming equipment. The court said that while the taxpayer argued that the customers' use of the coin-operated machines to ride or play a game constituted control, it was the taxpayer that determined the predominant features of the machines and their use, including the volume, length of play time and skill level. The customers must use the games and their settings as they are presented by the taxpayer and are not allowed to change any of the equipment's settings, even when they have paid to play or ride. It is also the taxpayer that determines where the equipment is placed, and customers are not allowed to move the equipment, even when they have paid to play or ride. Customers do not have access to the equipment outside of the taxpayer’s operating hours. The taxpayer’s employees are responsible for maintaining, cleaning, and repairing the coin-operated machines and their component parts and the employees also supervise customers' use of the coin-operated machines and, if necessary, correct inappropriate behavior.

The court rejected the taxpayer’s economic reality argument, finding that the taxpayer misconstrued the doctrine, which simply provides that in the area of tax law a plain-meaning determination should not disregard the economic reality underlying the transactions in issue.
The court found that the reality underlying the transactions at issue in this matter was that the taxpayer did not “transfer” its coin-operated gaming equipment to customers who pay to play or ride those machines, but simply allows them access to the games or rides provided by that equipment on the taxpayer’s terms. CEC Entm't Inc. v. Hegar, Texas Court of Appeals, No. 03-18-00375-CV. 12/5/19


Court Affirms Taxation of Out-of-State Chemical Purchases

The Illinois Supreme Court upheld an appellate court judgment that affirmed the imposition of use tax on a company's out-of-state purchases of metallurgical coke. The court found that the taxpayer's purchases were not eligible for the use tax chemical exemption. The court, however, the penalties associated with the assessment.

The taxpayer is a Delaware corporation with its primary place of business in Pittsburgh, Pennsylvania and has a manufacturing facility located in Illinois, where it operates a zinc refining facility. The Department of Revenue (DOR) issued the taxpayer notices of tax liability related to its out-of-state purchases of metallurgical coke, a solid material consisting almost entirely of carbon, for which it had not paid any state use tax. The taxpayer filed a petition for hearing with the state’s Independent Tax Tribunal (Tribunal), arguing that it was. exempt from paying use tax on the coke under a statutory exemption for machinery and equipment used primarily in the manufacturing of tangible personal property. The taxpayer relied upon the “chemical exemption” found in the definition of “equipment” that includes certain chemicals that are exempt from paying use tax. That definition provides that equipment includes chemicals but only if the chemicals effect a direct and immediate change in the product being manufactured or assembled.

The facts show that at its state facility the taxpayer is primarily in the business of recovering zinc from electric arc furnace dust (EAF dust) generated by steel mill producers. Under a process referred to as the “Waelzing process,” based on the Waelz kiln in which it takes place, rotary kilns are used to reduce and recover the zinc as crude oxide. As part of this overall manufacturing process, the taxpayer purchases metallurgical coke outside of the state. Prior to the start of the Waelzing process, the EAF dust is converted into pellet form and the coke can either be mixed into the EAF dust pellets or can be added separately. The furnace dust and coke mixture is fed into the rotary kiln and the process requires the heating of the coke in order to release the carbon in the coke. At the hearing before the Tribunal, the taxpayer called three witnesses to explain the Waelzing process and these witnesses established that the overall Waelzing process takes approximately two-and-a-half hours with virtually all of the coke consumed in the process. All three witnesses testified that carbon monoxide, not carbon from the coke, is the agent that reduces EAF dust to zinc oxide and iron oxide. The tribunal issued a decision affirming the two notices of tax liability, concluding that the coke did not qualify for the claimed exemption because, in the Waelzing process, the coke does not effect a direct and immediate change upon the product being manufactured. The Tribunal found that the coke did not react with zinc or zinc oxide directly and immediately. The Tribunal also upheld the late payment and late filing penalties imposed by the DOR. The taxpayer filed an appeal with the appellate court which affirmed the Tribunal’s final order, finding that the Tribunal’s conclusion that the coke did not effect a direct and immediate change on the zinc and iron in the EAF dust was supported by the evidence presented at the hearing. The appellate court also held that the Tribunal's finding that the taxpayer was not entitled to abatement of penalties was not against the manifest weight of the evidence. The taxpayer filed this appeal.

The court said the issue here is whether the tax tribunal properly found the taxpayer was not entitled to the statutory use tax exemption because the coke did not effect a direct and immediate change on the manufactured product. Under state law, taxation is the rule, and exemption is the exception and the burden of establishing entitlement to a tax exemption rests upon the party seeking it. The taxpayer argued that it was entitled to the use tax chemical exemption because the coke it uses in the manufacturing process has the necessary “direct and immediate change” on the zinc and iron products it sells and contended that the Tribunal's interpretation and application of the provision was overly restrictive and improperly prohibited all “intervening factors or intermediate steps.” The court turned to the language of the statutory exemption for manufacturing and assembling machinery and equipment, noting that the definition of “equipment” included certain chemicals. The court reviewed the rules of statutory construction, including the fundamental rule of statutory interpretation is to ascertain and effectuate the legislature’s intent. The court said it found the terms “direct” and “immediate” in section at issue to be clear and unambiguous, so there was no need to resort to other aids of statutory construction. The court said that to be eligible for the use tax chemical exemption, the coke used by the taxpayer in the manufacturing process must effect a change on the zinc and iron in the EAF dust at once and without any intermediate steps.

The court rejected the taxpayer’s argument that the definition of “proximate cause” should be used to define “direct” in the statute, saying that the legal phrase is a tort concept that appears nowhere in the pertinent section and the court cannot simply graft the term “proximate cause” onto the statute. The tax tribunal concluded that the coke did not qualify for the exemption because it did not directly and immediately cause a change to the zinc or iron being sold by the taxpayer and the court noted that the taxpayer’s own witness acknowledged that simply placing coke next to the solid oxide would not create any chemical reaction. The court found that at no time in the described chemical processes and reactions does the coke have a direct and immediate effect on the zinc or iron being manufactured. The court found that based upon the plain language of the statute, the legislature chose to limit the exemption to only those chemicals that effect a “direct and immediate change” on the final manufactured product and given that tax exemptions are to be strictly construed, any doubts concerning the applicability of such an exemption must be resolved in favor of taxation. The court held that the Tribunal did not commit clear error in determining that the taxpayer’s coke purchases did not qualify for the use tax chemical exemption.

The taxpayer also argued that the Tribunal's conclusion that it was not entitled to abatement of late payment and late filing penalties was against the manifest weight of the evidence. The court noted that the existence of reasonable cause justifying abatement of a tax penalty is a factual determination that is to be decided on a case-by-case basis. DOR’s regulation on what should be considered as reasonable cause to avoid penalties provides that all pertinent facts and circumstances should be taken into account, but an important factor was the extent to
which the taxpayer made a good faith effort to determine his proper tax liability and to file and pay his proper liability in a timely fashion. The court note that the taxpayer had shown good conduct in complying with its tax obligations and it acted in good faith when it failed to pay the use tax on the coke. The court also noted that the Tribunal acknowledged that the term “direct and immediate change” in the use tax chemical exemption has no specific statutory definition and there was no case law in existence at the time of the audit that the taxpayer could have used for guidance. The court recognized the unique factual circumstances surrounding the manufacturing process at issue in this case and found the Tribunal's decision to uphold DOR’s imposition of late payment and filing penalties was against the manifest weight of the evidence. Horsehead Corp. v. Dep't of Revenue, Illinois Supreme Court Docket No. 124155. 11/21/19


Personal Income Tax Decisions

Fund Manager Can Claim Credit for Taxes Paid to New York

The Connecticut Supreme Court ruled that the revenue commissioner had not challenged one of the two grounds that the trial court concluded entitled a Connecticut resident who managed a New York hedge fund to claim a credit for income taxes paid to New York on income from the hedge fund. The court found that the failure to do so required the appeal to be dismissed.

The taxpayer resided in Connecticut but worked in New York and was a member of a limited liability company (LLC) which served as the general manager for two limited partnerships. The taxpayer sought income tax credits on his Connecticut return for nonresident income taxes paid to New York on the distributive share of profits he received for managing the two limited partnership which operated as hedge funds and primarily traded their own stock index options. They paid the LLC a share of their profits for the LLC’s services and the LLC allocated to the plaintiff his distributive share of those profits. In 1997 and 1998, the taxpayer reported the income he received from the LLC as capital gains on his New York state income tax returns, paid taxes on that income to New York, and sought a credit against his Connecticut resident income taxes for the taxes he paid to New York, pursuant to a statutory provision that allows a resident of this state to receive a credit against nonresident income tax paid to another state when the nonresident income being taxed would otherwise be subject to taxation in Connecticut. The Commissioner of Revenue Services (Commissioner) disallowed the credit reasoning that the taxpayer’s income must be treated as if it derived from trading intangible property for his own account because the limited partnerships were trading their own intangible property and the character of the partnerships’ income passed through to the income of their general partner. The Commissioner noted that Connecticut does not tax nonresidents on income from the trading of intangible property for the nonresident’s own account. The taxpayer filed an appeal and the trial court held for the taxpayer, concluding that the taxpayer was not trading intangible property for his own account but was engaging in the trade or business of trading intangible property owned by others, and even if the taxpayer was trading intangible property for his own account, he nonetheless must be deemed to have been engaged in a trade or business, on the basis of the frequency and volume of his trading activity. The trial court concluded, on the basis of either of those two grounds, that the taxpayer would be taxed in Connecticut on such income and, therefore, that he was entitled to the credits that he sought for the nonresident income taxes he paid to New York. The Commissioner appealed, claiming that the trial court incorrectly concluded that the taxpayer was not trading intangible property for his own account.

The court concluded that the Commissioner’s appeal was moot because he challenged only one of the trial court’s two independent bases for its determination that the taxpayer was entitled to the income tax credits he sought and dismissed the appeal. The Commissioner conceded that he challenged the trial court’s judgment only on the issue of whether the taxpayer was trading intangible property for his own account. The court rejected the Commissioner’s argument that the trial court determination that under prior case law the taxpayer was deemed to have been engaged in a trade or business on the basis of the frequency and volume of his trading activity did not constitute an alternative independent basis for its decision. Sobel v. Comm'r of Revenue Servs., Connecticut Supreme Court, SC 20215. 11/15/19


Corporate Income and Business Tax Decisions

DOR Failed to Properly Notify LLC of Assessments

The Indiana Tax Court held that a limited liability company was entitled to a refund of its filing fee and the entire amount levied by the Department of Revenue (DOR) for withholding tax, a collection fee, and a bank fee. The court found that DOR failed to properly notify the taxpayer of its assessments in accordance with state code.

The undisputed facts show that the taxpayer, during the period at issue, was located at 155 East Market Street, Suite 860, Indianapolis, Indiana 46204 (Suite 860 address). The company had no employees and had not paid wages to any individual since the third quarter of 2009 and, as a result, stopped result, stopped filing withholding tax returns in 2009. The taxpayer did not, however, close its withholding registration account with the DOR until several years later. On March 23, 2015, DOR issued a Proposed Assessment to the taxpayer for over $2,000 of withholding tax, interest, and penalties for the period at issue and sent the Proposed Assessment to the address of the taxpayer’s former attorney-in-fact, Summit PM, LLC (Summit), at 241 North Pennsylvania Street, Indianapolis, Indiana 46204-2405. Summit forwarded the Proposed Assessment to the taxpayer. On April 29, 2015, the taxpayer’s owner filed an Indiana Business Tax Closure Request form with DOR, requesting that it close the company's withholding registration account because it had no employees. The DOR did not process the closure form because it lacked supporting documentation and was not notarized.
On June 15, 2015, DOR converted the Proposed Assessment into a Demand Notice that provided the taxpayer had ten days to pay over $2,500 of withholding tax, interest, and penalties and sent the Demand Notice to the taxpayer at the Pennsylvania Street address.
After the taxpayer failed to pay the liability, DOR on July 13, 2015 converted the Demand Notice into a Tax Warrant for the full amount of the tax, interest, penalties, and collection fees and sent the Tax Warrant to the taxpayer at the Pennsylvania Street address and filed it with the clerk of the county circuit court. Two days later, DOR’s collection agent filed a duplicate tax warrant with the county clerk for over $3,000 of withholding tax, interest, penalties, collection fees, clerk's costs, and damages. Nearly a year later, DOR’s collection agent levied $1,711.30 from the taxpayer’s bank account. As a result, the bank charged the taxpayer a $100.00 fee. On October 13, 2017, the taxpayer sent a letter to the DOR requesting a refund of any assets and/or money that has been seized because its closure form showed that it was no longer required to be registered for withholding tax as of December 31, 2009. The taxpayer followed up that letter with filing another closure form that was notarized and DOR closed the taxpayer’s withholding account. The taxpayer subsequently filed a refund claim for the amount levied plus the bank fee and the claim provided that its mailing address was 155 East Market Street, Suite 750, Indianapolis, Indiana 46204 (Suite 750 address), not the Suite 860 address. On January 30, 2018, the DOR sent a letter to the taxpayer at the Suite 750 address, requesting that it submit additional information so that the DOR could complete the processing of its refund claim. On February 20, 2018, after the taxpayer failed to submit the requested information, the DOR denied its refund claim. On March 22, 2018, the taxpayer filed a protest, claiming that its refund claim was “wrongfully denied” because it never received the DOR’s January 30 letter and the DOR did not have the authority to collect the withholding tax in the first place. DOR held a hearing and issued a Letter of Findings that sustained the taxpayer’s protest in part and denied it in part. The final determination explained that although the taxpayer established it was entitled to a refund of the amount attributable to the withholding tax assessment, it failed to show it should recoup the collection and bank fees because nothing indicated that the DOR failed to follow proper procedures. The taxpayer filed this appeal, arguing that DOR failed to provide it with adequate notice of its purported withholding tax liability as required by statute. The taxpayer also sought damages in addition to attorney's fees pursuant to the state statute.

The parties agreed that the crux of the issue before the court was whether DOR’s Withholding Notifications were valid because they were issued in conformance with the notice requirements under the state statute. If DOR’s Withholding Notifications are valid, then its final determination is correct, and the DOR is entitled to judgment as a matter of law. If, however, the DOR’s Withholding Notifications are invalid, then the taxpayer is entitled to a full refund because all of the fees arising from the DOR taking the Demand Notice to the Tax Warrant stage are likewise invalid.

During the period at issue, the state statute provided that DOR shall send a person notice of the proposed assessment through the U.S. mail and the person has ten days from the date DOR mails the notice to either pay or show reasonable cause for not paying. The statute further provided that when DOR issues a tax warrant, it may not file the warrant with the circuit court clerk of any county in which the person owned property until at least twenty days after the demand notice was mailed to the taxpayer. The court found the language here to be clear. While DOR was required to provide the taxpayer with notice of the Withholding Notifications through the U.S. mail, it did not need to provide it with actual notice to satisfy the statutory notice requirements. The court noted that the statute id not, however, prescribe where DOR was to mail the notices or whether a taxpayer has a duty to inform DOR of its current mailing address. The court said the question here was whether DOR’s mailing of the taxpayer’s Withholding Notifications to the Pennsylvania Street address, under these specific facts, comported with basic principles of fairness and justice, i.e., was the mailing reasonably calculated to apprise the taxpayer of the Withholding Notifications.

DOR maintained that it complied with all applicable statutory notice requirements because the facts show that it provided the taxpayer with notice and multiple opportunities to avoid the bank levy by sending the Withholding Notifications to the best address in its files, i.e., the Pennsylvania Street address. DOR argued that because taxpayers may authorize any number of individuals to receive their tax information, it should be able to rely on the contact information in its possession as well as any updated address information provided to DOR by taxpayers themselves. DOR claimed that the de facto attorney’s Pennsylvania Street address was the taxpayer’s most recent filing in its possession and it never provided DOR with an updated address after it terminated its relationship with the attorney.

The court noted, however, that the designated evidence did not show that DOR relied on “the most recent filing its possession” for purposes of complying with the statutory notice requirements in the code and also pointed out that the power of attorney was for the period of 2006 through 2009 only. The court found that even though the de facto attorney continued to serve as the taxpayer’s property manager until 2013, the designated evidence does not establish that the property manager was authorized to represent the taxpayer in tax matters beyond the 2006 through 2009 tax years. The court also said that DOR had not identified any legal authority that allowed it to satisfy the statutory notice requirements by sending the Withholding Notifications to an entity that was not authorized to receive them.

The court rejected DOR’s argument that these facts should be overlooked because the taxpayer failed to notify DOR it had no employees when it stopped filing the required returns in 2009 and it filed a defective closure form after it had notice of the withholding liability.
The court pointed out that the evidence indisputably showed that the power of attorney form contained the taxpayer’s correct mailing address and limited the de facto attorney’s representation to the 2006 through 2009 tax years. As a result, the court found for purposes of the notice provisions the taxpayer did not need to update its mailing address with DOR or advise DOR that it had no employees in 2009 or that Summit's tenure as its property manager concluded in 2013. The court also determined that even if actual notice were required, the evidence did not reasonably indicate that the taxpayer received actual notice of the Demand Notice or the Tax Warrant. When the taxpayer’s owner received the Proposed Assessment from the de facto attorney, he promptly filed the first closure notice with DOR, which contained its appropriate mailing address, in an attempt to halt the entire assessment process.
The court concluded that the only reasonable inference to be drawn from the facts is that the taxpayer did not receive actual notice of the rejected Form BC-100, the Demand Notice, or the Tax Warrant because if it had, it would have attempted to follow-up with DOR in some manner, just as it did when it received the Proposed Assessment. The court also found that DOR had not designated any evidence or provided persuasive argument to explain why it was overly burdensome to send the Withholding Notifications to the taxpayer’s address on the power of attorney form, a form that DOR both maintains in its records and requires taxpayers to file before disclosing their confidential tax information to other entities. The court rejected the taxpayer’s demand for attorney’s fees finding that it failed to raise the issue in a timely manner. Crown Prop. Grp. LLC v. Dep't of Revenue, Indiana Tax Court, Cause No. 18T-TA-00027. 11/13/19


Property Tax Decisions

Reduction in Value of Ethanol Plant Upheld

The Nebraska Supreme Court affirmed the reduction in value of an ethanol plant by the Tax Equalization and Review Commission (Commission). The court found that the Commission's decision was supported by competent evidence and was not arbitrary, capricious, or unreasonable.

The taxpayer owned an ethanol plant on commercial real estate in the state. The county assessor assessed the value of the property for the 2017 tax year and the taxpayer filed a protest to the county Board of Equalization (BOE). At the hearing on the matter, the taxpayer did not present evidence, and the BOE affirmed the assessment. The taxpayer appealed to the Tax Equalization and Review Commission (TERC). The county used the mass appraisal method for its appraisal of the subject property. The appraiser had appraised five other ethanol plants in different counties using the mass appraisal approach. The appraiser prepared a spreadsheet of the values of all ethanol plants in Nebraska, obtaining the values directly from the other counties' assessors. She was unaware how those counties assessed their ethanol plants but maintained that the $16 million value was the proper value for the property. The evidence showed that the value shown on the spreadsheet for the Furnas County ethanol plant had incorrect nameplate capacity, a critical element in determining the value of the plant. Its nameplate capacity was actually 44 million gallons, not 22 million gallons as shown on the spreadsheet.

The taxpayer’s appraiser, a real property appraiser for 35 years, utilized the cost approach method to appraise the property. He stated that the income approach would not be useful, and the sales comparison approach would not be effective as a stand-alone method of appraisal for the property, because most sales of ethanol plants were older and not from the area. He described his application of the cost approach method and discussed the depreciation of the buildings and improvements. TERC found that because the taxpayer’s appraiser performed the appraisal according to professionally approved standards, his appraisal report was competent evidence sufficient to rebut the presumption in favor of the BOE’s determination. TERC then found that it was unreasonable and arbitrary for the BOE to rely upon the county’s valuation. TERC agreed that physical depreciation should be applied to the property and pointed to the incorrect information the county appraiser’s spreadsheet contained and the absence of a revised opinion based upon the correct information. The BOE filed this appeal.

The court began by noting that the presumption of validity did not apply at this stage. A presumption exists that a board of equalization has faithfully performed its official duties in making an assessment and has acted upon sufficient competent evidence to justify its action and that presumption remains until there is competent evidence to the contrary presented.
Neither party disputed that the taxpayer presented competent evidence through its appraisal and thereby overcame the presumption of validity of the BOE’s valuation. The court said that once the challenging party overcomes the presumption of validity by competent evidence, the reasonableness of the valuation fixed by the BOE becomes one of fact based upon all of the evidence presented. The court found that the evidence showed that the BOE’s valuation was unreliable, because it failed to take into account any depreciation, which in turn resulted in an excessively high valuation. Because the evidence showed that a plant in another county was comparable and that the BOE’s valuation was unreliable, there was competent evidence to show that the BOE’s valuation was grossly excessive. Accordingly, the court concluded, TERC's determination that it was arbitrary and unreasonable to rely on the BOE’s determination of value was supported by competent evidence and was not arbitrary, capricious, or unreasonable. Because the taxpayer established that the BOE’s valuation was unreasonable and arbitrary, the court said that TERC did not err in relying upon the taxpayer’s appraisal. The appraiser observed the state of the ethanol industry, the decrease in the price per gallon of ethanol, and the reduction of the rate of ethanol plant construction. He emphasized that the state had 39 ethanol plants in 2010 and 26 ethanol plants in 2017 and opined that economic depreciation of 40 percent was appropriate. The court said it could not say that TERC's reliance on the appraiser opinion was arbitrary, capricious, or unreasonable.
Wheatland Indus. LLC v. Perkins Cnty. Bd. of Equalization, Nebraska Supreme Court, 304 Neb. 638; No. S-19-305. 12/6/19

Poultry Houses Ineligible for Exemption

The Delaware Superior Court determined that poultry houses were not eligible for a property tax exemption for nutrient management facilities. The court found that the county Board of Assessment (Board) did not make an error in its decision because the statute in question does not apply to poultry houses.

The taxpayers own a farm in the state with a poultry operation which was assessed by the county assessment office. The taxpayers filed a challenge to the assessment claiming that the poultry houses on the farm should be exempt under state law. The Board denied the challenge and the taxpayers filed this appeal, arguing that the poultry houses fall within the tax exemption in the statute because they represent nutrient management facilities. The Board argued that the poultry houses were not covered by the statute because the statute does not explicitly exempt them, and the statute should be read narrowly. The court said the standard of review here was whether the Board’s conclusions were supported by substantial evidence and free from legal error. In addition, the court said it could not consider new evidence that had not been presented to the Board. The taxpayers submitted a letter from the Administrator of the Delaware Nutrient Management Program, which the court said could not be considered here because it appeared that the letter was obtained after the Board had its hearing.

The court said the question here is whether poultry houses fall within the category of the structures described in the statute. If a statute is unambiguous, the words in it are interpreted using their plain meaning. If it is ambiguous, then it is considered as a whole, rather than in parts, and each section should be read in light of all others. The court said that in this case, some ambiguity exists as to what exactly is included in “other nutrient storage, disposal or management structures or facilities pursuant to the nutrient management plan” and the statute should, therefore, be considered as a whole to determine the legislative intent. The state statute begins with the assertion that all real property in the state shall be liable to taxation except as otherwise provided. The court said this language suggested that there must be a specific exception mentioned in the statute for a particular type of real property to be exempt from taxation. The pertinent provision provides examples of specific types of real property exempt under the statute, compost bins and manure sheds. These types of structures are used for the primary purpose of collecting and distributing waste. The court said this section also refers to facilities pursuant to a nutrient management plan, which is defined as “a plan by a certified nutrient consultant to manage the amount, placement, timing and application of nutrients in order to reduce nutrient loss or runoff and to maintain the productivity of soil when growing agricultural commodities and turfgrass.” The court said that it did not appear that poultry houses represent facilities situated on the land for the purpose of facilitating the activities described in the statute. The court concluded that even though it is true that poultry houses produce nutrients, the purpose of these structures is to raise and house poultry not to generate nutrients, and the structures are not involved in the application of nutrients. The court found that reading the statute in its entirety and analyzing the provision together lead to the conclusion that the Board did not make a legal error in interpreting the law involved in this case. Spence v. Kent Cnty. Bd. of Assessment, Delaware Superior Court, No. K19A-03-001 WLW. 11/27/19


Other Taxes and Procedural Issues

No cases to report.

 

 


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