United States: Washington Supreme Court Upholds Retroactive Application Of Amendment To B&O Tax Exemption

The Washington Supreme Court held that the retroactive application of the legislature's amendment to a Business & Occupation (B&O) tax exemption revising the definition of "direct seller's representative" to conform to the Washington Department of Revenue's interpretation of the exemption did not violate a taxpayer's rights under due process, collateral estoppel, or separation of powers principles.1 The intervening, retroactive application of the amendment to the law made the company ineligible for the tax exemption. While the taxpayer argued that it should continue to be eligible for the exemption based on successful prior litigation on the issue, the Court rejected this argument pointing out that the prior decision was not applicable because it involved a different tax period than the case at hand.


Washington imposes the B&O tax on businesses for "the act or privilege of engaging in business activities" in the state.2 The law must specifically provide for any exemptions. Under former law, certain out-of-state sellers were exempt from the B&O tax if they made "sales in this state exclusively to or through a direct seller's representative" (also known as the direct seller's exemption).3

The taxpayer, an Illinois-based food reseller, sold products to service companies in Washington through a wholly owned subsidiary. In 1999, the Department changed its interpretation of the statute by amending Wash. Admin. Code Sec. 458-20-246, while the wording of the statute did not change.

The taxpayer successfully challenged the Department's narrowed interpretation of the exemption in prior litigation. In Dot Foods Inc. v. Department of Revenue,4 the Washington Supreme Court held that the Department's interpretation of Wash. Rev. Code Sec. 82.04.423 was "contrary to the statute's plain and unambiguous language" and held that the taxpayer remained "qualified for the B&O tax exemption to the extent its sales continue to qualify for the exemption." The Court's decision in Dot Foods I applied to the taxpayer's tax periods from January 2000 to April 2006.

Based on the judgment in Dot Foods I, in December 2009, the taxpayer sought a refund for B&O taxes paid from January 2005 to August 2009 – a time period that extended beyond the tax periods covered by Dot Foods I. Meanwhile, in response to Dot Foods I, the Washington legislature, in April 2010, retroactively narrowed the scope of Wash. Rev. Code Sec. 82.04.423(2) and prospectively repealed the direct seller's exemption.

Based on the retroactive application of the Washington legislature's amendment, in July 2010, the Department denied the refund request for those periods that fell outside the tax periods covered in Dot Foods I (May 2006 to August 2009) but indicated that the retroactive application of the amendment would not impact the periods covered by Dot Foods I.

The taxpayer and the Department ultimately negotiated a settlement for the refund periods covered by Dot Foods I, in which the taxpayer received over 97 percent of the B&O taxes paid during the January 2000 to April 2006 tax periods. The taxpayer then sought a refund of B&O taxes paid from May 2006 to December 2007.5 The Department denied the request and the taxpayer filed a refund action challenging the retroactive application of the amendment under the theories of collateral estoppel, separation of powers, and due process.

At the trial court, Dot Foods won on its due process claim and the Department won on the collateral estoppel and separation of powers claims. Both parties appealed and the Court of Appeals certified the case to the Washington Supreme Court.

Due Process Challenge

Under United States v. Carlton,6 the due process standard for retroactive tax legislation is the same as that generally applicable to retroactive economic legislation and requires that "the statute must be 'supported by a legitimate legislative purpose furthered by rational means.'" Retroactive legislation must also show that its application "is itself justified by a rational legislative purpose."

The Washington Supreme Court explained that its recent decision in In re Estate of Hambleton7 served as controlling precedent. The Court said that, although Hambleton involved a different tax scheme, the case contained an analogous fact pattern. Using the Carlton rational basis standard, as applied in Hambleton, the Court found that the retroactive application of the 2010 amendment to the taxpayer did not violate due process protections.

Serves Legitimate Legislative Purpose

Carlton requires that, as with other economic legislation, the 2010 amendment serve a legitimate legislative purpose. The legislature had argued that the prevention of "large and devastating revenue losses" was the primary purpose for narrowing Wash. Rev. Code Sec. 82.04.423. The Washington Supreme Court pointed out that this same legislative intent was found by the U.S. Supreme Court to be a legitimate purpose in Carlton and furthermore, was upheld by the Washington Supreme Court itself in Hambleton.

The legislature also concluded that former Wash. Rev. Code Sec. 82.04.423 "provided 'preferential tax treatment for out-of-state businesses over their in-state competitors and now creates a strong incentive for in-state businesses to move their operations outside Washington.'" The Washington Supreme Court explained that this goal was analogous to the goal of restoring parity between different classes of taxpayers which was found to serve a legitimate legislative purpose in Hambleton. Based on the above, the Court determined that the 2010 amendment served a legitimate legislative purpose.

Rationally Related to Legitimate Legislative Purpose

Carlton also requires that a retroactivity period be rationally related to the amendment's legitimate purpose. Citing to Tesoro Refining & Marketing Co. v. Department of Revenue,8 the taxpayer argued that the "27-year retroactivity period is 'irrational on its face.'" The Washington Supreme Court disagreed, explaining that Tesoro was not controlling authority. The Court also rejected the taxpayer's argument that a 27-year retroactivity period was per se unconstitutional. The Court pointed to its decision in W.R. Grace & Co. v. Department of Revenue9 which upheld a 37-year retroactivity period. The Court explained that "the length of time that has elapsed since a statute's original enactment is not dispositive." The Court also noted that, while the 2010 amendment does date back to the enactment of the statute, the issue in this case is whether the 2010 amendment applies retroactively to the taxpayer's May 2006 to December 2007 tax periods. The Court explained that this retroactivity period only spanned four years.

The Court went on to explain that the taxpayer incorrectly alleged that the 2010 amendment actually reached back 27 years. The statute of limitations10 "limits retroactive application of the amendment to four years." The Court explained that this four-year period "is well within the range of retroactivity periods that we have previously upheld."11

The Court explained that, while there are constitutional limits on retroactivity, "there is no 'absolute temporal limitation on retroactivity.'" Carlton only requires that the retroactive period must be "'rationally related' to a legitimate legislative purpose."

The Court said that the function of a retroactivity period, and not its length, controls for due process analysis. Applying this standard, the Court found that there was no due process violation because the actual retroactive effect of the amendment, as applied to the taxpayer, was rationally related to the legislature's legitimate purpose of preventing revenue loss from the expanded interpretation of the exemption.

Collateral Estoppel and Separation of Powers Claims

The taxpayer also claimed that, under the collateral estoppel doctrine, the May 2006 to December 2007 tax periods were encompassed by the Dot Foods I judgment, preventing the Department from assessing B&O taxes against it under the 2010 amendment. The Court rejected this argument explaining that collateral estoppel does not apply to subsequent taxing periods that were not previously adjudicated. Dot Foods I covered only the period January 2000 through April 2006, and not the May 2006 through December 2007 tax periods.12

The Court also rejected the taxpayer's separation of powers claim. The Court explained that a separation of powers issue arises when the legislature "infringes on a judicial function." However, the Court pointed out that retroactive legislative amendments that reject a judicial interpretation have been upheld if the legislature was careful not to reverse a judicial decision. The Court explained that there was no evidence that the legislature intended to "affect or curtail" the Dot Foods I decision. The Court noted that the legislature preserved prior judgments through Sec. 1706 of the legislative amendment and, because Dot Foods I did not cover the time period at issue in this case, the retroactive application of the amendment to that time period did not violate the separation of powers doctrine.


Although this decision marks the third time that Washington has narrowed tax preferences in the last several years as a result of a taxpayer-favorable court decision,13 the importance of the case lies in its reflection of the recent trend among state courts to uphold retroactive amendments to statutes when there is a potential for substantial revenue losses. At the core of the retroactive legislation controversy are two competing interests – the need for taxpayers to have certainty when relying on tax statutes and the need for states to be able to prevent large revenue losses.14 This controversy surrounding retroactive legislation may soon come to a head as Michigan gears up to hear challenges to the retroactive repeal of the Multistate Tax Compact. In Michigan, the driving force behind the retroactive repeal of the Compact was the potential $1.1 billion in refunds that otherwise would have had to be paid to taxpayers, many of which are primarily located outside Michigan. The courts' approval of retroactive legislation in Michigan is troubling because it reflects the view that court cases decided on the merits in favor of a taxpayer, even by the highest court in the state, effectively can be overruled by a legislature whenever the cost of such litigation is deemed to be too great. This same rationale was relied on by the Washington Supreme Court to uphold the retroactive application of the 2010 amendment to the taxpayer in this case.


1 Dot Foods, Inc. v. Department of Revenue, Washington Supreme Court, No. 92398-1, March 17, 2016.

2 WASH. REV. CODE § 82.04.220(1).

3 Former WASH. REV. CODE § 82.04.423(1)(d) (1983). "Direct seller's representative" was defined in former WASH. REV. CODE § 82.04.423(2).

4 215 P.3d 185 (Wash. 2009), referenced as "Dot Foods I."

5 These 20 months represented the length of time beginning immediately after the tax periods at issue in Dot Foods I and ending when Dot Foods' business practices changed in 2008.

6 512 U.S. 26 (1994).

7 335 P.3d 398 (Wash. 2014), cert. denied, 136 S. Ct. 318 (2015).

8 246 P.3d 211 (Wash. Ct. App. 2010), rev'd on other grounds, 269 P.3d 1013 (Wash. 2012).

9 973 P.2d 1011 (Wash. 1999).

10 WASH. REV. CODE § 82.32.060(1).

11 Citing to In re Estate of Hambleton, 335 P.3d 398 (Wash. 2014), cert. denied, 136 S. Ct. 318 (2015) (eight-year retroactivity period); Digital Equip. Corp. v. Department of Revenue, 916 P.2d 933 (Wash. 1996) (four-year retroactivity period); W.R. Grace & Co. v. Department of Revenue, 973 P.2d 1011 (Wash. 1999) (eight-year retroactivity period).

12 The Court also rejected the taxpayer's argument that Laws of 2010, 1st Spec. Sess., ch. 23, § 1706 extended the judgment in Dot Foods I to the taxpayer's May 2006 to December 2007 tax periods. Section 1706 provides that the substantive amendment to WASH. REV. CODE § 82.04.423 "does not affect any final judgments, not subject to appeal, entered by a court of competent jurisdiction before the effective date of this section." The Court held that because "a refund for the interim period was not reduced to a final judgment prior to the date that the 2010 amendment went into effect, §1706 is not implicated."

13 See also Homestreet Bank, Inc. v. Department of Revenue, 210 P.3d 297 (Wash. 2009); Agrilink Foods, Inc. v. Department of Revenue, 103 P.3d 1226 (Wash. 2005).

14 Council On State Taxation, Second Corrected Brief of Amicus Curiae Council On State Taxation (COST) in Support of Plaintiffs-Appellants' Application for Leave to Appeal, Feb. 12, 2016.

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