United States: Oregon Tax Court Denies Use Of Multistate Tax Compact's Three-Factor Apportionment Formula Election

On September 9, 2015, the Oregon Tax Court granted the Oregon Department of Revenue's motion for summary judgment and denied a taxpayer's election to use the equally-weighted three-factor apportionment formula provided by the Multistate Tax Compact.1 The state of Oregon was a full member of the Compact for the 2005-2007 corporate excise (income) tax years at issue, but the state enacted legislation in 1993 directing that inconsistencies between the Compact provisions and the Oregon apportionment statutes be construed in favor of the Oregon statutes. The Court determined that the 1993 legislation was enacted for the purpose of disabling the Compact election and did not violate the U.S. or Oregon Constitutions or federal statutory law. As a result, the taxpayer could not make the apportionment election under the Compact.

Background

The taxpayer, a Delaware corporation headquartered in California, was engaged in the delivery of managed health care services through health plans and government-sponsored managed care plans. During the 2005-2007 tax years at issue, the taxpayer engaged in a multistate, unitary business that included activities in Oregon. In its original return for the relevant tax years, the taxpayer apportioned income to Oregon using the state statutory method that includes a single sales factor for apportionment.2 The taxpayer subsequently filed amended returns and refund claims for the 2005-2007 tax years based on an election to use an equally-weighted three-factor apportionment formula as provided in the Oregon statute that adopted the Compact. The Department denied the refund claims for the 2005 and 2006 tax years and partially denied the refund claim for the 2007 tax year on the basis that the Compact election was not available to the taxpayer. The taxpayer appealed the refund denials and requested a conference with the Department. After the Department upheld the refund denials on the basis that the Compact election was not available, the taxpayer timely appealed to the Oregon Tax Court.

Historical Oregon Apportionment

Oregon has been a member state of the Compact since 1967.3 Historically, the evenlyweighted three-factor apportionment formula rule in Oregon was consistent with the model provisions of the Compact.4 Under Article III of the Compact, taxpayers were afforded the ability to elect an equally-weighted three-factor apportionment formula to apportion an income tax.5 In 1991, the state moved to a property, payroll and doubleweighted sales formula.6 In 1993, Oregon shifted further from Compact apportionment by adopting a statute, Or. Rev. Stat. Sec. 314.606, providing that: "In any case in which the provisions of ORS 314.605 to 314.675 [Oregon apportionment statutes] are inconsistent with the provisions of ORS 305.655 [statute adopting the Compact prior to 2013], the provisions of ORS 314.605 to 314.675 shall control."7 Oregon continued to move further from Compact apportionment and transitioned from an 80 percent sales factor to a singlesales apportionment formula that is effective for tax years beginning on or after July 1, 2005.8 In 2013, Oregon repealed the entirety of the Compact and simultaneously reenacted a substantially similar statute, exclusive of Articles III and IV of the Compact.9

1993 Legislation Disabled Compact Election

In determining that the taxpayer could not make the equally-weighted three-factor apportionment election under the Compact, the Oregon Tax Court thoroughly analyzed the statute, Or. Rev. Stat. Sec. 314.606, which provides that the Oregon apportionment statutes have priority over inconsistent provisions in the Compact. The Court first considered the legislative intent behind the enactment of Sec. 314.606 in 1993. According to the Court, the context of the statute as well as the legislative history supported a conclusion that the legislature intended the statute to disable the Compact's equallyweighted three-factor apportionment election. This issue became important in Oregon when the state shifted from an equally-weighted three-factor apportionment formula to a formula with a more heavily weighted sales factor.

Following its initial interpretation of Sec. 314.606, the Tax Court addressed five separate taxpayer arguments attacking the validity of this statute. The taxpayer claimed a violation of the Full Text Provision and the Oregon Contract Clause of the Oregon Constitution. Also, the taxpayer argued that there was a violation of a federal statute as well as violations of the Federal Contract Clause and Compact Clause of the U.S. Constitution. As discussed below, the Court rejected each of the taxpayer's arguments.

Full Text Provision of Oregon Constitution

The Tax Court determined that Sec. 314.606 did not violate the Full Text Provision of the Oregon Constitution. This section provides that "[n]o act shall ever be revised, or amended by mere reference to its title, but the act revised, or section amended shall be set forth, and published at full length."10 The Court determined that Sec. 314.606 did not purport to amend the Compact, but provided a "tie-breaker" for inconsistences between the Oregon apportionment statutes and the Compact. The statute was an independent and complete law. Rather than repealing the Compact election, the statute effectively disabled the election. The Court took an additional step in its analysis, and determined that even if the Compact election were considered to be repealed, the Oregon Full Text Provision would not be violated.

Contract Clause of Oregon Constitution

According to the Tax Court, Sec. 314.606 did not violate the Contract Clause of the Oregon Constitution. This section provides that "[n]o . . . law impairing the obligation of contracts shall ever be passed."11 The Court determined that Sec. 314.606 did not impair the obligation of contracts because the Compact was not a contract, as determined by state law. For a statutory contract to exist, traditional elements of a contract must be present, including offer, acceptance and consideration. However, the only consideration to sign the Compact was the reciprocal promises of other states to participate. When combined with the unconditional right of cancellation or withdrawal contained in the Compact,12 there essentially was no promise to participate, and hence there was no contract. The Court explained that several member states have amended or disabled the provisions of the Compact. Even if the Compact were a contract, the ability to change the terms of the Compact in each state, and the ability to withdraw mitigated against a finding that the Oregon Contract Clause was violated. Furthermore, the provisions of the Compact do not clearly and unambiguously indicate an intention to bind future state legislatures.

Federal Statute

The taxpayer did not offer to the Court a federal statute containing a procedural or substantive limitation on the actions of the Oregon legislature in adopting Sec. 314.606. Because the Compact was not approved by Congress, the Compact was not a federal statute that could be violated by the contested state statute.

Contract Clause of U.S. Constitution

The Tax Court held that Sec. 314.606 did not violate the Federal Contract Clause of the U.S. Constitution. Under this clause, "[n]o State shall . . . pass any . . . Law impairing the Obligation of Contracts[.]"13 The Tax Court's determination that the Compact was not a contract ultimately meant that a violation of the Federal Contract Clause did not occur. There was nothing in the record to support a reasonable inference that the taxpayer ever expected the actions of the Compact states and the Compact election to involve a binding agreement. The taxpayer did not change its business practices or initially file its returns making a Compact election. Again, the Court took an additional step in its analysis, determining that even if the Compact constituted a contract, the many changes made by states mitigated against a finding that the Federal Contract Clause was violated.

Compact Clause of U.S. Constitution

Finally, the Tax Court determined that Sec. 314.606 did not violate the Compact Clause of the U.S. Constitution. This clause provides that "[n]o state shall, without the Consent of Congress, . . . enter into any Agreement or Compact with another State."14 The Court held that the Compact is not a compact covered by the Federal Compact Clause. Finding that this clause only applies to agreements directed to form a combination tending to increase the political power of states which would encroach on federal supremacy, the Court noted that the Compact never received the approval of Congress. The Compact was a state law entered into by state legislatures which did not bind itself to a contract.

The taxpayer unsuccessfully argued that Oregon was prohibited from unilaterally overriding or altering the Compact's terms to eliminate the apportionment election. After discussing the fundamental nature of interstate compacts, the Court rejected the taxpayer's argument that the principle of the precedence of interstate compacts over other state law applies regardless of Congressional consent. The Court noted that this issue was particularly important because the Compact did not receive or need Congressional approval. Prior to analyzing the numerous cases cited by the taxpayer, the Court took the unusual step of explaining that "[a]s will be seen, quotations and borrowed phrases from various cases can easily suggest answers to the important questions in this case that simply are unsupportable." After commenting that the Contract Clauses, assuming a contract exits, are the limits on state legislatures, the Court noted that "[c]areless citations and observations by litigants and courts cannot support the existence of another limit on state legislative action."

Following an analysis of each case cited by the taxpayer, the Court noted that "[n]otwithstanding general statements found in cases and often repeated, there is simply no authority for the proposition that under the Compact Clause, an independent limitation on state legislatures exists when no approval by Congress was necessary or given." Although limitations exist, "in the absence of approval of a compact by Congress, they derive from either the state or federal Contract Clauses." The Court concluded that "[t]he label 'compact' does not have a talismanic power to create a substantive limitation on the actions of state legislatures."

Commentary

The Tax Court provided an expansive analysis concluding that: (i) the Compact is not a contract; and (ii) the Oregon legislature may override components of the Compact through the adoption of a broad "inconsistency" statute. This case is likely to be appealed to, and considered by the Oregon Supreme Court. While this decision will be viewed as a victory for states from a revenue preservation perspective, it is fair to ask whether the ability of states to pursue any level of uniformity through a collaborative agreement (even if such agreement is named a compact) is impossible to achieve. This case also is noteworthy because the Tax Court uses unusually strong language, as discussed above, in rejecting the taxpayer's Federal Compact Clause argument.

The state of Oregon enacted legislation in 2013 that repealed the statute adopting the Compact and re-enacted the Compact without Articles III and IV.15 The Tax Court did not address this legislation in its exhaustive opinion, presumably because the legislation was not effective until after the relevant tax years. However, if Sec. 314.606 disabled the Compact election provision as determined by the Tax Court, there apparently would not have been a need for the state to enact the 2013 legislation that effectively repealed the Compact's apportionment provisions. Based on the legislative action in 2013, it can be implied that the legislature believed that there was some level of validity to the argument that the Compact's three-factor apportionment election was applicable prior to this action.

The decision is consistent with the recent trend of taxpayer defeats on this issue in several states in the last 12 months. With defeats in Minnesota16 and Texas,17 and the legislative reversal of a taxpayer-favorable decision in Michigan,18 taxpayers have seen their overall chances of success on this issue decline significantly. It will be interesting to see whether components of the Tax Court's analysis are woven into the upcoming California Supreme Court hearing in Gillette scheduled for October 2015.19

Footnotes

1 Health Net, Inc. v. Department of Revenue, Oregon Tax Court, No. TC 5127, Sept. 9, 2015.

2 The taxpayer used a single sales factor for a portion of the 2005 tax year and the entire 2006 and 2007 tax years.

3 OR. REV. STAT. § 305.655, enacted by Ch. 242, Laws 1967.

4 OR. REV. STAT. § 314.650, prior to 1989 amendments.

5 Former OR. REV. STAT. § 305.655.

6 OR. REV. STAT. § 314.650, prior to 2001 amendments.

7 OR. REV. STAT. § 314.606, enacted by Ch. 726, Laws 1993.

8 OR. REV. STAT. § 314.650, as amended by Ch. 793 (H.B. 2281), Laws 2001; Ch. 739 (H.B. 3183), Laws 2003.

9 Ch. 407 (S.B. 307), Laws 2013, effective Oct. 7, 2013. This legislation repealed the statute that had adopted the Compact (OR. REV. STAT. § 305.655) and replaced it with a new version of the Compact (OR. REV. STAT. § 305.653) that intentionally omits Articles III and IV. For a discussion of this legislation, see GT SALT Alert: Oregon Effectively Repeals Multistate Tax Compact Apportionment Election Provisions.

10 OR. CONST. art. IV, § 22.

11 OR. CONST. art. I, § 21.

12 The Compact provides that "[a]ny party state may withdraw from this compact by enacting a statute repealing the same." OR. REV. STAT. § 305.653(Art. X)(2).

13 U.S. CONST. art. I, § 10.

14 U.S. CONST. art. I, § 10.

15 Ch. 407 (S.B. 307), Laws 2013, effective Oct. 7, 2013.

16 Kimberly-Clark Corp. v. Commissioner of Revenue, Minnesota Tax Court, File No. 8670-R, June 19, 2015. For a discussion of this case, see GT SALT Alert: Minnesota Tax Court Denies Use of Multistate Tax Compact's Equally-Weighted Three-Factor Apportionment Formula Election.

17 Graphic Packaging Corp. v. Hegar, Texas Court of Appeals, Third District, at Austin, No. 03-14- 00197-CV, July 28, 2015. For a discussion of this case, see GT SALT Alert: Texas Appeals Court Denies Use of Compact's Three-Factor Formula As Revised Texas Franchise Tax Is Not Considered an Income Tax.

18 In International Business Machines v. Department of Treasury, 852 N.W.2d 865 (Mich. 2014), the Michigan Supreme Court ruled in favor of the taxpayer's use of the Compact's three-factor election for purposes of the Michigan Business Tax (MBT). For a discussion of this case, see GT SALT Alert: Michigan Supreme Court Allows Multistate Tax Compact Three-Factor Apportionment Election for 2008 MBT Return. However, the state of Michigan promptly enacted legislation that retroactively repealed the Compact and may have eliminated virtually all rights to refunds. Act 282 (S.B. 156), Laws 2014. For further discussion of this Michigan legislation, see GT SALT Alert: Michigan Enacts Legislation Designed to Eliminate Multistate Tax Compact Apportionment Election Refunds Allowed by IBM Case.

19 Gillette Co. v. Franchise Tax Board, California Supreme Court, No. S206587.

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