United States: Court Vacates Its Order Holding Kentucky Consolidated Income Tax Returns Required, Refuses To Hold Department Of Revenue To Its Letter Ruling

The Franklin Circuit Court recently granted the Kentucky Department of Revenue's (the "KDOR") motion to alter, amend, or vacate the Court's August 14, 2015 Order holding an out-of-state corporation and its Kentucky subsidiary were required to file consolidated income tax returns.1 In so doing, the Court affirmed the final ruling of the KDOR and the Kentucky Board of Tax Appeals (the "KBTA").  The taxpayers, World Acceptance Corporation ("WAC") and its wholly-owned subsidiary, World Finance Corporation of Kentucky ("WFCKY") (collectively "Taxpayers") amended the separate returns initially filed by WFCKY to reflect the consolidated filing of the Taxpayers for tax years 2007-2010.  The amended returns resulted in significant refund claims being owed to the Taxpayers, and the KDOR denied the refund claims.  Notably, the Taxpayers relied upon a letter ruling issued by the KDOR advising WAC to file a consolidated return. 

The Taxpayers appealed the KDOR's denial of their refund claims to the KBTA, which ruled in favor of the KDOR.  The Taxpayers appealed the KBTA's decision to the Franklin Circuit Court, which initially reversed the KBTA and ordered the KDOR to grant the Taxpayers' refund claims.  The Court held the KDOR's interpretation of the relevant statutes contradicted fundamental rules of statutory construction.  Nevertheless, the Court recently granted the KDOR's motion to alter, amend, or vacate the Court's judgment, finding its initial Order was "erroneous".

Kentucky Revised Statute ("KRS") § 141.200(10)(b) requires taxpayers to file separate returns unless there is a "common parent corporation doing business in Kentucky" that has nexus with an affiliate.  Under KRS § 141.200(9)(c), a "common parent corporation" is defined as the member of an "affiliated group" that meets the ownership requirement of paragraph (a)1 or (b)1 of KRS § 141.200(9).   Because KRS § 141.200(9)(a)1 applies to taxable years prior to January 1, 2007, only KRS § 141.200(9)(b)1 applied in the instant case.  KRS § 141.200(9)(b)1 defines an "affiliated group" as "(1) or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation if [the common parent owns 80% or more of the stock and value in at least one other includible corporation and 80% of the stock in each of the includible corporations, excluding the common parent, is owned directly by one or more of the other corporations]."

An "includible corporation" is defined as any corporation doing business in Kentucky unless the corporation falls within one of the nine exceptions enumerated in KRS § 141.200(9)(e).  Of relevance here, KRS § 141.200(9)(e)7 provides that a corporation is not an includible corporation if the corporation realizes a net operating loss and the corporation's Kentucky property, payroll and sales factors pursuant to KRS § 141.120(8) are de minimis.  Similarly, KRS § 141.200(9)(e)8 states that a corporation is not an includible corporation if the sum of its property, payroll, and sales factors described in KRS § 141.120(8) is zero.

The KDOR argued that under KRS § 141.200(9)(b)1, the parent, WAC, must, but does not, meet the definition of "includible corporation" because WAC was a corporation realizing a net operating loss whose property, payroll and sales factors were de minimis.  The Taxpayers argued the definition of "includible corporation" applicable to a "common parent corporation" is set forth at KRS § 141.200(9)(b), i.e., a common parent corporation is an includible corporation if the ownership requirements set forth in that section are satisfied. Furthermore, the Taxpayers argued that even if KDOR was correct that KRS § 141.200(9)(e)7 is applicable, WAC's apportionment factors were not de minimis (per KDOR's own letter ruling), and therefore, this section does not prohibit WAC from meeting the definition of "includible corporation". 

In its Order, the Court rejected the Taxpayers' argument that KRS § 141.200(9)(b) contains the definition of "includible corporation" applicable to a "common parent corporation".  The Court found KRS § 141.200(9)(e) sets forth the definition of "includible corporation" for both "common parent corporations" and other non-parent companies, while KRS § 141.200(9)(b) enumerates the ownership requirements for the affiliated group as a whole.  The Court reasoned it must presume that when the legislature uses a defined term in a section in which it has already defined the term, the term must mean what is written in its definition and nothing else.  The Court also held WAC's interpretation was contrary to the legislative history of KRS § 141.200(9), finding the legislature amended the statute in 2006 to narrow the types of common parent corporations that could be part of an affiliated group.

After holding WAC must meet the definition of "includible corporation" in KRS § 141.200(9)(e), the Court next found WAC did not meet this definition because WAC fell within the exceptions in either KRS § 141.200(9)(e)7 or KRS § 141.200(9)(e)8, as its property, payroll, and sales factors were either zero or de minimis.  Because the Court found WAC did not meet the definition of "includible corporation" in KRS § 141.200(9)(e) and therefore could not file a consolidated return, the Court proceeded to address whether the KDOR should be bound by its letter ruling stating that WAC should file a consolidated return. 

The KDOR argued the facts contained in the anonymous request for a letter ruling submitted by WAC were materially different from the facts provided in WAC's amended return because WAC failed to disclose that management services were performed outside Kentucky or that the employee providing services in Kentucky also worked in another state. The Court concluded the KBTA's finding that the facts presented in WAC's amended returns were materially different from the facts presented in WAC's request for a letter ruling was based upon substantial evidence.  The Court noted that WAC did not disclose that its employee working in Kentucky also worked the majority of the time in other states or that management services were performed outside Kentucky.  Furthermore, in a holding that provides unprecedented protections to the KDOR and greatly undermines the utility of the letter ruling process, the Court held that:

[A]n anonymous request for a letter ruling submitted by a taxpayer is not binding on either [the KDOR], the taxpayer, or a Kentucky court of law so long as that request contains facts that are materially different from those submitted in a subsequent filing with [the KDOR] or if [the KDOR] misapplies the applicable statutes and regulations to the facts submitted to it by the taxpayer.

(emphasis added).  The Court also summarily dismissed the Taxpayers' arguments that the KDOR's denial of their refund claims violated KRS § 13A.130, Sections 27 and 28 of the Kentucky Constitution, and the doctrine of contemporaneous construction.

The Court's Order gives short shrift to the standard that must be satisfied for a motion to alter, amend, or vacate to be granted, which the Court acknowledges is "an extraordinary remedy and should be used sparingly." 

The Taxpayers have thirty days from the date of the Court's Order to appeal to the Court of Appeals.

The authors' firm represents the Taxpayers in this action.

Footnote

1 World Acceptance Corporation, et al. v. Commonwealth of Kentucky, Finance & Administration Cabinet, Department of Revenue, Franklin Circuit Court, Civil Action No. 2014-CI-1193 (Aug. 14, 2015).

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