United States: Michigan Court Of Appeals Finds SBTA Did Not By Implication Repeal Compact Apportionment Election Provision

On February 25, 2016, the Michigan Court of Appeals held that the Single Business Tax Act (SBTA) did not impliedly repeal the apportionment election provision contained in the Multistate Tax Compact.1 As a result, the Court of Appeals held that the more heavily weighted sales factor apportionment formula under the SBTA for the 2005, 2006 and 2007 tax years was not mandatory, allowing taxpayers to elect to apportion their tax base to Michigan using the Compact's equally-weighted three-factor apportionment formula.

Business Taxation in Michigan and the Multistate Tax Compact

Michigan replaced its corporate income tax with the Single Business Tax (SBT), which took effect on January 1, 1976, and governed business taxation in the state.2 The SBT originally utilized an equally-weighted three-factor apportionment formula. In keeping with the trend in other states, Michigan began implementing a heavier weighted sales factor under the SBT.3 The SBTA was repealed effective December 31, 2007, and, in 2008, the SBT was replaced with the Michigan Business Tax (MBT).4 For tax years beginning on or after January 1, 2012, Michigan replaced the MBT with a corporate income tax.5

Michigan enacted the Compact effective in 1970. Article III6 of the Compact allowed a taxpayer subject to an income tax to elect to use the equally-weighted three-factor apportionment formula found in Article IV7 in lieu of a state's apportionment formula. On May 25, 2011, Michigan enacted legislation8 amending the Compact to provide that a multistate taxpayer subject to the Michigan Business Tax Act (MBTA) or the Income Tax Act of 1967 could not elect the Compact apportionment formula beginning on January 1, 2011. On July 14, 2014, in International Business Machines Corp. v. Department of Treasury,9 the Michigan Supreme Court held that a taxpayer was allowed to use the Compact's three-factor apportionment formula for MBT purposes for the 2008 tax year. In response to the IBM decision, Michigan enacted legislation on September 11, 2014 providing that the Michigan statutes that adopted the Compact were repealed retroactively effective beginning January 1, 2008, making single sales factor apportionment mandatory for calculating the MBT and the corporate income tax.10

Michigan Court of Claims' Decision

Taxpayers, in 23 separate cases, sought to reduce their SBT liability by utilizing the Compact's equally-weighted three-factor apportionment formula to apportion their income rather than the more heavily weighted sales factor formula found under the SBT. The taxpayers sought SBT refunds for at least one tax year during the 2005, 2006 and 2007 tax years.

In each of the cases, the Michigan Court of Claims considered the issue of "whether the SBT apportionment formula for the tax years in question is mandatory or whether an SBT taxpayer may elect to apportion its tax base to Michigan using the Compact's equally-weighted, three-factor apportionment formula."

The Court of Claims concluded that "the SBTA apportionment provision was controlling and had impliedly repealed the Compact's apportionment election provision" and granted summary judgment in each of the cases to the Michigan Department of Treasury. The Court issued an opinion in one of the cases, EMCO Enterprises, Inc. v. Department of Treasury,11 and entered identical orders granting summary judgment in the other cases based on the reasoning in the EMCO decision.

In the EMCO decision, the Court of Claims held that: (1) the Compact was advisory and did not bind future legislatures; (2) the Compact was not a binding contract under Michigan law, and therefore the legislature could mandate the use of apportionment formulas that deviated from the Compact formula; (3) for the tax years at issue, the SBTA required a different apportionment formula than the Compact and the two conflicting provisions in the SBTA and the Compact could not be harmonized; and (4) the SBTA apportionment provision was controlling and impliedly repealed the Compact's apportionment election provision. The decision was appealed with 23 taxpayers' claims on this issue consolidated for hearing.

Implied Repeal of Compact Election Provision

On appeal, the Michigan Court of Appeals held that the SBTA did not impliedly repeal the Compact apportionment election provision. In reaching its holding, the Court of Appeals looked to the legislative intent behind the statute and relied on the reasoning of the Michigan Supreme Court in IBM. The Michigan Supreme Court's holding in IBM was predicated on the conclusion that the Michigan legislature did not implicitly repeal the three-factor formula for the 2008 through 2010 tax years.

SBT and Compact Election Provision

During the tax years at issue, Sec. 41 of the SBTA provided for a mandatory three-factor apportionment formula with a more heavily weighted sales factor.12 In contrast, Article IV of the Compact provided for an equally-weighted three-factor apportionment formula. Unlike the mandatory language found in the SBTA, the Compact allowed a taxpayer subject to an income tax whose income is subject to allocation and apportionment to choose between its equally-weighted three-factor apportionment formula and a state's apportionment formula.

The Court of Claims had determined that there was a conflict between the SBTA language and the Compact election provision. Because "the SBTA during the tax years in question mandates the use of one apportionment formula, while the Compact provides for the discretionary use of another apportionment formula, the statutes are in apparent conflict." The Court of Claims had concluded that these conflicting provisions could not be harmonized. The Michigan Court of Appeals rejected this conclusion.

The Court of Appeals held that, by utilizing the reasoning of the Michigan Supreme Court in IBM, which dealt with the "interplay between the MBT and the Compact," Sec. 41 of the SBTA and Articles III(1) and IV(9) of the Compact could be harmonized. The IBM court noted that repeals by implication would only be allowed "when the inconsistency and repugnancy are plain and unavoidable," and conflicting statutes would be construed "harmoniously to find any other reasonable construction than a repeal by implication." Furthermore, under the rules of statutory construction, statutes that were "in pari materia, although in apparent conflict, should, so far as reasonably possible, be construed in harmony with each other, so as to give force and effect to each."

Using this reasoning, the Court of Appeals explained that the Compact's election provision and Sec. 41 of the SBTA "should be construed together as statutes in pari materia because they share, like the Compact and the MBTA, 'the common purpose of setting forth the methods of apportionment of a taxpayer's multistate business income.'" According to the Court of Appeals, reviewing the statutes in pari materia allowed the same reasoning used by the court in IBM to harmonize the MBTA and the Compact to be applied to harmonize the SBTA and the Compact.

The IBM court had read the use of the term "may elect" in the Compact election provision to signal a potential "divergence between a party state's mandated apportionment formula and the Compact's own formula," and allowing taxpayers a choice in the event that divergence occurred. Reading the two provisions in this manner allowed them to be compatible with each other. Furthermore, the IBM court had explained that because the Michigan legislature did not give any clear indication that it wanted to repeal the Compact's election provision, the assumption was that the Michigan legislature wanted both laws to be in effect.

Applying the same analysis and reasoning in this case, the Court of Appeals explained that the Michigan legislature, in Article III of the Compact, provided taxpayers with a choice between the equally-weighted three-factor apportionment method contained in the Compact and the heavily weighted sales factor apportionment method required by the SBTA. Thus, the Court of Appeals held that a reasonable construction harmonizing the two statutes existed, and the presumption against implied repeals was not rebutted in this case.

The Court of Appeals noted that the 2014 legislation13 clarifying the Michigan legislature's intent to impliedly repeal the Compact when it originally enacted the MBT, was made explicit by its subsequent express repeal of the Compact election provision, effective January 1, 2011. When enacting the 2014 legislation, however, the Court of Appeals determined that the legislature did not address the validity of the Compact election provision for multistate taxpayers subject to the SBTA before the effective date of the MBTA. Therefore, in light of the Michigan legislature's clear intent to repeal the Compact election provision in conjunction with the enactment of the MBTA, and the lack of such intent to repeal the Compact election provision during the period the SBTA was in effect, the Court of Appeals concluded that the Compact election provision could be used alongside the SBTA.

SBT Is an Income Tax

The Court of Appeals also rejected the argument that the Court of Claims erred in finding that the SBT was an income tax and, as a result, was subject to and conflicted with the Compact's election provision. The Court of Appeals explained that the Compact's apportionment election provision is available to "[a]ny taxpayer subject to an income tax." An "income tax" under the Compact is defined as "a tax imposed on or measured by net income including any tax imposed on or measured by an amount arrived at by deducting expenses from gross income, 1 or more forms of which expenses are not specifically and directly related to particular transactions."14

The Court of Appeals held that the SBT met this definition. The Court of Appeals noted that both the U.S. Supreme Court and the Michigan Supreme Court characterized the SBT as a value-added tax. The relatively broad definition of the term "income tax" under the Compact, which characterized the modified gross receipts tax component of the MBT as an income tax for purposes of the Compact in IBM, compelled the conclusion that the SBT was an income tax for purposes of the Compact.

Impact of Retroactive Repeal of Compact on SBTA

The Court of Appeals also rejected the argument that the repeal of the Compact by Public Act 282 extended to the tax years at issue in the case – 2005, 2006 and 2007 – and taxpayers subject to the SBTA during those years.

The Court of Appeals noted that the plain language of Public Act 282 provides that the Compact was repealed beginning January 1, 2008. The Court explained that on that day, the SBTA was no longer in effect, having been repealed effective December 31, 2007. Furthermore, while Public Act 282 referenced both the MBTA and the Income Tax Act of 1967, it was silent as to the SBTA. "There is no language in the enacting section that suggests a legislative intent to repeal the Compact with respect to tax years affected by the SBTA or with respect to SBT taxpayers," the Court of Appeals said.15

Commentary

This case marks a new twist in the battle between the state of Michigan and taxpayers over the ability to use the Compact's three-factor apportionment election in lieu of Michigan's apportionment formula. Since the IBM decision, taxpayers have been frustrated by legislative and judicial developments in this area. This decision marks a positive outcome for the few taxpayers that still have open statutes of limitation under the SBT.

Assuming the decision stands (and one never knows, particularly if recent history in Michigan is a guide), one subject for consideration is whether the Michigan legislature would again respond to a decision adverse to the state by enacting retroactive legislation that reaches even further into the past. Given the length of retroactivity that would be needed to fully protect Michigan from refund claims, and the markedly smaller amount of the refunds at issue under the SBT when compared to the approximately $1.1 billion in refunds had the retroactive legislation following IBM not been enacted,16 it would be surprising if the Michigan legislature resorts to such an overture.

While this case is expected to be appealed to the Michigan Supreme Court, a reversal would require the Supreme Court to reevaluate and essentially contradict its own reasoning in IBM, which was heavily relied upon by the Court of Appeals.

On appeal, the Department may challenge the characterization of the SBT as an income tax. In its opinion, the Court of Appeals upheld the Court of Claims finding that the SBT was an income tax. The issue of whether or not the SBT is an income tax is crucial because the Compact's apportionment election provision is only available to taxpayers "subject to an income tax." The Court of Appeals acknowledged that both the U.S. Supreme Court17 and the Michigan Supreme Court,18 in the Trinova decisions, have characterized the SBT as a value-added tax. However, the Court of Appeals explained that "those characterizations were not made in the context of the Compact definition of an income tax." Nevertheless, on appeal, the Department could rely on the U.S. Supreme Court's decision in Trinova to argue that the SBT is not an income tax. There is some uncertainty over whether the portion of the Trinova decision that addressed the classification of the SBT is dicta or law. Both parties conceded to the SBT classification issue and, as a result, a strong argument can be made that the language in Trinova is dicta. The case may also have an impact on the ongoing MBT litigation surrounding the validity of the legislature's retroactive repeal of the Compact. The Court of Appeals appears to validate the legislature's decision to retroactively repeal the Compact by relying on it to show that the legislature left the door open with regard to the SBT. In its opinion, the Court of Appeals points out that, while the Legislature clarified its intent to repeal the Compact back to 2008 when it enacted the MBT, it was silent as to the SBT. According to the Court of Appeals, this silence "left open the application of the Compact apportionment formula during tax years subject to the SBTA."

The ongoing litigation surrounding the retroactive repeal of the MBT may be considered by the Michigan Supreme Court. In response to the Michigan Court of Appeals decision which upheld the constitutionality of Public Act 282,19 the taxpayers have filed an Application for Leave to Appeal.20 Additionally, approximately 50 similarly situated taxpayers have filed Applications for Leave to Appeal in four companion cases.21 The Michigan Supreme Court is expected to decide soon on whether to grant leave.22

Footnotes

1 AK Steel Holding Corp. v. Department of Treasury, Michigan Court of Appeals, Nos. 327175, 327251, 327313—327331, 327333 and 327334, Feb. 25, 2016.

2 Former MICH. COMP. LAWS § 208.1 et seq.

3 For tax years 1999 through 2005, the sales factor was weighted at 90 percent, and for 2006 and 2007, the sales factor was weighted at 92.5 percent.

4 MICH. COMP. LAWS § 208.1101 et seq.

5 MICH. COMP. LAWS § 206.601 et seq.

6 MICH. COMP. LAWS § 205.581(Art III)(1). "Article III of the Compact provided that a taxpayer subject to an income tax 'in two or more party states may elect to apportion and allocate his income in the manner provided by the laws of such states . . . without reference to this compact, or may elect to apportion and allocate in accordance with article IV.'"

7 MICH. COMP. LAWS § 205.581(Art IV)(9).

8 Act 40 (H.B. 4479), Laws 2011, amending MICH. COMP. LAWS § 205.581(Art III)(1).

9 852 N.W.2d 865 (Mich. 2014), reh'g denied, 855 N.W.2d 512 (2014). 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.

10 Act 282 (S.B. 156), Laws 2014. For further discussion of this legislation, see GT SALT Alert: Michigan Enacts Legislation Designed to Eliminate Multistate Tax Compact Apportionment Election Refunds Allowed by IBM Case. See also GT SALT Alert: Michigan Court of Claims Reconsiders and Rules Against IBM in Multistate Tax Compact Three-Factor Apportionment Case.

11 Michigan Court of Claims, Docket No. 327313.

12 See former MICH. COMP. LAWS § 208.41.

13 Act 282 (S.B. 156), Laws 2014.

14 Citing to MICH. COMP. LAWS § 205.581(Art III)(1).

15 The Court also noted that the lead and concurring opinions in IBM also support the conclusion that Public Act 282's explicit repeal of the Compact effective January 1, 2008 did not extend to tax years before 2008.

16 Bill Analysis of S.B. 156, Michigan Senate Fiscal Agency, Sep. 20, 2014.

17 Trinova Corp. v. Michigan Department of Treasury, 498 U.S. 358 (1991).

18 Trinova Corp. v. Department of Treasury, 445 N.W.2d 428 (Mich. 1989).

19 Gillette Commercial Operations North America v. Department of Treasury, ___ N.W.2d ___ (Mich. Ct. App. 2015). The case included 50 consolidated appeals.

20 Brief of Amicus Curiae, Tax Executives Institute, Inc., Gillette Commercial Operations North America v. Department of Treasury, Jan. 5, 2016.

21 Id. According to the brief, the companion cases to Gillette are: Sonoco Products Co. v. Department of Treasury, Docket Nos. 152598—152610 (consolidated) (leave to appeal filed Nov. 10, 2015); Lubrizol Corp. v. Department of Treasury, Docket No. 152613 (leave to appeal filed Nov. 10, 2015); Yaskawa America, Inc. v. Department of Treasury, Docket Nos. 152615—152648 (consolidated) (leave to appeal filed Nov. 10, 2015); and International Business Machines Corp. v. Department of Treasury, Docket No. 152650 (leave to appeal filed Nov. 10, 2015). Further, the Michigan Court of Appeals recently affirmed the Court of Claims decisions and held similarly for the Department in Harley Davidson Motor Co. v. Department of Treasury, Michigan Court of Appeals, Nos. 325498—328967, March 15, 2016. These cases could also become companion cases.

22 Amy Hamilton, Deadlines Approaching in Several Multistate Tax Compact Cases, TAX ANALYSTS STATE TAX TODAY, March 16, 2016.

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