Minnesota Supreme Court upholds partial MTC repeal
Enactment of MTC did not create a contractual obligation with taxpayer
INSIGHT ARTICLE |
The Multistate Tax Compact (MTC) was drafted as a model law intended to promote uniformity of direct taxation of businesses operating in more than one state. Enacted in 1967, many states joined the MTC and formally adopted the Compact’s apportionment provisions. Under these provisions, a taxpayer could elect to utilize the MTC’s equally-weighted three-factor apportionment formula in lieu of any state-specific formula; however, historically, this election was not used because there was little to no difference between the MTC and state-specific apportionment provisions. Over time, states adopted apportionment rules that were significantly out of sync with MTC Articles III and IV (such as increasing the weight of the sales factor and moving to market-based sourcing for sales of services), doing so by either enacting mandatory state-specific apportionment rules alongside of those provided by the MTC or by repealing and replacing just the MTC apportionment provisions. Both of these approaches, however, arguably violated the terms of the MTC, which required full repeal and withdrawal from the MTC for a state to eliminate the Compact’s apportionment election, and taxpayers elected to utilize the Compact’s apportionment provisions in lieu of those provided by the state, resulting in a number of legal challenges regarding the binding nature of the MTC and whether the apportionment election was valid in the absence of a state’s full repeal of, and withdrawal from, the Compact.
The Minnesota Supreme Court recently addressed this issue in Kimberly-Clark Corp. v. Commissioner of Revenue, holding that state’s enactment of the MTC did not create a binding contractual obligation that prohibited the legislature from later repealing the apportionment formula provided in the MTC.
Kimberly-Clark mixes tax policy, Constitutional questions, and statutory interpretation to determine the state’s power to enact and repeal tax statutes. Minnesota adopted the MTC in 1983, permitting taxpayers to use the state’s statutory apportionment methodology, or to elect a three-factor, equally weighted formula using sales, payroll, and property as provided under Articles III and IV of the MTC. Minnesota subsequently repealed Articles III and IV in 1987, requiring all taxpayers to use the more heavily-weighted sales factor provided for in the state’s statutory apportionment methodology. Minnesota later repealed the Compact in its entirety in 2013.
In 2013, Kimberly-Clark amended its corporate franchise (income) tax returns for tax years 2007 through 2009, asserting the right to use the three-factor apportionment methodology provided in the MTC because the state had not provided a full withdrawal, or repeal, from the MTC in the years at issue. The Tax Court, concluding that the state’s 1987 repeal of the apportionment formula was constitutional, focused on whether the MTC created a binding contract or served as an advisory model law. The Tax Court observed that Articles III and IV provide for the apportionment election, but no where else in the MTC was a separate and distinct promise that the state could not alter or otherwise repeal the election.
On appeal to the Minnesota Supreme Court, the court focused on whether the MTC created a contractual obligation that prohibited the legislature from later repealing Articles III and IV. According to Kimberly-Clark, by enacting the apportionment formula in 1983, the State created a binding obligation that could not be terminated without a full and complete withdrawal from the Compact (which did not occur until 2013) and thereby violated the Contract Clauses of the United States and Minnesota Constitutions. The court concluded that even if there was a contractual obligation to the taxpayer prohibiting a partial repeal of the MTC, the legislative power of taxation could not be surrendered, suspended or contracted away. The court noted that the enactment of a statute does not create a contract right, but merely declares a policy to be pursued until the legislature decides otherwise through amendment or repeal.
The court also addressed the “unmistakability doctrine,” a rule of contract construction that provides the sovereign powers of a state cannot be contracted away except in “unmistakable” terms. Kimberly-Clark argued that by enacting the apportionment option in Article III, the state unmistakably promised to be bound by the MTC’s terms until withdrawal from the MTC or the member states collectively agree to amend the MTC.
The court found that while the MTC allowed a state to withdraw by repealing the statute, there was no “all or nothing” repeal requirement as argued by Kimberly-Clark. The court refused to read into the statute that silence or ambiguous terms construed a waiver of sovereign authority, thus, there was no provision representing a clear and unmistakable promise by the state to refrain from amending or repealing Articles III and IV.
In affirming the Minnesota Tax Court, the Minnesota Supreme Court did not address the arguments concerning the Contracts Clause of the U.S. and Minnesota Constitutions.
Other Pending Compact Repeal Litigation
On May 29, 2016, the taxpayers in The Gillette Company, et al. v. Franchise Tax Board case filed a petition for writ of certiorari with the U.S. Supreme Court to review the decision of the California Supreme Court that taxpayers were not entitled to elect to utilize the Compact’s three-factor apportionment election in calculating franchise tax. Recently, both the Council on State Taxation and the Tax Foundation have filed amicus curie briefs urging the U.S. Supreme Court to grant certiorari to hear the issues presented in Gillette. For more information on the Gillette decision, please read our Alert, California, Gillette, and the Multistate Tax Compact.
On June 24, 2016, the Michigan Supreme Court declined to review the Michigan Court of Appeals’ decision in Gillette Commercial Operations v. Department of Treasury, which rejected claims by over 50 taxpayers challenging the constitutionality of the state’s retroactive repeal of the Compact. In that decision, the Michigan Court of Appeals held that the MTC was an advisory agreement, not a binding compact or contract, and thus, removal from the agreement was not prohibited. For more information on the Michigan Gillette decision, please read our Alert, Michigan Supreme Court declines retroactive MTC repeal challenge.
On September 9, 2015, the Oregon Tax Court issued its decision in Health Net, Inc. v. Oregon Dep’t of Revenue, finding that the taxpayer could not elect to utilize the Compact’s three-factor apportionment election when determining its Oregon corporate excise tax. On October 26, 2015, Health Net appealed the Tax Court’s decision to the Oregon Supreme Court where the case is currently pending.
On July 28, 2015, the Texas Court of Appeals issued its decision in Graphic Packaging Corp. v. Hegar determining that the Compact’s three-factor election did not apply to the Texas Franchise Tax because that tax was not a tax imposed on net income. On December 14, 2015, Graphic Packaging petitioned the Texas Supreme Court for review of the Texas Court of Appeals’ decision where it is currently pending.
Taxpayers impacted by the availability of the Compact election should follow the litigation in the above states as it progresses through the courts. With no state’s highest court finding the Compact election available after a repeal, all eyes will be on whether the U.S. Supreme Court grants review of Gillette. What’s clear is that ultimate resolution of the issue is still pending.