Michigan Supreme Court upholds and expands MTC apportionment election
TAX ALERT |
On July 14, 2014, the Michigan Supreme Court issued its decision in International Business Machines Corporation v. Michigan Department of Treasury, Mich., No. 146440, 7/14/14, holding that IBM was entitled to elect to utilize the Multistate Tax Compact’s (MTC’s) three-factor apportionment formula to calculate the business income tax (BIT) component of its 2008 Michigan business tax (MBT) because Michigan had not repealed its enactment of the MTC’s apportionment election, either expressly or by implication, prior to 2011. Additionally, the court held that IBM was entitled to utilize the MTC’s apportionment formula to calculate the modified gross receipts tax (MGRT) component of its 2008 MBT because that portion of the tax “fits within the broad definition of ‘income tax’ under the Compact by taxing a variation of income.” This decision reversed the unpublished 2012 per curiam decision of the Michigan Court of Appeals holding that IBM could not make the MTC apportionment election because the Michigan Business Tax Act had (1) repealed the election by implication, and (2) effectively upheld in part and reversed in part the Michigan Court of Claims holding in Anheuser-Busch, Inc. v. Michigan Department of Treasury, Case No. 11-85-MT (6/6/2013), discussed in our prior alert on this issue.
The MTC is a multistate compact, the provisions of which provide for a uniform body of laws intended to facilitate the determination of state and local tax liabilities of multistate taxpayers. To become a member of the MTC, a state must enact the provisions of the MTC in their entirety. Article III of the MTC allows a multistate corporate taxpayer to elect whether to use the MTC rules or state-specific rules, if they differ, to apportion or allocate income for the purpose of calculating its corporate income tax liability in a member state. Article IV of the MTC provides that business income for income tax purposes must be apportioned using an equally weighted, three-factor apportionment formula consisting of a taxpayer’s property, payroll and sales within the member state over its total property, payroll and sales, respectively. Article X of the MTC permits any member state to withdraw from the MTC at any time by enacting a statute repealing its enactment of the MTC.
Michigan adopted the MTC by statute effective July 1, 1970, arguably providing corporate taxpayers with the option to make the Article III apportionment election and use the provisions of Article IV to apportion income for purposes of Michigan’s corporate net income tax. In 1976, however, Michigan replaced its corporate net income tax with the single business tax (SBT), a value-added tax to which the provisions of Article IV arguably did not apply. Pursuant to the Michigan Business Tax Act, Michigan enacted the MBT and repealed the SBT effective for the 2008 tax year. The MBT was a hybrid of the BIT, a net income tax, and the MGRT, a gross receipts tax. Each tax base was subject to apportionment using a single sales factor formula. Effective for tax years beginning after Dec. 31, 2011, the MBT was repealed and replaced with the Michigan corporate income tax (CIT), which also provides for apportionment using a single sales factor formula.
Michigan did not at any point repeal by statute its enactment of the MTC, as required under Article X of the MTC as a prerequisite for withdrawal, and remains a member state. However, effective Jan. 1, 2012, Michigan statutorily repealed Article III of the MTC, stating that the three-factor apportionment election was not available for income recognized after Dec. 31, 2010. The effectiveness of this partial repeal of the MTC has not been challenged in Michigan courts.
The facts under consideration in IBM are relatively straightforward. In its original MBT return for the 2008 tax year, IBM took the position that, pursuant to Michigan’s enactment of Article III of the MTC, it could elect to apportion its income for BIT purposes and gross receipts for MGRT purposes using the MTC’s three-factor apportionment formula provided under Article IV in lieu of the state’s single sales factor formula. Because IBM had a significant portion of its property and payroll located outside of Michigan, the introduction of the property and payroll factors as an offset to its sales factor effectively diluted its overall apportionment factor.
The Michigan Department of Treasury (Department) audited IBM’s 2008 MBT return and made adjustments to apportion IBM’s income and gross receipts using the single sales factor formula provided by the Michigan Business Tax Act. IBM protested this adjustment and filed suit in the Michigan Court of Claims, which upheld the Department’s determination. IBM subsequently appealed this decision to the Michigan Court of Appeals, which upheld the ruling of the Michigan Court of Claims on the grounds that, by mandating the use of the state’s single sales factor formula, the Michigan Business Tax Act had repealed the MTC apportionment election by implication. IBM appealed this decision to the Michigan Supreme Court.
The Michigan Supreme Court strongly disagreed with the state’s lower courts and the Department. To begin with, the court noted the Michigan Court of Appeals’ determination that the MTC’s apportionment election had been repealed by implication could not be rationalized because the election and the Michigan Business Tax Act single sales factor apportionment mandate were not “so incompatible that both cannot stand.” Furthermore, the court found that the legislature showed no intent to repeal the state’s enactment of the MTC’s apportionment election because it repealed numerous other tax statutes that were inconsistent with the Michigan Business Tax Act, but left the MTC in place. Finally, the court noted that the legislature’s amendment to repeal the MTC election for 2011 and future tax years was “evidence that the legislature had not impliedly repealed the provision when it enacted the [Michigan Business Tax Act].”
Having found that Michigan had enacted the MTC’s apportionment election and that the election was still in force in the 2008 tax year, the Michigan Supreme Court declined to consider whether the MTC was binding and could not be repealed piecemeal. Instead, the court determined that the election clearly applied to the BIT and turned its focus to whether it also applied to the MGRT. Here, the court determined that the MGRT was an income tax to which the MTC apportionment election could properly apply because the MGRT was imposed on gross receipts less deductions for expenses “not specifically and directly related to particular transactions,” such as inventory, assets eligible for depreciation, amortization, accelerated capital cost recovery, materials and supplies to the extent not included in inventory or depreciable property, some compensation, and payments to independent contractors. Accordingly, the court ruled in favor of IBM and overturned the decision of the Michigan Court of Appeals in full.
Impact on Anheuser-Busch
In Anheuser-Busch, the Michigan Court of Claims held, in substantially similar circumstances to those in IBM, that Anheuser-Busch was entitled to elect to utilize the MTC three-factor apportionment formula to calculate the BIT component of its 2008 though 2010 MBT, but could not utilize the election to calculate its MGRT. Because the Michigan Supreme Court in IBM held that the MTC’s apportionment election applies to both the BIT and MGRT, the Anheuser-Busch decision would be upheld in relation to the BIT and invalidated in relation to the MGRT. However, while the Michigan Supreme Court focused on the state’s statutory enactment of the MTC and found that the election was reconcilable with the apportionment provisions of the Michigan Business Tax Act, the Michigan Court of Claims found that there could be no such reconciliation and instead ruled that the election could be used because the MTC was a binding interstate compact that trumped the provisions of the Michigan Business Tax Act. Clearly, the IBM decision invalidates the Michigan Court of Claims’ finding regarding statutory reconciliation, but the Michigan Supreme Court’s approach also makes moot the Michigan Court of Claims’ analysis regarding the binding nature of the MTC, leaving this issue open.
The Michigan Supreme Court’s decision in IBM, while clearly significant, does not settle the MTC election issue for all taxpayers in all tax years. To begin with, the IBM case and the Anheuser-Busch case only concern a taxpayer’s ability to make the MTC apportionment election on an original return. While there is no statutory or regulatory authority that explicitly bars a taxpayer from making this election on an amended return, it is possible that the Department would challenge a taxpayer’s ability to make the MTC election outside of an original return. Accordingly, taxpayers that made the election on an amended return may be subject to additional challenge.
Second, IBM and Anheuser-Busch only address the applicability of the MTC apportionment election to the 2008 through 2010 tax years and do not address the applicability of the election to the 2011 MBT year or 2012 and later CIT years. Although the Michigan Supreme Court referenced Michigan’s partial repeal of the MTC, the effectiveness of this partial repeal was not at issue in either IBM or Anheuser-Busch. Accordingly, whether Michigan’s partial repeal of its MTC provisions violates its contractual obligations under the MTC or the Contracts Clause of either the Michigan or U.S. Constitution remains unsettled, and it is not clear whether a taxpayer may utilize the MTC apportionment election in calculating its 2011 MBT or post-2011 CIT returns.
Third, neither IBM nor Anheuser-Busch addressed the applicability of the MTC apportionment election to the SBT. Although it may be presumed that the election could not apply to the SBT because the SBT is a value-added tax, the Michigan Supreme Court’s decision to allow the use of the election for the MGRT, a gross receipts tax, calls this presumption into question. Although the statute of limitations for filing amended returns for the 2007 and earlier SBT years is closed for many taxpayers, taxpayers that still have an open statute should consider the potential impact of making the election for those open years.
Fourth, the specific application of the MTC apportionment rules under Article IV of the MTC was not at issue in IBM; however, some of the MTC-to-state differences outside of the number of factors can have a substantial apportionment impact. For example, in relation to the sourcing of sales of services, the MTC provides that receipts from sales of services are sourced based on a cost-of-performance methodology, while the apportionment rules under the Michigan Business Tax Act would require the use of market-based sourcing. This and other differences could result in material tax reductions or increases in certain instances.
Given the favorable decision in IBM and the limits of that decision, it is advisable for Michigan taxpayers to review all open tax years and consider whether making the MTC apportionment election on an amended return would be beneficial. Further, in light of the questionable validity of Michigan’s partial repeal of the MTC, it is advisable for taxpayers to consider whether to make the MTC apportionment election going forward on their original CIT returns.