US Supreme Court denies certiorari in First Marblehead
FIET sourcing provision does not violate internal consistency
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UPDATE (2/21/2017): On Feb. 21, 2017, the U.S. Supreme Court denied the taxpayers’ petition for writ of certiorari to review the Massachusetts Supreme Judicial Court’s Aug. 12, 2016, decision in First Marblehead Corp. v. Commissioner of Revenue. The Massachusetts court had reexamined the issue in light of the U.S. Supreme Court’s decision in Comptroller of the Treasury v. Wynne, finding that sourcing student loans to Massachusetts under the financial excise tax when the taxpayers had its commercial domicile in Massachusetts, even though the loan servicing activities occurred outside the Commonwealth by independent contractors, did not violate internal consistency.
On appeal to the U.S. Supreme Court, the taxpayers presented the following questions: 1) whether an apportionment factor reflects a reasonable sense of how income is generated when it disregards the activities and entities that actually generate the income and instead arbitrarily assigns the income to the commercial domicile of an owner of the income-producing entities, and 2) whether the court below properly followed this Court’s precedents when it based its conclusion that an apportionment formula was internally consistent on an assumption that other states would apply an apportionment formula different from the formula in the statute it upheld. The denial is noteworthy as it was an early opportunity for the U.S. Supreme Court to review the application of the internal consistency test as the court recently articulated in Wynne.
UPDATE (8/12/2016): On Aug. 12, 2016, the Massachusetts Supreme Judicial Court affirmed its opinion in First Marblehead Corp. v. Commissioner of Revenue, holding that a financial institution taxpayer is required to determine the situs of loan portfolio property for the purposes of computing its financial institutions excise tax property factor using only its own activities, and that, therefore, a financial institution’s Massachusetts commercial domicile was sufficient to support sourcing to Massachusetts even though the financial institution’s loan servicing activities occurred entirely out of state because those loan servicing activities were performed by independent contractors. This case came back to the Massachusetts Supreme Judicial Court on remand from the U.S. Supreme Court, which ordered reconsideration of whether this taxing scheme violated the internal consistency test in light of the U.S. Supreme Court’s decision in Comptroller of the Treasury v. Wynne. In affirming its prior decision, the Massachusetts Supreme Judicial Court found that its interpretation of the state’s taxing scheme did not violate the internal consistency test because, if every state adopted the approach followed by Massachusetts, no double taxation would occur. This decision may not be the end of the matter, as, given the constitutional issues involved, this taxpayer may file a Petition for Certiorari with the U.S. Supreme Court seeking further guidance.
ORIGINAL (10/23/2015): On Oct. 13, 2015, the U.S. Supreme Court granted certiorari and issued an order in First Marblehead Corp., Et Al. v. Massachusetts Commissioner of Revenue, vacating the Massachusetts Supreme Judicial Court’s decision in First Marblehead Corp. v. Commissioner of Revenue, No. SJC-11609 (Mass. Jan. 28, 2015), and remanding the case back to the Supreme Judicial Court for further consideration in light of the U.S. Supreme Court’s decision earlier this year in Comptroller of the Treasury v. Wynne, 575 U.S. __ (2015), previously covered in US Supreme Court issues Wynne ruling.
Law in question
Under Massachusetts law, financial institutions use the traditional evenly weighted three-factor apportionment formula crafted by the Multistate Tax Commission (MTC) for the purposes of calculating the Massachusetts financial institution excise tax (FIET). Loans are considered property includable in the property factor and are generally assigned to the regular place of business with which the loan has a “preponderance of substantive contacts.” When a taxpayer does not have a regular place of business, there is a rebuttable presumption that loans should be assigned to the taxpayer’s commercial domicile. However, this presumption can be rebutted by a taxpayer if the facts and circumstances surrounding the loan, including solicitation, investigation, negotiation, approval and administration (the SINAA factors), indicate that the preponderance of substantive contacts regarding the loan occurred somewhere other than the taxpayer’s commercial domicile.
Massachusetts Supreme Judicial Court’s prior decision
In the instant case, the taxpayer was a financial institution for Massachusetts FIET purposes, had a Massachusetts commercial domicile, and held a portfolio of student loans. The taxpayer did not engage in originating any loans to students. Rather, third-party banks entered into agreements with the taxpayer’s parent, and these banks dispersed loans to student borrowers. Thereafter, loan servicing was outsourced to independent entities. The banks then sold student loan portfolios to various Delaware trusts controlled by the taxpayer. The taxpayer did not own or lease office space or have employees, payroll or tangible assets and, therefore, did not have a regular place of business. However, the taxpayer did not assign the loans to its commercial domicile, but instead assigned the loans to locations outside of Massachusetts where loan servicing activities were performed by third parties on behalf of the taxpayer. This resulted in the taxpayer reporting a zero Massachusetts property factor.
On review from the Massachusetts Appellate Tax Board, the Massachusetts Supreme Judicial Court determined that the taxpayer is required to determine the situs of loan portfolio property for property factor purposes using only its own activities and is not permitted to include the activities of independent contractors who performed work on the taxpayer’s behalf. Accordingly, the only applicable SINNA factor was administration of the loan, as the other four factors related solely to work performed by the taxpayer’s agents or independent contractors. Application of this one factor could not overcome the presumption requiring sourcing to the taxpayer’s commercial domicile. This resulted in adjustment of the taxpayer’s Massachusetts property factor from zero to 100 percent, which the Supreme Judicial Court found to be valid under the Commerce Clause of the U.S. Constitution because the taxpayer was not subject to actual double taxation.
Appeal to the U.S. Supreme Court
Following the Wynne decision, the taxpayer in First Marblehead filed a petition for writ of certiorari with the U.S. Supreme Court. The taxpayer argued that the financial institution excise tax statute, as construed by the Supreme Judicial Court, violated the “internal consistency” requirement reaffirmed by the Court in the Wynne decision. As stated in the taxpayer’s petition, for a tax to be internally consistent, it must be structured such that if every state were to impose an identical tax, no multiple taxation would result. Thus, a Massachusetts court is required to employ a hypothetical application of Massachusetts’ tax regime in every state to determine if it creates double taxation.
In its petition, the taxpayer in First Marblehead stated that the Massachusetts Supreme Judicial Court “made no attempt to do what the internal consistency test requires when it held that its construction of the Massachusetts statute did not give rise to concerns about double taxation.” The taxpayer claimed that the Massachusetts Supreme Judicial Court neither focused on the statute’s text or the structure of such a tax nor opined on the hypothetical of other states passing or applying the same statute. Further, the taxpayer stated that the Massachusetts Supreme Judicial Court’s application of the tax “raises serious concerns of double taxation for financial institutions that outsource the servicing of their loans” and incentivizes taxpayers to have their servicing activities conducted by in-state rather than out-of-state loan servicers.
The U.S. Supreme Court granted certiorari and in an order vacated the Massachusetts Supreme Judicial Court’s decision and remanded the case. The Massachusetts Supreme Judicial Court will now need to correctly apply the internal consistency test, as applied in Wynne, to determine whether the Massachusetts financial institution apportionment statute is unconstitutional.
The Massachusetts Supreme Judicial Court’s decision in First Marblehead was a rare judicial foray into property factor apportionment for financial institutions, particularly with respect to whether activities performed by third-party independent contractors should be disregarded for sourcing purposes. As the MTC explained in its filed amicus brief in support of the Massachusetts Commissioner of Revenue, despite its widespread adoption by the states, the MTC’s recommended apportionment formula for financial institutions has not been the subject of any reported appellate court decisions. Now, in the wake of the U.S. Supreme Court’s decision, the Massachusetts Supreme Judicial Court will need to revisit the case and determine whether the Massachusetts financial institution apportionment statute violates the internal consistency test, as applied in Wynne. The resulting decision on remand is likely to have a significant impact on how the SINNA factors are applied in Massachusetts and, given the dearth of guidance across the nation in this area, in other states that have adopted the MTC approach.
 Petition for Writ of Certiorari, First Marblehead Corp. v. Comm’r of Revenue, Docket No. 14-1422 (May 29, 2015).
 Brief of Amicus Curiae Multistate Tax Commission in Support of Defendant-Appellee the Commissioner of Revenue, No. SJC-11609.