Vectren Case Remanded to Determine Tax Calculation under MBT’s Statutory Apportionment Formula
On November 25, 2020, the Supreme Court of Michigan vacated the judgment of the Court of Appeals and remanded the case back to that court to address the proper method of calculating the plaintiff’s tax due under the statutory formula of the Michigan Business Tax (“MBT”). Vectren Infrastructure Services Corp. successor-in-interest to Minnesota Limited, Inc. v. Dept. of Treas., 950 NW2d 746 (Mich. 2020). According to the Supreme Court’s order, the Court of Appeals’ conclusion that an alternative apportionment method was required for the taxpayer was premature because this issue had not been addressed by that court.
The facts of the case are discussed in the Court of Appeals decision, Vectren Infrastructure Services Corp. successor-in-interest to Minnesota Limited, Inc. v. Dept. of Treas., Mich. App. No. 345462 (2020). The plaintiff in the case was Minnesota Limited, Inc. (“MLI”), an S-Corporation headquartered in Minnesota that built and maintained oil and gas pipelines ranging across 24 states. MLI’s services were provided on a contract basis, because of which its work locations changed from year to year depending on the location of the project. MLI did not have a permanent business location in Michigan or retain permanent employees in the state, but it sometimes did work there. In 2010 and 2011, MLI worked on a cleanup project in Kalamazoo, Michigan, renting most of its equipment and hiring Michigan union employees to perform the work.
In March of 2011, after 52 years as a family business, albeit one that employed 600 people at its seasonal peak, the business was sold by its owners, a pair of siblings, one of whom was experiencing health issues. The purchaser was Vectren Infrastructure Services Corp., who paid $80 million for the business. MLI elected to treat the stock sale as a sale of the company’s assets under Internal Revenue Code Section 338(h)(10).
In filing its short year return for the period from Jan. 1 through the sale date of March 31, 2011, MLI included the large gain from the sale in its tax base and its sales factor denominator, bringing the Michigan sales factor to just under 15%. Upon audit, the Michigan Department of Treasury (“Department”) left the gain in the tax base but removed it from the sales factor denominator, a move which increased the factor to just under 70%, creating an additional tax liability under the single sales factor apportionment used by the MBT. In its request for an informal conference and the use of alternative apportionment for the short year, MLI asserted that the receipts and income from the sale of the business should be treated as a “sale” under MCL 208.1115(1) and sourced to Minnesota in the sales factor to arrive at equitable apportionment. They argued in the alternative that the sale should not be subject to tax because it was not conducted in MLI’s regular course of business and was, therefore, nonbusiness income. The Department rejected both arguments by determining that MLI had not overcome the presumption that the statutory formula as applied by the Department fairly represents MLI’s business activity in Michigan for the period at issue. It handed MLI an assessment of over $2.9 million including penalty and interest.
MLI challenged the assessment in the Court of Claims, raising four objections, all of which were rejected by the court as it granted summary disposition to the Department. Two of MLI’s objections would have excluded the gain on the sale from the tax base. The first argument was that the gain was nonoperational, nonrecurring, nonbusiness income, and its inclusion would unconstitutionally tax extraterritorial values. The second was that under the MBT, the sale of a shareholder’s stock is not a business activity to be included in an S corporation’s tax base, not withstanding the federal 338(h)(10) election. As summarized by the Court of Appeals, the Court of Claims “rejected plaintiff’s argument that the Sale does not qualify as ‘business income’ because it cannot be ‘attributable’ to MLI and relied heavily on the fact that the shareholders had elected to treat the Sale as a sale of MLI’s assets under [IRC section] 338(h)(10).” In addition to rejecting the non-business income argument, the Court of Claims rejected the extraterritorial income argument, even though the Michigan income in the year of sale was out of proportion with the company’s business in earlier years. The Court of Claims also rejected MLI’s argument that not including the gain in the sales factor denominator was grossly distortive in calculating the tax. In the absence of a finding of distortion or extraterritorial taxation, the constitutional claims were rejected, as was the taxpayer’s request for penalty abatement.
In deciding MLI’s appeal, the Court of Appeals did not respond to all of MLI’s arguments. The Court of Appeals did not, for instance, reject the Court of Claims’ holding that the gain on the sale was properly classified as business income. Instead, the Court of Appeals determined that application of the statutory formula “to the circumstances of this case would result in the imposition of a tax in violation of the Commerce Clause” because the choice of factors did not “reflect a reasonable sense of how [the business activity] is generated,” citing Container Corp of America v. Franchise Tax Board, 463 U.S. 159, 169 (1983). The application of the statutory formula did not meet the constitutional requirement that the taxable portion of income must be “fairly attributed to in-state activities.” Id. Because the MBT has a provision for alternative apportionment at MCL 208.1309, the Court of Appeals held that this provision must be used, regardless of the fact that the taxpayer did not follow the state’s procedural requirements of petitioning for alternative apportionment prior to filing its return, an argument that was not raised by the Department, and thus was judged to have been waived.
The Michigan Supreme Court’s vacating of the Court of Appeals’ judgment was not necessarily a disagreement that the tax as calculated by the Department was unfair in violation of the U.S. Constitution. The Supreme Court did, however, demand that the Court of Appeals address the “foundational issue” of the proper method for calculating the business tax due under the statutory formula. On remand, the Court of Appeals will address questions such as whether the gain on the sale of the business should or should not be included in the tax base, and if included, how it should be dealt with in the apportionment factor. Only once those questions are answered may the Court of Appeals determine whether the result is fair or not under constitutional standards.