This article first appeared in the May 26, 2015 edition of State Tax Notes.
In A Sharper Focus, senior reporter Amy Hamilton asks practitioners and a former chair of the Multistate Tax Commission about the significance of a trial court judge's order applying Michigan's retroactive repeal of the Multistate Tax Compact to IBM Corp.
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After the Michigan Supreme Court ruled in July 2014 that IBM Corp. had the ability to elect to use the apportionment formula in the Multistate Tax Compact, the state moved swiftly to retroactively repeal the compact to avoid paying an estimated $1.1 billion in refunds to other out-of-state companies. In May, Michigan Court of Claims Chief Judge Michael Talbot ruled that the retroactive repeal of the compact also applies to litigant IBM.
Several practitioners had strong reactions to Talbot's opinion and order, with some arguing that the trial court decision effectively overturns the Michigan Supreme Court. What significance, if any, is there in the application of Michigan's retroactive repeal of the compact to litigant IBM?
In an opinion and order entered on April 28 in IBM Corp. v. Department of Treasury, Talbot, who was hearing the case on remand, applied the state's retroactive repeal of the Multistate Tax Compact to IBM.1 Talbot's order continued court proceedings in the compact election case successfully litigated by IBM at the Michigan Supreme Court.2 The attorney general's motion for reconsideration of IBM was pending at the Michigan Supreme Court when the Legislature passed SB 156 to avoid paying an estimated $1.1 billion in refunds to out-of-state taxpayers as a result of IBM.3
Shortly after Michigan enacted P.A. 282, repealing the compact from the state's code effective January 1, 2008, the state filed a supplemental brief asking the court to apply the retroactive law to IBM itself; the Michigan Supreme Court denied the state's motion for rehearing in IBM on November 14, 2014, and five days later, Talbot, acting according to the court's instructions, entered an order granting summary disposition to IBM. Treasury then filed a motion for reconsideration with the Court of Claims, asserting that the retroactive repeal of the compact applies to and controls the outcome in IBM.
In his April 28 order, Talbot granted the state's motion for reconsideration, while also granting summary disposition in favor of Treasury, effectively dismissing IBM's claim for nearly $6 million in Michigan business tax refunds. Talbot cited his previous analysis of the retroactive application of P.A. 282 to other taxpayers in Yaskawa America Inc. v. Department of Treasury, which he has used as the basis for dismissing several more taxpayer refund claims.4
Talbot wrote that the procedural posture of the case does not mandate that IBM be given a unique status among taxpayers seeking a refund. "Essentially, plaintiff is left in the position of arguing why the procedural history of its case means that plaintiff's refund case, unlike those of all other similarly situated taxpayers, should not be governed by P.A. 282," Talbot wrote.
Rule of Law
Erica Horn of Stoll Keenon Ogden PLLC in Lexington, Kentucky, said the question raised by Talbot's April 28 opinion and order is whether the judge acted inconsistently with the Michigan Supreme Court's order that he enter summary judgment in favor of IBM.
"Judge Talbot said the court of claims wasn't bound by the 'law of the case' -- that is, the Michigan Supreme Court's decision that IBM was entitled to use the three-factor apportionment formula -- because of the 'intervening legislation' passed by the Michigan Legislature," Horn said. However, Horn said the Michigan Supreme Court was aware of SB 156 by way of the state's supplemental authority accompanying its motion for rehearing, which the court denied.
"Whenever any segment of our legal system -- law enforcement, prosecutors, the judiciary -- acts contrary to the law, there is a reason for significant concern," Horn said. "I'm sure a plausible defense will be made for Judge Talbot's ruling, but the decision is difficult for taxpayers and others concerned about the rule of law."
Horn was using the term "rule of law" in the sense of the following definition: "No branch of government is above the law, and no public official may act arbitrarily or unilaterally outside the law." But Jeff Friedman of Sutherland Asbill & Brennan LLP said the case also raises significant issues associated with the rule of law in terms of whether a person subject to a law can rely on it.
Protecting the Fisc
Horn, who has coauthored articles5 on retroactive tax legislation and refunds, had no comment on the compact election and apportionment formula litigation generally. However, she said, "I have a grave concern about legislative bodies retroactively distinguishing claims of taxpayers that have been determined by the courts to be legitimate."
"'Correcting' tax laws, or retroactively changing the law to protect the fisc, is eroding the 'interest in finality and repose' to which taxpayers are entitled, to use Justice [Sandra Day] O'Connor's words in her concurring opinion in Carlton," Horn said.
In United States v. Carlton, the U.S. Supreme Court allowed a change to the federal estate tax when the amendment's retroactive application was rationally related to its legitimate purpose, as Congress acted promptly in proposing the amendment within a few months and established a modest retroactivity period that extended only slightly longer than a year.6
Jorge Rodriguez of Rodriguez Law Firm PLLC said Talbot's recent decisions in IBM, Anheuser-Busch, Ingram Micro, and Yaskawa America show that Carlton continues to lurk in the background.7 "Even though U.S. v. Carlton arose in the context of a retroactive federal tax law, the influence of Carlton is particularly felt in the state tax rather than the federal context, and this can be seen in Judge Talbot's decisions upholding retroactive application of Michigan's repeal of the Multistate Tax Compact for a far greater period of time than the retroactive period at issue in Carlton itself," Rodriguez said.
In December at a panel on due process during New York University's Institute on State and Local Taxation, Rodriguez argued that there's no limit to the constitutionality of a state's retroactive application of tax laws if protecting the state's budget from the revenue hit of paying out refunds owed always serves a legitimate public purpose.
Horn agreed. "Justice [Antonin] Scalia made this very point in his concurring opinion in Carlton," she said. "He stated, 'The reasoning the Court applies to uphold the statute in this case guarantees that all retroactive tax laws will henceforth be valid.' To pass constitutional muster the retroactive aspects of the statute need only be 'rationally related to a legitimate legislative purpose.'"8
David Fruchtman of Rimon PC said that too often, states argue in court that a decision in a taxpayer's favor will be applied by other taxpayers as well and will cost the jurisdiction an unverifiable enormous amount in refunds. Michigan cited avoiding the potential $1.1 billion revenue hit as a result of refunds owed as a significant, legitimate public purpose for the retroactive repeal of the compact. "The Michigan Supreme Court rightly refused to be moved by such an argument," Fruchtman said.
More generally, Fruchtman said, states are implying that they should be able to keep the money because they need it and cannot afford to return it. "Well, taxpayers need the money, too -- and it's their money," Fruchtman said. "Moreover, what is one to think about a state that makes such an assertion but, shortly thereafter, announces that it is running a huge budget surplus, as occurred earlier this year in Minnesota?" In court documents filed in Minnesota's lead compact election case, Kimberly-Clark Corp. v. Commissioner of Revenue, the state's solicitor general cited estimates that Minnesota would have to refund nearly $700 million in taxes before interest if out-of-state taxpayers prevailed in asserting the right to apportion their business income using the compact's evenly weighted three-factor formula.9 "The point is that none of this has anything to do with the merits of the case, except as a signal to the court that the state lacks confidence in its position," Fruchtman said.
Bruce Johnson, a past chair of the Multistate Tax Commission and the Utah State Tax Commission, said that procedurally, IBM is fascinating but is unique to IBM. Johnson said that to him, all of Talbot's interesting analysis of the compact and the retroactive application of P.A. 282 is in the earlier Ingram Micro and Yaskawa America opinions.
Wayne D. Roberts of Varnum LLP agreed. Roberts said he believes the separation of powers analysis from Yaskawa is one of the most interesting portions of the Court of Claims' decisions in these matters. "In that section of the opinion, the Court of Claims highlights how specific the Michigan Supreme Court plurality holding in IBM was, and notes that the Michigan Supreme Court's finding that there was no implicit repeal does not prevent -- and possibly invites -- an explicit repeal of the compact's three-factor election," Roberts said.
Talbot's IBM order appears to be a natural extension of the Court of Claims' general holdings in Yaskawa and the other cases involving the application of the retroactive law, Roberts said. He also said IBM is procedurally unique because the ultimate resolution of the case was specifically affected by the retroactive legislation after the Michigan Supreme Court held that IBM was entitled to the refund under pre-P.A. 282 law. "However, this is not necessarily an anomaly because retroactive legislation in Michigan generally has been upheld as applied to cases that are pending at the time the legislation is enacted," Roberts said.
"Based on the IBM holdings to date, the question whether retroactive legislation is good policy appears to be separate from the question whether such legislation is legally allowable," Roberts continued. "But the story likely is not over. There is little doubt that there will be additional litigation to more fully develop the remaining questions presented by the IBM case."
Correcting an Error
Johnson said there are really two different aspects of retroactivity in the application of tax laws. One would be if Utah lawmakers were to decide the state could get more revenue from a single sales factor and enact the formula effective three years ago -- a scenario he said most people would find egregious. But he said that's not really the case with Talbot's opinion in IBM or in Carlton, in which lawmakers were trying to correct an error. When it turned out there was a technical error in the way the Legislature corrected an error, taxpayers who thought they were complying with the law saw an opportunity to get some of that money back, Johnson said.
"And that's entirely appropriate, but it's not like the expectations they had when they originally filed their returns had been frustrated," Johnson said. "They all thought they needed to use a single-sales-factor formula, and the Legislature thought they needed to use a single-sales-factor formula."
The reason there is so much money at issue in the Michigan litigation generally, Johnson said, is because taxpayers understood what the Legislature thought it was requiring and filed their taxes accordingly. "It's when you have the confluence of two different bodies of law that seem to go in different directions that you have this kind of misunderstanding where states are relying on one revenue stream and taxpayers are paying accordingly," Johnson said, referring to statutes that are presumed valid but then are argued to be trumped by the constitution or, in these cases, the compact.
While good lawyers legitimately can argue that there was an error in the way the lawmakers did it -- and that thus, there is an argument that the three-factor formula is still available -- "it's not, I guess, offensive to me when the Legislature says we screwed up and we're going to go back and make sure that the law is what you thought it was in the first place," Johnson said.
Johnson said this perspective is based on the understanding that -- as Talbot said in his earlier analysis -- the Multistate Tax Compact is an advisory compact and not binding on the state. Johnson said that to him, the interesting question is what would have happened if instead of challenging the compact in U.S. Steel, taxpayers had gone with the states to Congress to receive approval of the compact so that it became federal law.
"I think we'd have a whole different ball game, and I would think we'd have a much better tax system," Johnson said. "I think the law would be better -- I think the system would be more equitable -- if multistate companies did have that option [the compact's elective three-factor formula] available to them, because I don't think the single sales factor does a good job of fairly representing the business activity in the state."
Horn said pinpointing the predominant constitutional issues in the Michigan cases is tough. "There are multiple questions raised in IBM and similar cases, including contract clause claims, due process, separation of powers -- and how these questions get raised procedurally also will impact what questions are presented," she said. However, Horn added, because not all states have the compact election question, the issue with the broadest impact is the due process question.
Friedman, meanwhile, said Talbot's order in IBM further emphasizes the separation of powers issue associated with Michigan's retroactive withdrawal from the Multistate Tax Compact.
"While the Michigan Supreme Court ruled in IBM that the 2008 Michigan Legislature did not intend to explicitly or impliedly repeal the compact's three-factor election, the court of claims decision -- if left standing -- would empower the 2014 Legislature to essentially overturn the Michigan Supreme Court's decision by reinterpreting what prior Legislatures intended," Friedman said. "In some sense, this decision could be viewed as a do-over by the Michigan Legislature which could undermine the rule of law and whether taxpayers can rely on statutory and judicial law in Michigan." Rodriguez agreed that retroactive tax laws like P.A. 282 in Michigan raise significant due process issues and give rise to other constitutional concerns, including possible separation of powers issues.
"The retroactivity pendulum has swung too far in the direction of state tax authorities," Rodriguez said. However, he added that the recent Caprio and James Square decisions in New York in favor of taxpayers in due process challenges to retroactive changes may signify that the pendulum has started to swing back in favor of taxpayers.10
"If so, the IBM and related cases may be the best test cases we have seen in years for the U.S. Supreme Court to revisit and possibly limit the influence of the ghost of Carlton," Rodriguez said.
The U.S. Supreme Court took three state tax cases this session. Horn said this could mean the Court is open to taking more state tax cases -- or it could just as easily mean it will be another several decades before the Court reviews another.
Friedman agreed, saying, "It is likely that the Court will receive more cert petitions because taxpayers and states have increased confidence that they have better than a puncher's chance of having a cert granted." But ultimately, Friedman said, the significance of Talbot's April 28 order and opinion in IBM "is that we will see an appeal, which will most likely ultimately be decided by the Michigan Supreme Court, concerning retroactive tax legislation and separation of powers, among other challenges."
IBM had a May 19 deadline for filing a claim of appeal with the Michigan Court of Appeals.
Separately, the Michigan Court of Appeals on April 24 entered an order expediting the calendaring of a large group of consolidated cases in which taxpayers are challenging the state's retroactive repeal of the compact so that the cases proceed ahead of all other cases challenging P.A. 282. Arby's Restaurant Group Inc., the first known taxpayer to file a complaint in the court of claims directly challenging the validity of the retroactive repeal of the compact, is no longer the lead case on the matter.
Instead, IBM -- in a later case involving refund claims for the 2010 tax year denied by Talbot -- is the first listed case in the group of consolidated cases.11 The taxpayers in the group of consolidated cases have filed briefs. The Department of Treasury's deadline for filing briefs in the consolidated cases was May 21.
1IBM Corp. v. Dep't of Treasury, No. 11-000033-MT (Mich. Ct. Cl. 2015).
2IBM Corp. v. Dep't of Treasury, No. 146440 (Mich. 2014).
3 SB 156, P.A. 282 of 2014.
5See Gregory A. Castanias et al., "Retroactivity and Refunds: Can They Really Keep Your Money?" State Tax Notes, Aug. 16, 2010, p. 419; Erica Horn and Stephen Sherman, "Retroactive Tax Legislation: Where Is the Modesty?" Bloomberg BNA Tax Management Weekly State Tax Report, Vol. 19, Issue 47, Nov. 23, 2013.
6United States v. Carlton, 512 U.S. 26 (1994).
7 Talbot order in Anheuser-Busch Inc. v. Dep't of Treasury, Case No. 11-85-MT (Mich. Ct. Cl. 2015).
8Carlton, 512 U.S. at 40.
9 Notice of Appeal, Kimberly-Clark Corp. & Subsidiaries v. Comm'r of Rev., No. 08670 (Minn. T.C. 2013).
10Caprio v. Dep't of Taxation and Finance, 2012 N.Y. slip op. 22273 (N.Y. Sup. Ct. 2012); James Square Associates LP v. Mullen, 993 N.E.2d 374 (N.Y. 2013).
11IBM Corp. v. Dep't of Treasury, No. 325484 (Mich. Ct. App. 2015). See also Hamilton, "State's Retroactive Repeal of Tax Compact Is Subject of New IBM Motion," State Tax Notes, Feb. 9, 2015, p. 317.
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