State & Local Tax Alert

Transcription

1 State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP Michigan Tax Tribunal Finds Passive Holding Company Did Not Have Nexus for Detroit Income Tax On May 2, 2017, the Michigan Tax Tribunal granted a passive holding company s motion for summary disposition and held that it did not have the requisite nexus with the city of Detroit for purposes of the City of Detroit Income Tax (CDIT). 1 Although the company was doing business under the broad definition of the term contained in the City Income Tax Act, the company had no physical presence or minimum connection to Detroit. Furthermore, the Tribunal determined that even though the company was part of a unitary business group that was based in Detroit, the company itself did not have nexus with the city for purposes of the CDIT. Background Huron, a private equity firm, created a fund to invest in Labstat International, ULC ( Labstat ), a Canadian company. The taxpayer, Apex Laboratories International Inc. ( Apex ), was created during the acquisition process to hold the fund s investment in Labstat. In 2010, Apex received a dividend from Labstat. Apex filed a CDIT return and paid CDIT on the income at a 1 percent tax rate. In 2012, Apex sold its interest in Labstat and filed a CDIT return reporting the gains and dividend income from the sale of Labstat. In March 2015, Detroit issued a proposed assessment to Apex indicating that it had nexus with the city and thus owed an additional 1 percent of CDIT, interest, and penalties for 2010 and 2012 resulting from dividends and capital gains received. 2 Arguing that it did not conduct business in the city, Apex filed for a refund of CDIT paid on its 2012 income tax return and amended 2010 income tax return. Detroit denied the refund claim and Apex filed an appeal with the Tribunal. Apex and Detroit subsequently filed cross-motions for summary disposition. Structure of the CDIT The CDIT is imposed on the taxable net profits of a corporation doing business in the city and is levied on the taxable net profits earned by the corporation as a result of work Release date July 5, 2017 States Michigan Issue/Topic City of Detroit Income Tax Contact details Terry Conley Southfield (Detroit) T E terry.conley@us.gt.com Bryan Bays Southfield (Detroit) T E bryan.bays@us.gt.com Jamie C. Yesnowitz Washington, DC T E jamie.yesnowitz@us.gt.com Chuck Jones Chicago T E chuck.jones@us.gt.com Lori Stolly Cincinnati T E lori.stolly@us.gt.com Priya D. Nair Washington, DC T E priya.nair@us.gt.com 1 Apex Laboratories International Inc. v. City of Detroit, Michigan Tax Tribunal, No , May 2, The tax rate was 1 percent for 2010 and 2 percent for According to the city s workpapers submitted to the Tribunal, Apex only paid tax at the 1 percent rate for Most of the proposed assessment resulted from Apex paying tax at the 1 percent rate rather than the 2 percent rate for

2 Grant Thornton LLP - 2 done, services rendered and other business activities conducted in the city. 3 Subject to certain exceptions, 4 doing business is the conduct of any activity with the object of gain or benefit. 5 Definition of Doing Business Satisfied Employing a statutory construction analysis, the Tribunal first addressed the threshold issue of whether Apex met the statutory definition of doing business under the City Income Tax Act (CITA). Detroit s City Code, under which Apex s assessment was imposed, incorporates the CITA. 6 The Tribunal noted that Apex was created to hold Labstat s stock and debt, and this activity, although passive in nature, falls within CITA s broad definition of doing business, which only requires a showing of any activity. Additionally, as required under the definition, Apex was created with the objective of gain or benefit. Specifically, once the investment opportunity in Labstat was identified, Apex was created to maximize this investment. Apex received a dividend as a result of its Labstat stock holding and the sale of its Labstat interest gave rise to gain and return of capital. As a result, the Tribunal concluded that Apex met the doing business statutory definition. Requisite Nexus Not Established Having determined that Apex was doing business, the Tribunal considered whether Apex was doing business in Detroit and had the nexus needed for imposition of the CDIT. Citing Quill, the Tribunal explained that the Due Process Clause of the U.S. Constitution requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax. 7 Specifically, in order for Apex to be subjected to tax, some minimum connection or physical presence must be shown between Detroit and the transaction that the city sought to tax, the sale of the Labstat shares. Detroit raised three arguments to support its position that nexus existed between the city and Apex. Commercial Domicile First, Detroit argued that Apex had sufficient nexus because its commercial domicile was in the city. The Tribunal rejected this argument, explaining that the concept of commercial domicile has no bearing on the determination of nexus between Apex and Detroit. Commercial domicile refers to the principal place a business is directed or 3 MICH. COMP. LAWS [D]oing business does not include: (a) the solicitation of orders by a person or his representative in the city for sales of tangible personal property, which orders are sent outside the city for approval or rejected, and if approved, are filled by shipment or delivery from a point outside the city; (b) the solicitation of orders by a person or his representative in the city, in the name of or for the benefit of a prospective customer of a person, if orders by the customer to such person to enable the customer to fill orders resulting from the solicitation are orders described in paragraph (a); and (c) the mere storage of personal property in the city in a warehouse neither owned nor leased by the taxpayer. MICH. COMP. LAWS MICH. COMP. LAWS The assessment was imposed under Detroit City Code, Part III, Ch. 18, Art. X, Ordinance (c). 7 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

3 Grant Thornton LLP - 3 managed. Because Apex is a passive holding company, it does not engage in an active trade or business that requires either a physical location or express direction or management. Physical Presence Detroit next argued that Apex had a physical presence in the city. Noting that physical presence is key to establishing nexus, the Tribunal explained that, while the CITA does not provide a definition for the term, the Michigan Income Tax Act defines physical presence as: [A]ny activity conducted by the taxpayer or on behalf of the taxpayer by the taxpayer s employee, agent, or independent contractor acting in a representative capacity. Physical presence does not include the activities of professionals providing services in a professional capacity or other service providers if the activity is not significantly associated with the taxpayer s ability to establish and maintain a market in this state. 8 Relying on this definition, the Tribunal concluded that there was no nexus between Apex and Detroit. Central to the Tribunal s analysis was the distinction between Apex, Huron and Labstat. Detroit based its nexus argument on the activities of Apex s officers and directors, conducted in the Detroit office, and the contracted consulting services used during the sale of Labstat. However, the Tribunal explained that the activities of the officers and directors were performed for Huron and Labstat and not at the direction of Apex. The Tribunal also explained that the use of professional consultants does not establish physical presence because the definition of physical presence specifically excludes the activities of professionals providing services that are not significantly associated with the taxpayer s ability to establish and maintain a market. 9 The Tribunal noted that the conduct of Apex s officers and directors was directed by Huron and they were only incidental to Apex s primary activity of holding the shares and debt of Labstat. Additionally, the Tribunal noted that Apex did not engage in the sale of goods or services in Detroit and, as a passive holding company, did not engage in an active trade or business. Based on these findings, the Tribunal concluded that Apex s income came from Labstat s activities, which could not be attributable to Apex and did not establish a physical presence in Detroit. No Nexus Through Unitary Business Group The Tribunal also rejected Detroit s argument that Apex had nexus with the city as a member of Huron s Detroit-based unitary business group. The Tribunal explained that the unitary business principle is not a method to determine nexus but rather is an 8 MICH. COMP. LAWS (2)(b). 9 Id.

4 Grant Thornton LLP - 4 apportionment concept. Furthermore, the CITA does not provide language that allows for the unitary business concept to create a nexus link to a corporation. Based on these findings, the Tribunal granted Apex s motion for summary disposition, concluding that it did not have nexus with Detroit and, as a result, was not required to pay any CDIT for the 2010 and 2012 tax years. Commentary Detroit is currently emerging from a historic bankruptcy and is looking to boost income tax revenues. 10 Key to achieving this goal is a plan that focuses more of the city s resources on tax enforcement. 11 According to Detroit s chief deputy chief financial officer and finance director, the city is now in a much better position to enforce tax laws aggressively and fairly review taxpayers filings to ensure everyone is paying their fair share toward city services. 12 This case could arguably be seen as a reflection of the aggressive compliance climate in Detroit. For example, Detroit s attempt to rely on the unitary business principle as a mechanism to establish nexus could be viewed as pushing certain boundaries. As the Tribunal noted, the unitary business principle is an apportionment concept and furthermore, the CITA itself does not allow for this concept to be used to establish nexus. Ultimately, taxpayers conducting business in Detroit should closely monitor the evolving compliance climate. Detroit has already identified certain areas of big potential for its compliance efforts, which include law firms with lawyers who work in the city proper, hospitals and physicians groups with doctors and surgeons working in the city, and 63 of the city s largest purchasers of spirits through the state s Liquor Control Commission, primarily party stores in Detroit. 13 Detroit is also planning, in the near future, to target athletes and entertainers who perform in Detroit and has preliminary plans to target tobacco wholesalers, funeral homes, real estate sales companies and developers, construction projects, medical marijuana shops and even the North American International Auto Show. 14 In addition, since January 2017, the Michigan Department of Treasury is administering Detroit s corporate, partnership and fiduciary income tax return processing. 15 The transfer of this tax administration to the state may increase the probability of aggressive audits. The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant 10 Matt Helms, Income Tax Crackdown Brings Detroit More Revenue, DETROIT FREE PRESS, Dec. 17, Id. 12 Id., quoting John Naglick, the city s chief deputy chief financial officer and finance director. 13 Id. 14 Id. 15 For more information, see

5 Grant Thornton LLP - 5 Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed.