State & Local Tax Alert

Transcription

1 State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP Michigan Court of Appeals Holds Indirect Ownership for Unitary Determinations Excludes Constructive Ownership The Michigan Court of Appeals has held that the language in the unitary business group statutory definition requiring that a member owns or controls, directly or indirectly more than a 50 percent interest in the other members refers to ownership through an intermediary and does not include constructive ownership. 1 Because Michigan tax law does not define indirect ownership or control, the Court of Claims considered provisions in the Internal Revenue Code (IRC). The Court of Appeals concluded that the Court of Claims incorrectly concluded that indirect ownership includes constructive ownership. After determining that there was no comparable federal context in the IRC, the Court of Appeals considered the plain and ordinary meaning of the statutory language. Under this approach, the Court of Appeals held that indirect ownership means ownership through an intermediary rather than constructive ownership. Background This case involved three different entities during the relevant tax periods. The taxpayer, LaBelle Management, Inc. (LMI), was a Michigan corporation owned by two brothers. Originally, LMI was a subsidiary of another Michigan corporation, Pixie, Inc. (PI), but PI sold all of its interest in LMI to the brothers on January 1, During the relevant tax periods, neither brother ever owned more than 50 percent of the common stock of LMI or PI. The third entity, LaBelle Limited Partnership (LLP), was formed by the two brothers. Each brother originally held a 1 percent general partnership interest and a 49 percent limited partnership interest, but their shares in the limited partnership were later reduced when their children were added as limited partners. Release date May 3, 2016 States Michigan Issue/Topic Michigan Business Tax Contact details Terry Conley Southfield (Detroit) T E terry.conley@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 After being sold by PI, LMI reported its Michigan Business Tax (MBT) as a separate company. Following an audit conducted during 2011 and 2012, the Michigan Department of Treasury determined that all three entities should be treated as a unitary business group. The Department concluded that LMI indirectly owned 100 percent of PI and LLP, and that PI indirectly owned 100 percent of LMI and 90 percent of LLP. LMI paid the resulting tax bill in protest and commenced a lawsuit in the Michigan Court of Claims. LMI and the Department brought cross-motions for summary disposition. 1 LaBelle Management, Inc. v. Department of Treasury, Michigan Court of Appeals, No , March 31,

2 Grant Thornton LLP - 2 Michigan Court of Claims Decision The Michigan Court of Claims was required to decide whether the Department correctly concluded that the three entities satisfied the unitary business group definition under Michigan law which requires one member of the group to directly or indirectly own or control more than 50 percent of the ownership interests of the other members. 2 Because it was undisputed that no entity directly owned more than a 50 percent interest of the others, the Court had to determine whether there was sufficient indirect ownership or control to satisfy the statutory definition. After finding that Michigan law did not define indirect ownership, the Court of Claims considered federal provisions, IRC Sections 957 and 958, which concern the treatment of controlled foreign corporations. The Court explained that [t]he provisions most contextually analogous to a state s determination of indirect ownership or control for combined return purposes are the IRC s international taxation provisions that require a U.S. shareholder to include in its return the income of a controlled foreign corporation. Similar to the Michigan statute defining unitary business group, IRC Section 957 refers to more than 50 percent ownership. Based on IRC Sections 957 and 958, the Court determined that indirect ownership included constructive ownership. The Court held that the three entities were unitary for purposes of the MBT because they satisfied the indirect ownership requirement through constructive ownership. As a result, the Court denied LMI s motion for summary disposition and granted the Department s motion for summary disposition. LMI appealed this case to the Michigan Court of Appeals. Court of Appeals Decision Interpreting Indirect Ownership In reversing the Court of Claims, the Court of Appeals rejected the application of the federal definition and considered the plain and ordinary meaning of owns or controls, directly or indirectly. Using this approach, the Court of Appeals concluded that the statutory language means ownership through an intermediary rather than constructive ownership. Because none of the entities owned, through an intermediary or otherwise, more than 50 percent of any other entity, the Court granted LMI s motion for summary disposition. No Comparable Federal Context The Court of Appeals determined that the Court of Claims erred in using the federal income tax definition of constructive ownership when defining Michigan s statutory indirect ownership requirement. The MBT statutes do not define indirect ownership or control, but they provide that [a] term used in this act and not defined differently shall 2 Because this case concerned the MBT, the Court considered the MBT statute that defines unitary business group. MICH. COMP. LAWS (6). However, the Michigan corporate income tax, which applies to tax years beginning on or after January 1, 2012, has a similar unitary business group definition that contains the same owns or controls, directly or indirectly language. MICH. COMP. LAWS (6). Note that the Department also supported its argument with Revenue Administrative Bulletin , Michigan Department of Treasury, Feb. 5, This document, which provides a unitary business group control test for purposes of the MBT, explains that an ownership interest is indirectly owned by a person when that person constructively owns such an interest.

3 Grant Thornton LLP - 3 have the same meaning as when used in comparable context in the laws of the United States relating to federal income taxes in effect for the tax year unless a different meaning is clearly required. 3 However, the federal context must be comparable to the Michigan context. 4 In a case where no comparable context was apparent, the Michigan Supreme Court concluded that the Legislature intended that the word was to be constructed according to its ordinary and primarily understood meaning. 5 In the instant case, the Court of Claims acknowledged that no federal income tax provision is directly comparable to the disputed indirect ownership provision under Michigan law. The Court of Appeals determined that the Court of Claims should have used the normal rules of statutory construction to determine the meaning of indirect ownership, rather than looking to the IRC. According to the Court of Appeals, the Court of Claims mistakenly searched for contextually analogous provisions in the IRC and considered the federal controlled foreign corporation provisions that apply to international tax. IRC Section 957 concerns whether more than 50 percent of a corporation s voting stock or total value of stock is owned (within the meaning of section 958(a)), or is considered as owned by applying the rules of ownership of section 958(b). 6 IRC Section 958(a) addresses direct and indirect ownership, while IRC Section 958(b) concerns constructive ownership. 7 The Court of Appeals explained that, assuming IRC Section 958 is a comparable context, the correct section to apply is IRC Section 958(a), which uses the same direct and indirect ownership language used by the Michigan statute, rather than IRC Section 958(b). These rules of actual and constructive ownership apply to indirectly owned stock, but they do not define indirect ownership. After considering a variety of federal tax statutes and regulations, the Court of Appeals concluded that federal law provides many examples indicating that indirect ownership and constructive ownership are two different concepts. Federal statutes and regulations never provide that indirect ownership means constructive ownership. The Court explained that rules of constructive ownership are not broadly applied any time indirect ownership is involved, but only when the statute or regulation expressly mandates applying those rules. Plain and Ordinary Meaning Applied Because there was no comparable federal context in the IRC, the Court of Appeals considered the plain and ordinary meaning of the owns or controls, directly or indirectly language contained in the Michigan statute. Following a thorough examination of the dictionary definitions of indirect and indirectly, the Court held that indirect ownership means ownership through an intermediary rather than ownership by operation of legal fiction (constructive ownership). 3 MICH. COMP. LAWS (emphasis added). 4 Town & Country Dodge, Inc. v. Department of Treasury, 362 N.W.2d 618 (Mich. 1984). 5 Id. 6 IRC 957(a) (emphasis added). 7 Constructive ownership is not true ownership but is a legal fiction.

4 Grant Thornton LLP - 4 As explained by the Court of Appeals, [w]hile federal law often substitutes rules of constructive ownership when addressing stock indirectly owned, it does not do so consistently, and the constructive ownership rules only apply when the statute specifically so directs. In this case, the Michigan statute did not provide that indirect ownership included constructive ownership. Further, the Department s argument could not avoid using the phrase considered as owned even though this language was absent from the statute. The Court acknowledged that [t]he constructive ownership rules from federal law may apply when a statute involves stock owned or considered as owned, but to apply it to [the Michigan unitary business group definition] expands the statute beyond the meaning intended by the Legislature. There was no unitary business group in the instant case because none of the three entities actually owned more than 50 percent of any other entity. As a result, the Court granted LMI s motion for summary disposition. Commentary In this case, the Court of Appeals reversed the Court of Claims and prevented the Department from expanding the definition of unitary business group to include constructive ownership. Although this case addresses the MBT definition of unitary business group, it should also apply to unitary business group determinations for purposes of Michigan s corporate income tax adopted in The unitary business group definitions provided in the corresponding MBT 8 and corporate income tax 9 statutes both use the owns or controls, directly or indirectly language. This case illustrates the analysis that should be applied when a statutory term is not expressly defined by Michigan law. If a term is used in a comparable context under federal law, courts generally should apply the federal definition to Michigan law. However, if a term is not used in a comparable context under federal law, courts should consider the plain and ordinary meaning of the term. In the instant case, the Court of Claims mistakenly considered the federal meaning of the term even though it was not used in a comparable context. The Court of Appeals indicated that a comparable context will be scrutinized and that a merely contextually analogous threshold is not sufficient to consider a federal provision over the plain and ordinary meaning of a term. Furthermore, the Court of Claims erroneously concluded that federal law indicated that indirect ownership generally was satisfied by constructive ownership. The Court of Appeals clarified that indirect ownership does not usually include constructive ownership. Although this case provides some clarity regarding the analysis to use when a statutory term is not defined by Michigan law, it leaves some unanswered questions. The Court of Appeals expressly holds that indirect ownership means ownership through an intermediary, not ownership by operation of legal fiction. 10 However, the Court does not define intermediary or provide much guidance on its meaning. Indirect ownership presumably continues to include ownership through attribution. Furthermore, this decision seems to at least partially contradict a Revenue Administrative (RAB) that provides the unitary 8 MICH. COMP. LAWS (6). 9 MICH. COMP. LAWS (6). 10 Emphasis in original.

5 Grant Thornton LLP - 5 business group control test for purposes of the MBT. 11 This guidance clarifies that [i]ndirect ownership includes ownership through attribution and an ownership interest is indirectly owned by a person when that person constructively owns such an interest. The Department used this RAB to support its argument that indirect ownership includes constructive ownership. A more recent RAB providing the unitary business group control test for purposes of the corporate income tax contains identical language. 12 This case apparently invalidates the indirect ownership provisions contained in these RABs, suggesting that there may be continuing implications with respect to the Michigan corporate income tax. There may be further developments concerning this case. On April 21, 2016, the Department filed a motion for stay and a motion for reconsideration. Because the decision does not clearly define intermediary and seems to invalidate provisions in two RABs published by the Department, there likely will be additional news concerning the indirect ownership issue in the near future. 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 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. 11 Revenue Administrative Bulletin , Michigan Department of Treasury, Feb. 5, Revenue Administrative Bulletin , Michigan Department of Treasury, Jan. 7, 2013.