MALPASS v DEPARTMENT OF TREASURY; WHEELER ESTATE v DEPARTMENT OF TREASURY; HUZELLA v DEPARTMENT OF TREASURY; WRIGHT v DEPARTMENT OF TREASURY; WHEELER v DEPARTMENT OF TREASURY
Docket Nos. 144430, 144431, 144432, 145367, 145368, 145369, and 145370
Michigan Supreme Court
June 24, 2013
494 MICH 237
VIVIANO, J.
Argued March 5, 2013 (Calendar Nos. 1, 6).
The Wheeler estate (Docket No. 145367), Nicholas and Lisa J. Huzella (Docket No. 145368), Patrick and Michaelon Wright (Docket No. 145369), and Thomas R. and Patsy Wheeler (Docket No. 145370) (collectively, the taxpayers) filed petitions in the Tax Tribunal, challenging the assessment of taxes for the tax years 1994 and 1995. Members of the Wheeler family were shareholders of Electro-Wire Products, Inc., a Michigan-based S-corporation. Electro-Wire acquired the assets of Temic Telefunken Kabelsatz, GmbH, which resulted in two general partnerships: Temic Telefunken Kabelsatz (TKG), the operating partnership, and Electro-Wire Products, GmbH (EWG), the holding partnership. The acquisition resulted in one S-corporation (Electro-Wire) and two general partnerships (TKG and EWG), with all the income and losses passing through to the owners as individual income. The taxpayers reported the income by treating the businesses as unitary and apportioned the income using the combined apportionment factors of both Electro-Wire and TKG. Following an audit, the department asserted that the unitary business principle did not apply to individuals and that the taxpayers were required to apply Electro-Wirе‘s apportionment factors to its income alone, resulting in liabilities and interest totaling more than $2 million. The tribunal granted the taxpayers’ motion for summary disposition, determining that under the ITA, the unitary business principle applied to individuals as well as to separate corporate entities. The Court of Appeals, HOEKSTRA, P.J., and SAWYER and SAAD, JJ., affirmed, concluding that Electro-Wire and TKG were a unitary business, the taxpayers could use combined reporting under the ITA, and that the apportionment could include income from business activity that was unitary with its Michigan business, Electro-Wire. 297 Mich App 411 (2012). The Supreme Court granted the Department of Treasury‘s application for leave to appeal. 493 Mich App 865 (2012).
In a unanimous opinion by Justice VIVIANO, the Supreme Court held:
Under the ITA, individual taxpayers may combine the profits and losses frоm unitary flow-through businesses and then apportion that income on the basis of those businesses’ combined apportionment factors. For the 1994 and 1995 tax years, the
- The unitary business principle provides that a state may tax multistate businesses on an apportionable share of the multistate business conducted in the taxing state. The following factors are appropriate guides for determining whether business operations are unitary: (1) economic realities; (2) functional integration; (3) centralized management; (4) economies of scale; and (5) substantial mutual interdependence. Individual taxpayers in Michigan may use either a sepаrate-entity reporting method to apportion income, or a combined reporting method. Separate-entity reporting requires each entity with a nexus to the taxing state to be considered as a separate and distinct entity, regardless of whether it could comprise a unitary business with other entities. Combined reporting requires each member of a unitary business to compute its individual taxable income attributable to activities in the state by taking a portion of the combined net income of the group through the utilization of combined apportionment factors. In Malpass, the parties did not dispute that East Jordan and Ardmore were unitary. In Wheeler, considering the totality of the circumstances, the tribunal‘s finding that Electro-Wire and TKG were a unitary business was supported by competent, material, and substantial evidence on the whole record, and the Court of Appeals properly affirmed that conclusion.
MCL 206.4(2) ,206.102 ,206.103 , and206.110(1) clearly require an individual taxpayer with business income stemming from business activity both within and outside of the state to allocate and apportion all business income using the formula set forth inMCL 206.115 . Section 115 provides for the application of formulary apportionment, but does not expressly require that a particular method of apportionment be used. Rather, theMCL 206.115 language is broad enough to allow both the separate-entity reporting and combined reporting method of formulary apportionment. Although the department has required individuals to use separate-entity reporting for flow-through business income in the past, it has not promulgated such a rulе and the Supreme Court declined to adopt the department‘s preferred methodology; the ITA permits combined reporting because it satisfies the clear mandate ofMCL 206.115 that all business income be apportioned to the state.- Taken together,
MCL 206.103 ,206.105 , andMCL 206.20 require unitary businesses that include foreign entities to allocate and apportion their income as provided by the ITA. For the taxyears 1994 and 1995, the version of MCL 206.115 in effect at that time stated in part that all business income shall be apportioned to Michigan; the language of the statute did not limit formulary apportionment to the domestic entities of a unitary business. Accordingly, for the 1994 and 1995 tax years, underMCL 206.115 an individual may use combined reporting for income derived from a foreign entity that is unitary with a domestic business taxable in Michigan. In Malpass, the Court of Appeals erred by concluding that the ITA did not allow the Malpasses to first combine the incomе from their unitary flow-through entities and then apportion it on the basis of the combined apportionment factors of East Jordan and Ardmore. In Wheeler, the Court of Appeals properly affirmed the tribunal‘s conclusion that the ITA contained no geographical limitation for the 1994 and 1995 tax years; combined reporting was proper even though the unitary business of Electro-Wire and TKG included an entity located in a foreign country.
Malpass reversed and remanded to the Court of Claims for reinstatement of the order granting summary disposition in favor of the Malpasses.
Wheeler affirmed, but part III(A) of the Court of Appeals’ opinion vacated because it relied on Malpass, which was reversed by this decision.
1. TAXATION - INCOME TAX - MULTISTATE BUSINESSES - UNITARY BUSINESSES - SEPARATE-ENTITY AND COMBINED REPORTING.
The unitary business principle provides that a state may tax multistate businesses on an apportionable share of the multistate business conducted in the taxing state; individual taxpayers in Michigan may use either a separate-entity reporting method to apportion income, or a combined reporting method; separate-entity reporting requires each entity with a nexus to the taxing state to be considered as a separate and distinct entity, regardless of whether it could comprise a unitary business with other entities; combined reporting requires each member of a unitary business to compute its individual taxable income attributable to activities in the state by taking a portion of the combined net income of the group through the utilization of combined apportionment factors;
2. TAXATION - INCOME TAX - COMBINED REPORTING - UNITARY BUSINESSES - FOREIGN BUSINESSES.
For the 1994 and 1995 tax years, under
Warner, Norcross & Judd, LLP (by Jason L. Byrne, Stephen R. Kretschman, and Nicole L. Mazzocco), for Tad and Brenda L. Malpass, Tracy and Brenda K. Malpass, and Fred and Barbara Malpass.
Honigman, Miller, Schwartz & Cohn, LLP (by June Summers Haas and John D. Pirich), for the estate of Thomas M. Wheeler, Nicholas and Lisa J. Huzella, Patrick and Michaelon Wright, and Thomas R. and Patsy Wheeler.
Bill Schuette, Attorney General, B. Eric Restuccia, Deputy Solicitor General, Richard A. Bandstra, Chief Legal Counsel, and Kevin T. Smith, Assistant Attorney General, for the people.
Amici Curiae:
Marjorie B. Gell for the State Bar of Michigan Taxation Section.
VIVIANO, J. In these consolidated cases, we address the application of Michigan‘s statutory apportionment formula for individuals with flow-through business income under the Michigan Income Tax Act (ITA).1 In both cases, the individual taxpayers received income
We hold that the ITA does not prohibit individual taxpayers from combining the profits and losses from unitary flow-through businesses and then apportioning that income on the basis of the businesses’ combined apportionment factors. Moreover, we hold that the ITA did not limit apportionment of income to domestic businesses during the 1994 and 1995 tax years, and that the apportionment could properly be applied to a foreign entity to the extent that the foreign entity and the individual taxpayer‘s in-state business were unitary.
Accordingly, (1) we reverse the Court of Appeals’ judgment in Malpass and reinstate the order entered by the Court of Claims granting summary disposition in favor of the Malpasses, and (2) we affirm the Court of Appeals’ judgment in favor of the Wheelers.
I. FACTS AND PROCEDURAL HISTORY
A. MALPASS v DEPARTMENT OF TREASURY
Plaintiffs, individual members of the Malpass family, owned and operated East Jordan Iron Works (East Jordan), an iron foundry in East Jordan, Michigan. They also owned and operated Ardmore Foundry, Inc. (Ardmore), an iron foundry in Ardmore, Oklahoma. Both were Michigan corporations. Because of their S-corporation classification under the Internal Revenue
For the tax years of 2001, 2002, and 2003, East Jordan operated at a profit and Ardmore operated at a loss. In their initial returns, the Malpasses treated the companies as separate, non-unitary entities. Accordingly, the Malpasses attributed East Jordan‘s income to Michigan and Ardmore‘s losses to Oklahoma. The Malpasses then amended their returns for the 2001, 2002, and 2003 tax years, treating East Jоrdan and Ardmore as a unitary business, and combining East Jordan‘s profits with Ardmore‘s losses. The combined amount from the unitary business was then apportioned to Michigan on the basis of the Michigan apportionment factors, resulting in claims for refunds totaling over $1 million.
After the Department rejected the Malpasses’ amended returns, the individual taxpayers brought actions in the Court of Claims. The actions were consolidated, and on November 19, 2009, the Court of Claims granted summary disposition in favor of plaintiffs. The Court of Claims determined that East Jordan and Ardmore were a unitary business on the basis of an undisputed affidavit. It then concluded that the unitary business principle applied to the ITA and that the Malpasses could first combine the income and losses of East Jordan and Ardmore and then apportion the аggregate.
In a published opinion, the Court of Appeals reversed, concluding that East Jordan and Ardmore were separate and legally distinct business entities and that the ITA did not allow for combined reporting of separate entities.3 The Court of Appeals concluded that the
B. WHEELER v DEPARTMENT OF TREASURY
Members of the Wheeler family were shareholders of Electro-Wire Products, Inc. (Electro-Wire), a Michigan-based S-corporation that made electrical systems. Electro-Wire acquired the assets of Temic Telefunken Kabelsatz, GmbH, a German company. The asset purchase resulted in two general partnerships: Temic Telefunken Kabelsatz, GmbH (TKG), the operating рartnership, and Electro-Wire Products, GmbH (EWG), the holding partnership. The end result of the acquisition was one S-corporation (Electro-Wire) and two general partnerships (TKG and EWG), with all the income and losses passing through to the owners as individual income.
For the tax years 1994 and 1995, the Wheelers reported the pass-through Electro-Wire income on their individual tax returns; the income included partnership income from TKG. The Wheelers treated the businesses as unitary and then apportioned the income using the combined apportionment factors of both companies. After an audit and a determination that the unitary business principle did not apply to individual taxpayers, the Department required the Wheelers to apportion the income stemming from Electro-Wire on the basis оf Electro-Wire‘s apportionment factors and to disregard TKG‘s factors, resulting in liabilities and interest totaling over $2 million.
The Tax Tribunal granted summary disposition in favor of the Wheelers, finding that there was no language in the ITA that supported the Department‘s assertion that
II. STANDARD OF REVIEW
In Malpass, we review de novo the trial court‘s decision on a motion for summary disposition.7 Our review of the Tax Tribunal‘s decision in Wheeler is limited. In the absence of fraud, we review a Tax Tribunаl decision for “misapplication of the law or adoption of a wrong principle.”8 We consider the Tax Tribunal‘s factual findings conclusive if they are “supported by competent, material, and substantial evidence on the whole record.”9 However, we review issues of statutory interpretation de novo.10
III. ANALYSIS
A. FORMULARY APPORTIONMENT IN MICHIGAN
The Due Process Clause of the Fourteenth Amendment imposes two requirements on a state‘s taxation of
To answer this question, we turn first to the statutory language.19 Our goal in interpreting a statute “is to
Under the ITA, an individual taxpayer‘s entire income is taxable in Michigan if it is derived solely from activity within the state.22 However, if the income is derived from business activity taxable both within and without this state, the ITA requires an individual taxpayer to “allocate and apportion his net income. . . .”23 The ITA further states that, “[f]or a resident individual, . . . all taxable income from any source whatsoever, except that attributable to another state under [
These provisions require an individual taxpayer with business income stemming from business activity both
The Department argues that combined reporting is prohibited because it is not expressly authorized in the ITA for individual taxpayers, like it is for corporate taxpayers.28 However, the Department‘s argument is flawed. The argument is self-defeating because the ITA does not expressly authorize either method of reporting. Moreover, the provision of the corporate tax law applicable at the time of these returns,
The Department also argues that it has always required the use of separate-entity reporting and hаs never approved combined reporting. Although the Department has certain rule-making authority, in this case, the Department has not promulgated a rule requiring separate-entity reporting for individual taxpayers.30 To the extent that the Department has interpreted the statute to prohibit combined reporting, that interpretation is inconsistent with the broad scope of section 115; therefore, it ” ‘conflict[s] with the indicated spirit and purpose of the legislature.’ ”31
In sum, we reject the Department‘s position that the ITA requires separate-entity reporting. Instead, we hold that combined reporting is permitted by the ITA because it satisfies the clear statutory mandate that “[a]ll business income . . . shall be apportioned to this state. . . .”34
B. THE ITA‘S APPLICATION TO FOREIGN ENTITIES
Beyond our determination that an individual taxpayer can use combined reporting for flow-through business income, we also must consider whether this method could extend geographically outside the United States during the tax years of 1994 and 1995. In Wheeler, the Department argues that even if combined
The statutory basis for taxing out-of-state income is § 103, which states:
Any taxpayer having income from business activity which is taxable both within and without this state, other than the rendering of purely personal services by an individual, shall allocate and apportion his net income as provided in this act.37
For purposes of allocation and apportionment of income from business activity under this act, a taxpayer is taxable in another state if (a) in that state he is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business or a corporate stock tax, or (b) that state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not.38
Finally,
We turn now to the ITA provisions dealing with business income to determine if the act otherwise excludes the income of a foreign entity for purposes of allocation and apportionment. Section 115, which deals with the apportionment of business income, states in pertinent part, ”All business income . . . shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is 3.”42 Moreover, the apportionment factors themselves employ universal language when explaining the scope of relevant business activity.
Nowhere in the ITA did the Lеgislature limit formulary apportionment to the domestic entities of a unitary business. In fact, to the extent that the Legislature
Accordingly, we conclude that a unitary business with income from a business in a foreign country could be apportioned under the version of the ITA in effect during the tax years of 1994 and 1995.46
C. APPLICATION TO MALPASS
On appeal, the parties in Malpass do not dispute whether East Jordan and Ardmore were a unitary business. The Court of Appeals, dеspite determining that the businesses had unitary characteristics, wrongly concluded that the ITA does not allow individual taxpayers with flow-through business income from separate legal entities to use combined reporting.47
For the reasons already stated, we hold that the ITA did not prohibit the Malpasses from first combining the income from their unitary flow-through entities and then apportioning it on the basis of the combined apportionment factors of East Jordan and Ardmore. Therefore, we reverse the Court of Appeals’ judgment in Malpass and reinstate the order entered by the Court of Claims granting summary disposition in favor of the Malpasses.
D. APPLICATION TO WHEELER
Unlike in Malpass, the parties in Wheeler dispute whether the Michigan and German entities were a unitary business. The Tax Tribunal found that they were, and the Court of Appeals affirmed. To consider business operations unitary, the United States Supreme Court has held, “[T]here [must] be some sharing or exchange of value not capable of precise identification or measurement—beyond the flow of funds arising out of a passive investment or a distinct business operation—which renders formula apportionment a reasonable method of taxation.”48 Accordingly, a unitary business exists when the income-producing companies have “functional integration, centralization of management, and economies of scale.”49 Other United States Supreme Court decisions have added to these guideposts.50 The Court of Appeals relied on the following five factors
Turning to the evidence offered by the parties, and aware of our limited review of the factual determinations made by the Tax Tribunal, we agree with that body‘s conclusion that the businesses here were unitary. The Court of Appeals affirmed the findings of the Tribunal. Because we agree with the thorough analysis of the Court of Appeals, we adopt its conclusions and holding in full:
The first factor, economic realities, addresses whether the regularly conducted activities of the businesses in question are related. Holloway, 152 Mich App at 832. The record shows that the underlying businesses of Electro-
Wire and TKG were identical because both were engaged in the manufacturing and assembling of electrical distribution systems. Respondent claims that this is immaterial because the two businesses were engaged in the same underlying business before Electro-Wire purchased TKG. However, there is no requirement under Holloway or related cases that potentially unitary businesses develop the same underlying activities collaboratively; the only requirement is that the underlying businesses be related to each other. The second factor, functional integration, concerns the extent to which business functions are blended to promote a unitary relationship. Petitioners presented evidence that, before it was acquired by Electro-Wire, TKG was part of the Daimler Group. Once Electro-Wire purchased TKG, however, this relationship was severed, leaving TKG without critical support services, which were assumed by Electro-Wire. These services included direct management of TKG‘s business activities and support for component engineering, manufacturing and industrial engineering, cost estimating, business development, finance, and executive administration. Respondents presented no rebuttal evidence, but set forth on appeal a list identifying ways in which Electro-Wire and TKG were not integrаted. However, this belated argument is not persuasive because there is no requirement that businesses be 100 percent integrated in order to classify them as unitary.
The third factor examines the extent to which management was centralized across the potentially unitary business. Petitioners submitted unrebutted evidence that TKG‘s overall management decisions were centralized and directed by Electro-Wire managers in North America and that Electro-Wire hired and fired all TKG officers and managers. Again, respondent presented no rebuttal evidence, but alleges that Electro-Wire did not engage in day-to-day management of TKG. Again, however, the only requirement under Holloway is centralized management, not complete management.
The fourth factor looks for the presence of economies of scale. Petitioners presented unrebutted evidence of eco-
nomic benefits generated by the combination of Electro-Wire and TKG, such as an expanded customer base, sharing of unique and proprietary processes, and improved financing terms. Respondent presented no evidence to challenge this, but argues that petitioners failed to show profits through bulk purchasing or improved allocation of resources. These are typically considered to be common economies of scale, but respondent does not explain how cheaper component parts, an expanded customer base, increasing economic diversification, and improved financing conditions are not also benefits derived from economies of scale. The fifth and final factor сonsiders whether substantial mutual interdependence exists. Petitioners submitted unrebutted evidence that acquiring TKG was essential for Electro-Wire to remain a supplier for Ford and that remaining a supplier for Ford was essential for Electro-Wire‘s survival. The Tax Tribunal found that Electro-Wire was dependent on TKG, but was unable to conclude whether or not TKG was similarly dependent on Electro-Wire, and thus resolved this factor partially in favor of petitioners.54
Based on the foregoing, we hold that the Tax Tribunal‘s factual finding that Electro-Wire and TKG were a unitary business was “supported by competent, material, and substantial evidence on the whole record.”55 Because there was evidentiary support for all of the unitary factors, the Court of Appeals properly affirmed the Tax Tribunal‘s сonclusion that Electro-Wire and TKG constituted a unitary business. Because we discern no limitations on the geographical boundaries to which the combined reporting could extend, the Wheelers could combine the profits and losses from Electro-Wire and TKG and then apportion, using the companies’ combined apportionment factors.
In Malpass, we hold that the ITA permitted the individual taxpayers to combine the flow-through business income from the unitary business of East Jordan and Ardmore and then apportion, using the combined apportionment factors of the unitary business. Accordingly, we reverse the Court of Appeals and remand to the Court of Claims for reinstatement of the order granting summary disposition in favor of plaintiffs.
In Wheeler, we hold that the Court of Appeals properly determined thаt the Wheelers could combine their flow-through income from the unitary business of Electro-Wire and TKG. In so doing, we hold that the ITA contained no geographical limitations for the tax years of 1994 and 1995 and that combined reporting was proper even though the unitary business included an entity located in a foreign country. We affirm the judgment of the Court of Appeals, but we vacate Section III(A) of the Court of Appeals’ opinion because that analysis is inconsistent with our analysis herein and relied on the Court of Appeals’ erroneous decision in Malpass, which we reverse today.
YOUNG, C.J., and CAVANAGH, MARKMAN, KELLY, ZAHRA, and MCCORMACK, JJ., concurred with VIVIANO, J.