State & Local Tax Alert

Transcription

1 State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP Mississippi Supreme Court Holds Dividends Received Exclusion Statute Violates Dormant Commerce Clause On October 27, 2016, the Mississippi Supreme Court held that the portion of the state s corporate income tax dividends received exclusion statute that imposes a geographical limitation on the ability to qualify for the exclusion violates the dormant Commerce Clause of the U.S. Constitution. 1 Under the geographical limitation, the Court held that the exclusion is impermissibly limited to dividends received from affiliates that do business in Mississippi and file income tax returns in the state. The Court remedied the defect in the statute by severing the unconstitutional portion of the statute, thereby allowing the exemption to taxpayers who already have borne a tax in Mississippi or another state. Background Miss. Code Ann. Sec (4)(i) Miss. Code Ann. Sec (4)(i) provides an exemption from taxation for [i]ncome from dividends that has already borne a tax as dividend income under the provisions of this article, when such dividends may be specifically identified in the possession of the recipient. The case examined whether the use of the term under the provisions of this article is unconstitutional because it creates a geographic distinction between subsidiaries which have paid tax in Mississippi and those that have not, resulting in discrimination against out-of-state subsidiaries. Procedural History In 2003, under Miss. Code Ann. Sec (4)(i), the Mississippi Tax Commission (now the Mississippi Department of Revenue) assessed AT&T Corporation over $11.75 million in additional income tax, penalties, and interest based on the inclusion of income from dividends from non-mississippi subsidiaries. Release date November 16, 2016 States Mississippi Issue/Topic Corporate Income Tax Contact details Tom Coley Charlotte T E tom.coley@us.gt.com Anna Harris Atlanta T E anna.harris@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 failing to obtain relief through the administrative appeal process, AT&T appealed to the Chancery Court of the First Judicial District of Hinds County. The stipulation of facts 1 Mississippi Department of Revenue v. AT&T Corp., Mississippi Supreme Court, No CA SCT, Oct. 27,

2 Grant Thornton LLP - 2 on appeal to the Chancery Court provides insight on the Department s interpretation of Miss. Code Ann. Sec (4)(i). The stipulation provides that the Department interprets Miss. Code Ann. Sec (4)(i) to allow a recipient to exclude an intercompany dividend from its gross income calculation if the distributing corporation is doing business in Mississippi in the year of the distribution and files a Mississippi income tax return for that year. If the distributing corporation is not doing business in Mississippi in the year of the distribution or does not file a Mississippi income tax return for that year, the exclusion is not available. Furthermore, the stipulation of facts provides that the Department applied Miss. Code Ann. Sec (4)(i) without any consideration of whether the income of the distributing corporation which gave rise to the dividends at issue had already been fully taxed by that distributing corporation s home state, state of domicile, or states in which it conducted business and/or was taxable. AT&T argued that a portion of Miss. Code Ann. Sec (4)(i) violated the dormant Commerce Clause because it allowed an income tax exemption for dividends received from AT&T s Mississippi subsidiaries (nexus subsidiaries) while denying an exemption to similarly situated non-mississippi subsidiaries (non-nexus subsidiaries). Specifically, AT&T argued that the statute treated interstate commerce less favorably than intrastate commerce. The Chancery Court agreed with AT&T, granting AT&T s motion for summary judgment and holding the offensive portion of Miss. Code Ann. Sec (4)(i) to be unconstitutional. This appeal to the Mississippi Supreme Court followed. Dormant Commerce Clause The Mississippi Supreme Court began its analysis 2 with a discussion of the evolution of the dormant Commerce Clause and its purpose to prohibit economic protectionism. 3 The Mississippi Supreme Court explained that, in order to determine if a tax violates the dormant Commerce Clause, it has applied the four-prong test set out by the U.S. Supreme Court in Complete Auto. 4 Under the Complete Auto test, in order to pass muster under the Commerce Clause, a tax must: (1) be imposed on an activity with a substantial nexus with the taxing state; (2) be fairly apportioned, based on the activity within the taxing state; (3) not discriminate against interstate commerce; and (4) be fairly related to the services provided by the taxing state. 5 2 The Mississippi Supreme Court rejected the Department s argument that it should apply an arbitrary and capricious standard to the 2003 Tax Commission assessment against AT&T. The Court explained that it applies a de novo standard of review when evaluating a statute s constitutionality. The Court noted that the only tribunal that considered the constitutionality of MISS. CODE ANN (4)(i) was the Chancery Court; there was no Tax Commission decision for it to review. As a result, the Mississippi Supreme Court held that the appropriate standard to review the Chancery Court s decision that MISS. CODE ANN (4)(i) is unconstitutional is the de novo standard. 3 Citing to Comptroller of the Treasury v. Wynne, 135 S. Ct (2015) and Fulton Corp. v. Faulkner, 516 U.S. 325 (1996). 4 Citing to Commonwealth Brands, Inc. v. Morgan, 110 So. 3d 752 (Miss. 2013). 5 Id.

3 Grant Thornton LLP - 3 The Court explained that the controlling Complete Auto factor in this case was whether the dividends received exemption was fairly apportioned. Fair apportionment seeks to ensure that a state only taxes its fair share of an intestate transaction. 6 Fair apportionment is determined by examining whether the tax is both internally consistent and externally consistent. 7 The Court explained that the internal consistency test is met when the imposition of a tax identical to the one in question by every other State would add no burden to interstate commerce that intrastate commerce would not also bear. 8 Applying the internal consistency test to Miss. Code Ann. Sec (4)(i), the Court concluded that the statute failed the test. 9 The Court explained that, while nexus subsidiaries of AT&T can take advantage of Mississippi s dividend exclusion, under Miss. Code Ann. Sec (4)(i), non-nexus subsidiaries are not eligible for the exemption because the dividend income has not already borne a tax under Section (4)(i). The Court explained that, as a result, the total tax burden on AT&T is disparate because AT&T s non-nexus subsidiaries face an additional tax burden not faced by its nexus subsidiaries. The Court noted that if a nonnexus subsidiary distributes its already-taxed income to the parent as a dividend, the parent faces a second layer of taxation apportioned on the dividend. Nexus subsidiaries are not subject to this second layer of taxation. The Court thus concluded that Miss. Code Ann. Sec (4)(i) was internally inconsistent and its application results in malapportionment, thereby violating the dormant Commerce Clause. 10 Remedy Turning to the issue of the appropriate remedy for AT&T, the Court explained that Mississippi s severability statute 11 provides that [a]bsent contrary intent, the rule of severability applies and, when a portion of a statute is declared unconstitutional, the remaining sections continue in effect. 12 However the Court noted that if the constitutionally offensive language were removed from Miss. Code Ann. Sec (4)(i), the statute would provide that all corporate dividends would be exempt. The Court explained that such an exemption would be contrary to Miss. Code Ann. Sec (1) which provides that gross income includes the income of a taxpayer derived from dividends. 6 Citing to Oklahoma Tax Comm n v. Jefferson Lines, 514 U.S. 175 (1995). 7 The Court explained that external consistency looks to the economic justification for the State s claim upon the value taxed, to discover whether a State s tax reaches beyond that portion of value that is fairly attributable to economic activity within the taxing State. Id. 8 Id. 9 In its decision, the Court noted that the U.S. Supreme Court recently addressed the issue of internal consistency in Comptroller of the Treasury v. Wynne. The Court provided an overview of the Wynne decision in its opinion and the application of the internal consistency test therein. 10 Having concluded that MISS. CODE ANN (4)(i) violated the dormant Commerce Clause, the Mississippi Supreme Court declined to address AT&T s argument that the dividends received exemption violated both the Due Process and Equal Protection Clauses. 11 MISS. CODE ANN (Rev. 2014). 12 Citing to Oxford Asset Partners, LLC v. Oxford, 970 So. 2d 116 (Miss. 2007).

4 Grant Thornton LLP - 4 The Court noted that California courts remedied their unconstitutional dividends received exemption statute by declaring the statute unconstitutional in its entirety, rather than severing a portion of it. 13 In Abbott Laboratories v. Franchise Tax Board, the California Fourth District Court of Appeal, faced with a similar situation, considered two options: (1) hold the entire dividends received exemption statute unconstitutional and preclude any corporation from receiving the deduction; or (2) sever the constitutionally offensive portions of the statute such that all corporations, irrespective of whether they would be subject to tax in California, would receive the dividends received deduction. The California Fourth District Court of Appeal explained that, under California law, severability turns on the concept of volitional separability. Under volitional separability, the remainder of the statute is looked at to see if it is complete in itself and would have been adopted by the legislative body had the latter foreseen the partial invalidation of the statute or constitutes a completely operative expression of the legislative intent. 14 The Abbott Labs court concluded that severing portions of the statute gave it a purpose different than the one enacted by the California legislature, thus failing the volitional separability test. Accordingly, the Abbott Labs court held the entire statute to be unconstitutional. Taking into consideration the volitional separability test, the Mississippi Supreme Court adopted AT&T s suggested severance of Miss. Code Ann. Sec (4)(i) which would strike the under the provisions of this article language. Miss. Code Ann. Sec (4)(i) restricts the exemption to dividends that have already borne a tax as dividend income under the provisions of this article. AT&T argued that the words under the provisions of this article establish a geographic distinction between those subsidiaries which have paid tax in Mississippi and those which have not. This distinction creates a constitutional problem because it discriminates against out-of-state subsidiaries. AT&T argued that removing the under the provisions of this article language would solve the constitutional infirmity and still reflect the Mississippi legislature s intent to tax dividend income, giving an exemption only to taxpayers whose dividend income already has been taxed in Mississippi or in any other state. The Mississippi Supreme Court agreed and held that the language under the provisions of this article be struck from Miss. Code Ann. Sec (4)(i) and the severed statute be applied to AT&T for the tax years in issue. Commentary Barring an appeal by the Department to the U.S. Supreme Court, AT&T s lengthy challenge to Miss. Code Ann. Sec (4)(i) will ultimately result in a taxpayer victory that may serve to benefit other taxpayers that have been denied the dividend exclusion for dividends received from affiliates that did not do business in Mississippi. These taxpayers 13 Abbott Labs. v. Franchise Tax Bd., 96 Cal. Rptr. 3d 864 (Cal. App. 4th 2009); River Garden Retirement Home v. Franchise Tax Bd., 113 Cal. Rptr. 3d 62 (Cal. App. 4th 2010). 14 Id.

5 Grant Thornton LLP - 5 should carefully review their facts to see if they are eligible for any potential refund opportunities for open tax years. If eligible, taxpayers may stand to recoup substantial amounts in refunds. 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.