On September 29, 2015, the Michigan Court of Appeals in Gillette Commercial Operations v Dep’t of Treasury, No 325258 (consolidated with about 50 other cases), held that Michigan’s retroactive repeal of the Multistate Tax Compact (MTC) to avoid paying $1.1 billion in tax refunds did not violate the Contract Clause, or the Due Process Clause. Further, the Court of Appeals held that the retroactive repeal of the MTC did not violate the Separation of Powers Clause in the Michigan Constitution because it did not reverse or repeal the Michigan Supreme Court’s decision in IBM v Dep’t of Treasury. In addition to these claims, the Court of Appeals also rejected a host of other theories advanced by taxpayers.
By way of background, businesses that operated in a number of states deal with an important question: How should their tax liability be spread across many states? In other words, what portion of their business activity should be subject to tax in Michigan? This question is frequently answered through the establishment of an “apportionment” formula contained in state law.
When Michigan adopted it’s now repealed Michigan Business Tax (MBT), that tax required multi-state businesses to apportion both their income and gross receipts to Michigan based on a single factor: their gross sales within Michigan. However, while enacting the MBT in 2008, the legislature made no changes to another state law relevant to business taxation – the MTC Act. Michigan enacted the MTC Act in 1969 as part of a joint effort by many states to coordinate their tax policies and fend off federal efforts to preempt some state control over business tax provisions that were the subject of debate at that time. The MTC Act has its own provision regarding apportionment. That Act allows businesses that operate in two or more states to elect, at the businesses’ discretion, to apportion any “income tax” imposed by the state according to a three-factor apportionment that included sales, property, and payroll.
The apparent conflict between the MBT and MTC’s apportionment formula was addressed by the Michigan Supreme Court’s July 2014 decision in IBM v Dep’t Treasury. That case allowed IBM to elect to use the Compact’s three-factor apportionment formula on its MBT return for the 2008 tax year.
Before the Supreme Court’s judgment became final, however, the Michigan legislature swiftly enacted legislation in September 2014 to prevent taxpayers from claiming MBT refunds based on the election to use the MTC’s three-factor apportionment formula. Specifically, legislation retroactively repealed the MTC Act retroactively to January 1, 2008.
IBM, along with a number of other business taxpayers including Gillette Commercial Operations, with pending tax refund claims challenged the legislature’s retroactive repeal in the Court of Claims. The Court of Claims ruled in favor of the state and the various taxpayers appealed to the Court of Appeals.
Due process concerns are implicated when a retroactive law takes away a vested right. That said, while due process protects vested property rights, it does not protect one’s mere expectation of a right. Here, the taxpayers argued that they had a vested right to the tax refunds resulting from the MTC election. But the Court of Appeals pointed out that Michigan has long held that taxpayers have no vested right in the tax laws and that the Legislature is free to take away any provision at any time. Furthermore, correcting the Supreme Court’s arguable interpretative mistake, as well as protecting the public fisc were, according to the Court of Appeals, legitimate legislative purposes further by rational means.
The taxpayers also argued that the Legislature’s retroactive action violated the separation of powers clause. Specifically, that the Legislature overstepped its bounds as the retroactive legislation was an attempt to reach into pending court cases and direct the courts to find a different result.
In addressing the taxpayers separation of powers arguments, the Court of Appeals reasoned that the Legislature did not overturn IBM or overrule the Michigan Supreme Court’s final judgment. Instead, the legislature acted within its authority to correct the Supreme Court’s misinterpretation of a statute.
The decision by the Court of Appeals was fairly anticipated and is consistent with the recent trend of taxpayer defeats on this issue in several states in the last 12 months. Taxpayers have suffered defeats in Minnesota, New York, Oregon, Texas, and Washington and have seen their overall chances of success on this issue decline significantly. The California Supreme Court is scheduled to take up the issue in October and the taxpayers in the Washington case have filed an application for cert to the US Supreme Court which is also scheduled to be addressed in October. It is highly likely that the taxpayers in Gillette Commercial Operations and the consolidated cases, will appeal the Court of Appeals decision to the Michigan Supreme Court.