Dow Chemical Co. v. Department of Treasury

• Decision Date: 06 November 1990
• Docket Number: Docket No. 117858
• Citation: 462 N.W.2d 765,185 Mich.App. 458
• Parties: DOW CHEMICAL COMPANY, Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee. 185 Mich.App. 458, 462 N.W.2d 765
• Court: Court of Appeal of Michigan — District of US

Page 765

462 N.W.2d 765

DOW CHEMICAL COMPANY, Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee.

Docket No. 117858.

185 Mich.App. 458, 462 N.W.2d 765

Court of Appeals of Michigan.

Submitted May 10, 1990.

Decided Sept. 12, 1990.

Released for Publication Nov. 6, 1990.

[185 MICHAPP 459] David Brady, Midland, for petitioner-appellant.

Frank J. Kelley, Atty. Gen., Gay Secor Hardy, Sol. Gen., and Richard R. Roesch and Ross H. Bishop, Asst. Attys. Gen., for respondent-appellee.

Before GRIBBS, P.J., and HOOD and LESINSKI, ^* JJ.

PER CURIAM.

Petitioner, Dow Chemical Company, appeals as of right from the May 23, 1989, opinion and judgment of the Michigan Tax Tribunal[185 MICHAPP 460] affirming the single business tax liability assessed against Dow by respondent, Michigan Department of Treasury. The liability arose out of the department's finding that Dow's transfer of its oil and gas division constituted a sale requiring recapture of a capital acquisition deduction pursuant to M.C.L. Sec. 208.23(b); M.S.A. Sec. 7.558(23)(b). We affirm.

The facts of this case are undisputed. Dow, a Delaware corporation with its principal place of business in Midland, Michigan, is the parent corporation of an affiliated group of corporations conducting business throughout the world. Dow's primary business operations include the manufacture and sale of organic and inorganic chemicals. Dow's hydrocarbon department is responsible for the acquisition of hydrocarbon raw materials (natural gas, naptha, petroleum and liquid petroleum gas) for United States manufacturing sites.

Prior to 1982, Dow's hydrocarbon department included an oil and gas division. This division provided approximately twenty-five percent of Dow's hydrocarbon raw materials. Dow acquired the majority of its raw materials from third-party suppliers.

In early 1982, Dow's management decided to dispose of its oil and gas division and rely solely on third-party suppliers for hydrocarbon raw materials. Later that year, Dow commenced discussions with Apache Corporation (Apache) for sale of the oil and gas division to Apache Petroleum Company (APC), a limited partnership. Apache is the general partner in APC.

Dow and Apache's negotiations concluded in September, 1982. As a result, Dow and APC executed an acquisition, exchange and partnership formation agreement on September 30, 1982. The agreement provided that in exchange for Dow transferring its oil and gas division to APC, Dow [185 MICHAPP 461] received: (1) $79,425,976; (2) ten million units (certificate of interest) of APC worth $18.90 per unit; and (3) APC's assumption of $150,000,000 of Dow's debts.

Dow reported the transaction with APC on its 1982 federal income tax return. Dow reported that it had sold an undivided portion of its oil and gas division assets to APC for $79,425,976. Dow treated the remainder of the transaction as a transfer to a partnership under Sec. 721 of the Internal Revenue Code, 26 U.S.C. Sec. 721. Furthermore, on its 1982 Michigan single business tax return, Dow showed no recapture of a capital acquisition deduction resulting from the transaction with APC.

Subsequently, the Michigan Department of Treasury audited Dow's single business tax return. The department concluded that the APC transaction was an event requiring full recapture of a capital acquisition deduction resulting in a $50,473,840 tax liability (before apportionment to Michigan) against Dow. Dow conceded that liability for nineteen percent of this amount was proper, as it represented the cash payment Dow received. However, Dow took issue with the remainder of the amount.

After completion of the audit, Dow petitioned the Michigan Department of Treasury for administrative review of the question whether Dow's transfer of its oil and gas division to APC constituted a "sale" requiring recapture of a capital acquisition deduction under M.C.L. Sec. 208.23(b); M.S.A. Sec. 7.558(23)(b).

Following a hearing before a referee, the Department of Treasury issued its decision and order of determination on October 10, 1986. The decision and order concluded that Dow had "sold" its oil and gas division to APC, necessitating recapture. The department then issued a Notice of Final [185 MICHAPP 462] Assessment as to the $50,473,840 tax liability against Dow.

On November 16, 1986, Dow filed a petition with the Michigan Tax Tribunal requesting review of the Department of Treasury's decision. On May 23, 1989, the Tax Tribunal issued its opinion and judgment, ruling that there was a single transaction between Dow and APC in which Dow "sold" its oil and gas division to APC. The Tax Tribunal affirmed the Department of Treasury's decision.

On appeal, Dow does not dispute that the $79,425,976 cash payment for the oil and gas division required recapture of a capital asset deduction. Thus, Dow agrees that a portion of the transaction was a sale or other disposition requiring recapture. However, Dow contends that the remaining consideration it received from APC (10,000,000 units of APC and APC's assumption of $150,000,000 of debt) was not a sale or other disposition. Rather, Dow argues that the remaining consideration constituted a transfer in exchange for a partnership interest under Sec. 721 of the Internal Revenue Code, 26 U.S.C. Sec. 721. Dow claims that no gain or loss is recognized and, therefore, recapture does not occur. In essence, Dow asserts that there were two transactions with respect to transfer of its oil and gas division: (1) a sale, and (2) a contribution in exchange for a partnership interest.

The Tax Tribunal disagreed with Dow's characterization and found that only one transaction occurred which was a sale requiring recapture of a capital acquisition deduction.

This Court's review of Tax Tribunal decisions, in the absence of fraud, is limited to whether the tribunal made an error of law or adopted a wrong principle. We accept the factual findings of the tribunal as final, provided they are supported by [185 MICHAPP 463] competent, material, and substantial evidence. Const. 1963, art. 6, Sec. 28; Antisdale v. City of Galesburg, 420 Mich. 265, 277, 362 N.W.2d 632 (1984); Fisher v. Sunfield Twp., 163 Mich.App. 735, 741, 415 N.W.2d 297 (1987). Substantial evidence must be more than a scintilla of evidence, although it may be substantially less than a preponderance of the evidence required in most civil cases. Russo v. Dep't of Licensing & Regulation, 119 Mich.App. 624, 631, 326 N.W.2d 583 (1982). The burden of proof in an appeal from an assessment, decision, or order of the Tax Tribunal is on the appellant. Holloway Sand & Gravel Co. Inc. v. Dep't of Treasury, 152 Mich.App. 823, 831, n. 2, 393 N.W.2d 921 (1986).

Under the Michigan Single Business Tax Act, M.C.L. Sec. 208.1 et seq.; M.S.A. Sec. 7.558(1) et seq., taxpayers are allowed to recover the cost of certain tangible assets for the year of acquisition. The recovery is accomplished by taking what is known as a capital acquisition deduction. However, when an asset is sold or otherwise disposed of, the taxpayer must recapture (pay back) that portion of the capital acquisition deduction that has not been economically exhausted.

The recapture of a capital acquisition deduction is specifically provided for in Sec. 23(b) of Michigan's Single Business Tax Act, M.C.L. Sec. 208.23(b); M.S.A. Sec. 7.558(23)(b), which states:

After allocation as provided in section 40 or apportionment as provided in section 41, the tax base shall be adjusted by the following:

* * * * * *

(b) Add the gross proceeds or benefit derived from the sale or other disposition of the tangible assets defined in subdivision (a) minus the gain and plus the loss from the sale reflected in federal taxable income and minus the gain from the sale or other disposition added to the tax base in section 9(6). This addition shall be multiplied by a fraction, the numerator of which is the payroll factor plus the property factor and the denominator of which is 2. As used in this subdivision, "sale or other disposition" shall not include the transfer of tangible assets that are leased back to the transferor under section 168(f)(8) of the internal revenue code.

[185 MICHAPP 464] The formula contained in this section effectuates recapture in situations where a "sale or other disposition" is taxable at the federal level. The formula does not provide for recapture in "non-recognition dispositions," which are situations in which gain or loss is not recognized under federal income tax law. An example of such a situation is a transaction involving contributions to partnerships.

While M.C.L. Sec. 208.23(b); M.S.A. Sec. 7.558(23)(b) does not address the question of recapture and contributions to partnerships, we are given some guidance by the Michigan Department of Treasury in its Tax Bulletin 1981-Z. In this publication, the department has indicated that certain transfers of property, for single business tax purposes, do not cause recapture of a capital acquisition deduction by the transferor. The department, utilizing federal income tax law, listed one such transfer as:

Contribution to a partnership. The transfer of property where no gain or loss is recognized under IRC Section 721.

The issue involved in the instant case concerns whether that portion of Dow's transfer of its oil and gas division to APC in which Dow received 10,000,000 units of APC and assumption of [185 MICHAPP 465] $150,000,000 of its debt in exchange constituted contribution to a partnership within the context of Sec. 721 of the Internal Revenue Code, thereby eliminating recapture, or whether the entire transaction constituted a sale outside the scope of Sec. 721 thus requiring recapture.

In order to address this issue we must first review the language of Sec. 721, which states in relevant part:

(a) General rule--No gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the...