E.I. Dupont De Nemours & Co. v. Ind. Dep't of State Revenue

• Decision Date: 11 July 2017
• Docket Number: Cause No. 49T10-1307-TA-00065
• Citation: E.I. Dupont De Nemours & Co. v. Ind. Dep't of State Revenue, 79 N.E.3d 1016 (Ind. Tax 2017)
• Parties: E.I. DUPONT DE NEMOURS AND COMPANY, Petitioner, v. INDIANA DEPARTMENT OF STATE REVENUE, Respondent.
• Court: Indiana Tax Court

79 N.E.3d 1016

E.I. DUPONT DE NEMOURS AND COMPANY, Petitioner,

v.INDIANA DEPARTMENT OF STATE REVENUE, Respondent.

Cause No. 49T10-1307-TA-00065

Tax Court of Indiana.

July 11, 2017

ATTORNEYS FOR PETITIONER: FRANCINA A. DLOUHY, DANIEL R. ROY, FAEGRE BAKER DANIELS LLP, Indianapolis, IN, HOLLIS L. HYANS, MORRISON & FOERSTER LLP, New York, New York

ATTORNEYS FOR RESPONDENT: CURTIS T. HILL, JR., ATTORNEY GENERAL OF INDIANA, WINSTON LIN, DEPUTY ATTORNEY GENERAL, Indianapolis, IN

ORDER ON PARTIES' CROSS-MOTIONS FOR SUMMARY JUDGMENT

Martha Blood Wentworth, Judge Indiana Tax Court

E.I. DuPont De Nemours and Company ("DuPont") has appealed the Indiana Department of State Revenue's final determination assessing it with additional adjusted gross income tax (AGIT) and interest for the 2006 and 2007 tax years and a penalty for 2007. DuPont's appeal is currently before the Court on the parties' cross-motions for summary judgment. In resolving those cross-motions, the Court grants each in part and denies each in part.

FACTS AND PROCEDURAL HISTORY

DuPont, a Delaware corporation, was founded in 1802. (App. Pet'r Mot. Summ. J. ("Pet'r Des'g Evid."), Vol. III, Aff. of Gary M. Pfeiffer ("Pfeiffer Aff.") ¶ 3). Originally, DuPont manufactured gunpowder. (See Pet'r Br. Supp. Mot. Summ. J. ("Pet'r Br.") at 30-31.) See also Wikipedia, https://en.www.wikipedia.org/wiki/DuPont (last visited July 10, 2017). Today, however, it is engaged with its subsidiaries and affiliates in a variety of industrial, agricultural, and chemical manufacturing businesses worldwide. (Pfeiffer Aff. ¶ 3.)

A. DuPont's Pharmaceutical Business

In 1991, DuPont and Merck & Co., Inc. formed the DuPont Merck Pharmaceutical Company ("DMPC"). (Pfeiffer Aff. ¶¶ 6-7.) DuPont and Merck each owned equal 50% interests in DMPC, which researched, developed, manufactured, and sold human pharmaceutical products, imaging agent products, and other related product lines. (Pfeiffer Aff. ¶¶ 6, 9; Pet'r Des'g Evid., Vol. I, Ex. 1 at DIN 1161.) DMPC operated independently of DuPont and Merck: it maintained its own management team, its own separate research agenda and development facilities, its own employees, its own profit objectives, and its own separate operating policies and procedures. (Pfeiffer Aff. ¶¶ 9-12; Pet'r Des'g Evid., Vol. III, Aff. of Kurt M. Landgraf ("Landgraf Aff.") ¶¶ 17-18.) While DuPont initially leased certain facilities to DMPC and provided it with some "start-up" personnel and administrative services, DuPont charged DMPC arm's-length fees for the services it rendered. (See Resp't Des'g Evid., Ex. 2G at DIN 1555-62, 1577-78.)

In 1998, Merck sold its 50% interest in DMPC to DuPont Pharma, Inc., a subsidiary of DuPont. (See, e.g. , Pfeiffer Aff. ¶¶ 13-14, 17; Resp't Des'g Evid., Ex. 2H.) At that point, DMPC was renamed DuPont Phamaceuticals Company ("DPC"). (Pfeiffer Aff. ¶ 17.) While DPC received certain start-up services from DuPont, for which it paid arm's-length fees, it otherwise operated independently of DuPont. (Landgraf Aff. ¶ 29; Resp't Des'g Evid., Ex. 5 at 56.)

In 2001, DuPont sold DPC to Bristol-Meyers Squibb Company. (Pfeiffer Aff. ¶¶ 37, 41; Pet'r Des'g Evid., Vol. II, Ex. 9.) The sale generated a gain of over $4 billion to DuPont. (Resp't Des'g Evid., Ex. 6 at 4.)

B. DuPont's Financing Arrangements

In 1995, DuPont Energy Company ("DEC"), a subsidiary of Dupont through Dupont's ownership of Conoco, Inc. and its subsidiaries, loaned DuPont nearly $8 billion at an interest rate of 8.528% ("1995 Loan"). (Pet'r Des'g Evid., Vol. III, Aff. of Sharon E. Smith ("Smith Aff.") ¶ 3, Ex. 10, Aff. of Noah Schreiber ("Schreiber Aff.") ¶ 3, Aff. of Sherif Assef ("Assef Aff.") ¶ 4a; Resp't Des'g Evid., Ex. 2J.) The 1995 Loan terms did not require DuPont to make any payments on either the interest or the principal until 2005. (Resp't Des'g Evid., Ex. 2J.)

In 1998, DEC assigned the promissory note associated with the 1995 Loan to another DuPont subsidiary, DuPont Global Operations, Inc. ("DGOI"). (Smith Aff. ¶ 3; Pet'r Des'g Evid., Vol. III, Ex. 10.) In 1999, DGOI loaned DuPont $3.9 billion at an interest rate of 7.40% ("1999 Loan"). (Smith Aff. ¶ 4; Pet'r Des'g Evid., Vol. III, Ex. 11.) The 1999 Loan terms did not require DuPont to make any payments on either the interest or the principal until 2009. (Pet'r Des'g Evid., Vol. III, Ex. 11.)

On August 31, 2005, the 1995 Loan came due. (Resp't Des'g Evid., Ex. 2J at DIN 2027.) That same day, DGOI loaned DuPont $12.2 billion ("2005 Loan")—which equaled the full value of the principal and the total interest due on the 1995 Loan—at an interest rate of 5.64%. (See Resp't Des'g Evid., Exs. 2L at DIN 2065, 4 at 7-8 (Petitioner's Response to Respondent's First Request for Admissions at No. 8 (indicating that because DuPont never made any payments on the 1995 Loan, the principal and accrued interest on the 1995 Loan were rolled over and became the principal balance on the 2005 Loan)).) Similar to the 1995 Loan, the 2005 Loan terms did not require DuPont to make any payments on the principal or the interest for ten years. (See Resp't Des'g Evid., Ex. 2L at DIN 2065.)

C. Indiana Audit

For tax years 1997 through 2007, DuPont and its subsidiaries filed consolidated Indiana AGIT returns. (See Pet'r Des'g Evid., Vol. III, Ex. 16; Resp't Des'g Evid., Confd'l Ex. 2O.) In 2009, the Department audited the consolidated 2005, 2006, and 2007 returns. (See Resp't Des'g Evid., Ex. 3 ¶¶ 5-6.) As a result of the audit, the Department determined that DuPont had improperly reported 1) net operating losses ("NOLs") by characterizing the gain from the 2001 sale of DPC as nonbusiness income; 2) interest expense deductions on the loans it received from DEC and DGOI; and 3) a research and development ("R&D") expense deduction. (See Resp't Des'g Evid., Ex. 3 ¶¶ 8-20.) Accordingly, the Department made the following adjustments to DuPont's consolidated returns:

1) it reclassified the gain DuPont received from the sale of DPC as apportionable business income, increasing DuPont's 2001 adjusted gross income by nearly $5 billion and reducing the amount of NOLs DuPont could carry forward to subsequent years;

2) it eliminated the interest expense deductions DuPont reported between 2005 and 2007 that were related to the 1995, 1999, and 2005 Loans, increasing DuPont's adjusted gross income in 2006 and 2007 by approximately $3 billion and further reducing DuPont's available NOLs carry forward;

3) it eliminated DuPont's 2007 R&D expense deduction, increasing DuPont's 2007 adjusted gross income by another $43 million.

(See Resp't Des'g Evid., Ex. 3 ¶¶ 9-20, Confd'l Ex. 8 at 4.)

The Department's three adjustments culminated in the issuance of Proposed Assessments against DuPont for an additional $394,490 in AGIT liability plus interest for 2006 and $376,328 plus interest for 2007. (Resp't Des'g Evid., Ex. 3 ¶¶ 21-22; Ex. 7.) The Department also assessed a $37,627 penalty against DuPont for tax year 2007. (Resp't Des'g Evid., Ex. 7 at 6.) DuPont subsequently protested the Proposed Assessments but, after conducting a hearing, the Department denied the protest in a Letter of Findings. (Resp't Des'g Evid., Confd'l Ex. 8.)

On July 26, 2013, DuPont filed an original tax appeal, claiming the Department's audit adjustments were improper. DuPont and the Department filed cross-motions for summary judgment, and the Court conducted a hearing on the motions on March 4, 2016.

STANDARD OF REVIEW

Summary judgment is appropriate when there are no genuine issues of material fact and the moving party is entitled to a judgment as a matter of law. Ind. Trial Rule 56(C). Cross-motions for summary judgment do not alter this standard. Horseshoe Hammond, LLC v. Indiana Dep't of State Revenue , 865 N.E.2d 725, 727 (Ind. Tax Ct. 2007), review denied .

ISSUES

The parties' cross-motions for summary judgment present the following questions for the Court's resolution:

I. Did the Department have the authority to make adjustments to DuPont's NOLs in years that were closed to assessment under the applicable statute of limitations?

II. Did the Department err when it reclassified DuPont's gain on its 2001 sale of DPC from nonbusiness income to business income?

III. Did the Department err when it disallowed the interest expense deductions DuPont reported on its 2006 and 2007 returns on the basis that the underlying loans were sham transactions?

IV. Did the Department err when it disallowed DuPont's 2007 R&D expense deduction?

V. Did the Department err when it imposed a penalty for 2007?

(Compare Pet'r Br. at 14, 20, 33, 41, 44 with Resp't Br. Opp'n Pet'r Mot. Summ. J. & Supp. Resp't Cross-Mot. Summ. J. ("Resp't Br.") at 2.)

ANALYSIS AND ORDER

I. Retroactive Adjustments

The Department's Proposed Assessments against DuPont were partly the result of reductions it made to the NOLs DuPont reported on its pre-2005 tax returns that resulted in lower NOL carry forwards that DuPont could deduct on its 2006 and 2007 returns. See supra , p. 1019. DuPont gives two primary reasons why the Department's retroactive adjustments are improper. First, it claims that Indiana Code § 6-8.1-5-2 prohibited the Department from making adjustments to the pre-2005 tax years because those tax years were "closed," i.e., outside the statute of limitations. (See, e.g. , Pet'r Br. at 1-2, 14-15, 18.) Second, DuPont asserts that strong policy reasons auger against allowing the Department to make the adjustments it did. (See Pet'r Br. at 15 (claiming that adjustments like the ones at issue disrupt settled expectations, create uncertainty for taxpayers, and increase the costs of preserving evidence).) The Court is not persuaded by DuPont's reasoning, however, for the following four reasons.

First, the Department's audit reviewed DuPont's 2005 through 2007 returns for accuracy. See, e.g. , IND. CODE §§ 6-8.1-1-1, -2-1 (2009) (providing that the Department is charged with the administration, collection, and enforcement of the AGIT); IND. CODE §§ 6-8.1-3-1, -3-12(a) (2009) ...