VAS Holdings & Invs. LLC v. Comm'r of Revenue

• Citation: 489 Mass. 669,186 N.E.3d 1240
• Decision Date: 16 May 2022
• Docket Number: SJC-13139
• Parties: VAS HOLDINGS & INVESTMENTS LLC v. COMMISSIONER OF REVENUE.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

489 Mass. 669

186 N.E.3d 1240

VAS HOLDINGS & INVESTMENTS LLC

v.COMMISSIONER OF REVENUE.

SJC-13139

Supreme Judicial Court of Massachusetts, Suffolk.

Argued January 5, 2022.

Decided May 16, 2022

The following submitted briefs for amici curiae:

Michael J. Bowen, for the taxpayer.

Brett M. Goldberg, for Commissioner of Revenue.

Bruce Fort, of New Mexico, for Multistate Tax Commission.

Richard L. Jones, David J. Nagle, & Caroline A. Kupiec, Boston, for American College of Tax Counsel.

Present: Budd, C.J., Gaziano, Lowy, Cypher, Kafker, Wendlandt, & Georges, JJ.

WENDLANDT, J.

This case requires us to consider the constitutional constraints on the Commonwealth's ability to tax a nondomiciliary corporation on the capital gain it reaped from the sale of its fifty percent membership interest in an in-State limited liability company. The nondomiciliary corporation, VAS Holdings & Investments LLC (VASHI), maintains that the "unitary business principle" is the only constitutionally permissible methodology pursuant to which the Commonwealth may impose a tax on such capital gain. Under that principle, the Commonwealth may tax the capital gain only where (i) there is functional integration, centralization of management, and economies of scale between the out-of-State corporation and the in-State entity, or (ii) the investment in the in-State entity serves an operational function of the out-of-State corporation.

The Commissioner of Revenue (commissioner) concedes that, under the unitary business principle as applied to the facts of this case, the capital gain is not taxable in the Commonwealth. Nevertheless, he contends that the capital gain may be taxed because it reflects the in-State entity's growth in the Commonwealth. Because the nondomiciliary corporation reaped the benefit of that growth, the commissioner maintains, the Commonwealth may impose a tax on the nondomiciliary, consistent with the due process clause and the commerce clause of the United States Constitution. The Appellate Tax Board (board) agreed, and this appeal followed.

The constitutionality of the imposed taxes was the only issue raised before the board and before this court, and all parties, including the board, have a significant interest in its resolution. Because we are persuaded that the constitutional limitations on the Commonwealth's authority to tax a nondomiciliary corporation may be satisfied where, as here, the nondomiciliary corporation has reaped the financial benefits (in the form of a capital gain) from its fifty percent ownership interest in an in-State entity whose growth is tied inextricably to the protections, opportunities, and benefits afforded to it by the Commonwealth, we agree that the capital gain could be subject to the Commonwealth's tax. Before the board, the parties did not dispute the statutory authority of the commissioner to deviate from the unitary business principle. Yet, any tax beyond that which is authorized by statute is invalid; accordingly, following oral argument before this court, we asked the parties to address whether the Legislature had authorized the tax asserted by the commissioner; having reviewed the parties’ postargument briefs and the pertinent statutes, we conclude that the commissioner lacked the requisite statutory authority and reverse the decision of the board.¹

1. Background. a. Facts. Based on the parties’ agreed statement of facts, exhibits, and witness testimony, the board found the following facts.

i. Pre-merger operations. VASHI was formed in 1999 as an S corporation² with its commercial domicil and headquarters in Illinois. VASHI's headquarters housed its administrative, sales, marketing, and financial functions; it had approximately fifteen employees. Through its wholly owned subsidiaries, Virtual-Agent Services Canada, Inc. (VAS USA), and Virtual-Agent Services Canada Corp. (VAS Canada),³ VASHI operated call centers in Canada, which primarily served clients in the hospitality industry. VASHI, VAS USA, and VAS Canada had no clients or business connections in Massachusetts.

Thing5, LLC (Thing5), was a Massachusetts limited liability company owned by two Massachusetts residents, David Thor, who served as Thing5's chief executive officer (CEO), and his wife, Maura Thor. Thing5 had between forty and fifty employees; it was headquartered in Massachusetts and conducted all business from its offices in Springfield and Longmeadow, with its day-to-day operations managed by David Thor. Thing5 provided hosted telephone systems and voicemail, mobile applications, and support for legacy telephone systems for clients in the hotel business.

ii. 2011 merger. In August 2011, Cloud5 LLC (Cloud5), a Massachusetts limited liability company, was formed to effect the merger of VASHI and Thing5. Each business was valued separately at $17.5 million. In October 2011, in a single integrated transaction, VASHI contributed its shares of stock in VAS USA to Cloud5 in exchange for fifty percent of the membership units of Cloud5, and David and Maura Thor contributed their membership units in Thing5 to Cloud5 in exchange for fifty percent of the membership units of Cloud5. The total value of the merged business was estimated to be $35 million.

As a result of the merger, Thing5 became a wholly owned subsidiary of Cloud5, operating essentially as a division of Cloud5 for tax purposes. VAS USA also became a wholly owned subsidiary of Cloud5; VAS USA was restructured as a C corporation, and thus a separate taxable entity such that its property, activities, and income did not pass through to Cloud5 for either Federal or Massachusetts tax purposes. VAS Canada remained a wholly owned subsidiary of VAS USA.

iii. Post-merger operations. Following the merger, the business operations of VAS Canada and Thing5 were integrated. David Thor, who remained at all relevant times a Massachusetts resident, became the CEO of both Cloud5 and VAS Canada, assuming responsibility for the call center operations of VAS Canada in addition to his prior responsibilities at Thing5.⁴ Employees of Thing5 in Massachusetts performed the functions previously conducted by VASHI employees. The operations of Cloud5's subsidiaries consisted of the Thing5 headquarters and offices in Springfield and Longmeadow; a newly established Thing5 call center in Springfield that served as a satellite to the VAS Canada call centers; the VAS Canada call center operations in Canada; and one employee, Thing5's chief financial officer, who was located in Illinois.

Following the merger, VASHI had no employees or operations, did not own or lease any real or tangible property, and was not involved in the operations of Cloud5; other than bank accounts, its only material asset was its fifty percent membership interest in Cloud5. In December 2012, VASHI reincorporated in Florida after closing its Illinois offices.

iv. Growth of Cloud5. Between 2011 and 2013, under David Thor's management, the value of Cloud5 increased, which the parties attribute to business activities that took place primarily in Massachusetts. Cloud5 consolidated the business operations of VAS Canada and increased its over-all profitability. The staffing model of VAS Canada was changed based on data and tools available to Thing5, and the number of VAS Canada's employees was reduced from 1,400 to approximately 800. Unprofitable client contracts were not renewed, and the total number of VAS Canada's clients was reduced.

Meanwhile, Thing5's operations grew significantly. Thing5 established a call center in Springfield, leasing approximately 10,000 square feet of office space. Thing5's product offerings expanded, and its number of customers increased.

Cloud5 filed State tax returns in Massachusetts in 2011, 2012, and 2013. For tax purposes, Cloud5 was a partnership. Accordingly, VASHI's distributive share of Cloud5's business income -- that is, its income derived from Cloud5's regular business operations -- was apportioned or allocated to Massachusetts under G. L. c. 63, § 38 ; VASHI's distributive share was subject to (i) State personal income tax under G. L. c. 62, § 5A, as if realized directly by VASHI's shareholders under G. L. c. 62, § 17A, and (ii) corporate excise tax under G. L. c. 63, § 32D.⁵

v. Sale of Cloud5 and capital gain. In October 2013, VASHI sold its fifty percent membership interest in Cloud5 to an unrelated third party, realizing a capital gain of $37,280,849 (Cloud5 gain). The board found that "the increase in value, and likewise the [Cloud5] [g]ain, were inextricably connected to and in large measure derived from property and business activities in Massachusetts."

VASHI, being a pass-through entity for Federal tax reporting purposes,⁶ was not required to and did not pay tax to the Federal government on the Cloud5 gain; instead, VASHI's shareholders each paid personal income tax to the Federal government on the gain, and those shareholders who were required to report and pay tax on the Cloud5 gain to their State of residence did so. None of the shareholders of VASHI was a resident of Massachusetts. b. Massachusetts taxation of the capital gain. For the 2013 tax year, VASHI made estimated payments of Massachusetts corporate excise taxes and nonresident composite taxes, which included the Cloud5 gain. VASHI later reported that no tax was due on the Cloud5 gain, and the commissioner issued refunds to VASHI.

The commissioner audited VASHI for the 2013 tax year and timely issued notices of assessment, reflecting the position that the Cloud5 gain was taxable. VASHI timely filed for an abatement, which the commissioner denied. VASHI filed petitions with the board pursuant to G. L. c. 58A, § 7, and G. L. c. 62C, § 39, appealing from the assessment of the tax on its Cloud5 gain.

Following a hearing, the board upheld the assessments. Specifically, the board rejected VASHI's contention that the only permissible methodology pursuant to which the Commonwealth could tax its Cloud5 gain was the "unitary business principle."...