Carlson v. Commissioner of Revenue

• Decision Date: 24 July 2003
• Docket Number: 7443
• Parties: Robert and Virginia CARLSON, Appellants, v. COMMISSIONER OF REVENUE, Appellee.
• Court: Tax Court of Minnesota

Robert and Virginia CARLSON, Appellants, v. COMMISSIONER OF REVENUE, Appellee.

No. 7443

Tax Court of Minnesota, Regular Division, Second Judicial District, Ramsey County

July 24, 2003

The Honorable Kathleen H. Sanberg, Judge of the Minnesota Tax Court, heard this matter on May 14, 2003, at the Minnesota Judicial Center, 25 Rev. Dr. Martin Luther King Jr. Boulevard, St. Paul, Minnesota.

Attorneys and Law Firms

Thomas R. Muck, Attorney at Law, Fredrikson & Byron, represented the Appellants.

Thomas Overton, Assistant Attorney General, represented the Appellee, Commissioner of Revenue (“Commissioner”).

FINDINGS OF FACT, CONCLUSIONS OF LAW AND ORDER FOR JUDGMENT

KATHLEEN H. SANBERG, Judge.

Both parties submitted trial briefs and a joint Stipulation of Facts. The matter was submitted to the Court for decision on May 14, 2003.

The Court, having heard and considered the evidence stipulated to by the parties, and upon all of the files, records and proceedings herein, now makes the following:

FINDINGS OF FACT

1. Robert W. Carlson and Virginia Carlson (“Appellants”) are shareholders of and received income from Quadion Corporation (“Quadion”).

2. Quadion has a valid election in effect under I.R.C. § 1362 as an S corporation.

3. From December 31, 1995, through December 31, 1996, (“years at issue”) Quadion did business in the State of Michigan as a manufacturer and seller of precision molded rubber and plaster parts used in various industries including the auto industry.

4. Appellants filed Minnesota Individual Income Tax Returns for 1995 and 1996:

a) on which they reported their pro rata share of Quadion's income and

b) on which they also claimed a credit for their pro rata share of Michigan Single Business Taxes, which Quadion paid in 1995 and 1996.

5. Following an audit, the Commissioner issued Individual Income Tax Audit Report/Tax Orders dated March 31 2000, denying the claimed credit. Appellants administratively appealed.

6. The Commissioner denied the appeal in a Notice of Determination of Appeal dated December 11, 2001, and assessed taxes and interest for the years 1995 and 1996 as follows: $67, 266.08 tax and $32, 220.59 interest for 1995 and $76, 120.00 tax and $29, 092.40 interest for 1996. The totals are $99, 486.67 for 1995 and $105, 212.40 for 1996.

7. On March 8, 2002, Appellants timely appealed the Notice of Determination of Appeal to the Minnesota Tax Court.

8. The Minnesota Tax Court has jurisdiction over this matter.

CONCLUSIONS OF LAW

1. The Order of the Commissioner of Revenue dated December 11, 2001, imposing individual income tax and interest is hereby affirmed.

LET JUDGMENT BE ENTERED ACCORDINGLY. THIS IS A FINAL ORDER. A STAY OF 15 DAYS IS HEREBY ORDERED.

MEMORANDUM

Background

Robert W. Carlson and Virginia Carlson are shareholders of and received income from an S corporation doing business in Michigan. In filing their Minnesota Individual Income Tax Returns for 1995 and 1996 the Appellants claimed a credit under Minn.Stat. § 290, subd. 22 (1994) for their pro rata share of Michigan Single Business Taxes, which were paid by the S corporation in 1995 and 1996. Following an audit, the Commissioner issued Individual Income Tax Audit Report/Tax Orders denying the claimed credit. Appellants appealed this administratively, which appeal was denied by the Commissioner in a Notice of Determination of Appeal dated December 11, 2001. Appellants were assessed taxes and interest totaling $99, 486.67 for 1995 and $105, 212.40 for 1996.

On March 8, 2002, Appellants timely appealed the Notice of Determination of Appeal to the Minnesota Tax Court The parties submitted a written Stipulation of Facts and documents. The issue in this case is whether Appellants, as residents of the State of Minnesota, are entitled to an income tax credit under Minn.Stat. § 290.06 subd. 22 (1994 and 1996) for taxes paid Quadion pursuant to the Michigan Single Business Tax. (“Michigan SBT”).

Analysis

Minnesota Statute Section 290.06, subd. 22(g) (1994 and 1996) provides a credit against Minnesota income taxes for S corporation shareholders whose S corporation pays to another state taxes which are on or measured by net income. The purpose of this credit is to avoid double taxation of the same income by two or more states. The statute states:

Subd. 22. Credit for taxes paid to another state. (a) A taxpayer who is liable for taxes on or measured by net income to another state or province or territory of Canada, as provided in paragraphs (b) through (f), upon income allocated or apportioned to Minnesota, is entitled to a credit for the tax paid to another state or province or territory of Canada if the tax is actually paid in the taxable year or a subsequent taxable year. A taxpayer who is a resident of this state pursuant to section 290.01, subdivision 7, clause (2), and who is subject to income tax as a resident in the state of the individual's domicile is not allowed this credit unless the state of domicile does not allow a similar credit.

(g) For the purposes of this subdivision, a resident shareholder of a corporation having a valid election in effect under section 1362 of the Internal Revenue Code must be considered to have paid a tax imposed on the shareholder in an amount equal to the shareholder's pro rata share of any net income tax paid by the S corporation to another state. For the purposes of the preceding sentence, the term “net income tax” means any tax imposed on or measured by a corporation's net income.

Minn.Stat. § 290.06, subds. 22(a) and (g) (1994 and 1996). (Emphasis added).

The language to be considered is “on or measured by net income.” The parties agree that the Michigan SBT tax is not on income but disagree as to whether the Michigan SBT is measured by net income. Because there is no definition under Minnesota law of “measured by net income, ” we will look to other states and courts which have analyzed the issue, after first reviewing the parties' arguments.

Appellants argue that the Michigan SBT is the principal Michigan business tax which commences with an income measure (federal taxable income) which is then adjusted. Because the starting point and, thus, the “core” of the Michigan SBT is federal taxable income, Appellants maintain, the Michigan SBT is a tax “measured by net income.”^[1]

The Commissioner argues that the Michigan SBT is a tax on or measured by “value added” rather than a tax on or measured by “net income.” The argument is that the tax is computed on a tax base designed to calculate the contribution the business makes to the total economy and is based on the income or profit plus numerous additions, including the cost of labor, depreciation, dividends paid and interest paid by the taxpayer. These items are deducted in order to arrive at federal taxable income, but are added back in for the Michigan SBT. Thus, according to the Commissioner, while the Michigan SBT computation begins with federal taxable income (a net income amount), it adds back the items deducted in reaching federal taxable income and then further deducts items that are clearly components of “income” such as dividends, interest and royalties. Thus, the Michigan SBT is not a net income amount, but rather, is what is economically considered to be the value added, to the products produced.

Appellants cite no authority for its position that the Michigan SBT is a tax based on or measured by net income. The Commissioner cites United States Supreme Court, ^[2] federal court^[3] and state court^[4] cases which have held or stated that the Michigan SBT is a value added tax and not tax based on net income.

In Trinova, the United States Supreme Court, in determining a constitutional issue regarding income tax, stated that “[t]he Michigan SBT is an addition method VAT [value added tax], although it inevitably permits various exclusions, exemptions, and adjustments that depart from the simple value added examples.” Appellants argue that this statement is not a holding of the case, as the Court was merely discussing the philosophy of a VAT, and should carry no weight. Further, Appellants maintain that even if the Court said that the Michigan SBT was a VAT, it did not say that it was not an income tax. We disagree. The Court's failure to say that the Michigan SBT was not an income tax, does not mean that it is an income tax. This is absurd. If the Court said that something is red, it need not say that it “is not” blue to avoid ambiguity. Further, in discussing the Michigan SBT as a VAT, the Court stated: “[b]ecause value added is a measure of actual business activity, a VAT correlates more closely to the volume of governmental services received by the taxpayer than does an income tax. Further because value added does not fluctuate as widely as net income, a VAT provides a more stable source of revenue than the corporate income tax ...” Trinova, 498 U.S. at 367 (emphasis added). Even though the main issue before the United States Supreme Court was a constitutional issue regarding the Michigan VAT, it is clear from these statements that the United States Supreme Court considered the Michigan SBT to be a VAT different from a net income tax.

This is consistent with the lower court in the Trinova case, where the Michigan Supreme Court concluded that the Michigan SBT is a tax on value added or business activity, not on income.

The single business tax is a form of value added tax, although it is not a pure value added tax. ‘Value added is defined as the increase in the value of goods and services brought about by whatever a business does to them between the time of purchase and the time of sale.' In short, a value added tax is a tax upon business activity. The act employs a value added measure of business

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