Carmax Auto Superstores W. Coast, Inc. v. S.C. Dep't of Revenue

• Decision Date: 23 December 2014
• Docket Number: No. 27474.,27474.
• Citation: 411 S.C. 79,767 S.E.2d 195
• Court: South Carolina Supreme Court
• Parties: CARMAX AUTO SUPERSTORES WEST COAST, INC., Respondent/Petitioner, v. SOUTH CAROLINA DEPARTMENT OF REVENUE, Petitioner/Respondent. Appellate Case No.2012–212203.

411 S.C. 79

767 S.E.2d 195

CARMAX AUTO SUPERSTORES WEST COAST, INC., Respondent/Petitioner

v.SOUTH CAROLINA DEPARTMENT OF REVENUE, Petitioner/Respondent.

Appellate Case No.2012–212203.

No. 27474.

Supreme Court of South Carolina.

Heard March 19, 2014.

Decided Dec. 23, 2014.

Adam N. Marinelli, Milton G. Kimpson, and Roxanna M. Tinsley, all of South Carolina Department of Revenue, of Columbia, for Petitioner/Respondent.

John C. von Lehe, Jr. and Bryson M. Geer, both of Nelson Mullins Riley & Scarborough, LLP, of Charleston, for Respondent/Petitioner.

Robert L. Widener and Erik P. Doerring, both of McNair Law Firm, PA, of Columbia, for Amicus Curiae, South

Carolina State Chamber of Commerce.

Burnet R. Maybank, III, of Nexsen Pruet, LLC, of Columbia and Alexandra E. Sampson, of Reed Smith, LLP, of Washington, DC, for Amicus Curiae, Council on State Taxation.

Opinion

Chief Justice TOAL.

Both CarMax Auto Superstores West Coast, Inc., (CarMax West) and the South Carolina Department of Revenue (the Department) appeal the court of appeals' decision, reversing and remanding the decision of the Administrative Law Court (ALC) upholding the Department's use of an alternative apportionment formula to calculate CarMax West's income tax for tax years 20022007. We affirm as modified in an opinion which resolves all matters with finality and decline to remand at both parties' request.

Facts/Procedural Background

CarMax, Inc., (CarMax) was formed in 1993 as a subsidiary of Circuit City Stores, Inc., and is the nation's largest retailer of used automobiles. In 2002, CarMax became a separate, publicly-traded holding company of CarMax Auto Superstores, Inc., (CarMax East) and CarMax West, two wholly owned subsidiaries, which primarily performed retail automobile sales. CarMax East owned and operated the used car superstores on the East Coast and in the Midwest, including South Carolina, and managed all of the financial operations and corporate overhead of CarMax. CarMax West owned and operated the used car superstores on the West Coast and owned all of the intellectual property. From 2002–2004, CarMax East paid royalties to CarMax West for the use of this intellectual property in accordance with a licensing agreement.

In 2004, CarMax reorganized its corporate structure, and created CarMax Business Services, LLC (CBS), a multi-member limited liability company with two members: CarMax East and CarMax West. CarMax East contributed the financing operations and corporate overhead management to the partnership, and CarMax West contributed the intellectual property. Ownership percentages of CBS were based on the value of the assets contributed, and the members' income derives from their respective percentages of ownership.¹

After the restructuring, CarMax East and CarMax West became vehicle retailers only, and CBS began to provide all of the corporate overhead services, house financing operations through its financing arm (CAF), and manage the intellectual property for its members. Both CarMax East and CarMax West pay CBS a management fee for these services.²

CarMax West claims that it has no financial connection to South Carolina outside of royalty payments from CarMax East. From 2002–2004, CarMax East made direct payments to CarMax West for use of the intellectual property; and since 2004, CarMax East has made management fee payments to CBS on a per-vehicle-sold basis, and CAF has generated further financing revenue in South Carolina. Because of its status as an LLC, CBS is taxed as a partnership; therefore, both sources of revenue “flow through” CBS to its members, and thus indirectly, to CarMax West.³

At issue is how an allocated portion of this income should be taxed in South Carolina. CarMax West initially filed timely corporate income tax returns for tax years 2002–2007.⁴

In 2008, the Department audited CarMax West, and issued a proposed assessment, adjusting CarMax West's apportionment formula and imposing penalties. CarMax West filed a protest, and in early 2009, the Department issued a Determination upholding the Department's assessment.

Six months later, CarMax West filed the amended tax returns in question, using the statutory apportionment method found in section 12–6–2290 of the South Carolina Code. See S.C.Code Ann. § 12–6–2290 (2000 & Supp.2009). This method, commonly referred to as the “gross receipts method,” calculates a multistate taxpayer's taxes due by creating an apportionment ratio that divides the taxpayer's receipts from financing and intangibles in South Carolina by the taxpayer's receipts from financing, intangibles, and retail sales everywhere else the taxpayer does business.⁵ CarMax West then multiplied its net income by the apportionment ratio, and multiplied that number by South Carolina's income tax rate to arrive at its South Carolina income tax.

The Department rejected CarMax West's use of the gross receipts method, claiming it did not fairly represent the extent of CarMax West's business dealings in South Carolina. Rather, the Department proposed an alternate apportionment method pursuant to section 12–6–2320(A)(4) of the South Carolina Code. See S.C Code Ann. § 12–6–2320 (2000 & Supp.2009).

The Department's proposed alternative formula employed an apportionment ratio of CarMax West's South Carolina income from intangibles and financing divided by CarMax West's intangibles and financing income from everywhere else that it does business. According to the Department, this alternative formula focused on CarMax West's actual business activity in South Carolina. The Department sought to prevent CarMax West from diluting its income by inflating the denominator of its apportionment ratio with sales from its Western retail operations. Furthermore, the Department sought to include the income from the sale of securitized consumer lending contracts in CarMax West's South Carolina income. The Department still sought penalties.

After the Department issued a Final Agency Determination upholding the Department's use of the alternate formula, CarMax West filed a contested case in the ALC. The ALC affirmed the Department's use of an alternative apportionment formula, but dismissed the penalties assessed against CarMax West. The ALC found that (1) the Department demonstrated that the gross receipts formula failed to fairly represent CarMax West's business in South Carolina; (2) the Department's alternate apportionment formula was reasonable with respect to the extent of CarMax West's business activity in South Carolina; (3) the financing receipts were appropriately sourced to South Carolina; and (4) the alternative apportionment formula did not violate the Commerce Clause.

CarMax West appealed the ALC's decision to the court of appeals. See CarMax Auto Superstores W. Coast, Inc. v. S.C. Dep't of Revenue, 397 S.C. 604, 725 S.E.2d 711 (Ct.App.2012). On appeal, CarMax West argued the ALC erred in: (1) applying the wrong burden and standard of proof; (2) failing to consider that CarMax West operates a unitary business and permitting the Department to use separate accounting procedures when calculating tax liability of a unitary business; (3) finding that CarMax West's South Carolina business activities were not accurately calculated using the gross receipts method; (4) using the wrong test in deciding that CarMax West's financing receipts should be sourced to South Carolina; and (6) finding that the Department did not violate CarMax West's constitutional rights by applying a separate accounting to a unitary business and by sourcing financing receipts to South Carolina. Id. at 606, 725 S.E.2d at 712. The court of appeals reversed and remanded the case to the ALC for application of the proper burden of proof, without considering the remaining issues. Id. at 611, 725 S.E.2d at 714.

Both parties filed petitions for a writ of certiorari. This Court granted review and accepted amici curiae briefs from the Council on State Taxation and the South Carolina State Chamber of Commerce.

Standard of Review

The Administrative Procedures Act⁶ (the APA) “governs appellate review of a final decision from an administrative agency.” Hill v. Eagle Motor Lines, 373 S.C. 422, 427, 645 S.E.2d 424, 428 (2007) (citation omitted). In appeals taken pursuant to the APA,

[t]he court may affirm the decision of the agency or remand the case for further proceedings. The court may reverse or modify the decision if substantial rights of the appellant have been prejudiced because the administrative findings, inferences, conclusions, or decisions are:

(a) in violation of constitutional or statutory provisions;

(b) in excess of the statutory authority of the agency;

(c) made upon unlawful procedure;

(d) affected by other error of law;

(e) clearly erroneous in view of the reliable, probative, and substantial evidence on the whole record; or

(f) arbitrary or capricious or characterized by abuse of discretion or clearly unwarranted exercise of discretion.

S.C.Code Ann. § 1–23–380(5)(a)–(f) (Supp.2013). However, the Court “may not substitute its judgment for the judgment of the agency as to the weight of the evidence on questions of fact.” S.C.Code Ann. § 1–23–380(5) ; MRI at Belfair, LLC v. S.C. Dep't of Health & Envtl. Control, 379 S.C. 1, 6, 664 S.E.2d 471, 474 (2008).

Analysis

In South Carolina, corporate income tax “is imposed annually at the rate of five percent on the South Carolina taxable income of every corporation ... transacting, conducting, or doing business within this State or having income within this State, regardless of whether these activities are carried on in intrastate, interstate, or foreign commerce.” S.C.Code Ann. § 12–6–530 (2014). “A corporation's taxable income in South Carolina is computed using the Internal Revenue Code with modifications as provided by South Carolina law, and this amount is ‘subject to allocation and apportionment as provided in Article 17 of this chapter.’ ” Media Gen. Commc'ns, Inc. v. S.C. Dep't of Revenue, 388 S.C. 138, 145, 694 S.E.2d 525, 528...