Doctor's Assocs. v. Dept. of Rev. And Reg.
| Decision Date | 01 March 2006 |
| Docket Number | No. 23744.,23744. |
| Citation | 2006 SD 18,711 N.W.2d 237 |
| Parties | DOCTOR'S ASSOCIATES, INC., Plaintiff and Appellant, v. DEPARTMENT OF REVENUE AND REGULATION, Defendant and Appellee. |
| Court | South Dakota Supreme Court |
Todd C. Miller, Sioux Falls, South Dakota, Attorney for plaintiff and appellant.
Harvey M. Crow, Jr., South Dakota Department of Revenue and Regulation, Rapid City, South Dakota, Attorney for defendant and appellee.
[¶ 1.] Doctor's Associates, Inc., headquartered in Milford, Connecticut, owns the international Subway fast-food restaurant franchise. South Dakota has fifty-three restaurants in the Subway chain. Subway collects an 8% "royalty" fee from each franchisee's weekly gross sales. After an audit, the Department of Revenue and Regulation determined that Subway's royalty fees constitute taxable gross receipts. Since Subway failed to report these fees on its sales tax returns, the Department issued a certificate of assessment for sales tax and interest. Subway contested the assessment. Following an unsuccessful administrative appeal, Subway now seeks review before us, claiming that its royalty fees are non-taxable intangibles and that the Department failed in its burden of proving taxability. Because Subway's franchise agreement provides that its royalty fees are collected in exchange for tangible personal property and services, these fees constitute taxable gross receipts under South Dakota law. Therefore, we uphold the assessment.
[¶ 2.] On August 17, 2000, the senior auditor for the Department sent Subway a notice of intent to audit. As part of the notice, the Department requested that Subway submit certain corporate records. The Department further informed Subway in the notice of intent to audit that "(1) the audit period was July, 1997 through October, 2000; (2) the audit would commence on December 5, 2000; and (3) Subway had sixty days from December 5, 2000 to present to the auditor `all documents evidencing reduction, deduction or exemption from tax,' and any such records not presented would not have to be considered by the auditor."
[¶ 3.] To operate as a franchisee, each Subway restaurant owner was required to sign and accept, as is, Subway's franchise agreement, pay a one-time, non-refundable franchise fee, and thereafter, pay an 8% "royalty" fee on the restaurant's gross weekly sales. When Subway received the notice of intent to audit, it provided the Department with financial information about the South Dakota franchisees. Subway submitted "(1) a sales quarterly ledger detailing the royalty fees paid to Subway each week; (2) a copy of the April, 1997, `Limited Amnesty Program for the Franchise Industry,' outlining the Department's policy regarding taxation of royalty fees beginning July 1, 1997; and, (3) a copy of the Franchise Agreement."
[¶ 4.] The audit took place in Milford and began on December 5, 2000. It lasted approximately six months. During the audit, the Department reviewed Subway's records and concluded that the 8% royalty fee received by Subway from its franchisees constituted gross receipts and should have been reported in Subway's sales tax returns. In reaching its conclusion, the Department relied on the language of the franchise agreement. Paragraph three states that Subway provides tangible personal property to franchisees.1 Paragraph four indicates that services are provided to franchisees.2 Because the franchise agreement stipulates that the royalty fees are consideration for allowing the franchisees access to Subway's body of knowledge, among other things, the Department deemed the royalty fees collected by Subway to be taxable gross receipts under SDCL 10-45-2 and 10-45-4.3
[¶ 5.] Subway had the opportunity to submit any evidence to show that the royalty fees should not be subject to sales tax. Beginning on December 5, 2000, Subway had sixty days to present materials to the Department that would reduce, deduct, or exempt the royalty fees from tax. When the sixty days ended on February 5, 2001, Subway had not submitted any evidence. Subway then requested an extension in order to present additional evidence. The extension was granted. On February 23, 2001, the Department sent Subway a "listing showing the [r]oyalty fees subject to sales tax to Subway for review." When the extension expired on March 5, 2001, Subway still had not presented any evidence. Then, in May 2001, Subway requested another extension, this time "to review the South Dakota Code and Regulations." Because the extension was not requested for the purpose of presenting additional evidence, the Department denied Subway's request.
[¶ 6.] In the end, the auditor received no evidence from Subway to reduce, deduct, or exempt any portion of the royalty fees from sales taxation. Consequently, the Department issued Subway a certificate of assessment for $270,660.70 on June 21, 2001. Subway requested a hearing and argued that the royalty fees should not be taxed because they were not received as consideration for taxable services or property contained within the franchise agreement. At the hearing in June 2004, Subway attempted to offer new evidence that should have been submitted before the sixty days expired under SDCL 10-59-7 or during the thirty-day extension. The hearing examiner excluded the evidence and affirmed the Department's certificate of assessment.
[¶ 7.] Subway appealed the decision to the circuit court. That court also excluded Subway's evidence for not having been timely presented within the statutory time and affirmed the certificate of assessment. Subway now appeals to this Court, claiming that the circuit court erred when it affirmed the hearing examiner's decision that (1) the royalty fees paid by the fifty-three South Dakota franchisees to Subway were taxable; (2) Subway failed to overcome the presumption of correctness of the certificate of assessment; and (3) certain testimony and documentary evidence were inadmissible.
[¶ 8.] Our review of an administrative appeal is governed by SDCL 1-26-36. Watertown Coop. Elevator Ass'n v. S.D. Dept. of Rev., 2001 SD 56, ¶ 10, 627 N.W.2d 167, 171. "We give deference to the agency on factual matters, applying the clearly erroneous standard of review." Id. (citing Sopko v. C & R Transfer Co., Inc., 1998 SD 8, ¶ 6, 575 N.W.2d 225, 228 (citations omitted)). However, the agency's conclusions of law are reviewed de novo. W. Wireless Corp. v. Dept. of Rev., 2003 SD 68, ¶ 5, 665 N.W.2d 73, 75 (citing Sopko, 1998 SD 8, ¶ 6, 575 N.W.2d at 228).
[¶ 9.] Subway first contends that the circuit court erred when it concluded that the royalty fees, which Subway claims are intangibles, could be subject to sales tax under SDCL 10-45-2 and 10-45-4. The Department, on the other hand, asserts that the terms of the franchise agreement illustrate that Subway provided tangible personal property and services to South Dakota franchisees in return for the royalty fees. Thus, the Department deems the royalty fees in this case to be taxable under SDCL 10-45-2 and 10-45-4.
[¶ 10.] We begin by first examining the statutes in question. Whether SDCL 10-45-2 and 10-45-4 impose a sales tax under these circumstances is a question of law, reviewed de novo. See S.D. Dept. of Rev. v. Sanborn Tel. Coop., 455 N.W.2d 223, 225 (S.D.1990) (citations omitted). Under SDCL 10-45-2, "the gross receipts of all sales of tangible personal property consisting of goods, wares, or merchandise" are subject to sales tax, and, under SDCL 10-45-4, a tax is imposed on "the gross receipts of any person from the engaging in or continuing in the practice of any business in which a service is rendered."
[¶ 11.] In examining SDCL 10-45-2 and 10-45-4 together, we see that the royalty fees will be subject to sales tax if they constitute gross receipts for the sale of tangible personal property or service. "Gross receipts" is defined in SDCL 10-45-1(6) as the "consideration, including cash, credit, property, and services, for which tangible personal property or services are sold, leased, or rented, valued in money, whether received in money or otherwise...." And "tangible personal property" is defined as "personal property that can be seen, weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses." SDCL 10-45-1(14). Finally, the definition of "service" is contained in SDCL 10-45-4.1, which includes "all activities engaged in for other persons for a fee, retainer, commission, or other monetary charge, which activities involve predominantly the performance of a service as distinguished from selling property."
[¶ 12.] By applying these statutory definitions to the facts of this case, the royalty fees received by Subway were properly considered gross receipts from the sale of tangible personal property and services. This determination is based on the records Subway provided the Department for the audit, specifically the franchise agreement. First, in the section entitled Agreement, paragraph three states that Subway "grants" the franchisee access to, among other things, "the Company's recipes, formulas, food preparation procedures, business methods, business forms, business policies and body of knowledge. . . ." From this language it is clear that Subway is providing its franchisees with "tangible personal property" as defined in SDCL 10-45-1(14). Then in paragraph four, Subway agrees to "provide" franchisees a "Company Representative that the Franchisee may call upon during normal business hours for consultation concerning the operation of his business[.]" Based on the language of paragraph four, Subway is providing its franchisees with "services" as defined in SDCL 10-45-4.1. Finally, in the Recitals section of the agreement, we see that Subway receives consideration, i.e. "royalty," constituting "gross receipts" under SDCL 10-45-1(6), for the tangible personal...
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