Hoosier Energy Rural Elec. Co-op., Inc. v. Indiana Dept. of State Revenue, 53T05-8709-TA-00041

• Decision Date: 29 September 1988
• Docket Number: No. 53T05-8709-TA-00041,53T05-8709-TA-00041
• Citation: 528 N.E.2d 867
• Parties: HOOSIER ENERGY RURAL ELECTRIC COOPERATIVE, INC., Petitioner, v. INDIANA DEPARTMENT OF STATE REVENUE, Respondent.
• Court: Indiana Tax Court

Page 867

528 N.E.2d 867

HOOSIER ENERGY RURAL ELECTRIC COOPERATIVE, INC., Petitioner, v. INDIANA DEPARTMENT OF STATE REVENUE, Respondent.

No. 53T05-8709-TA-00041.

Tax Court of Indiana.

Sept. 29, 1988.

J. David Huber, Zoercher, Huber & McEntarfer, Tell City, for petitioner.

Linley E. Pearson, Atty. Gen. by Joel Schiff, Deputy Atty. Gen., Indianapolis, for respondent.

FISHER, Judge.

Hoosier Energy Electric Cooperative appeals the final determination of the Indiana Department of State Revenue. Hoosier protested the Department's assessment of gross income tax on the sale-lease back of property. The Department partially sustained the protest, but assessed gross income tax on the sale of federal income tax benefits. Hoosier's protest and subsequent claim for refund of the second assessment was denied by the Department.

Hoosier was an Indiana corporation. It owned and operated the Merom Generating Station, a coal-fired electric generating facility in Sullivan County, Indiana. In 1982, Hoosier sold its rights to claim certain federal income tax benefits to Amoco Tax Leasing IV Corporation, a Delaware corporation with its principal office in Illinois, and J.C. Penney Company, a Delaware corporation with its principal office in New York. The tax benefits consisted of accelerated cost recovery deductions and investment tax credits relating to personal property located at the Merom Generating Station.

The transaction was structured as a sale-lease back of property, whereby Hoosier sold its property to Amoco and Penney, then leased the property back. Unlike a traditional sale-lease back, however, title was never transferred to Amoco and Penney. Title remained at all times in Hoosier. The parties negotiated the value of the tax benefits, to be paid up front in cash. The difference between Hoosier's tax basis in the property and the value of the tax benefits was represented by notes from Amoco and Penney.

Amoco and Penney then leased the property to Hoosier. The amount of rental due on the lease was equal to the amount of principal and interest on the notes. At the end of the lease, Hoosier had the option to buy the property for a nominal amount. The effect of the transaction was thus a complete wash, save the transfer of tax benefits. Congress recognized the transaction as a safe harbor lease under section 201(a) of the Economic Recovery Tax Act (1981), I.R.C. Sec. 168(f), to allow the transfer of tax benefits for the purpose of encouraging capital investment.

Hoosier was audited by the Department for the tax years 1980 through 1983. The Department assessed gross income taxes of $9,443,457 on Hoosier's 1982 "sale" of personal property to Amoco and Penney. Hoosier protested the assessment.

Prior to its hearing, Hoosier's representative contacted the Department by letter. The letter explained that the safe harbor lease did not constitute a sale of property because no transfer of title had occurred, that the parties merely transferred tax benefits, and that the sale of tax benefits was an interstate transaction exempt from state taxation under the commerce clause. Hoosier reiterated its position at the hearing.

The Department's hearing officer agreed that the safe harbor lease did not constitute a sale of property subject to the gross income tax, but he found that the proceeds from the sale of tax benefits were subject to the gross income tax. The Department issued both a letter of findings and a new assessment for $2,035,406 of gross income tax on the sale of tax benefits represented by the up front money paid by Amoco and Penney. Hoosier paid the tax in full. The Department denied Hoosier's claim for refund. This appeal followed.

The issues presented are:

(1) Whether collection is barred by the statute of limitations; and

(2) Whether the interstate sale of tax benefits under an I.R.C. Sec. 168(f) safe harbor lease is exempt from taxation under the commerce clause.

I. STATUTE OF LIMITATIONS

Hoosier Energy claims the collection of tax is barred by the statute of limitations because the second assessment, issued March 18, 1987, was not issued within three years of the date the return was filed, as required by IC 6-8.1-5-2(a). The Department claims that the second assessment is a reduction of the original timely assessment, therefore collection is not barred by IC 6-8.1-5-2.

The Department also contends that Hoosier has waived the issue by its failure to raise it in its claim for refund. Hoosier responds that the Department cannot argue waiver because of its failure to plead waiver in its answer.

Hoosier is correct in asserting that the Department's responsive pleading should have included waiver. Ind. Rules of Procedure, Trial Rule 8(C). Notwithstanding Trial Rule 8(C), the Department's contention is meritless because original tax appeals involving a claim for refund are de novo proceedings. IC 6-8.1-9-1(d) (Supp.1986). The court's scope of review extends beyond issues argued at the administrative level; questions regarding the statute of limitations are no exception.

Hoosier's characterization of the second assessment as one completely unrelated to the original is not persuasive. The "sales price" of the property was $632,153,389. Amoco and Penney paid part of the sales price in cash, amounting to $196,318,566, and the remainder in notes. The amount of the notes equaled the amount of the rental due on the lease when Hoosier "leased back" its own property. The up front money represented the amount the parties negotiated as the value of the tax benefits, constituting the substance of the transaction.

When the Department finally looked to substance over form, it found that only the up front money, or the proceeds from the sale of tax benefits, was subject to tax. In this sense, the second assessment was merely a reduction of the original. Collection is therefore not barred by the statute of limitations.

II. COMMERCE CLAUSE

Hoosier claims that the sale of tax benefits is an interstate transaction exempt from state taxation under the commerce clause. It argues that the tax falls squarely within the facts of Freeman v. Hewit (1946), 329 U.S. 249, 67 S.Ct. 274, 91 L.Ed. 265, and Indiana Department of State Revenue v. Nebeker (1953), 233 Ind. 58, 116 N.E.2d 104, aff'd (1955), 348 U.S. 933, 75 S.Ct. 354, 99 L.Ed. 731. The Department acknowledges that the sale is an interstate transaction, but argues that the gross receipts from the sale are subject to state taxation under Complete Auto Transit, Inc. v. Brady (1977), 430 U.S. 274, 97 S.Ct. 1076, 51 L.Ed.2d 326.

Hoosier argues Freeman is controlling because it has not been overruled and the sale of tax benefits is indistinguishable from the sale of stock in Freeman, therefore this court is required to invalidate the tax. The Department argues that Complete Auto is controlling because the Supreme Court has rejected the reasoning of Freeman. Hoosier responds that even if the underpinnings of Freeman were overruled in Complete Auto, the result must be the same as it was in Freeman because the Complete Auto court adopted the reasoning of Justice Rutledge's concurring opinion in Freeman.

Prior to World War II, the Supreme Court's taxation decisions under the commerce clause provided interstate businesses with virtual immunity from state and local taxes. Many state taxes were considered "direct burdens" on interstate commerce and were thus considered impermissible under the commerce clause.

The Supreme Court sharply changed its course with the introduction of the multiple tax doctrine in Western Live Stock v. Bureau of Revenue (1938), 303 U.S. 250, 58 S.Ct. 546, 82 L.Ed. 823. Under the multiple tax doctrine, interstate businesses were required to pay their share of the state tax burden, but the commerce clause protected them from cumulative tax burdens not borne by local businesses. Id. at 258, 58 S.Ct. at 550. Freeman v. Hewit represented the Supreme Court's temporary reversion to the direct burden analysis. See J. HELLERSTEIN, STATE TAXATION: CORPORATE INCOME & FRANCHISE TAXES paragraphs 4.5-4.8 (1983); Hellerstein, W., State Taxation of Interstate Business: Perspectives on Two Centuries of Constitutional Adjudication, 41 TAX LAW. 37, 38-50 (1987).

In Freeman, the taxpayer was the trustee of an estate created by a will of a decedent domiciled in Indiana at the time of death. The trustee sold securities held by the estate through an Indiana broker, who arranged for the sale of securities on the New York Stock Exchange by New York brokers. Indiana imposed a tax on the gross receipts of the sale.

Justice Frankfurter, writing for the majority, began his analysis of the commerce clause issue: "Our starting point is clear. [T]he Commerce Clause was not merely an authorization to Congress to enact laws for the protection and encouragement of commerce among the states, but by its own force created an area of trade free from interference by the States." Freeman, 329 U.S. at 252, 67 S.Ct. at 276 (emphasis added) The Court rejected Indiana's arguments that the tax was valid because it neither discriminated against interstate commerce nor subjected the taxpayer to multiple taxation. The Court concluded that the tax constituted a direct burden on interstate commerce and as such, constituted impermissible interference with the freedom of interstate commerce. Id. at 257, 67 S.Ct. at 279.

Justice Rutledge concurred in the result, but declined to join the majority because they disregarded apportionment and the risk of multiple taxation. Id. at 260, 67 S.Ct. at 280 (Rutledge, J., concurring). He believed that Indiana had sufficient contacts with the taxpayer to justify the tax under the due process clause, id. at 271 n. 27, 67 S.Ct. at 287 n. 27, but that the tax was nevertheless invalid because the taxpayer was subject to the risk of multiple taxation since New York had "equally close and important" connections to the taxpayer. Id. at 272, 67 S.Ct. at 287.

In Nebeker, the ...