Kmart Corp. v. Taxation and Revenue Dept.

• Decision Date: 29 December 2005
• Docket Number: No. 27,269.,27,269.
• Citation: 131 P.3d 22
• Parties: KMART CORPORATION, a Michigan corporation, Petitioner, v. TAXATION AND REVENUE DEPARTMENT OF THE STATE OF NEW MEXICO, Respondent.
• Court: New Mexico Supreme Court

Page 22

131 P.3d 22

KMART CORPORATION, a Michigan corporation, Petitioner, v. TAXATION AND REVENUE DEPARTMENT OF THE STATE OF NEW MEXICO, Respondent.

No. 27,269.

Supreme Court of New Mexico.

December 29, 2005.

Modrall, Sperling, Roehl, Harris & Sisk, P.A., Curtis W. Schwartz, Timothy R. Van Valen, Santa Fe, McDermott, Will & Emery, L.L.P, Donald M. Griswold, Melise R. Blakeslee, William L. Goldman, Joshua D. Odintz, Washington, DC, for Petitioner.

Jeffrey W. Loubet, Bruce J. Fort, Santa Fe, for Respondent.

Rubin, Katz, Salazar, Alley, Rouse & Herdman, James S. Rubin, Santa Fe, Morrison and Foerster, L.L.P., Paul H. Frankel, Hollis L. Hyans, Amy F. Nogid, New York, NY, for Amicus Curiae Lanco Inc.

OPINION

MAES, Justice.

{1} We granted a Petition for Certiorari filed by Kmart Properties, Incorporated ("KPI"). On appeal, Kmart Corporation ("Kmart") was substituted as a party for KPI because KPI subsequently merged with Kmart, who assumed KPI's state and local taxation rights and obligations. Kmart asks this Court to reverse the opinion by our Court of Appeals, which upheld the imposition of the Gross Receipts Tax ("GRT") and the Corporate Income Tax on KPI by the New Mexico Taxation and Revenue Department ("the Department"). Kmart presented six questions for our review: (1) Whether New Mexico has jurisdiction to tax KPI under the Commerce Clause of the United States Constitution; (2) Whether New Mexico has jurisdiction to tax KPI under the Due Process Clause of the United States Constitution; (3) If New Mexico has taxing jurisdiction, whether New Mexico's Corporate Income and Franchise Tax Act, NMSA 1978, §§ 7-2A-1 to -17 (variously amended through 2003), and Uniform Division of Income for Tax Purposes Act, NMSA 1978, §§ 7-4-1 to -21 (variously amended through 2002), subject KPI income to state taxation; (4) If New Mexico has taxing jurisdiction, whether the GRT applies to receipts from the granting (a "sale") of a license to use property when the granting occurs outside of New Mexico; (5) If New Mexico has taxing jurisdiction, whether the administrative hearing process, as implemented by the Department, violates KPI's due process rights; and (6) If New Mexico has taxing jurisdiction, whether the Hearing Officer, by failing to render his Decision and Order within thirty days of the completion of briefing during the administrative protest renders the Decision and Order void, and requires a holding that KPI was entitled to a grant of its protest?

{2} We find that the New Mexico GRT does not apply to the transaction at issue because it involved the sale of property and the GRT does not impose a tax on sales that take place entirely out of the state. Because analysis of New Mexico state statutes wholly resolves this issue, we do not need to address Kmart's constitutional challenges to the imposition of the GRT as raised in questions one and two above. With respect to questions five and six, this case is resolved completely without examining the Department's administrative hearing process. Additionally, we now quash certiorari on the Corporate Income Tax issues identified in question number three and order that the Court of Appeals opinion, Kmart Properties, Inc. v. New Mexico Taxation & Revenue Dep't, 2006-NMCA-026, ___ N.M. ___, 131 P.3d 17, shall be filed concurrent with the filing of this opinion.

FACTS AND PROCEDURE BELOW

{3} The facts of this case are not disputed. Kmart is a well-known retailer of consumer goods throughout the United States. During the tax years at issue, 1991 through 1996, Kmart owned and operated twenty-two stores in New Mexico. Kmart is both registered as a corporation and has its principal place of business in Michigan. In 1991, Kmart formed KPI as a wholly owned subsidiary. KPI is also a Michigan corporation with its principal place of business there. KPI was housed in rented office space near Kmart's corporate headquarters. Its employees consisted of two intellectual property attorneys and support staff transferred from Kmart.

{4} In 1991, Kmart assigned to KPI certain trademarks, trade names and domestic services marks (collectively, "Marks"), along with their associated goodwill. The Marks included the name "Kmart" and many of its well-known brand names. The Marks were valued at between $2,734,100,000 and $4,101,200,000 by an independent appraiser. KPI's primary business purpose was the licensing of the Marks. Pursuant to a plan created by Price-Waterhouse, Kmart and KPI entered into a License Agreement concerning the Marks. The License Agreement granted Kmart the exclusive right to use the Marks, subject to quality control restrictions, and in exchange, Kmart paid KPI a license fee of 1.1% of Kmart's national net sales. All activity related to the License Agreement took place in Michigan. Michigan law governs the Agreement and the parties are required to bring any legal actions related to it in Michigan courts. KPI managed Kmart's trademark portfolio, monitored its compliance with the License Agreement, and provided trademark-related services to Kmart and its subsidiaries. KPI's operations were contained within Michigan, and the record contains no indication that any of its employees or agents ever had the pleasure of visiting New Mexico. KPI did not file tax returns in New Mexico for the years at issue here, 1991 through 1996.

{5} It seems apparent that KPI was created to reduce Kmart's state tax liability. KPI's formation and the plan for reducing Kmart's state tax liability are spelled out in a Price-Waterhouse document prepared for Kmart entitled Utilization of an Investment Holding Company to Minimize State and Local Income Taxes. KPI was formed as an "investment holding company," also known as an "intangible holding company," in Michigan, which does not tax royalty or interest income. Its direct activities were restricted to Michigan so that it would not be taxed by another state. As a result of the formation of KPI, Kmart was able to deduct two different "losses" from its income tax liability in other states. First, Kmart could deduct the royalty payments it made to KPI, as a business expense. Second, because KPI loaned back to Kmart the money it received from the royalty payments at market interest rates, Kmart could claim a deduction for interest expenses. As a result of these deductions and expenses, Kmart's stated profits declined and its state income tax liability was consequently reduced. In one year, Kmart was able to completely eliminate its corporate income tax liability in New Mexico.

{6} Kmart's royalty deductions caught the eye of an auditor for the New Mexico Taxation and Revenue Department in 1997. The Department requested a copy of the License Agreement. It applied the 1.1% royalty rate to the relevant New Mexico sales revenue from Kmart stores to determine KPI's income attributable to New Mexico under the License Agreement. This resulted in a determination that KPI earned in excess of two million dollars per year from business in New Mexico Kmart stores. The Department then performed an audit on KPI, which calculated corporate income tax and gross receipts tax on KPI. The Department assessed $758,142 corporate income tax due from 1991 through 1996 and $478,099.55 in gross receipts tax due from the same period. The Department also assessed penalties and interest on KPI for failing to pay the taxes on time. The Department did not challenge the validity of the transactions creating KPI, but attempted to assert taxes on KPI income generated from Kmart's stores in New Mexico.

{7} KPI filed a timely protest of all assessments in accordance with NMSA 1978, Section 7-1-24(B) (2000). A Department officer heard the protest and affirmed the assessment of corporate income tax and gross receipts tax plus interest, but reversed the assessment of penalties. KPI appealed this ruling to the Court of Appeals. In that appeal, the Department did not appeal the hearing officer's determination to eliminate the penalties.

{8} The Court of Appeals upheld the Department's imposition of both taxes. In its discussion, the Court of Appeals focused on the constitutionality of imposing corporate income tax and gross receipts tax on KPI. It held that neither the Commerce Clause nor the Due Process Clause of the United States Constitution prohibit New Mexico from imposing the corporate income tax or gross receipts tax on KPI. Further, the court held that the taxes as written applied to KPI, specifically that the GRT applied to the License Agreement. We granted Kmart's Petition for Certiorari concerning both taxes pursuant to Rule 12-502 NMRA 2005. Subsequently, the case was stayed when Kmart filed for bankruptcy on July 30, 2002. In Re: Kmart Corp., Cause No. 02-B0247 (Bankr. N.D.Ill.). We entered an Order lifting the stay on June 13, 2003. In doing so, we lifted the stay as to all issues on certiorari, but limited briefing and oral argument to whether the GRT applies to receipts from the granting of a license to use property when the granting occurs outside of New Mexico, including how the constitutional issues in the first and second questions in the petition for certiorari relate to the gross receipts issue. The Department filed a motion to quash certiorari on the Corporate Income Tax issue contained in issue three. After considering the response of Kmart, we now quash certiorari on the issue of Corporate Income Tax.

STANDARD OF REVIEW

{9} Because the facts in this case are undisputed, we review de novo the court's or administrative agency's application of the law to the facts. TPL, Inc. v. N.M. Taxation & Revenue Dep't, 2003-NMSC-007, ¶ 10, 133 N.M. 447, 64 P.3d 474. The interpretation of phrases within a statute is a question of law that is reviewed de novo. Id.

DISCUSSION

{10} This case requires us to decide if the Legislature intended to apply the GRT to the receipts generated from the License Agreement between KPI and Kmart. The Court of Appeals opinion in Kmart...