Malpass v. Dep't of Treasury

• Decision Date: 19 January 2012
• Docket Number: 299058,Docket Nos. 299057,and 299059.
• Citation: 815 N.W.2d 804,295 Mich.App. 263
• Parties: MALPASS v. DEPARTMENT OF TREASURY.
• Court: Court of Appeal of Michigan — District of US

295 Mich.App. 263

815 N.W.2d 804

MALPASS

v.DEPARTMENT OF TREASURY.

Docket Nos. 299057, 299058, and 299059.

Court of Appeals of Michigan.

Submitted Oct. 4, 2011, at Lansing.

Decided Dec. 6, 2011.

Approved for publication Jan. 19, 2012, at 9:10 a.m.

Warner Norcross & Judd LLP (by Jason L. Byrne, Stephen R. Kretschman, Grand Rapids, and Jeffrey W. Bracken, Lansing) for Tad and Brenda L. Malpass, Tracy and Brenda K. Malpass, and Fred and Barbara Malpass.

Bill Schuette, Attorney General, John J. Bursch, Solicitor General, and Bradley K. Morton and Heidi L. Johnson–Mehney, Assistant Attorneys General, for the Department of Treasury.

Before: SHAPIRO, P.J., and SAAD and BECKERING, JJ.

PER CURIAM.

In this consolidated appeal, the Michigan Department of Treasury (Treasury) appeals the June 9, 2010, judgment of the Court of Claims that reversed Treasury's decision to deny plaintiffs' amended individual income tax returns for the years 2001, 2002, and 2003. For the reasons set forth below, we reverse.

I. FACTS AND PROCEEDINGS

Plaintiffs own and control East Jordan Iron Works, Inc. (EJIW). EJIW is a Michigan corporation with its corporate offices, resident agent, and principal place of business located at 301 Spring Street, East Jordan, Michigan. During the years in question, EJIW operated a foundry in East Jordan. In 1999, plaintiffs established Ardmore Foundry, Inc. Ardmore is a Michigan corporation with its resident agent located at 301 Spring Street, East Jordan. However, Ardmore's sole business is the ownership and operation of a foundry and distribution center known as EJIW–Ardmore Foundry, located in Ardmore, Oklahoma. All of Ardmore's stock is owned directly, or through trust, by members of the Malpass family.

Both EJIW and Ardmore have elected to be treated as S corporations for federal tax purposes. As the trial court stated, “This means that the two corporations do not pay federal income taxes. Instead the corporations income and/or losses are passed through to their shareholders and reported by those shareholders on their individual federal and Michigan income tax returns.” In the years 2001, 2002, and 2003, plaintiffs filed their Michigan individual income tax returns “treating the corporations' business incomes as if from separate, non-unitary businesses.” Accordingly, plaintiffs apportioned their business income from EJIW attributable to Michigan and included it as income on their Michigan individual income tax returns. The losses incurred by Ardmore were attributed to Oklahoma and added back into plaintiffs' adjusted gross income for Michigan individual income tax purposes.

Plaintiffs later filed amended individual income tax returns for the years 2001, 2002, and 2003. In their amended returns, plaintiffs treated EJIW and Ardmore as a unitary business and applied the Michigan apportionment factors to both companies as a unitary business. In so doing, plaintiffs sought to offset gains earned by EJIW with losses incurred by Ardmore. Through their amended returns, plaintiffs requested refunds totaling over $1 million.

Treasury denied plaintiffs' amended returns, and plaintiffs filed three actions in the Court of Claims requesting reversal. The three cases were consolidated by stipulation of the parties. After submitting a partial stipulation of facts, Treasury moved for summary disposition and argued that Michigan's Income Tax Act (ITA), MCL 206.1 et seq., does not allow the unitary-business principle to be applied to individual income tax situations. Treasury also asserted that the ITA does not allow plaintiffs to use a combined filing method based on the unitary-business principle.

Plaintiffs opposed Treasury's motion and asked the court to grant summary disposition in their favor. Plaintiffs argued that EJIW and Ardmore are a unitary business and supported the motion with an affidavit from William Lorne, treasurer of EJIW, who averred that the two companies are functionally integrated. After hearing arguments, the Court of Claims issued a written opinion and order dated November 19, 2009, granting summary disposition to plaintiffs. The Court of Claims stated that although the Legislature had not explicitly referred to the unitary-business principle in the ITA, it nonetheless adopted the principle into the act. The court based its conclusion on MCL 206.110(1), which provides, “For a resident individual ... all taxable income from any source whatsoever, except that attributable to another state under [MCL 206.111 to MCL 206.115] and subject to [MCL 206.255], is allocated to this state.” The court noted that MCL 206.111 to MCL 206.114, and MCL 206.255 were not applicable, but MCL 206.115 was. It provides, “All business income, other than income from transportation services shall be apportionedto this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is 3.”

Taking MCL 206.110 and MCL 206.115 together, the court stated: “Clearly, based on the plain language set forth in Sections 110 and 115, the Michigan Legislature has adopted the unitary business principle, because it has chosen to require the apportionment of all business income according to a statutory formula.” The Court of Claims further observed that the language of MCL 206.115 is so broad that it does not distinguish between unitary and nonunitary businesses. However, the court recognized that the ITA's apportionment formula could only be constitutionally applied to a unitary business. Because it ruled that plaintiffs' businesses are unitary, the court allowed apportionment and ordered Treasury to make the requested refunds.

II. DISCUSSION

This Court reviews de novo the grant or denial of a motion for summary disposition. Int'l Business Machines v. Dep't of Treasury, 220 Mich.App. 83, 86, 558 N.W.2d 456 (1996). To the extent this appeal requires us to interpret the ITA, our review is also de novo. Briggs Tax Serv., LLC v. Detroit Pub. Sch., 485 Mich. 69, 75, 780 N.W.2d 753 (2010).

We hold that the Court of Claims erred when it ruled that the unitary-business principle allows plaintiffs to apportion their business income from Ardmore to Michigan.

Although the United States Constitution does not impose a single tax formula on the states, apportionment is often implemented because of the difficulties of attempting to allocate taxable income on the basis of geographic boundaries. Allied–Signal, Inc. v. Dir., Div. of Taxation, 504 U.S. 768, 778, 112 S.Ct. 2251, 119 L.Ed.2d 533 (1992); Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159, 164–165, 103 S.Ct. 2933, 77 L.Ed.2d 545 (1983). Because of these difficulties, states are permitted to tax multistate businesses “on an apportionable share of the multistate business carried on in part in the taxing State.” Allied–Signal, 504 U.S. at 778, 112 S.Ct. 2251. This is known as the “unitary business principle.” Id. Using the unitary-business principle, Michigan has incorporated an apportionment formula into the ITA. MCL 206.110(1) provides: “For a resident individual, ... all taxable income from any source whatsoever, except that attributable to another state under [MCL 206.111 to MCL 206.115] and subject to [MCL 206.255], is allocated to this state.” As noted, MCL 206.115 provides: “All business income ... shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is 3.” “The property, payroll, and sales factors represent the percentage of the total property, payroll, or sales of the business used, paid, or made in this state.” Grunewald v. Dep't of Treasury, 104 Mich.App. 601, 606, 305 N.W.2d 269 (1981), citing MCL 206.116, MCL 206.119, and MCL 206.121.

For an individual or business to apply the unitary-business principle, there must “be some sharing or exchange of value not capable of precise identification or measurement—beyond the mere flow of funds arising out of a passive investment or a distinct business operation—which renders formula apportionment a reasonable method of taxation.” Container Corp., 463 U.S. at 166, 103 S.Ct. 2933. In the absence of some underlying unitary business, multistate apportionment is precluded. Holloway Sand & Gravel Co., Inc., v. Dep't of Treasury, 152 Mich.App. 823, 829–830, 393 N.W.2d 921 (1986). To determine whether a multistate business is unitary or discrete, this Court looks at (1) economic realities, (2) functional integration, (3) centralized management, (4) economies of scale, and (5) substantial mutual interdependence. Id. at 831, 393 N.W.2d 921.

Plaintiffs argue in this case that they are allowed to apportion their income from Ardmore and EJIW because the two corporations form a unitary business. Given Lorne's affidavit, there is no doubt that Ardmore and EJIW have many characteristics of a unitary business. See Holloway, 152 Mich.App. at 830–835, 393 N.W.2d 921. However, they remain separate and legally distinct business entities, and nothing in the ITA allows for combined-entity reporting.

The Court of Claims focused on the word “all” in MCL 206.115 and ruled that it meant that all business income, no matter what the source, must be added together and then apportioned by the apportionment factors. The problem with this approach, which the Court of Claims recognized, is that “[u]nder both the Due Process and the Commerce Clauses of the Constitution, a State may not, when imposing an income-based tax, ‘tax value earned outside its borders.’ ” Container Corp., 463 U.S. at 164, 103 S.Ct. 2933 (citation omitted). Therefore, under the Court of Claims' approach, in order to comply with due process, business income may only be combined if the separate entities operate in a unitary fashion. If business income is earned from entities that do not operate in a unitary fashion, then the income must be...