Steven Klein, Inc. v. State, Dep't of Revenue

• Decision Date: 27 August 2015
• Docket Number: No. 91072–3.,91072–3.
• Citation: 183 Wash.2d 889,357 P.3d 59
• Court: Washington Supreme Court
• Parties: STEVEN KLEIN, INC., dba Klein Honda, Petitioner, v. STATE of Washington, DEPARTMENT OF REVENUE, Respondent.

183 Wash.2d 889

357 P.3d 59

STEVEN KLEIN, INC., dba Klein Honda, Petitioner

v.STATE of Washington, DEPARTMENT OF REVENUE, Respondent.

No. 91072–3.

Supreme Court of Washington, En Banc.

Argued June 11, 2015.

Decided Aug. 27, 2015.

Michele G. Radosevich, Dirk Jay Giseburt, Davis Wright Tremaine LLP, Seattle, WA, for Petitioner.

Heidi A. Irvin, Andrew J. Krawczyk, Atty. Generals Office/Revenue Division, Dept. of Revenue A.G. Office, Attorney at Law, Olympia, WA, for Respondent.

Opinion

OWENS, J.

¶ 1 Klein Honda is a Honda dealership. It purchases vehicles from Honda at wholesale and sells them at retail. From time to time, Honda offers a “dealer cash” incentive program for its dealerships. Under that program, dealerships can earn dealer cash (i.e., a specific amount of extra money) if they sell specific Honda models during specific times and comply with other terms and conditions.

¶ 2 This case requires us to determine whether Klein Honda's dealer cash earnings are taxable. We hold that they are. The catchall business and occupation (B & O) tax provision applies to other or additional business activities that do not constitute retail sales. By participating in the dealer cash program, Klein Honda received additional, separate income beyond its ordinary retail sales. That constitutes an additional taxable business activity under the catchall provision. Although dealer cash would not be taxable under one of the Washington State Department of Revenue's (Department) regulations if it represented a “bona fide discount” on Klein Honda's wholesale purchase of vehicles, former WAC 458–20–108(1), (5) (1987), dealer cash is not a bona fide discount because Klein Honda does not purchase vehicles from Honda subject to a dealer cash discount. Dealer cash payments are not necessarily quantified or even knowable at the time that Klein Honda purchases vehicles from Honda. Thus, Klein Honda's dealer cash is taxable.

FACTS

¶ 3 Klein Honda is a Honda franchisee car dealership in Everett, Washington. Klein Honda's business relationship with Honda is governed by a “Sales and Service Agreement” between them. Admin. Record (AR) at 20, 309. Under that agreement, Klein Honda purchases cars from Honda at wholesale and then sells those cars to customers at retail.

¶ 4 Klein Honda has “little discretion over [its] inventory.” Id. at 20. “Honda sends [Klein Honda] a presumptive order,” and Klein Honda “may remove vehicles from the order, but it cannot add them.” Id. Once Honda ships vehicles to Klein Honda, it issues an invoice to Klein Honda for each vehicle.

¶ 5 “The invoice states a price, and [Klein Honda] remits that amount to Honda.” Id. A typical invoice also states, “ ‘Dealer's invoice may not reflect dealer's ultimate vehicle cost given any rebates, allowances, collections, discounts, holdback, incentives, etc.’ ” Id.; see, e.g., id. at 765. A “holdback,” for example, is a credit that Honda issues to Klein Honda the month following Klein Honda's wholesale purchase of a vehicle. Honda provides this holdback credit, along with other similar credits, regardless of whether Klein Honda sells the vehicle—they are an adjustment to Klein Honda's purchase price of the vehicle. “The ... credits are quantified at or about the time the vehicle is purchased by the dealership and delivered by the manufacturer.” Id. at 20. Some of the credits that Honda provides are specifically listed on each vehicle's invoice. “The Department recognizes that [those] credits reduce the dealer's purchase price for the vehicle.” Id. All payments from Klein Honda to Honda for new vehicles and all credits from Honda to Klein Honda are reflected in a monthly balance forward statement.

¶ 6 From time to time, Honda also offers dealer cash incentive programs to dealerships. The dealer cash incentive program is designed to stimulate sales of specific Honda models during specific periods of time to compete with rival car manufacturers. As the general manager of Klein Honda testified,

Dealer cash is a means by which American Honda kind of puts more momentum behind a particular vehicle line or model. And when I say that, I mean that what they do is they adjust the vehicle's presence in the marketplace, usually as a reaction to competitive action, which typically would be rebates, consumer rebates, and allowing the Honda dealers to remain in a competitive position on that particular model.

Verbatim Tr. of Proceedings (VTP) at 50. When Honda decides to offer a dealer cash incentive program, it sends a marketing bulletin to dealerships informing them what they need to do to earn dealer cash. For example, on October 3, 2006, Honda sent out a marketing bulletin for dealer cash on the 2006 Honda Pilot, informing dealerships that they could receive “$2,500 Dealer Cash on eligible 2006 Pilot models” by selling the cars between October 3 and October 31, 2006, provided the dealerships complied with detailed rules, terms, and conditions. AR at 754. Among other terms and conditions, dealerships could not sell the car to an entity that would resell the vehicle and they were required to perform a self-audit at the end of every dealer cash program and verify by “signed affidavit” that they met the eligibility requirements. Id. at 757.

¶ 7 Klein Honda's general manager characterized Honda's dealer cash incentive program as a “conditional offer,” and he agreed it was conditional “because you don't get the dealer cash unless you sell a particular vehicle model during a particular time.” VTP at 62. Klein Honda's owner, Steven Klein, also recognized the detailed and conditional nature of the offer, saying that “this is our contract with the factory to get our money, and if we don't do everything to the letter of these bulletins they can say, we're not going to give you the dealer cash.” AR at 100. If Klein Honda meets all the requirements of Honda's dealer cash offer, Honda issues a credit in the monthly balance forward statement, and Honda also sends a separate “miscellaneous billing invoice” detailing how much dealer cash Klein Honda earned for a time period. Id. at 779 (formatting omitted). “Klein Honda does not account for dealer cash in its accounting records as a reduction in the cost of goods sold.” Id. at 26.

¶ 8 Klein Honda earned $1,037,450 in dealer cash from Honda during the audit period of January 1, 2003 to December 31, 2006. The Department assessed Klein Honda $16,963 in B & O taxes under the catchall “Service and Other Activities” B & O tax category. Id. at 795. Klein Honda paid the assessment but petitioned the Department's appeals division for a refund. The appeals division ultimately upheld the assessment.

¶ 9 Klein Honda appealed to the Board of Tax Appeals (Board), and the Board affirmed the Department's assessment. In its conclusions of law, the Board stated that a “taxpayer engaged in any business activity not specifically set forth in [the provisions regarding specific taxable business activities] shall be taxed at the rate of 1.5 percent.” Id. at 26. The Board concluded that the dealer cash credits were taxable as business revenue.

¶ 10 Klein Honda appealed to the Thurston County Superior Court. The superior court affirmed, concluding “that the Board's Decision affirming the Department's treatment of dealer cash as part of Klein Honda's taxable ‘gross income of the business' was not an error of law.” Clerk's Papers at 84.

¶ 11 Klein Honda appealed again, and the Court of Appeals affirmed with two separate holdings. Steven Klein, Inc. v. Dep't of Revenue, 184 Wash.App. 344, 353–54, 356, 336 P.3d 663 (2014). First, it held that Klein Honda's participation in the dealer cash program was a separate business activity subject to the catchall B & O provision. Id. at 353–54, 336 P.3d 663. The court reasoned that “[t]he business activity was accepting the offer of American Honda to apply for dealer cash, selling specific models during specific times, documenting those sales as required by the manufacturer, applying to the manufacturer for the dealer cash, and accepting the payment.” Id. at 353, 336 P.3d 663. However, in its analysis, the court included language that—when taken out of context—appears to blend the concept of “business activities” with the definition of “gross income of the business,” such that one could conclude the court held that the B & O tax applies to gross income instead of business activities. See id. at 352, 336 P.3d 663. As discussed further below, the petitioners seize on that language to challenge the Court of Appeals' decision.

¶ 12 For the court's second holding, it recognized that if Klein Honda's dealer cash represented “an adjustment or bona fide discount to the wholesale purchase price of the vehicles,” it would not be taxable under one of the Department's regulations. Id. at 354, 336 P.3d 663. The court held, however, that Klein Honda's dealer cash was not a bona fide discount because Klein Honda did not originally purchase the relevant vehicles from Honda subject to dealer cash discounts. Id. at 355, 336 P.3d 663. The court reasoned that “dealer cash payments are not automatic upon Klein Honda's vehicle purchases from ... Honda. Rather, dealer cash applies to eligible vehicles already in Klein Honda's inventory and is contingent upon Klein Honda selling those vehicles during a specified time period.” Id.

¶ 13 We granted discretionary review. Steven Klein, Inc. v. Dep't of Revenue, 182 Wash.2d 1020, 345 P.3d 784 (2015).

ISSUE

¶ 14 Is Klein Honda's dealer cash subject to the B & O tax?

STANDARD OF REVIEW

¶ 15 When the Board renders decisions pursuant to a formal hearing, we review those decisions under the Administrative Procedure Act (APA), chapter 34.05 RCW. RCW 82.03.180. Under the APA, we may grant relief from an agency order when “[t]he agency has erroneously interpreted or applied the law.” RCW 34.05.570(3)(d). We review the Board's factual findings for substantial evidence, RCW 34.05.570(3)(e), and we review the Board's legal conclusions de novo, Olympic Tug &...