U.S. Bank v. S. Dakota Dep't of Revenue

• Decision Date: 05 October 2022
• Docket Number: 29338-a-MES
• Citation: 2022 S.D. 59
• Parties: U.S. BANK NATIONAL ASSOCIATION, Appellant, v. SOUTH DAKOTA DEPARTMENT OF REVENUE, Appellee.
• Court: South Dakota Supreme Court

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2022 S.D. 59

U.S. BANK NATIONAL ASSOCIATION, Appellant,
v.
SOUTH DAKOTA DEPARTMENT OF REVENUE, Appellee.

No. 29338-a-MES

Supreme Court of South Dakota

October 5, 2022

ARGUED FEBRUARY 16, 2021

APPEAL FROM THE CIRCUIT COURT OF THE SIXTH JUDICIAL CIRCUIT HUGHES COUNTY, SOUTH DAKOTA; THE HONORABLE BOBBI J. RANK Judge

CRAIG B. FIELDS

NICOLE L. JOHNSON of Blank Rome LLP

JUSTIN L. BELL of May, Adam, Gerdes & Thompson LLP

Attorneys for appellant.

JOHN T. RICHTER of South Dakota Department of Revenue

Attorneys for appellee.

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SALTER, JUSTICE

[¶1.] The South Dakota Department of Revenue (the Department) rejected U.S. Bank's^[1] method of calculating its federal income tax deduction from net income subject to South Dakota's bank franchise tax for tax years 2010, 2011, and 2012. As a result, the Department denied U.S. Bank's request for a refund for 2010 and 2011 and disallowed the entire deduction for 2012. The Department issued a certificate of assessment for additional tax and interest for 2012. U.S. Bank appealed the administrative decision to the circuit court, which affirmed the Department's decision. U.S. Bank now appeals to this Court. We affirm.

Facts and Procedural History

[¶2.] U.S. Bank is a financial institution principally engaged in the business of banking. It operates in South Dakota and other states and is a member of a larger, consolidated group of affiliates owned by U.S. Bancorp, which is a publicly traded holding company.

[¶3.] By virtue of its business within the State, U.S. Bank is subject to South Dakota's bank franchise tax (SD BFT). See SDCL ch. 10-43. The tax is applied to a financial institution's "taxable income as defined in the United States Internal Revenue Code . . . and reportable for federal income tax purposes for the taxable year . . . ." SDCL 10-43-10.1; see also SDCL 10-43-1(12) (defining taxable income as "all net income").

[¶4.] U.S. Bank does not, itself, directly report its income to the Internal Revenue Service (IRS). Instead, U.S. Bancorp, in its role as the parent company, is

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responsible for filing a consolidated federal corporate income tax return for the group of affiliates using an IRS Form 1120-U.S. Corporation Income Tax Return. For the tax years at issue here, U.S. Bancorp filed the group's Form 1120, which included U.S. Bank's activities.

[¶5.] Schedule J of IRS Form 1120, entitled "Tax Computation," provides the method used to calculate the total federal tax due. The calculation on Schedule J begins by multiplying taxable income by the appropriate tax rate to arrive at the federal income tax amount listed on line 2 of Schedule J. That number is then reduced by any number of applicable tax credits, which include, among others, general business credits, recapture of investment credit, and credit for foreign taxes. After applying all of a taxpayer's credits to reduce its tax liability, the total tax figure is recorded on line 11 of Schedule J and then transferred to the Form 1120. The total tax due is, therefore, a net calculation of federal tax liability that must be paid to the IRS. The excerpt of Form 1120's Schedule J below illustrates the sequence of the calculation.

(Image Omitted)

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[¶6.] U.S. Bank, the other affiliates, and U.S. Bancorp are parties to a Tax Sharing Agreement designed to allocate the federal tax liability or benefit among the members of the group according to the income or loss each generates. Under the Tax Sharing Agreement, U.S. Bank pays to U.S. Bancorp "an amount up to [U.S. Bank's] separate income tax liability attributable to the net taxable income of [U.S. Bank] that would have been paid if [U.S. Bank] had filed a separate tax return." According to U.S. Bank, each member of the consolidated group computes its federal taxable income, which is the amount before credits, and multiplies it by the federal tax rate of 35%. If the member incurs a loss, the member receives a refund of that tax benefit to the extent the loss is used in determining the consolidated taxable income. Members also receive refunds or cash payments for the credits they generate. A U.S. Bancorp executive explained that "payments are made back and forth so that each company is theoretically made whole either for the benefit that is generated for the group or for the tax it had to pay for the group."

[¶7.] At issue in this appeal are the tax years 2010, 2011, and 2012. The total federal income tax for U.S. Bancorp (Schedule J, line 2) for these years was:

Tax Year Ended	Total Income Tax Due
December 31,2010	$1,142,253,649
December 31, 2011	$1,248,535,908
December 31, 2012	$1,985,176,947

[¶8.] However, the application of certain tax credits reduced the total tax liability due to the IRS for the U.S. Bancorp group (Schedule J, line 11) as follows:

Tax Year Ended	Total Tax Liability
December 31, 2010	$524,920,206
December 31,2011	$617,186,234
December 31, 2012	$981,865,059

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[¶9.] Because U.S. Bank's activities are included in U.S. Bancorp's consolidated Form 1120, U.S. Bank does not file a separate Form 1120 with the IRS. It does, however, prepare a "pro forma"^[2] Form 1120 (the pro forma 1120) to use in connection with reporting its taxable income subject to the S.D. BFT. The pro forma 1120 is not signed or filed with the IRS. It purports to show what U.S. Bank's federal taxable income would be, before applying tax credits, if it was operating as a single entity and not part of U.S. Bancorp.

[¶ 10.] According to the pro forma 1120, U.S. Bank's federal taxable income for tax years 2010, 2011, and 2012 accounted for the majority of U.S. Bancorp's taxable income:

Tax Year Ended	U.S. Bank Fed. Taxable Inc.	U.S. Bancorp Fed. Taxable Income	%
Dec. 31,2010	$2,400,896,642	$3,263,581,855	74%
Dec. 31,2011	$2,342,731,149	$3,567,245,451	66%
Dec. 31,2012	$4,925,219,278	$5,671,934,133	87%

[¶11.] Critical to our consideration of this appeal is a deduction allowed to S.D. BFT taxpayers for the amount of their federal taxes. For purposes of calculating its S.D. BFT liability, the statute in effect at the time allowed U.S. Bank to subtract from its taxable income the "taxes imposed upon the financial institution within the tax year, under the Internal Revenue Code . . . ." SDCL 10-43-10.3(3).^[3] However, the way U.S. Bank has calculated this deduction has varied over the years.

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[¶12.] From 2005 to 2007, U.S. Bank calculated the deduction for federal "taxes imposed" by multiplying its federal taxable income by the applicable 35% federal income tax rate. But from 2008 to 2011, U.S. Bank changed the way it calculated the deduction by "taking separate income of U.S. Bank, as a ratio over the total positive taxable income of the consolidated group, and that ratio was multiplied by total federal tax after credits."

[¶13.] Using this latter method, U.S. Bank timely filed its tax year 2010 and 2011 S.D. BFT returns, attaching to each return a copy of its pro forma 1120 for that tax year. U.S. Bank did not, however, include a copy of the U.S. Bancorp consolidated Form 1120.

[¶14.] At some point after submitting the original 2010 and 2011 S.D. BFT returns, U.S. Bank realized the discrepancy between how its pre-2008 and post-2008 federal income tax deduction had been calculated on its S.D. BFT returns. As a result, U.S. Bank decided to go back to calculating the deduction in the same way it had for tax years 2005 to 2007, which meant multiplying its separate federal taxable income by 35%. U.S. Bank amended its 2010 and 2011 S.D. BFT returns,^[4]and filed its 2012 S.D. BFT return, using this methodology.

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