Wisconsin Dept. of Revenue v. Menasha, 2004AP3239.

• Citation: 2008 WI 88,754 N.W.2d 95
• Decision Date: 11 July 2008
• Docket Number: No. 2004AP3239.,2004AP3239.
• Parties: WISCONSIN DEPARTMENT OF REVENUE, Petitioner-Respondent-Petitioner, v. MENASHA CORPORATION, Respondent-Appellant.
• Court: United States State Supreme Court of Wisconsin

754 N.W.2d 95

2008 WI 88

WISCONSIN DEPARTMENT OF REVENUE, Petitioner-Respondent-Petitioner, v. MENASHA CORPORATION, Respondent-Appellant.

No. 2004AP3239.

Supreme Court of Wisconsin.

Argued November 29, 2007.

Decided July 11, 2008.

For the petitioner-respondent-petitioner the cause was argued by F. Thomas Creeron III, assistant attorney general, with whom on the briefs was J.B. Van Hollen, attorney general.

For the respondent-appellant there were briefs by Andrew L. Nelson, Michael B. Van Sicklen, and Foley & Lardner L.L.P., Madison, and Maureen A. McGinnity and Foley & Lardner L.L.P., Milwaukee, and oral argument by Maureen A. McGinnity.

An amicus curiae brief was filed by Rebecca Kathryn Mason, Brady Williamson, and Godfrey & Kahn, S.C., Madison, on behalf of Wisconsin Manufacturers & Commerce.

¶ 1 ANNETTE KINGSLAND ZIEGLER, J

This is a review of a published court of appeals' decision,¹ which reversed the decision of the Dane County Circuit Court, Steven D. Ebert, Judge. In the underlying dispute between Menasha Corporation (Menasha) and the Wisconsin Department of Revenue (DOR), the Wisconsin Tax Appeals Commission² (Commission) concluded that the "R/3 System," which Menasha purchased from SAP, was a custom computer program under Wis. Admin. Code § Tax 11.71(1)(e) (Sept.2006),³ and thus, the R/3 System was exempt from sales and use tax. See Wis. Stat. § 77.51(20) (2003-04).⁴ The DOR appealed that decision to the Dane County Circuit Court. The circuit court reversed the Commission's decision and concluded that the R/3 System was a non-custom software program and thus was taxable as tangible property. Menasha then appealed that decision to the court of appeals. The court of appeals reversed the circuit court's decision and therefore affirmed the Commission's initial decision that the R/3 System was custom and thus exempt from sales and use tax. We affirm the court of appeals' decision.

¶ 2 This appeal presents the following two issues: (1) what is the proper level of deference that this court should give to the Commission's decision; and (2) did the Commission reasonably conclude that the R/3 System was a custom program and therefore not subject to sales and use tax.

¶ 3 As to the first issue, we consider the level of deference that this court must give to the Commission's interpretation of the statute and the administrative rule. As a part of that determination, we also consider whether the Commission was required to give deference to the DOR's interpretation of Wis. Admin. Code § Tax 11.71(1)(e). We conclude that the Commission's statutory interpretation of Wis. Stat. § 77.51(20) is entitled to due weight deference and that its rule interpretation of Wis. Admin. Code § Tax 11.71(1)(e) is entitled to controlling weight deference. We further conclude that when a DOR decision is appealed by the taxpayer to the Commission, the Commission is not required to give deference to the DOR's interpretation of Wis. Admin. Code § Tax 11.71(1)(e) when deciding that appeal.

¶ 4 The second issue this court must decide is whether the Commission reasonably concluded that the R/3 System was a custom program and therefore not subject to sales and use tax. We conclude that when applying the controlling weight deference standard to the Commission's interpretation of Wis. Admin. Code § Tax 11.71(1)(e), the Commission reasonably interpreted the rule and concluded that the R/3 System was custom.

¶ 5 This decision has great import to the average taxpayer in this state. More typically, it is the individual taxpayer who seeks a fair and neutral hearing before the Commission when that person believes that he or she has been taxed incorrectly by the DOR. If the Commission must defer to the DOR, the average taxpayer does not receive a fair hearing before a neutral tribunal. Although the Commission is subject to judicial review, the legislature specifically charged the Commission as "the final authority for hearing and determination of all questions of law and fact" under the tax code. We must not second guess that act of the legislature.

I. UNDISPUTED FACTS

¶ 6 The Commission made the following findings of fact in the underlying dispute:⁵ Menasha is a Wisconsin corporation with headquarters in Neenah, Wisconsin. It has more than 5,700 employees and maintains 63 business locations in 20 states and 8 countries. In 1993, Menasha, in an effort to address shortcomings in its systems, hired an independent accounting firm to evaluate its business and accounting software systems. Menasha sought an application software system that would accommodate its special processing needs. The independent consultant recommended that Menasha "standardize its systems by implementing a single business software environment to serve as the foundation information system for all of [Menasha's] business locations." The independent consultant also recommended that another consulting firm conduct feasibility studies to determine if a software system could integrate all of Menasha's subsidiaries. With its consultants, Menasha concluded that "one" global application software system was feasible for Menasha's needs, but "this conclusion was predicated on locating a software system which would allow custom modification to meet [Menasha's] unique business requirements."

¶ 7 In April of 1995, Menasha began discussions with SAP regarding its R/3 System and made it clear that "a critical factor in its selection of a software system was one that could be customized to fit its business needs." The initial R/3 System consists of more than 70 software modules each of which is designed to "provide a rudimentary business and accounting computer software system for a segment of the client's business" such as "accounting and finance" or "personnel." The client, in this case Menasha, can select the modules it wishes to use. SAP provides a company, such as Menasha, with CD-ROMs containing all of the R/3 System modules, but SAP provides the client with the access codes only for modules that the client licenses for its particular business operation.

¶ 8 "As provided, the basic modules of the R/3 System contain a business and accounting system that must be customized to fit a client's business operations." "It is only after this customization process is completed that the client has a usable software system that will serve its business and accounting needs." In other words, the system is not usable to a client as sold and must be modified to fit a client's business operations. By use of a computer language—ABAP/4—the R/3 System is customized. However, "the ABAP programming is part of a larger development environment within the R/3 System called the Development Workbench, which offers many tools for customizing the R/3 System to fit a customer's business needs." SAPScript is used, within the Development Workbench, to create client-specific forms. Data Dictionary Objects "is used for changing and adding fields to tables provided by the basic R/3 System modules," and Data Dictionary Objects "is also used to create search helps" and "to create indices to make table access times more efficient."

¶ 9 "The two most common uses for ABAP are to permit the design of custom reports and to develop custom interfaces for the R/3 System." However, the ABAP programming is also used in the "creation of conversion programs that change data into a format usable by the R/3 System, and the creation of custom programs to run parallel to the R/3 System to fulfill business functions not provided by the R/3 System." By virtue of the licensing of the R/3 System, SAP customers "almost always retain either SAP or SAP's designated consultants to assist" in customizing the basic R/3 System.

¶ 10 When arguing to the Commission, the parties disagreed over how to characterize the sophistication of the initial or basic R/3 System modules that are provided to all customers. Menasha argued that the R/3 System provided "only a very basic" business and accounting system. The DOR, on the other hand, argued that the modules provided a "sophisticated" business and accounting system. The DOR cited to two treatises on implementing the R/3 System for its assertions regarding the sophistication of the R/3 System. The Commission, however, concluded that excerpts from the treatises that the DOR cites to "appear to describe the overall R/3 System and do not specifically address the [initial or basic] R/3 System modules." Furthermore, the Commission concluded that the "sophistication of the modules is largely immaterial because both parties agree that the R/3 System modules are only usable once the software system has been customized."

¶ 11 On April 20, 1995, SAP conducted a demonstration of its R/3 System. Following the initial demonstration, SAP was asked to conduct a demonstration with sample data from Menasha. Prior to preparing the demonstration, SAP spent a number of days at Menasha collecting information regarding Menasha's business operations, and SAP had extended conversations with Menasha's officers and employees regarding its diverse operations. It took SAP four weeks to prepare the demonstration. Menasha subsequently requested additional explanations and clarifications on the modification tools and techniques available within the R/3 System and a demonstration of the ABAP programming tools used to make modifications to the system.

¶ 12 Menasha understood that the requisite customization process could take years to complete and would cost tens of millions of dollars. Menasha's budget for purchasing the R/3 System included the costs that it expected to pay both SAP and SAP's designated consultants for the configuration, modification, and customization of the R/3 System. In addition, Menasha understood that "without this customization, the system would be of no value to its operations." "The customization was necessary to justify any amount spent on the licensing of the basic R/3 System modules."...