Yam Special Holdings, Inc. v. Comm'r of Revenue, A20-0021
| Decision Date | 12 August 2020 |
| Docket Number | A20-0021 |
| Parties | YAM SPECIAL HOLDINGS, INC., Relator, v. COMMISSIONER OF REVENUE, Respondent. |
| Court | Minnesota Supreme Court |
Susan J. Markey, Barry A. Gersick, Maslon LLP, Minneapolis, Minnesota; and Andrew T. Bernknopf, De Castro, West, Chodorow, Mendler & Glickfeld, Inc., Los Angeles, California, for relator.
Keith Ellison, Attorney General, Kristine K. Nogosek, John M. O'Mahoney, Assistant Attorneys General, Saint Paul, Minnesota, for respondent.
The question presented in this case is whether the income from the sale of a partial interest in a business is subject to Minnesota corporate income tax. Relator YAM Special Holdings, Inc. sold a majority interest in its Go Daddy business and reported the gain from the sale as income that was not subject to Minnesota tax. The Commissioner of Revenue disagreed and assessed tax on an apportioned share of the income. YAM appealed. The tax court determined that Minnesota could tax an apportioned share of the income from the sale as unitary business income. YAM Special Holdings, Inc. v. Comm'r of Revenue , No. 9122-R, 2019 WL 6213168, at *8 (Minn. T.C. Nov. 12, 2019). Because we conclude that the gain from the sale is business income of a unitary business, we affirm.
The facts are undisputed. YAM is an Arizona "S" corporation. Its principal place of business and commercial domicile is in Scottsdale, Arizona. Until the transaction at issue in this case, YAM's founder, Robert Parsons, was its sole shareholder. At all relevant times, YAM operated an internet-based business called Go Daddy, which provides internet domain names, website hosting, and related services to its customers. Customers accessed Go Daddy's business through its website—hosted by computer servers in Arizona—and through phone calls to its service facilities, which were located outside of Minnesota. Go Daddy operated its business through 12 tax-disregarded wholly-owned U.S. subsidiaries and 9 foreign tax-disregarded subsidiaries.1
At all relevant times, YAM did not own real or tangible personal property in Minnesota nor did it employ any person based in Minnesota. YAM did not have any interest in any business entities or assets that were physically located in Minnesota. But about 1 percent of YAM's revenue came from transactions with Minnesota customers. Based on its Minnesota revenue, YAM reported Minnesota taxable income in 2010 of $56,829 and paid Minnesota $4,461 in taxes on that income.
On July 1, 2011, Go Daddy announced in a press release that "it ha[d] signed a definitive agreement to receive a strategic investment and enter into a partnership with [certain investors]." The chief executive officer of Go Daddy explained that Go Daddy was "partnering with [the investors] because of their technology expertise, their understanding of Web based businesses and because their values align with [Go Daddy's]." The chief executive officer and the investors believed that the partnership would "take the company to the next level, especially when it comes to accelerating international growth." One of the investors echoed these remarks, stating that "there is significant opportunity to expand the current portfolio of products and services as well as accelerate growth internationally."
YAM took several steps in anticipation of this transaction. Using its own funds, YAM paid all of its bank debt, about $51 million. YAM then formed two limited liability companies—Desert Newco, LLC and Go Daddy Operating Company LLC—as wholly-owned subsidiaries, and converted the 12 domestic subsidiaries into 12 wholly-owned limited liability companies. YAM contributed the 12 subsidiaries and its sole interest in Go Daddy Operating Company to Desert Newco. YAM also transferred its remaining liabilities to Go Daddy Operating Company. As a result of these steps, YAM became the sole owner of Desert Newco, Desert Newco became the sole owner of Go Daddy Operating Company, and Go Daddy Operating Company became the sole owner of the 12 subsidiaries, which were the active operating entities for the Go Daddy business.
On December 16, 2011, the investors paid YAM roughly $899.5 million for 71.39 percent of the membership interest units in Desert Newco. That same day, Go Daddy Operating Company borrowed $750 million from bank lenders. The funds were used (1) to pay for the investors’ transaction expenses ($46 million); (2) to pay for YAM's transaction expenses ($21.5 million); (3) "to buy out restricted stock units and stock options in" YAM ($368 million); (4) to provide "adequate working capital" for Go Daddy Operating Company and the 12 operating subsidiaries ($31.8 million); and (5) to pay a portion of the purchase price of the Desert Newco membership units ($279.8 million). Also on December 16, certain employee options in YAM were converted to options in Desert Newco, and Go Daddy Operating Company issued a $300 million promissory note to YAM.
As a result of the sale, YAM maintained a 28.61 percent membership interest and the investors maintained a 71.39 percent interest in Desert Newco. YAM distributed the net cash proceeds of the sale—$1.168 billion—to its sole shareholder, Parsons.
After the sale, an executive committee managed Desert Newco and the board of directors provided oversight. The committee consisted of three managers, two appointed by the investors and one appointed by YAM. The board included five investor members, one YAM member, the chief executive officer of Desert Newco, and an independent board member.
On YAM's 2011 federal income tax return, YAM treated the transaction as a sale of a share of the assets that comprised the Go Daddy business. Doing so resulted in a long-term capital gain of about $1.353 billion, offset by a long-term capital loss of $1.664 million. On its 2011 Minnesota income tax return, YAM treated the gain from the sale as income that was not subject to Minnesota tax; YAM also apportioned 1.0471 percent of its ordinary business loss to Minnesota.
The Commissioner determined that the gain on the sale was apportionable business income and assessed additional Minnesota income tax for 2011—approximately $1.247 million—on a portion of that gain, plus penalties and interest.2 YAM appealed the Commissioner's assessment administratively, and the Commissioner affirmed the assessment.
YAM then appealed the Commissioner's determination to the tax court, and YAM and the Commissioner each moved for summary judgment. YAM , 2019 WL 6213168, at *1. The tax court concluded that the income from the sale was business income subject to Minnesota tax. Id. at *8. Accordingly, the tax court granted the Commissioner's motion for summary judgment and denied YAM's motion for summary judgment. Id. YAM appeals and argues that the income from the sale is nonbusiness income that is not subject to Minnesota income tax.
This case comes to us from a final order of the tax court. Our court "review[s] the tax court's conclusions of law and interpretation of statutes de novo ... and its findings of fact for clear error." Antonello v. Comm'r of Revenue , 884 N.W.2d 640, 643–44 (Minn. 2016) (citations omitted). We presume that the Commissioner's tax assessments are "valid and correctly determined." F-D Oil Co. v. Comm'r of Revenue , 560 N.W.2d 701, 704 (Minn. 1997). The taxpayer bears "the burden of demonstrating the incorrectness or invalidity" of the assessments. Id.
YAM argues that Minnesota cannot tax the income from the sale because that income is nonbusiness income. YAM's argument is based on two theories. YAM's first theory is that Minnesota does not have a sufficient connection with the sale and thus due process principles prevent Minnesota from apportioning the income for tax purposes. YAM's second theory is that the income from the sale is income derived from a capital transaction that solely serves an investment function and therefore it is nonbusiness income not subject to apportionment under Minn. Stat. § 290.17, subd. 6 (2018).
Before turning to YAM's first theory—that due process principles prevent Minnesota from taxing the income from the sale through apportionment—we review the relationship between Minnesota corporate tax law and due process requirements. Under the Due Process Clause of the U.S. Constitution, a state may not impose an income tax on "value earned outside its borders."3 Container Corp. of Am. v. Franchise Tax Bd. , 463 U.S. 159, 164, 103 S.Ct. 2933, 77 L.Ed.2d 545 (1983) (citation omitted) (internal quotation marks omitted). In the case of a business operating in more than one state, however, determining the "precise territorial allocations of ‘value’ is often an elusive goal." Id. As a result, Minnesota has adopted the unitary business principle and apportionment approach to determine the portion of the income that is subject to tax. See Minn. Stat. § 290.17, subds. 3–4 (2018) ; Minn. Stat. § 290.191, subd. 1(a) (2018) ; see also Container Corp. , 463 U.S. at 165, 103 S.Ct. 2933 ().
Minnesota law defines a unitary business as "business activities or operations which result in a flow of value between them." Minn. Stat. § 290.17, subd. 4(b). When a trade or business is conducted partly within and partly outside of Minnesota, and that trade or business is part of a unitary business, "the entire income of the unitary business is subject to apportionment pursuant to section 290.191." Id. , subd. 4(a). Once the State determines that the trade or business is part of a unitary business, it applies an apportionment formula—based on a percentage of the business's Minnesota sales, property, and payroll—to determine the amount of business income subject to tax, Minn. Stat. § 290.191, subd. 2(a) (2018). Under Minnesota law, "[a]ll income of a trade or business is subject to apportionment except nonbusiness income." Minn. Stat. § 290.17, subd. 3.
The U.S. Supreme Court has upheld the unitary...
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