Michigan Supreme Court Allows Three-Factor Apportionment for Business Tax

On July 14, Michigan's State Supreme Court ruled that the Multistate Tax Compact (MTC) election applies to both modified gross receipts and net income tax bases. The case was International Business Machines (IBM) v. the Michigan Department of Treasury.

The international tax firm Ryan says the major issue was whether taxpayers could elect to apportion their tax base according to the MTC provisions utilizing the equally weighted three-factor formula, as opposed to apportioning based on the 100% sales factor provided for in the Michigan Business Tax (MBT) statute. The MTC also provides for the allocation of nonbusiness income.

The Michigan Supreme Court decision rested on statutory grounds as opposed to contractual or constitutional grounds. The decision states:

Because the Legislature gave no clear indication that it intended to repeal the Compact's election provision, we proceed under the assumption that the Legislature intended for both to remain in effect. After reading the statutes in pari materia, we conclude that a reasonable construction exists other than a repeal by implication.

Another significant development was that it was concluded that the modified gross receipts tax (MGRT) component of the MBT qualified as an “income tax” as defined in the MTC. The determination was as follows:

We hold that the MGRT fits within the broad definition of “income tax” under the Compact by taxing a variation of net income—the entire amount received by the taxpayer as determined from any gainful activity minus inventory and certain other deductions that are expenses not specifically and directly related to a particular transaction.

This issue benefits out-of-state companies that have Michigan sales that are higher in proportion to their physical presence in Michigan in terms of property and payroll. There are also benefits to companies not based in Michigan that sell services because the MTC provisions source sales based on the state where the services are performed.

The decision applies to MBT years 2008 through 2010. The statute of limitations for 2008 has expired, so refund claims are not allowed unless the taxpayer is under audit for that year. Refund claims can still be filed for MBT years 2009 and 2010, as these periods are within the four-year statute of limitations. The decision did not take up the issue of whether taxpayers can make the MTC election on an amended return, as opposed to the original return filing.

The decision of the Michigan Supreme Court is final unless it is appealed to the U.S. Supreme Court, and if appealed, the U.S. Supreme Court is not required to review the case. Since the Michigan decision was based on statutory grounds, it is unlikely that the U.S. Supreme Court would review this case.

Claims may be filed for 2011 and beyond for MBT, and Corporate Income Tax (CIT) can still be filed, but there is another issue for these years. The MTC statute was changed in 2011 to state that the MTC election was not available for years beginning after January 1, 2011. This decision did not resolve the question of whether this legislation violated the contractual obligation of the contract or the contracts clause of the Constitution. Other states are litigating these issues, notably Gillette v. California Franchise Tax Board now pending at the California Supreme Court. A decision in this case is expected in late 2014 or early 2015. This decision would impact this issue in Michigan.

Michigan adopted the MTC in 1970. As stated in MCL § 205.581, the purpose of the MTC is as follows:

(1) Facilitate proper determination of state and local tax liability of multistate taxpayers, including the equitable apportionment of tax bases and settlement of apportionment disputes.

(2) Promote uniformity or compatibility in significant components of tax systems.

(3) Facilitate taxpayer convenience and compliance in the filing of tax returns and in other phases of tax administration.

(4) Avoid duplicative taxation.