2016 doled out some major disappointments to taxpayers challenging state rules for determining corporate franchise taxes and sales and use tax obligations, while the European Commission’s efforts to tackle tax avoidance left businesses feeling uncertain about whether their tax arrangements can be retroactively deemed as illegal state aid.
Here, Law360 takes a look back at five major decisions of 2016.
Direct Marketing Association v. Brohl et al.
The beginning of the year saw an important ruling from the Tenth Circuit that affects how online retailers operate across state boundaries. The appellate court in February upheld a Colorado law imposing tax reporting obligations on out-of-state sellers, and experts say it may motivate states to step up tax collection efforts against online retailers.
The reporting obligations were challenged by the Direct Marketing Association, a New York-based retail trade association, which said the Colorado “Amazon tax” law should be struck down in light of the U.S. Supreme Court’s 1992 ruling in Quill Corp. v. North Dakota, which determined that states may not impose use tax collection obligations on vendors without a physical presence in the state. The Tenth Circuit said, however, that Quill is limited to the actual collection of taxes by out-of-state retailers and does not encompass the notice and reporting obligations in the Colorado law.
Much of the attention surrounding the DMA v. Brohl case is directed at its potential as a vehicle for the Supreme Court to reconsider its position in Quill, which was delivered before the era of online sales and has been criticized as outdated.
The DMA has appealed its loss, and in an unusual twist, Colorado’s Revenue Department also filed a conditional cross-petition to the Supreme Court, saying that if the court takes up the DMA’s appeal, it should also review Quill. Eleven states are backing Colorado’s petition, but the DMA contends that Colorado can’t appeal a case it has already won.
Even if the high court grants certiorari, experts are divided on whether the DMA’s appeal will actually directly challenge Quill, because Quill focuses on tax collection whereas Colorado’s statute, passed in 2010 to ultimately boost tax revenues, only requires remote retailers to report an annual tally of purchases made by Colorado buyers.
“It doesn’t address the central issue that states want to press in Quill which is: Is the physical presence standard outdated?” Andrew Yates of Alston & Bird LLP said. “One of the reasons that courts were able to hold for Colorado was that they felt that the use tax reporting requirements that Colorado had put on remote sellers did not violate interstate commerce in a way that Quill prohibited. They basically said that Quill’s not a problem. It’s not an issue here.”
A decision on whether the Supreme Court will review the petitions is expected as early as Dec. 12.
The cases are Direct Marketing Association v. Brohl, case number 16267, and Brohl v. Direct Marketing Association, case number 16458, in the Supreme Court of the United States.
Medtronic Inc. et al. v. Commissioner of Internal Revenue
In a win for the taxpayer, the U.S. Tax Court squarely rejected the IRS’ $1.36 billion tax deficiency calculation in a transfer pricing dispute with Medtronic Inc., finding in June that the agency’s calculations for intercompany license royalty rates don’t reflect a Puerto Rican subsidiary’s contributions to company profits.
In a 144-page ruling that could result in Medtronic not owing any more taxes for the disputed 2005 and 2006 tax years, Judge Kathleen Kerrigan said the IRS arbitrarily and unreasonably attributed only about 7 percent of the company’s profits to contributions from Medtronic Puerto Rico Operations Co.
According to experts, the case serves as a roadmap for taxpayers in similar transfer pricing disputes by highlighting the importance of marshaling specific evidence about ownership, job functions, economic risks of various manufacturing operations, the use of comparables and other facts that could lead to a favorable ruling.
“What is significant is that the Tax Court was moved by the strength of Medtronic’s case, the ownership of intangibles, the nature of the work that was done, the oversight [and the U.S. Food and Drug Administration] licensure,” Reed Smith LLP’s Kelley Miller said shortly after the ruling. “The Tax Court rightfully took it upon itself to validate that rate and did so by looking at facts and circumstances that were evidenced throughout the trial.”
Reed Smith’s Jeffrey Korenblatt said the Medtronic ruling is reassuring to taxpayers who are worried that the arm’s-length standard between related parties in transfer pricing cases is under siege as a result of changing domestic and global tax regulations.
“The IRS lost in Medtronic because of the court’s perception that it was improperly trying to deviate from the arm’s length standard,” Korenblatt said. “Medtronic was a reminder that the Tax Court continues to believe that the arm’s-length standard must rule any transfer pricing adjustments.”
The case is Medtronic Inc. et al. v. Commissioner of Internal Revenue, docket number 694411, in the U.S. Tax Court.
The Gillette Co. et al. v. California Franchise Tax Board
In a major disappointment to businesses fighting states across the country that are ditching an interstate tax agreement for calculating corporate franchise taxes, the U.S. Supreme Court in October refused to take up a petition from The Gillette Co. and about 40 big-name corporations and left intact a California high court decision allowing the Golden State to use its own formula.
Gillette had appealed the California Supreme Court’s decision that the state Legislature is not bound by the 1967 Multistate Tax Compact, which weighs property, payroll and sales equally. California enacted the compact in 1974 but adopted a rule in 1993 requiring most multi-state businesses to use a double-weighted sales factor formula instead.
Gillette had tried to argue that California had to respect its obligations as a signatory to the compact and could not simply withdraw or change the rules, but the California Franchise Tax Board retorted that companies have no right to interfere in its tax policies. In addition, it said, the state justices’ judgment is consistent with opinions from other courts tackling challenges to the MTC in other states, and with the positions taken by the commission and every state that is a party to the agreement.
Mardiros “Marty” Dakessian of Dakessian Law Ltd., who submitted an amicus brief in the case, told Law360 that since taxpayers had come to rely on the compact’s existence, he had hoped the U.S. Supreme Court could have taken a serious look at whether California had breached its obligations under the compact and determined whether the implementation of the state’s new formula was in line with the compact’s withdrawal provisions.
“It’s really a case about compacts, and how states treat compacts and how they respect other party states that are members to the compact,” Dakessian said. “There’s a reason why the MTC contains a withdrawal provision, and ... all these years later to come up and start to argue that ...it was a model code that really didn’t have any teeth is completely disingenuous.”
The case is The Gillette Co. et al. v. California Franchise Tax Board, case number 151442, in the Supreme Court of the United States.
The Williams Cos. Inc. v. Energy Transfer Equity LP et al.
Energy Transfer Equity LP scored the right to walk out of a planned $38 billion deal with The Williams Cos. Inc. after a Delaware vice chancellor ruled that its tax counsel Latham & Watkins LLP could not in good faith issue a crucial opinion on the merger.
ETE said in an April filing that Latham had advised it that declines in the companies’ stock prices since the deal was announced could trigger the IRS to find that a component of the transaction would be taxed. Williams then filed suit in Delaware Chancery Court accusing Latham of acting in bad faith and helping ETE weasel out of the deal.
Vice Chancellor Sam Glasscock III let ETE abandon the mega-deal in June when he ruled that Latham had acted in good faith by resisting issuing an opinion that the merger would be taxexempt.
Peter Connors, a tax partner at Orrick Herrington & Sutcliffe LLP, said it is rare for tax issues to be such a main driver of merger decisions, especially where the deals end up in litigation.
“It’s usually some other factor other than tax that the parties litigate over,” Connors said. “It’s the first time I’ve ever seen litigation over a tax-closing condition.”
Williams has appealed the vice chancellor’s decision to the Delaware Supreme Court, telling the justices that ETE could have done much more to overcome the fatal tax issues, and that the Chancery Court wrongly placed the burden of showing what ETE could have done to save the merger on Williams.
The big dollar amounts and the major parties involved, including the law firms as well as the oil and gas pipeline giants, means that the case could drag on for a long time with appeals, Connors said.
The lower court case is The Williams Cos. Inc. v. Energy Transfer Equity LP et al., case numbers 12337 and 12168, in the Court of Chancery of the State of Delaware.
Apple Ordered To Pay $14.5B In Back Taxes To Ireland
The European Commission has adopted a hard stance on tackling tax avoidance in recent years, and in its mission to investigate illegal state aid, which would favor some companies over others, it delivered a stunning decision in August ordering Apple Inc. to pay up to €13 billion ($14.5 billion) in back taxes, plus interest, to Ireland.
Apple had entered into a sweetheart tax deal with Ireland to “substantially and artificially” lower its taxes, the commission said after a nearly three-year investigation that drew heavy criticism from the Obama administration. The commission concluded that two tax rulings Ireland had issued to Apple in 1991 and 2007 were in violation of the European Union’s state aid rules and allowed the software giant to allocate almost all its sales profits to “head offices” that existed only on paper.
The ruling reverberated around the globe not only because of the eye-popping size of the tax bill but also because it now creates an environment of uncertainty for businesses operating in Europe, according to Ryan Dudley, a partner at Friedman LLP.
“When a national government confirms a tax position you plan to take in accordance with its laws, then a supranational authority retroactively rejects this position, it becomes impossible for businesses to make sound investment decisions,” Dudley said. “How far these rulings will eventually go is unknown, but the uncertainty makes the EU a less attractive location for doing business.”
The decision was soon followed by an announcement from the U.S. Department of the Treasury that it is drafting rules to curb the ability of multinational companies to lower their U.S. tax bills by claiming a credit for taxes paid abroad when foreign governments make tax adjustments.
Both Ireland and Apple are appealing the commission’s decision.