Hard Case Makes Bad Law: Interest Payable on SAIC Refund Claim Needs Qualification

All lawyers are familiar with the expression, “hard cases make bad law.” A recent Maryland Court of Appeals decision affirming an award of interest on an income tax refund well illustrates the meaning of that hoary chestnut. Comptroller of the Treasury v. Science Applications International Corporation, 2008 Md. LEXIS 320 (June 16, 2008).

In 2000, Science Applications International Corporation (“SAIC”) filed a Maryland state income tax return that reported tax due in the amount of $4,216,431. The tax was entirely due to SAIC’s sale of stock in Network Solutions, Inc. (“NSI”), which resulted in a realized gain of $715,850,753. SAIC had held the NSI stock solely for investment purposes.

Three years later, SAIC filed a claim for refund of Maryland state income tax erroneously paid on its gain in NSI, asserting that the sale of the NSI stock lacked a sufficient nexus with the State of Maryland for the gain to be taxable under the United States Constitution and Maryland law. The Comptroller denied the claim and SAIC appealed to the Maryland Tax Court which ruled that SAIC was entitled to the refund. The Comptroller did not appeal the Tax Court’s ruling and paid the refund claim, without interest.

SAIC filed a motion in the Tax Court to compel the Comptroller to pay interest on the refund, from the date the refund claim was filed until the date the claim was paid. The Comptroller asserted that, while interest on refunds is ordinarily mandatory, no interest is due when the claim was based on a mistake of the claimant not attributable to the State. The Comptroller argued that since the tax had been voluntarily paid, and was not the result of an assessment or other affirmative act by the Comptroller, the mistaken payment was not attributable to the State. The Tax Court ruled against the Comptroller and directed the payment of interest.

On appeal to the Maryland Court of Appeals, the Court affirmed the award of interest. The Court rejected the Comptroller’s position that no interest is payable on a refund claim unless the claim resulted from an assessment or other affirmative act to collect the tax. Instead, the Court ruled that an error is attributable to the State when a taxpayer using reasonable judgment under the circumstances is led by the laws, regulations, or policies expressed by the State to the mistaken conclusion that tax is owed.

As a general proposition, the Court’s holding is undoubtedly correct. For example, a taxpayer could mistakenly pay tax because of an erroneous policy statement published by the Comptroller. Even if the tax was paid voluntarily, such a payment would clearly be due to a mistake attributable to the State. But as applied to the facts of the SAIC case, the holding is overly broad. In ruling that SAIC reasonably relied on a policy expressed by the State, the Court based its ruling on the letter the Comptroller wrote SAIC denying its refund claim, which asserted that there was no basis to back out the realized gain from SAIC’s return. As a matter of logic, this cannot be a correct basis for the Court’s decision, for the simple fact that the letter was written three years after the tax had been paid and therefore could not possibly have influenced the taxpayer’s prior mistake in paying the tax. The necessary implication of the Court’s decision is that a taxpayer is entitled to interest on a refund claim whenever the Comptroller denies the claim.

It is a basic fact of tax administration life that refund claims of this magnitude always present a dilemma for the tax agency. While the Comptroller has no interest in retaining erroneous tax payments, the reality is that the legislative auditor is likely to question the Comptroller’s voluntary payment of such a large claim, merely on the taxpayer’s uncorroborated assertion that no tax was due on a transaction for which the taxpayer had voluntarily paid tax. The Court of Appeals decision in SAIC creates a “Catch 22” for the Comptroller when he is presented with a large refund claim. In order to avoid the payment of interest, he must voluntarily grant the claim even if the tax was arguably correctly paid. If he chooses to deny the claim, that denial will be asserted as the basis for showing that in paying the tax, the taxpayer reasonably relied on the State’s policies.

It is likely that the Court’s overly broad rationale was influenced by the Comptroller’s overly narrow framing of the case. As I’ve noted above, a taxpayer’s mistaken payment can be attributable to the State in cases other than assessments. The Comptroller should have framed the case by arguing that the statutory term “error or mistake of the claimant not attributable to the State” must be construed as of the date of the erroneous payment. Whether or not the Comptroller subsequently asserts that the tax was correctly paid is beside the point because that assertion could not have induced the prior erroneous payment. Nor should it be sufficient, as the Court states, that the letter may have reflected preexisting state policy. If that preexisting state policy was never communicated to the taxpayer prior to the payment – and the Court’s reliance on the post hoc claim denial implies that it was not so communicated to SAIC – the mere existence of the policy cannot mean that the taxpayer’s erroneous payment is attributable to the State.

For now, taxpayers in Maryland may rely on SAIC for the proposition that interest is due on a refund claim whenever the Comptroller denies the claim on the basis that the tax was correctly paid. I doubt highly that, given current bleak state budgetary realities, the Maryland General Assembly will let that decision stand. A requirement that a mistaken payment is attributable to the State whenever the State, as of the date of the payment, erroneously expresses the view that tax is due is reasonable and fair to both the taxpayer and the State. The Comptroller would then be free to contest refund claims following voluntary payments where the State had not previously taken a position on the issue, without fear that an adverse decision will automatically result in interest. But in cases where the State had previously declared an incorrect position, the price of contesting the refund claim will appropriately include an award of interest.