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Tax Law

Michigan Court of Appeals Finds an Almost Five-Fold Sales Factor Increase to be Unconstitutionally Distortive

The Michigan Court of Appeals recently held that the state’s statutory apportionment formula was unconstitutionally distortive as applied to a taxpayer’s Michigan Business Tax (MBT) liability. Therefore, the taxpayer was entitled to use an alternative formula. The court noted that this is an exceptional case where the taxpayer met its burden to show that the business activity attributed to it was “out of all appropriate proportion to the actual business activity transacted in Michigan,” leading to a grossly distorted result.

The taxpayer is the successor company to MLI, an S corporation engaged in oil and gas pipelines and providing HAZMAT response services. During the period prior to the sale, MLI was retained to assist in the cleanup of a severe oil pipeline spill in Kalamazoo, Michigan. MLI operated a multistate business but did not maintain a permanent business location in Michigan or retain permanent employees in the state. During the cleanup project, MLI sold all its assets to the taxpayer on March 31, 2011 and elected to treat the sale of its stock as a sale of its assets under IRC § 338(h)(10).).

In its return for the short year, MLI included the sale in its tax base and in the denominator of the sales factor, resulting in a sales factor of approximately 15 percent. On audit, Michigan excluded the sale from the sales factor denominator, increasing it to almost 70 percent due to the Kalamazoo cleanup activity compared to its historic 7% Michigan sales factor.

The court held that to impose a tax on 70 percent of the gain of the sale was not commensurate with the “protection, opportunities and benefits” that Michigan conferred on MLI, where the majority of the activities making up MLI’s fair market value at the time of the sale had occurred outside Michigan’s borders. By looking at the short year and its unusual concentration of activity in Michigan, an unconstitutional distortion was created that ran afoul of the Due Process and Commerce Clauses, incorporated in Michigan’s apportionment statute, because it did not fairly determine the portion of income from the sale reasonably attributed to in-state activities.

Vectren Infrastructure Services Corp. v. Department of Treasury, Mich. Ct. App., Dkt. No. 345462 (March 12, 2020)