Several months ago, we explained a Michigan Court of Appeals decision that came down in June; it concluded a series of appeals in favor of that state’s tax assessments against several companies, including Gillette, Sonoco, and Lubrizol. The main issue was whether the legislature’s 2014 retroactive repeal of the Multistate Tax Compact (Compact) was lawful. Prior to the retroactive repeal, businesses had the choice of deploying the Compact to apportion and allocate income in accordance with its three-factor apportionment formula, rather than apportioning income by multiplying the firm’s tax base by a sales factor. The plaintiffs appealed the repeal to the Michigan Supreme Court, which refused to hear the case, so the conclusion, that the legislature’s action eliminating the three-factor apportionment option was lawful, remains in place.
Earlier this month, the question of the constitutionality of the repeal was proposed to the United States Supreme Court, in a different Michigan lawsuit, DIRECTV Group Holdings, LLC v. Michigan Department of Treasury, where it remains to be seen whether the Court will grant certiorari. Considering both the June refusal and the U.S. Supreme Court’s recent rejection of a Minnesota case also pertaining to the Compact, Kimberly-Clark Corp. & Subsidiaries v. Minn. Commissioner of Rev., DIRECTV is facing difficult odds.
Background facts in Kimberly-Clark
The Tax Court that heard the first appeal laid out the operative facts of the case in its June 2015 opinion. The Kimberly-Clark Corporation, and its subsidiaries, have been doing business in Minnesota since 1958, and filing Minnesota tax returns there since at least 1983. During the tax years at issue, 2007, 2008, and 2009, the company engaged in a unitary, multi-state business, and computed its corporate franchise tax liability by a formula contained in Articles III and IV of Minnesota’s version of the Compact. These articles allowed a taxpayer to apportion income under the laws of the state, without reference to the Compact, or to apportion income using an equally weighted three-factor formula utilizing sales, payroll, and property.
In 1987, Minnesota repealed Articles III and IV, while also amending its equally weighted three-factor formula by increasing the weight of the sales factor, and reducing the weight of the property and payroll factors. Lawmakers justified this on the grounds of simplifying the tax code, improving predictability and conformity with other states, and transferring tax burdens away from in-state corporations. In 2013, Minnesota withdrew from the Compact entirely in order to avoid “even the possibility” of having to pay refunds on previously filed returns.
Kimberly-Clark calculated its tax utilizing the non-equally weighted formula for tax years between 1989 and 2000. In April 2013, it amended those returns for the relevant tax years using the equally weighted formula, and sought a refund of $1.2 million.
When the Tax Commissioner denied the refund, Kimberly-Clark’s appeal argued that the state had violated a binding contract, the Compact, between Minnesota and other states.
The Tax Court’s conclusion in favor of the Minnesota focused on the unmistakability doctrine, which the state’s supreme court described as a rule of contract construction providing that the “sovereign powers of a state cannot be contracted away except in ‘unmistakable’ terms.’” The Tax Court’s application of the doctrine “turn[ed] on whether enforcement of the contractual obligation alleged would block the exercise of a sovereign power of the Government.”
Over Kimberly-Clark’s objection that the doctrine should not apply, the Tax Court disagreed on the principle of state sovereignty, citing the Michigan case Int’l Bus. Machines Corp. v. Dep’t. of Treasury, which concluded that the Compact did not create any obligation to adhere to Articles III and IV. Ultimately, the Tax Court asserted, there is no Compact provision that “contains or constitutes a separate clear and unmistakable promise that the State would not alter or repeal the election [provision].”
Kimberly-Clark appealed the Tax Court’s decision to the Supreme Court of Minnesota. In its June 22, 2016, opinion, the court proclaimed that Articles III and IV did not create a contractual obligation between the Minnesota Legislature and Kimberly-Clark that prohibited the Legislature from later repealing those articles.
In the United States Supreme Court
Arguing that the Compact is a “multistate agreement that addresses significant aspects of the state taxation of multistate businesses,” including over-taxation of out of state businesses, Kimberly-Clark’s request for review disputed the Minnesota Supreme Court’s conclusion that states that have signed on to the Compact can prevent taxpayers from electing to apportion their income. The Minnesota Supreme Court justified this conclusion on the grounds that “the Compact does ‘not contain a separate and distinct promise that the State would not alter or repeal the election.’”
By denying review, the Supreme Court never answered the question that Kimberly-Clark contends remains open: “Whether, under the ‘unmistakability doctrine,’ [s]tates are bound by contractual promises embodied in multistate compacts only if the contracting [s]tates make a separate and express “second promise” to abide by their initial contractual promise.”
Just last week, the Michigan Court of Appeals decided a different apportionment case, Solo Cup Operating Corp. v. Department of Treasury. This was a consolidated appeal involving similar issues that those described above: Solo Cup, the plaintiff, wanted to use the Compact’s three-factor apportionment formula to calculate its tax base pursuant to Michigan law. The state instead required Solo Cup to use the sales factor apportionment formula.
Once again, the Court of Appeals found in favor of Michigan’s Treasury Department. Whether this will be yet another apportionment case that goes to the Supreme Court of the United States remains to be seen. But even if Solo Cup does decide to appeal, it seems unlikely that the high court will choose to take it in light of the other recent Compact case denials.