Tad Malpass v. Department of Treasury , 494 Mich. 237 ( 2013 )

Michigan Supreme Court
Lansing, Michigan
Chief Justice: Justices:
Syllabus Robert P. Young, Jr. Michael F. Cavanagh
Stephen J. Markman
Mary Beth Kelly
Brian K. Zahra
Bridget M. McCormack
David F. Viviano
This syllabus constitutes no part of the opinion of the Court but has been Reporter of Decisions:
prepared by the Reporter of Decisions for the convenience of the reader. Corbin R. Davis
MALPASS v DEPARTMENT OF TREASURY
WHEELER ESTATE v DEPARTMENT OF TREASURY
HUZELLA v DEPARTMENT OF TREASURY
WRIGHT v DEPARTMENT OF TREASURY
WHEELER v DEPARTMENT OF TREASURY
Docket Nos. 144430, 144431, 144432, 145367, 145368, 145369, 145370. Argued March 5,
2013 (Calendar Nos. 1, 6). Decided June 24, 2013.
Tad and Brenda L. Malpass (Docket No. 144430), Tracy and Brenda K. Malpass (Docket
No. 144431), and Fred and Barbara Malpass (Docket No. 144432) brought separate actions in
the Court of Claims, seeking a reversal of the Department of Treasury’s decision to deny the
Malpasses’ amended individual income tax returns for the years 2001, 2002, and 2003. The
Malpasses owned East Jordan Iron Works, a Michigan corporation that operated an iron foundry
in East Jordan, Michigan; they also owned Ardmore Foundry, Inc., a Michigan corporation that
operated an iron foundry located in Ardmore, Oklahoma. Both companies were classified as S-
corporations under the Internal Revenue Code. For the specified years, the Malpasses treated the
companies as separate, non-unitary entities for taxation purposes, which resulted in income from
East Jordan being attributed to Michigan and Ardmore’s losses being attributed to Oklahoma.
The Malpasses later filed amended returns for those tax years and requested refunds totaling
more than $1 million, claiming that they could combine East Jordan and Ardmore’s profits and
losses because they were a unitary business. The department denied the Malpasses’ amended
returns. The court, Rosemarie E. Aquilina, J., granted the Malpasses’ motion for summary
disposition, finding that East Jordan and Ardmore were a unitary business, that the unitary
business principle applied to the Income Tax Act, MCL 206.1 et seq. (ITA), and that the
Malpasses could combine the income and losses of East Jordan and Ardmore and then apportion
the aggregate. The Court of Appeals, SHAPIRO, P.J., SAAD and BECKERING, JJ., reversed, finding
that East Jordan and Ardmore were separate business entities and that the ITA did not allow
individual taxpayers to combine their business income from separate business entities and then
apportion on the basis of the combined apportionment factors of the entities. 295 Mich App 263(2012). The Supreme Court granted the Malpasses’ application for leave to appeal. 493 Mich
864 (2012).
The Wheeler estate (Docket No. 145367), Nicholas and Lisa J. Huzella (Docket No.
145368), Patrick and Michaelon Wright (Docket No. 145369), and Thomas R. and Patsy
Wheeler (Docket No. 145370) (collectively, the taxpayers) filed petitions in the Tax Tribunal,
challenging the assessment of taxes for the tax years 1994 and 1995. Members of the Wheeler
family were shareholders of Electro-Wire Products, Inc., a Michigan-based S-corporation.
Electro-Wire acquired the assets of Temic Telefunken Kabelsatz, GmbH, which resulted in two
general partnerships: Temic Telefunken Kabelsatz (TKG), the operating partnership, and
Electro-Wire Products, GmbH (EWG), the holding partnership. The acquisition resulted in one
S-corporation (Electro-Wire) and two general partnerships (TKG and EWG), with all the income
and losses passing through to the owners as individual income. The taxpayers reported the
income by treating the businesses as unitary and apportioned the income using the combined
apportionment factors of both Electro-Wire and TKG. Following an audit, the department
asserted that the unitary business principle did not apply to individuals and that the taxpayers
were required to apply Electro-Wire’s apportionment factors to its income alone, resulting in
liabilities and interest totaling more than $2 million. The tribunal granted the taxpayers’ motion
for summary disposition, determining that under the ITA, the unitary business principle applied
to individuals as well as to separate corporate entities. The Court of Appeals, HOEKSTRA, P.J.,
and SAWYER and SAAD, JJ., affirmed, concluding that Electro-Wire and TKG were a unitary
business, the taxpayers could use combined reporting under the ITA, and that the apportionment
could include income from business activity that was unitary with its Michigan business, Electro-
Wire. 297 Mich App 411 (2012). The Supreme Court granted the Department of Treasury’s
application for leave to appeal. 493 Mich App 865 (2012).
In a unanimous opinion by Justice VIVIANO, the Supreme Court held:
Under the ITA, individual taxpayers may combine the profits and losses from unitary
flow-through businesses and then apportion that income on the basis of those businesses’
combined apportionment factors. For the 1994 and 1995 tax years, the apportionment could
properly be applied to a foreign entity if the foreign entity and the individual taxpayer’s in-state
business were unitary.
1. The unitary business principle provides that a state may tax multistate businesses on
an apportionable share of the multistate business conducted in the taxing state. The following
factors are appropriate guides for determining whether business operations are unitary: (1)
economic realities; (2) functional integration; (3) centralized management; (4) economies of
scale; and (5) substantial mutual interdependence. Individual taxpayers in Michigan may use
either a separate-entity reporting method to apportion income, or a combined reporting method.
Separate-entity reporting requires each entity with a nexus to the taxing state to be considered as
a separate and distinct entity, regardless of whether it could comprise a unitary business with
other entities. Combined reporting requires each member of a unitary business to compute its
individual taxable income attributable to activities in the state by taking a portion of the
combined net income of the group through the utilization of combined apportionment factors. In
Malpass, the parties did not dispute that East Jordan and Ardmore were unitary. In Wheeler,
considering the totality of the circumstances, the tribunal’s finding that Electro-Wire and TKG
were a unitary business was supported by competent, material, and substantial evidence on the
whole record, and the Court of Appeals properly affirmed that conclusion.
2. MCL 206.4(2), 206.102, 206.103, and 206.110(1) clearly require an individual
taxpayer with business income stemming from business activity both within and outside of the
state to allocate and apportion all business income using the formula set forth in MCL 206.115.
Section 115 provides for the application of formulary apportionment, but does not expressly
require that a particular method of apportionment be used. Rather, the MCL 206.115 language is
broad enough to allow both the separate-entity reporting and combined reporting method of
formulary apportionment. Although the department has required individuals to use separate-
entity reporting for flow-through business income in the past, it has not promulgated such a rule
and the Supreme Court declined to adopt the department’s preferred methodology; the ITA
permits combined reporting because it satisfies the clear mandate of MCL 206.115 that all
business income be apportioned to the state.
3. Taken together, MCL 206.103, 206.105, and MCL 206.20 require unitary businesses
that include foreign entities to allocate and apportion their income as provided by the ITA. For
the tax years 1994 and 1995, the version of MCL 206.115 in effect at that time stated in part that
all business income shall be apportioned to Michigan; the language of the statute did not limit
formulary apportionment to the domestic entities of a unitary business. Accordingly, for the
1994 and 1995 tax years, under MCL 206.115 an individual may use combined reporting for
income derived from a foreign entity that is unitary with a domestic business taxable in
Michigan. In Malpass, the Court of Appeals erred by concluding that the ITA did not allow the
Malpasses to first combine the income from their unitary flow-through entities and then
apportion it on the basis of the combined apportionment factors of East Jordan and Ardmore. In
Wheeler, the Court of Appeals properly affirmed the tribunal’s conclusion that the ITA contained
no geographical limitation for the 1994 and 1995 tax years; combined reporting was proper even
though the unitary business of Electro-Wire and TKG included an entity located in a foreign
country.
Malpass reversed and remanded to the Court of Claims for reinstatement of the order
granting summary disposition in favor of the Malpasses.
Wheeler affirmed, but part III(A) of the Court of Appeals’ opinion vacated because it
relied on Malpass, which was reversed by this decision.
©2013 State of Michigan
Michigan Supreme Court
Lansing, Michigan
Chief Justice: Justices:
Opinion Robert P. Young, Jr. Michael F. Cavanagh
Stephen J. Markman
Mary Beth Kelly
Brian K. Zahra
Bridget M. McCormack
David F. Viviano
FILED JUNE 24, 2013
STATE OF MICHIGAN
SUPREME COURT
TAD MALPASS and BRENDA L.
MALPASS,
Plaintiffs-Appellants,
v No. 144430
DEPARTMENT OF TREASURY,
Defendant-Appellee.
TRACY MALPASS AND BRENDA K.
MALPASS,
Plaintiffs-Appellants,
v No. 144431
DEPARTMENT OF TREASURY,
Defendant-Appellee.
FRED MALPASS and BARBARA
MALPASS,
Plaintiffs-Appellants,
v No. 144432
DEPARTMENT OF TREASURY,
Defendant-Appellee.
WHEELER ESTATE,
Petitioner-Appellee,
v No. 145367
DEPARTMENT OF TREASURY,
Respondent-Appellant.
NICHOLAS HUZELLA and LISA J.
HUZELLA,
Petitioners-Appellees,
v No. 145368
DEPARTMENT OF TREASURY,
Respondent-Appellant.
PATRICK WRIGHT and MICHAELON
WRIGHT,
Petitioners-Appellees,
v No. 145369
DEPARTMENT OF TREASURY,
Respondent-Appellant.
2
THOMAS R. WHEELER and PATSY
WHEELER,
Petitioners-Appellees,
v No. 145370
DEPARTMENT OF TREASURY,
Respondent-Appellant.
BEFORE THE ENTIRE BENCH
VIVIANO, J.
In these consolidated cases, we address the application of Michigan’s statutory
apportionment formula for individuals with flow-through business income under the
Michigan Income Tax Act (ITA).1 In both cases, the individual taxpayers received
income from in-state and out-of-state, flow-through businesses. The Michigan
Department of Treasury (Department) refused the taxpayers’ attempts to combine the
flow-through income from their respective businesses and then apportion the income
using the businesses’ combined apportionment factors, and instead required the income
of each entity to be apportioned separately.
We hold that the ITA does not prohibit individual taxpayers from combining the
profits and losses from unitary flow-through businesses and then apportioning that
1
MCL 206.1 et seq. The statutory provisions at issue in this opinion are to the versions
of the ITA applicable to the tax years at issue. The Legislature has since amended many
of these provisions. Except as discussed herein, those amendments have no bearing on
these cases.
3
income on the basis of the businesses’ combined apportionment factors. Moreover, we
hold that the ITA did not limit apportionment of income to domestic businesses during
the 1994 and 1995 tax years, and that the apportionment could properly be applied to a
foreign entity to the extent that the foreign entity and the individual taxpayer’s in-state
business were unitary.
Accordingly, (1) we reverse the Court of Appeals’ judgment in Malpass and
reinstate the order entered by the Court of Claims granting summary disposition in favor
of the Malpasses, and (2) we affirm the Court of Appeals’ judgment in favor of the
Wheelers.
I. FACTS AND PROCEDURAL HISTORY
A. MALPASS v DEPARTMENT OF TREASURY
Plaintiffs, individual members of the Malpass family, owned and operated East
Jordan Iron Works (East Jordan), an iron foundry in East Jordan, Michigan. They also
owned and operated Ardmore Foundry, Inc. (Ardmore), an iron foundry in Ardmore,
Oklahoma. Both were Michigan corporations. Because of their S-corporation
classification under the Internal Revenue Code,2 all profits and losses flowed through the
corporation to the family members individually.
For the tax years of 2001, 2002, and 2003, East Jordan operated at a profit and
Ardmore operated at a loss. In their initial returns, the Malpasses treated the companies
as separate, non-unitary entities. Accordingly, the Malpasses attributed East Jordan’s
income to Michigan and Ardmore’s losses to Oklahoma. The Malpasses then amended
2
26 USC § 1361.
4
their returns for the 2001, 2002, and 2003 tax years, treating East Jordan and Ardmore as
a unitary business, and combining East Jordan’s profits with Ardmore’s losses. The
combined amount from the unitary business was then apportioned to Michigan on the
basis of the Michigan apportionment factors, resulting in claims for refunds totaling over
$1 million.
After the Department rejected the Malpasses’ amended returns, the individual
taxpayers brought actions in the Court of Claims. The actions were consolidated, and on
November 19, 2009, the Court of Claims granted summary disposition in favor of
plaintiffs. The Court of Claims determined that East Jordan and Ardmore were a unitary
business on the basis of an undisputed affidavit. It then concluded that the unitary
business principle applied to the ITA and that the Malpasses could first combine the
income and losses of East Jordan and Ardmore and then apportion the aggregate.
In a published opinion, the Court of Appeals reversed, concluding that East Jordan
and Ardmore were separate and legally distinct business entities and that the ITA did not
allow for combined reporting of separate entities.3 The Court of Appeals concluded that
the Malpasses had received income from two separate businesses and were required to
apportion the income of each entity separately.4
B. WHEELER v DEPARTMENT OF TREASURY
Members of the Wheeler family were shareholders of Electro-Wire Products, Inc.
(Electro-Wire), a Michigan-based S-corporation that made electrical systems. Electro-
3
Malpass v Dep’t of Treasury, 295 Mich App 263, 275; 815 NW2d 804 (2011).
4
Id.5
Wire acquired the assets of Temic Telefunken Kabelsatz, GmbH, a German company.
The asset purchase resulted in two general partnerships: Temic Telefunken Kabelsatz,
GmbH (TKG), the operating partnership, and Electro-Wire Products, GmbH (EWG), the
holding partnership. The end result of the acquisition was one S-corporation (Electro-
Wire) and two general partnerships (TKG and EWG), with all the income and losses
passing through to the owners as individual income.
For the tax years 1994 and 1995, the Wheelers reported the pass-through Electro-
Wire income on their individual tax returns; the income included partnership income
from TKG. The Wheelers treated the businesses as unitary and then apportioned the
income using the combined apportionment factors of both companies. After an audit and
a determination that the unitary business principle did not apply to individual taxpayers,
the Department required the Wheelers to apportion the income stemming from Electro-
Wire on the basis of Electro-Wire’s apportionment factors and to disregard TKG’s
factors, resulting in liabilities and interest totaling over $2 million.
The Tax Tribunal granted summary disposition in favor of the Wheelers, finding
that there was no language in the ITA that supported the Department’s assertion that the
unitary business principle applied only on a separate-legal-entity level. In a published
opinion, the Court of Appeals affirmed, concluding that the Wheelers could use
combined reporting under the ITA and that the apportionment could extend to foreign-
6
business activity that was unitary with its Michigan business.5 The Court of Appeals also
concluded that Electro-Wire and TKG were a unitary business.6
II. STANDARD OF REVIEW
In Malpass, we review de novo the trial court’s decision on a motion for summary
disposition.7 Our review of the Tax Tribunal’s decision in Wheeler is limited. In the
absence of fraud, we review a Tax Tribunal decision for “misapplication of the law or
adoption of a wrong principle.”8 We consider the Tax Tribunal’s factual findings
conclusive if they are “supported by competent, material, and substantial evidence on the
whole record.”9 However, we review issues of statutory interpretation de novo.10
III. ANALYSIS
A. FORMULARY APPORTIONMENT IN MICHIGAN
The Due Process Clause of the Fourteenth Amendment imposes two requirements
on a state’s taxation of a business operating in interstate commerce: “a ‘minimal
connection’ between the interstate activities and the taxing State, and a rational
5
Wheeler v Dep’t of Treasury, 297 Mich App 411, 420, 422; 825 NW2d 588 (2012).
6
Id. at 425.
7
Debano-Griffin v Lake Co, 493 Mich 167, 175; 828 NW2d 644 (2013).
8
Briggs Tax Serv, LLC v Detroit Pub Sch, 485 Mich 69, 75; 780 NW2d 753 (2010).
9
Klooster v City of Charlevoix, 488 Mich 289, 295; 795 NW2d 578 (2011), quoting Mich
Bell Tel Co v Dep’t of Treasury, 445 Mich 470, 476; 518 NW2d 808 (1994) (quotation
marks omitted).
10
Klooster, 488 Mich at 295.
7
relationship between the income attributed to the State and the intrastate values of the
enterprise.”11 A state is not required to isolate a business’s intrastate activities from its
interstate activities; instead, “it may tax an apportioned sum of the corporation’s
multistate business if the business is unitary.”12 This latter concept, known as the unitary
business principle, has been referred to as the “linchpin of apportionability.”13 It allows a
state to “tax multistate businesses ‘on an apportionable share of the multistate business
carried on in part in the taxing state.’”14
11
Mobil Oil Corp v Comm’r of Taxes of Vermont, 445 US 425, 436-437; 100 S Ct 1223;
63 L Ed 2d 510 (1980), citing Moorman Mfg Co v Bair, 437 US 267, 272-273; 98 S Ct
2340; 57 L Ed 2d 197 (1978).
12
Allied-Signal, Inc v Director, Div of Taxation, 504 US 768, 772; 112 S Ct 2251; 119 L
Ed 2d 533 (1992).
13
Mobil Oil, 445 US at 438-439. Typically, controversies involving the unitary business
principle and formulary apportionment feature the taxpayer raising constitutional
objections to the state’s taxation scheme. See Mobil Oil Corp, 445 US at 439; Container
Corp of America v Franchise Tax Board, 463 US 159, 165-175; 103 S Ct 2933; 77 L Ed
2d 545 (1983); F W Woolworth Co v Taxation & Revenue Dep’t of New Mexico, 458 US
354, 364-372; 102 S Ct 3128; 73 L Ed 2d 819 (1982); ASARCO Inc v Idaho State Tax
Comm, 458 US 307, 322-330; 102 S Ct 3103; 73 L Ed 2d 787 (1982). Although there are
no constitutional claims in this case, that does not render the basic constitutional
principles underlying Michigan’s formulary apportionment scheme irrelevant because the
unitary business principle is the predicate for any formulary apportionment scheme.
14
Preston v Dep’t of Treasury, 292 Mich App 728, 733; 815 NW2d 781 (2011), quoting
Allied-Signal, Inc, 504 US at 778. Until recently, the Department has taken the position
that the unitary business principle does not apply to individual taxpayers, but now
concedes that it does. Michigan adopted the Uniform Division of Income for Tax
Purposes Act (UDITPA) when it enacted the Michigan Income Tax Act in 1967;
UDITPA embodies the application of the formulary apportionment method in
conjunction with the unitary business principle. See Container Corp, 463 US at 165,
170.
8
Our state has adopted formulary apportionment for individual taxpayers in the
ITA.15 Recognizing that Michigan is a formulary apportionment state, however, does not
resolve the issue in this case because there are at least two different methods of applying
the apportionment formula.16 First, a state may use separate-entity reporting, which
requires each entity with a nexus to the taxing state to be considered as a separate and
distinct entity, regardless of whether it could comprise a unitary business with other
entities.17 Alternatively, a state may use combined reporting, which requires “each
member of a group carrying on a unitary business [to] compute[] its individual taxable
income attributable to activities in [the state] by taking a portion of the combined net
income of the group through the utilization of combined apportionment factors.”18 The
question in this case is whether the ITA prohibits individual taxpayers from using
combined reporting.
15
MCL 206.115. During the tax years at issue in these cases, Michigan used three
factors—payroll, property, and sales—to apportion in-state and out-of-state business
income for individuals. Michigan’s apportionment formula changed as of January 1,
2012, with the enactment of Michigan’s corporate income tax act, MCL 206.601 et seq.
Michigan now apportions solely on a sales factor. See MCL 206.115(2), as amended by
2011 PA 38 and 2011 PA 178.
16
See, generally, 2 Pomp, State and Local Taxation (6th ed), pp 10:43-10:48.
17
Media Gen Communications v SC Dep’t of Revenue, 388 SC 138, 142, 146; 694 SE 2d
525 (2010); see also Pomp, pp 10:42, 10:43.
18
Media Gen Communications, 388 SC at 142. The combined income is not used for
taxing purposes, but it is used to determine the “portion of income from the entire unitary
business attributable to sources within [the state] that is derived by members of the group
subject to [the state’s] taxing jurisdiction.” Id. See also Pomp, pp 10:42-10:43.
9
To answer this question, we turn first to the statutory language.19 Our goal in
interpreting a statute “is to give effect to the Legislature’s intent, focusing first on the
statute’s plain language.”20 In so doing, we examine the statute as a whole, reading
individual words and phrases in the context of the entire legislative scheme.21
Under the ITA, an individual taxpayer’s entire income is taxable in Michigan if it
is derived solely from activity within the state.22 However, if the income is derived from
business activity taxable both within and without this state, the ITA requires an individual
taxpayer to “allocate and apportion his net income . . . .”23 The ITA further states that,
“[f]or a resident individual, . . . all taxable income from any source whatsoever, except
that attributable to another state under [MCL 206.111 to MCL 206.115] and subject to
[MCL 206.255], is allocated to this state.”24 Section 115, the only one of these sections
applicable here, provides: “All business income, other than income from transportation
services shall be apportioned to this state by multiplying the income by a fraction, the
numerator of which is the property factor plus the payroll factor plus the sales factor, and
19
Casco Twp v Secretary of State, 472 Mich 566, 571; 701 NW2d 102 (2005).
20
Klooster, 488 Mich at 296, citing Sun Valley Foods Co v Ward, 460 Mich 230, 236;
596 NW2d 119 (1999).
21
Sun Valley Foods Co, 460 Mich at 237; Herman v Berrien Co, 481 Mich 352, 366; 750
NW2d 570 (2008).
22
MCL 206.102.
23
MCL 206.103.
24
MCL 206.110(1).
10
the denominator which is 3.”25 The ITA defines “business income” as “income arising
from transactions, activities, and sources in the regular course of the taxpayer’s trade or
business . . . .”26
These provisions require an individual taxpayer with business income stemming
from business activity both within and outside of the state to allocate and apportion “[a]ll
business income” using the formula contained in MCL 206.115. Section 115 is
unambiguous—it plainly provides for the application of formulary apportionment.
However, the statute does not require that any particular method of apportionment be
used—it is silent on this question. When, as here, “the language of the statute is
unambiguous, the Legislature must have intended the meaning clearly expressed, and the
statute must be enforced as written. No further judicial construction is required or
permitted.”27 Although section 115 does not require or prohibit any particular method of
applying the statutory formula, the phrase, “[a]ll business income . . . shall be
apportioned[,]” is certainly broad enough to encompass either of the approaches
advocated by the parties.
The Department argues that combined reporting is prohibited because it is not
expressly authorized in the ITA for individual taxpayers, like it is for corporate
taxpayers.28 However, the Department’s argument is flawed. The argument is self-
25
Emphasis added.
26
MCL 206.4(2).
27
Sun Valley Foods, 460 Mich at 236.
28
MCL 208.77. During the tax years at issue, a combined return provision existed in the
Single Business Tax Act, MCL 208.1 et seq., as replaced by 2006 PA 325, giving the
11
defeating because the ITA does not expressly authorize either method of reporting.
Moreover, the provision of the corporate tax law applicable at the time of these returns,
MCL 208.77(1), allowed for combined or consolidated returns by multiple corporate
entities engaged in affiliated business that would otherwise be required to file separate
returns. This is because Michigan imposes corporate taxes at the entity level; thus, absent
a combined filing provision, unitary corporations would lack a means to file a single
combined return. By contrast, income for individuals is already disbursed from the
income-producing entities, aggregated by the taxpayer at the time of filing, and included
on a single return. Thus, while the Legislature has included a combined return provision
in the corporate tax code, such a provision is unnecessary for individual taxpayers,
because they are already required to aggregate all their income on a single return.29
The Department also argues that it has always required the use of separate-entity
reporting and has never approved combined reporting. Although the Department has
certain rule-making authority, in this case, the Department has not promulgated a rule
requiring separate-entity reporting for individual taxpayers.30 To the extent that the
Department discretion to allow a corporation to file a consolidated or combined return.
29
See MCL 206.315.
30
The Department is free to promulgate administrative rules consistent with the ITA in
accordance with procedures set forth in the Administrative Procedure Act, MCL 24.201
et seq. and MCL 205.3(b); see also MCL 206.471(1)(b) (providing that the Department
may promulgate rules for “[t]he computation of the [income] tax”); MCL 206.471(1)(d)
(providing that the Department may promulgate rules regarding the “ascertainment,
assessment, and collection of the tax”). We do not address whether, or the extent to
which, the Department may promulgate a rule requiring that an individual taxpayer use a
particular method of reporting in the taxpayer’s initial filing. We note, however, that any
such rule would be subject to the current MCL 206.195, which gives the taxpayer the
12
Department has interpreted the statute to prohibit combined reporting, that interpretation
is inconsistent with the broad scope of section 115; therefore, it “‘conflict[s] with the
indicated spirit and purpose of the legislature.’”31
Faced with a statutory provision that is broad enough to encompass both reporting
options—but does not choose between them—the Department asks this Court to adopt its
preferred methodology. However, we decline this invitation to engage in interstitial rule
making because “[t]o supply omissions transcends the judicial function.”32 Instead, in the
absence of a policy choice by the Legislature, we conclude that the ITA permits either
reporting method.33
In sum, we reject the Department’s position that the ITA requires separate-entity
reporting. Instead, we hold that combined reporting is permitted by the ITA because it
right to petition for an alternative method if the initial filing required by the Department
“do[es] not fairly represent the extent of the taxpayer’s business activity in this state.”
MCL 206.195(1)(c).
31
In re Complaint of Rovas Against SBC Mich, 482 Mich 90, 103; 754 NW2d 259
(2008), quoting Boyer-Campbell Co v Fry, 271 Mich 282, 296-297; 260 NW 165 (1935).
32
Iselin v United States, 270 US 245, 251; 46 S Ct 248; 70 L Ed 566 (1926).
33
Although not significant to the Court’s analysis, we note that combined reporting
ensures that “the substance of the business activities in the state [] control tax
consequences, not the organizational structure of the business or the entities conducting
those activities,” Pomp, p 10-48; is “wholly consistent with, and a natural extension of,
the apportionment method[,]” Coca Cola Co v Dep’t of Revenue, 271 Or 517, 528; 533
P2d 788 (1975); and, perhaps for these reasons, is a “growing trend[.]” Pomp, p 10-44.
However, the separate-entity approach is also consistent with formulary apportionment.
See W. Hellerstein, Income Allocation, 12 Int’l Transfer Pricing J. 103, 105 (2005).
13
satisfies the clear statutory mandate that “[a]ll business income . . . shall be apportioned
to this state . . . .”34
B. THE ITA’S APPLICATION TO FOREIGN ENTITIES
Beyond our determination that an individual taxpayer can use combined reporting
for flow-through business income, we also must consider whether this method could
extend geographically outside the United States during the tax years of 1994 and 1995.
In Wheeler, the Department argues that even if combined reporting is permitted under the
ITA, it does not apply to a foreign entity that is unitary with a domestic business taxable
in Michigan.35 Again, our analysis of this issue begins with the statute’s text.36
The statutory basis for taxing out-of-state income is § 103, which states:
Any taxpayer having income from business activity which is taxable
both within and without this state, other than the rendering of purely
personal services by an individual, shall allocate and apportion his net
income as provided in this act.[37]
MCL 206.105 specifies when a taxpayer’s income is taxable in another state and, thus,
required to be allocated and apportioned under § 103. It provides:
For purposes of allocation and apportionment of income from
business activity under this act, a taxpayer is taxable in another state if (a)
34
MCL 206.115.
35
We note that the United States Supreme Court has upheld the apportionment of
business income of unitary foreign entities. See, e.g., Barclays Bank PLC v Franchise
Tax Bd of Cal, 512 US 298; 114 S Ct 2268; 129 L Ed 2d 244 (1994); Container Corp of
America, 463 US 159 (1983).
36
Casco Twp, 472 Mich at 571.
37
MCL 206.103 (emphasis added).
14
in that state he is subject to a net income tax, a franchise tax measured by
net income, a franchise tax for the privilege of doing business or a
corporate stock tax, or (b) that state has jurisdiction to subject the taxpayer
to a net income tax regardless of whether, in fact, the state does or does
not.[38]
Finally, MCL 206.20 defines “state” as “any state of the United States, the District of
Columbia, the Commonwealth of Puerto Rico, any territory or possession of the United
States, and any foreign country, or political subdivision, thereof.”39 Taken together,
these provisions require a taxpayer to allocate and apportion his income if “in [a foreign
country] he is subject to a net income tax . . . or [a foreign country] has jurisdiction to
subject the taxpayer to a net income tax . . . .”40 Thus, unitary businesses that include
foreign entities must allocate and apportion their income as provided by the ITA.41
We turn now to the ITA provisions dealing with business income to determine if
the act otherwise excludes the income of a foreign entity for purposes of allocation and
apportionment. Section 115, which deals with the apportionment of business income,
states in pertinent part, “All business income . . . shall be apportioned to this state by
multiplying the income by a fraction, the numerator of which is the property factor plus
the payroll factor plus the sales factor, and the denominator of which is 3.”42 Moreover,
the apportionment factors themselves employ universal language when explaining the
38
MCL 206.105.
39
MCL 206.20 (emphasis added).
40
MCL 206.105.
41
MCL 206.103.
42
Emphasis added.
15
scope of relevant business activity. MCL 206.119 states that “[t]he payroll factor is a
fraction, . . . the denominator of which is the total compensation paid everywhere during
the tax period.”43 Likewise, MCL 206.121 states that “[t]he sales factor is a fraction, . . .
the denominator of which is the total sales of the taxpayer everywhere during the tax
period.”44
Nowhere in the ITA did the Legislature limit formulary apportionment to the
domestic entities of a unitary business. In fact, to the extent that the Legislature
discussed geographic limitations, it expressly required taxpayers with income taxable in a
foreign country to allocate and apportion their income as provided in the act, which
includes § 115’s directive that all business income be apportioned using the
apportionment factors.45 Therefore, we reject the Department’s argument that the ITA
prohibits application of formulary apportionment to income from a foreign entity that is
unitary with a domestic business.
Accordingly, we conclude that a unitary business with income from a business in a
foreign country could be apportioned under the version of the ITA in effect during the tax
years of 1994 and 1995.46
43
Emphasis added.
44
Emphasis added.
45
See MCL 206.20, 206.103, and 206.105.
46
The Legislature has limited the scope of the corporate income tax to domestic
corporations in recent amendments. 2011 PA 38. The ITA now defines “unitary
business group” as a “group of United States persons that are corporations, insurance
companies, or financial institutions, other than a foreign operating entity . . . .” MCL
206.611(6). The Department argues that this shows that the Legislature only intended to
include businesses within the United States. However, we are not persuaded that the
16
C. APPLICATION TO MALPASS
On appeal, the parties in Malpass do not dispute whether East Jordan and Ardmore
were a unitary business. The Court of Appeals, despite determining that the businesses
had unitary characteristics, wrongly concluded that the ITA does not allow individual
taxpayers with flow-through business income from separate legal entities to use
combined reporting.47 For the reasons already stated, we hold that the ITA did not
prohibit the Malpasses from first combining the income from their unitary flow-through
entities and then apportioning it on the basis of the combined apportionment factors of
East Jordan and Ardmore. Therefore, we reverse the Court of Appeals’ judgment in
Malpass and reinstate the order entered by the Court of Claims granting summary
disposition in favor of the Malpasses.
D. APPLICATION TO WHEELER
Unlike in Malpass, the parties in Wheeler dispute whether the Michigan and
German entities were a unitary business. The Tax Tribunal found that they were, and the
Court of Appeals affirmed. To consider business operations unitary, the United States
recent amendment limiting the scope of corporate income tax should affect our
interpretation of the ITA for the tax years 1994 and 1995.
47
Malpass, 295 Mich App at 270. In its opinion, the Court of Appeals erroneously
concluded that the ITA does not allow combined reporting. Id. (“[N]othing in the ITA
allows for combined-entity reporting.”); id. at 272 (“There is no provision in the ITA that
allows individuals to combine their business income from separate businesses and then
use a combined apportionment formula on the total.”). However, the Court of Appeals
reached this conclusion in cursory fashion without analyzing the relevant provisions of
the ITA. Instead, the Court of Appeals fixated on the corporate form of the business
entities, even though the ITA makes no distinctions based on corporate formalities.
17
Supreme Court has held, “[T]here [must] be some sharing or exchange of value not
capable of precise identification or measurement—beyond the flow of funds arising out
of a passive investment or a distinct business operation—which renders formula
apportionment a reasonable method of taxation.”48 Accordingly, a unitary business exists
when the income-producing companies have “functional integration, centralization of
management, and economies of scale.”49 Other United States Supreme Court decisions
have added to these guideposts.50 The Court of Appeals relied on the following five
factors in determining whether the Michigan and German entities were a unitary
business: “(1) economic realities; (2) functional integration; (3) centralized management;
(4) economies of scale, and (5) substantial mutual interdependence.”51 We agree that
these factors are appropriate guides for determining whether businesses are unitary.
Moreover, as the United States Supreme Court held in Container Corp, “We need not
decide whether any one of these factors would be sufficient as a constitutional matter to
prove the existence of a unitary business.”52 These factors are not exhaustive or
48
Container Corp, 463 US at 166.
49
Mobil Oil, 445 US at 438.
50
See F W Woolworth Co, 458 US at 364-372; ASARCO Inc, 458 US at 319, 322-329;
Container Corp, 463 US 159.
51
Wheeler Estate, 297 Mich App at 422-423, citing Holloway Sand & Gravel, Co, Inc v
Dep’t of Treasury, 152 Mich App 823, 831; 393 NW2d 921 (1986).
52
Container Corp, 463 US at 179-180.
18
exclusive. Nor is any one factor dispositive. Instead, a court should consider the totality
of the circumstances when determining if businesses are unitary.53
Turning to the evidence offered by the parties, and aware of our limited review of
the factual determinations made by the Tax Tribunal, we agree with that body’s
conclusion that the businesses here were unitary. The Court of Appeals affirmed the
findings of the Tribunal. Because we agree with the thorough analysis of the Court of
Appeals, we adopt its conclusions and holding in full:
The first factor, economic realities, addresses whether the regularly
conducted activities of the businesses in question are related. Holloway,
152 Mich App at 832. The record shows that the underlying businesses of
Electro-Wire and TKG were identical because both were engaged in the
manufacturing and assembling of electrical distribution systems.
Respondent claims that this is immaterial because the two businesses were
engaged in the same underlying business before Electro-Wire purchased
TKG. However, there is no requirement under Holloway or related cases
that potentially unitary businesses develop the same underlying activities
collaboratively; the only requirement is that the underlying businesses be
related to each other.
The second factor, functional integration, concerns the extent to
which business functions are blended to promote a unitary relationship.
Petitioners presented evidence that, before it was acquired by Electro-Wire,
TKG was part of the Daimler Group. Once Electro-Wire purchased TKG,
however, this relationship was severed, leaving TKG without critical
support services, which were assumed by Electro-Wire. These services
included direct management of TKG’s business activities and support for
component engineering, manufacturing and industrial engineering, cost
estimating, business development, finance, and executive administration.
53
See, generally, Holloway Sand, 152 Mich App at 835 (mentioning a “sixth factor”
resulting from the taxpayer’s treatment of capital gains from one of the businesses); see
also Container Corp, 463 US at 179 (approving a California Court of Appeals reliance on
“a large number of factors” to conclude that a domestic corporation and its foreign
subsidiaries were unitary).
19
Respondents presented no rebuttal evidence, but set forth on appeal a list
identifying ways in which Electro-Wire and TKG were not integrated.
However, this belated argument is not persuasive because there is no
requirement that businesses be 100 percent integrated in order to classify
them as unitary.
The third factor examines the extent to which management was
centralized across the potentially unitary business. Petitioners submitted
unrebutted evidence that TKG’s overall management decisions were
centralized and directed by Electro-Wire managers in North America and
that Electro-Wire hired and fired all TKG officers and managers. Again,
respondent presented no rebuttal evidence, but alleges that Electro-Wire did
not engage in day-to-day management of TKG. Again, however, the only
requirement under Holloway is centralized management, not complete
management.
The fourth factor looks for the presence of economies of scale.
Petitioners presented unrebutted evidence of economic benefits generated
by the combination of Electro-Wire and TKG, such as an expanded
customer base, sharing of unique and proprietary processes, and improved
financing terms. Respondent presented no evidence to challenge this, but
argues that petitioners failed to show profits through bulk purchasing or
improved allocation of resources. These are typically considered to be
common economies of scale, but respondent does not explain how cheaper
component parts, an expanded customer base, increasing economic
diversification, and improved financing conditions are not also benefits
derived from economies of scale.
The fifth and final factor considers whether substantial mutual
interdependence exists. Petitioners submitted unrebutted evidence that
acquiring TKG was essential for Electro-Wire to remain a supplier for Ford
and that remaining a supplier for Ford was essential to Electro-Wire’s
survival. The Tax Tribunal found that Electro-Wire was dependent on
TKG, but was unable to conclude whether or not TKG was similarly
dependent on Electro-Wire, and thus resolved this factor partially in favor
of petitioners.[54]
Based on the foregoing, we hold that the Tax Tribunal’s factual finding that
Electro-Wire and TKG were a unitary business was “supported by competent, material,
54
Wheeler Estate, 297 Mich App at 423-425.
20
and substantial evidence on the whole record.”55 Because there was evidentiary support
for all of the unitary factors, the Court of Appeals properly affirmed the Tax Tribunal’s
conclusion that Electro-Wire and TKG constituted a unitary business. Because we
discern no limitations on the geographical boundaries to which the combined reporting
could extend, the Wheelers could combine the profits and losses from Electro-Wire and
TKG and then apportion, using the companies’ combined apportionment factors.
IV. CONCLUSION
In Malpass, we hold that the ITA permitted the individual taxpayers to combine
the flow-through business income from the unitary business of East Jordan and Ardmore
and then apportion, using the combined apportionment factors of the unitary business.
Accordingly, we reverse the Court of Appeals and remand to the Court of Claims for
reinstatement of the order granting summary disposition in favor of plaintiffs.
In Wheeler, we hold that the Court of Appeals properly determined that the
Wheelers could combine their flow-through income from the unitary business of Electro-
Wire and TKG. In so doing, we hold that the ITA contained no geographical limitations
for the tax years of 1994 and 1995 and that combined reporting was proper even though
the unitary business included an entity located in a foreign country. We affirm the
55
Klooster, 488 Mich at 295.
21
judgment of the Court of Appeals, but we vacate Section III(A) of the Court of Appeals’
opinion because that analysis is inconsistent with our analysis herein and relied on the
Court of Appeals’ erroneous decision in Malpass, which we reverse today.
David F. Viviano
Robert P. Young, Jr.
Michael F. Cavanagh
Stephen J. Markman
Mary Beth Kelly
Brian K. Zahra
Bridget M. McCormack
22