Emhart Industries, Inc. v. Mississippi State Tax Commission
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IN THE SUPREME COURT OF MISSISSIPPI
NO. 1999-CA-01100-SCT
EMHART INDUSTRIES, INC.
v.
MISSISSIPPI STATE TAX COMMISSION
DATE OF JUDGMENT:
TRIAL JUDGE:
COURT FROM WHICH APPEALED:
ATTORNEYS FOR APPELLANT:
ATTORNEYS FOR APPELLEE:
NATURE OF THE CASE:
DISPOSITION:
MOTION FOR REHEARING FILED:
MANDATE ISSUED:
05/26/1999
HON. STUART ROBINSON
HINDS COUNTY CHANCERY COURT
JAMIE G. HOUSTON, III
FRANK A. WOOD, JR.
BOBBY R. LONG
AMANDA LEE TRAWICK
CIVIL - STATE BOARDS AND AGENCIES
AFFIRMED - 7/27/2000
BEFORE BANKS, P.J., WALLER AND DIAZ, JJ.:
WALLER, JUSTICE, FOR THE COURT:
¶1. Emhart Industries, Inc. ("Emhart") is a Connecticut corporation authorized to do business in the State of
Mississippi. On July 19, 1989, the Emhart Board of Directors declared a dividend of $1,000,000,000 to
be paid to its sole shareholder and parent, Emhart Corporation. In a written consent, Emhart's directors
declared that the dividend would be paid out of Emhart's retained earnings and capital surplus. The Emhart
directors also declared that the dividend would be paid by way of a promissory note issued by Kwikset
Corporation(1) to Emhart in the amount of $73,600,000, and by way of a promissory note issued by
Emhart to the Emhart Corporation in the amount of $926,400,000. Emhart endorsed and transferred to
Emhart Corporation the Kwikset promissory note of $73,600,000, as partial payment of the declared
dividend. Additionally, Emhart transferred its promissory note, in the amount of $926,400,000, to Emhart
Corporation as payment of the balance of the declared dividend.
¶2. The purpose of the dividend was to enable Emhart Corporation [Emhart's parent] and its parent, Black
& Decker Corporation, to pay off a portion of a loan they received in connection with Black & Decker's
acquisition of Emhart Corporation. Emhart did not provide any security for the promissory note, making the
note payable on demand. Furthermore, interest was to be paid semi-annually on the dates of January 19th
and July 19th of each year, commencing January 19, 1990.
¶3. Pursuant to an audit of Emhart's Mississippi franchise tax returns for the years ending September 24,
1989, and September 30, 1990, the Mississippi Tax Commission recomputed the book value of the
accounts reflected on Emhart's returns. The Commissioner determined that the amount of capital employed
within the State of Mississippi for the periods ending September 24, 1989, and September 30, 1990, was
$51,804,507 and $61,668,774, respectively. Emhart, however, had reported [$27,595,716] for the period
ending on September 24, 1989, and $18,720,000 for the period ending on September 30, 1990. Since
Emhart's financial operation was not affected and did not diminish during these periods, even after the $1,
000,000,000 dividend was issued to Emhart Corporation, the Commission found that Emhart's reported
capital was not true capital employed within the State of Mississippi and therefore taxed it on the true book
value pursuant to Miss. Code Ann. § 27-13-11 (1999). The Chancery Court of the First Judicial District of
Hinds County affirmed the Commission's decision. Aggrieved, Emhart timely perfected this appeal.
STATEMENT OF THE CASE
¶4. Emhart argues that capital subject to the corporate franchise tax is determined by statute and specifically
points to Miss. Code Ann. § 27-13-9 (1999), which provides that amounts designated for payment as
dividends, when "definitely and irrevocably placed to the credit of stockholders, subject to withdrawal on
demand," should be excluded from capital. In the present case, the Chancellor found that Emhart's
promissory note, which was used to partially pay the July 19, 1989, dividend, did not satisfy the statute.
Emhart contends the Chancellor's decision was "arbitrary, capricious, and repugnant to the plain meaning of
the statute."
¶5. Emhart further asserts that it followed generally accepted accounting principles and all formalities
required in declaring, paying and recording the dividend. Emhart also argues that the promissory note was a
legally binding negotiable instrument with commercially reasonable rates. Likewise, Emhart contends that
there was no basis for treating the Kwikset note and the Emhart note differently, although the Chancellor
found the Emhart note was not a true reduction in capital, but was merely a "paper transaction undertaken
for perceived tax benefits." Finally, Emhart asserts that there was no capital infusion into Emhart and that the
dividend was property that was treated on its books as a debt.
¶6. The Commission, however, argues that Emhart declared a dividend but never fully placed the payments
to the credit of its sole shareholder, Emhart Corporation. The Commission contends that the promissory
note was not created out of a true debtor/creditor relationship because no security was provided and no
actual payments on the note were provided until three years after the first payment was due. The
Commission further asserts that Emhart only "shuffled some money figures from its capital section to its
notes payable section of its balance sheet." Likewise, it argues that Emhart continued to employ the same
amount of capital before and after declaring the dividend. The Commission also points out that no assets of
any kind were reduced when Emhart paid the dividend to Emhart Corporation, unlike the Kwikset note,
where the transferred note to Emhart Corporation reduced Emhart's accounts receivable. Finally, the
Commission cites Miss. Code Ann. § 27-13-9 and argues that notes which are payable to an affiliated
company should also be included in the franchise tax base when the note is a substitute for paid-in capital.
STANDARD OF REVIEW
¶7. The test to be applied by an appellate court to a decision of a commission or administrative agency is
whether such decision is supported by substantial evidence or whether such action is arbitrary, capricious,
unreasonable, an abuse of discretion or violated some statutory or constitutional right of the complaining
party. State Tax Comm'n v. Earnest, 627 So. 2d 313, 319 (Miss. 1993); see Mississippi Real Estate
Comm'n v. Hennessee, 672 So.2d 1209,1214 (Miss. 1996). "While this review is limited, this Court is
not totally bound by the Commission's interpretation of a taxation statute." Earnest, 627 So. 2d at 320.
DISCUSSION
I. WHETHER THE PROMISSORY NOTE FROM A SUBSIDIARY TO ITS PARENT
SHOULD BE EXCLUDED FROM CAPITAL AS DEBT IN ACCORDANCE WITH
MISS. CODE ANN. § 27-13-9.
¶8. This case involves the proper interpretation of Mississippi's corporate franchise tax laws. The
Mississippi Legislature imposes on all corporations doing business in this state, a franchise tax which is
computed based on the capital of the corporation. See Miss. Code Ann. § 27-13-7 (1999). The legislature
bases the franchise tax on the value of the collateral as reflected in the corporation's financial books and
records. Miss. Code Ann. § 27-13-11 (1999) provides in relevant part as follows:
For the purpose of determining the amount of capital, as defined in Section 27-13-9 (1972), as
amended, the book value of the accounts as regularly employed in conducting the affairs of the
corporation shall be accepted as prima facie correct, except where the commissioner determines
that the book value does not properly reflect capital employed in this state and in that
situation the commissioner's determination of capital shall be prima facie correct.
(emphasis added). The law, thus, provides that the corporation's records shall be deemed correct unless the
commissioner determines the book value fails to properly reflect capital. In such a case, the commissioner's
determination is then found to be prima facie correct.
¶9. Miss. Code Ann. § 27-13-9 sets forth the method by which franchise taxes are imposed upon capital
within this state, and reads in relevant part as follows:
(1) The tax imposed, levied and assessed, under the provisions of this chapter, shall be calculated on
the basis of the value of the capital employed in this state for the year preceding the date of filing the
return, whether a calendar year, or fiscal year, except where otherwise provided in this chapter,
measured by the combined issued and outstanding capital stock, paid-in capital, surplus and retained
earnings; provided, that in computing capital, paid-in capital, surplus and retained earnings, there shall
be included deferred taxes, deferred gains, deferred income, contingent liabilities and all true reserves,
including all reserves other than for definite known fixed liabilities which do not enhance the value of
assets; and amounts designated for the payment of dividends shall not be excluded from such
calculations until such amounts are definitely and irrevocably placed to the credit of
stockholders, subject to withdrawal on demand; provided, however, there shall not be
included in the value of the capital stock any sums representing debts, notes, bonds and
mortgages due and payable, except where notes or debts due are provided by an affiliated
company as a substitute for stock or paid-in capital; nor depreciation reserves, bad debt
reserves, nor reserves representing valuation accounts. . . .
(emphasis added). Accordingly, Emhart argues that the promissory note issued to Emhart Corporation
should be excluded from capital because the note was "definitely and irrevocably placed to the credit of
stockholders, subject to withdrawal on demand."
¶10. This case is one of first impression in Mississippi and centers around one question: whether a
promissory note issued by a subsidiary to its parent is excluded as debt for purposes of computing the
corporate franchise tax under Miss. Code Ann. § 27-13-9? Both Emhart and the Commission agree that
had the promissory note been to a third party, and not to the parent itself, the debt would be excluded from
capital under the statute. The parties do not agree, however, on whether a subsidiary should be able
exclude a promissory note from capital when the note is issued to a parent corporation.
¶11. While recognizing that a debt from the subsidiary to a third party would have been a legitimate debt
and excluded from capital under Miss. Code Ann. § 27-13-9, this Court must then address the concerns of
allowing the same exclusion for notes made between subsidiary and parent companies. This Court
concludes that it is possible to have a legitimate debt between a subsidiary and its parent, which would be
excluded from capital as debt under the statute. However, we do not hold such a "true debt" existed in the
present case.
¶12. First, the Commission contends the note was not "definitely and irrevocably placed to the credit of the
stockholders, subject to withdrawal on demand." See Miss. Code Ann. § 27-13-9 (1999). This Court
agrees with the Commission's interpretation. If the $926,400,000 had been placed definitely and
irrevocably within the hands of Emhart's parent, then Emhart would not have been able to operate in the
same manner as it did before issuing the note. Emhart did, however, continue to operate in the same
manner, generating the same amount of receipts, and did so with negative capital. Furthermore, the note
was not subject to withdrawal on demand. If Emhart's parent had demanded the note be paid, it would
have been impossible to do so without distributing property or borrowing from an unrelated financial
institution.
¶13. Second, Emhart did not pay the note out of its retained earnings and surplus as instructed by the
directors. Instead, Emhart issued a note to its parent without providing any security and without reducing
any assets as is normally done when a dividend is declared. Likewise, Emhart did not pay interest in
accordance with the promissory note and waited over three years after the first payment was due to make a
payment on the promissory note itself. When Emhart did finally pay off the note, it issued another
intercompany note payable in the amount of $1 billion.
¶14. Emhart counters these allegations by asserting that the dividend had a valid business purpose.
According to Emhart, when Black & Decker acquired the stock of Emhart Corporation in April 1989, the
financing agreement imposed material restrictions on Black & Decker and its subsidiaries which prohibited
incurring any outside debt. To meet the obligations under the financing agreement, Black & Decker and its
subsidiaries had to reduce their debt by approximately $1 billion by June 1991.
¶15. After hearing the above testimony, the Chancellor, in his Opinion and Order of the Court, affirmed the
decision of the Commission and reasoned in relevant part as follows:
The terms of Emhart's promissory note provided that the note was unsecured and payable upon
demand. Further, the note provided that interest would be paid semi-annually on January 19 and July
19 of each year, commencing January 19, 1990. Emhart did not comply with this interest requirement
and in fact made no payment for a period of more than three years. Subsequently, interest was paid in
full, with interest at the stated rate. However, the record reflects that Emhart's business activity in
Mississippi did not diminish after the dividend was issued. . . .
***
Although Emhart and its parent company went through the formalities in declaring a dividend, the
evidence demonstrates that this was merely a paper transaction undertaken for perceived tax benefits.
Emhart argues that the "complete payment of the note is the most basic evidence of a true debtor
creditor relationship that was respected by both parties from the beginning. . . ." However, better
evidence of the true relationship may be found in the fact that the interest was not paid in strict
accordance with the promissory note and that actual payments on the promissory note were not made
for a period in excess of three years. The statutory requirement that dividends be "definitely and
irrevocably placed to the credit of stockholders" envisions that the capital would no longer be
available to the declaring corporation's business and would not be subject to the franchise tax. In the
case sub judice, however, the dividend was never "definitely and irrevocably placed to the credit of
stockholders." This was not an arms length transaction conducted in accordance with normal business
practices, but instead was a transaction between a parent and subsidiary which was conducted in
accordance with the benefit of both.
This Court finds the chancellor's reasoning persuasive. The Commission's determination is considered to be
prima facie correct, and the burden is on Emhart to demonstrate that the Commission's determination was
wrong. Miss. Code Ann. § 27-13-11 (1999). Emhart has failed to meet this burden.
CONCLUSION
¶16. This Court finds that the decision of the Chancery Court of the First Judicial District of Hinds County,
Mississippi, was neither arbitrary nor capricious and was not contrary to the plain meaning of the statute.
Furthermore, this Court recognizes that while it is possible to have a true debt relationship between a parent
and subsidiary, such a relationship did not exist here. Therefore, we affirm the findings that the amount of the
promissory note between Emhart and its parent, Emhart Corporation, should be included as capital for
purposes of determining the amount of state corporate franchise tax owed.
¶17. AFFIRMED.
PRATHER, C.J., PITTMAN AND BANKS, P.JJ., McRAE, MILLS AND DIAZ, JJ.,
CONCUR. SMITH, J., DISSENTS WITH SEPARATE WRITTEN OPINION JOINED BY
COBB, J.
SMITH, JUSTICE, DISSENTING:
¶18. The majority holds that a true debt relationship between the parent company and subsidiary does not
exist in the ase at bar and includes as capital for state corporate franchise tax purposes the amount of the
promissory note between Emhart and Emhart Corporation. I disagree and therefore dissent.
¶19. The definition of capital is governed by Miss. Code Ann § 27-13-9. Dividends paid are clearly
excluded by the statute. Here, Emhart paid a dividend which is shown as such on both its records and tax
returns. The Commission cannot ignore these facts for franchise tax purposes and interpret the statute by
expansion so as to include a liability. This Court has repeatedly held that such expansion of the definition of
capital beyond that set forth under the statute cited above is not permissible. Mississippi State Tax
Comm'n v. Lady Forest Farms, Inc., 701 So. 2d 294, 296-97 (Miss. 1997).
¶20. Additionally, it is equally clear that the Commission's treatment of the Emhart note was inconsistent
with its treatment of the note issued by Emhart's subsidiary, Kwikset Corporation. The Kwikset note was
never included in Emhart's capital as partial payment of the dividend. The Commission excluded the
Kwikset note from capital. This was clearly inconsistent with its decision to include the Emhart note as
capital. The Emhart note was excludable from capital as a dividend and because it was a demand note on
its very face. Emhart received absolutely nothing in consideration or exchange, or pledge any security for
Emhart's issuance of the promissory note. Thus, a true debtor-creditor relationship was established here.
The note in question was not substituted capital, but rather was simply a note which was excludable both
from capital and the franchise tax.
¶21. I respectfully dissent.
COBB, J., JOINS THIS OPINION.
1. Kwikset Corporation was a subsidiary of Emhart.
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