Ardire v. Tracy

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1 Ardire et al., Appellants, v. Tracy, Tax Commr., Appellee. 2 [Cite as Ardire v. Tracy (1997), __ Ohio St.3d __.] 3 Taxation -- Income tax -- Credits against income tax otherwise due -- 4 Taxpayer not entitled to resident income tax credit under former 5 R.C. 5747.05(B) on that portion of adjusted gross income that 6 was subjected to Michigan s Single Business Tax. 7 (No. 95-1535 -- Submitted November 12, 1996 -- Decided February 12, 8 9 1997.) APPEAL from the Board of Tax Appeals, No. 94-K-347. 10 During 1988, Philip and Donna Ardire, appellants, received income from 11 Simplex Communications Corporation ( Simplex ), a Subchapter S corporation 12 which engaged in business in Michigan and California.1 For tax year 1988, 13 Simplex had filed, on behalf of its shareholders, a California Corporation 14 Franchise or Income Tax Return and a Michigan Single Business Tax Annual 15 Return. Thus, when appellants filed their 1988 Ohio Individual Income Tax 16 Return, they claimed a resident income tax credit of $19,076.41 for taxes that 17 had been paid by Simplex to Michigan and California. Specifically, appellants 18 claimed a resident income tax credit of $1,302.28 for that portion of their 1 adjusted gross income from Simplex which had been subjected to the 2 California Corporation Franchise or Income Tax, and a resident income tax 3 credit in the amount of $17,774.13 for that portion of their adjusted gross 4 income which had been subjected to the Michigan Single Business Tax. In 5 their personal income tax return, appellants indicated that they were entitled to 6 a tax refund in the amount of $19,749.22, which they eventually received. 7 However, following an audit of appellants 1988 tax return, appellee Roger 8 Tracy, the Tax Commissioner, disallowed the entire amount of the resident 9 income tax credit that had been claimed by appellants. Thus, on October 26, 10 1991, the commissioner issued a tax assessment against appellants in the 11 amount of $19,076.41, plus interest of $5,306.38, for a total tax assessment of 12 $24,382.79. 13 On November 25, 1991, appellants filed a petition for reassessment 14 pursuant to R.C. 5747.13. After reviewing appellants petition, the 15 commissioner modified the tax assessment by allowing appellants to take the 16 previously claimed resident income tax credit for that portion of their adjusted 2 1 gross income which had been subjected to a tax on income or a tax measured 2 by income in the state of California. The commissioner also reduced the 3 amount of preassessment interest to $910.62. However, the commissioner 4 denied appellants petition with respect to that portion of the resident tax credit 5 claimed by appellants for the taxes paid by Simplex to Michigan, finding that 6 the Michigan Single Business Tax was not a tax on income or a tax measured 7 by income. The commissioner modified the tax assessment to reflect a total 8 balance due of $18,684.75. 9 10 On appeal, the Board of Tax Appeals ( BTA ) affirmed the order of the commissioner. The cause is now before this court upon an appeal as of right. 11 Phillips & Co., L.P.A., and Gerald W. Phillips, for appellants. 12 Betty D. Montgomery, Attorney General, Robert C. Maier and Steven L. 13 Zisser, Assistant Attorneys General, for appellee. 14 DOUGLAS, J. The sole issue that has been properly presented for our 15 consideration is whether appellants were entitled to a resident income tax credit 16 under R.C. 5747.05(B) on that portion of their adjusted gross income which 3 1 was subjected to Michigan s Single Business Tax ( SBT ), Mich.Comp.Laws 2 Ann. 208.1 et seq. Resolution of this issue hinges on the question whether the 3 SBT is either a tax on income or a tax measured by income. For the reasons 4 that follow, we find that the decision of the BTA upholding the Tax 5 Commissioner s denial of the resident income tax credit for that portion of 6 appellants adjusted gross income which was subject to the SBT was neither 7 unlawful nor unreasonable and, accordingly, we affirm the decision of the 8 BTA. 9 R.C. 5747.02 levies an annual tax on every individual residing in or 10 earning or receiving income in Ohio. 11 individual is measured by adjusted gross income less certain exemptions. R.C. 12 5747.05 allows certain tax credits against adjusted gross income, including a 13 resident income tax credit for those portions of the adjusted gross income of a 14 resident taxpayer that in another state or in the District of Columbia are 15 subjected to a tax on income or a tax measured by income. As it existed in 16 1988, R.C. 5747.05 provided, in part: 4 The annual tax in the case of an 1 2 The following credits shall be allowed against the income tax imposed by section 5747.02 of the Revised Code: 3 * * * 4 (B)(1) The amount of tax otherwise due under section 5747.02 of the 5 Revised Code on such portion of the adjusted gross income of a resident 6 taxpayer that in another state or in the District of Columbia is subjected to a tax 7 on income or measured by income[.] (Emphasis added.) Am.Sub.H.B. No. 8 171, 142 Ohio Laws, Part II, 2170, 2380.2 9 The parties agree that the SBT is not a tax on income. Indeed, the fact 10 that the SBT is not a tax on income is a well-established principle of Michigan 11 law. In Trinova Corp. v. Dept. of Treasury (1989), 433 Mich. 141, 149-150, 12 445 N.W.2d 428, 431-432, affirmed (1991), 498 U.S. 358, 111 S.Ct. 818, 112 13 L.Ed.2d 884, the Michigan Supreme Court described some of the components 14 of the SBT and specifically determined that the SBT is a value-added tax and 15 not a tax on income: 5 1 The single business tax is a form of value added tax, although it is not a 2 pure value added tax. * * * Value added is defined as the increase in the value 3 of goods and services brought about by whatever a business does to them 4 between the time of purchase and the time of sale. [Haughey, The Economic 5 Logic of the Single Business Tax (1976), 22 Wayne L.Rev. 1017, 1018.] In 6 short, a value added tax is a tax upon business activity. The act [the Michigan 7 Single Business Tax Act] employs a value added measure of business activity, 8 but its intended effect is to impose a tax upon the privilege of conducting 9 business activity within Michigan. 10 It is not a tax upon income. MCL [Mich.Comp.Laws] 208.31(4); MSA [Mich.Stat.Ann.] 7.558(31)(4). 11 * * * 12 The computation of the tax involves several steps beginning with the 13 calculation of the taxpayer s tax base. Under the act, tax base is defined as 14 business income (or loss) before apportionment subject to certain adjustments. 15 MCL 208.9; MSA 7.558(9). Business income is essentially federal taxable 16 income. MCL 208.3(3); MSA 7.558(3)(3). Common adjustments to business 6 1 income include additions to reflect the business consumption of labor and 2 capital. Those include adding back compensation, depreciation, dividends, and 3 interest paid by the taxpayer to the extent deducted from federal taxable 4 income. 5 interest, and royalties received by the taxpayer to the extent included in federal 6 taxable income. This income is deducted for the purpose of value added 7 computation because it does not result from capital expenditure by the 8 taxpayer. 9 Theory and mechanics, 22 Wayne L R 1069, 1081 (1976). (Emphasis added 10 in part; footnotes omitted in part.) See, also, Trinova Corp. v. Michigan Dept. 11 of Treasury (1990), 498 U.S. 358, 362-368, 111 S.Ct. 818, 823-826, 112 12 L.Ed.2d 884, 896-901 (recognizing that the SBT is a value-added tax as 13 opposed to a tax on income); Mobil Oil Corp. v. Dept. of Treasury (1985), 422 14 Mich. 473, 496-497, 373 N.W.2d 730, 741, and fn. 14 (finding that the SBT is 15 a consumption-type value-added tax); Caterpillar, Inc. v. Dept. of Treasury 16 (1992), 440 Mich. 400, 408, 488 N.W.2d 182, 185 (same principle); Gillette Common deductions from business income include dividends, Kasischke, Computation of the Michigan single business tax: 7 1 Co. v. Dept. of Treasury (1993), 198 Mich.App. 303, 308-309, 497 N.W.2d 2 595, 597-598 (holding that the SBT is a consumption-type value-added tax and 3 not a tax on income); Town & Country Dodge, Inc. v. Dept. of Treasury (1986), 4 152 Mich.App. 748, 753-754, 394 N.W.2d 472, 475 (recognizing that the SBT 5 is a tax imposed upon business activity rather than upon the income which 6 results from that activity); and Wismer & Becker Contracting Engineers v. 7 Dept. of Treasury (1985), 146 Mich.App. 690, 696, 382 N.W.2d 505, 507 8 ( The single business tax is a tax upon the privilege of doing business and not 9 upon income. ). 10 In Trinova, 498 U.S. 358, 111 S.Ct. 818, 112 L.Ed.2d 884, the United 11 States Supreme Court described some of the general differences between a 12 value-added tax (a VAT ) and a corporate income tax: 13 A VAT differs in important respects from a corporate income tax. A 14 corporate income tax is based on the philosophy of ability to pay, as it consists 15 of some portion of the profit remaining after a company has provided for its 16 workers, suppliers, and other creditors. A VAT, on the other hand, is a much 8 1 broader measure of a firm s total business activity. Even if a business entity is 2 unprofitable, under normal circumstances it adds value to its products and, as a 3 consequence, will owe some VAT. Because value added is a measure of actual 4 business activity, a VAT correlates more closely to the volume of governmental 5 services received by the taxpayer than does an income tax. Further, because 6 value added does not fluctuate as widely as net income, a VAT provides a more 7 stable source of revenue than the corporate income tax. Id. at 363-364, 111 8 S.Ct. at 824, 112 L.Ed.2d at 898. 9 Although the SBT is clearly not a tax on income, appellants contend that 10 the SBT is a tax measured by income. Specifically, appellants suggest that 11 the tax base of the SBT is essentially federal taxable income and that the SBT 12 is therefore based upon, computed, and measured by a taxpayer s net income. 13 Conversely, the commissioner argues that [a]lthough the MSBT starts its 14 calculation with federal taxable income, numerous adjustments are made to that 15 amount in order to derive the Michigan tax base. Among those adjustments are 16 additions of salary, depreciation, rent, interest, and other expenses that were 9 1 deducted by the corporation for purposes of computing its federal taxable 2 income. Those adjustments are so significant that any relationship that the 3 starting point for the MSBT may have had to income was lost on the way to 4 computing the MSBT base. Thus, the commissioner urges that the SBT is not 5 a tax measured by income. 6 In Gillette, 198 Mich.App. 303, 497 N.W.2d 595, a Michigan appellate 7 court specifically addressed the question whether the SBT is a tax measured 8 by net income. 9 certain single business tax assessments that had been issued against it by the 10 Michigan Department of Treasury. Gillette challenged the assessments based 11 on Section 381, Title 15, U.S.Code, which prohibits states from levying a net 12 income tax on certain interstate commerce. Section 383, Title 15, U.S.Code 13 defines net income tax as any tax imposed on, or measured by, net income. 14 Thus, the issue presented in Gillette was whether the Michigan SBT is a tax 15 imposed on, or measured by, net income. The court in Gillette found that the 16 SBT is a consumption-type value-added tax and not a tax on income. Id. at In Gillette, the Gillette Company ( Gillette ) challenged 10 1 308-309, 497 N.W.2d at 597-598. The court then turned its attention to the 2 question whether the SBT is a tax measured by net income: 3 Next, we consider whether the single business tax is a tax measured 4 by net income. The computation of the single business tax begins with the 5 calculation of the taxpayer s tax base. 6 income (or loss) before apportionment subject to certain adjustments. MCL 7 208.9; MSA 7.558(9); Trinova, supra * * * [433 Mich. 141, 150, 445 N.W.2d 8 428, 432]. Business income is essentially federal taxable income. MCL 9 208.3(3); MSA 7.558(3)(3). Tax base is defined as business Adjustments to business income include 10 additions to reflect business consumption of labor and capital. Additions to 11 business income include adding back compensation, depreciation, dividends, 12 and interest paid by the taxpayer to the extent deducted from federal taxable 13 income. 14 interest, and royalties received by the taxpayer to the extent included in federal 15 taxable income. This income is deducted for the purpose of value added 16 computation because it does not result from capital expenditure by the Common deductions from business income include dividends, 11 1 taxpayer. MCL 208.9; MSA 7.558(9); Trinova, supra, 433 Mich. [at 150-151, 2 445 N.W.2d at 432]. Once the tax base is calculated, the portion of the value 3 added that is attributable to Michigan must be determined. MCL 208.45; MSA 4 7.558(45). After the tax base has been apportioned and subjected to certain 5 adjustments, it is multiplied by 2.35 percent to determine the taxpayer s tax 6 liability. MCL 208.31(1); MSA 7.558(31)(1). 7 It is clear from the theory underlying the single business tax and the 8 methods used to calculate the tax base and the apportionment formula, that the 9 single business tax is not a tax measured by net income. Although business 10 income or federal taxable income is a starting point for and a component of the 11 tax base, because of the extensive adjustments required to compute the single 12 business tax, we cannot say that the tax is measured by net income. 13 Accordingly, we conclude that the restriction imposed by * * * [Section 381, 14 Title 15, U.S.Code] does not apply to taxes imposed under the Single Business 15 Tax Act. 16 Mich.App. at 309-311, 497 N.W.2d at 598-599. (Emphasis added in part; footnotes omitted.) 12 Gillette, 198 1 Therefore, the Michigan appellate courts have clearly determined that the 2 SBT is neither a tax on income nor a tax measured by income. Research 3 reveals that a number of authorities throughout this country agree with the view 4 that Michigan s SBT is neither a tax on income nor a tax measured by income. 5 See, e.g., Kellogg Sales Co. v. Dept. of Revenue (1987), 10 Ore. Tax Rep. 480; 6 In re Appeal of Dayton Hudson Corp. (Feb. 3, 1994), Cal. Bd. of Equalization 7 Nos. 89A-0405-JV and 90R-0247-JV, unreported; and In re Ruling Request 8 (Oct. 17, 1994), Va.Dept. of Tax. No. P.D. 94-313, unreported. See, also, 9 Revenue Cabinet v. Gen. Motors Corp. (Ky.App. 1990), 794 S.W.2d 178. We 10 find no compelling reason to deviate from the Michigan decisional law on this 11 issue. Accordingly, we follow the lead of the Michigan appellate courts in 12 finding that the SBT is not a tax on income or a tax measured by income. 13 The BTA determined that the SBT is neither a tax on income nor a tax 14 measured by income and that, therefore, appellants were not entitled to a 15 resident income tax credit under former R.C. 5747.05(B) relative to the single 13 1 business taxes paid by Simplex to Michigan. The decision of the BTA is 2 neither unlawful nor unreasonable and, accordingly, we affirm. Decision affirmed. 3 4 5 MOYER, C.J., RESNICK, F.E. SWEENEY, PFEIFER, COOK and LUNDBERG STRATTON, JJ., concur. 6 14 1 FOOTNOTES: 2 1 3 26, U.S.Code) permits the owners of qualifying corporations to elect a special 4 tax status under which the corporation and its shareholders receive conduit- 5 type taxation that is comparable to partnership taxation. For tax purposes, a 6 Subchapter S corporation differs significantly from a normal corporation in that 7 the profits generated through the S corporation are taxed as personal income to 8 the shareholders. 9 essentially as if the corporation were an individual. Section 1363, Title 26, 10 U.S.Code. Items of income, loss, deduction, and credit are then passed thru 11 to the shareholders on a pro rata basis and are added to or subtracted from each 12 shareholder s gross income. See, generally, Section 1366, Title 26, U.S.Code. 13 The income appellants received from Simplex during 1988 was apparently 14 profits generated through the S corporation and passed thru to appellants as 15 shareholders. Subchapter S of the Internal Revenue Code (Section 1361 et seq., Title The taxable income of an S corporation is computed 15 1 2 2 version of that statute in allowing a resident income tax credit. The current 3 version of R.C. 5747.05 provides, in part: 4 5 6 7 The current version of R.C. 5747.05 is substantially similar to the 1988 As used in this section, income tax includes both a tax on net income and a tax measured by net income. The following credits shall be allowed against the income tax imposed by section 5747.02 of the Revised Code: 8 * * * 9 (B) The lesser of division (B)(1) or (2) of this section: 10 (1) The amount of tax otherwise due under section 5747.02 of the 11 Revised Code on such portion of the adjusted gross income of a resident 12 taxpayer that in another state or in the District of Columbia is subjected to an 13 income tax. * * * 14 (2) The amount of income tax liability to another state or the District of 15 Columbia on the portion of the adjusted gross income of a resident taxpayer 16 1 that in another state or in the District of Columbia is subjected to an income 2 tax. * * * (Emphasis added.) 17

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