Michigan Addresses the Inclusion/Exclusion of Gains in the Sales Factor
Large capital gains resulting from sales of businesses have been coming under increasingly greater scrutiny from both taxing agencies and taxpayers. With an equally weighted three-factor formula, distortion can typically be avoided by simply excluding the proceeds of these gains from the sales factor. However, due to the rise in single-sales factor apportionment regimes, distortion may not be remedied by exclusion.
In Vectren Infrastructure Services Corp. v. Department of Treasury, a Michigan Court of Appeals decision from November 2020, an S corporation headquartered in Minnesota (MLI) was engaged in the business of constructing, maintaining, and repairing oil and gas pipelines, as well as providing responses to hazardous materials incidents. MLI provided its services to its customers on a contract-by-contract basis, so MLI’s project locations were different every year. At no time did MLI maintain a permanent business location in Michigan or retain permanent employees in the state. In 2011, MLI’s owners sold their stock for $80 million and elected to treat the sale as an asset sale by MLI (including MLI’s intangible assets of receivables, cash, and goodwill) under Internal Revenue Code Section 338(h)(10). At that time, MLI had undertaken a project in Michigan.
The Michigan Business Tax (MBT), which was measured by both business income and gross receipts, employed a single-factor sales formula to apportion the tax base. Although the gain from the deemed asset sale was included in MLI’s apportionable tax base, there was a dispute about whether the proceeds from the sale should be included in the sales factor. MLI took the position that such receipts should be included, resulting in a Michigan apportionment percentage of roughly 15 percent, whereas the Michigan Department of Treasury argued the proceeds should be excluded, resulting in a Michigan apportionment percentage of roughly 70 percent.
Ultimately, the court concluded this was an exceptional case where the single-sales factor formula attributed business activity to it “is out of all appropriate proportion to the actual business activity transacted in this state ...” The statutory formula as applied, which included 100 percent of the gain on the sale in MLI’s pre-apportioned tax base, included income from the sale that is not related to MLI’s Michigan business activities. The court noted that more than a majority of the value inherent in MLI arose not from its activity in Michigan during the short year or even over the years, but from intangible assets accrued in multiple other states over time. Therefore, to impose a tax on 70 percent of the gain of the sale is not commensurate with the “protection, opportunities, and benefits” offered by Michigan.
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