Michigan Supreme Court Rules Three-Factor Apportionment Allowed for Michigan Business Tax.

On July 14, 2014, the Michigan Supreme Court ruled that the Multistate Tax Compact (MTC) election applies to both the modified gross receipts and net income tax bases in International Business Machines v. Michigan Department of Treasury.

The major issue was whether taxpayers could elect to apportion their tax base according to the MTC provisions utilizing the equally weighted three-factor formula, as opposed to apportioning based on the 100% sales factor provided for in the Michigan Business Tax (MBT) statute. The MTC also provides for the allocation of nonbusiness income.

This issue benefits out-of-state companies that have Michigan sales that are higher in proportion to their physical presence in Michigan in terms of property and payroll. There are also benefits to companies not based in Michigan that sell services because the MTC provisions source sales based on the state where the services are performed.

The decision applies to MBT years 2008 through 2010. The statute of limitations for 2008 has expired, so refund claims are not allowed unless the taxpayer is under audit for that year.  Refund claims can still be filed for MBT years 2009 and 2010, as these periods are within the four-year statute of limitations. The decision did not take up the issue of whether taxpayers can make the MTC election on an amended return, as opposed to the original return filing, but it is expected that some guidance should be released shortly.

The decision of the Michigan Supreme Court is final unless it is appealed to the U.S. Supreme Court, and if appealed, the U.S. Supreme Court is not required to review the case. Since the Michigan decision was based on statutory grounds, it is unlikely that the U.S. Supreme Court would review this case.

Claims could potentially be filed for 2011 and beyond for MBT and/or Michigan Corporate Income Tax (CIT), but there is another issue for these years. The MTC statute was changed in 2011 to state that the MTC election was not available for years beginning after January 1, 2011. This decision did not resolve the question of whether this legislation violated the contractual obligation of the contract or the contracts clause of the Constitution. Other states are litigating these issues, notably Gillette v. California Franchise Tax Board now pending at the California Supreme Court. A decision in this case is expected in late 2014 or early 2015.  This decision would impact this issue in Michigan for 2011 forward.

Another significant development was that it was concluded that the modified gross receipts tax (MGRT) component of the MBT qualified as an “income tax” as defined in the MTC. The determination was as follows:

We hold that the MGRT fits within the broad definition of “income tax” under the Compact by taxing a variation of net income—the entire amount received by the taxpayer as determined from any gainful activity minus inventory and certain other deductions that are expenses not specifically and directly related to a particular transaction.

This is important to note as state income taxes paid are added back on most other state income tax returns.  If the MGRT was not added back previously, taxpayers may want to consider if other state returns need amended to account for the add-back.

Filing refund claims for 2009 and 2010 are great opportunities for out of state clients who filed those returns.  This should be evaluated for anyone who filed.  Holbrook & Manter is available to assist you in filing these returns.  We are also staying up to date on the potential decisions that may affect 2011 returns forward.