The Louisiana Court of Appeals recently determined that the gain from the sale of an LLC should be included in the denominator of the apportionment sales factor, rather than excluded from the entire sales factor calculation.1 Finding that a regulation promulgated by the Louisiana Department of Revenue did not comport with the Louisiana tax statute, the Court upheld a Louisiana Board of Tax Appeals decision and vacated the Department’s corporate income tax assessment against the taxpayer.
The taxpayer, Davis-Lynch, is a Texas corporation that conducted no business in Louisiana during the 2011 tax year at issue. Its only business activity consisted of serving as the sole member of Davis-Lynch, LLC, which manufactured float and cementing equipment and maintained a Louisiana warehouse. On July 29, 2011, Davis-Lynch sold its entire interest in Davis-Lynch, LLC, creating a significant gain recognized for federal and Louisiana corporation income tax purposes.2
In determining the apportionment factor necessary to calculate its Louisiana corporate income tax liability, the taxpayer determined that while the sale did not occur in the regular course of business, the gain from the sale was apportionable income under the applicable statute.3 To apportion its income, Davis-Lynch applied Louisiana’s three-factor formula consisting of property, payroll, and sales. The sales factor numerator on the taxpayer’s originally filed Louisiana 2011 corporate income tax return included approximately $10.5 million of gain from the sale of manufacturing equipment in Louisiana. The sales factor denominator included the total gain from sales of manufacturing equipment everywhere along with the capital gain from the sale of Davis-Lynch LLC.
The Department audited the 2011 return and adjusted Davis-Lynch’s apportionment percentage upward. Specifically, the Department eliminated the capital gain amount from the sales factor denominator based on the premise that sales which were not made in the regular course of business should be excluded from the apportionment factor. The Department agreed with the taxpayer that while the gain occurred outside the regular course of business, such gain should be treated as apportionable income.
As a result of the audit adjustment, the Department assessed Davis-Lynch approximately $1.5 million, including penalties and interest of nearly $485,000. The taxpayer filed a petition for redetermination and the Louisiana Board of Tax Appeals vacated the assessment, finding that “the clear meaning of La. Rev. Stat. Ann. Sec. 47:287.95(F)(1)(c) requires that the ‘other gross apportionable income’ be included in the ratio, and as defined by La. Rev. Stat. Ann. Sec. 47:287.92, all items of gross income are either ‘allocable’ or ‘apportionable’.”4 The Department appealed, resulting in this controversy.
Court of Appeals decision
The sole issue for consideration by the Court was whether the capital gain recognized upon the sale of Davis-Lynch, LLC was properly includable in the taxpayer’s sales factor denominator. The Department argued that the Board erred in failing to allow the applicable and relevant administrative guidance, which mandates that sales not made in the regular course of business be excluded from the sales factor computation, to operate with the full force and effect of law.5 In response, the taxpayer argued that Louisiana law requires sales made outside of the regular course of business to be included in the Louisiana sales factor computation6 and that the relevant regulation, Louisiana Admin. Code, Title 61, pt. I, Sec. 1134(D),7 exceeds the scope of the statute.
For Louisiana corporate income tax purposes, all items of taxable gross income are classified as either allocable income or apportionable income, unless otherwise exempt.8 Allocable income is taxed only if earned in Louisiana, while a percentage of apportionable income is subject to tax without regard to where it is earned. While the taxpayer and the Department agreed that the gain from the sale of Davis-Lynch LLC was apportionable income, taxed based on the appropriate apportionment formula as provided in La. Rev. Stat. Ann. Sec. 47:287.95(F), they disagreed as to whether such gain should have been apportioned. Specifically, they disagreed as to the proper application of the sales factor as described in La. Rev. Stat. Ann. Sec. 47:287.95(F)(1)(c), which provides that the sales factor is based on “the ratio of net sales made in the regular course of business and other gross apportionable income attributable to this state to the total net sales made in the regular course of business and other gross apportionable income of the taxpayer.”9
In analyzing the statute, the Court recognized that the fundamental question was one of legislative intent.10 Applying the principles of statutory construction, the Court found that the legislature did not intend to exclude sales not made in the regular course of business from “other gross apportionable income” in the denominator of the sales factor.11 Further, the statute currently in force does not contemplate that sales made outside of the regular course of business are to be excluded from the apportionment factor and makes no mention of such sales. While a prior version of the statute included such language, that statute has since been repealed with no subsequent attempt by the legislature to reinstate it.12 Notably, in 2005 the Louisiana legislature removed “profits or losses from sales or exchanges of property, including such items as stocks, bonds notes, land, machinery, and mineral rights not made in the regular course of business” from the definition of allocable income under La. Rev. Stat. Ann. Sec. 47:287.92, rendering it apportionable income by default. The Court concluded that if sales not made in the regular course of business were not actually included in the sales apportionment factor under La. Rev. Stat. Ann. Sec. 47:287.95(F)(1)(c), then the existing statutory language relating to “other gross apportionable income” would be rendered meaningless.
As to the applicability of La. Admin. Code, Title 61, pt. I, Sec. 1134(D), which clearly excludes from the sales factor denominator proceeds from sales made outside the regular course of business, the Court first noted that the statutory language is binding. While recognizing the need for administrative agencies to adopt enforceable regulations, regulations are necessarily limited by the plain wording of the related statute. When the statute and regulations clearly conflict, the statute controls. Therefore, because La. Admin. Code, Title 61, pt. I, Sec. 1134(D) impermissibly expanded the scope of La. Rev. Stat. Ann. Sec. 47:287.95(F)(1)(c), the Department’s reliance on the regulation was misplaced.13
This decision provides a clear example illustrating the importance of comparing the Department’s regulations to source income against the governing statute to determine if such regulations should be relied upon. Regulations are helpful and often serve as a useful tool to understand the law and the Department’s position. However, they do not replace or supersede the statute. If a statute is clear and unambiguous on its face, such statute holds precedence over a regulation that seeks to clarify ambiguity where it may not exist. Additionally, a court typically will accept a plain reading of a legislative statute as reflective of the legislature’s intent, on the basis that the legislature is aware of other adopted laws, along with relevant current court interpretations. In this instance, the interplay between La. Rev. Stat. Ann. Sec. 47:287.95, which includes “other gross apportionable income” as includable in the denominator of the sales factor, and La. Rev. Stat. Ann. Sec. 47:287.92, which includes income from sales not in the regular course of business as defined apportionable income, proved crucial to interpreting statutory intent.
Further, the ruling provides clarity for Louisiana taxpayers regarding the application of an often confusing regulation. By including gains from sales outside the normal course of business in apportionable income as well as allowing such gains to be included in the apportionment factor computation, the Louisiana courts have reached a logical conclusion allowing for matching of taxable income and factor representation. It should be noted that states do not uniformly reach this conclusion, and that there are instances in which an occasional sale such as the one at issue in this case would be excludible from the sales factor in its entirety.
Finally, the facts of this case include a gain from the sale of an interest in a wholly owned limited liability company. However, the Court does not appear to limit its interpretation of any sales not made in the regular course of business to gains from the sale of a business interest. Thus, taxpayers with any recognized income or gains from sales not in the regular course of business should consider whether this decision might impact their Louisiana sales factor computation, either favorably or otherwise.
1 Davis-Lynch Holding Co., Inc. v. Kimberly Robinson, Sec’y, Louisiana Department of Revenue, 2019 CA 1574, Louisiana Court of Appeal, First Circuit, Dec. 30, 2020.
2 For federal income tax purposes, Davis-Lynch reported nearly $246 million of capital gain and almost $9 million of gain from the sale of business property.
3 LA. REV. STAT. ANN. § 47:287.92(C).
4 Davis-Lynch Holding Co., Inc. v. Kimberly Robinson, Sec’y, Louisiana Department of Revenue, No. 9586, Louisiana Board of Tax Appeals, Parish of East Baton Rouge, Dec. 11, 2018.
5 The Department also argued that the Board erred in allowing certain evidence to be presented by the taxpayer at trial. Specifically, based on the Board’s rules of practice and procedure, the taxpayer’s counsel made a clerical error and neglected to file a witness and exhibit list by the required time prior to the trial. The Board found the allegation lacked merit and noted that the Department could have sought a continuance in advance of the trial to resolve the issue, which it failed to do.
6 LA. REV. STAT. ANN. § 47:287.95(F)(1)(c), which provides the apportionment factor formula to be used for manufacturing, merchandising, and other business, provides in relevant part: “(1) Except as provided in this Subsection, the Louisiana apportionment percent of any taxpayer whose net apportionable income is derived primarily from the business of transportation by pipeline or from any business not included in subsection A through E of this section shall be the arithmetical average of three ratios, … (c) The ratio of net sales made in the regular course of business and other gross apportionable income attributable to this state to the total net sales made in the regular course of business and other gross apportionable income of the taxpayer” (emphasis added).
7 LA. ADMIN. CODE tit. 61, pt. I, § 1134(D), which describes the revenue ratio, provides in relevant part: “Revenue Ratio. This ratio is generally composed of sales charges for services and other gross apportionable income. Neither allocable income nor income excluded from gross income, such as interest and dividends, is included in the ratio. For all formulas except that provided by R.S. 47:287.95(F), the revenue ratio consists of the ratio of the gross apportionable income of the taxpayer. For the formula provided by R.S. 47:287.95(F), the revenue ratio consists of the ratio of net sales made in the regular course of business and other gross apportionable income of the taxpayer. Sales not made in the regular course of business are not included in the formula provided by R.S. 47:287.95(F)” (emphasis added).
8 LA. REV. STAT. ANN. §§ 47:287.92-47:287.94.
9 LA. REV. STAT. ANN. § 47:287.95(F)(1)(c) (emphasis added).
10 Citing M.J. Farms, Ltd. v. Exxon Mobil Corp., 998 So.2d 16 (La. 2008).
11 LA. REV. STAT. ANN. § 47:287.95(F)(1)(c).
12 Statutory language was enacted during 1993 to modify LA. REV. STAT. ANN. § 47:287.95 by removing the exclusion of income not derived from the regular course of business from the definition of gross apportionable income. However, the law was declared unconstitutional and ultimately repealed.
13 La. Admin. Code tit. 61, pt. I, § 1134 was originally promulgated in 1988, and the regulation was subsequently revised on several occasions. It is likely that the current regulatory language was simply carried over from a version in effect prior to the related statutory change.
Jamie C. Yesnowitz
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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