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Jamie C. Yesnowitz
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On July 24, 2018, the Michigan Court of Appeals determined that the materials and supplies deduction contained in the Michigan Business Tax (MBT) means tangible personal property
purchased in the tax year that is an ordinary and necessary expense to be used in carrying on a trade or business.1
The decision is consistent with the Michigan Department of Treasury’s documented interpretation of the term.2
In the case at issue, the taxpayer had included intangible expenses in computing its deduction.
The MBT took effect on Jan. 1, 2008, and during its brief four-year existence was comprised of a business income tax (BIT) and a modified gross receipts tax (MGRT).3
The MGRT base consisted of gross receipts less purchases from other firms before apportionment.4
Purchases from other firms was statutorily defined to mean: “(a) inventory acquired during the tax year, including freight, shipping, delivery, or engineering charges included in the original contract price for that inventory; (b) assets, including the costs of fabrication and installation, acquired during the tax year of a type that are, or under the internal revenue code will become, eligible for depreciation, amortization, or accelerated capital cost recovery for federal income tax purposes; (c) to the extent not included in inventory or depreciable property, materials and supplies, including repair parts and fuel.
The MBT Act does not define the term “materials and supplies.”6
Notably, the Department has consistently maintained a position that the term “materials and supplies” only applies to tangible personal property, as evidenced by Departmental guidance, including FAQs.7
However, several taxpayers have challenged this interpretation, including some addressed by the Michigan Tax Tribunal and the Michigan Court of Claims. In Plastic Surgery Associates, PC v. Department of Treasury
, the Tax Tribunal held that a taxpayer’s purchase of drugs, implants and office supplies constituted “materials and supplies” that may be included as purchases from other firms.8
Most recently, in Andrie Inc. v. Department of Treasury
, the Court of Claims held that the Department’s interpretation of “materials and supplies” in its FAQs was inconsistent with the statutory language.9
According to the Court, to qualify for deduction from the tax base, the “materials and supplies” must be “ordinary, necessary expenses actually consumed and used within the tax year in the carrying on of a trade or business.” While these cases are not precedential or binding on courts,10
they reflect a more expansive view of the term “materials and supplies” than the Department’s conception of the term. Based on this interpretation, as well as the findings in Andrie and Plastic Surgery Associates
, some taxpayers have maintained that the term “materials and supplies” applies to ordinary and necessary expenses that are both tangible and intangible in nature, particularly with respect to expenses incurred by taxpayers that facilitated day-to-day business operations.
The taxpayer at issue, Total Armored Car Services, Inc. (TAC), filed MBT returns claiming a substantial materials and supplies deduction. Following an audit, the Department determined that TAC underpaid its taxes by $144,924 during the 2009-11 tax years, part of which was related to the composition of the “materials and supplies” deduction.11
According to the audit report, the materials and supplies deductions taken in the 2010 tax year included the cost of “repairs and maintenance, gas and oil, parts, rental equipment, lease contract, outside courier services, contract labor and purchased transportation.” The Department concluded that costs related to “operating leases, contract labor, purchased transportation and outside courier services” were intangible in nature and improperly included in the category, which resulted in an adjustment to TAC’s 2010 and 2011 tax years. TAC challenged the findings in the Michigan Tax Tribunal, which granted summary disposition in favor of the Department.12
TAC appealed the Tribunal’s decision to the Michigan Court of Appeals.
Michigan Court of Appeals
The Department, consistent with its official position, asserted that the “materials and supplies” deduction solely includes items related to tangible personal property and disallowed the portion of the deduction related to the taxpayer’s intangible expenses. In its analysis to ascertain the original intent of the legislation, the Court of Appeals first turned to the overall statute at issue. Focusing on the entire deduction, the Court noted that, based on plain language and when read as a whole, the statute implies that “materials and supplies” only refers to tangible personal property (which includes inventory, depreciable assets and other materials and supplies). Further, the Court cited the dictionary definition of “materials and supplies,” noting that the MBT Act does not define these terms. Specifically, “material” is defined as “relating to, derived from, or consisting of matter,” and “being of a physical or worldly nature.”13
“Supplies” are defined as “provisions” or “stores.” 14
Finally, the Court stated that the “qualifying clause immediately following ‘materials and supplies’ – ‘including repair parts and fuel’ – indicates an intent to limit ‘materials and supplies’ to tangible property.” 15
Accordingly, the Court determined that the type of property included in the definition of “materials and supplies” is limited to tangible items. Thus, the taxpayer’s intangible expenses at issue were properly excluded from the deduction by the Department.
This decision by the Court of Appeals clarifies an ongoing point of contention between taxpayers and the Department. Although the case is for publication and stands as precedent for stare decisis, there are other pending cases focused on the same issue. If the Court of Appeals comes to a different conclusion in one of the other cases, Michigan court rules maintain that a prior published decision will have precedent over a subsequent decision.16
For this case to lose its precedential treatment, it would have to be overturned by the Michigan Supreme Court or by a special panel of the Court of Appeals that rehears the case and comes to a different determination.
With Michigan’s four-year statute of limitations and the repeal of the MBT in 2012, the opportunity for most taxpayers to challenge the definition of “materials and supplies” under the statute at issue has expired, though taxpayers with outstanding audits can and often do raise this issue. As the specter of litigation on this issue does not appear to be going away any time soon based on pending Court of Appeals cases, it remains to be seen whether these cases consider the treatment of capitalized assets such as rent or leases that may qualify as materials and supplies under the IRC definition of the term, or the treatment of other items that were not specifically addressed in this matter.
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