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The Michigan Court of Appeals recently held that the tax base for computing the franchise tax applicable to financial institutions under the Michigan Business Tax (MBT) should be determined at the unitary business group (UBG) level rather than the member level.1
In reversing the Michigan Court of Claims, the Court of Appeals determined that UBGs must be recognized and treated as the “taxpayer” for purposes of computing the tax. While the decision relates to the MBT, the Court of Appeals’ analysis also may affect the calculation of the Michigan corporate income tax (CIT).
TCF is a federal bank with branches in Michigan and a wholly-owned subsidiary of TCF Financial Corporation, a Delaware holding company headquartered in Minnesota. For the 2008 and 2009 tax years at issue, TCF filed its MBT return as the designated member of a UBG comprised of TCF Financial Corporation and its subsidiaries. On its MBT returns, TCF identified each member of the UBG and “elimination” entities used to account for intramember investments and adjustments for negative capital before eliminations. Using this method, TCF reported the UBG’s total net capital tax base. The Michigan Department of Treasury conducted an audit and used a different computation to determine the net capital. After computing the average net capital for each member of the group, the Department added these amounts to derive the UBG’s net capital. This method resulted in a franchise tax deficiency of over $558,000.
After the Department issued its final assessment, TCF requested an informal conference to challenge the Department’s calculation of its net capital. The Department upheld its determination that net capital should be computed at the group level rather than the UBG level. TCF subsequently filed a complaint with the Michigan Court of Claims alleging that the Department imposed an unlawful assessment and violated its equal protection rights by calculating the UBG’s net capital for each member, rather than calculating net capital at the UBG level, which failed to wholly eliminate investments into subsidiaries. According to TCF, this treatment discriminated against taxpayers with subsidiaries compared to taxpayers without subsidiaries. Both parties filed cross-motions for summary disposition.
The Court of Claims held in favor of the Department and concluded that net capital should be determined at the individual member level rather than at the UBG level. Because a UBG is not a separate and distinct legal entity that keeps its own books and records, the Court of Claims held that the net capital computation should be applied to individual UBG members which have a separate and distinct legal existence. TCF appealed this decision to the Michigan Court of Appeals.
Taxation of financial institutions
Under the MBT, financial institutions were subject to a franchise tax imposed on net capital prior to 2012.2
Through Dec. 31, 2011, the MBT defined “taxpayer” as “a person or a unitary business group liable for a tax, interest, or penalty under this act.”3
A “financial institution” was defined as: (i) a type of bank; (ii) an entity owned by a bank that is a member of the UBG; or (iii) a UBG made up of either or both of these types of entities.4
The franchise tax was imposed on the tax base of the financial institution after allocation or apportionment to the state.5
The tax base was the financial institution’s net capital, which was equity capital as computed under GAAP less goodwill and the average daily book value of federal and Michigan obligations.6
Net capital was determined by averaging the financial institution’s net capital over a five-year period.7
For a UBG of financial institutions, net capital did not include the investment of one member of the UBG in another member of that UBG.8
The MBT statutes further provided that a “unitary business group shall file a combined return that includes each United States person . . . that is included in the unitary business group.”9
Also, the MBT statutes provided that “[e]ach United States person included in a unitary business group or included in a combined return shall be treated as a single person and all transactions between those persons included in the unitary business group shall be eliminated from the business income tax base, modified gross receipts tax base, and the apportionment formula under this act.”10
Court of Appeals holds UBG is the ‘taxpayer’
In reversing the Court of Claims, the Court of Appeals agreed with TCF that the net capital tax base for financial institutions should be determined at the UBG level rather than the individual member level. The Court of Appeals accepted the taxpayer’s arguments that the Department erred by: (i) not fully eliminating member investments; (ii) averaging each individual UBG member’s net capital over its individual years in existence; and (iii) adding each member’s averaged net capital to derive the UBG’s net capital. Therefore, the averaging computation should be performed at the UBG level.
The Court was required to decide the statutory interpretation of the laws governing the computation of net capital for financial institutions. After reading the statutory provisions discussed above in harmony, the Court determined that the statutes “unambiguously indicate that the Legislature intended the term ‘financial institution’ to mean a UBG when a UBG taxpayer’s franchise tax liability is at issue.” The Court explained that a UBG’s tax base may not be computed by applying the averaging formula to each individual member and then adding these amounts together. A UBG’s net capital is properly computed by adding the individual net capital amounts, after the elimination adjustments for intramember investments. The statutory averaging provision is applied at the UBG level rather than the individual member level. The Court rejected the Department’s argument that the averaging must occur at the individual member level because a UBG has no independent existence. According to the Court, UBGs exist for purposes of Michigan business tax law even though UBGs do not exist as separate and distinct legal entities.11
The Court of Appeals held that the Court of Claims erroneously interpreted the statutory meaning of “financial institution” because a UBG “must be understood as ‘the
financial institution’ whose net capital must be derived ... for franchise tax purposes.”12
In reversing and remanding the Court of Claims’ decision, the Court of Appeals explained that the lower court’s determination that UBGs do not exist and its conclusion that the statutory averaging provision must be applied at the individual member level contradict the legislative intent that UBGs must be treated as a single taxpayer.
Although this case concerns the computation of the financial institution franchise tax under the MBT for the 2008 and 2009 tax years, the holding that the UBG is the
taxpayer arguably has much broader ramifications. First, the relevant statutory language and definitions essentially have been adopted for the financial institutions franchise tax that is imposed under the CIT for tax years beginning on or after Jan. 1, 2012.13
The tax base for financial institutions is substantially changed for tax years beginning after Dec. 31, 2018,14
but the principles of this decision remain relevant to many UBG tax base determinations outside the realm of financial institutions. Similar to the MBT statute, a CIT statute provides that a “unitary business group shall file a combined return that includes each United States person ... that is included in the unitary business group.”15
Also, the CIT statute provides that “[e]ach United States person included in a unitary business group or included in a combined return shall be treated as a single person, and all transactions between those persons included in the unitary business group shall be eliminated from the corporate income tax base, the apportionment formulas, and for purposes of determining exemptions, credits, and the filing threshold under this part.”16
Because the CIT statute concerning filings by UBGs is very similar to the corresponding MBT statute considered by the Court, the determination that the UBG is the
taxpayer is relevant to a variety of issues under the CIT. For example, the Tax Cuts and Jobs Act (TCJA)17
amended IRC Sec. 163(j) to limit the deduction for net business interest in excess of interest income to 30% of adjusted taxable income for tax years beginning after Dec. 31, 2017. Specifically, under the current IRC Sec. 163(j) limitation, the amount of deductible business interest expense in a taxable year cannot exceed the sum of: (i) the taxpayer’s business interest income for the year; (ii) 30% of the taxpayer’s adjusted taxable income for the year; and (iii) the taxpayer’s floor plan financing interest expense for the year. The limitation is computed at the consolidated return level for the federal tax return computation. While the effect of the IRC Sec. 163(j) limitation is includible in the interest deduction reflected in the Michigan CIT base,18
the Department has not published actionable guidance with respect to how UBGs are specifically required to perform the IRC Sec. 163(j) calculation. However, based on the rationale in this decision, a reasonable argument can be made that the IRC Sec. 163(j) interest expense limitations should be determined at the UBG level rather than the individual member level.
This case also is significant because it is a published opinion that has precedential effect under the rule of stare decisis
A panel of the Court of Appeals must follow the rule of law established by a prior published opinion of the Court of Appeals that has not been reversed or modified by the Michigan Supreme Court.20
Thus, the instant case remains controlling authority even if a subsequent Court of Appeals decision reaches a different conclusion. On Dec. 26, 2019, the Department filed a motion with the Court of Appeals to reconsider this opinion.
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