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Jamie C. Yesnowitz
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The Vermont Supreme Court recently determined that a capital gain from the sale of two unutilized Federal Communications Commission (FCC) telecommunications licenses to broadcast in New York was subject to tax as nonbusiness income.1
The licenses were properly categorized as intangible assets with no situs and therefore, the associated gain was sourced to Vermont, the taxpayer’s commercial domicile. Further, the Court upheld the imposition of related underpayment penalties.
Relevant Vermont allocation and apportionment rules
Pursuant to regulation, business income is apportioned to Vermont to the extent the income is derived from any trade, business or activity conducted within the state.2
Nonbusiness income is allocated in full to the state where the income-producing assets are located or have a situs.3
If the assets have neither a location nor a situs, the income is allocated to the state of the taxpayer’s commercial domicile, which is defined as “the princip[al] place from which the business is directed or managed.”4
The taxpayer, Vermont National Telephone Company (VNT),5
purchased two FCC licenses in 2013 granting the exclusive right to broadcast in parts of upstate New York. VNT purchased the licenses for investment, and never used the licenses for broadcasting. In 2013, VNT sold the licenses and recognized a capital gain of approximately $24 million. During the relevant time period, VNT’s daily business operations were generally conducted from its Vermont headquarters. Its Chief Financial Officer filed all of VNT’s 2012 and 2013 Vermont non-income tax returns and paid sales and payroll withholding tax from that location. During 2012 and 2013, fifty-seven of its fifty-nine employees were subject to Vermont withholding tax. Further, most of VNT’s business records were maintained there. . On its 2013 Connecticut corporate income tax return, VNT’s return signer affirmed that, under penalty of perjury, its principal place of business was in Vermont.
On its 2013 Vermont corporate income tax return, VNT reported the capital gain from the sale of the FCC licenses as nonbusiness income allocated entirely to New York based on written advice provided by its accounting firm.6
Specifically, VNT concluded that the licenses giving rise to the capital gain had acquired a New York situs and the related gain should be allocated entirely to New York. In 2015, the Vermont Department of Taxes audited VNT and assessed corporate income tax on the capital gain, as well as related interest of $334,899 and an automatic underpayment penalty of $445,223. VNT appealed to the Commissioner.
In a written decision, the Commissioner affirmed the assessment, finding that the FCC licenses were neither located in nor had a situs in New York and that the gain should be fully allocated to Vermont, VNT’s commercial domicile. Further, the Commissioner declined to abate the underpayment penalty. VNT appealed to the trial court, which upheld the decision based on its own analysis. VNT then appealed to the Vermont Supreme Court.
Vermont Supreme Court decision
VNT and the Department agreed that the gain from the sale of the FCC licenses constituted a capital gain subject to allocation as nonbusiness income. On appeal, VNT argued that the gain should be allocated to New York as the licenses convey privileges that could only be exercised in New York. Alternatively, VNT asserted that its commercial domicile was in Connecticut, the location where high-level decisions of officers and directors were made. Finally, VNT proposed that the Department’s penalty imposition violated due process standards because the applicable statute required the Department to conduct a “particularized inquiry into the considerations pertinent to a specific defendant,” and also violated the Excessive Fines Clauses of the Vermont and U.S. Constitutions.
‘Situs’ vs. location
While the parties agreed as to the nonbusiness character of the gain at issue, they differed in their determination of how to allocate the gain. While VNT believed that the licenses had acquired a situs in New York7
based on the fact that they granted a right that could only be exercised there, the Commissioner contended that the income-producing assets were neither located nor had a situs anywhere. This assessment was based on the understanding that intangible property, by definition, has no physical location. The fact that the licenses conveyed rights that could be exercised in New York was irrelevant. Further, the Commissioner contended, they did not acquire a New York situs because VNT never engaged in business activities related to the licenses there. VNT argued that the Commissioner erred in interpreting the relevant regulation by conflating the term “situs” with the concept of nexus. Specifically, VNT stated, nexus is “the constitutional standard that considers the sufficiency of connections between a taxpayer and the state seeking to impose a tax.” As defined by a Vermont regulation, the term situs “simply asks where an asset is located for purposes of allocating nonbusiness income.”8
Noting that the Department itself, rather than the legislature, drafted the regulations at issue, the Court nonetheless conducted an independent review, concluding that the Commissioner correctly determined that “situs” is a term of art referring to where intangible property is constitutionally subject to taxation and did not err in finding that the licenses failed to obtain a New York situs. With respect to VNT’s contention that the term “situs,” as used in Vt. Code R. 1.5833-1(e), was synonymous with location, the Court found the use of both terms in the same subsection of the law compelling, ultimately inferring that they must have separate meanings. While “location” refers to physical location, “situs” is “the location or position (of something) for legal purposes,”9
and for tax purposes refers to where an intangible asset is constitutionally subject to taxation.10
The Court cited several U.S. Supreme Court decisions in support of its general observation that the Due Process clause of the U.S. Constitution requires some definite link between a state and the property it seeks to tax.11
Specifically, tangible property is exclusively subject to tax within the jurisdiction of the taxing state because the state has provided the benefit and protection of laws. Finding this rule inapplicable to intangible assets, which have no tangible location, the Court concluded that intangibles are generally subject to tax at the owner’s domicile.12
Because the FCC licenses are intangible assets, and therefore have no tangible location, they could be taxed at the location of VNT’s commercial domicile.
VNT argued that the Commissioner erred in concluding the FCC licenses did not have a situs in New York. Specifically, citing Graves
VNT contended that the FCC licenses should have had a New York situs because they conveyed “privileges that can only be exercised in a particular place.” Further, an intangible asset has a situs, regardless of actual business use, if the asset grants a right that can only be exercised in a particular place. While acknowledging that an intangible asset may have a situs, based on the cited decision, if either: (i) the intangible is used in the actual transactions of a localized business or (ii) the intangible grants a right that is “fixed exclusively or dominantly” at a particular place, the Court distinguished the current situation from Graves
. The intangible at issue in Graves
was created and/or protected by a state’s laws. In contrast, the FCC licenses were created and protected by a federal licensing agency, not by New York law. Therefore, New York did not protect or benefit VNT’s passive investment and, therefore, the licenses did not acquire a situs there.
VNT alternatively argued that the gain from the FCC licenses should be sourced to its commercial domicile in Connecticut, rather than Vermont, because that is where VNT’s president made high-level strategic decisions and VNT’s board of directors met. While VNT had no property or employees in Connecticut and did not store its business records there, VNT argued that the most important factor in determining commercial domicile is “the center of authority and control.”14
Notably, the relevant regulation defines commercial domicile as “the princip[al] place from which the business is directed or managed.”15
Relying upon a litany of previous precedents interpreting the term, the Court found that the Commissioner did not err in finding that VNT’s commercial domicile was located in Vermont, as VNT’s day-to-day business operations were conducted there, along with the vast majority of its personnel.
The Department assessed an automatic statutory penalty because VNT failed to report the gain from the sale of the licenses and failed to pay taxes on a portion of its president and CEO’s wages. VNT asserted that the penalty violated due process standards because the relevant statute requires the Department to expressly exercise discretion requiring individualized consideration.16
Alternatively, VNT argued that the penalty was constitutionally excessive.17
Citing an earlier decision directly on point,18
the Court noted that the relevant statutory language does not compel the Commissioner to determine whether to assess a penalty on a case-by-case basis. Instead, automatic penalties merely represent the full extent to which the Commissioner may exercise his discretionary authority. Further, the statutorily available appeal to the Commissioner provides such an opportunity for individual review.19
Finally, the Court found that the Commissioner was correct in rejecting VNT’s argument that, given the complexity of the legal issues, it acted reasonably and in good faith by relying on the advice of its accountants to allocate the gain to New York. The penalty was appropriate because the taxpayer chose that option rather than seeking formal guidance from the Department as to the correct treatment of the gain.
The Court also considered and rejected VNT’s contention that the penalty violated the excessive fine provisions of the U.S. and Vermont Constitutions.20
Acknowledging a clear presumption against statutorily defined penalties, the Court found that although the penalty constituted punishment, its amount was not excessive when compared to the outstanding tax liability. Therefore, the penalty was not considered to be constitutionally excessive.
Given the parties’ relatively unique agreement to treat the sale of the FCC license as nonbusiness income, this controversy solely focused on whether to allocate the gain fully within or outside Vermont. In doing so, the Court analyzed how to determine a taxpayer’s commercial domicile when different functions of the business are claimed to be located in more than one state. One of the distinctive aspects of this case was the novelty of the regulatory language at issue regarding the location and/or situs of the intangible asset which created the gain. Although the analysis was informative as to how to allocate nonbusiness income from intangible assets for Vermont corporate income tax purposes, its usefulness in interpreting other state statutes may be limited, particularly as states continue to attempt to move away from nonbusiness income classifications except in fairly unusual circumstances. Query whether the Court would have sourced nonbusiness income from other types of intangibles, such as sales of stocks or bonds, in the same manner as the FCC license, even though the tangible evidence of a stock or bond could have been stored at the taxpayer’s commercial domicile, or in any other location the taxpayer desired.
With respect to the issue of penalties, it is noteworthy that the Court stressed that the taxpayer in this instance could have potentially avoided the imposed penalty by availing itself of the opportunity to seek a declaratory Department ruling, rather than relying upon advice from its accountants. By failing to seek formal guidance, the Court determined, VNT “assumed the risk” of a penalty. Although not dispositive in other states, the Court’s penalty analysis may motivate taxpayers to utilize the letter ruling process when determining whether a particular position can be included on an income tax return. By the same token, the Court’s admonition that the taxpayer should have pursued formal guidance from the Department presupposes that the taxpayer could have timely received such guidance prior to filing the Vermont corporation income tax return. Further, the Court’s commentary on this point assumes that the taxpayer could have done so on anonymous basis to confirm the validity of its uncertain tax position, or that the taxpayer was comfortable eschewing anonymity in requesting guidance. Pursuant to the Department’s website
, a taxpayer must provide identifying details to request a formal ruling.
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