November 5, 2014
The Second Circuit did not make the parties wait very long to learn the outcome of the Barnes Group’s appeal from the Tax Court’s imposition of dividend treatment on its multi-step transaction that enabled it to use in the United States cash that was located in Singapore. See our prior reports here and here. Little more than a month after oral argument, the court of appeals today issued a summary order affirming the Tax Court in all respects. The first page of such unpublished orders recites that they “do not have precedential effect,” but they can be cited in future cases pursuant to Fed. R. App. P. 32.1 (albeit only in limited circumstances in the Second Circuit, see 2d Cir. Local Rule 32.1.1). In any event, the court issued a nine-page opinion briefly touching on the issues.
First, the court of appeals quickly agreed with the Tax Court that the IRS had not run afoul of the principle that it should not argue against its own revenue rulings. Even though Barnes had relied on Rev. Rul. 74-503 in determining the tax consequences of a key step in the transaction, the court of appeals accepted the Tax Court’s explanation that Rev. Rul. 74-503 could be disregarded because it “addressed the tax treatment of an isolated exchange of stock, and therefore provided no guidance on when the individual steps in an integrated series of transactions will be disregarded under the step transaction doctrine.”
The court then upheld the application of the step-transaction doctrine, agreeing with the Tax Court that the intermediate steps would have been fruitless unless they were part of a single integrated plan. The court rejected the taxpayer’s argument that the doctrine should not apply because the steps had a valid business purpose, finding that the Tax Court’s contrary finding of no valid business purpose was not clearly erroneous. Specifically, the court of appeals stated that “any non-tax benefit of including the financing subsidiaries was, at best, a mere afterthought.” Similarly, the court held that the Tax Court did not clearly err in premising its constructive dividend conclusion on a finding that Barnes failed to show that certain interest or preferred dividend payments were ever made.
Finally, the court of appeals upheld the imposition of the 20% accuracy-related penalty. It ruled that its previous distinction of Rev. Rul. 74-503 as not applying to a situation involving multiple steps also made that ruling unavailable as “substantial authority” that could eliminate the penalty. And it ruled that Barnes had no “reasonable cause and good faith” defense because the PwC opinion on which it had relied “does not advise as to the tax consequences of the entire series of transactions transferring funds from ASA to Barnes.”
Supreme Court Set to Hear Argument in Wynne on Constitutionality of Failing to Give an Income Tax Credit for Taxes Paid to Other States
November 4, 2014
[Note: Miller & Chevalier filed an amicus brief in this case in support of the taxpayers on behalf of the National Association of Publicly Traded Partnerships.]
Supreme Court briefing is now complete in Comptroller of the Treasury of Maryland v. Wynne, No. 13-485. The issue presented is whether the U.S. Constitution requires a state to allow residents to take a credit against their state income tax liability for income taxes paid to other states on income earned in those states.
Maryland’s state income tax system taxes its residents at both the state level and the county level. Like other states, Maryland recognizes that its residents might earn income out-of-state that will be taxed by the state in which the income is earned, and it provides a dollar-for-dollar credit against the Maryland state income tax liability for those payments. Since 1975, however, Maryland has not provided a similar credit against the county income tax.
Whether Maryland’s failure to give a credit against the county income tax is constitutional depends on the application of the so-called “negative” or “dormant” Commerce Clause. The Commerce Clause is an affirmative grant of authority to Congress to regulate interstate commerce, but the Supreme Court has long understood it to have a negative aspect as well, which “denies the States the power unjustifiably to discriminate against or burden the interstate flow of articles of commerce.” Oregon Waste Systems, Inc. v. Department of Environmental Quality, 511 U.S. 93, 98 (1994). This principle often comes into play in invalidating state taxes that favor in-state businesses and in assessing the fairness of apportionment formulas used to calculate what portion of a multistate corporation’s income is taxable by a particular state.
The Maryland Supreme Court held that Maryland’s failure to grant a credit against the county tax resulted in impermissible double taxation. The State, however, argues that nothing in the Supreme Court’s Commerce Clause jurisprudence requires a state to give such a credit. To the contrary, Maryland argues, the Court has remarked that states have the power to tax the income of their residents, even if it is earned out-of-state, and that power should not be diminished just because of the decision of another state to tax the same income. The taxpayers, however, note that the statements relied upon by Maryland were made in the context of the Due Process Clause and do not indicate that the Commerce Clause can abide the double taxation inherent in Maryland’s failure to give a credit.
Although all states, even Maryland, currently give a credit against the state income tax, the arguments for not requiring a credit against the county tax are equally applicable to the state. Thus, if Maryland prevails in this case, it could open the door for cash-strapped states to decide to eliminate the credits that they currently provide. (If that were to happen, Congress would have the power under the Commerce Clause to pass legislation requiring states to grant a credit.) Thus, the potential importance of this case goes well beyond the particulars of the Maryland tax system, and the case has generated a slew of amicus briefs on both sides. Linked below are the briefs filed by the parties, by the Solicitor General as amicus in support of Maryland, and by Miller and Chevalier on behalf of the National Association of Publicly Traded Partnerships in support of the taxpayers.
Oral argument is scheduled for November 12.