Recently posted in the National Law Review, Winner of the Winter 2011 Student Legal Writing Contest, Adam Blander of Brooklyn Law School wrote an article regarding the recent decision of Ford Motor Credit Company v. Chesterfield County:
In the recent decision of Ford Motor Credit Company v. Chesterfield County,[1] the Virginia Supreme Court held that the gross receipts of a taxpayer’s local business branch reflected activity generated outside of the branch itself, and was therefore not taxable to Chesterfield County as a licensing privilege. This Note argues that despite the rather case-specific and constrictive holding of the decision (which was decided on state-statutory grounds), the facts of the case actually confronted the Court with a much broader, yet more delicate constitutional and public policy determination — what constitutes “fair” tax apportionment of large multi-state businesses?
I. Background: Constitutional Boundaries of State Tax Apportionments
Tax apportionment is the attempt by a governing body to levy taxes based on a corporation’s earned income in that jurisdiction.[2] Almost by definition, “[a]ny state tax apportionment formula will be inaccurate – either overstating or understating the portion of a corporation’s income that should be subject to tax.”[3] Consequently, any formula, at some level, is unfair. In Complete Auto Transit, Inc. v. Brady, the Supreme Court held that the U.S. Constitution required all state taxes affecting multi-state businesses to be, among other things, “fairly apportioned.”[4] In Container Corp. of America v. Franchise Tax Board, the Court explained that a “fairly apportioned” tax must be both “internally” and “externally consistent.”[5] Container directed courts to test for “internal inconsistency” through engaging in a hypothetical exercise: if more than 100 percent of the business’s income would be taxed if every jurisdiction applied the challenged apportionment formula, then formula was internally inconsistent.[6]Internal inconsistency is a facial challenge – the taxpayer need only prove that he faces a “theoretical risk of multiple taxation.”[7] The more elusive element of externalinconsistency, on the other hand, requires the challenged formula to “actually reflect a reasonable sense of how income is generated.”[8] As such, the taxpayer must show by “clear and cogent evidence that the income attributed to the State is in fact out of all appropriate proportions to the business transacted in that State” or that it “has led to a grossly distorted result.”[9] In Goldberg v. Sweet, the Court clarified that that “[t]he external consistency test asks whether the State has taxed only that portion of the revenues from the interstate activity which reasonably reflects the in-state component of the activity being taxed.”[10]
The practical effect of these Supreme Court decisions is that state courts have been entrusted with the daunting task of determining what constitutes “fair apportionment.” State courts have analyzed challenges to tax schemes utilizing these Supreme Court directives, but have also taken cues from their state’s common law tradition, the state’s own statutory code, and, when possible, the legislative intent of the state’s taxing body. Patrolling for constitutional defects presents an interpretative and political challenge to any court adjudicating tax disputes- how should it reconcile a taxpayer’s right to be free from unfairly apportioned taxes (even if the “unfairness” is entirely theoretical), while at the same time, faithfully interpret the tax systems passed by the legislative body, whose purpose is to collect vital revenue from all taxpayers in its jurisdiction? This dilemma becomes all the more problematic when the taxpayer is a complex interstate business, which may organize its corporate make-up or accounting scheme in an attempt to avoid payingthese taxes. The Virginia Supreme Court faced such a dilemma in Ford Motor Credit Company.
II. Ford Motor Credit Company v. Chesterfield County: The Facts
In February 2007, Ford Motor Credit Company (FMCC), filed in Virginia circuit court an “Application for Correction of Erroneous Assessment of Business, Profession and Occupation License [“BPOL”] Tax,”[11] claiming it had mistakenly overpaid Chesterfield County, Virginia for the tax years of 2001, 2002, 2003, and 2004. FMCC asserted that its BPOL payments to Chesterfield County, which was based on “the entire gross receipts of loans related to its Richmond branch,”[12] did not actually “reflect the limited contribution of the Richmond Branch to [its] nationwide business.”[13] As such, FMCC sought a refund of $1,515,935.05.[14]
FMCC, a subsidiary of Ford Motor Company, is a “financial services provider, primarily to the automobile purchase or loan lessee environment,” headquartered in Dearborn, Michigan, with hundreds of sales branches throughout the Country, the Richmond branch being one of them.[15] The FMCC headquarters provided the Richmond branch with the capital needed to provide loans, and dictated to the branch “the policies and criteria governing loan approval, contract terms, and other management issues.”[16]
Roughly 75 percent of the branch’s revenue came from “retail and lease contracts,” in which the branch would provide financing to customers wishing to purchase or lease a vehicle from a Ford Motor Company dealership. While the Richmond branch provided the administrative duties necessary to effectuate a loan, such as reviewing the loan application, collecting paperwork and forwarding account information, [17] it generally “did not process funds, receive payments, engage in collection or other customer service activities, or handle delinquent debts.”[18] Upon approval of the loan, the paperwork was forwarded to a service center, in charge of taking title to the vehicle,[19] and the “branch had no further involvement in the loans.”[20] FMCC would then record these loans as receivables in its internal “management, analysis and performance system” (“MAPS”).[21] FMCC would also “book” as revenue any payments due to FMCC. In the event of default on a loan, FMCC would record revenue once the “principle was satisfied on the note.”[22] FMCC paid BPOL taxes based on the gross receipts that MAPS attributed to the Richmond Branch.
FMCC argued that MAPS, in fact, was not an “an activity based system,” but merely a “contract revenue-based system.”[23] In other words, MAPS tracked revenue via the branch in which the loan was originally processed, but was unable to verify which office was actually responsiblefor the specific revenue-generating activities.[24] An FMCC accounting expert testified that it would be “very difficult” to design a system which actually “attribute[d] revenue based on where services are performed.”[25]Accordingly, the BPOL tax assessment, which was based on the gross receipts of “all loans originating in the Richmond Branch” failed to consider the role of other offices in the administering of these loans, including, in particular, the Dearborn headquarters. Because reliance on the gross receipts did not actually reflect revenue collected based on the Richmond branch’s activities, FMCC argued that the BPOL tax, as administered, violated the “fair apportionment prong” for local taxation set forth in Brady.[26] The expert proposed that a BPOL tax based on payroll apportionment would more accurately reflect “all the activities [of the Richmond branch] thatgeneratedrevenues” which, incidentally, would entitle FMCC to a sizable refund.[27]
Unmoved, the circuit court dismissed FMCC’s application with prejudice, finding that the “MAPS figures accurately reflect the gross receipts generated as [a] result of the distinct efforts of the Richmond Branch” and consequently, was not “‘out of all appropriate proportion’ to the business transacted in the locality,” thus satisfyingBrady’s fair apportionment requirement.[28]
III. Ford Motor Credit Company: The Decision
On appeal, the Supreme Court of Virginia reversed the circuit court’s decision, and found for FMCC. Writing for the majority, Chief Justice Cynthia D. Kinser declined to directly address the constitutional challenges under Brady, and instead held that the assessment contravened the Virginia Taxation Code. Nonethless, this Note contends that the decision was not an exercise in “constitutional avoidance”: while the Court did not state so explicitly, it read into the state Tax Code its own value-laden interpretation of what constitutes “fair apportionment,” regardless of whether such an interpretation was a faithful interpretation of the actual legislation. In so doing, the Court hinted that any alternate interpretation of the Code faced the risk of being challenged on constitutional grounds as well.
The Virginia Tax Code allows the “governing body of any county” to collect “liscence taxes” (BPOL taxes) upon any person, firm, or corporation “engaged” in any business or trade “within the county.”[29] The question, therefore, was whether “gross receipts [] falls within a locality’s statutory power to tax.”[30] Citing a prior Virginia case, City of Winchester v. American Woodmark (Woodmark I), the Court noted that additional tax burdens “are not to be extended by implication beyond the clear import of the language used. Whenever there is just doubt, that doubt should absolve the taxpayer.”[31] The Code provides that local BPOL taxes may only tax “those gross receipts attributed to the exercise of a privilege subject to licensure at a definite place of business within this jurisdiction.”[32] With regards to service businesses in particular, gross receipts should be “attributed to the definite place of business at which the service is performed…directed, or controlled.”[33] Nonetheless, if the licensee “has more than one definite place of business and it is impractical or impossible to determine to which definite place of business gross receipts should be attributed under the general rule,” then gross receipts are to be “apportioned based on payroll.”[34]
The Court, relying upon its prior holding in City of Winschester v. American Woodmark Corp. (Woodmark II), which itself relied upon the language of the Supreme Court decision, Goldberg v. Sweet, concluded that the gross receipts werenotattributable solely to FMCC services rendered in the County.[35]Woodmark II held that a BPOL tax may be levied “only to the portion of the revenues from the interstate activity which reasonably reflects the in-state component of the activity being taxed.”[36] In Woodmark II, American Woodmark, a furniture manufacturer with 24 facilities in different states, alleged that city’s imposition of BPOL taxes on 100% of its revenue constituted “unfair apportionment” because only its corporate headquarters were located in Winchester. Woodmark argued that an assessment of the gross receipts was not “attributable to [its] business activities within the city.”[37] The Court determined it a matter of “common sense” that the value by the headquarters alone could “not possibly produce 100% of the revenues.”[38] It thus held that American Woodmark had presented “clear and cogent evidence” that the “assessments attributed to operations conducted in Winchester [were] out of all appropriate proportions to…the business transacted in Winchester.”[39]
The FMCCcourt noted that “[a]lthough a statutory challenge was not presented inWoodmark II” the case nonetheless stood for the proposition that a locality, under the Code, may only tax the gross receipts “attributed to the exercise of a privilege subject to licensure at a definite place of business.”[40] Regarding the facts of this case, the court observed that service centers outside the County had refinanced loans (initially contracted into at the Richmond branch), assisted customers with administration changes, titled vehicle, and tracked the progress of loan payments. The court also recognized that FMCC headquarters directly provided the Richmond branch with capital. In light of these realities, the court held that FMCC had demonstrated “by clear and cogent evidence” that the gross receipts attributed to the Richmond Brach, were in fact, the product of “financial services provided in other jurisdictions.”[41] “In other words, the operation of the Richmond Branch did not produce 100 percent of the gross receipts that the County taxed.”[42] Therefore, a tax assessment based on these gross receipts was invalid. Finally, because MAPS only tracked revenues by contract, the Court determined it would be “impossible, or, at least, impractical” for FMCC to track the actual services performed over the lives of the approximately 20,000 loans which originated in the Richmond Branch. As such, the court concluded that the “BPOL tax assessment must be calculated using payroll apportionment.”[43]
IV. Possible Consequences
FMCC received a significant windfall from the ruling, which, as the dissent observed, was now entitled to recover approximately 93% of its past payments.[44] Still, the Court’s uncritical acceptance of FMCC’s contention that it would be “very difficult” to design an alternative accounting system may spawn unanticipated mischief in the near future. Without judicial incentives (punitive or otherwise), a complex interstate business, well aware of the financial stakes, will simply fail to create an accounting system which records revenue generated by each definite places of business. At that stage, the business will self-servingly insist to the taxing authority that redesigning the system would be “very difficult,” entitling itself to the more attractive BPOL based on payroll. In effect, a company may fleece itself from paying higher taxes simply through its own negligence, willful blindness, or lack of innovative impetus.
Perhaps more significantly, the court’s reliance on Woodmark II, which was decided on non-statutory based grounds, in interpreting the BPOL statutory provisions seems to be an effort by the court to inject constitutional principles of “fair apportionment” into the Tax Code itself. The FMCC court could have determined the extent of Chesterfield County’s authority to tax through utilizing the traditional maxims of statutory interpretation, in which the provisions dealing with the BPOL tax were analyzed within the context to the Code as a whole. Instead, the FMCC court relied onWoodmark II’s broad “reasonableness” standard of external inconsistency, set forth by the Supreme Court in Goldberg v. Sweet. Apparently, the court signaled that it would interpret the Code itselfto mandate that all assessments reasonably reflect the in-state component of the taxed activity in accordance with Goldberg. The Virginia Supreme Court, moreover, has set a considerably higher external inconsistency standard than Goldberg’s – Both Woodmark II and FMCC held that an assessment which taxed anythingmore than revenue attributed to that definite place of business constituted clear and cogent evidence that the assessments were out of all appropriate proportion. Proportionality was measured, not through any mathematical ratio or formula, but rather through an appeal to “common sense” (Woodmark II), or through realization that the revenue could not be quantified (FMCC). Both decisions’ reference to an opaque “100% of revenue” hypothetical exercise indicates that the Court has attempted to articulate a “reasonableness” standard which (rather coarsely) incorporates both internal and external consistency models.
V. Trending Towards a More Business-Friendly Virginia
To appreciate how far-reaching the FMCC decision is, it is crucial to highlight the actual holding in WoodmarkI, approvingly cited in FMCC. Woodmark Iheld that office equipment located at a manufacturer’s headquarters was sufficiently “used in manufacturing” under the Virginia Tax Code, thus exempting it from local property taxes.[45] The Virginia legislature thereafter amended the Code to codifyWoodmark’s broad interpretation of “manufacturing.”[46] The practical consequence of these actions was that anybusiness involved in manufacturing, however tangentially, could now claim exemptions for its personal property.[47] FollowingWoodmark I, the Virginia courts further broadened these exceptions to include, among other things, vending machines and advertising scoreboards used by a manufacturer, and even raises questions of whether the exemption may extend to property leased to a manufacturer which is owned by a non-manufacturer.[48] One scholar opined that Woodmark I’s interpretation of the Virginia Codeare “convoluted” and “not easily categorized by [ ] theoretical rationales.”[49] She concluded that “on a more practical level, Virginia…seems willing to enlarge the tax breaks offered to manufacturing businesses.”[50]
FMCC’s reference to Woodmark I, regardless of its actual relevance to the facts of the case, evinces how broad Woodmark I’s holding has become. Instead of being constrained only to the manufacturing realm, Woodmark Iapparently has evolved into a judicial mandate to create additional tax breaks for interstate companies, even those engaged in distinctly non-manufacturing enterprises, such as financing loans. Seen in this light, Ford Motor Credit Company, inspired by Woodmark I (and to a degree, Woodmark II) is the latest incident of a growing trend in Virginia to resolve discrepancies in the tax code in favor of big business. The creation of these corporate “tax-loopholes,” either through judicial fiat or legislative codification, is likely an attempt to lure large businesses, particularly manufacturers, into locating or expanding their operations inside Virginia. As the Circuit Court in Woodmark I put it, “the term manufacturing is to be construed liberally because ‘the public policy of Virginia is to encourage manufacturing in the Commonwealth.’”[51]
Virginia, in essence, has endorsed a localized version of “supply side economics,” predicting that the lowering of taxes on the production of both goods (e.g., furniture, as in Woodmark I) and services (e.g., financing, as in FMCC)[52] will, in turn, spur economic growth in Virginia, particularly in the form of job creation. As a result, Virginia localities, faced with a subtle yet significant decrease in millions of dollars of property tax and BPOL tax revenue, may be compelled to shift this burden directly onto consumers, whom, incidentally, are less capable lobbyists than large corporations.[53] If the courts succeed in incentivizing large employers to make Virginia their home, it may come at the cost of overtaxing less lucky Virginians.
[1] Ford Motor Credit Company v. Chesterfield County, 2011 WL 744985 (Va. 2011).
[[2] David Shipley, The Limits of Fair Apportionment: How Fair is Fair Enough?, 93 St. & Loc. Tax Law 34, 34 (2007).
[8] Container,463 U.S. at 169 (emphasis added).
[10] 488 U.S. 252, 262 (emphasis added).
[11] Ford Motor Credit Company, at *3.
[27] Id. at *5 (emphasis added).
[31] Id. The Court also ruled that a “tax assessment made by the proper authorities isprima facie correct and valid, and the burden is no the taxpayer to show that such assessment is erroneous.” Id.
[45] American Woodmark Corp. v. City of Winchester, 464 S.E.2d 148 (Va. 1995).See generally, Stacey Wilson, Good Intentions, But Unintended Consequences: Expanding Virginia’s Manufacturing Tax Exemption Under City of Winchester v. American WoodmarkCorp, 41 WM & MARY L. REVIEW 67 (2000)
[46] Virginia Code § 58.1-1101(A)(2), cited in Wilson at 69.
[49] Id.
[51] 34 Va. Cir. 421, 434 (1994) (citing County of Chesterfield v. BBC Brown Boveri, Inc., 380 S.E.2d 890, 893 (Va. 1989)), cited by Wilson at 84.
[52] Ford Motor Company, at *8. (“Neither party contests that FMCC was a service business for purposes of Code § 58.1–3703.1(A)(3)(a)(4).”)
Adam Blander © Copyright 2011
