Opinion
Docket No. 75585.
Decided September 3, 1985.
Miller, Canfield, Paddock Stone (by Samuel J. McKim, III, and Robert F. Rhoades), for petitioner.
Frank J. Kelley, Attorney General, Louis J. Caruso, Solicitor General, and Richard R. Roesch and Terry P. Gomoll, Assistants Attorney General, for respondent.
Respondent, Michigan Department of Treasury, appeals as of right from a December 8, 1983, judgment of the Michigan Tax Tribunal canceling an income tax assessment against petitioner, Detroit Bank Trust Company. We affirm.
The issue in this appeal concerns the treatment for income tax purposes of petitioner's losses from participating in out-of-state partnerships trusts. In 1974, petitioner, a Michigan banking corporation, agreed to become an equity lender in a leveraged-lease transaction involving the National Railroad Passenger Corporation (Amtrak). Amtrak wished to purchase 110 diesel locomotives manufactured by General Motors Corporation. Since no single bank would want to handle this $50 to $60 million deal, Amtrak arranged with ITEL Leasing Corporation for leveraged-lease financing. In this arrangement, petitioner and eight other financial institutions agreed to contribute 27% of the financing, with the remainder to come from secured long-term lenders. Petitioner's share was 15% to 17% of the 27%.
On January 1 and May 1, 1974, petitioner and the other banks executed two trust agreements involving purchase and leaseback arrangements. Two trusts were established because the locomotives were not available for delivery at the same time. Both trusts were leveraged leases in which the trusts purchased, as owners, the locomotives and leased them to Amtrak. The leases were for 15-year terms, apparently representing the useful lives of the locomotives.
The trusts were under the trusteeship of the First Security Bank of Utah, as arranged by ITEL. The trusts were administered in Utah and had no offices, property, payroll or receipts in Michigan.
Before petitioner entered into the leveraged leases, First Security Bank of Utah obtained a letter ruling from the Internal Revenue Service on behalf of petitioner and the other owner-participants and Amtrak. The ruling provided that for federal tax purposes the participants were viewed as "owners" of the lease equipment. In addition, the trusts created by the owner-participants were considered "partnerships" and not taxable "corporations" for federal income tax purposes. The partners/owners-participants each had to take into account their proportionate shares of the income, gain, loss, deductions and credit of the partnerships. Each owner-participant would be entitled to deductions for accelerated depreciation, interest expense and investment tax credits in determining federal taxable income.
In computing their informational federal partnership income tax returns, the partnership trusts deducted depreciation, interest expenses and other fees from the gross income from renting the locomotives to Amtrak. Both partnership trusts had separate employer identification numbers, which were different from petitioner's employer identification number. The principal business activity of the partnership trusts, as indicated on the federal informational returns, was "equipment leasing".
Petitioner's distributive share of partnership losses was $1,313,865 in 1974, and $960,273 in 1975. For the tax years 1974 and 1975, petitioner deducted these losses in arriving at its taxable income for its Michigan financial institutions tax returns (MI-1120 FIN). On each MI-1120 FIN return, petitioner designated its principal business activity as "finance".
Since petitioner maintained an office in London, England, as well as its Michigan offices, petitioner followed § 151 of the Michigan Income Tax Act of 1967, MCL 206.151; MSA 7.557(1151), and apportioned 94.635% (1974) and 94.4575% (1975) of its federal taxable income to Michigan, as otherwise adjusted by MCL 206.34; MSA 7.557(134). Petitioner attributed the remainder of its taxable income to its London office. Petitioner did not attribute any of its income to Utah or any other state.
These and other pertinent provisions of the Michigan Income Tax Act of 1967, 1967 PA 281; MCL 206.1 et seq.; MSA 7.557(101) et seq., were repealed by 1975 PA 233 and replaced by the Single Business Tax Act, MCL 208.1 et seq.; MSA 7.558(1) et seq.
Respondent disagreed with petitioner's treatment of the partnership losses and contended that these losses should have been allocated entirely to Utah. Respondent conducted an audit of petitioner's 1974 and 1975 returns. In June 1978, respondent issued a notice of intent to assess tax and interest. In June 1979, respondent afforded petitioner an informal conference with a hearing referee, and on November 26, 1980, respondent issued a decision assessing a tax of $208,591 plus $88,832.79 interest.
Petitioner appealed to the Michigan Tax Tribunal. The tribunal held a hearing on May 24 and 25, 1982. At the hearing petitioner presented two witnesses, Robert Olsen, petitioner's vice-president and director of corporate taxes, and Donald Mann, assistant director of the bank and trust division of the Michigan Department of Commerce, Financial Institutions Bureau. These witnesses testified that a leveraged-lease transaction, where a Michigan bank acts as a partner in a multi-bank partnership trust to purchase equipment, is an activity in the regular course of the bank's Michigan banking business.
According to Olsen, petitioner had previously been involved as a single investor in out-of-state leveraged-lease transactions with a grantor trust. In addition, approximately 25% of petitioner's commercial loans were made to customers outside Michigan. Such loans were often handled by a number of banks joining together in participation-loan agreements. However, the Utah trust agreements represented the first time that petitioner had engaged in an out-of-state leveraged-lease transaction with a number of banks acting as partners in a partnership trust.
Petitioner called as adverse witnesses, Frederick Lynch, an administrator of the single business tax for the Department of Treasury, and Francis Gould, an administrator of respondent's inheritance tax division and previously an administrator of the financial institutions tax. These witnesses opined that petitioner's share of the partnership losses should have been attributed to Utah, not Michigan. Both saw the partnership trusts as separate legal entities distinct from petitioner bank.
In Lynch's view, the trusts were separate "persons" and "taxpayers" under the Michigan Income Tax Act of 1967. The department took the position it did because partnerships were involved; previously, the department had taken no exception to other similar activities undertaken by petitioner bank without the existence of partnerships. Witness Lynch acknowledged that the activities of the Utah trusts were a single trade or business with petitioner's other banking activities.
The Michigan Tax Tribunal hearing officer found that petitioner, in determining its Michigan taxable income, had properly attributed to Michigan its distributive share of the partnership trust losses. The hearing officer concluded that although the trusts had been designated "partnerships" by the IRS, in no other particulars had they taken on a partnership entity form of identification. They could not properly be viewed as "persons" or "taxpayers" under the Michigan act. Insofar as the partnership trusts were organized to conduct leveraged-leasing activities in which petitioner was a "partner" or equity lender, the hearing officer found that the trusts were nothing more than an extension of petitioner's regular trade or business of investing and financing.
In an opinion and judgment issued December 8, 1983, the Tax Tribunal adopted the hearing officer's findings of fact and conclusions of law. The tribunal ordered the assessment canceled.
On appeal respondent argues that the assessment was valid because the partnership trusts constituted business entities separate and distinct from their individual partners. Respondent maintains that none of the income or loss from the trusts' business activities was attributable to Michigan, since the trusts were based in Utah and had no property, payroll or sales in Michigan. Respondent relies on Grunewald v Dep't of Treasury, 104 Mich. App. 601; 305 N.W.2d 269 (1981), lv den 412 Mich. 875 (1981).
We find respondent's arguments unpersuasive. To begin with, we note the following well-settled principles governing construction of tax laws:
"In the interpretation of statutes levying taxes, it is the established rule not to extend their provisions, by implication, beyond the clear import of the language used, or to enlarge their operations so as to embrace matters not specifically pointed out. In case of doubt they are construed most strongly against the government, and in favor of the citizen." Hart v Dep't of Revenue, 333 Mich. 248, 252; 52 N.W.2d 685 (1952), quoting Gould v Gould, 245 U.S. 151, 153; 38 S Ct 53; 62 L Ed 211 (1917).
In reviewing a decision of the Tax Tribunal, not related to valuation or allocation of property tax, this Court is limited to determining whether the decision is authorized by law and whether it is supported by competent, material and substantial evidence on the whole record. Terco, Inc v Dep't of Treasury, 127 Mich. App. 220, 223; 339 N.W.2d 17 (1983); Kalamazoo Aviation History Museum v Kalamazoo, 131 Mich. App. 709, 713; 346 N.W.2d 862 (1984), lv den 419 Mich. 936 (1984). After carefully reviewing the briefs and record in the present case, we find that this standard is satisfied.
Under the provisions of the Michigan Income Tax Act of 1967 as they existed during the tax years 1974 and 1975, petitioner was a "financial organization" as defined in MCL 206.10(3); MSA 7.557(110)(3). As such, petitioner could not employ the apportionment provisions of § 115, MCL 206.115; MSA 7.557(1115):
MCL 206.10(3); MSA 7.557(110)(3) provided:
"`Financial organization' means a bank, national banking association, industrial bank, trust company, savings and loan association, savings and loan holding company as defined in section 1730a, chapter 13, title 12 of the laws of the United States which pursuant to that section controls a savings and loan subsidiary located in this state, incorporated bank holding company as defined in section 1841, chapter 17, title 12 of the laws of the United States which pursuant to that section controls a bank, national banking association, trust company, or industrial bank subsidiary located in this state, credit union, safety and collateral deposit company, regulated investment company as defined in section 851 and the following sections of the internal revenue code, under whatever authority organized, and any other association, joint stock company or corporation at least 90% of whose assets consist of intangible personal property and at least 90% of whose gross income consists of dividends or interest or other charges resulting from the use of money or credit."
"All business income, other than income from transportation services, domestic insurers and financial organizations, shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is 3." (Emphasis added.)
Since § 115 does not apply to income of a "financial organization", respondent's argument that this provision is applicable here is clearly lacking in merit.
The Tax Tribunal found that petitioner properly utilized MCL 206.103 and 206.105; MSA 7.557(1103) and 7.557(1105) — provisions dealing with allocation and apportionment where, as here, petitioner's income was attributable to activities in Michigan and London — in conjunction with MCL 206.151; MSA 7.557(1151), dealing with taxable income of a financial organization. We agree. Contrary to the testimony of witness Gould, petitioner could not use § 102, MCL 206.102; MSA 7.557(1102), because that section dealt solely with "taxable income of a taxpayer whose income-producing activities are confined solely to this state". The existence of petitioner's London office required it to begin with §§ 103 and 105. These sections stated as follows:
"Sec 103. Any taxpayer having income from business activity which is taxable both within and without this state, other than the rendering of purely personal services by an individual, shall allocate and apportion his net income as provided in this act." MCL 206.103; MSA 7.557(1103).
"See 105. For purposes of, allocation and apportionment of income from business activity under this act, a taxpayer is taxable in another state if (a) in that state he is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business or a corporate stock tax, or (b) that state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not." MCL 206.105; MSA 7.557(1105).
Section 71(1) of the Income Tax Act of 1967 imposed a 9.7% income tax on petitioner as follows:
"(1) There is levied and imposed upon every financial institution a tax measured by 9.7% of taxable income as defined in section 34 subject to the applicable source and attribution rules contained in this act." MCL 206.71(1); MSA 7.557(171)(1), as amended by 1972 PA 181.
This section was applicable because petitioner, in addition to being a "financial organization" under MCL 206.10(3), was also a "financial institution" as defined in MCL 206.10(2); MSA 7.557(110)(2). Taxable income of a financial institution was governed by § 34 of the act, which stated in pertinent part:
MCL 206.10(2); MSA 7.557(110)(2) provided:
"(2) `Financial institution' means a bank, national banking association, trust company, savings and loan association, savings and loan holding company as defined in section 1730a, chapter 13, title 12 of the laws of the United States which pursuant to that section controls a savings and loan subsidiary located in this state, industrial bank or incorporated bank holding company as defined in section 1841, chapter 17, title 12 of the laws of the United States which pursuant to that section controls a bank, national banking association, trust company, or industrial bank susidiary located in this state."
"(1) `Taxable income' in the case of a financial institution means federal taxable income subject to the following adjustments:
* * *
"(g) Any adjustments resulting from the allocation and apportionment provisions of chapter 3." MCL 206.34; MSA 7.557(134), as amended by 1970 PA 140.
The allocation and apportionment provisions of chapter 3, referred to in § 34, included §§ 103 and 105, quoted above, and also § 151, the provision specifically applicable to financial organizations. During the tax years 1974 and 1975 this section provided in pertinent part:
"See 151. The taxable income of a financial organization attributable to Michigan sources shall be taken to be:
* * *
"(b) In the case of taxable income of a taxpayer who conducts income-producing activities as a financial organization partially within and partially without this state, that portion of its net income as its gross business in this state is to its gross business everywhere during the period covered by its return, which portion shall be determined as the sum of:
"(i) Fees, commissions or other compensation for financial services rendered within this state;
* * *
"(v) Any other gross income resulting from the operation as a financial organization within this state, divided by the aggregate amount of such items of the taxpayer everywhere." MCL 206.151; MSA 7.557(1151).
Further, § 195 of the act stated that if the allocation and apportionment provisions did not fairly represent the extent of the taxpayer's business activity in this state, the commissioner could approve an alternative method or require the use of different factors than those specified in the act. MCL 206.195; MSA 7.557(1195). See Donovan Construction Co v Dep't of Treasury, 126 Mich. App. 11; 337 N.W.2d 297 (1983), lv den 419 Mich. 894 (1984). In the present case, the commissioner did not approve any alternate method, and respondent has made no claim that it was acting under § 195. Therefore, the attribution of petitioner's income must be determined under the other sections of the act.
Section 115 of the act, MCL 206.115, provided the usual method for apportioning business income. However, § 115 excepted the income of a financial organization from its provisions. Section 151, MCL 206.151, then set forth the only rule for attribution of the taxable income of a financial organization. Thus, even though all of a financial organization's income would be business income, the apportionment formula of § 115 would not control. Sections 115 and 151 are mutually exclusive provisions. The only possible way that a financial organization's income might be apportionable under § 115 would be if it conducted activity in some capacity other than as a financial organization. This it is not legally permitted to do. Here, the great weight of the evidence clearly indicated that petitioner's participation in the subject leveraged-lease transaction was undertaken in the normal, regular course of its banking business. Thus, § 151 is the applicable provision to determine the proper attribution of petitioner's taxable income.
In applying § 151, we note that there was no evidence of any fees, commissions or other compensation for financial services rendered in Utah. Nor was there any evidence of gross income resulting from the petitioner's operation as a financial organization in Utah. Rather, the bank's activities of considering, studying and arranging participation in the leveraged-lease transaction took place in Michigan. In addition, the evidence indicated that petitioner had engaged in a number of transactions in which customers and property were located in different states, and that the banking activity in those transactions was considered to have taken place within Michigan. Thus, the business due to petitioner's London branch was the only business conducted elsewhere than in this state. The apportionment percentages applied in petitioner's tax returns were proper.
Respondent argues that Grunewald, supra, requires a different result. We do not agree. We find, as did the Tax Tribunal, that Grunewald is clearly distinguishable. In Grunewald two Michigan attorneys purchased shares in a limited partnership organized in Pennsylvania to acquire and operate an apartment project in that state. The project sustained losses, and the taxpayers deducted their distributive shares in determining adjusted gross income on their federal returns. In computing taxable income on their Michigan returns, the taxpayers carried over the federal figures without adjusting for the limited partnership losses. The Department of Treasury claimed that such losses were attributable to Pennsylvania and could not be used to reduce income subject to Michigan tax. The Board of Tax Appeals and the Court of Claims agreed.
On appeal the Court of Appeals affirmed in Grunewald, finding that the limited partnership income was income from business activity taxable both within and without this state. MCL 206.103. The Court noted that Pennsylvania had jurisdiction to tax the limited partnership income earned in that state. MCL 206.105; Shaffer v Carter, 252 U.S. 37; 40 S Ct 221; 64 L Ed 445 (1920). Then, applying § 115 of the act, MCL 206.115, the Grunewald panel found that the property, payroll and sales factors were all zero. Thus, none of the taxpayers' income from the limited partnership was attributable to Michigan.
In the case at bar, Utah could not have taxed the income from the partnership trusts. During the tax years at issue, a federal law declared a moratorium on imposing any tax measured by income, receipts, or any other "doing business" tax by any state other than that in which a federally insured depository had its principal office, PL 93-100; 87 Stat 347; 12 U.S.C. § 548. This moratorium precluded Utah from taxing petitioner, a Michigan-domiciled bank.
Respondent argues that Grunewald is identical to this case and requires us to reverse the Tax Tribunal's decision. We cannot agree. Grunewald is different from this case in several respects. First, MCL 206.115, the section relied on in Grunewald, applied to the income of individuals, but not to the income of a financial organization. Here, the taxpayer bank was required to use § 151, MCL 206.151. Second, Grunewald involved individual taxpayers who were taxable under a different tax rate and a different section of the act. Third, the federal moratorium of PL 93-100 was not a factor in Grunewald, where the Court specifically pointed out that Pennsylvania could tax the partnership's income. Finally, in Grunewald, the individual taxpayers were unquestionably engaged in two separate business activities — their law practice in Michigan and their apartment project in Pennsylvania. In the present case, the evidence showed that petitioner's activities in the leveraged-lease transaction were a part of petitioner's regular banking business. The existence of the partnership trusts as separate legal entities was not relevant in determining petitioner's taxable income.
Respondent's argument that Grunewald applies depends on a view of the partnership trusts as taxpayers. At the hearing, witness Lynch saw the partnership trusts as separate "persons" and "taxpayers". However, under the Income Tax Act of 1967, partnerships were not taxed as business entities. See MCL 206.16, 206.26; MSA 7.557(116), 7.557(126). Compare § 6(1) of the Single Business Tax Act which expressly includes partnerships in the definition of "person". MCL 208.6(1); MSA 7.558(6)(1). In the instant case it is the petitioner bank which is the "taxpayer" — not the partnership trusts in which petitioner participated.
Further, in response to respondent's argument that a taxpayer "is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice", we note that petitioner specifically conditioned its participation in the transaction on obtaining a ruling from the IRS indicating that the tax consequences would be favorable. Section 2(3) of the Income Tax Act of 1967 stated, "It is the intention of this act that the income subject to tax be the same as taxable income as defined and applicable to the subject taxpayer in the internal revenue code, except as otherwise provided in this act". MCL 206.2(3); MSA 7.557(102)(3). Thus, petitioner had no reason to expect that respondent would require a different treatment of petitioner's partnership losses for state tax purposes.
Comm'r of Internal Revenue v National Alfalfa Dehydrating Milling Co, 417 U.S. 134, 149; 94 S Ct 2129; 40 L Ed 2d 717 (1974).
Finally, it appears that the department's position was at odds with the opinion of the department's hearing referee who presided at the informal conference on June 20, 1979. The hearing referee concluded his summary of the conference as follows, with reference to a then-pending case which was later settled:
"Although I personally find that the taxpayer's arguments, both to the matter at hand and the OLD KENT FINANCIAL matter, are more persuasive and more properly founded on sound doctrines of statutory construction, I must recommend that the above intent [to assess issued June 10, 1978] be finalized without adjustment of the tax because the matter at hand is so factually identical to the OLD KENT FINANCIAL matter * * *. Taxpayers who present identical facts and raise identical questions of law must be treated uniformly and with consistency."
Here we find that the Tax Tribunal properly analyzed the provisions of the income tax act, made findings of fact which were supported by the evidence and correctly rejected the arguments made by the respondent. Hence we must affirm the Tax Tribunal's decision.
Affirmed.