Opinion
10-P-1071
08-09-2011
MICHAEL J. McTYGUE & another v. COMMISSIONER OF REVENUE.
NOTICE: Decisions issued by the Appeals Court pursuant to its rule 1:28 are primarily addressed to the parties and, therefore, may not fully address the facts of the case or the panel's decisional rationale. Moreover, rule 1:28 decisions are not circulated to the entire court and, therefore, represent only the views of the panel that decided the case. A summary decision pursuant to rule 1:28, issued after February 25, 2008, may be cited for its persuasive value but, because of the limitations noted above, not as binding precedent.
MEMORANDUM AND ORDER PURSUANT TO RULE 1:28
The taxpayers, Michael J. McTygue and Ann M. McTygue, filed applications for abatement of personal income tax on interest income they received during the tax years 2002, 2003, 2004, and 2005. The McTygues reside in Florida and, as a result, they claimed that the interest income, which was earned from a promissory note Mr. McTygue received in consideration for his sale of stock in a Massachusetts corporation, is not subject to taxation under G. L. c. 62, § 5A(a), the nonresident taxation statute. The Commissioner of Revenue (commissioner) disagreed, and denied the abatement applications. The McTygues appealed to the Appellate Tax Board (board), which affirmed the commissioner's denial of the abatement applications.
Background. We summarize the findings of the board, which are based on a statement of agreed facts. For nearly thirty years, Mr. McTygue owned a successful construction and real estate development business in Massachusetts called Builders Systems, Inc. (BSI). BSI was organized as a Subchapter C corporation. Mr. McTygue was the sole shareholder, owning all 500 outstanding shares. In 2002, he sold his entire ownership interest in BSI to three of his employees (the buyers) for $2.5 million. The sale agreement provided that Mr. McTygue would receive $500,000 (for one hundred shares) at the time of closing, and the balance of $2 million (for the remaining 400 shares) would be paid in accordance with the terms of a promissory note (the note) executed on the same day as the sale agreement. The note provided for payment of principal and accrued interest over ten years. Mr. McTygue retained a security interest in all of the shares until the note was paid in full.
At the same time that the sale agreement and that note were executed, Mr. McTygue entered into an employment agreement with BSI for a term of five years. The employment agreement provided that, 'as a condition to the consummation of the [purchase of BSI], [Mr. McTygue] is to remain employed by [BSI].' The employment agreement assigned Mr. McTygue responsibility 'for the development and implementation of business plans, business development, providing management advice and developing budgets for [BSI's] business.' In consideration of his continuing work with the company, BSI paid Mr. McTygue a base annual salary of $50,000, with bonus compensation of fifty percent of any bonus compensation paid to the buyers. Mr. McTygue also was eligible to participate in BSI's executive employee health plan, to receive sick leave, sick pay, and disability benefits, and was provided with other amenities such as an office, a secretary, and a company car.
In September of 2002, the McTygues became domiciliaries of the State of Florida. During the tax years at issue, however, Mr. McTygue continued to actively participate in the operation of BSI's business in Massachusetts pursuant to the terms of the employment agreement. For each of those years, the McTygues filed Massachusetts income tax returns as nonresidents and included income received pursuant to Mr. McTygue's employment agreement with BSI, but excluded the interest income from the note. As a result of an audit that was initiated in April, 2005, the commissioner issued a notice of intention to assess and then a notice of assessment for the tax years 2002, 2003, 2004, and 2005, in the amounts of $3,725.19, $6,953.78, $5,959.88, and $15,059.95 respectively. As noted, supra, the McTygues filed applications for abatement, which were denied.
In affirming the commissioner's decision, the board reasoned that because the interest income at issue was 'directly and solely traceable' to Mr. McTygue's sale of BSI, and because BSI's financial success and ability to meet its obligations under the note were dependent upon Mr. McTygue's fulfilling the terms of his employment agreement, the interest income was 'derived from or effectively connected with' Mr. McTygue's trade or business in Massachusetts. As such, the interest income was subject to taxation under G. L. c. 62, § 5A(a), which governs the income taxation of nonresidents of Massachusetts.
Discussion. 'A decision of the board will not be reversed or modified if it is based on substantial evidence and a correct application of the law.' Boston Gas Co. v. Assessors of Boston, 458 Mass. 715, 721 (2011). 'Because the board is authorized to interpret and administer the tax statutes, its decisions are entitled to deference.' Onex Communications Corp. v. Commissioner of Rev., 457 Mass. 419, 424 (2010).
General Laws c. 62, § 5A(a), limits income taxation of nonresidents to 'items of gross income from sources within the commonwealth.' G. L. c. 62, § 5A(a), inserted by St. 1973, c. 723, § 2. In 2002, the statute defined that phrase, in relevant part, as follows: 'gross income derived from or effectively connected with . . . any trade or business, including any employment carried on by the taxpayer in the commonwealth . . .' (emphasis supplied). G. L. c. 62, § 5A(a), as appearing in St. 2003, c. 4, § 7. The McTygues do not dispute that BSI's continuing operations constitute a trade or business in Massachusetts, or that Mr. McTygue, as required by his employment contract with BSI, personally 'carried on' employment for BSI within the Commonwealth during the tax years at issue. The sole issue is whether the board erred in concluding that the interest income from the note was 'effectively connected with' Mr. McTygue's employment at BSI.
Section 5A was amended, effective for tax years beginning on or after January 1, 2003. St. 2003, c. 4, § 7. The amendment expanded the definition of Massachusetts source income. For the 2002 tax year, the board applied the 2002 version of the statute. For the tax years 2003, 2004, and 2005, the board determined that the amended (expanded) statute applied. The McTygues assert that because the stock sale and the execution of the note occurred before the effective date of the amendment, the application of the amended statute (with its expanded definition of Massachusetts source income) would be retroactive and, therefore, unconstitutional. Because we conclude that the interest income at issue is taxable under the narrower version, i.e., the 2002 version, of the statute, we do not reach the issue of whether the amended statute properly was applied -- the result is the same in that the income was taxable.
The phrase 'effectively connected with' is not defined by the statute, nor have our appellate decisions interpreted the phrase in connection with § 5A(a). The same phrase, however, appears in G. L. c. 62, § 2(c), which governs the deduction of expenses against certain investment income, allowing such deductions where the income is effectively connected with a Massachusetts trade or business. In Rosse v. Commissioner of Rev., 430 Mass. 431 (1999), a case arising under § 2(c), the Supreme Judicial Court noted that the phrase 'does not convey the precise dimensions of the requisite quantum of connection.' 430 Mass. at 436. The court concluded that the phrase 'certainly conveys something more than any connection,' but declined to define conclusively the level of connection contemplated by the Legislature by its use of the phrase. Id. at 437.
'Although the proper interpretation of a statute is for a court to determine, we recognize the board's expertise in the administration of tax statutes and give weight to the board's interpretations.' Raytheon Co. v. Commissioner of Rev., 455 Mass. 334, 337 (2009), citing Bell Atl. Mobile of Mass. Corp. v. Commissioner of Rev., 451 Mass. 280, 283 (2008). We 'will affirm [the board's] statutory interpretation if that interpretation is reasonable.' AA Transp. Co. v. Commissioner of Rev., 454 Mass. 114, 119 (2009).
Here, the board found not only that Mr. McTygue's employment was a condition to the sale of BSI and an integral part of the transaction that produced the interest, but also that Mr. McTygue's responsibilities were 'central to the successful operation of BSI's business.' In light of these facts, the board's conclusion that the interest income earned on the note was 'effectively connected with' Mr. McTygue's employment in Massachusetts was reasonable and, therefore, entitled to deference. Boston Professional Hockey Assn. v. Commissioner of Rev., 443 Mass. 276, 285 (2005) (where mixed questions of fact and law are presented, 'the board's expertise in tax matters must be recognized, and its decisions are due 'some deference''), quoting from Koch v. Commissioner of Rev., 416 Mass. 540, 555 (1993).
The McTygues argue for the first time on appeal that the board was required to apply either the asset use test or the business activity test, as set forth in the Federal Internal Revenue Code. This claim was not made to the board. Thus, we decline to consider the issue. See Still v. Commissioner of the Dept. of Employment & Training, 423 Mass. 805, 808 n.3 (1996).
Decision of Appellate Tax Board affirmed.
By the Court (Cohen, Katzmann & Vuono, JJ.),