The Michigan Court of Claims has upheld the validity of legislation that retroactively repeals the Michigan statutes adopting the Multistate Tax Compact effective January 1, 2008.1 On September 11, 2014, this legislation was enacted to prevent taxpayers from claiming Michigan Business Tax (MBT) refunds based on an election to use the Compact’s three-factor apportionment formula.2 This legislation was in response to the Michigan Supreme Court’s decision in International Business Machines Corp. v. Department of Treasury that allowed a taxpayer to elect to use the Compact’s three-factor apportionment formula on its MBT return for the 2008 tax year.3 In the instant case, the Court of Claims determined that the retroactive repeal of the Compact provisions was constitutional and provided clarity on the original intent of the MBT Act. The Court granted summary disposition for the Michigan Department of Treasury after concluding that the legislation retroactively applied to the instant case and all pending similar MBT refund actions.
Background
Effective July 1, 1970, the state of Michigan adopted the Compact.4 Under the Compact, a taxpayer subject to income tax may elect to use a state’s apportionment formula or the Compact’s equally-weighted three-factor apportionment formula.5Michigan has changed its method of taxing businesses several times after adopting the Compact. In 1976, the state replaced its corporate income tax with the Single Business Tax (SBT).6 In 2008, Michigan replaced the SBT with the MBT.7This tax, which consists of business income tax (BIT) and modified gross receipts tax (MGRT) components,8 expressly repealed the SBT, but did not expressly repeal the Compact. The MBT generally requires taxpayers to apportion their income using a single sales factor formula.9 Michigan returned to a corporate income tax (CIT) for tax years beginning on or after January 1, 2012.10 In May 2011, Michigan amended the statute adopting the Compact to expressly provide that the three-factor apportionment election is unavailable beginning January 1, 2011.11 This amendment was thought to imply that the election was available prior to that date.
On July 14, 2014, the Michigan Supreme Court held in IBM that a taxpayer was allowed to elect to use the Compact’s three-factor apportionment formula for purposes of the MBT for the 2008 tax year.12 The Court found that the legislature did not repeal by implication the three-factor formula for tax years 2008 through 2010. Also, the Court determined that the BIT and MGRT components of the MBT were “income taxes” for purposes of the Compact, but did not consider whether the Compact constituted a contract.
On September 11, 2014, Michigan enacted legislation that included an “enacting section” providing that the Michigan statutes that adopted the Compact13 are repealed retroactively and effective beginning January 1, 2008.14 Furthermore, the legislation explained that it expressed the original intent of the legislature to eliminate the Compact’s three-factor apportionment election.
Out-of-state taxpayers, including the taxpayer in the instant case, filed MBT returns in which they made the three-factor apportionment election. The Department denied the resulting refund claims, but the Court of Claims held the cases in abeyance until the Michigan Supreme Court decided IBM. After IBM was decided, the Court of Claims lifted its order holding the cases in abeyance. In the instant case, the Court of Claims considered the retroactive application of the legislation that repealed the Compact.
Unilateral Repeal of Compact Was Permissible
The Court of Claims first considered whether the legislature was authorized to unilaterally repeal the Compact provisions. In determining that the legislature acted constitutionally and within its sovereign authority, the Court examined whether: (i) the Compact created a binding contract with member states; (ii) enactment of the legislation impaired contractual obligations under the Contracts Clauses of the U.S. and Michigan Constitutions; and (iii) the Michigan legislation originally enacting the Compact could restrict subsequent legislatures from repealing the Compact provisions.
The Court concluded that the Compact does not create a binding contract with member states. Not all interstate compacts are binding contracts that restrict future legislatures.15 An interstate compact that has not been approved by Congress can be either a binding compact or an advisory compact. The Court determined that the Compact lacks the “classic indicia” of a binding interstate compact under federal law because: (i) the Compact does not establish a joint regulatory agency; (ii) the Compact does not require reciprocal action; and (iii) the Compact allows unilateral withdrawal and modification.16 As a result, the Compact is an advisory compact that does not bind future legislatures. Furthermore, the Compact is not a binding contract under Michigan law. There was no indication in the statute adopting the Compact that Michigan contracted away its ability to select a different apportionment formula or repeal the Compact. Therefore, the Court concluded that no contractual obligation was created that would prohibit legislation that repeals the Compact.
According to the Court, the repeal of the Compact does not violate the U.S. or Michigan Constitutions’ Contracts Clauses that prohibit laws that impair the obligation of contracts.17 Because the Compact creates no binding contract, the repeal of the Compact does not unconstitutionally impair an obligation of contract.
Finally, the Court concluded that the statute that enacted the Compact does not restrict the ability of a subsequent legislature to prospectively or retroactively correct an error. Legislatures cannot bind subsequent legislatures under Michigan law provided that contractual obligations are not impaired. By enacting the 2014 legislation to correct its drafting error in the 2007 legislation, the legislature acted within the scope of its power under the Michigan Constitution. Furthermore, the language in the original legislation contemplated the possibility of withdrawing from the Compact in the future.
Retroactive Application of Legislation Was Constitutional
The Court of Claims determined that the retroactive application of the legislation does not violate other provisions of the U.S. or Michigan Constitutions. Specifically, the Court considered whether the retroactive legislation impaired due process, separation of powers, the Commerce Clause, or the First Amendment right to petition the government.
According to the Court, the retroactive application of the law does not violate due process because: (i) the taxpayers had no vested interests; (ii) the legislature had a legitimate purpose for giving retroactive effect to the law; and (iii) retroactive application of the law is a rational means of furthering this legitimate purpose. The taxpayers had no vested right in a tax refund based on a continuation of the Compact election provisions. The legislation served the legitimate governmental purpose of correcting a legislative error and preventing the potential loss of over $1 billion of MBT revenue in the form of tax refunds. Finally, the retroactive application of the statute was a rational means of furthering this legitimate purpose. The Court examined the “totality of the circumstances” and considered: (i) whether the retroactive amendment created a “wholly new tax;” (ii) whether the taxpayer acted in reliance on an expectation its activity would not be taxed; (iii) how promptly the legislature acted to correct the statute; and (iv) the period of time to which the amendment retroactively applies.18 These factors supported the conclusion that the legislature’s decision to stem the revenue loss by giving retroactive effect to the law was a rational means of furthering a legitimate governmental purpose.
The Court also concluded that the retroactive application of the legislation does not violate principles of separation of powers under the Michigan Constitution.19 A legislature is permitted to retroactively change legislation if it does not reverse a judicial decision. Also, a legislature may correct its mistakes through retroactive legislation. The Court determined that the legislation did not purport to overturn IBM and did not repeal the final judgment as applied to the taxpayer. The legislation reflected the legislature’s original intent in enacting the MBT and did not conflict with or disturb the ruling in IBM. The retroactive repeal was consistent with the language in IBM suggesting that retroactive repeal would be an appropriate legislative response to the challenges being made.
According to the Court, the legislation did not violate the Commerce Clause, which prohibits state laws that: (i) facially discriminate against interstate commerce; (ii) have a discriminatory effect; or (iii) are enacted for a discriminatory purpose.20Under the dormant Commerce Clause, states may not unduly burden interstate commerce.21
Finally, the Court held that there was no merit to an argument that the legislation violates the First Amendment right to petition the government by retroactively revoking the right to petition the Department and appeal to a court for a tax refund. A taxpayer’s First Amendment rights on matters of tax legislation are properly protected by the taxpayers’ power over the legislature. Also, to the extent that the legislation may impact taxpayers’ procedural rights of petitioning the court for a tax refund, these rights are properly safeguarded under rights of due process.
No Procedural Violations
The Court held that the legislation satisfied the procedural requirements that the legislature must follow under the Michigan Constitution. The legislation did not violate the Title- Object Clause that provides “[n]o bill shall be altered or amended on its passage through either house so as to change its original purpose as determined by its total content and not alone by its title.”22 The Court concluded that, given the presumption that the legislation is constitutional, and the fact that the Title-Object Clause must be liberally construed, the legislation did not violate this clause. Similarly, the Court determined that the Michigan Constitution’s “five-day rule”23 that provides that no bill can be passed until it has been printed or reproduced and in the possession of each house for at least five days was satisfied. Moreover, the legislation did not violate the “tax-title” clause24 because both the title and body of the legislation made clear that it related distinctly to tax.
Commentary
This is the latest development in the Michigan three-factor apportionment election litigation, but undoubtedly there will be further decisions concerning this topic. Following this decision granting the Department summary judgment and dismissing the taxpayer’s refund claim, the Court of Claims dismissed numerous similar MBT three-factor apportionment election refund claims filed by other taxpayers, though many of these taxpayers are likely to appeal the Court of Claims’ decision. Also, the Michigan Court of Appeals is considering the same retroactive legislation repealing the Compact in Anheuser- Busch Inc. v. Department of Treasury.25 Furthermore, the Department has asked the Michigan Supreme Court to consider a Michigan Court of Appeals case, Lorillard Tobacco Co. v. Department of Treasury,26 which followed IBM and did not consider the retroactive legislation.
The Court of Claims’ endorsement of the retroactive legislation repealing the Compact can be debated on several points. In light of the fact that Michigan has been an active member of the Multistate Tax Commission in recent years, including participation in the Commission’s audit initiatives, the legislature’s determination in 2014 that Michigan actually repealed the Compact in 2008 and, accordingly, has not been a member of the Commission since this time can be attacked as logically flawed. Clearly, the driver for the retroactive legislation was the $1.1 billion in refunds that otherwise would have had to be paid to taxpayers, many of which are primarily located outside Michigan. The Court of Claims’ explicit endorsement of this purpose in this decision is troubling, as court cases decided on the merits by a taxpayer effectively can be overruled by a legislature whenever the cost of such litigation for similarly situated taxpayers is deemed to be too great.
While the Court of Claims cited to the IBM decision as implied proof that the Michigan Supreme Court endorsed the legislature’s adoption of retroactive legislation, that position may also be challenged as internally inconsistent. In fact, one can argue that the retroactive legislation effectively overrules IBM because it precludes similarly situated taxpayers from receiving refunds. The Michigan Supreme Court explained in IBM that by only repealing the Compact’s election provision starting January 1, 2011, the legislature created a window from 2008 through 2010 in which it did not expressly preclude the use of the Compact’s election for MBT purposes. However, the retroactive legislation prevents taxpayers from claiming refunds for these years. In any event, the Court of Claims’ decision again presents the Michigan Supreme Court with another opportunity, one that it rejected in IBM itself, to consider the validity of this retroactive legislation.