In reversing a Court of Claim's (COC) ruling, the Michigan Court of Appeals (COA) held that a group of three entities — two corporations and a limited partnership — were not a "unitary business group" as defined in MCL 208.1117(6) because no one member of the group owns, through an intermediary or otherwise, more than 50% of any other entity. In reaching this conclusion, the Court held that the Michigan Department of Treasury (Department) in using the federal income tax law definition of "constructive" ownership when defining Michigan's "indirectly" ownership requirement improperly broadened its interpretation of "unitary business group" beyond the scope intended by the Legislature.¹

During audit, the Department determined that the taxpayer was a member of a unitary business group and redetermined the taxpayer's MBT liability accordingly. Subsequently, the taxpayer filed suit and alleged that the Department improperly broadened its interpretation of "unitary business group" beyond the scope intended by the legislature.

At issue in this case is the Department's interpretation of MCL 208.1117(6), which defines the term "unitary business group" for purposes of the Michigan Business Tax (MBT). The parties agreed that no entity directly held more than 50% of the ownership interest of any of the other entities; therefore, the courts had to determine whether there was sufficient indirect ownership or control to satisfy the statutory definition. While MCL 208.1117(6) defines the term "unitary business group," it does not define indirect ownership or control. The MBT provided that if a term was not defined by the MBTA it shall have the same meaning as when used in a comparable context to that used in the federal income tax laws.

The COA found that the COC erred in using the federal income tax definition of "constructive" ownership as set forth in Section 958 of the Internal Revenue Code when defining Michigan's "indirect" ownership requirement in MCL 208.1117(6). The COA found that despite finding that the constructive ownership test set forth in Section 958 (which deal with controlled foreign corporations) do not address a "comparable context" under Michigan law, the COC should have used the ordinary rules of statutory construction and not "contextually analogous" provisions of the federal income tax laws that did not have any relationship to the Michigan tax law. The COA held that indirect ownership in MCL 208.1117(6) means ownership through an intermediary, not ownership by operation of legal fiction, as the Department argued. While federal law often substitutes rules of constructive ownership when addressing stock indirectly owned, it does not do so consistently, and constructive rules only apply when the statute specifically so directs, which MCL 208.1117(6) does not. As a result, the COA ruled that a unitary business group did not exist since none of the involved entities owned, through an intermediary or otherwise, more than 50% of any other entity.

Subsequent to this decision, the Department issued a notice to taxpayers indicating that it is evaluating the decision and next steps impacted taxpayers should take.² Further, the COA has issued a stay on the enforcement of its decision until the Department exhausts its appeal rights.³

Implications

The COA's decision challenges the Department's interpretation of the control test as laid out in Revenue Administrative Bulletin 2010-1, Michigan Business Tax Unitary Business Group Control Test. This COA decision was published and therefore initially binding, but the COA agreed to issue a stay on the opinion. Accordingly, while the stay is in effect taxpayers should review their unitary business groups to confirm whether their evaluation of indirect ownership is consistent with this decision and determine if protective refund claims should be filed for open periods.

Further, although this case addressed the MBT, taxpayers should also evaluate this decision with respect to the Corporate Income Tax (CIT). The control test as defined for a unitary business group is essentially the same under both the MBT and CIT.

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ENDNOTES

¹ LaBelle Management, Inc. v. Department of Treasury, Dkt. No. 324062 (Mich. Ct. App. March 31, 2016).

² Mich. Dept. of Treas., Notice to Taxpayers Regarding Labelle Management Inc. v Dep't of Treasury (issued May 4, 2016 and updated on May 11, 2016).

³ Id.