On remand from the US Supreme Court, the Massachusetts Supreme Judicial Court (MSJC) affirmed its earlier decision in First Marblehead that the Commissioner of Revenue properly treated the loans of an out-of-state "holding" company as being located wholly in Massachusetts and, therefore, included in the numerator of its property factor, because the company failed to rebut the presumption that the loans should be sourced to its commercial domicile, which was Massachusetts. In doing so, the MSJC found that Massachusetts' statutory provisions, as applied to the company, did not violate the internal consistency test (in light of the US Supreme Court's recent ruling in Wynne) or the dormant commerce clause. The First Marblehead Corporation v. Commissioner of Revenue, 475 Mass. 159 (2016) (First Marblehead II).

On October 13, 2015, the US Supreme Court vacated and remanded the MSJC's first decision in the First Marblehead litigation, "for further consideration in light of Comptroller of Treasury of Md. v. Wynne, [135 S. Ct. 1787] (2015)."¹ The First Marblehead litigation has garnered a great deal of attention in the tax community because, among other reasons, First Marblehead was the first reported appellate decision in any state interpreting the Recommended Formula for Apportionment and Allocation of Net Income of Financial Institutions of the Multistate Tax Commission (MTC and MTC Model Formula),² which is utilized in nearly 20 states. Additionally, this opinion is an early application by a state court of the US Supreme Court's watershed Wynne decision on the issue of internal consistency.

Specifically, the issue under consideration in First Marblehead II was whether the Massachusetts Financial Institutions Excise Tax (FIET), a corporate income tax applicable to banking institutions, violated the internal consistency requirement as recently applied in the Wynne decision. Under the US Supreme Court's dormant Commerce Clause jurisprudence, the internal and external consistency tests, as set forth in the Court's Complete Auto decision, together determine whether a tax is "fairly apportioned."³ According to Wynne, the internal consistency test "looks to the structure of the tax at issue to see whether its identical [and hypothetical] application by every State in the Union would place interstate commerce at a disadvantage," (e.g., by taxing more than 100% of the income of a multistate taxpayer).

The focus of the internal consistency analysis in First Marblehead II was the calculation of the Taxpayer's property apportionment factor, which includes loans in the case of the FIET. Under the statute, loans are sourced to a state based upon where the "preponderance of substantive contacts" with the loan occurred, based on the so-called SINAA⁴ analysis. In First Marblehead I, however, the MSJC held that, for purposes of the SINAA analysis, the actions of third parties may never be considered. In this case, the taxpayer had no employees, did not originate the loans and had outsourced all loan servicing to a third party. As a result, the MSJC held that, by operation of the FIET apportionment statute, a default provision would source all loans to the Taxpayer's commercial domicile, which was, in this case, Massachusetts.

On remand in First Marblehead II, the MSJC explained:

"This result does not contravene the internal consistency test. An example will illustrate the point. Assume that another State — for example, Florida — is the taxing State and that Florida has enacted a [FIET] … [The Taxpayer] has no regular place of business in any State, including Florida, and therefore, there is no statutory basis to assign any loan to Florida as the taxing State under the FIET … and no statutory basis to assign any loan to any other State … If every State follows the interpretation of [the FIET] … that this court adopted in [First Marblehead I] … [The Taxpayer] could not establish that there is another State in which the preponderance of substantive loan-related contacts occurred … the statutory factors listed and defined in that section to be taken into account in conducting the individual case review do not apply to [the Taxpayer], with its lack of employees and office locations. Accordingly, the default presumption in [the FIET] — that the taxpayer's commercial domicile defines the place where "the preponderance of substantive contacts regarding [the] loan occurred" — applies. Because [the Taxpayer's] commercial domicile is Massachusetts, the numerator of [Taxpayer's] property factor in Florida would be zero — i.e., no loans assigned to Florida — which means mathematically that its property factor as a whole would also be zero … Assuming that [the FIET] were in effect in every other State, the same analysis would apply to the property factor calculation for [the Taxpayer] in each such State. The exception is Massachusetts, [the Taxpayer's] commercial domicile."

On remand, the Taxpayer argued that the statute's default provision, which assigns loans to the Taxpayer's commercial domicile, would not by its terms be operative in any state other than the state of commercial domicile. Thus, if the Taxpayer sourced some portion of its loans to Florida, there would be no mechanism for the State of Florida (or any state other than Massachusetts) to reassign those loans to Massachusetts. In response, the MSJC stated that, "the difficulty with this argument is that … there is no proper statutory basis in [the FIET] for [the Taxpayer] to assign loans to Florida. We reject a claim that the Massachusetts apportionment formula, as we have construed it, violates the internal consistency test when the claim is premised on the taxpayer's erroneous application of the formula in the first instance."

The Taxpayer also argued that, due to the facts established at trial, it was impossible for the Taxpayer to rebut the presumption sourcing 100% of its loans to Massachusetts under the FIET as interpreted by the MSJC and that this also violated the internal consistency requirement. The MSJC did not disagree with the Taxpayer on the issue of impossibility, but did disagree that this violated the internal consistency requirement of the Commerce Clause. The MSJC, citing Container Corporation,⁵ noted that an internally consistent tax structure results in "no more than all of the unitary business'[s] income being taxed," and whether the tax's application in every state would place interstate commerce at a disadvantage. Here, no more than 100% of the Taxpayer's income was being taxed; similarly, if the Taxpayer was only doing business intrastate in Massachusetts, so no apportionment of income would be allowed, 100% of its income would also be subject to tax.

Possibly in a nod to the all-or-nothing apportionment result in this instance, the MSJC also noted in a final footnote, that this result was "principally a consequence of [the Taxpayer's] holding company status." If the Taxpayer believed that the FIET did not properly reflect taxable income derived from "business carried on within the Commonwealth," the MSJC noted, the FIET statutes allowed for the Taxpayer to petition for alternative apportionment, which the Taxpayer did not opt to do in this case.

Implications

As indicated, the MSJC's two First Marblehead decisions are the first reported appellate level decisions in any state interpreting the MTC Model Formula and therefore, could be influential or persuasive in states beyond Massachusetts. Further, given the facts at issue here, these decisions may be especially relevant for taxpayers that are not registered banking intuitions but conduct some "bank-like" activities; taxpayers with purchased loan portfolios; and taxpayers that outsource the servicing of their loans.

Finally, it should be noted that the Taxpayer could again petition the US Supreme Court for certiorari so this decision could be subject to further review.

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ENDNOTES

¹ See Tax Alert 2015-574 and Tax Alert 2015-2301 for prior coverage of the First Marblehead litigation.

² According to the MTC, approximately 18 states have enacted some portion of the MTC Model Formula by regulation or legislation. Those states include Alabama, Arkansas, California, Colorado, Hawaii, Idaho, Kansas, Kentucky, Maine, Maryland, Massachusetts, Mississippi, New Hampshire, New Mexico, Ohio, Oregon, Rhode Island, & Utah. See the MTC's Amicus Brief at pp. 4 & 5.

³ In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the Court articulated a four-pronged test that any tax must pass under the dormant Commerce Clause of the US Constitution: 1) It must be applied to an activity with a substantial nexus with the taxing state; 2) It must be fairly apportioned; 3) It must not be discriminatory towards interstate commerce; and 4) It must be fairly related to the services provided by the state.

⁴ Solicitation, Investigation, Negotiation, Approval and Administration.

⁵ Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159, 169 (1983).