It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.
— Louis D. Brandeis, former United States Supreme Court Justice
Within the bounds allowed by the United States Constitution, it is often taken for granted that each individual state is a sovereign entity. Given the forthcoming litigation initiated by several state attorneys general in response to the pending federal healthcare legislation — which litigation is, at least nominally, premised on the theory of state sovereignty — this promises to be a topic oft-discussed by cable news talking heads over the course of the next several months.
However, a state’s sovereignty is not limited to its interactions with the federal government; rather, that sovereignty extends to each state’s autonomous character in its dealings with the other 49 states. Yet traditional notions of state sovereignty can become much less clear when a state attempts, by statute or otherwise, to take into account the laws of other states in determining the application of its own.
Recently, in a case of first impression among states adopting the Uniform Division of Income for Tax Purposes Act (UDITPA), the Oregon Tax Court, Magistrate Division, addressed the impact of that interplay in the context of Oregon’s statutory and regulatory provisions purporting to mandate uniform and consistent reporting of business income. Below we examine that case and explore the potentially broader impact of the Oregon decision on taxpayers’ actions in other UDITPA states.
The Wisdom of the Oracle Decision
In Oracle Corp. v. Dep't of Revenue, No. TC-MD 070762C, 2010 Ore. Tax LEXIS 32 (Or. Tax Ct., Magis. Div. Feb. 11, 2010), a California-domiciled Oregon taxpayer sold corporate stock and certain business assets. The taxpayer treated the gain associated with that sale as apportionable business income for California corporate income tax purposes and as allocable nonbusiness income for Oregon corporate income tax purposes.
Before the Magistrate Division of the Oregon Tax Court, the Oregon Department of Revenue filed a motion for partial summary judgment regarding the taxpayer’s “duty to uniformly and consistently report business income to Multistate Tax Compact states that have adopted the UDITPA ‘business income’ definition.” Specifically, the Department challenged the taxpayer’s ability to treat the gain as nonbusiness income, arguing inter alia that under Oregon statute, the taxpayer was required to report items of income consistently to all states adopting the provisions of UDITPA. According to the Department, since California and Oregon both generally adopted the UDITPA definitions of business and nonbusiness income for the years at issue, with only minor differences in the states’ definitions, the taxpayer was required to treat the gain as business income for Oregon purposes, since it had done so for California purposes.
The Department further cited Oregon Supreme Court precedent that indicated uniformity should be “considered in construing the provisions of UDITPA.” Along those lines, the Department noted Oregon’s membership in the Multistate Tax Compact (MTC), the purposes of which include promoting uniformity in state taxation. Moreover, the Department argued that the taxpayer frustrated that goal of uniformity by taking inconsistent income reporting positions in California and Oregon.
The taxpayer responded in kind, advancing the position that, despite California and Oregon’s similar UDITPA-based statutory definitions of business and nonbusiness income, material differences existed between the states’ laws. Additionally, the taxpayer maintained, divergent judicial and administrative interpretations of those materially-different laws necessarily result in income being reported inconsistently across the jurisdictions. Thus, the reporting of business income in California neither “inform[s]” nor “control[s]” the taxpayer’s method of reporting the sale income to Oregon.
The Department further argued that the taxpayer was in violation of Oregon Administrative Rule 150-314.615-(A), which imposes a disclosure requirement on taxpayers reporting their income inconsistently to states that adopt the MTC or UDITPA or both. However, the taxpayer pointed out the lack of jurisprudence applying this regulation, and argued that the rule is not relevant when a taxpayer reports “its income in other jurisdictions in a manner consistent with the laws of those jurisdictions.” Additionally, while the taxpayer failed to disclose its “inconsistent” reporting on its Oregon return, the taxpayer maintained that it did later disclose the treatment to an Oregon Department of Revenue employee.
The Oregon Tax Court, Magistrate Division, ruled that the taxpayer’s decision to report the relevant items of income as business income to California did not preclude the taxpayer from reporting that same income as nonbusiness income to Oregon. In doing so, the court expressly declined to create a duty for Oregon taxpayers to report their items of income uniformly to the various UDITPA states. The court recognized that UDITPA’s stated purpose includes the goal of uniformity, that the Oregon Supreme Court had previously instructed Oregon authorities to consider uniformity when applying the state’s UDITPA statutes, and that the MTC seeks to promote uniformity. Nevertheless, the court found that those are all “aspirational goals and ‘consideration’ of such goals represent matters of policy, not law.”
In so ruling, the court set forth a number of reasons for declining to promulgate judicially an equitable doctrine mandating that Oregon taxpayers report their income for Oregon purposes in a manner consistent with their reporting to other UDITPA states.
First, the court noted the practical consideration that enforcing this duty of consistency would unreasonably burden Oregon courts because it would require them to become experts in each state’s business-nonbusiness laws, including all related state judicial and administrative interpretations.
Second, and possibly most important, the court recognized that imposing a duty of uniform reporting on taxpayers could potentially compromise Oregon’s rights as a sovereign entity. Both practically speaking and from the larger philosophical perspective, to mandate that Oregon taxpayers must treat items of income consistently among all states has the potential to render impotent Oregon’s own laws. The court noted that the Department’s proposed doctrine could require Oregon to accept a taxpayer’s characterization of its income under another state’s rules, even if the faithful application of Oregon’s own laws would require a contrary result. For example, why in the case at hand should the taxpayer be forced to treat its income as business income for Oregon purposes under the laws of California, if the taxpayer’s income is properly characterized as nonbusiness income under Oregon law? Ultimately, the court maintained that issues such as the determination of whether income is business or nonbusiness income for Oregon purposes should be decided under the laws of Oregon and on a case-by-case basis.
Finally, the court noted that the taxpayer did not timely notify the Department of its inconsistent reporting position but eventually disclosed its inconsistent reporting to the Department upon audit. However, the court ruled that, while the taxpayer may have been in technical violation of the state’s regulation requiring such disclosure, “there are no legal sanctions for untimely disclosure.”
Alvarez & Marsal Taxand Says:
At first blush, the Oracle decision may appear to be a Departmental defeat, and under the particular facts of this case, it very well may be. In actuality though, the court’s well-considered ruling allows the Department flexibility in future cases that would not have been available under the Department’s proposed position. Thus, the ruling favors both the taxpayer and the state. For the state, the court’s ruling was an acknowledgement of Oregon’s right as a sovereign entity to interpret its own laws as it sees fit, without being compelled to follow the laws chosen by another state. For taxpayers, the court’s ruling brings with it an increased degree of fairness, symmetry and transparency.
Oracle is significant in that it was a case of first impression among UDITPA states. As such, it is necessarily difficult to predict how other UDITPA states would rule on the same issue, given that their body of laws is not identical to Oregon’s. It is somewhat ironic that the same principles of state sovereignty at play in this case could also prevent the application of its holding in other UDITPA states.
Nevertheless, the Oracle decision provides non-Oregon taxpayers with a greater level of guidance than was available before, particularly since the decision was grounded in logic and practicality, principles normatively applicable in every state. In essence, since the treatment of business or nonbusiness income can differ among the states, it follows that taxpayers should be allowed to take various income reporting positions in accordance with those differences. However, as always, taxpayers should be mindful of potential selective enforcement issues, yet not fearful to challenge a state taking the contrary position, particularly if their facts are distinguishable from the taxpayer’s in Oracle.
New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting).
Donald Roveto III
Managing Director, New York
Jonathan Calhoun, Senior Associate, and Samuel Lee, Senior Associate, contributed to this article
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