M&A and state taxes

M&A and state taxes

April 05, 2020 | By Keith Martin in Washington, DC

Asset sales can trigger taxes in multiple US states on the gain.

A Michigan court said in March that the formula the state used to calculate the share of gain on which taxes had to be paid in Michigan after a Minnesota company was sold led to too large a share being attributed to Michigan. It told the company and the Michigan tax department to work out a more reasonable number.

Minnesota Limited, Inc. was a family-owned business in Big Lake, Minnesota that grew to 600 employees during peak seasons. It builds, maintains and repairs oil and gas pipelines and does occasional cleanup after spills. It operates in 24 states. Its jobs are on a contract-by-contract basis. It has no office or permanent employees in Michigan.

Enbridge, a pipeline company, hired it in 2010 to clean up after a major pipeline spill near Kalamazoo, Michigan. The job took into early 2011 to complete.

This was around the time that Minnesota Limited, Inc. was being sold after the health of one of the two siblings that owned the company declined. The company sale closed on March 31, 2011. The buyer paid $80 million. The buyer and seller made a section 338(h)(10) election at the federal level to treat the share sale as if the buyer bought the company’s assets.

Michigan collects a business tax of 4.95%.

Like other states, Michigan starts with the adjusted taxable income reported on the federal return and then apportions part of it to Michigan. It uses a single-factor formula to determine how much of the income that a multi-state company earns in a year should be apportioned to Michigan. The formula is Michigan sales as a percentage of total sales.

Minnesota Limited, Inc. said the percentage for 2011 was 14.986%.

The state tax department said the percentage should have been 69.9761%. It said the company incorrectly included the gain on the sale of the company in the denominator of the sales fraction.

The company argued the gain was sales income that should be taken into account in the sales fraction, but that it belonged in the denominator because it should be attributed to Minnesota.

Alternatively, it argued that the gain should not be taxed at all in Michigan since it was nonbusiness income not earned in the regular course of business that was earned outside the state. The value built up over time based on work in 24 states.

The Michigan claims court said it does not “necessarily disagree” with how the state tax department applied the statutory apportionment formula, but the result was untenable. It said that not only had the value reflected in the company sales price built up over many years, but also most of the activity had no connection to Michigan and the distortion was compounded because the sale occurred in a year when the company just happened to have a major job in Michigan.

The result was unconstitutional under the Commerce Clause of the US constitution, the court said. The Commerce Clause bars states from imposing taxes that discriminate against out-of-state companies or impede interstate commerce. However, rather than set aside the formula, it said state law allows taxpayers to propose alternative apportionment percentages and told the parties to work something out.

The case is Vectren Infrastructure Services Corp. v. Department of Treasury. The court released its decision on March 12.