In a landmark (and somewhat surprising) decision issued June 20, the Mississippi Supreme Court reversed the Mississippi Court of Appeals’ decision in Equifax, Inc. and Equifax Credit Info. Services, Inc. v. Miss. Dep’t of Revenue, 2012 WL 1506006 (Miss. Ct. App. May 1, 2012), by upholding the trial court’s ruling in favor of the Mississippi Department of Revenue and its use of an alternative apportionment method in determining the taxpayers’ Mississippi income. The Supreme Court also upheld the trial court’s ruling requiring the taxpayers to carry the burden of proving that the Department’s use of an alternative apportionment method was arbitrary and capricious. The Court also found that the Department’s use of an alternative apportionment method was not the promulgation of a new “rule,” in violation of the Mississippi Administrative Procedures Act, and to rub salt in the wound, found the Department had not abused its discretion by imposing penalties on the taxpayers.
The taxpayers, Equifax, Inc. and Equifax Credit Information Services, Inc., sold credit reports, credit scores, and fraud alerts to approximately 800 customers located in Mississippi during the four-year audit period. The taxpayers did not have a corporate office in Mississippi but did employ three Mississippi residents. The taxpayers reported no taxable income in Mississippi during the audit period, relying on the Department’s regulations and the standard “costs of performance” apportionment method for service companies. The Department determined that the apportionment method used by the taxpayers did not fairly reflect the extent of their business in Mississippi and applied market-based sourcing. The taxpayers appealed the assessment to the (then) Mississippi State Tax Commission’s Board of Review. The Board upheld the assessments but in a reduced amount. The taxpayers then appealed to the three-member State Tax Commission, which upheld the Board’s reduced assessments. The taxpayers paid the assessments under protest and appealed to the Hinds County Chancery Court. The trial court held an evidentiary hearing on all issues presented and entered an order affirming the Department’s assessments, employing an “arbitrary and capricious” standard of review for the Department’s rulings. The taxpayers then appealed to the Court of Appeals.
The Court of Appeals held that (1) a de novo standard applies to judicial review of Department decisions, and (2) as the party invoking alternative apportionment, the Department has the burden to prove that the standard apportionment method is not a fair representation of the taxpayer’s activity in the state and that its chosen alternative method is reasonable. The Court of Appeals recognized that the arbitrary and capricious standard normally applies to state agency decisions, but opined that a different standard of review should be used when considering Department decisions.
Quoting the general understanding that “[a] de novo review ‘means that the case shall be tried the same as if it had not been tried before, and the court conducting such a trial may substitute its own findings and judgment for those of the inferior tribunal from which the appeal is taken[,]’” the Court of Appeals concluded that the trial court’s review of the Department’s decision should have been conducted just as if the trial court were sitting as the Department. The Court of Appeals concluded that the trial court had erred both by applying an incorrect standard of review and by imposing the burden of proof on the wrong party, and therefore reversed the trial court’s decision and remanded the case to the trial court. In doing so, the Court of Appeals found all other issues raised on appeal moot. The Supreme Court granted the Department’s petition for certiorari.
In a 17-page opinion, the Supreme Court first examined the pertinent provisions of Miss. Code Ann. § 27-77-7(4) and concluded that a trial court must hold a judicial hearing to determine whether a taxpayer can prove entitlement to any or all of the relief requested, by a preponderance of the evidence. According to the Court, the instruction in Section 27-77-7(4) to “try the case de novo” is misdirected because the trial court hearing is the first time a taxpayer may judicially challenge the legality of the Department’s final decision. In the instant case, the taxpayers’ complaint sought judicial review of the merits of the Department’s decision, a determination which, according to the Supreme Court, was outside of the trial court’s authority. In so holding, the Supreme Court refused to impose the burden of proof on the Department, in contradiction to the Legislature’s explicit placement of the burden on the taxpayers, concluding that the cases to the contrary cited by the taxpayers were inapposite; those courts were interpreting Section 18 of UDITPA, which Mississippi has not enacted.
Since the Court of Appeals had reversed the trial court’s judgment on standard of review and burden of proof grounds, it found the remaining issues raised by the taxpayers to be moot. But since the Supreme Court held that the trial court properly interpreted the applicable standard of review and burden of proof under Section 27-77-7(4), the Court examined the taxpayers’ remaining claims of error. The taxpayers had also argued that the trial court erred by finding (1) that the use of an alternative apportionment method was not a promulgation of a new “rule,” in violation of the Mississippi APA, and (2) that the imposition of penalties was not arbitrary and capricious.
As for the first remaining claim of error, the taxpayers argued that the Department promulgated a new rule for all service companies doing business in Mississippi when it required them to use market-based sourcing, because the Department did not rely on a single fact unique to the taxpayers in support of invoking alternative apportionment. The Supreme Court agreed with the trial court’s conclusion that the Department utilized an existing alternative method, as prescribed under Miss. Admin. Code 35-III-8.06-402.10, and therefore no violation of the Mississippi APA had occurred.
Finally, the Supreme Court agreed with the trial court’s determination that it could not reverse the Department’s decision to impose penalties solely because it would have found differently than the Department. Rather, the trial court could reverse only if the taxpayers proved that the imposition of penalties was unsupported by substantial evidence presented to the Department, was arbitrary and capricious, or beyond the power of the Department, or in violation of the taxpayers’ statutory or constitutional rights—which the trial court found the taxpayers had failed to do.
The appropriate burden of proof when proposing an alternative apportionment method has been addressed recently by courts in several other states. For example, the South Carolina Court of Appeals held (properly, we think) that the party seeking to override the legislatively-determined apportionment method bears the burden of proving that the method is not appropriate and that an alternative method more accurately reflects the taxpayer’s business activity within the state. See CarMax Auto Superstore West Coast, Inc. v. South Carolina Dep’t of Revenue, No. 4953 (S.C. Ct. App. March 14, 2012). For a useful discussion of the issue, see Cara Griffith, “Because I Said So: Uncertainties With Apportionment,” State Tax Notes 595 (May 20, 2013).