[authors: Rick Reames & Jim Rourke]
Businesses operating as multi-state taxpayers in South Carolina should take note of a recent ruling by the state’s Court of Appeals.
In CarMax Auto Superstores West Coast, Inc. v. South Carolina Department of Revenue, Op. No. 4953 (filed March 14, 2012), the court reversed an Administrative Law Court (“ALC”) decision. The appeals court ruled that a party seeking to use an alternative apportionment method must show by a preponderance of the evidence that both (1) the statutory apportionment method is improper and (2) the alternative method more accurately reflects the taxpayer’s business activity within the state.
During the period of time in question, CarMax, Inc. operated as a holding company with two subsidiaries: CarMax West and CarMax East. CarMax West owned substantially all of the businesses’ intellectual property. In 2004, CarMax reorganized its corporate structure to include CarMax Business Services (“CBS”) as a disregarded entity owned by both subsidiaries. CBS was created to house the business’s financing operations, to provide shared services to CarMax East and CarMax West, and to shift ownership of intellectual property outside the state. CBS charged both entities a per-vehicle management services fee, which included an IP royalty component.
CarMax West filed corporate income tax returns from 2002-2007 using the standard apportionment formula for multi-state taxpayers under S.C. Code Ann, § 12-6-2250 (repealed for years after 2010), which calculates taxable income using a ratio of the taxpayer’s total property, payroll and sales. After audit, the Department determined that the taxpayer’s returns did not fairly reflect the extent of its business activity in South Carolina. It then modified the apportionment formula used by CarMax West and issued an assessment for $829,490. This alternative formula bifurcated CarMax’s business operations by separating royalty and financing income from income attributable to retail sales; it then calculated CarMax West’s income based only on the elevated royalty and financing income ratio. In response, CarMax West filed amended returns using the gross receipts method. In upholding its determination, the Department concluded that neither the standard formula nor the gross receipts formula fairly represented the extent of CarMax West’s business in South Carolina.
In an order dated April 22, 2010, the ALC upheld the Department’s use of an alternative apportionment method. It found that because the taxpayer requested the contested case hearing to challenge the proposed assessment, the taxpayer bore the burden of proof. The ALC concluded that the Department’s alternative method was reasonable and did not violate constitutional limitations.
Citing at least five cases in accord from other jurisdictions, CarMax West argued in its appeal that the ALC should have placed the burden of proof on the party seeking to deviate from the standard apportionment method to show by clear and convincing evidence why the standard method should not be used and why the alternative method is reasonable. The Department argued that the case law cited was non-binding and that the “clear and convincing” standard of proof was unfounded in both statute and South Carolina Supreme Court jurisprudence.
Reversing and remanding the ALC decision, the Court of Appeals found that although the “clear and convincing” standard was unsupported by either South Carolina authority or legislative intent, the Department should bear the burden of “proving its alternative accounting method is reasonable and more fairly represents [the taxpayer]’s business activity in South Carolina” by a preponderance of the evidence.
The court relied on both case law and legislative intent. It noted that in Media General Communications, Inc. v. South Carolina Department of Revenue, 388 S.C. 138, 694 S.E.2d 525 (2010), a case where it was undisputed that the taxpayer’s alternative method fairly measured its business activity in South Carolina, the Supreme Court upheld the taxpayer’s alternative method because the Department had failed to establish that another method would be more appropriate. According to the Court of Appeals, when determining the appropriateness of an alternative apportionment method, the Media General decision compels a finding not only that the alternative method chosen is appropriate, but also that it is more appropriate than any competing methods.
Additionally, the court noted that it was only logical that a party seeking to override a “legislatively determined apportionment method” should bear the burden of proving both that the legislative apportionment method is improper and that the alternative method “more accurately reflects the taxpayer’s business activity within the state.” Thus, the court of appeals reversed the ALC and remanded for a reconsideration of all the issues.