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Associated Bank, N.A. v. Commissioner of Revenue

Supreme Court of Minnesota

July 5, 2018

Associated Bank, N.A. and Affiliates, Respondents,
v.
Commissioner of Revenue, Relator.

         Tax Court Office of Appellate Courts

          Walter A. Pickhardt, Faegre Baker Daniels LLP, Minneapolis, Minnesota, for respondents.

          Lori Swanson, Attorney General, Jennifer A. Kitchak, Assistant Attorney General, Saint Paul, Minnesota, for relator.

          Mary L. Knoblauch, Anthony Ostlund Baer & Louwagie P.A., Minneapolis, Minnesota; and Helen Hecht, Bruce J. Fort, Washington, D.C., for amicus curiae Multistate Tax Commission.

         SYLLABUS

         1. HMN Financial, Inc. v. Commissioner of Revenue, 782 N.W.2d 558 (Minn.2010), does not preclude the Commissioner of Revenue from using the alternative-apportionment authority permitted by Minnesota Statutes section 290.20, subdivision 1 (2016), if that authority is properly invoked and applied.

         2. To exercise the alternative-apportionment authority under Minnesota Statutes section 290.20, subdivision 1, the Commissioner must present substantial evidence to show (1) that the apportionment method required by Minnesota Statutes section 290.191 (2016) does not "fairly reflect" the taxpayer's taxable net income arising from Minnesota sources, and (2) that an alternative apportionment method does so.

         Reversed and remanded.

          OPINION

          CHUTICH, JUSTICE

         In this appeal, we consider whether the Commissioner of Revenue ("the Commissioner") properly invoked her alternative-apportionment authority under Minnesota Statutes section 290.20, subdivision 1 (2016), and if so, what burden the Commissioner bears when using that authority. Respondents Associated Bank, N.A., and its affiliates ("the Bank"), which include the members of two Wisconsin limited liability companies (LLCs), objected to the Commissioner's assessment of additional state corporate franchise tax liability for tax years 2007 and 2008. Although the Bank correctly calculated the tax owed based on the relevant statutes for apportioning income to Minnesota, the Commissioner concluded that the method used did not "fairly reflect" the Bank's income from Minnesota sources under section 290.20, subdivision 1. Accordingly, the Commissioner invoked her authority under section 290.20, subdivision 1, and applied an alternative apportionment method that she contends fairly reflects the Bank's income allocable to Minnesota.

         After exhausting its administrative remedies, the Bank appealed to the tax court, arguing that the Commissioner improperly invoked her authority under section 290.20, subdivision 1. Relying on our decision in HMN Financial, Inc. v. Commissioner of Revenue, 782 N.W.2d 558 (Minn. 2010), the tax court agreed with the Bank and reversed the Commissioner's order. Because we conclude that HMN Financial is not dispositive and that the Legislature plainly gave the Commissioner the authority to use an alternative apportionment method under the circumstances presented here, we reverse and remand.

         FACTS

         The parties have stipulated to the underlying facts. During 2007 and 2008, Associated Bank, N.A. ("Associated Bank"), was a nationally-chartered bank headquartered in Wisconsin, operating as a wholly-owned subsidiary of Associated Banc-Corp, a bank holding company. Associated Bank had banking locations in Wisconsin, Illinois, and Minnesota, as well as loan-production offices in other states.

         In September 2007, Associated Banc-Corp created two LLC[1] partnerships under Wisconsin law: Associated MN Commercial RE, LLC ("Commercial LLC") and Associated MN Retail RE, LLC ("Retail LLC"). It is undisputed that Associated Banc-Corp created the two LLCs to minimize the Minnesota corporate franchise tax liability of the LLCs' members.

         Each LLC had two members, and each member transferred either a loan portfolio or money to the LLC to secure its partnership interest. Associated Bank and ASBC Investment Corporation ("ASBC"), a wholly-owned subsidiary of Associated Bank, became members of Commercial LLC. Associated Bank exchanged its entire Minnesota commercial loan portfolio (consisting of commercial loans, consumer loans, and construction loans worth $1.359 billion) for a 99-percent interest in Commercial LLC. ASBC paid $13.7 million for a 1-percent interest in Commercial LLC.

         Retail LLC also had two members: Associated Minnesota Real Estate Corporation ("MN Real Estate") and Associated Bank.[2] MN Real Estate transferred its Minnesota retail loan portfolio (consisting of residential home loans worth $707 million) in exchange for a 99-percent interest in Retail LLC. Associated Bank paid $7.1 million for the remaining 1-percent interest in Retail LLC.

         Transferring the loans to the LLCs did not change the management of the loans, except that new reports were generated to track the loan portfolios. The loans continued to be secured by tangible or real property located in Minnesota, and to the extent that any loans were unsecured, the borrowers had Minnesota mailing addresses. After the loans were transferred to the LLCs, the loans earned nearly $28 million in interest income during the remaining months of 2007 and another $114.6 million in interest income in 2008.

         Minnesota imposes a tax on the taxable income of businesses, including the Bank, [3]that "engage in contacts with [Minnesota] that produce gross income attributable to [Minnesota]." Minn. Stat. § 290.02 (2016). When a taxpayer conducts business in Minnesota and other states, the combined income is allocated to each state through "an apportionment formula that generates a fair share of the combined income attributable to each state for tax purposes." Kimberly-Clark Corp. v. Comm'r of Revenue, 880 N.W.2d 844, 846 (Minn. 2016); see Minn. Stat. § 290.17, subd. 3 (2016); Caterpillar, Inc. v. Comm'r of Revenue, 568 N.W.2d 695, 696-97 (Minn. 1997).

         The income of a multi-state unitary business, [4] such as the Bank, is apportioned to Minnesota by using a method, or "formula," prescribed by Minnesota Statutes section 290.191 (2016). The applicable apportionment method depends on the type of entity.[5] See generally Minn. Stat. § 290.191. In 2007 and 2008, for a "financial institution," a three-factor formula apportioned net income by accounting for: (1) sales or receipts, which included loan interest; (2) property, which included the value of intangible property, such as loans; and (3) payroll. Minn. Stat. § 290.191, subds. 3, 6, 11. Non-financial entities used the "[a]pportionment formula of general application," another three-factor formula, accounting for: (1) sales, (2) property, and (3) payroll.[6] Id., subds. 2, 5, 9-10, 12. Accordingly, loan-interest receipts and intangible property were not accounted for in the general apportionment formula. See id.; see also id., subd. 6(f)-(i) (accounting for "[i]nterest income" only when determining the receipts factor for financial institutions).

         The parties agree that, in 2007 and 2008, each LLC member was a "financial institution," but each LLC was not, and therefore different apportionment methods applied to the members and the LLCs under section 290.191. Specifically, the general apportionment formula applied to the LLCs and the financial-institution apportionment formula applied to the members. Because the LLCs were not financial institutions, the LLCs, unlike the members, did not have to include certain interest income in calculating their taxable net income using the general apportionment formula.[7] As a result, each LLC reported zero receipts, zero property, zero payroll, and an overall apportionment factor of zero on its 2007 and 2008 Minnesota partnership tax returns.[8] In turn, the LLCs reported zero apportionment factors to their members, Associated Bank, ASBC, and MN Real Estate.[9]

         The Bank, including the members of the LLCs, then filed combined Minnesota Corporation Franchise Tax Returns for 2007 and 2008.[10] In the returns, the Bank apportioned income to Minnesota by calculating apportionment factors for each member of the LLCs-Associated Bank, MN Real Estate, and ASBC. Each member combined its apportionment factor (from the financial-institution apportionment formula) with its share of its LLC's apportionment factor of zero (from the general apportionment formula), as required by Minnesota Statutes section 290.17, subdivision 4(j) (2012) (requiring "the entire net income of the unitary business" to be "apportioned among the entities by using each entity's Minnesota factors for apportionment purposes").[11] The Bank's sales factors therefore excluded the interest earned from the Minnesota loans held by the LLCs, and the Bank's property factors excluded the value of the LLCs' Minnesota loans. As intended, the resulting income allocable to Minnesota excluded all of the Bank's interest income from the LLCs' Minnesota business activities.

         The Commissioner subsequently audited the Bank and issued a Notice of Change in Tax. The Commissioner found that applying the general apportionment formula to the LLCs-the method prescribed under section 290.191-did not "fairly reflect" the Bank's "taxable net income allocable" to Minnesota because applying the prescribed formula to the LLCs failed to account for the Bank's Minnesota business activities. The result of using the prescribed formula, the Commissioner concluded, distorted the Bank's income by failing to report "Minnesota sourced income" that should have been allocated to the State.

         Accordingly, the Commissioner invoked her authority under section 290.20, subdivision 1, and applied an alternative apportionment method to correct that distortion of reported income by accounting for the Bank's interest income from Minnesota loans. Specifically, the Commissioner recalculated apportionment at the LLC level by including interest income and loan values from the LLCs' Minnesota loans in the "receipts factor" and the "property factor"-income that was not included in the general apportionment formula for non-financial institutions. She then incorporated, on a pro-rata basis, each member's share of the LLCs' "receipts factor" and "property factor" into the Bank's apportionment percentages. In effect, the Commissioner's alternative apportionment method treated the LLCs, which were not financial institutions, as financial institutions.

         Based on the recalculation of net income, the Commissioner assessed the Bank approximately $2.16 million and $2.78 million in additional corporate franchise tax for 2007 and 2008, respectively. Following an administrative appeal, the Commissioner upheld the audit determination, explaining that the general apportionment formula, although correctly applied, excluded interest earned from Minnesota loans and the value of those loans, which resulted in a "distortion" of the taxpayer's taxable net income allocable to Minnesota, not a fair reflection of that income. In contrast, the Commissioner concluded, the alternative apportionment method applied during the audit fairly reflected the Bank's net income allocable to Minnesota.

         The Bank appealed to the tax court. The case was submitted to the tax court for decision based on stipulated facts and an agreed upon set of exhibits. Agreeing with the Bank, the tax court concluded that the Commissioner could not exercise her authority under section 290.20 in the manner that she did. Associated Bank, N.A. v. Comm'r of Revenue, No. 8851-R, 2017 WL 1430657, at *6-7 (Minn. T.C. Apr. 18, 2017). Explaining that it was "bound" by our decision in HMN Financial, id. at *6 n.52, the tax court concluded that the Commissioner failed to rebut the statutory presumption under section 290.20, subdivision 1, that the prescribed apportionment methods in section 290.191 "fairly and correctly" apportioned the Bank's net income to the State, id. at *6-7. The tax court therefore held that the Commissioner had impermissibly used an alternative apportionment method to determine the Bank's Minnesota tax liability. It further explained that the Commissioner could not "look through or disregard the taxpayers' corporate structure" to apply the financial-institution apportionment formula to the LLCs. Id. at *6. Doing so, the tax court reasoned, "circumvent[ed] Minn. Stat. § 290.191 and HMN Financial" because the Commissioner merely objected to the resulting reduction in the Bank's tax liability rather than the apportionment method used by the Bank. Id. at *7.

         The Commissioner appeals from the tax ...


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