Michigan: Deemed Asset Sale Not Included In Sales Factor

The Michigan Court of Claims recently addressed whether a sale treated as an asset sale under IRC section 338(h)(10) was included the sales factor. In computing its Michigan Business Tax (MBT) liability on a short year return, the taxpayer included the sale in its business income tax base; it also included the sale in the denominator of its sales factor. The sale was not included in the Michigan sales factor numerator.  On audit, the Michigan Department of Treasury determined that the sale was not includable in the sales factor. As a result, the Department assessed additional MBT.  

The taxpayer subsequently filed a complaint with the Court of Claims on multiple grounds, including arguing that it was entitled to use an alternative apportionment formula because to include the sale as business income while also excluding the asset sale from the sales factor would disproportionally attribute long-term gain to Michigan. The taxpayer also alleged that excluding the sale violated the Commerce and Due Process Clauses. The Court of Claims originally analyzed and decided the issue in favor of the Department. However, the appeals court reversed, holding that applying the statutory formula violated the Commerce Clause. On application for leave to appeal, the Michigan Supreme Court vacated the Court of Appeals decision and remanded the matter back to the appeals court to determine the proper method of calculating MBT liability under the statutory apportionment formula. In the high court’s view, this foundational issue must be addressed before the alternative apportionment position could be addressed. The Court of Appeals then remanded the matter to the Court of Claims to address whether the sale was included in the sales factor.

Under Michigan law for the MBT tax year at issue, the sales factor equaled the total sales of the taxpayer within Michigan over the total sales of the taxpayer everywhere during the tax year. The definition of a “sale” meant  “the transfer of title to, or possession of, property that is stock in trade or other property of a kind that would properly be included in the inventory of the taxpayer if on hand at the close of the tax period or property held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business.” The key issue was whether the IRC section 338(h)(10) asset sale was a “sale” as defined in the MBT law. The court determined that it was not. In the court’s view, the statutory reference to “inventory held by a taxpayer” anticipated that a sale was something less than the sale of a taxpayer’s entire business. Further, the definition of “inventory” excluded property subject to depreciation, and many of the assets that were transferred as a result of the sale were depreciable assets. Finally, the taxpayer was not in the business of selling property to customers, and the assets at issue were used in providing its services. As such, the court concluded that the sale was not a sale of stock in trade or inventory and the resulting amounts were not includable in the sales factor. For questions on Vectron Infrastructure Services Corp (Vectron II) please contact Dan De Jong.