A Tennessee appellate court determined that an out-of-state limited partnership (taxpayer) had incorrectly listed its total earnings subject to Tennessee excise tax by improperly classifying approximately $117 million (disputed income) as nonbusiness income when the income actually constituted business earnings.
The taxpayer contended that the disputed income was nonbusiness income because it resulted from a passive investment in a related entity, and that it was not business income under the relevant Tennessee statute. The taxpayer also asserted that the Department of Revenue’s assessment of tax was in violation of the Commerce Clause of the U. S. Constitution. Finally, the taxpayer argued that, should the income be determined to be business income and the assessment of tax constitutional, the apportionment ratio used by the DOR was unfair and “drastically out of proportion.”
The court determined that the disputed income was business earnings under the functional test adopted by the state supreme court in Blue Bell Creameries, L.P. v. Roberts. (TAXDAY, 2011/01/26, S.23) The disputed income in this case came from a related entity that apparently served no purpose other than to hold stock in the parent company and to pass dividend income to the taxpayer in the form of investment income. The disputed income did not arise from a one-time extraordinary transaction, but from funds that flowed between the related entity and the taxpayer on a regular basis. Thus, the disputed income was properly characterized as business earnings.
A taxpayer challenging a tax assessment has the burden to demonstrate that it is unconstitutional. Here, there was no evidence in the record that the related entity conducted operations that were discrete from those of the taxpayer. Accordingly, under Blue Bell, the taxpayer did not carry its burden of demonstrating that the DOR’s assessment was unconstitutional.
The taxpayer also asserted that the state’s apportionment formula was unfair because it lacked factor representation. The court rejected this assertion and noted that the taxpayer relied on cases involving dividends from foreign affiliates. In the case at hand, the DOR was seeking to tax partnership investment income from the taxpayer’s investment in a related domestic entity, not income from foreign affiliates. The taxpayer failed to demonstrate, by clear and cogent evidence, that the DOR’s apportionment was grossly distorted or unfair.
Based on the reasons stated above, the trial court’s decision awarding summary judgment to the DOR was affirmed.
H.J. Heinz Co. v. Chumley, Tennessee Court of Appeals, No. M2010-00202-COA-R3-CV, June 28, 2011