Opinion ID: 2225262
Heading Depth: 3
Heading Rank: 2

Heading: Claimed Statutory Authority

Text: The Commissioner asserts that several Minnesota statutes combine to vest him with sweeping statutory authority to disregard tax-avoidance business structures like the one employed by HMN. HMN contends that while the statutes cited by the Commissioner do grant him some discretion, such discretion is limited to specific situations and does not apply in this case. The Commissioner first claims authority under Minn.Stat. § 289A.35, which states in relevant part: The commissioner has the authority to make determinations, corrections, and assessments with respect to state taxes, including interest, additions to taxes, and assessable penalties. The Commissioner then cites a case for the proposition that section 289A.35 grants him [a]bundant power to compute tax upon any theory [he] might entertain. State v. Duluth, Missabe & N. Ry. Co. ( Duluth ), 207 Minn. 637, 641, 292 N.W. 411, 413 (1939). But Duluth makes clear what the Commissioner's abundant power entails. It is a power to compute tax in accordance with Minnesota law and then challenge a taxpayer's returns in court if the Commissioner believes that taxpayer has reported its taxes incorrectly. See id. Such a reading comports with common sense. Surely the Commissioner's determinations, corrections, and assessments are not the final word on how much tax an entity must pay. If they were, neither this nor any tax case would ever come before the tax court, let alone our court. Rather, we conduct a de novo review of all matters of law at issue in a tax case. See Chapman v. Comm'r of Revenue, 651 N.W.2d 825, 830 (Minn.2002). We conclude, therefore, that section 289A.35 does not grant the Commissioner the sweeping power he claims in this case. The Commissioner next claims authority under Minn.Stat. § 290.07, subd. 2. That section provides, in relevant part: [N]et income and taxable net income shall be computed in accordance with the method of accounting regularly employed in keeping the taxpayer's books. If no such accounting system has been regularly employed, or if that employed does not clearly or fairly reflect income or the income taxable under this chapter, the computation shall be made in accordance with such method as in the opinion of the commissioner does clearly and fairly reflect income and the income taxable under this chapter. Id. By its plain language, section 290.07, subd. 2, is about methods of accounting. See Duluth, 207 Minn. at 627, 292 N.W. at 406 (stating that an earlier version of the section was aimed exclusively at methods of accounting). The statute provides that, if an accounting method employed by a taxpayer does not fairly reflect income, the Commissioner may compute tax according to a different method of accounting. The tax court in the case before us made no finding that HMN used a flawed accounting method in computing its taxable income. At trial, HMN's accounting expert testified that HMN kept records regarding its captive REIT strategy according to generally accepted accounting principles. The Commissioner does not assert that HMN used an improper accounting method or that the generally accepted accounting principles used by HMN failed to fairly reflect its taxable income. Rather, the Commissioner's issue appears to be with the result reached when accounting methods allowed by statute were employed. We conclude that section 290.07, subdivision 2, does not grant the Commissioner the power to disregard HMN's structure and to tax HMN as the Commissioner sees fit. The Commissioner also claims authority to attribute income and assess taxes to HMN under Minn.Stat. § 290.20, subd. 1. This provision deals with the allocation of taxable income among states for corporations doing business in more than one state. See id. Subdivision 1 provides, in relevant part: The methods prescribed [for allocation of taxable income] by section 290.191 shall be presumed to determine fairly and correctly the taxpayer's taxable net income allocable to this state. If the methods prescribed by section 290.191 do not fairly reflect all or any part of taxable net income allocable to this state, the taxpayer may petition for or the commissioner may require the determination of net income by the use of another method, if that method fairly reflects net income. Id. Minnesota Statutes § 290.20, subd. 1, by its plain language, includes a presumption that a taxpayer has fairly and correctly determined its Minnesota taxable income if that taxpayer used the reporting methods outlined in section 290.191. Section 290.20, subdivision 1, conditions any authority granted to the Commissioner on the methods prescribed by section 290.191 failing to fairly reflect taxable net income in Minnesota. Id. Importantly, the Commissioner makes no assertion or argument that HMN did not properly follow the methods prescribed by section 290.191, nor does the Commissioner make any attempt to rebut the presumption that those methods produce fair and correct results. Rather, the Commissioner appears to take issue with the result rather than the methods HMN used to reach that result. We thus conclude that section 290.20, subdivision 1 does not grant the Commissioner the authority to attribute income and assess taxes he claims. The Commissioner also claims authority under Minn.Stat. § 290.34, subd. 2, which provides that the Commissioner may require such combined report as, in the commissioner's opinion, is necessary in order to determine the taxable net income of any one of the affiliated or related corporations. The issue before us, however, is not whether the Commissioner had authority to require a different combined report, but whether he had authority to disregard HMN's captive REIT structure in assessing HMN's income and taxes. Indeed, in arguing that the foregoing four provisionsMinn. Stat. §§ 289A.35; 290.07, subd. 2; 290.20, subd. 1; and 290.34, subd. 2grant him statutory authority to disregard HMN's captive REIT strategy, the Commissioner does not appear to argue that any one of the provisions alone grants him the authority he claims. Rather, the Commissioner essentially argues that the four provisions, taken together, add up to a broad grant of authority to close statutory tax loopholes. This argument is not convincing, especially in light of the issue raised in this case. HMN complied with the requirements of all relevant statutes in structuring its business. The Commissioner does not dispute this point, but instead the Commissioner would have us allow him to ignore HMN's statutory compliance based on the amorphous authority that he argues is created by a series of other statutes. But for all the previously stated reasons, we decline to do so. Finally, the Commissioner argues that Minn.Stat. § 290.34, subd. 1, grants him authority to act as he did. Section 290.34 subdivision 1, upon which the tax court relied heavily, states, in relevant part: [ clause 1 ] [4] When any corporation liable to taxation under this chapter conducts its business in such a manner as, directly or indirectly, to benefit its members or stockholders or any person or corporation interested in such business or to reduce the income attributable to this state by selling the commodities or services in which it deals at less than the fair price which might be obtained therefor, or buying such commodities or services at more than the fair price for which they might have been obtained, [ clause 2 ] or when any corporation, a substantial portion of whose shares is owned directly or indirectly by another corporation, deals in the commodities or services of the latter corporation in such a manner as to create a loss or improper net income or to reduce the taxable net income attributable to this state, [ clause 3 ] the commissioner of revenue may determine the amount of its income so as to reflect what would have been its reasonable taxable net income but for the arrangements causing the understatement of its taxable net income or the overstatement of its losses, having regard to the fair profits which, but for any agreement, arrangement, or understanding, might have been or could have been obtained from such business. The Commissioner argues that he had authority to disregard HMN's captive REIT structure under clause 1 of subdivision 1, because HF Bank gave HF Holding the free services of some of HF Bank's officers. HMN responds to this argument by asserting that the services in question were de minimis and therefore should not trigger clause 1. HMN also argues that, even if the free services did trigger clause 1, the Commissioner's only remedy under clause 3 was to assign a reasonable value to the free services. The parties appear to agree that the free services HF Bank's officers performed for HF Holding are services that were sold for purposes of section 290.34, subdivision 1. Contrary to HMN's arguments, even if the services were as minimal as HMN claims, they had some value greater than zero. Because HF Bank reduced its income by giving away free services, these services triggered clause 1. But, as HMN argues, the plain language of clause 3 limits the remedy that the Commissioner has to correct HF Bank's selling its employees' services ... at less than the fair price which might be obtained therefor. § 290.34, subd. 1. Clause 3 specifically provides that, to correct a violation under the rest of subdivision 1, the Commissioner may determine the amount of [a corporation's] income so as to reflect what would have been [that corporation's] reasonable taxable income but for the arrangements causing the understatement of [that corporation's] taxable net income.... Id. Here, if HF Bank understated its income, it did so only by an amount equal to the actual value of the services that its officers gave away. The Commissioner apparently made no attempt to ascertain the value of those services, nor did he purport to adjust HMN's taxable net income by an amount equal to their value. Rather, the Commissioner disregarded HMN's captive REIT structure altogether and assessed taxes to HMN as if that structure was never in place. These actions by the Commissioner are not authorized by the plain language of clause 3. Therefore, we conclude that the remedy sought by the Commissioner is outside of the authority granted to him under clause 3 of section 290.34, subdivision 1. [5] Additionally, the Commissioner argues that he had statutory authority to disregard HMN's captive REIT structure because HF Bank transferred interests in loans to HF REIT triggering clause 1 of section 290.34, subdivision 1. As mentioned above, clause 1 is triggered when a corporation sells services at other than a fair price. HMN concedes that the loans are services under section 290.34, subdivision 1, and it is uncontested that HF Bank sold interests in those loans to HF REIT. Thus, clause 1 would have been triggered if HF Bank sold the loans at other than a fair price. The only finding the tax court made with respect to the price at which HF Bank sold loan interests to HF REIT was a finding that the agreement between the two required that the interest in the loans purchased by the REIT would be the fair market value.... At trial, the Commissioner never challenged the fairness of the price of the loan interests, nor does he challenge the fairness of the prices now. Rather, the Commissioner emphasizes that the profits from the loans in this case were passed on from HF REIT to HF Holding, and finally to HF Bank. This sequence of events is true and uncontested; but these facts are not relevant to Minn.Stat. § 290.34, subd. 1. Therefore, we conclude that the Commissioner's arguments that HMN's transfer of loan interests triggers clause 1 lack merit. The Commissioner also argues that HF Bank's sale of loan interests to HF REIT, and the flow of the profits to HF Bank from those interests, triggers clause 2 of subdivision 1. Clause 2 is triggered, when any corporation, a substantial portion of whose shares is owned directly or indirectly by another corporation, deals in the commodities or services of the latter corporation in such a manner as to create a loss or improper net income or to reduce the taxable net income attributable to this state.... Minn.Stat. § 290.34, subd. 1. In essence, the Commissioner argues that clause 2 applies because HF Holding, which is wholly owned by HF Bank, and HF REIT, which is essentially wholly owned by HF Holding, dealt in the services of HF Bank in such a manner as to reduce its taxable net income attributable to Minnesota. While HMN concedes that loans can be services for the purposes of section 290.34, subdivision 1, it does not appear that HF Holding and HF REIT dealt in those services and neither party squarely addresses this issue. The only action that an affiliate of HMN took that could be construed as dealing in the loan interests at issue is when HF Bank sold its loan interests to HF REIT. But if HF Bank sold loan interests to HF REIT at other than a fair price, thereby triggering clause 1 or 2 of section 290.34, subdivision 1, the Commissioner's remedy is limited by clause 3. As discussed above, clause 3 states that if either clause 1 or 2 is triggered, the Commissioner may determine the amount of [a corporation's] income so as to reflect what would have been [that corporation's] reasonable taxable income but for the arrangements causing the understatement of [that corporation's] taxable net income.... As applied here, clause 3 grants the Commissioner the power to determine a fair price for the loan interests and then to assign income to HF Bank, and subtract income from HF REIT, in an amount equal to the difference between the fair price and the price for which the loan interests actually sold. Indeed, this is what happened in the only case in which we have interpreted section 290.34, subdivision 1 Addison Miller, Inc. v. Commissioner of Taxation ( Addison ), 249 Minn. 24, 81 N.W.2d 89 (1957). Addison involved two businesses, a corporation and a partnership, both owned by the same people. Id. at 24-25, 81 N.W.2d at 90. The corporation rented equipment to the partnership at a low rate and gave the partnership an interest-free loan. Id. at 25, 81 N.W.2d at 90. The Commissioner determined the fair rental value of the equipment and a fair interest rate for the loan. Id. at 25-26, 81 N.W.2d at 90. Acting under the authority granted to him by section 290.34, subdivision 1, the Commissioner then increased the corporation's taxable net income to reflect the fair values that should have been paid. Id. Our decision in Addison upheld the Commissioner's action. Id. at 29, 81 N.W.2d at 92. In Addison, the Commissioner did not disregard the taxpayers' business structurethe fact that one business was a corporation and the other was a partnership. He merely corrected the pricing in the questioned transactions and corrected the businesses' incomes accordingly. Here the Commissioner claims authority to disregard HMN's business structure entirely. Consistent with Addison, if the Commissioner believed the loan interests were sold at other than a fair price, the Commissioner could have corrected the selling price of the loan interests and adjusted HF Bank's and HF REIT's incomes accordingly. But the Commissioner does not allege that the loan interests were sold at other than a fair price, and the tax court made no such finding. Thus, on the facts in this case, we conclude that section 290.34, subdivision 1 does not give the Commissioner the authority he claims. Moreover, as HMN points out, it is important to note that nothing in section 290.34, subdivision 1 or any of the other statutes under which the Commissioner claims authority for his action, expressly gives the Commissioner the authority to override other statutes. Indeed, the Commissioner does not cite any authority addressing the issue of whether the Commissioner can tax according to substance rather than form when a taxpayer has structured its business to be in full compliance with the relevant tax statutes. HF Holding qualifies as a foreign operating corporation, and the Commissioner does not challenge the tax court's findings on this point. During the tax years at issue, foreign operating corporations received beneficial tax treatment under Minnesota statutes. The Commissioner clearly dislikes the tax consequences that occur under the relevant statutes, but it is for the legislature, not the Commissioner, to change the law that creates such consequences. Indeed, the legislature did just that when it changed the definition of a foreign operating corporation in 2005 to do away with the captive REIT strategy. See Act of July 13, 2005, 1st Spec. Sess., ch. 3, art. 3, § 5, 2005 Minn. Laws 2273, 2321. In sum, we conclude that none of the statutes cited by the Commissioner give him the authority to disregard HMN's captive REIT business structure.