As we previously reported, last year the Appellate Tax Board issued a decision expanding the application of the sham transaction doctrine to transactions intended to transfer Massachusetts payroll and property to a corporation that otherwise lacked nexus with Massachusetts. The case, Allied Domecq Spirits and Wines USA, Inc. v. Commissioner, Mass. App. Ct. Dckt No. 2013-P-0984, involved the unusual scenario where the Department disputed taxpayer’s claim that an affiliated parent corporation (“ADNAC”) had nexus with Massachusetts. The Department took this position in order to prevent the taxpayer from including ADNAC in its combined Massachusetts return and claiming the benefit of ADNAC’s net operating loss carryforwards.
On April 2, 2014, the Massachusetts Appeals Court heard oral argument in the taxpayer’s appeal. Most of the Appellant’s time was spent covering familiar ground, with the justices focusing on a memorandum from 1996 extolling the tax benefits for the transactions and the limited contemporaneous documentation supporting the taxpayer’s claim that the transactions had a valid non-tax business purpose.
Some of the most interesting questions from the justices were directed at the Commonwealth. For example, one justice questioned why the Commonwealth was arguing that ADNAC did not have nexus with Massachusetts in 2000, when it was advertising an available Massachusetts position to potential external hires during that year. He went on to ask whether the Commonwealth’s position would mean “corporations cannot reorganize” and raised the example of a hypothetical company where an employee employed by a subsidiary and located in a satellite office slowly takes over a function that serves the entire affiliated group; the justice questioned whether the Commonwealth’s position would prevent the company from ever transferring that employee to the affiliated group’s parent and relocating the employee to the home office without it being a sham, as long as the transfer and relocation would result in a tax benefit. (He then seemed to answer his own question by stating that such a transaction would not be a sham as long as there was a contemporaneous memorandum justifying the transfer and relocation on a non-tax basis.)
Another justice expressed concerns with the 2003 statutory codification of the sham transaction doctrine, specifically focusing on the statutory requirement that taxpayers challenging the Department’s assertion of sham must establish by clear and convincing evidence that a “nontax business purpose” be “commensurate” with the tax benefit. He asked how a taxpayer would ever be able to quantify the benefit of certain internal functions like audit in a way that they could reasonably compare the value of the function to an easily quantifiable tax benefit. The same justice also questioned what would happen in a situation in which a taxpayer makes a “mistake” in business judgment, entering into a transaction that has much less financial benefit than originally anticipated . This lead the justice to ask the Commonwealth whether the “commensurate value” analysis was conducted based on actual results, or subjective belief, noting “that’s a tough one isn’t it?”
Overall, the Court asked probing questions of both sides, focusing more on the facts in the record with the Appellant while considering the broader policy implications while questioning the Commonwealth.
Regardless of whether the Appeals Court decides to sustain or reverse the Appellate Tax Board’s decision, one takeaway from the oral argument is that taxpayers restructuring their business should contemporaneously document the non-tax business purpose for the restructuring, and attempt to attach a value to the accomplishment of that business purpose that outweighs any potential Massachusetts tax benefit.