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Corporate Income Tax Developments

Everything old is new again! Although unitary is all the rage across the country, seemingly spreading like wildfire from the west coast to the east coast, here in Kentucky, “unitary” is still, to some, a four-letter word – well, actually seven, but who’s counting? It was quite a shocker to many when H.B. 302 was introduced early in the 2008 Regular Session of the General Assembly, which would have required corporations to compute their Kentucky corporation income tax liabilities using the unitary combined reporting method. It was quickly withdrawn on January 28, 2008.

Given the massive changes to Kentucky’s income tax laws during the past three years, I would not have been surprised if a collective sigh of relief was heard across the Commonwealth. 2008 was not a year characterized by tax changes of a significant scope, but at a luncheon in the Governor’s Mansion at the KyCPA Government Relations Day, Governor Beshear made an appearance and hinted that he may look into making changes to Kentucky’s tax laws. It will be interesting to see if anyone has an appetite for that challenge.

With the change in gubernatorial administrations comes changes to the Department of Revenue. William “Bill” M. Cox Sr. is now the Commissioner of the Kentucky Department of Revenue. However, Elyse Weigel remains the Deputy Commissioner, and Gary Morris remains the Executive Director of the Office of Income Taxation. Over the past few months, the Department has not attempted to promulgate any new income tax regulations, although some may welcome additional guidance regarding a variety of topics including the limited liability entity tax.

While there does not seem to be much support for legislation to bring back the unitary method, litigation continues; this has its genesis in the landmark case of GTE v. Revenue Cabinet, 889 S.W.2d 788 (Ky. 1994), which the Kentucky Supreme Court decided on December 22, 1994 – a date which may very well “live in infamy” or at least in seeming perpetuity. In response to the GTE decision, the 1996 General Assembly enacted legislation to prohibit the filing of unitary returns, for tax years ending on or after December 31, 1995 (and, thus, 2008 H.B. 302 would have been quite an “about face”), and provided for elective consolidated returns.

Two years later, the 1998 General Assembly included a provision in a Budget Bill which purported to bar refund claims based on unitary returns first filed after December 22, 1994 (the decision date of GTE). The Franklin Circuit Court declared that provision unconstitutional as it violated Section 51 of the Kentucky Constitution, and that litigation ended as the Budget Bill had expired. Elk River Res., Inc. v. Revenue Cabinet, Nos. 98-CI-1221 & 98-CI-1223 (Franklin Cir. Ct., Div. I 2000).

The 2000 General Assembly also enacted another statutory provision which purported to retroactively extinguish taxpayers’ unitary refund claims filed after the GTE decision date. That bill became the subject of a judicial challenge, which in 2006 resulted in an opinion by the Kentucky Court of Appeals that the provision at issue was unconstitutional on due process grounds. Johnson Controls, Inc. v. Rudolph, No. 2004-CA-001566-MR (Ky. App. May 5, 2006). The Department made a request to the Kentucky Supreme Court for discretionary review of the opinion, which the Court granted on December 12, 2007. The case remains there.

Not missing a beat, the 2007 General Assembly enacted yet another statutory provision, this one which purported to amend Kentucky’s general refund statute toretroactively revoke the Commonwealth’s consent to suit and to bar a refund based on unitary returns requested after (you guessed it) December 22, 1994. Johnson Controls again sought relief, this time in U.S. District Court, to enjoin enforcement of the 2007 law – suing the Department of Revenue and certain state officers in their official capacities. Johnson Controls, Inc. v. Finance & Admin. Cabinet, No. 3:07-CV-65-KKC (E.D.Ky.).

Responding to Revenue’s motion to dismiss Johnson Control’s lawsuit, in an order dated February 29, 2008, the U.S. District Court dismissed the suit against Revenue as the Eleventh Amendment of the United States Constitution barred the claims; however, the Court found that there was no jurisdictional bar to the relief requested in the form of declaring the 2007 law unconstitutional as violating the Due Process and Equal Protection Clauses and enjoining the Secretary of the Finance and Administration Cabinet and the Commissioner of the Kentucky Department of Revenue from enforcing the law at issue. The Court also found that the Tax Injunction Act and common law principles of federal equity/comity did not bar the lawsuit. In essence, this means that the case will continue against the Secretary and the Commissioner (in their official capacities), and that the Court will hear the case on its merits.

Perhaps not coincidentally, a taxpayer has challenged Revenue’s interpretation of the elective consolidated return provisions (which were effective generally for calendar tax years 1995 to 2004, and will continue in effect until the expiration of the involved election) put into place by the 1995 General Assembly in response to GTE. In that challenge, the involved taxpayer, AT&T, had argued that a Kentucky consolidated return did not include those corporations organized in states other than Kentucky which had no property or payroll in Kentucky. However, on January 4, 2008, the Kentucky Board of Tax Appeals essentially concluded that a Kentucky consolidated return generally includes all members of a federal consolidated return (with certain exceptions). AT&T Corporation and Subsidiaries v. Finance and Administration Cabinet, File No. K01-R-18, Order No. K-19978 (KBTA Jan. 4, 2008). Notably, the Board did not address AT&T’s constitutional claims, and AT&T has requested the Jefferson Circuit Court to review the Board’s order.

The “Tax Modernization” legislation enacted in 2005 (H.B. 272) phased-out the elective consolidated return methodology and replaced it with a mandatory nexus consolidated return. It also, perhaps some would say infamously, retroactively imposed the corporation income tax on those traditional pass-through entities with the characteristic of limited liability for roughly a two-year period (generally, calendar years 2005 and 2006).

Not surprisingly, at least one taxpayer has challenged the retroactive imposition of the corporation income tax on it in a rather factually unique case. Sand Lake Properties, Ltd. v. Dep’t of Revenue, File No. K07-R-01, Order No. K-20006 (KBTA Feb. 22, 2008). Sand Lake Properties, Ltd., a limited partnership which had as its sole asset a parcel of land, sold its land on March 7, 2005, and dissolved before H.B. 272 became law. Sand Lake took the position that, because it sold its sole asset and dissolved prior to the enactment of H.B. 272, that the new law cannot be made to retroactively apply to the subject transaction; however, Revenue argued that in light of specific language, the new law applied to tax years beginning on and after January 1, 2005, and thus, the transaction was taxable to the limited partnership entity, rather than to its partners. Without citing any case law, the Board held for the taxpayer. It will be interesting to see how this plays out.

About the author: Mark A Loyd, Esq., CPA, is an associate in thetax and finance practice group of Greenebaum Doll & McDonald in Louisville. He is a member of the KyCPA Board of Directors, Editorial Board and Industry Task Force; and former chair of the Taxation Committee. He can reached at mal@gdm.com; 502.587.3552.

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