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Court of Appeals Excludes Towboat Employees’ Compensation from Payroll Factor Because They Did Not Perform “Some” Services in Kentucky


In Department of Revenue v. Marquette Transportation Co., LLC, Nos. 2006-CA-002639 & 2007-CA-001666, the Kentucky Court of Appeals held: (1) compensation of all of the towboat employees of Marquette Transportation Company, LLC (“Marquette”) should have been excluded from the numerator of its payroll factor because such employees did not perform services in Kentucky that rose to the level of “some” service as required under KRS 141.120(8)(b)3 and (2) the Kentucky Department of Revenue (“Department”) should have filed its Petition for Judicial Review of the Kentucky Board of Tax Appeal’s (“Board”) Order in the McCracken Circuit Court because Marquette had already properly filed a Petition for Judicial Review with that Court.

Marquette is a Delaware company that owns and operates towboats along the upper and lower Mississippi River and the Illinois River. Marquette has a Kentucky office, but has no customers in Kentucky, its towboats never stop in Kentucky and its towboat employees are never in Kentucky. The proof of record was undisputed that Marquette’s towboat employees merely sail by a 63-mile stretch of Kentucky.

Marquette filed amended corporate income and license tax returns with the Department requesting refunds for tax years 1995 and 2001. The Department issued a Final Ruling letter which stated that under KRS 141.120(8)(b)3, Marquette had failed to include the proper percentage of employee compensation in its payroll factor for its income and license taxes.

The Department acknowledged that not all of Marquette’s towboat employees performed “some” service in Kentucky. But, even so, it took the position that either their services were directed and controlled from Marquette’s Kentucky office or their base of operations was in Kentucky, and adjusted Marquette’s payroll factor to 100% Kentucky. Marquette contended that the towboat captains directed and controlled the towboat employees and that their base of operations was their homes, or, alternatively, the towboats.

I. Payroll Factor Issue

Marquette filed an appeal with the Board and argued that its towboat employees, including captains and pilots, who worked on the lower Mississippi River only briefly passed through Kentucky waters while traveling to different states. Thus, it argued that the compensation for such employees should have been excluded from the numerator of the payroll factor.

KRS 141.120(8)(b)3 provides that compensation is paid or payable in Kentucky and thus, included in the numerator of a corporate taxpayer’s payroll factor when:

Some of the service is performed in the state and the base of operations or, if there is no base of operations, the place from which the service is directed or controlled is in the state, or the base of operations or the place from which the service is directed or controlled is not in any state in which some part of the service is performed, but the individual’s residence is in this state.

The Board held that the compensation for Marquette’s towboat employees should have been excluded from the numerator of its payroll factor, but it did not address the compensation of the captains and pilots. Ultimately, both the McCracken and Franklin Circuit Courts affirmed the Board’s holding as to the “some” requirement of KRS 141.120(8)(b)3. The McCracken Circuit Court also held that the Department’s taxation of 100% of the towboat employees’ payroll violated the U.S. Commerce Clause.

The Court of Appeals focused on the “some” service test, and held that there was substantial evidence for the Board to find that the Department “had no reasonable basis in fact to conclude that Marquette’s towboat employees ‘were in fact performing services in Kentucky sufficient to bring them within the purview of KRS 141.120(8)(b).’” The Court stated, “[w]e are only concerned with actual service performed in Kentucky. It is irrelevant whether they could have performed some service in Kentucky.” Accordingly, the Court held that compensation of the towboat employees, including the captains and pilots, should have been excluded from Marquette’s payroll factor for the relevant tax periods.

II. Procedural Issue

Marquette filed a Petition for Judicial Review from the Board’s decision with the McCracken Circuit Court because the Board failed to grant all of the relief it had requested. The Board failed to clearly address the payroll factor treatment of the captains and pilots or to order Marquette’s 1995 and 1996 refunds. The Department did not file a cross-appeal with the McCracken Circuit Court, even though it was aggrieved by the Board’s Final Order. Nor did the Department file an Answer to Marquette’s Petition. Instead, the Department appealed to the Franklin Circuit Court, even though it had been previously served with Marquette’s Petition for Judicial Review filed in McCracken Circuit Court. The McCracken Circuit Court ruled in Marquette’s favor.

The Franklin Circuit Court also held in Marquette’s favor on the 1995 and 1996 refunds, but remanded the 2001 refund issue to the Department for review. The Department filed an appeal with the Court of Appeals and Marquette filed a cross-appeal regarding the Court’s ruling on the 2001 refund claim.

The Court agreed with Marquette that it was a “party aggrieved” since the Board failed to address whether the compensation of Marquette’s captains and pilots should have been excluded from the payroll factor and failed to address Marquette’s 1995 and 1996 refunds. Thus, the Court held that Marquette properly appealed to the McCracken Circuit Court and held that the Department appealed to the “wrong court.” The Court of Appeals vacated the Opinion and Order of the Franklin Circuit Court and remanded the decision to that Court with instructions to dismiss the Department’s Petition for Judicial Review.

The Court also vacated the McCracken Circuit Court’s Opinion and the Board’s Order addressing the 2001 refund requests and remanded the issue to the Department for review. The Court noted that Marquette did not establish that it was entitled to the 2001 refunds because the Department had not finished processing the claim and had prematurely denied the claim. The Department will likely petition the Supreme Court of Kentucky for discretionary review of the Court of Appeals’ decision.

The authors’ law firm represents Marquette in this matter.

If you have questions about this topic or any other legal issue, please contact any member of the firm's State and Local Tax Team.

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