Menu
Tax Notes logo

More Than a Mere Denial: A Review of Kentucky Final Rulings

Posted on Oct. 15, 2019

A review of hundreds of final letter rulings pried loose from the Kentucky Department of Revenue offers insights for taxpayers when challenging an assessment or refund denial.

Generally, state revenue departments allow taxpayers to protest assessments or refund denials by submitting a written request within a specified period of time. In Kentucky, taxpayers must file a protest and supporting statement within 60 days of a notice of assessment to prevent the assessment from becoming final, but may request a conference or final ruling at any time after filing a timely protest.

Tax Notes received copies of 406 final rulings after intervening in a lawsuit filed by Mark Sommer of Frost Brown Todd LLC over the Kentucky Finance and Administration Cabinet and DOR declining to comply with a 2012 open records request.

After the Kentucky Court of Appeals held that the DOR had to release redacted copies of the final rulings, the Kentucky Supreme Court affirmed the appellate court on a 3–3 vote in November 2018 and declined to reconsider its decision in an April 18 order.

The rulings, all of which are unappealed final rulings issued by the DOR between January 1, 2004, and April 23, 2013, are overwhelmingly in favor of the DOR.

More Than a Mere Denial

Many of the rulings upheld either an assessment or a refund denial because taxpayers failed to provide documentation or supporting statements stating the grounds upon which the protest was made. The rulings cite KRS 131.110(1) and two Kentucky Court of Appeals cases: Eagle Machine Co. Inc. v. Commonwealth ex rel. Gillis from 1985 and Scotty’s Construction Co. v. Revenue Cabinet from 1989.

Quoting Eagle Machine, the DOR stated in the rulings that the courts have held that KRS 131.110(1) imposes a legal duty on a taxpayer protesting an assessment or refund denial to provide the DOR with “something more substantial than mere denials of tax liability.” The DOR explained that the taxpayer must provide some documentation that would allow the department a basis for reconsideration.

The DOR added that the statutory provision is mandatory in nature and the failure to submit documentation in accordance with the provision results in the loss of the taxpayer’s right to further review.

In an April 2012 ruling, the DOR lowered a portion of a sales and use tax assessment relating to supply purchases and disallowed deductions after an auto repair store submitted documentation. However, the department declined to further reduce the assessment after the business failed to respond to requests for additional documentation.

But the DOR seems to have a lower threshold for correspondence to be treated as a protest, determining in a September 2011 ruling that the return of an assessment with a notation that the account number and name on the notice is the property of the United States or the state of Kentucky should be treated as a protest. The DOR, however, concluded that the protest was not accompanied by a supporting statement and held that the assessment was valid.

Mark Loyd of Bingham Greenebaum Doll LLP told Tax Notes that it's not surprising that a common scenario involves taxpayers filing a protest but failing to provide a basis for their position. He said this could be because there is no basis for their position or they are unable to articulate it.

Rulings of Note

Tax Notes in its review found several rulings of note, including one that seemed to address remote seller taxation in the state more than seven years before the U.S. Supreme Court’s decision in South Dakota v. Wayfair Inc.

The DOR in a January 2011 ruling determined that a Kentucky company that sells textbooks online as a third-party seller was responsible for sales and use tax on books shipped to in-state residents from an in-state location.

The taxpayer had argued that it didn't owe the tax because it didn't deal with the purchasers directly and sold the books through online retailers. It claimed that it wasn't the retailer and was not a factor or agent that would be deemed a retailer and subject to tax under regulation 103 KAR 25:050.

The DOR concluded that the transactions were taxable retail sales in the state because the online companies “whose efforts resulted in these sales” remitted to the taxpayer the amounts paid for the books, minus their fees, and the taxpayer had shipped or delivered its books to in-state customers from a Kentucky location. The company “had either made these sales itself or acted as a factor or agent” because the online companies had entrusted the sold books to the company for delivery in Kentucky, the DOR ruled.

In an October 2012 ruling, the DOR found that a corporation had failed to add back related expense deductions to nontaxable income. The company had argued that it had related expenses in accordance with the definition of net income in KRS 141.010(13)(d) and IRC section 482. But the department took the position that the transfer pricing statute does not address expenses related to nontaxable income. It also maintained “that transfer pricing does not apply to portfolio income.”

According to Loyd, the taxpayer in that ruling appeared to have disputed the DOR’s disallowance of 1.75 percent of the cost of the assets producing the nontaxable income by arguing that section 482 was analogous. While the DOR determined that KRS 141.010(13)(d)(4) disallowed the deduction for expenses related to nontaxable income, Loyd added that it “would seem that a taxpayer could dispute a particular allocation of costs to nontaxable or exempt income as arbitrary.”

The DOR also concluded in a January 2012 ruling that a tobacco products retailer was not eligible for a  deduction for taxes paid on purchases that have been resold because of the taxpayer's failure to exercise due diligence.

The company had claimed that it paid sales tax when it purchased cigarettes for resale and deducted the cost of the cigarettes on its sales and use tax returns, but the department determined that the sales tax was never remitted to the DOR.

The DOR said the company had a valid seller’s permit during the time the purchases were made and had apparently issued resale certificates for other purchases but had not issued certificates for the cigarette purchases from its supplier of common ownership.

Under regulation 103 KAR 31:090, a retailer may take the deduction if it resells tangible personal property before making any use of it and has either paid the vendor the sales tax or paid the use tax in four circumstances, including when “through error, sales tax reimbursement or use tax is paid by the retailer with respect to the purchase price of property purchase for resale in the regular course of business.”

But because the company had failed to exercise due diligence, the DOR determined that the company had not met the requirement and was not eligible to take the deduction. The department also contended that the company’s sales and use tax returns and payments did not reflect that it had charged tax on the cigarettes it sold.

Loyd said the retailer appeared to have paid sales tax to a supplier that did not remit the tax to the DOR, adding that this is a trap for the unwary. “Many small retail businesses are unsophisticated and probably don’t realize that if you sell for resale, then you have to purchase for resale to take advantage of the resale exemption according to this regulation,” he said. 

But Loyd added that the retailer may have been able to argue that the regulation was inconsistent with the statutory resale exemption.

Redactions

In a July 2019 revenue procedure, the DOR announced that it would be publicly releasing redacted private letter rulings beginning October 1. To facilitate redaction of the rulings, DOR Executive Director J. Todd Renner said the format of the rulings would be changed to mirror that of the IRS’s letter rulings.

Under the new procedure, each private ruling letter will consist of four sections: a legend, the facts, the law, and the conclusion. The DOR will redact the legend before posting the rulings on its website. Renner said that under the new procedures, the taxpayer or an authorized representative would also need to acknowledge that the redaction is appropriate.

Tax Notes found seven rulings issued in 2011 and one in 2004 in which the names of the taxpayers requesting the ruling were not redacted, including in the body of the letters.

There seemed to be a lack of uniformity in the ruling letters provided to Tax Notes, which can be seen in three June 2011 ruling letters concerning the new home credit that all reached the same conclusion but were written slightly differently. The names of the taxpayers were not redacted by the DOR in the body of two of those rulings. (Tax Notes redacted the names of the taxpayers in the linked rulings.)

Also, generally the DOR only redacted taxpayer names and assessment amounts in the rulings, but in a May 2011 ruling, the department redacted details of collaboration agreements to which the corporate taxpayer was a party, including the length of a research agreement.

Copy RID