The Burden of Burden of Proof

Roxanne Bland

Roxanne Bland is Tax Notes State’s contributing editor. Before joining Tax Analysts, Bland spent 17 years with the Multistate Tax Commission, where she worked with state revenue agency representatives to draft model legislation pertaining to sales and use taxation and corporate income, analyzed and reported on proposed federal legislative initiatives affecting state taxation, worked with legislative consultants and representatives from other state organizations on international issues affecting states, and assisted member state representatives in federal lobbying efforts. Before that, she was an attorney with the Federation of Tax Administrators for over seven years.

In this installment of The SALT Box, Bland reviews how taxpayers should handle meeting their burden of proof standard.

In state tax appeal cases, the taxpayer bears the burden of proof. The reason for this, it is argued, is that the taxpayer possesses the necessary information and is in the best position to establish proper tax liability. Although many cases of dispute involve tax liabilities, some involve questions of constitutionality. For example, a taxpayer may allege that a state levy is discriminatory, whether on its face, as applied, or by its impact. Or a taxpayer may charge that a tax is an undue burden on interstate commerce. In each case, the taxpayer still bears the burden of proving the law in question is constitutionally faulty, and must do so by demonstrating its weaknesses under to the applicable constitutional standard laid down by the U.S. Supreme Court. That standard can be high, as under the commerce clause, or low, as under the equal protection clause.

How Not to Handle Burden of Proof

New Jersey requires entities classified as partnerships for federal income tax purposes to file informational returns showing income or loss if the partnership has a resident partner/owner, or derives income from New Jersey sources. In 2002 the state, aiming to address the large and multinational corporations earning billions of dollars in income derived from New Jersey sources yet paying only the minimum tax, enacted a processing fee levied on partnerships and other passthrough entities to defray the substantial costs of processing the large volume of partnership returns and of compliance enforcement. The statute requires partnerships to pay 100 percent of the fee for the year plus 50 percent of the fee due the following year.¹ The latter is applied as a credit when the following year’s fee is due and, to the extent it exceeds that fee, is credited in future years.² The fee is imposed on the partnership owners, but assessed at the entity level and passed through to the owners.

Targa makes a prima facie case for taxpayers on how not to handle its burden of proof.³ Targa is a publicly traded Delaware limited partnership, with a principal place of business in Texas. Its structure is complex, with indirect ownership of several other limited partners, two of which operate in the natural gas industry and earn income derived from New Jersey. Targa’s remaining limited partners are members of the public. For the tax years at issue, the partnership had several thousand limited partners who were members of the public and New Jersey residents.

The Division of Taxation notified Targa of its failure to pay processing fees for several years, and imposed penalties and interest. The partnership challenged the imposition of a fee imposed on partnership entities, arguing that it violated the dormant commerce clause by contravening the four prongs of the Complete Auto test: It is applied to an activity that has substantial nexus with the taxing state, it discriminates against interstate commerce, it is not fairly apportioned, and it is not fairly related to the services provided by the state. Further, Targa argued, the fee violates the internal consistency test, which functions as an indicator of whether a tax is fairly apportioned.

Following a review of relevant U.S. Supreme Court precedent, the tax court concluded that fees are subject to dormant commerce clause analysis — The Supreme Court had noted that although it has invalidated flat fees under the dormant commerce clause, its decision in ATA-Michigan found “nothing in our case law suggests that a neutral, locally focused and unapportioned fee or tax is inconsistent with the dormant commerce clause.” It thereby upheld the validity of Michigan’s $100 flat fee that taxed intrastate trucking activities even though some interstate haulers could become subject to the fee if they engaged in intrastate activity.⁴

Having determined that a fee is subject to dormant commerce clause scrutiny, the court turned to whether the taxpayer was engaged in interstate commerce, thereby invoking the dormant commerce clause in its claim of discrimination. After extensive analysis, the court found the taxpayer was engaged in interstate commerce and turned to the question of what activity the fee targets. Finding the fee is imposed on a purely local activity — the examination of partnership returns by the department — the court said it does not qualify as intra- or interstate commerce, even if it falls on a partnership that engages in interstate commerce.

After finding the fee was not facially discriminatory and applied in an even-handed manner, the court turned to the taxpayer’s argument that the fee had a disparate impact on its investment activity. The question the court asked was whether the fee prevents “out-of-state entities or businesses from doing business in New Jersey by making them pay more than their share of a state-imposed levy or by making it so expensive, disproportionately for them, to participate in New Jersey business, and thus, cause a disparate impact on [the taxpayer’s] investment activity.”

Addressing the issue of proof in what seemed like a scolding tone, the court explained that resident and nonresident partnerships, all else being equal, are subject to the same fee and cap. And while acknowledging the cost of doing business in the partnership model increases, as it would for any other kind of levy, this does not mean the fee contravenes the dormant commerce clause by overly burdening or discriminating against interstate commerce. Smaller partnerships will pay less than larger partnerships like the taxpayer. However, the partnership model was what the taxpayer chose to conduct its business, and the dormant commerce clause is not implicated by the mere differences in the nature of two businesses, as opposed to location or category. The court points out that in terms of the economies of scale, the taxpayer, even though it pays the fee up to its cap, will pay less per partner than will the partnership with fewer partners. If this means the fee somehow affects interstate commerce, for the taxpayer, that impact is minimal or incidental, the court said.

Further, the court added, if the fee is unduly burdensome, the taxpayer failed to show proof of this effect, as there was no evidence showing: the largest number of returns processed were filed by out-of-state entities; the largest percentage of those entities’ income was from non-New Jersey sources; and those percentages would be discriminatory in practical effect, favoring local businesses. There was no evidence showing that the largest out-of-state passthrough entities like the taxpayer were the most prejudiced by the fee because the “cost to invest in, or contribute capital to, the affiliate partnerships, which sell/trade tangible goods, or sell services, in-state and out-of-state, is much greater than the cost to an in-state similar investor.”

The court seemed disturbed that Targa’s sole proof of a discriminatory fee was through applying the internal consistency test. A hypothetical math problem, it said, “is not a substitute for [the taxpayer’s] proving, at least prima facie, that the [fee] results in a disparate impact on its interstate investment activity.” The court cited a string of cases in which the plaintiff, whether it won the day or not, made a prima facie showing of the disparate impact on its interstate activities. In ATA-Michigan, the Supreme Court rejected the plaintiff’s argument that it “need not provide any empirical evidence to show that the flat fee was burdensome or had a practical discriminatory effect.” The court also quoted a 2017 decision by the Idaho Supreme Court: “Wynne endorsed the internal consistency test as a method of identifying discriminatory tax schemes, but does not do away with the other showing to implicate the commerce clause, i.e., ‘a substantial effect on an identifiable interstate activity or market.’”⁵ Finally, the court noted that although the Supreme Court upheld the $100 flat fee at issue, ATA-Michigan failed the internal consistency test. The fee, the Court said, “did not tax activity, in whole or in part, outside the state,” yet conceded that under the hypothetical internal consistency test, “if the same fee was imposed by all states, an interstate truck would pay much more in fees.” The Court explained away the problem by stating “that a trucker transporting goods in- and out-of-state [pays] much more only because it engages in local business in all those states.” Thus, the New Jersey court said, the taxpayer’s reliance on the internal consistency test is misplaced, “and is certainly not the law.” Internal consistency, the court added, “should not be seen as a rule of general application, and precedent did not establish a grandiose version of the internal consistency test as the constitutional measure of all state taxes under the dormant commerce clause, thus, do not stand for the proposition that nondiscriminatory state taxes must also be generally internally consistent to pass constitutional muster.”⁶

Conclusion

Whether an issue is one of liability or one of constitutionality, the taxpayer carries burden of proving his case before a tribunal, whether administrative or a court. Indeed, perhaps the most oft-seen phrases in an administrative law judge’s opinion is “the taxpayer failed to carry meet its burden of proof.” A tax agency’s final determination of liability is generally presumed valid; it is up to the taxpayer to present its evidence, such as contemporary business records and accounting data, to show the agency’s calculation is incorrect, or that its presumably taxable income is nontaxable or exempt. It is no different for the taxpayer when challenging the constitutionality of a tax. It is not enough for a taxpayer to simply say “it’s not fair,” he must show the administrative judge or court proof why the law fails to meet whatever constitutional standard is applicable; that is, it is unconstitutional on its face, as applied, or in effect. A standard may come with tools to help a court dig deeper into the constitutionality of a statute, but these tools, by themselves, are not constitutional standards. Such is the case with the internal consistency test. The test is not the law; indeed, the Supreme Court has upheld a fee in one case where it failed the test, but there were other factors, far more significant than the internal consistency test, that carried the day in favor of the state. Given all this, it makes one wonder why the taxpayer in Targa chose to rely solely on the internal consistency test to prove the fee’s unconstitutionality. It seems that if the taxpayer could not prove the fee’s discriminatory effect, it should have just held its nose and paid the fee, rather than spend the time and money litigating a losing case.