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Financial Institutions Win Michigan Methodology Dispute

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Posted on Dec. 16, 2019

The Michigan Department of Treasury incorrectly determined the tax base of two unitary business groups (UBGs) for purposes of the franchise tax on financial institutions, the state appellate court has held.

The Michigan Court of Appeals ruled December 12 in the consolidated appeals, TCF National Bank v. Department of Treasury and Flagstar Bancorp Inc. v. Department of Treasury, that the department misinterpreted the state’s statutory scheme by applying the method for calculating a financial institution’s tax base to each member of the UBG and adding the amounts together instead of treating the UBG as a single taxpayer.

Lynn Gandhi of Honigman LLP, who filed an amicus brief on behalf of the Michigan Chamber of Commerce in the case, applauded the decision. She told Tax Notes December 13 that businesses now have a precedential opinion that a UBG is “the taxpayer.” Gandhi added that the lower court judge had concluded that a UBG is a fiction and the taxpayers were the members of the UBG.

Under MCL 208.1265, the tax base of a financial institution for the franchise tax is its net capital, which is “determined by adding the financial institution’s net capital as of the close of the current tax year and preceding 4 tax years and dividing the resulting sum by 5.” The statute also provides that net capital for a UBG of financial institutions does not include the investment of one member in another member of the UBG.

Auditing TCF National Bank for January 1, 2008, through December 31, 2009, the department computed the net capital of each member of the UBG by taking the member’s equity capital as reported on TCF’s federal return and subtracting any investment it made in another member, goodwill, and government obligations. The department then averaged each member’s net capital for the current year with the four preceding tax years and added the amounts together to get the UBG’s franchise tax base.

This computation method resulted in a franchise tax deficiency of close to $560,000 for the company, with the hearing referee upholding an assessment of $323,872.

The department similarly audited Flagstar Bancorp for January 1, 2008, through December 31, 2011, and computed its tax base using the same method, which reduced its refund by approximately $3 million.

Both financial institutions filed complaints with the Michigan Court of Claims, arguing that the assessment was unlawful and the department had violated its equal protection rights by calculating the net capital as to each member of the UBG instead of calculating it for the UBG as a “single person.” The financial institutions argued that the department’s methodology did not wholly eliminate intramember investments as required by law.

The financial institutions contended that the department should have averaged the UBG’s net capital for the five tax years instead of averaging the net capital of each UBG member then adding those amounts together.

The financial institutions also claimed that the department had erred by taking the net capital of members that had been in existence for fewer than five years and averaging the net capital for the years the member had been in existence instead of a five-year average.

The court of claims agreed with the department, finding that a UBG is not a separate and distinct entity and the statutory reference to a financial institution’s net capital refers to the UBG member’s net capital. The court concluded that a UBG is a creation of tax law, and that the department was correct to apply the computation method in MCL 208.1265(2) to the individual UBG members.

However, the court of appeals disagreed, finding that the plain language of MCL 208.1261(f), which defines “financial institution,” establishes that a financial institution “may be a type of bank, or an entity owned by such a bank that is a member of the UBG, or a UBG made up of either of both of these two types of entities.”

Read together in harmony, the statutes defining a financial institution, imposing the franchise tax on financial institutions, and setting out the method for computing net capital “unambiguously indicate that the Legislature intended the term ‘financial institution’ to mean a UBG when a UBG taxpayer’s franchise tax liability is at issue,” the court stated.

The court continued that “the specified methodology applies to the single UBG taxpayer that files the return in the same manner as when a single individual financial institution is the taxpayer filing the return.”

Concluding that the UBG’s net capital for a tax year is the total of its members’ net capital for that tax year, the court held that “all intramember investments must be determined and eliminated for the UBG’s net capital calculation” to avoid double counting net capital.

The court also rejected the department’s argument that the averaging must occur at the individual UBG member level because a UBG does not have an independent existence, and its years of existence can't be measured.

“Although UBGs are not separate and distinct legal entities like other business entities, they do exist for purposes of Michigan business tax law,” the court stated.

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Tax Analysts Document Number
DOC 2019-47321
Tax Analysts Electronic Citation
2019 TNTS 241-4
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