Travelocity.com v. Comptroller of Maryland (Ct. of Appeals)

 

Filed: April 30, 2021

Opinion by: Judge Michele D. Hotten 

Holding: 

Online travel companies that facilitate hotel room or car rental reservations were not liable for Maryland sales and use tax prior to the 2015 amendment to Md. Code § 11-102(a) of the Tax-General Article; that amendment specifically added such companies to § 11-102(a)’s statutory definition of “vendors” liable for sales tax.

Facts: 

Petitioner (“Business”) operated an online travel company that facilitated web-based transactions between customers and third-party airlines, hotels, and rental car agencies.  Business entered into contracts with the third-party providers whereby it gained access to their reservation systems and subsequently listed the available flights, rooms, and vehicles on its internet portal.  In real-time, Business would connect interested customers’ selected reservations to the third-party providers; if a specific transaction matched an interested customer with an availability, the customer received the reservation, the third-party provider received the booking, and Business handled the communications, payments, and cancellations.  Business marked up the base rates charged by the third-party providers in return for the service it provided.

In November 2011, Respondent (“Comptroller”) assessed Business based on an audit of its 2003-2011 operations (the “audit period”) for the difference in tax rates between that ordinarily paid by Business and that paid by the third-party providers.  Comptroller issued a final determination in November 2012 which assessed Business over $6.4 million in taxes, fees, and interest.

In December 2012, Business appealed the tax assessment to the Maryland Tax Court, arguing that only a vendor of rooms, and vehicles was required to pay sales tax, and that as an online travel company it neither owned nor controlled the right to possess any of the rooms or vehicles that might give rise to sales tax liability.  Business further argued that the Maryland General Assembly’s 2015 amendment of the Tax Code to expand the definition of “vendor” to include “accommodations intermediaries” supported its position that it was excluded from the definition of “vendor,” and thus not subject to sales tax until 2015.  In December 2017, the Tax Court held Business liable for sales tax because Business was engaged in the business of a retail vendor, sold the right to occupy rooms or rent vehicles, and that the act of facilitating such reservations and rentals constituted sale of tangible personal property subject to sales tax.  However, the Tax Court found Business not negligent in failing to pay the tax during the audit period, to have made a good faith appeal, and to be entitled to enjoy a four-year statute of limitations, arriving at an adjusted assessment of $295,000.

Both parties petitioned for review in the Circuit Court for Anne Arundel County.  The Circuit Court in 2018 heard Comptroller’s appeal and affirmed the Tax Court’s decision.  The circuit court initially dismissed Business’s appeal for procedural errors, but in 2019 vacated the dismissal, heard the appeal, and affirmed the Tax Court’s decision.

In May 2019 Comptroller noted its appeal to the Court of Special Appeals, which stayed the appeal pending the circuit court’s decision on Business’s appeal.  In March 2020 the Court of Special Appeals lifted the stay and consolidated the appeals.  Prior to consideration by that court, Business petitioned and the Comptroller cross-petitioned to the Court of Appeals for certiorari, which the Court of Appeals granted.

Analysis: 

The Court initially noted that the Tax Court’s interpretations of tax law often necessarily involve mixed questions of fact and law entitled to a degree of deference and that it would use the same standard of review appropriate to administrative agencies’ factual findings: whether a reasoning mind could reasonably have reached the agency’s conclusion.  By contrast, the Tax Court’s purely legal conclusions would be afforded great weight, but would not bind the Court and would be considered de novo.

The Court continued its inquiry with statutory construction in order to construe § 11-102(a) (which imposes sales and use tax liability on “retail sale in the State; and a use, in the State, of tangible personal property or a taxable service”) as it existed during the audit period in question.  In order for Business to be liable, its conduct must have been both (1) “a sale or use” (2) “of tangible personal property”.  Finding hotel rooms and car rentals to clearly qualify as concerning tangible personal property or rights thereto, the Court turned to whether the transactions constituted a sale or use.

Evaluating relevant contract language of contracts spanning 2004 to 2010 between Business and its various third-party providers, the Court determined the contracts not to have transferred title or possession of the hotel rooms or rental cars to Business, but merely to have given Business the right to make those rooms and cars available to customers of its web portal and thereby broaden the distribution of the third-party providers’ products and services. Business did not purchase inventory nor accept any risk of loss of that inventory pursuant to the contracts.  The third-party providers remained owners & operators of their hotels and vehicles. Business merely facilitated transactions between customer and provider. In light of that analysis, the Court found Business’s transactions not to have constituted a sale or use under § 11-102(a), and not to be liable for sales tax in the audit period.

The Court similarly found Comptroller’s alternate argument unavailing: that Business should be liable for sales tax as an out-of-state or retail vendor under § 11-701(b) or (c). The Court’s earlier analysis finding Business not to have acquired title or possession of the tangible personal property meant Business could not possibly qualify as an 11-701(b) out-of-state vendor or 11-701(c) retail vendor because Business’s conduct did not meet the Tax Code’s definition of a sale.  Nor were the third-party providers acting as agents of Business within the State; each party acted according to contractually-agreed terms for mutual benefit.  Business facilitated the transaction but third-party providers ultimately delivered the rooms and vehicles.

The Court determined that, as it existed during the audit period, the sales and use statute (1) excluded online travel companies from the definition of vendor (2) left no debate about whether Business’s service concerned tangible personal property, but (3) left open whether an online travel company (such as Business) constituted a vendor that sold or delivered such tangible personal property.  In 2015, the Maryland General Assembly clarified that third item by expanding the statutory definition of vendors to specifically include “accommodations intermediaries,” or those other than an accommodations provider who facilitate the sale or use of an accommodation for a fee.  The Court found this subsequent clarification by the General Assembly in adding  “accommodations intermediary” to the statutory definition of vendor meant that an intermediary such as Business was not a vendor liable for sales tax prior to the amendment; to find otherwise would render the new language mere surplusage. As to any potential ambiguity in the statute before the 2015 amendment, the Court interpreted that ambiguity in Business’ favor to further conclude that Business was not liable for sales tax during the audit period.

Accordingly, the Court reversed, finding the circuit court to have erred in its decision affirming the Tax Court.

Three Judges noted their dissent and would have affirmed the Tax Court’s conclusion that Business was a “vendor” under the Tax Code as it existed during the audit period.

The full opinion is available in PDF.

ConAgra Foods RDM v. Comptroller

ConAgra Foods RDM v. Comptroller (Ct. of Special Appeals)

Filed: June 27, 2019

Opinion by: Judges Woodward, Arthur and Leahy

Holding:

Foreign intellectual property holding company subsidiaries of corporations doing business in Maryland have no economic substance and are taxable separately from the parent.

Facts:

ConAgra is a processed food conglomerate that sold products in Maryland from 1996 through 2003, filed tax returns in Maryland and paid income tax.  One of its subsidiaries, Brands, was formed for the sole purpose of serving as an intellectual property holding company.  Brands licensed the trademarks to ConAgra and received royalties, and paid royalties back to the parent.

In 2007, the Comptroller of Maryland issued a Notice and Demand to File Maryland Corporation Income Tax Returns for 1996 through 2003 as well as a Notice of Assessment totaling $2,768,588 in back taxes, interest and penalties.  The Maryland Tax Court upheld the Comptroller’s assessment because Brands lacked “economic substance” as a separate business entity, which satisfied the U.S. Constitution requirements of “minimum contacts” and “nexus”. 

Analysis:

To meet U.S. Constitutional standards, the government’s tax collection procedures must provide taxpayers with “fair warning” to satisfy the Due Process Clause of the U.S. Constitution.  Under the Mobil Oil standard there must be a minimal connection between the interstate activities and the taxing State, and a rational relationship between the income attributed to the State and the intrastate values of the enterprise.  Mobil Oil Corp. v. Comm’r of Taxes of Vermont, 445 U.S. 425 (1980).  The Commerce Clause is designed to prevent States from engaging in economic discrimination, and requires that a tax (1) apply to an activity with a substantial nexus with the taxing State, (2) be fairly apportioned, (3) not discriminate against interstate commerce, and (4) be fairly related to the services the State provides.  Philadelphia v. New Jersey, 437 U.S. 617.

These criteria have been implemented by the Court of Special Appeals in several cases, and the Court agreed with the Maryland Tax Court in this case after reviewing the standards from Gore Enter. Holdings, Inc. v. Comptroller, 437 Md. 492 (2013) and Comptroller v. SYL, Inc., 375 Md. 78 (2003) as well as Comptroller v. Armco Exp. Sales Corp., 82 Md. App. 429 (1990).  In Gore, Gore assigned all of its patents and certain other assets to the wholly owned subsidiary in exchange for the subsidiary’s entire stock.  The four factors in Gore that helped the Court determine if the wholly owned foreign subsidiary lacked economic substance and was consequently subject to income tax in Maryland were:  1. How dependent the subsidiary is on the parent for its income; 2. Whether there is a circular flow of money between the two companies; 3. How much the subsidiary relies on the parent for its core functions and services;  4. Whether the subsidiary engages in substantive activity that is in any meaningful way separate from the parent.  Also, in SYL, the Court of Appeals adopted the Armco reasoning and found that sheltering income from state taxation was the predominant reason for the creation of SYL.

Here, Brands was dependent on ConAgra for the “vast majority” of its income, there was a circular flow of money between the companies, Brands relied on the parent for its core functions, and it did not have any meaningful substantive activity separate from ConAgra.

Separately, the Court also approved the State’s blended apportionment formula to determine Brands’ taxable income as an altered formula is permitted by Tax General Article 10-402(d) to clearly reflect income.  Here, the popular 3-factor apportionment formula based on property, payroll and sales would have yielded an apportionment factor of zero.  The blended formula accounted for ConAgra taking deductions for the royalty expenses.

The full opinion is available PDF.

Comptroller of the Treasury v. Jalali (Ct. of Special Appeals)

Filed: January 31, 2018

Opinion by: Judge James A. Kenney III

Holding: The Court of Special Appeals held that: (1) the question of whether advances of money to a business are considered debt or equity (the “debt-equity” question) is a mixed question of law and fact; (2) in deciding the debt-equity question, the Maryland Tax Court applied correct legal principles and properly evaluated the relevant facts and circumstances when it found that a taxpayer’s advances of money to business entities were advances of debt; and (3) the Court of Special Appeals would not consider an issue not raised by the Comptroller before the Tax Court because, on judicial review of administrative agency decisions, the Court of Special Appeals is restricted to the record before the agency and generally does not consider issues not encompassed in the agency’s final decision (although the Court went on to find that a taxpayer’s advances constituted bad business debt because the record supported a finding that the taxpayer’s dominant motivation for making the advances was to protect his employment).

Facts: Taxpayer made several advances to businesses he owned or in which he had an ownership interest. Each advance was documented by a written promissory note containing a loan amount, loan period, interest rate, and other repayment terms. The interest and repayment terms of the notes were not strictly complied with or enforced. None of the advances were secured. Ultimately, the businesses failed and the advances were not repaid. Taxpayer filed amended tax returns with the Maryland Revenue Administration division and the Internal Revenue Service for the relevant tax year. The amended returns reported the unpaid advances as unreimbursed business expenses and sought a resulting carried-back net operating loss and tax refund. The Comptroller rejected the returns. Taxpayer requested a final determination, and the Comptroller issued a Notice of Final Determination denying the requested refunds, in part, because (i) proof of acceptance of one applicable return by the IRS had not been provided; and (ii) the advances were not bona fide loans. Taxpayer appealed to the Maryland Tax Court, which reversed the Comptroller’s determination and granted the requested refunds. The Comptroller filed a petition for judicial review, and the Circuit Court for Anne Arundel County affirmed the Tax Court. On appeal by the Comptroller, the Court of Special Appeals affirmed the Tax Court’s decision.

Analysis:  The Court of Special Appeals first held (in contrast to Fourth Circuit precedent) that the debt-equity question is a mixed question of fact and law. Therefore, the Court limited its review of the Tax Court decision to determining whether “a reasoning mind reasonably could have reached the factual conclusion that the Tax Court reached”. Applying this standard, the Court found that, in addressing the debt-equity question, the Tax Court properly evaluated the facts of the case in light of many of the factors deemed relevant by applicable case law, including the adequacy of capitalization of the businesses, availability of outside financing, the presence of written promissory notes, the presence of stated loan terms, the unsecured position of the advances, the failure of the businesses to comply with interest and repayment terms, the taxpayer’s subjective intent, and the source of repayments. The Court then addressed the Comptroller’s claim that, even if the advances at issue were debt, the advances were non-business bad debt and therefore not deductible. The Court held that it would not consider the argument because it had not been raised before the Tax Court, noting that “[o]n judicial review of administrative agency decisions, we do not ordinarily ‘pass upon issues presented to us for the first time on judicial review.’” Nevertheless, the Court went on to find that there was sufficient evidence in the record that the taxpayer’s “dominant motivation” in making the advances at issue was to protect his employment, and, as such, the advances constituted deductible bad business debt.

The full opinion is available in PDF.

Zorzit v. Comptroller of Md. (Ct. of Special Appeals)

Filed:  October 1, 2015

Opinion by:  Judge Douglas R. M. Nazarian

Holdings:  (1) Maryland Court of Special Appeals upheld Tax Court’s finding of fraud, holding that appellant taxpayer’s (“Taxpayer”) intent to defraud Maryland Comptroller of Admissions and Amusement tax revenues could be inferred from  circumstantial evidence of understatement of income, failure to maintain records, and concealment of assets.  (2) In the absence of Taxpayer’s relevant records of sales or income, the Comptroller’s tax liability assessment was supported by substantial evidence of reasonableness, making the Tax Court’s affirmance of the assessment not in error.  (3)  No actionable claim of spoliation occurred where duty to preserve and evidentiary advantage were not present.

Facts:  From 1993 until 2009, Taxpayer owned and operated a business providing video poker machines and other coin-operated entertainment to establishments.  Under Md. Code §17-405, 408, and 414 of the Business Regulation Article, it is lawful to operate video poker machines without making cash payouts, provided that the machines are properly licensed and taxes paid on all revenues generated.  However, Taxpayer ran afoul of the Code in several ways.  First, with Taxpayer’s knowledge and approval, proprietors of the establishments made cash payments to video poker winners, deducting the payouts from the profit split between Taxpayer and proprietors.  Second, Taxpayer kept no records of the cash payments, nor any records of individual revenues on a per-machine basis.  Third, Taxpayer calculated its tax liability net of the cash payments.

A wide-scale undercover police investigation conducted from 2006 to 2009 led to the seizure of 83 video poker machines owned by Taxpayer.  Forensic analysis of the motherboards allowed police to determine the in- and out-credits from each machine and compile the data into a report later issued to the Comptroller’s Office.  Although the investigating officers conceded that (1) proprietors likely did not pay out every credit won and (2) in- and out-credits from prior ownership of the machines could not be distinguished, the Comptroller calculated its assessment assuming that every out-credit was paid.  Applying its hypothesis that 55% of in-credits would be paid out, the Comptroller assessed a tax deficiency of $2,159,724.97 for the 2000-2009 period, added interest and imposed a 100% fraud penalty.

Taxpayer appealed the assessment to the Tax Court in 2013, arguing that the payoff percentage was more likely between 20 and 25% due to (1) proprietors often declining to pay out-credits and (2) the unreliability of the in- and out-credits data where significant number of video poker machines had been purchased used.  Accounting for these differences, Taxpayer’s expert testimony provided by a statistician placed the tax deficiency at $466,016.10.  Taxpayer further disputed the fraud penalty on the theory that neither his employed CPAs, his retained attorney, nor his staff were aware the payouts were taxable, thus Taxpayer lacked requisite intent to defraud.  The Tax Court was only partially persuaded, finding the record insufficient to change the Comptroller’s tax liability assessment, but using its discretion to adjust the fraud penalty to 50% by balancing the facts that the accounting was not perfectly accurate but Taxpayer’s fraud warranted a penalty.

Taxpayer filed petition for judicial review in the Circuit Court for Baltimore County which affirmed the Tax Court’s decision on June 5, 2014.  Taxpayer thereafter filed a timely notice of appeal.

Analysis:  Taxpayer presented the court with two questions for review:  first, whether the Tax Court erred in imposing its fraud penalty without a finding of intent to evade payment.  And second, whether the Tax Court erred in affirming an assessment based on admittedly erroneous assumptions and evidence the Comptroller failed to preserve.

The court began by pointing to a case both fully on-point and decided by the same court in 1993: Rossville Vending.  In that case, Rossville’s video poker units had been placed in establishments whose proprietors paid cash payments directly to winners, but Rossville paid no taxes on the cash payments.  Finding no ambiguity in the amusement tax statute’s operative phrase ‘gross receipts,’ the Rossville court found no room for reasonable argument for adjustments or deductions before calculation of the tax due.

Taxpayer pled ignorance: arguing that although he had personal relationships with Rossville Vending’s owners and knowledge of their business, he lacked actual knowledge of the Rossville court’s decision until after the Comptroller’s assessment, and so lacked any intent to withhold taxes.

The court next referenced Genie & Co., which held that direct evidence of fraud is unnecessary, but often inferred by circumstantial evidence.  The Genie court imported the federal “badges of fraud” doctrine to Maryland jurisprudence, highlighting seven factors to guide courts in identifying circumstantial evidence of fraud: 

1. Consistent and substantial understatements of income (or sales, in the sales tax arena);
2. Failure to maintain adequate records;
3. Implausible or inconsistent explanations of behavior, including lack of credible testimony before a tribunal;
4. Concealment of assets;
5. Failure to cooperate fully with tax authorities;
6. Awareness of the obligations to file returns, report income or sales, and pay taxes, and;
7. Failure to file returns.

Finding substantial evidence of badges one, two, and four in the failure to keep records of gross revenues, concealment to avoid criminal liability, and faulty accounting methods recording net income by location rather than per-machine basis, the court agreed with the Tax Court that the badges of fraud analysis indicated an intent to conceal revenue.  Even were the Taxpayer’s claimed ignorance legitimate, the court further found the failure to research its tax liability to be willful blindness, and tantamount to fraud.  Accordingly, the court affirmed the Tax Court’s penalty.

Turning next to Taxpayer’s arguments against the Comptroller’s method of calculation, the court noted that the Tax General Article TG §13-403 anticipated situations where parties neglected to keep accurate records (emphasis added):

(a)  If a person … fails to keep the records required under §4-202 of this article, the Comptroller may

(1)    Compute the admissions and amusement tax by using a factor….

* * *

(b)  The factor utilized by the Comptroller pursuant to this section shall be developed by:

(1)    a survey of the business… including any available records

(2)    a survey of other persons… engaged in the same or similar business

(3)    other means.

The court continued, pointing out that the plain meaning of the statute indicated the legislature had vested broad discretion in the Comptroller to use reasonable methods for calculating assessments against parties like Taxpayer.   Indeed, the court found the Comptroller’s calculation methods to be supported by substantial evidence of reasonableness in light of the lack of relevant financial records.  Using the only records available – those obtained by the police’s forensic investigation – the Comptroller calculated Taxpayer’s tax liability as best he could.  As a result, the court found Taxpayer’s request to substitute his expert’s “guesstimate” for the Comptroller’s assessment notwithstanding Taxpayer’s failure to retain adequate records unconvincing.  Such a finding would lead Maryland companies to keep no records, file no returns, and refer the Comptroller to unverifiable memories of employees; an untenable result.  Thus the court found that the Tax Court did not err by relying on the Comptroller’s calculation.

Dealing finally with Taxpayer’s spoliation claim (which arose after a police agency destroyed the motherboards of the video poker machines), the court found the Comptroller lacked any duty to preserve the video poker machine motherboards because he neither possessed nor had access to them.  Moreover, no evidentiary advantage existed because both the Comptroller and Taxpayer had copies of the police report.  Accordingly, the court found no misbehavior to sanction.

The full opinion is available in PDF.