Michigan's RAB 98-1: the implementation phase.

There has been much written recently to explain the Michigan Department of Treasury's revised nexus standards for the single-business tax (SBT). This article presents a slightly different perspective on the revised nexus standards.

Background

From 1976-1993, the Department's nexus position was documented in various bulletins, specifically Revenue Administrative Bulletin (RAB) 1989-46 (May 1989). This position clearly held that P.L. 86-272 was the nexus standard for the SBT.

In 1993, confusion arose after two Michigan Court of Appeals cases (Guardian Industries Corp. v. Mich. Dep't of Treasury (March 1993) and Gillette Co. v. Mich. Dep't of Treasury (March 1993)) held that, because the SBT was not a tax based on net income, P.L. 86-272 was not applicable. The Department subsequently adopted a narrow interpretation of the cases and determined that only in-state solicitation by resident employees created substantial SBT nexus. The Department failed to revise its published nexus standards following Guardian and Gillette. It was not until it issued RAB 98-1 that taxpayers' confusion and speculation over nexus for SBT purposes officially ended.

The Department communicated its latest official SBT nexus position through the release of RAB 98-1 on Feb. 24, 1998. RAB 98-1 superseded RAB 1989-46. As a result, activities relating to mere solicitation of tangible personal property occurring on a regular and continuous basis by any representative (employee or independent contractor, resident or nonresident) in Michigan subjected taxpayers to the SBT.

RAB 98-1 identifies numerous activities deemed to create sufficient nexus for the SBT. These activities are deemed to meet the narrower nexus definitions found under the Due Process and Commerce clauses of the U.S. Constitution. RAB 98-1 also indicated that the revised nexus standards apply retroactively to all open tax periods ending after 1988.

Voluntary Disclosure

To help reduce the cost of the retroactive application of RAB 98-1, Michigan authorized the Commissioner of Revenue to enter into voluntary disclosure agreements with nonfilers, effective July 1, 1998. Among other conditions, to qualify for voluntary disclosure, (1) a taxpayer must be a "nonfiler" for the tax sought under voluntary disclosure; (2) the Department must not have previously contacted taxpayers or their agents for the tax covered by an agreement; (3) the Department must not have sent a notice of impending audit; and (4) the taxpayer agrees to register going forward. If taxpayers qualify, they are allowed to limit their prior exposure to four (sometimes three) years without penalty. Before the adoption of the voluntary disclosure program in 1998, the Department indicated its willingness to abate the penalty for failure to file on outstanding tax liabilities from 1989-1997.

Department Letters

Although the voluntary disclosure conditions indicate that prior contact by the Department disqualifies a taxpayer from voluntary disclosure, leniency is being practiced. The Department has been contacting certain out-of-state taxpayers to inform them of its new nexus position and allowing them the opportunity to apply for voluntary disclosure.

The Department's first contact was via a notice of inquiry, sent to many nondomiciled corporations as early as 1993, soon after Gillette and Guardian. Taxpayers receiving these early letters were strictly manufacturers that had registered for Michigan payroll tax withholding, but were not filing SBT returns. The letters specifically highlighted that it was the Department's position that taxpayers employing a resident Michigan sales representative (working in Michigan) subjected taxpayers to the SBT. The letter was retroactive to years ending after 1988 and offered penalty abatement. Other bulk mailings with similar language were sent to specific groups of taxpayers from 1994-1996. After July 1998, the Department's letters offered the opportunity to enter into voluntary disclosure.

Opportunities and Pitfalls

The revised nexus standards in RAB 98-1 provide taxpayers opportunities and pitfalls. On the positive side, if a business were located in Michigan, RAB 98-1 provides those taxpayers the opportunity to take advantage of their non-Michigan activities (specifically, order solicitation of tangible personal property) to defeat Michigan's throwback rule, applicable to sales shipped or delivered outside Michigan. This may result in taxpayers filing SBT refund claims for years still open.

However, the imposition of RAB 98-1 adversely affects businesses located outside Michigan that conducted solicitation activities in Michigan from 1989 forward. Taxpayers hardest hit are those that followed the Department's position and solicited sales in Michigan by means other than a resident sales employee located in Michigan, but had no other Michigan activity. This activity was previously held by the Department not to create a filing requirement from 1989-1998. These taxpayers assumed they were exempt, but are now being sought by the Department and, if found for audit, being assessed tax, interest and penalties retroactively to 1989.

A number of taxpayers have filed suit against Michigan for RAB 98-1's retroactive rule. A minimum of eight such cases are currently pending at the Tax Tribunal or Michigan Court of Claims level. Until these cases are decided, taxpayers may file their own legal action or choose to file and pay the SBT, then file protective claims for refund.

A few examples of actual client situations created by RAB 98-1's revised nexus standards illustrate the Department's retroactive imposition of such standards:

Example 1: Company A had an office in Michigan until 1989, then withdrew all physical presence. Independent sales representatives were contracted to solicit in Michigan. Based on RAB 1989-46 and subsequent Department positions, A ceased filing its SBT return beginning in 1989. After receiving a notice of intent from Michigan subsequent to RAB 98-1, A decided to apply for voluntary disclosure. The Department then identified the taxpayer as a previous filer, thus disqualifying it from voluntary disclosure. The Department assessed A SBT retroactively to 1989.

Example 2: Company A, a manufacturer with a sales employee in Michigan, never fried SBT returns in Michigan, under the Department's pre-RAB 98-1 nexus position. A received a notice of intent for audit in 1997. When asked why it did not receive a previous notice of inquiry, the Department informed A that it was inadvertently registered as a service provider and, originally, only manufacturers were sent a notice offering revised nexus information and penalty abatement if they came forward within a specific time.

Example 3: Company E, an entity that ceased operations in 1994, transferred its assets to a related entity, Company F. F was under Michigan SBT audit. IS, the nonexistent entity, was also subsequently audited and its assessment was imposed on F.

Example 4: Company D, based in Oregon, solicited in Michigan through independent sales representatives from 1980-1999. Assuming it was not required to file in Michigan until RAB 98-1, no SBT returns were filed, and those sales were thrown back to Oregon. Michigan assessed D retroactively to 1989. Because of Oregon's statute of limitations, offsetting refunds in Oregon were not available beyond the statute, in effect requiring D to pay more tax than was properly due.

In addition to these examples, policy differences on the application of voluntary disclosure between divisions within the Department exist. For instance, the Audit Division considers that providing voluntary disclosure information specifically requested by a taxpayer who could benefit from the information for a related company not under audit to be a "conflict of interest." However, the Enforcement Division considers a company to be eligible for voluntary disclosure, even if its related entity is currently under audit. It appears that the taxpayer takes the brunt of this internal conflict.

Conclusion

If a company or clients have been conducting solicitation activities in Michigan since 1989, serious consideration should be given to applying for voluntary disclosure. By doing so, the company has the opportunity to limit prior-year exposure for four years and have penalties abated. However, it is critical that the situation be thoroughly investigated before pursuing such disclosure.

FROM STEVE SCHAMBERGER, CEDAR RAPIDS, IA