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Michigan IBM Decision May Provide More Opportunities Than the 3-Factor Election


On July 14, 2014, the Michigan Supreme Court ruled in IBM v. Department of Treasury, Docket No. 146440, that the taxpayer, IBM, was entitled to a refund of income taxes paid to the state by virtue of its election to apportion its income using the three factor apportionment formula provided in the Multistate Tax Compact, MCL 205.581 et seq. The opinion has garnered a lot of attention, as it is the first state supreme court decision addressing whether taxpayers should be permitted to elect the three factor formula in MTC states. However, the case did very little to assure taxpayers that a multistate compact is in fact binding on its state members. Instead, the case turned on statutory interpretation and a provision in the Business Tax Act that provided that a taxpayer could not utilize the three factor formula beginning January 1, 2011.

The Michigan Supreme Court failed to appreciate the binding nature of a multistate compact, and that a state may not simply unilaterally modify a compact. Instead, a state should totally withdraw from a compact. Notwithstanding the court’s failure to address this important issue, there is another component of the case which has been somewhat overlooked.

The Business Tax Act was composed of a few different taxes. Among them was the modified gross receipts tax (MGRT). Michigan had taken the position that the MGRT portion could not be subject to the election provision in the MTC because the MTC applies to income taxes. The MGRT, the State argued, is not an income tax, but is instead a gross receipts tax. Thus, even if Michigan had not adequately withdrawn from the MTC, taxpayers should still be required to utilize the single sales factor apportionment formula with respect to the MGRT. The court disagreed, and concluded that the MGRT is in fact an income tax “under the broad definition of ‘income tax’ under the Compact.”

For the MGRT to qualify as an income tax, the court stated that it must measure net income by starting with gross income and subtracting expenses, with at least one of the expense deductions not specifically and directly related to a particular transaction. Under the MGRT, “gross receipts are subject to a reduction for the purchase of inventory during the year, including freight, shipping, delivery, or engineering charges included in the original contract price.” Thus, the MGRT was found to be an income tax subject to the election provision in the Multistate Tax Compact.

This holding could have significant ramifications outside the context of the Multistate Tax Compact. Michigan has consistently taken the position that the MGRT is not an income tax and, therefore, is not subject to the limitations of Public Law 86-272 because PL 86-272 only applies to “net income taxes.” Although the Michigan Supreme Court noted in footnote 85 of the IBM opinion that its holding was “limited to the determination that the MGRT is included within the Compact definition of ‘income tax,'” the court’s analysis can easily be applied to whether PL 86-272 applies to the MGRT.

Taxpayers that are defending non-filing positions they have taken in Michigan should consider whether PL 86-272 might protect them from filing and payment obligations under the MGRT. Moreover, taxpayers otherwise protected by PL 86-272 who have already paid the MGRT should consider filing refund claims arguing that the IBM decision has brought about a change in law.

Gross receipts taxes are among the most unfair of business taxes because they purport to avoid the physical presence requirements set under Quill as well as the limitations of PL 86-272. Fortunately, Michigan no longer imposes the MGRT, so this issue is of a limited duration. With this recent IBM decision, taxpayers may have the opportunity to rectify Michigan’s unfair assertion of taxing jurisdiction under the MGRT.


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