No. 2014-37
13 October 2014
To the Point
Michigan enacts legislation that
could affect income apportionment
Companies with
operations in
Michigan should
consider the effects
of legislation
enacted in the
third quarter.
What you need to know
• In response to a July 2014 Michigan Supreme Court decision, Michigan enacted
legislation in September 2014 that may alter the way a taxpayer determines Michigan
taxable income for years beginning in 2008.
• Companies must account for the legislation in the period of enactment.
• An entity should consider the effect of the July 2014 Michigan Supreme Court decision
and the September 2014 legislation when evaluating the use of the Multistate Tax
Compact to determine Michigan taxable income.
Overview
In response to a Michigan Supreme Court (the Court) decision in IBM v. Department of
Treasury, Michigan enacted legislation (SB 156) on 11 September 2014 that expressly
repeals its participation in the Multistate Tax Compact (MTC) retroactively to 1 January 2008.
In IBM v. Department of Treasury, the Court ruled in July 2014 that IBM was permitted to use
the MTC equally weighted, three-factor apportionment formula (MTC election) to determine
tax liability under the Michigan Business Tax (MBT). Michigan has requested a rehearing of the
case. The Michigan Supreme Court has not yet responded.
At issue was whether Michigan implicitly repealed the MTC election available to Michigan
taxpayers in 2007 when it enacted the MBT, which used a calculation of gross receipts less a
variety of exclusions and deductions unrelated to specific transactions, such as inventory, assets,
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bad debts, materials and supplies, and certain types of compensation as its base. The Court
held for a variety of reasons that taxpayers could still use the MTC election. See the appendix
for a discussion of the Court’s decision.
Background
In July 2007, Michigan replaced its Single Business Tax with the MBT, which was comprised of
a modified gross receipts tax (MGRT) and a business income tax. Generally, the MGRT tax
base was calculated as gross receipts less purchases, and would include inventory and
depreciable assets acquired during the year. The business income tax base started with
federal taxable income as its base and provided for certain state modifications. Taxpayers
that previously hadn’t used the MTC then began electing the MTC apportionment method for
returns originally filed after 2007 and amended returns for years beginning in 2008,
contending that the MGRT qualified as an “income tax” for purposes of assessing applicability
of the MTC. Michigan denied their use of the MTC.
In May 2011, Michigan enacted legislation creating a corporate income tax (CIT) to replace
the MBT, effective 1 January 2012. In a separate piece of legislation enacted the same day,
Michigan declared that the MTC election to use three apportionment factors would not be
available to MBT or CIT taxpayers, effective 1 January 2011. This legislation did not explicitly
address the use of the MTC election for years prior to the effective date of 1 January 2011
(i.e., tax years from 2008 to 2010 are not explicitly addressed).
While initially the 2011 MTC law change appeared to resolve questions about the use of the MTC
election, uncertainty remained. Taxpayers and practitioners continued to maintain that the
state could not opt out of a portion of the MTC statutes as long as it was still a full “contractual”
member of the MTC. Courts in other states were also addressing this “contract” issue. Courts
have yet to weigh in on the effect of the 2011 MTC law change.
The state of Michigan asserts that the September 2014 legislation effectively eliminates a
taxpayer’s ability to make the MTC election for all years (i.e., from 2008 forward) because it
retroactively removed the state from the MTC. While Michigan appears to have the ability to
pass retroactive legislation, there is uncertainty about its ability to remove itself from the
MTC retroactively. While the Court in the IBM case declined to opine on whether the MTC
constitutes a binding contract that cannot be unilaterally altered or amended (Issue 3 in the
appendix discussing the Court’s decision), we anticipate that taxpayers will raise more legal
challenges in response to the retroactive repeal of the MTC related to issues such as the validity
of retroactively withdrawing from the MTC, due process and separation of powers. However,
based on current analysis, we believe that the September 2014 legislation passed by Michigan,
including the retroactive removal of Michigan from the MTC, will more likely than not be upheld.
Income tax accounting considerations
Enacted changes in tax law
Under Accounting Standards Codification (ASC) 740-10-45-15, the effects of changes in tax
rates and laws on deferred tax balances (including valuation allowances) are recognized in the
period the new legislation is enacted. The total effect of tax law changes on deferred tax
balances is recorded as a component of income tax expense related to continuing operations
(not an extraordinary item) for the period in which the law is enacted, even if the assets and
liabilities relate to discontinued operations, a prior business combination or items of
accumulated other comprehensive income. Further, ASC 740-10-25-48 requires the tax
effect of a retroactive change in enacted tax rates (and other changes in the law) on current
and deferred tax assets and liabilities to be determined at the date of enactment using
temporary differences and currently taxable income as of the date of enactment.
2 | To the Point Michigan enacts legislation that could affect income apportionment 13 October 2014
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For interim reporting purposes, the effects of a change in tax laws or rates on taxes currently
payable or refundable for the current year should be reflected in the computation of the
annual effective tax rate beginning as of the first interim period that includes the enactment
date of the new legislation even if the change in the tax rates is retroactive. Companies
cannot allocate the effects of changes in tax laws or rates to prior interim periods. Furthermore,
ASC 740-270-30-11 prohibits including the impacts of tax law changes in the computation of
the estimated effective tax rate for the year, effectively prohibiting spreading the effects of
the change over interim periods following enactment. The effects of new tax legislation on
taxes currently payable (or refundable) must be recognized in the period of enactment with
allocation to earlier or later periods prohibited. The effect of a change in tax laws or rates on
deferred tax assets or liabilities should be recognized as a discrete event as of the enactment
date and should not be allocated to subsequent interim periods by an adjustment of estimated
annual effective tax rate.
See Chapter 8, An enacted change in tax laws or rates, and Section 20.3, Effect of new tax
legislation, of our Financial reporting developments publication, Income taxes, for further
discussion.
An entity should
evaluate its tax
positions to
determine whether
the income
apportionment
used meets the
more likely than
not threshold.
Uncertain tax positions
Entities should consider the potential effects of (1) the 2014 legislation and (2) the Michigan
Supreme Court ruling when evaluating the income tax uncertainty associated with the use of
an MTC election in Michigan, taking into account their specific facts and circumstances.
The change in tax law removing Michigan from the MTC effective 1 January 2008 is
accounted for in the period of enactment as discussed above. However, ASC 740-10-25-6
includes resolution of the related appeals or litigation process as part of the determination of
whether the position meets the more-likely-than-not recognition criteria. Since the litigation
process would include the ability to appeal whether a tax law is in conflict with higher level
law, the outcome of that appeal should be considered in assessing compliance with the
more-likely-than-not criterion for initial recognition. If an entity applied the MTC election in
tax years 2008 through 2014 to calculate Michigan taxable income and the entity expects
to appeal the 2014 change in tax law to the court of last resort (i.e., the US Supreme Court),
the entity should carefully consider the tax technical analysis related to this position.
The Michigan Supreme Court ruling to sustain the taxpayer’s position and allow the use of
MTC when determining Michigan taxable income provides new information with respect to the
2008 through 2011 tax years. An entity should consider this new information, and consider
the retroactive effect of the September 2014 legislation, when evaluating its uncertain tax
positions relative to the use of MTC to determine Michigan taxable income.
ASC 740-10-25-14 emphasizes that a change in judgment as to recognition or measurement
is to be based on new information versus simply changing an interpretation or evaluation of
previous information. As a result, changes related to recognition and measurements are
expected to be supported by triggering events in the form of new information.
Changes in judgment that result in the subsequent recognition, derecognition or changes in
measurement of a tax position that was previously recognized in a prior annual period
(including any interest and penalties) are considered discrete events and are recognized in
earnings in the period (interim as well as annual) the change occurs. A change in judgment
related to a tax position taken in prior interim periods of the current year is an integral part of
an annual period and should be accounted for pursuant to the guidance on interim reporting
in ASC 740.
3 | To the Point Michigan enacts legislation that could affect income apportionment 13 October 2014
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See Sections 19.7.5, New information vs. new evaluation; 19.7.6, Changes in judgment; and
19.7.9, Interim reporting, of our Financial reporting developments publication, Income taxes,
for further discussion.
Next steps
• Companies should continue to monitor developments.
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4 | To the Point Michigan enacts legislation that could affect income apportionment 13 October 2014
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Appendix: A closer look at IBM v. Department of Treasury
When the Court agreed to hear the case, it asked IBM and the Michigan Department of
Treasury to address the following issues:
1. Whether the MTC election may be used to determine MBT liability
2. Whether the MBT implicitly repealed the MTC election
3. Whether the MTC constitutes a binding contract that cannot be unilaterally altered or
amended by the state
4. Whether the MGRT portion of the MBT constitutes an income tax under the MTC
In its ruling, the Court held the following related to the questions posed:
•
The MTC election may be used to determine the MBT liability. (Issue 1)
•
The MBT did not implicitly repeal the MTC election. (Issue 2)
•
The Court said “repeals by implication will be allowed ‘only when the inconsistency and
repugnancy are plain and unavoidable.’” (Issue 2)
•
The MTC election and the apportionment provisions of the MBT contain the common
purpose of setting forth apportionment methods for a multistate taxpayer’s business
income; therefore, providing potential for the two statutes to be harmonized. (Issue 2)
•
The legislature expressly repealed or amended other inconsistent acts when enacting the
new law (such as repealing the Single Business Tax when the MBT was enacted);
therefore, if the legislature believed the MTC election was no longer appropriate or
conflicted with the MBT statutes, it would have repealed the MTC election. (Issue 2)
•
The Court determined the MGRT fits within the MTC definition of income tax; therefore,
the MTC election may be used to determine the related MBT liability under the MGRT.
(Issue 2)
•
Because the Court determined the MTC election and MBT statutes could be harmonized,
and taxpayers could use the MTC three-factor apportionment formula under the MBT, the
Court’s lead opinion declined to discuss the third issue regarding the contractual and
constitutional considerations of the MTC. (Issue 3)
•
The Court determined that the MGRT fits within the MTC definition of income tax;
therefore, the MTC election may be used to determine the related MBT liability under
the MGRT. (Issue 4)
5 | To the Point Michigan enacts legislation that could affect income apportionment 13 October 2014