The Louisiana Court of Appeal reversed and remanded Bridges v. Polychim USA, Inc., No. 581,759 (La. Jud. Dist. Ct. Jan. 2, 2014) (unpublished), a case in which the trial court held that an out-of-state corporation was subject to the franchise tax by virtue of its indirect ownership interest in a general partnership doing business in Louisiana. Bridges v. Polychim USA, Inc., No. 2014 CA 0307 (La. Ct. App. April 24, 2015). The court of appeal’s decision is important because it rejected the Louisiana Department of Revenue’s taxability theories, including a unitary business-type standard and a tax avoidance argument, and likely impacts numerous taxpayers with pending refund or assessment cases.
Polychim USA, Inc. (Polychim), the out-of-state corporation, was not registered or qualified to do business in Louisiana during the tax years at issue. Polychim owned all of the stock in an out-of-state corporation and a 96.76% interest in an out-of-state limited liability company, which entities collectively owned 100% of the interests in a general partnership doing business in Louisiana.
Polychim reported its share of the flow-through income earned by the limited liability company, presumably conceding that it had income tax nexus with Louisiana. However, Polychim did not report any Louisiana franchise tax liability on the grounds that it did not meet any of the “incidents of taxation” set forth in La. Rev. Stat. § 47:601(A). Specifically, Polychim took the position that it was neither doing business in a corporate form nor exercising its corporate charter in the state. The Department assessed franchise tax, and Polychim protested.
The parties filed cross-motions for summary judgment, and Polychim asserted that the court of appeal’s decision in UTELCOM, Inc. v. Bridges, 77 So.3d 39 (La. Ct. App. 2011), cert. denied, 83 So.3d 1046 (La. 2012) was controlling. In UTELCOM, a case involving facts very similar to those in Polychim, the court of appeal rejected the Department’s attempt to attribute the activities of a limited partnership doing business in Louisiana to the partnership’s out-of-state limited partners based on an unfounded “unity of purpose” theory. Notwithstanding theUTELCOM decision, the Polychim trial court granted the Department’s motion for summary judgment and denied Polychim’s. Rather than issuing an opinion stating the reasons for its holding, the court simply adopted the Department’s legal memorandum. Polychim appealed the decision to the Louisiana Court of Appeal.
The Court of Appeal’s Reversal
The Department argued that Polychim was subject to Louisiana franchise tax for three reasons:
- Some of Polychim’s directors were also managers of the partnership doing business in the state, which effectively allowed Polychim to control and conduct the partnership’s in-state business;
- Since the business structure in question was a tax avoidance scheme, the court should apply a “single business enterprise” theory to breach the separate corporate walls between Polychim and the middle-tier, out-of-state corporation and limited liability company; and
- Polychim’s commercial domicile was in Louisiana.
The court of appeal rejected the Department’s first and second arguments and remanded the case to the trial court to resolve the third.
“Separate Juridical Entities”
In UTELCOM, the Department asserted that the out-of-state limited partners, together with the general partner, “acted in unison and with a common purpose, controlled by their common parent,” and thus were subject to Louisiana franchise tax. UTELCOM, 77 So.3d at 48. The court of appeal concluded that “unity of purpose” is not an incident of taxation provided in La. Rev. Stat. § 47:601(A) and therefore cannot serve as a basis for imposing franchise tax liability. The court also noted that the out-of-state limited partners were “separate juridical entities” under Louisiana law and that the Department was unable to offer any legal authority to support attributing the activities of the partnership, the general partner or the parent to the limited partners. Id. [Sutherland’s prior coverage of UTELCOM is available at Waiving the Baton: Louisiana Court of Appeal Rules No Nexus for Passive Limited Partner and No Louisiana Nexus Over Out-of-State Corporate Partners.]
Sutherland Observations: The Louisiana Court of Appeal’s decision inUTELCOM stands in stark contrast to the Maryland Court of Appeals’ decision inGore Enterprise Holdings, Inc. v. Comptroller of Treasury, 437 Md. 492, 87 A.3d 1263 (Md. 2014). In Gore, the Maryland Court of Appeals found that a parent company was subject to Maryland income tax because the company’s subsidiary was earning income in Maryland and the companies were engaged in a unitary business. Although Gore was an income tax case, rather than a franchise tax, it reflects a far more expansive theory of tax jurisdiction than the one rejected by the Louisiana Court of Appeal.
Drawing from its UTELCOM decision, the court disagreed with the Department’s position that the existence of common directors and managers as between Polychim and the partnership rendered Polychim taxable. The court found that the Department failed to present any evidence proving that Polychim controlled and conducted the partnership’s business. More importantly, the court said, the Department’s theory ignored the fact that Polychim and the partnership were “separate juridical entities” under Louisiana law and ignored the actual general partners of the partnership.
“Single Business Enterprise”
The Department also contended that Polychim was liable for franchise tax under the “single business enterprise” theory, which, according to the court, applies such that “when corporations integrate their resources in operations to achieve a common business purpose, each business may be held liable for wrongful acts done in pursuant of that purpose.” Polychim, No. 2014 CA 0307, at 11. The Department characterized Polychim’s “wrongdoing” as creating a business structure that was an “obvious” tax avoidance scheme. The court disagreed and concluded that “there is nothing that prevents a business from setting up its structure in such a way as to avoid paying taxes, as long as the business structure is legal.” Id. at 11 n.6. The court also noted that the “single business enterprise” theory adopted by the Department, which was not based on any of the incidents of taxation in La. Rev. Stat. § 47:601(A), was very similar to the “unity of purpose” theory court rejected in UTELCOM.
The court determined that genuine issues of material fact existed on the question of the location of Polychim’s commercial domicile, and the court remanded the case to the trial court for further fact-finding.
Sutherland Observations: The Polychim decision is an important step toward resolving the numerous UTELCOM-type refund and assessment cases pending in Louisiana. Following the UTELCOM decision, taxpayers and tax practitioners questioned whether the Louisiana Court of Appeal subsequently would limit its holding to the facts of the case, namely the particular business structure chosen by the taxpayer. The court’s Polychim decision suggests that UTELCOM applies beyond its specific facts. Consequently, the Polychim decision may limit the Department’s ability to avoid paying refund claims to those taxpayers who received income from an in-state limited liability company, as opposed to a general or limited partnership.