The Sparrow Decision
On February 15, 2011, the Michigan Court of Appeals upheld the Michigan Tax Tribunal's determination that Edward W. Sparrow Hospital Association ("Sparrow") could reduce its Michigan Single Business Tax ("SBT") liability by claiming a capital acquisition deduction ("CAD") and an investment tax credit ("ITC") for capital assets used in furtherance of its tax-exempt activities. Edward W. Sparrow Hosp. Ass'n v. Michigan Dept. of Treasury, 2011 WL 519954 (Mich. Ct. App., February 15, 2011).
Unrelated Business Income
Sparrow is organized as a Michigan not-for-profit corporation and is exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code. Sparrow conducted activities during the tax years 1993 through 2001 that were unrelated to its tax-exempt purpose. Sparrow was required to pay federal income tax on income derived from any unrelated trade or business ("Unrelated Business Taxable Income"). I.R.C. §512. Similarly Sparrow was also required to pay SBT on its Unrelated Business Taxable Income to the state of Michigan. MCL § 208.35(1)(c).
CAD and ITC
In calculating its SBT liability, Sparrow claimed a CAD (for years 1993 through 1999) and an ITC (for years 2000 and 2001). Sparrow included in its CAD and ITC calculations all of its capital assets, regardless of whether the assets were used for tax-exempt or nonexempt activities. The Michigan Department of Treasury challenged Sparrow's treatment, arguing that a nonprofit taxed on its unrelated business activities can only claim a deduction or credit for capital assets relating to those unrelated business activities.
The Michigan Court of Appeals confirmed the Michigan Tax Tribunal's analysis of the statutory provisions granting the CAD and the ITC, stating that the plain language of the statutes does not distinguish between capital assets used for tax-exempt and nonexempt activities. The Michigan Court of Appeals further pointed to the benefit that tax-exempt entities enjoy due to this treatment but foreclosed any potential argument that this benefit is so absurd as to preclude the Tax Tribunal's interpretation of the plain language of the statutes.
The Sparrow decision provides additional support for a tax exempt organization that must pay SBT to claim the benefit of a CAD or an ITC for its capital assets. Based on this decision, a CAD or an ITC can be claimed on all qualifying capital assets regardless of whether an asset is used for tax-exempt or nonexempt activities. Applying Sparrow could result in a material reduction to the amount of SBT tax owed to the state of Michigan.