Current Developments in State and Local Tax

Journal of State Taxation

Income & Franchise Taxes—Deductions

Massachusetts—Appeals Court Allows Deduction for Utility Taxes Paid to Indiana

The Massachusetts Appeals Court reversed a decision of the Appellate Tax Board and allowed Bay State Gas Company (“Bay State”) to deduct Indiana Utility Receipts Tax (“URT”) from its Massachusetts net income for corporate excise tax purposes.

Bay State is an energy company that operated in Massachusetts and, through two affiliates, in Indiana. Its affiliates were subject to and paid URT to Indiana. The URT is denominated as an “income tax” by Indiana statutes and imposes a tax on gross receipts received as consideration for the retail sale of utility services for consumption in Indiana.

Bay State claimed a deduction for the amounts paid to Indiana pursuant to Mass. Gen. Laws ch. 63, §30(4), which allows corporations to deduct from Massachusetts net income “deductions … allowable under the provisions of the Federal Internal Revenue Code.” The Commissioner disallowed the deduction, claiming that under Mass. Gen. Laws ch. 63, §30(4)(iii), no deduction is allowed for “taxes on or measured by income, franchise taxes measured by net income, franchise taxes for the privilege of doing business and capital stock taxes imposed by any [S]tate.” Although the Commissioner initially argued that the URT was an income tax, he later abandoned that argument and claimed on appeal that the URT is a “franchise tax for the privilege of doing business,” and therefore not deductible under Mass. Gen. Laws ch. 63, §30(4)(iii).

The Commissioner supported his position by relying on a “longstanding Department of Revenue position” that the key feature of all taxes which are not allowed as deductions “is that they are imposed on the corporation’s business as a whole, rather than on discrete events, or parts of the corporation’s activities, or ownership, within a State.” The Appeals Court reversed the Appellate Tax Board and found that Bay State had established that the URT is not a franchise tax on the entity as a whole, but rather is a tax on utilities’ retail sales.

The Appeals Court also rejected the Commissioner’s argument that the URT was not a sales tax because the URT is not separately collected from purchasers. In rejecting that argument, the court reasoned that “with or without separate collection, as a matter of economics, a rational economic actor can always be expected to attempt to pass increased costs from taxes on to the consumer.” Case law from Indiana substantiated that Indiana utility vendors had increased costs after enactment of the URT to minimize the impact of the tax on their profit margins. In addition, the court took note of the fact that Indiana had adopted a compensating URT use tax on gross receipts from utility services after Indiana customers began using out-of-state companies for utility services after the URT was initially adopted, which further supported the characterization of the URT as a sales tax.

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“Current Developments in State and Local Tax,” by Craig B. Fields and Matthew F. Cammarata was published in the Winter 2020 edition of CCH’s Journal of State Taxation (Vol. 39, Issue 1), a Wolters Kluwer publication. Reprinted with permission.