The Corporate Tax Case. The only corporate income tax case in the group is OAH No. 08 REV 2665, decided by the AOH 11/16/2009, decided by the DOR 1/22/2010, and posted on the DOR website in November 2010. We do not know the name of the taxpayer because that and other identifying language was redacted by the DOR. It is not clear that the redaction is legal. It also is not clear that the failure of the Office of Administrative Hearings to post its tax decisions is legal. The opinion reveals, however, that the taxpayer was a North Carolina based bank that had bought a lot of U.S. government debt at market discounts and claimed that the discount represented interest on the government debt that was not taxable as federal interest. This is a long standing state tax issue for banks because they commonly invest funds in Treasuries.
The OAH and the DOR rejeced the exclusion of the market discount. However, the DOR reversed the OAH decision relieving the bank of the interest on the assessment that accrued for the four years while the DOR sat on the bank’s protest. The interest dollars were not large, which suggests that the bank handled the appeal in house. Therefore, it is unlikely that the bank will now appeal for review by the NC Business Court, because it will both have to now pay the assessment (of course banks are where the money is) and likely hire outside counsel.
Lessons for Taxpayers. There are two important lessons for business taxpayers from this and the other recent postings of Final Decisions of the DOR. First, beware DOR delays and think carefully before you agree to postponements. The 2008 appeals procedure revision appears to place a nine month limit on the time for the DOR to initially review the taxpayer’s protest, but the limit has no teeth. The DOR can simple refuse to schedule a hearing or it can continue to ask the taxpayer questions and claim that the taxpayer has not fully answered questions and so it cannot schedule a hearing. The statute needs to be revised to deem a denial of the protest or claim for refund if not decided within nine months.
One price of delay is the interest that is running on the tax. The OAH thought that the delay of four years in this case was the fault of the DOR and so wanted to waive the tax for that period. The DOR did as it always does, standing on the statute, which gives no flexibility as to interest relief, and reversed the OAH decision on the interest waiver.
At this point readers might wonder what is going on with the DOR: why can it change the OAH decision? It appears that this is the standard way the OAH process works under Chapter 150B of the General Statutes. The agency can reject findings of fact and conclusions of law made by the OAH if “clearly contrary” to the facts or law. The agency must support its “clearly contrary” view in its Final Decision that changes the OAH decision. It is from the agency Final Decision that the taxpayer must appeal to the Business Court.
So the second and more important point for taxpayers to learn from the recent Final Decision is that appeal of a DOR assessment is a long and arduous process. The promise of an early review of the assessment by an independent tribunal (the OAH) has turned out to be a hollow promise. Maybe the power of the agency to reject the OAH decision make sense in cases of appeals from the Board of Cosmetology, for example, but it makes little sense for the DOR. It is like the IRS revising Tax Court opinions (which it cannot do).
No doubt the OAH is an independent tribunal. And no doubt its decisions have been and can be expected to be workmanlike and legally meticulous. However, the recent handful of Final Decisions shows that the NCDOR will treat the OAH decisions as an opening bid in the process of writing the Final Decision of the DOR. In this particular case the DOR did not even state that the OAH decision was “clearly contrary” to the facts; it simply restated the evidence it relied upon and reversed the OAH on that basis. This power of the DOR to reject OAH decisions needs to be changed.
Of course when and if the case is appealed to the Business Court, that court likely will give weight to the views of the OAH judge that the DOR reversed, but has no statutory duty to do so. The Business Court review is on the record; generally no new evidence can be introduced.
The Long Path. The taxpayer that wants to protest a proposed assessment by the NCDOR faces a long path that looks something like this:
- Audit (this can extend indefinitely unless taxpayer refuses to sign a waiver); THE DOR WILL DISCOVER DURING THIS PERIOD;
- Notice of proposed assessment;
- Protest by taxpayer;
- DOR review of protest (this is supposed to occur in nine months, but can go on indefinitely); THE DOR WILL DISCOVER DURING THIS PERIOD;
- Appeal to OAH (there is no time limit on the appeal hearing, but the OAH generally proceeds expeditiously); THE DOR WILL DISCOVER DURING THIS PERIOD;
- Period for DOR to review OAH decision and enter its own Final Decision;
- Appeal to Business Court on the record made in the OAH;
- Appeal to the N.C. Court of Appeals (there is no right to appeal to the Supreme Court, and it has refused in recent years to hear business tax cases).
From the date of protest this process will take at least four and a half years. In the case of the bank in the ruling it took several years longer due to the DOR stalling on the departmental informal hearing. During this long process the DOR will have three officially sanctioned opportunities to discover from the taxpayer and a fourth opportunity to send summonses to third parties, such as the taxpayer’s accountants, at any time during the process and independent of the appeal process.
Conclusion. The decline in litigation with the NCDOR that can be observed in recent years reflects the reluctance of business taxpayers to engage in this long and expensive process as the price of getting a fair answer in tax disputes. Taxpayers possibly such as the bank in the ruling might try to appeal on the cheap by not using outside counsel, but that is not a good idea due to the aggressive legal representation used by the DOR at all levels.
The best, but not perfect, solution for taxpayers facing this problem is to enter into a North Carolina tax appeal with a plan for staying the course with the least expense by avoiding to the extent possible expensive disputes over discovery and pursuing only the best arguments.
Market Discount. As to the merits of the exclusion of market discount on Treasuries, the Decision relied on the fact that G.S. 105-130.5(b)(1) purports to exempt Treasury interest only if the IRS exempts NC bond interest. Because market discount on NC state and local is not exempt for federal purpose, in parallel market discount on Treasuries cannot be exempt for NC tax purposes.
While there may be other reasons why the market discount on Treasuries is not exempt, this reason is clearly unconstitutional. The states’ ability to tax the federal government cannot be based on the degree to which the federal government reciprocates. See McCulloch v. Maryland, 17 U.S. 316 (1819).