The First Marblehead Corporation v. Commissioner of Revenue , 470 Mass. 497 ( 2015 )

NOTICE: All slip opinions and orders are subject to formal
revision and are superseded by the advance sheets and bound
volumes of the Official Reports. If you find a typographical
error or other formal error, please notify the Reporter of
Decisions, Supreme Judicial Court, John Adams Courthouse, 1
Pemberton Square, Suite 2500, Boston, MA, 02108-1750; (617) 557-
1030; SJCReporter@sjc.state.ma.us
SJC-11609
THE FIRST MARBLEHEAD CORPORATION & another1 vs. COMMISSIONER OF
REVENUE.
Suffolk. October 7, 2014. - January 28, 2015.
Present: Gants, C.J., Spina, Cordy, Botsford, Duffly, Lenk, &
Hines, JJ.
Financial Institution. Taxation, Excise, Apportionment of tax
burden. Constitutional Law, Taxation. Notice, Tax taking.
Appeal from a decision of the Appellate Tax Board.
The Supreme Judicial Court on its own initiative
transferred the case from the Appeals Court.
John S. Brown (Donald-Bruce Abrams with him) for the
taxpayer.
Brett M. Goldberg (Daniel J. Hammond, Assistant Attorney
General, with him) for Commissioner of Revenue.
Helen Hecht, Bruce Fort, Sheldon Laskin, & Lila Disque, of
the District of Columbia, for Multistate Tax Commission, amicus
curiae, submitted a brief.
BOTSFORD, J. The taxpayers appeal from a decision of the
Appellate Tax Board (board) issued pursuant to G. L. c. 58A,
1
GATE Holdings, Inc. (Gate).
2
§ 7, and G. L. c. 62C, § 39 (c); their focus is on the financial
institution excise tax (FIET) liability of the taxpayer GATE
Holdings, Inc. (Gate), that was at all relevant times a wholly
owned subsidiary of the taxpayer The First Marblehead
Corporation (FMC).2 In its decision, the board accepted Gate's
position that it qualified as a "financial institution" under
G. L. c. 63, § 1, and was entitled to apportion its income
pursuant to G. L. c. 63, § 2A (§ 2A). The board, however,
disagreed with Gate that in applying the apportionment rules of
§ 2A, all of Gate's taxable property, which consisted of
securitized student loans, should be assigned to States outside
the Commonwealth. Rather, the board determined that all such
property was properly assigned to Massachusetts, resulting in a
greater FIET liability than Gate had calculated. We affirm the
board's decision.3
Facts.4 At issue here are the tax years ending June 30,
2004; June 30, 2005; and June 30, 2006 (tax years at issue).
FMC was a publicly traded Delaware corporation with its
2
The First Marblehead Corporation (FMC) sold Gate in 2009,
which was after the tax years at issue in this proceeding.
3
We acknowledge the amicus brief submitted by the
Multistate Tax Commission (commission).
4
The facts are taken from the board's decision, which was
in turn based on the parties' statement of agreed facts and
attached exhibits as well as witness testimony and other
exhibits admitted during the hearing before the board. The
facts are not in dispute.
3
principal offices in Boston, and during the tax years at issue
was the principal tax-reporting corporation for itself, Gate,
and a number of other subsidiaries. FMC was involved in the
growing industry facilitating private loans to students seeking
to finance the cost of their postsecondary education. FMC did
not make any loans directly to student borrowers, but rather
brought together various parties involved in lending, including
postsecondary schools, banks that issued loans to borrowers
(originating banks), loan guarantors, loan servicing entities
(servicers), and underwriters. In particular, FMC and its
subsidiaries facilitated and coordinated the issuance and
securitization of student loans through a complex process in
which loans were purchased from originating banks with financing
obtained via the issuance of asset-backed securities (ABS). The
originating banks entered into agreements with FMC through which
the banks issued loans to student borrowers and then sold
portfolios of these loans to a number of different Delaware
statutory trusts (trusts). To finance the purchases of loan
portfolios, the trusts sold bonds, in the form of ABS, to
underwriters that in turn sold the bonds to investors. Once the
trusts acquired the loans, the loans became security for
repayment of the bonds.
Loans require loan servicing, an umbrella term that
includes accounting for accrued interest on the loans, billing,
4
receiving and processing payments, and working with borrowers in
various stages of delinquency. Neither FMC nor any of its
affiliates was directly involved in loan servicing but instead
outsourced these activities to independent entities in that
business (servicers). A large percentage of the loans
securitized by FMC were serviced by the Pennsylvania Higher
Education Assistance Agency (PHEAA), with a principal office in
Harrisburg, Pennsylvania. A number of other servicers also
serviced loans securitized by FMC, and, like PHEAA, were located
outside Massachusetts. The servicers were the custodians of the
loan records and all paper documents relating to the loans.
Gate played an integral role in the FMC student loan
securitization process. Gate's purpose within this system was
to hold residual beneficial interests in the trusts, either
directly or through its own wholly owned subsidiary, National
Collegiate Funding LLC. By the end of the tax years at issue,
Gate held a beneficial interest in each of sixteen trusts that
in turn held all of the student loans that had been securitized
by FMC and its affiliates. These interests in the trusts
constituted substantially all of Gate's assets. Income from the
trusts, which consisted of interest on the student loans, passed
through to Gate and comprised substantially all of Gate's gross
income for these years.
5
Gate was essentially a holding company with no employees,
payroll, tangible assets, or office space -- either owned or
leased. Gate's tax returns indicated that its principal office
was located at the same Boston address as FMC, and Gate's
corporate books and tax returns also were maintained and
prepared in Boston. Indeed, there is no dispute that Gate's
commercial domicile was in Massachusetts during the tax years at
issue. Like Gate, the trusts also had no assets other than the
loan portfolios, cash, and other related assets, and they had no
employees, payroll, or offices.
Procedural history. On September 15, 2006, FMC and Gate
filed a voluntary disclosure request with the Commissioner of
Revenue (commissioner) reporting their conclusion that Gate was
a "financial institution," not a corporation as they had
previously treated it for Massachusetts excise tax purposes, and
their intent to change Gate's tax filing status accordingly.
Gate then filed a Massachusetts financial institution excise
return (Form 63FI) for each of the tax years at issue, and also
sought an abatement of corporate taxes previously filed for the
tax year ending on June 30, 2004. The commissioner denied the
application for an abatement in July, 2007, and in September,
2007, FMC appealed to the board.
6
In December, 2009, following audits of the returns filed on
behalf of FMC and Gate for the tax years at issue,5 the
commissioner further assessed FMC and Gate for additional taxes
based on the commissioner's conclusion that Gate was taxable as
a foreign corporation, or in the alternative, that Gate owed
additional taxes as a financial institution. FMC and Gate
sought abatements of these assessments, which the commissioner
denied in February and March, 2010, respectively. Later in
March, 2010, both FMC and Gate appealed these denials to the
board.
The board heard the appeals and issued its findings of fact
and report in April, 2013. It concluded that Gate was a
financial institution as defined in G. L. c. 63, § 1, due to the
fact that Gate derived more than fifty per cent of its gross
income from "lending activities" in substantial competition with
other financial institutions. The board further agreed with FMC
and Gate that as a financial institution with loans held by
student borrowers in all fifty States, Gate was entitled to
apportion its income according to the rules established in § 2A,
and that Gate properly had reported its "receipts factor" for
5
The audits of FMC's returns appear to have only been for
the tax years ending June 30, 2005, and June 30, 2006. However,
the audits of Gate's returns appear also to have included the
tax year ending June 30, 2004.
7
each of the tax years at issue as required under § 2A.6 However,
the board found that Gate's "property factor" was one hundred
per cent for each of the taxable years at issue, not zero as had
been reported on Gate's tax returns, with the result that for
each taxable year, fifty-one per cent of Gate's income was
taxable in Massachusetts.7 The combined outcome of the board's
conclusions was that FMC's taxes were abated in the amount of
$8,134,549, and Gate's taxes were abated in the amount of
$4,382,870. While these amounts are substantial, Gate's
approved abatement was more than $4 million less than the amount
it originally had sought.8
6
As discussed infra, tax apportionment for a financial
institution is based on the average of the institution's
receipts, payroll, and property factors. G. L. c. 63, § 2A (b).
The parties agree that because it had no employees, Gate had no
payroll factor. Accordingly, its tax apportionment formula is
the average of its receipts and property factors.
7
This percentage is derived by adding Gate's receipts
factor -- determined to be two per cent -- and its property
factor -- determined to be one hundred per cent -- and then
dividing the total by two: 102%/2 = 51%. See note 6, supra.
8
Gate originally had sought a $1,205,002 abatement for the
tax year ending in June, 2004, and $7,646,698 abatement for the
tax years ending in June, 2005, and June, 2006, for a total of
$8,851,700.
8
FMC and Gate timely appealed the board's decision to the
Appeals Court.9 We transferred the case to this court on our own
motion.
Standard of review. "A decision by the board will not be
modified or reversed if the decision 'is based on both
substantial evidence and a correct application of the law.'"
Capital One Bank v. Commissioner of Revenue, 453 Mass. 1, 8,
cert. denied, 557 U.S. 919 (2009), quoting Boston Professional
Hockey Ass'n v. Commissioner of Revenue, 443 Mass. 276, 285
(2005). See Commissioner of Revenue v. Jafra Cosmetics, Inc.,
433 Mass. 255, 259 (2001); Towle v. Commissioner of Revenue, 397
Mass. 599, 601-602 (1986). "Because the board is authorized to
interpret and administer the tax statutes, its decisions are
entitled to deference. . . . Ultimately, however, the
interpretation of a statute is a matter for the courts"
(citation omitted). Onex Communications Corp. v. Commissioner
of Revenue, 457 Mass. 419, 424 (2010). Finally, in
circumstances where a taxpayer seeks an abatement of a tax,
"[t]he taxpayer has the burden of proving as a matter of law
[its] right to an abatement" (citation omitted). Boston
Professional Hockey Ass'n, supra at 285. This burden has been
9
Although both FMC and Gate appealed, the appeal solely
concerns Gate's tax liability. The taxpayers have filed one
brief and present a joint argument. For ease of reference, we
refer only to Gate as the appealing party in the remainder of
this opinion.
9
found to be particularly heavy in the context of taxpayer
challenges to an apportionment formula, because "the taxpayer
must prove by 'clear and cogent evidence' that the income
attributed to the Commonwealth is in fact 'out of all
appropriate proportion to the business transacted' here or has
'led to a grossly distorted result.'" See id., quoting Gillette
Co. v. Commissioner of Revenue, 425 Mass. 670, 679 (1997)
(discussing challenges to corporate tax apportionment under
G. L. c. 63, § 38). See also Container Corp. of Am. v.
Franchise Tax Bd., 463 U.S. 159, 170 (1983).
Discussion. Section 2A was enacted in 1995,10 an important
component of legislation that appears to have been intended to
reduce the tax burden on Massachusetts banks by lowering the
bank excise tax rate and by permitting financial institutions
that derive income from business activities conducted both
inside and outside the Commonwealth to apportion their income,
thereby avoiding double taxation and reducing incentives for
these businesses to move their operations out of State.11 See
10
See G. L. c. 63, § 2A (§ 2A), inserted by St. 1995,
c. 81, § 1.
11
For purposes of G. L. c. 63, §§ 2 and 2A, the term
"financial institution" encompasses banks, banking associations,
trust companies, and Federal and State savings and loan
associations, as well as other types of businesses, including
any that "in substantial competition with financial institutions
derive[] more than [fifty] per cent of [their] gross income . .
. from loan origination, from lending activities, including
10
Memorandum from Deputy Chief Legal Counsel Lon F. Povich to
Governor William F. Weld and Lieutenant Governor Paul Cellucci
(July 26, 1995) (Povich memorandum) (regarding House Bill No.
4975, "An Act relative to the equitable taxation of financial
institutions"). See also Memorandum from Barbara Kessner
Landau, Assistant General Counsel, Executive Office of Economic
Affairs, to Governor's Legal Office (July 26, 1995) (same).
Section 2A sets out income apportionment rules that define how
"[t]he commissioner shall determine the part of the net income
of a financial institution derived from business carried on
within the commonwealth." See G. L. c. 63, § 2A (b)-(g). These
rules incorporate a formula crafted by the Multistate Tax
Commission (commission),12 see Povich memorandum, supra, and
discounting obligations, or from credit card activities." G. L.
c. 63, § 1.
12
The commission was created by the Multistate Tax Compact
(compact) and serves to promote the compact's goals, including
"[p]romot[ing] uniformity or compatibility" among State tax
systems and "[a]void[ing] duplicative taxation." See The
Multistate Tax Compact: Suggested Legislation and Enabling Act,
art. I, at 1 (effective Aug. 4, 1967), available at
http://www.mtc.gov/uploadedFiles/Multistate_Tax_Commission/About
_MTC/MTC_Compact/COMPACT(1).pdf [http://perma.cc/3S85-TQR4]
(last visited Jan. 26, 2015. The compact is a model law that
"deals primarily with taxes which affect businesses that operate
in more than one state." Id. at preamble. Massachusetts is
currently an "Associate member" of the commission, which implies
participation in commission meetings and projects and
consultation and cooperation with the commission and its
members. Multistate Tax Commission, Member States, at
http://www.mtc.gov/The-Commission/ Member-States
[http://perma.cc/DE33-UEZ5] (last visited Jan. 26, 2015).
11
apply only to financial institutions that are taxable in both
the Commonwealth and in other States. They allocate income to
the Commonwealth for tax purposes by multiplying the taxpayer's
income by the "apportionment percentage" that is "determined by
adding the taxpayer's receipts factor, property factor and
payroll factor together and dividing the sum by three."13 G. L.
c. 63, § 2A (b). Each of these listed factors is a fraction,
the numerator of which reflects the taxpayer's receipts,
property, or payroll located within the Commonwealth for the
taxable year in question, and the denominator of which reflects
the taxpayer's receipts, property, or payroll both within and
without the Commonwealth. See G. L. c. 63, §§ 2A (d)-(f). In
this way, the apportionment formula attempts to "approximate the
net income derived from business carried on within the
commonwealth." See G. L. c. 63, § 2A (g). See also Final
Report of Hearing Officer Regarding Proposed Multistate Tax
Commission Formula for the Uniform Apportionment of Net Income
from Financial Institutions 20, 21 (Apr. 28, 1994) available at
http://www.mtc.gov/uploadedFiles/Multistate_Tax_Commission/Unifo
rmity/Uniformity_Projects/A_-_Z/Final%20HO%20Rpt%20FinInst.pdf
13
In other words, the "apportionment percentage" is the
average of the taxpayer's "receipts factor," "property factor,"
and "payroll factor." As mentioned, in Gate's case, the
apportionment percentage is the average of Gate's receipts and
property factors. See note 6, supra.
12
[http://perma.cc/99CH-XSDX] (last visited Jan. 26, 2015) (Final
Report) (apportionment formula is designed to "fairly represent
the taxpayer's business activities in the state," i.e., to
approximate the "income-producing activities of the taxpayer in
the state").
In this appeal, no party challenges the board's ruling that
Gate qualified as a "financial institution," was taxable in both
the Commonwealth and in other States, and was thus entitled to
apportion its income according to the rules in § 2A. There is
also no challenge to Gate's determination, approved by the
board, of its receipts factor for each of the years in
question,14 as well as Gate's position that it had no payroll
factor. The only issue presented is how Gate's property factor
is to be calculated. Specifically, we must determine whether
the loan portfolios that represented substantially all of Gate's
property for the tax years at issue should be treated as having
been located in whole or in part within the Commonwealth, and
14
With respect to Gate's receipts factor, the board,
applying the rules set out in § 2A (d), determined that
"substantially all of Gate's income was interest from the [l]oan
[p]ortfolios that was passed through to Gate from the [t]rusts,"
and that this income "comprised the whole of Gate's receipts
factor and was included in its numerator or [only its]
denominator [of the receipts factor fraction] based on the
location of the borrowers." Because "Gate's share of the
interest from borrowers located in Massachusetts represented
approximately two percent of Gate's total receipts," the board
found that Gate's receipts factor had been properly reported on
Gate's returns.
13
thus included in the numerator of Gate's property factor
fraction, or outside the Commonwealth, and therefore excluded
from the numerator and included only in the denominator of the
fraction. The answer to this question has a significant impact
on Gate's total tax liability for the relevant years: if all of
Gate's loans are treated as having been located within the
Commonwealth, as the board found, then Gate's property factor
was one hundred per cent. If, however, as FMC and Gate claim,
all of the loans were located outside the Commonwealth, then for
purposes of § 2A, Gate's property factor would be zero.15
The rules for determining a taxpayer's property factor are
contained in § 2A (e), and property consisting of loans is the
focus of § 2A (e) (vi). This section provides in relevant part:
"(vi) (A) (1) A loan is considered to be located within the
commonwealth if it is properly assigned to a regular place
of business of the taxpayer within the commonwealth.
"(2) A loan is properly assigned to the regular place of
business with which it has a preponderance of substantive
contacts. . . .
"(B) In the case of a loan which is assigned by the
taxpayer to a place without the commonwealth which is not a
regular place of business, it shall be presumed, subject to
rebuttal by the taxpayer on a showing supported by the
preponderance of evidence, that the preponderance of
substantive contacts regarding the loan occurred within the
commonwealth if, at the time the loan was made the
15
This is so because if all of the loans are deemed located
outside the Commonwealth, the numerator of Gates's property
factor fraction is zero, and therefore the entire fraction is
zero.
14
taxpayer's commercial domicile, as defined in [G. L. c. 63,
§ 1], was within the commonwealth.
"(C) To determine the state in which the preponderance of
substantive contacts relating to a loan have occurred, the
facts and circumstances regarding the loan at issue shall
be reviewed on a case-by-case basis and consideration shall
be given to such activities as the solicitation,
investigation, negotiation, approval and administration of
the loan."16
General Laws c. 63, § 1, defines "regular place of
business" as "an office at which the taxpayer carries on its
business in a regular and systematic manner and which is
consistently maintained, occupied and used by employees of the
taxpayer." The parties agree that Gate, which had no offices or
employees, had no "regular place of business" either within or
outside the Commonwealth. Thus, the loans could not have been
assigned under § 2A (e) (vi) (A) to a regular place of business
belonging to Gate. However, Gate argued before the board and
continues to argue, essentially, that under § 2A (e) (vi) (B)
and (C), the loans can and should be assigned to the locations
of the servicers, because those locations were where the
"preponderance of substantive contacts" relating to the loans
16
The terms "solicitation," "investigation," "negotiation,"
"approval," and "administration" are defined in § 2A (e) (vi)
(C) (1)-(5). The definitions are quoted and discussed infra.
15
occurred. As next discussed, the board rejected this argument,
as do we.17
1. Presumption of commercial domicile. First, the board
concluded that § 2A (e) (vi) (B) creates a rebuttable
presumption that where a taxpayer seeks to assign loans to a
location that is not a regular place of business of that
taxpayer, the loans should be assigned to its commercial
domicile. We agree. We view the language of § 2A (e) (vi) (B)18
to be unambiguous in establishing the rebuttable default
presumption described by the board. See Commissioner of Revenue
v. Cargill, Inc., 429 Mass. 79, 82 (1999) (court follows
17
Before the board, the Commissioner of Revenue
(commissioner) argued primarily that Gate was not engaged in
lending activities, and that therefore it should have been
characterized for taxation purposes as a "foreign corporation"
rather than as a "financial institution." At this point,
however, the commissioner has accepted the board's determination
that Gate was a "financial institution," and urges that we adopt
the board's interpretation of § 2A (e).
18
The establishment in § 2A (e) (vi) (B) of the taxpayer's
commercial domicile as the default location of a loan is
consistent with the reference to commercial domicile as a
default resolution for other apportionment issues addressed in
§ 2A. For example, in the context of the receipts factor
analysis, § 2A (d) (xiii) provides that "[a]ll receipts which
would be assigned under this section to a state in which the
taxpayer is not taxable shall be included in the numerator of
the receipts factor, if the taxpayer's commercial domicile is in
the commonwealth." Section 2A (a), as amended by St. 2004,
c. 262, § 35, also provides that any portion of the net income
of a financial institution that cannot be taxed to another State
under the United States Constitution will be allocated to the
Commonwealth if the commercial domicile of the institution is in
the Commonwealth.
16
language of statute "when its language is plain and unambiguous,
and its application would not lead to an absurd result, or
contravene the Legislature's clear intent" [quotations and
citation omitted]).
Gate notes the presence of the words "at the time the loan
was made" in § 2A (e) (vi) (B),19 and contends that this means
the presumption of commercial domicile applies only in the
context of an original lender, and that the presumption exists
specifically to prevent such a taxpayer from "artificially
assigning" a loan that originated at the taxpayer's actual place
of business to another State where it has no place of business.
Reading the language of this provision as narrowly as Gate
proposes, however, renders the statute unworkable for a taxpayer
like Gate. This is because § 2A (e) (vi) contemplates only two
assignment alternatives for a taxpayer's loans: the loans will
be assigned to a regular place of business of the taxpayer,
either within or outside the Commonwealth -- the alternative
described in § 2A (e) (vi) (A) (1) and (2); or the loan will be
assigned outside the Commonwealth to a place that is not a
19
For ease of reference, we quote again the relevant
portion of § 2A (e) (vi) (B): "In the case of a loan which is
assigned by the taxpayer to a place without the commonwealth
which is not a regular place of business, it shall be presumed,
subject to rebuttal by the taxpayer . . . that the preponderance
of substantive contacts regarding the loan occurred within the
commonwealth if, at the time the loan was made the taxpayer's
commercial domicile . . . was within the commonwealth" (emphasis
added).
17
regular place of business of the taxpayer -- the alternative
described in § 2A (e) (vi) (B). If the § 2A (e) (vi) (B)
alternative were to apply only to taxpayers who are original
lenders, the statute would provide no guidance when the
taxpayer, like Gate, is not an original lender but has no
regular place of business. Such a reading would leave open the
possibility that loans qualifying as property of the taxpayer
could exist without being assigned anywhere. This is clearly an
unintended and ultimately absurd result. A more reasonable
interpretation is that the phrase "at the time the loan was
made" is present in § 2A (e) (vi) (B) to resolve any ambiguity
in the case of a taxpayer whose commercial domicile may have
changed from within to outside the Commonwealth during the life
of the loan. No such ambiguity exists here. Accordingly, the
board properly ruled that the presumption in § 2A (e) (vi) (B)
applied to Gate without regard to the sites of origination of
the loans in question.
2. Preponderance of substantive contacts of Gate's loans.
Under § 2A (e) (vi), to determine the proper assignment of a
loan for apportionment purposes, it is necessary to determine
whether "the preponderance of substantive contacts regarding the
loan" was within or outside the Commonwealth. Because Gate's
commercial domicile was in the Commonwealth, application of the
§ 2A (e) (vi) (B) presumption to Gate means that "the
18
preponderance of substantive contacts regarding the loan
occurred within the commonwealth" for purposes of calculating
Gate's property factor, unless the presumption was rebutted.
And § 2A (e) (vi) (B) places the burden of rebuttal squarely on
Gate as the taxpayer.
In seeking to rebut the presumption, Gate points to § 2A
(e) (vi) (C), quoted supra, and specifically its language
indicating that the "preponderance of substantive contacts of a
loan" must be determined on a "case-by-case basis." The section
goes on to say that the required determination is to include
consideration of activities such as the "solicitation,"
"investigation," "negotiation," "approval," and "administration"
of the loan. G. L. c. 63, § 2A (e) (vi) (C) (1)-(5).20,21 The
20
The terms "solicitation," "investigation," "negotiation,"
"approval," and "administration" are defined in § 2A (e) (vi)
(C) as follows:
"(1) 'Solicitation' is either active or passive.
Active solicitation occurs when an employee of the taxpayer
initiates the contact with the customer. Such activity is
located at the regular place of business which the
taxpayer's employee is regularly connected with or working
out of, regardless of where the services of such employee
were actually performed. Passive solicitation occurs when
the customer initiates contact with the taxpayer. If the
customer's initial contact was not at a regular place of
business of the taxpayer, the regular place of business, if
any, where the passive solicitation occurred is determined
by the facts in each case.
"(2) 'Investigation' is the procedure whereby
employees of the taxpayer determine credit-worthiness of
the customer as well as the degree of risk involved in
19
board stated, and Gate agrees, that of these five listed
activities, only "administration" could possibly apply to Gate's
loans because all the other factors listed relate to the
origination of loans and Gate played no role in loan
origination. The statute defines "administration" as "the
making a particular agreement. Such activity is located at
the regular place of business which the taxpayer's
employees are regularly connected with or working out of,
regardless of where the services of such employees were
actually performed.
"(3) 'Negotiation' is the procedure whereby
employees of the taxpayer and its customer determine the
terms of the agreement such as the amount, duration,
interest rate, frequency of repayment, currency
denomination and security required. Such activity is
located at the regular place of business which the
taxpayer's employees are regularly connected with or
working out of, regardless of where the services of such
employees were actually performed.
"(4) 'Approval' is the procedure whereby employees or
the board of directors of the taxpayer make the final
determination whether to enter into the agreement. Such
activity is located at the regular place of business which
the taxpayer's employees are regularly connected with or
working out of, regardless of where the services of such
employees were actually performed. If the board of
directors makes the final determination, such activity is
located at the commercial domicile of the taxpayer.
"(5) 'Administration' is the process of managing the
account. This process includes bookkeeping, collecting the
payments, corresponding with the customer, reporting to
management regarding the status of the agreement and
proceeding against the borrower or the security interest if
the borrower is in default. Such activity is located at
the regular place of business which oversees this
activity." (Emphases added.)
21
These terms are collectively referred to as the "SINAA"
factors. Final Report, supra at 48.
20
process of managing the account," § 2A (e) (vi) (C) (5),
including bookkeeping, payment collection, customer
correspondence, and addressing situations of default -- which
are essentially the activities performed by the loan servicers
in the FMC securitization system.
The board rejected Gate's claim that because the servicers
"administer" the loans owned by the trusts (and therefore Gate),
the servicers' loan administration activities -- all performed
in States other than Massachusetts -- were attributable to Gate.
The board reasoned that, as a factual matter, Gate had not
proved the servicers were agents of the trusts (or derivatively
Gate), and that Gate had not offered any other legal basis for
attributing the activities of the servicers to Gate.
Accordingly, the board disregarded the activities of the
servicers in determining whether Gate had any "substantive
contacts" with the loans outside the Commonwealth, and finding
none, applied the presumption of commercial domicile in § 2A (e)
(vi) (B) to all the loans in question.
Gate challenges the board's determination. It asserts that
the board unilaterally, and improperly, inserted the concept of
agency into the analysis of § 2A (e) (vi) (B), and that even if
agency is the appropriate test, the loan documents make clear
that the servicers in fact were agents of the trusts and
therefore of Gate as the holder of a beneficial interest in each
21
of the trusts. We conclude, however, that an analysis whether
the servicers were agents of Gate, and if so, what type of
agents they were, is unnecessary in order to locate the
"preponderance of substantive contacts" of the loans. This is
because none of the types of "activities" regarding a loan that
§ 2A (e) (vi) (C) (1)-(5) describes -- the SINAA factors (see
note 21, supra) -- reasonably can be understood to encompass the
activities of an entity other than the taxpayer.
We begin with "administration." After identifying the
types of actions that collectively comprise the "activity" of
loan administration, § 2A (e) (vi) (C) (5) states expressly that
"[s]uch activity is located at the regular place of business
which oversees this activity." As previously discussed,
"regular place of business" is defined specifically in the
statute as "an office at which the taxpayer carries on its
business in a regular and systematic manner and which is
consistently maintained, occupied and used by employees of the
taxpayer" (emphases added). G. L. c. 63, § 1. Thus, the
language of § 2A (e) (vi) (C) (5) appears to contemplate that
when loan administration is used to determine the "preponderance
of substantive contacts" of a taxpayer's loan or loans, only the
loan administration activities of the taxpayer are taken into
consideration; work performed by agents or independent
contractors of the taxpayer, at least where the agents or
22
contractors are separate businesses with their own places of
business and their own staff, do not fit within the equation.22
Accordingly, it is irrelevant whether the servicers were or were
not agents of Gate, because in either case, their actions were
not appropriately included within the concept of administration
as defined in § 2A (e) (vi) (C) (5).23
It is true that this reading of loan administration as
requiring activity at the regular place of business of the
taxpayer leads to the conclusion that the loans appear to have
had no "substantive contacts" as that concept is described in
§ 2A (e) (vi) (C) (1)-(5). But § 2A contains within it a
straightforward solution to this problem, which is application
of the presumption of commercial domicile as specified in § 2A
(e) (vi) (B).
22
The principal loan servicer, the Pennsylvania Higher
Education Assistance Agency, for example, is a governmental
agency of the Commonwealth of Pennsylvania.
23
We agree with the board and Gate that the other four
types of activities listed in § 2A (e) (vi) (C) -- solicitation,
investigation, negotiation, and approval, see § 2A (e) (vi) (C)
(1)-(4) -- do not apply to Gate because they all concern loan
origination, an activity in which Gate was not involved.
Nevertheless, each of these subsections indicates that the
activity described is located at "the regular place of business"
which the taxpayer's employee is "regularly connected with or
working out of," or, in the case of some loan approvals, at the
"commercial domicile of the taxpayer." Id. Thus, like
administration, each of these activities focuses on a regular
place of business or commercial domicile of the taxpayer itself.
23
Nor does our reading of § 2A create an absurd result when
viewing the statute as a whole. The statute expressly
recognizes that its provisions regarding the receipts, property,
and payroll factors may not reasonably fit the nature of all
financial institutions' business models, and it has a separate
provision to accommodate this circumstance. Specifically,
§ 2A (g) provides that "[i]f the provisions of subsections (a)
to (f), inclusive, are not reasonably adapted to approximate the
net income derived from business carried on within the
commonwealth, a financial institution may apply to the
commissioner, or the commissioner may require the financial
institution, to have its income derived from business carried on
within this commonwealth determined by a method other than that
set forth in subsections (a) to (f), inclusive." Here, although
the board found that Gate qualified for taxation purposes as a
financial institution, Gate is unlike many if not most financial
institutions contemplated in the statute, in that Gate's narrow
role within FMC's loan securitization business is very different
from traditional concepts of banking.24 Given this fact,
24
As noted supra, the term "financial institution"
encompasses first and foremost banks, banking associations,
trust companies, and Federal and State savings and loan
associations. G. L. c. 63, § 1. Other businesses subject to
Federal or State banking and related laws are also incorporated.
Id. Thus, although the statute is constructed in such a way as
to include other types of businesses, including those that
"[derive] more than 50 per cent of [their] gross income . . .
24
application of an alternative apportionment approach as
permitted under § 2A (g) may well have offered a reasonable
option in this case, avoiding what might appear as an exercise
of fitting a square peg into a round hole. In fact, the record
indicates that the commissioner raised the idea of applying an
alternative approach under § 2A (g) to determine the proper
apportionment of Gate's income, albeit using an approach that
resulted in all or substantially all of Gate's income being
apportioned to Massachusetts. Ultimately, however, Gate
rejected the proposal to apply § 2A (g), asserting instead --
incorrectly, we conclude -- that the FIET was specifically
designed for taxpayers such as Gate. In these circumstances,
Gate's complaints regarding what may seem like an awkward result
arising from application of the provisions of § 2A (e) (vi) to
the loans in this case ring somewhat hollow.
As has been discussed, the rules set out in § 2A seek to
produce a reasonable approximation of a financial institution's
net income related to the business it carries on in the
Commonwealth. Gate's business was to assist in the FMC
securitization program through participating in the formation of
the trusts and holding residual beneficial interests in those
from lending activities," id. -- the basis of the board's
determination that Gate qualified as a financial institution --
many if not most of the businesses that fall within the
statute's definition are banks or closely related to banks.
25
trusts. It was a holding company, with no employees of its own.
Gate appears to have had no direct relationship with the loan
servicers, whose actual contracts were with FMC, and thus no
ability to control the work that they did in servicing the
student loans. In these circumstances, it is appropriate that
the servicers' activities in administering the student loans not
be attributed to Gate for the purpose of determining the
"preponderance of substantive contacts" regarding the loans
under § 2A (e) (vi) (C).
In sum, we agree with the board that the presumption
established in § 2A (e) (vi) (B) has not been rebutted, and all
of the loans were properly located at Gate's commercial domicile
in Massachusetts.
3. Constitutional considerations. In support of its
argument that the servicers' loan administration activities
should have been attributed to Gate, Gate invokes decisions of
the United States Supreme Court and this court concerning
constitutional standards for attributing activities of a
taxpayer's representative to the taxpayer for taxation-related
purposes. While the Supreme Court and this court have
identified constitutional issues bearing upon tax apportionment
(as we discuss below), all of the cases that Gate cites relate
to a State's capacity to assert jurisdiction over an out-of-
State taxpayer for purposes of imposing a tax. See Scripto,
26
Inc. v. Carson, 362 U.S. 207, 208 (1960) (considering whether
out-of-State taxpayer had "sufficient jurisdictional contacts"
with Florida to justify imposition of Florida tax). See also
Tyler Pipe Indus., Inc. v. Washington State Dep't of Revenue,
483 U.S. 232, 249, 251 (1987) (activities of taxpayer's in-State
representatives adequately supported Washington's jurisdiction
to tax out-of-State taxpayer);25 Commissioner of Revenue v. Jafra
Cosmetics, Inc., 433 Mass. at 255-256, 261-263 (in-State
activities of sales representatives justified sales and use
taxation of out-of-State taxpayer). The issue of State
jurisdiction to tax in this case is different. The
jurisdictional question here is whether any State besides the
Commonwealth could theoretically impose a tax on Gate. It is a
threshold question that relates only to whether Gate was allowed
to apportion its income in accordance with the formula laid out
in § 2A; if a "financial institution" like Gate does not have
income that is taxable in another State, all of its income is
taxable in the Commonwealth. See G. L. c. 63, § 2A (a). As
noted earlier, the board found that Gate was taxable in all
fifty States, and thus was entitled to apportion its income.
Neither party has appealed this issue.
25
Tyler Pipe Indus., Inc. v. Washington State Dep't of
Revenue, 483 U.S. 232, 251 (1987), also raised an issue of
apportionment, but that was not the basis for which Gate cited
it.
27
With respect to apportionment, both the United States
Supreme Court and this court have found that the due process
clause and the commerce clause require fairness in apportioning
the income of a business that may be taxed in multiple States.
See Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. at
169; Exxon Corp. v. Department of Revenue, 447 U.S. 207, 219,
227-228 (1980); Gillette Co. v. Commissioner of Revenue, 425
Mass. at 680. While the Federal Constitution "imposes no single
[apportionment] formula on the States," apportionment must
produce at least a "'rough approximation' of the corporate
income that is 'reasonably related to the activities conducted
within the taxing State.'" Gillette Co., supra at 680-681,
quoting Exxon Corp., supra at 223. However, if a taxpayer seeks
to challenge the appropriateness of an apportionment formula on
this basis, it is incumbent upon the taxpayer to show by "'clear
and cogent evidence' that the income attributed to the State is
in fact 'out of all appropriate proportions to the business
transacted . . . in that State.'" Container Corp. of Am., supra
at 170, quoting Hans Rees' Sons v. North Carolina ex rel.
Maxwell, 283 U.S. 123, 135 (1931). See Boston Professional
Hockey Ass'n, 443 Mass. at 285; Gillette Co., supra at 679-680.
Two elements of fairness arising under the due process
clause have been identified in this context and relate to the
present case. "The first . . . component of fairness in an
28
apportionment formula is what might be called internal
consistency -- that is, the formula must be such that, if
applied by every jurisdiction, it would result in no more than
all of the unitary business'[s] income being taxed. The second
and more difficult requirement is what might be called external
consistency -- the factor or factors used in the apportionment
formula must actually reflect a reasonable sense of how income
is generated." Gillette Co., 425 Mass. at 680, quoting
Container Corp. of Am., 463 U.S. at 169.26
Considering the first factor, we have no reason to conclude
that application of the apportionment statute as we have
interpreted it produces duplicative taxation of Gate's income,
given that Gate's Massachusetts apportionment percentage for the
tax year at issue was approximately fifty-one per cent, and the
record reflects that Gate filed tax returns only in
Massachusetts and Florida for the relevant years.27
26
A third element of fairness, that "an apportionment
formula must . . . not result in discrimination against
interstate or foreign commerce," has been identified under the
commerce clause. Gillette Co. v. Commissioner of Revenue, 425
Mass. 670, 682 (1997), quoting Container Corp. of Am. v.
Franchise Tax Bd., 463 U.S. 159, 170 (1983). However, "[i]n the
interstate context, the antidiscrimination principle has not in
practice required much in addition to the due process fairness
requirement." Id. at 682-683. Moreover, Gate has advanced no
argument that the board's interpretation of the apportionment
statute here discriminates against interstate commerce.
27
Based on Gate's Florida tax returns, it appears that
Gate's apportionment percentage in Florida was less than five
per cent for each of the tax years at issue.
29
With respect to the second factor -- whether the
apportionment scheme reasonably reflects how a business
generates income -- as previously mentioned, the underlying
economic activity giving rise to Gate's income was FMC's loan
securitization program. As the board's findings reflect, the
purpose of Gate's existence was to hold interests in trusts
containing loans as part of FMC's securitization process.
Furthermore, because Gate had no offices or employees of its
own, and because it was a wholly owned subsidiary of FMC, it
makes more sense to view the income-producing activity of Gate
as connected to FMC, its parent company, rather than as
connected to the servicers, which were independent and unrelated
entities. Viewed this way, we think an outcome that locates all
of the loans at Gate's and FMC's commercial domicile, rather
than at the place of business of the servicers, results in the
most appropriate approximation of how Gate generated income.28
Gate argues that it was unreasonable to allow Gate's
property factor to increase its over-all apportionment
percentage from approximately two per cent to more than fifty
per cent, given that the loans did not appear to have any
"substantive contacts" with Massachusetts in the sense described
by the SINAA factors. In addition, they argue that Department
28
The commission, as amicus curiae, advances a similar
analysis.
30
of Revenue Letter Ruling 87-9 (Sept. 18, 1987) permitted a trust
consisting of thousands of loans, only a small percentage of
which had connections to Massachusetts, to apportion its income
based solely on the percentage of income received from interest
on the Massachusetts loans, and that Gate should be entitled to
do the same. We disagree. The first point assumes a particular
interpretation of § 2A (e) (vi) -- specifically that loans must
have some "substantive contacts" of the kind described in
§ 2A (e) (vi) (C) -- that we have concluded is incorrect for the
reasons previously discussed. The analogy to the trust
described in Letter Ruling 87-9 is also unpersuasive, because
the income of that trust was to be apportioned using the formula
that applied to corporations, which involved three factors
(property, payroll, and sales), of which the trust claimed to
have none. Letter Ruling 87-9. Thus, the trust proposed a
unique method of apportionment that would apply only to the
"special circumstances" of that case. Id. Again, as noted
above, FMC and Gate have not requested alternative apportionment
under § 2A (g), and instead have argued that the general
apportionment formula under § 2A (b) applies.
In short, Gate has not met its burden to show that
apportionment as applied in this case was unfair or
unreasonable; we discern no violation of the due process or
commerce clause as a result of the decision we reach here.
31
4. Notice. Finally, Gate argues that the board improperly
resolved this case in favor of the commissioner based on a legal
theory that the commissioner did not raise before the board,
specifically, that an agency relationship was required between
Gate and the servicers in order to attribute the servicers'
activities to Gate. Gate claims that this action by the board
violates G. L. c. 58A, § 7, which states in pertinent part:
"the board shall not consider, unless equity and good conscience
so require, any issue of fact or contention of law not
specifically set out in the petition upon appeal or raised in
the answer."
In this case, it was Gate that put forward the theory that
Gate had "substantive contacts" with the loans through the
activities of the servicers. While Gate clearly did not argue
that an agency relationship was required in order to attribute
the servicers' activities to Gate, the board was within its
authority to consider Gate's argument concerning the servicers
and to determine whether it fit within an appropriate
interpretation of § 2A (e) (vi). The quoted limitation in G. L.
c. 58A, § 7, has been interpreted to prohibit more surprising or
unexpected legal turnabouts, such that one party could not have
been expected to adequately advance their position under the
circumstances. See, e.g., Deveau v. Commissioner of Revenue, 51
Mass. App. Ct. 420, 420-421, 426-428 (2001) (board decided
32
taxpayers' appeals based on new theory first advanced by
commissioner on morning of hearing; court suggested, without
needing to decide, that this approach would violate G. L.
c. 58A, § 7). We conclude that Gate had sufficient notice of
the basis of the board's decision pursuant to G. L. c. 58A, § 7.
Decision of the Appellate Tax
Board affirmed.