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Utah State Tax Commission v. See's Candies, Inc.

Supreme Court of Utah

October 5, 2018

Utah State Tax Commission, Respondent-Appellant,
See's Candies, Inc., Petitioner-Appellee.

         This opinion is subject to revision before final publication in the Pacific Reporter

          On Direct Appeal Fourth District, Utah County The Honorable Judge Samuel D. McVey No. 140401556

          Sean D. Reyes, Att'y Gen., Tyler R. Green, Solic. Gen., Brent A. Burnett, Asst. Solic. Gen., Clark L. Snelson, Michelle A. Lombardi, Asst. Att'y Gens., Salt Lake City, for respondent-appellant.

          Nathan Runyan, Steven P. Young, Salt Lake City, Eric S. Tresh, Jonathan A. Feldman, Atlanta, GA, Kelly M. Klaus, Mark R. Yohalem, Los Angeles, CA, for petitioner-appellee

          Gregory S. Matson, Helen Hecht, Sheldon H. Laskin, Bruce Fort, Lila Disque, Washington, D.C., for amici Multistate Tax Commission.

          Gary R. Thorup, Salt Lake City, for amici Council on State Taxation.

          G. Wesley D. Quinton, Farmington, for amici Utah Taxpayers Association.

          Justice Pearce authored the opinion of the Court in which Chief Justice Durrant, Associate Chief Justice Lee, Justice Himonas, and Justice Petersen joined.


          PEARCE, JUSTICE.


         ¶1 See's Candies (See's), a Berkshire Hathaway subsidiary, sold its intellectual property to Columbia Insurance Company, another Berkshire Hathaway subsidiary. In return, See's received shares of Columbia's stock. After the sale, See's was required to pay Columbia to use the See's trade name. See's deducted these royalty payments from its taxable income. A tax commission auditor reviewed See's[1] tax returns and called shenanigans, concluding that the transaction had been structured to permit See's to improperly reduce its taxes. Utah Code section 59-7-113 permits the Utah State Tax Commission (the Commission) to allocate income between related organizations if it is "necessary" to "prevent evasion of taxes" or "clearly to reflect the income" of the corporations. And that is what the Commission did; it allocated the royalty payment deductions back to See's as taxable income. This increased See's tax liability for the audited years.

         ¶2 See's appealed that assessment to the Commission, which decided that the allocation was appropriate. See's then appealed that decision to the district court, which, by statute, has the authority to conduct a trial de novo. After trial, the district court reached the opposite conclusion and allowed See's to take the deductions. To reach that conclusion, the district court analyzed section 113 to assess when the statute authorizes the Commission to allocate income between related companies. The Commission argued that it had plenary authority to allocate income whenever it, in its sole discretion, believed it was necessary to prevent tax evasion or to make a corporation's returns clearly reflect its income. See's argued that the statute should be interpreted in the same fashion as a similarly worded provision of the federal tax code. Under that interpretation, the Commission would be authorized to allocate when the transaction occurs on terms more favorable than those that two unrelated companies would reach after negotiating at arm's length.

         ¶3 The district court concluded that section 113 was ambiguous. To resolve the ambiguity, the district court interpreted the section in harmony with that similarly worded section of the federal tax code. The district court credited expert testimony opining that the See's-Columbia transaction looked like one that two unrelated companies would have reached. The Commission has not challenged this finding. Based on that testimony, the district court ultimately concluded that section 113 did not permit the allocation the Commission had imposed. The Commission appeals.

         ¶4 Like the district court, we conclude that the language of section 113 is ambiguous. We also conclude that the district court properly looked to section 113's federal counterpart and its accompanying regulations for guidance. The original version of section 113 was lifted directly from the 1928 Internal Revenue Code. Because the Legislature modeled the original version of section 113 on its federal counterpart, we look to the federal statute's history and interpretation for guidance. We affirm.


         ¶5 See's and Columbia Insurance Company are wholly owned subsidiaries of Berkshire Hathaway.[2] In 1997, See's sold intellectual property, including its trademarks, to Columbia in exchange for Columbia stock. The value of the intellectual property was independently assessed at the time of the transaction, and Columbia tendered shares that roughly equaled the value of See's intellectual property. As part of the transaction, Columbia and See's entered into a licensing agreement to permit See's to continue using its trade name. Under the agreement, Columbia would protect and develop the intellectual property; See's would pay royalties to license the intellectual property back.

         ¶6 See's deducted the royalty payments from its income as a business expense. The Multistate Tax Commission (MTC)[3] audited See's deductions for the years 1995 through 1998 and concluded the deduction was proper for various states, including Utah. The MTC recommended a 10 percent disallowance of the deduction to "represent an increase in Columbia's capital and reflect See's business activities in the State." The Commission accepted the MTC's recommendations and allowed the deduction with the 10 percent disallowance. That decision is not before us.

         ¶7 The Commission later audited See's for the years 1999 through 2007 and disallowed the royalty deductions. In an administrative proceeding, the Commission concluded that Utah Code "section 59-7-113 precluded shifting of income through royalty payments between See's and Columbia since Columbia does not file Utah corporate franchise tax returns."[4] The Commission concluded that the royalty deduction See's claimed "would decrease See's taxable income by 75% for the audited years and thus section 59-7-113 justified the disallowance to clearly reflect See's income." The Commission did not evaluate whether the royalty was priced at arm's length or if there was a business purpose for the transaction, but did state that See's would not have entered into this deal with an unrelated corporation.[5]

         ¶8 See's sought a trial de novo of the Commission's assessment in the district court. See Utah Code §§ 59-1-601, -602.[6] Section 113's meaning became a threshold question for the court. The Commission argued that section 59-7-113 "is a stand-alone section giving the Commission authority to reallocate income if it concludes in its broad discretion there is a distortion of income for tax purposes or avoidance of income," and that the "Legislature did not intend the statute to involve interpretation by reference to federal [Internal Revenue Service] regulations." See's contended that "section 59-7-113, being virtually identical to [Internal Revenue Code section] 482, depends on the [Internal Revenue Service] regulations for interpretation and application [and that] it me[t] those regulations' requirements for taking the deduction."

         ¶9 The district court concluded that the language of Utah Code section 59-7-113 "appears to be unambiguous regarding the Tax Commission's ability to redistribute deductions if necessary to clearly reflect income." But the district court also reasoned that the language "is less clear regarding conditions that should exist before it undertakes that task." The court reasoned that although the Commission "enjoys broad discretion to adjust income . . . there should be some law to guide how its discretion should operate in getting [the] deductions to clearly reflect income."

         ¶10 In addition, the court opined that the statutory inquiry was "rooted in whether the transaction [between related companies] was arm's length." The court concluded that

Utah income [and] franchise taxing relies heavily on federal definitions and section 59-7-113 is itself a virtual copy of [Internal Revenue Code] section 482, indicating, as provided in [a] [Utah] Attorney General Opinion and Utah case law on similar statutes cited above, the Legislature wants to use federal guidance to interpret and apply the statute when dealing with whether a transaction is arm's length or not.

         ¶11 With respect to the substance of the dispute, See's called multiple expert witnesses at trial. See's economist opined that "the purpose of transfer pricing evaluation is to ensure transactions between related parties reflect fair market pricing."[7] He explained that "[t]he practice . . . has a long history in sales and in application of [Internal Revenue Code] section 482." He concluded that "the royalty rate See's paid Columbia was in the arm's length range of royalty rates specified in" transfer pricing studies performed by an accounting firm.

         ¶12 See's also called a tax law professor to explain that "the purpose of [Internal Revenue Code] section 482 is to put transactions between related parties on the same footing as if they took place between unrelated parties." The professor also explained that "many other states have adopted statutes which, like section 59-7-113, are virtually identical to [Internal Revenue Code] section 482," and other states "refer to the [Internal Revenue Code] thus implicitly adopting section 482." The professor concluded that "[t]he Commission simply exercised unfettered discretion to reach its decision unguided by any reasonable standard."

         ¶13 Through its witnesses, See's introduced an independent transfer pricing study prepared by an accounting firm. The study concluded that the See's-Columbia transaction reflected terms like those that would be reached between unrelated parties dealing at arm's length. The study concluded that "[b]ased on the financial information for the last three years . . . the net royalty payments made to [Columbia] for these intangible assets . . . are appropriate." The study also noted that "[i]n evaluating the appropriateness of this royalty rate, we confirmed that [Columbia] pays certain costs associated with these intangible assets. This net royalty rate allows See's to earn a normal return on its intangible assets."

         ¶14 The court ultimately concluded that the transfer between See's and Columbia resembled a transaction that unrelated parties dealing at arm's length could have reached. The Commission appeals.


         ¶15 The Commission contends that the district court erred by interpreting Utah Code section 59-7-113 to reflect the federal arm's length transaction standard. The appropriate interpretation of a statute presents a question of law that we review for correctness. Bagley v. Bagley, 2016 UT 48, ¶ 7, 387 P.3d 1000.


         ¶16 The Commission contends that the district court erred by looking to federal law to interpret Utah Code section 59-7-113. The Commission argues that the language and history of section 113 indicate that the Legislature made a deliberate decision that federal law should not be used to interpret section 113. See's counters that because section 113 is ambiguous, the district court properly considered its federal counterpart and accompanying regulations to define the scope of the Commission's authority.

         ¶17 When faced with a question of statutory interpretation, "our primary goal is to evince the true intent and purpose of the Legislature." Marion Energy, Inc. v. KFJ Ranch P'ship, 2011 UT 50, ¶ 14, 267 P.3d 863 (citation omitted). "The best evidence of the legislature's intent is the plain language of the statute itself." Id. (citation omitted) (internal quotation marks omitted). Accordingly, "[w]hen interpreting a statute, we assume, absent a contrary indication, that the legislature used each term advisedly according to its ordinary and usually accepted meaning." Id. (alteration in original) (citation omitted).

         ¶18 When the meaning of a statute can be discerned from its language, we need no other interpretive tools. Id. ¶ 15. However, "when statutory language is ambiguous-in that its terms remain susceptible to two or more reasonable interpretations after we have conducted a plain language analysis-we generally resort to other modes of statutory construction and seek guidance from legislative history and other accepted sources." Id. (citation omitted) (internal quotation marks omitted).

         ¶19 Utah Code section 59-7-113 governs the Commission's authority to allocate income between corporations owned or controlled by the same interests:

If two or more corporations (whether or not organized or doing business in this state, and whether or not affiliated) are owned or controlled directly or indirectly by the same interests, the commission is authorized to distribute, apportion, or allocate gross income or deductions between or among such corporations, if it determines that such distribution, apportionment, or allocation is necessary ...

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