Michigan Supreme Court Clarifies Use Tax Exemption Apportionment Rules
On July 22, the Michigan Supreme Court decided Detroit Edison Company v. Department of Treasury, holding that the Michigan Use Tax apportionment rules apply in situations where property is simultaneously used for exempt and non-exempt purposes. The claim was initiated by Detroit Edison Company ("DTE") in response to a use tax audit by the Department of Treasury. The audit determined that DTE wrongly claimed an exemption from use tax for property used outside of its plant (transformers, fuses, circuit breakers, etc.), resulting in a deficiency assessment of over $13 million plus interest.
DTE claimed that its property was exempt from use tax under the industrial processing exemption, which exempts from use tax property used in the production of tangible personal property to ultimately be sold at retail. The Department of Treasury, on the other hand, argued that DTE's electrical system was used to distribute a product to consumers—a non-exempt use. The Court of Claims and Court of Appeals agreed with DTE, noting that the property in dispute was used concurrently in a single system for the purposes of both distribution and industrial processing. Because the property was used for an exempt purpose at all times, both courts held that the use tax exemption applied in full, despite the simultaneous presence of non-exempt purposes.
On appeal to the Supreme Court, the Department of Treasury argued that if the exemption applied at all, it must be reduced based on the presence of the non-exempt use. Treasury relied on the apportionment rule in MCL 205.94o(2), which provides that "the exemption is limited to the percentage of exempt use to total use determined by a reasonable formula or method approved by the department." DTE argued that the apportionment rule did not apply because the non-exempt use occurred simultaneously to its exempt use. In other words, the property was used at all times for an exempt purpose, so it should be completely exempt.
The Supreme Court found in favor of the Department of Treasury, holding that DTE's exemption must be apportioned according to a reasonable formula or method approved by Treasury. The Court defined the "total use" of property as the sum of the property's uses for all exempt and non-exempt activities. It is irrelevant whether the two types of activities occur simultaneously. Unfortunately, the Court neither described what a reasonable method of apportionment would be, nor suggested how DTE should apportion the use of its property that is used for exempt purposes at all times.
How Does This Decision Impact Your Business?
The apportionment language DTE relied upon is present in other use tax exemptions for other industries as well, including producers of agricultural products, wholesalers, 501(c)(3) and 501(c)(4) organizations, schools, and hospitals. What is clear from this decision is that any property that is simultaneously used for exempt and non-exempt purposes will not be entirely exempt from use tax. Instead, taxpayers will have to apportion their claimed exemption based upon a formula or method that is approved by the Treasury. What is unclear is how to identify a reasonable apportionment formula or method.
Apportionment is relatively straight-forward when property is used for exempt and non-exempt purposes over discrete periods of time. For example, if a piece of equipment is used 50 percent of the time for an exempt purpose and the other 50 percent of the time for a non-exempt purpose, it is clear the taxpayer should only claim 50 percent of the available exemption. However, if property is used 100 percent of the time for an exempt purpose and is simultaneously used for a non-exempt purpose, creating a reasonable method of apportionment becomes substantially more difficult.
For more information about how this decision could impact your business, please contact one of Foster Swift's Tax Attorneys.
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