Taxation Without Representation: Michigan Supreme Court Says Neither State Law Nor the U.S. Constitution Requires Inclusion of Receipts From Deemed Asset Sale in Sales Factor

In a split decision, the Michigan Supreme Court rejected a taxpayer’s assertion that applying the standard apportionment formula to gain derived from a deemed asset sale led to a grossly distorted, unconstitutional result.  The court held in Vectren InfrastructuCapture-300x300re Services Corporation v. Department of Treasury, No. 163742 (July 31, 2023), that applying the standard single sales factor apportionment formula—which did not include any receipts from the deemed asset sale—to apportion the gain did not violate the U.S. Constitution’s Due Process Clause or Commerce Clause.

The taxpayer was the successor in interest to a Minnesota-headquartered company that constructed, maintained, and repaired gas pipelines and provided HAZMAT cleanup services.  In 2010, the company was hired to perform significant work cleaning up an oil spill in Kalamazoo, Michigan.  In 2011, while the cleanup operation was still ongoing, the company’s owners sold the business in a transaction that was structured as an asset sale pursuant to IRC section 338(h)(10).  At the time, the now-repealed Michigan Business Tax Act required multistate businesses to apportion their income to Michigan using a single sales factor formula.  The company included the gain from the transaction in its apportionable tax base and in its sales factor denominator, the latter resulting in an apportionment percentage of approximately 15 percent.

The Michigan Department of Treasury (Department) audited the company’s return and eliminated the sale from the company’s sales factor denominator on the grounds that the transaction did not satisfy the statutory definition of “sale.”  For the tax year in question, the term “sale” was statutorily defined, in relevant part, as the amounts received by the taxpayer as consideration from the transfer of title to, or possession of, property that is stock in trade or other property of a kind that would properly be included in the taxpayer’s inventory.  The Department’s adjustment increased the company’s apportionment percentage to approximately 70 percent.  The taxpayer subsequently sought permission to use an alternative apportionment formula, but the Department denied the request.

The taxpayer filed suit contending that the standard apportionment formula did not fairly represent the extent of its business activity in the state and violated the Due Process Clause and Commerce Clause.  The Michigan Court of Appeals held that the standard formula was unconstitutional as applied, observing that the business’s value had appreciated over a number of years as a result of operations in many states, and that much of the business’s activity and assets involved in the deemed asset sale had no connection to Michigan.  The court also noted that, due to its work on the Kalamazoo oil spill, the company’s sales factor in the year of the deemed asset sale was unusually high relative to the historical average of its sales factor (about 7 percent).  The taxpayer’s win was short-lived, however, as the Michigan Supreme Court vacated the Court of Appeals’ decision and remanded the case with instructions to decide the threshold issue whether the deemed asset sale was a “sale” that was required to be included in the sales factor.

The Court of Appeals then held the deemed asset sale did not satisfy the statutory definition of “sale,” and reiterated its prior conclusion that an alternative apportionment formula was necessary.  On appeal, the Michigan Supreme Court agreed that the asset sale was not a “sale” under Michigan law, but it otherwise disagreed with the Court of Appeals regarding the need for an alternative apportionment formula.  At the outset of its legal analysis, the majority determined that the gain from the asset sale was apportionable income under both Michigan law and U.S. Supreme Court jurisprudence.  Having concluded that the gain was properly included in the tax base, the majority turned to the taxpayer’s argument that the standard formula attributed business activity to Michigan that was out of all appropriate proportion to the actual business activity transacted in the state led to a grossly distorted result.

After describing how the Due Process Clause and Commerce Clause inquiries “largely overlap,” the majority devoted much of its analysis to the “fair apportionment” prong under Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), which requires that a tax be internally and externally consistent to survive a Commerce Clause challenge.  The majority found that the standard formula was internally consistent because, although the formula attributed 70 percent of the gain from the deemed asset sale to Michigan, no more than 100 percent of the gain would be taxed if every state applied the same formula.  Likewise, it found that the standard formula was externally consistent because the evidence demonstrated Michigan was an important part of the company’s “geographic portfolio,” its growth between 2007 and 2010, and its growth strategy.  The majority rejected the notion that the company’s average apportionment percentage in the ten year-period preceding the deemed asset sale should inform whether the standard formula leads to a grossly distorted result in the year of the sale.  Rounding out its constitutional analysis, the majority held that the company’s activity had a substantial nexus with Michigan, the tax did not discriminate against interstate commerce, and the tax was fairly related to the services provided by Michigan.

In sum, the Michigan Supreme Court held that the use of the standard apportionment formula—which did not include any receipts from the deemed asset sale—to apportion the gain derived from the deemed asset sale did not violate the Due Process Clause or Commerce Clause, and that the Court of Appeals erred in concluding an alternative apportionment formula should be used.  The Michigan Supreme Court reversed the Court of Appeals’ opinion and remanded the case to determine the appropriateness of penalties imposed by the Department.

The case is Vectren Infrastructure Services Corp. v. Department of Treasury, No. 163742 (Mich. July 31, 2023).  The majority and dissenting opinions are available at