JONATHAN MILLER, SECRETARY OF THE FINANCE AND ADMINISTRATION CABINET OF THE COMMONWEALTH OF KENTUCKY; JUSTICE NOBLE - REVERSING SCHRODER, J., CONCURS IN RESULT ONLY BY SEPARATE
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2006-SC-000416-DG
2007-SC-000819-DG
JONATHAN MILLER, SECRETARY OF
THE FINANCE AND ADMINISTRATION
CABINET OF THE COMMONWEALTH OF
KENTUCKY ; COMMONWEALTH OF
KENTUCKY, DEPARTMENT OF
REVENUE
V
APPELLANTS/ CROSS-APPELLEES
ON REVIEW FROM COURT OF APPEALS
CASE NO . 2004-CA-001566-MR
FRANKLIN CIRCUIT COURT
NOS . 00-CI-00523 AND 00-CI-00661
JOHNSON CONTROLS, INC . ; SECURITY
GROUP, INC . AND SUBSIDIARIES,
INCLUDING SARGENT 8v GREENLEAF,
INC. ; WILLIS NORTH AMERICA, INC .
AND AFFILIATES ; BUNZL USA, INC. AND
SUBSIDIARIES INCLUDING MAK-PAK,
INC . ; TREDEGAR CORPORATION, INC .
AND SUBSIDIARIES ; COSMOS
BROADCASTING CORPORATION AND
AFFILIATES
APPELLEES/ CROSS-APPELLANTS
OPINION OF THE COURT BY JUSTICE NOBLE
REVERSING
This appeal addresses the constitutionality and application of certain
amendments to the corporate tax statutes passed by the General Assembly in
2000 that barred the filing of combined tax returns under the unitary business
concept and the issuance of tax refunds related to such a filing, even if by
amended return, for the years prior to 1995 . The Appellants (and Cross-
Appellees) Jonathan Miller, et al ., collectively on behalf of the Commonwealth
of Kentucky, assert that the amended tax statutes satisfy all constitutional
requirements, and that they were economic legislation enacted for a legitimate
purpose, even though they disallow filing combined returns or collecting a
refund thereon for the years before 1995 . The Appellants also argue that the
legislature effectively withdrew its consent to be sued for such refunds.
Appellees (and Cross-Appellants) Johnson Controls, et al., argue that their due
process rights will be violated if the 2000 amendments to the tax statutes are
allowed to prevent them from getting a refund . They also claim denial of equal
protection under the law and violation of other Kentucky Constitutional rights.
Because we find that the tax statute amendments were enacted for the
legitimate governmental purpose of regulating revenue, and that the
amendments are rationally related to that purpose, there is no due process or
other constitutional violation.
I. Background
A. Factual Background
Beginning in 1988, the Kentucky Revenue Cabinet began interpreting
KRS 141 .120 to disallow the filing of a combined tax return under the unitary
business concept. In Revenue Policy (RP) 41P225, the Cabinet determined to
literally apply the language in KRS 141 .120 which stated that such returns
were disallowed . Prior to this, for sixteen years, the Cabinet had allowed
qualified businesses to choose whether to file separate returns or a combined
return under the unitary business concept. RP 41P225 made it clear that only
separate returns would be allowed despite the fact that a group of corporations
might function under a unitary business plan.
Many corporate enterprises function as clusters or chains of related
corporations, often across many state lines . Determining how to apportion
corporate income to allow for taxation in each state can be extremely difficult
and can lend itself to tax "dodges" or fraud . One method to arrive at proper
taxation for a specific part of a business chain is to simply tax each part
separately . Another method, known as a combined return under a unitary
business plan, lets the corporate entity file as a whole, then apportions the
state tax according to some formula. There are pros and cons to both methods
which are not germane here .
The Appellees originally filed separate tax returns. In 1994, this Court
decided GTE v. Revenue Cabinet, Commonwealth of Kentucky , 889 S .W .2d 788
(Ky. 1994), which held that related corporations (such as a parent and
subsidiary) could file a combined tax return under the unitary business
concept. After GTE was decided, the Appellees in this case sought to amend
their returns by substituting combined returns under the unitary business
concept as allowed in GTE , because they would owe less tax under such an
approach and could therefore claim a refund of taxes they claim to have
overpaid.
Recognizing that applying GTE would result in a significant and
unanticipated revenue loss, the General Assembly repeatedly amended the
relevant statutes to bar the type of combined returns under the unitary
business plan that the Appellees amended to file, and to bar the payment of
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any tax refunds that would be due to persons filing this type of amended
return . The Appellees claim these statutory amendments have denied them
due process of law and violated equal protection.
B. Procedural and Legislative History of KRS 141 .120 and KRS 141 .200
Two statutes actually lie at the heart of this controversy: KRS 141 .120
and KRS 141 .200 . Because they have been subject to significant amendment
and shifting interpretations, some recounting of that history will be helpful in
understanding this case .
1 . Before 1996
GTE read the version of KRS 141 .120 in effect at that time to "authorize
multiple corporations engaged in a unitary business to file combined income
tax returns ." GTE, 889 S.W.2d at 791 . As noted above, this meant that related
corporations (e.g., a parent and subsidiary) could effectively file a single tax
return. The Court so held despite the fact that KRS 141 .200(1) at the time
required that "[c]orporations that are affiliated must each make a separate
return ." The Court read "corporation" as used in KRS 141 .200 to mean both
individual corporations and groups of corporations that operated as a "unitary
business." GTE, 889 S .W .2d at 793 . 1 This meant that GTE and its
'Specifically, the Court stated:
Although we recognize the argument by the Revenue Cabinet that KRS
141 .200(1) requires separate corporate filings, we do not agree with the
interpretation placed on the last sentence of that statute. "Corporations"
is defined by KRS 141 .010(24) as having a meaning consistent with the
definition of the word in § 7701(a)3 of the Federal Internal Revenue Code .
26 U.S.C. 7701 . Th e concept of apportionment among states obviously
has no place within the confines of the Federal tax plan . Our
interpretation of the word "Corporation" as used in KRS 141 .200(1) is,
however, consistent with the Federal definition . We interpret the last
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subsidiaries would be treated as a single business under the "unitary business
concept" and they could therefore file a combined return .
2. The 1996 Amendments
The General Assembly amended KRS 141 .120 substantially in 1996,
directly in response to the Court's decision in GTE, with the change having
retrospective effect to any tax year ending on or after December 31, 1995 . See
1996 Ky. Acts ch. 239, §§ 1, 3 . A section was added that read, "Nothing in this
section shall be construed as allowing or requiring the filing of a combined
return under the unitary business concept or a consolidated return ." KRS
141 .120(11) .
KRS 141 .200 was amended in its entirety, with its changes having
retrospective effect to any tax year ending on or after December 31, 1995 . See
1996 Ky. Acts ch . 239, §§ 2, 3 . The "[c]orporations that are affiliated must
each make a separate return" language was removed. In its place, the General
Assembly included definitions of "affiliated group" and "consolidated returns,"
both of which referenced the federal Internal Revenue Code. The General
Assembly also included language allowing "affiliated groups" to file
"consolidated returns."
phrase of § 1, which is "corporations that are affiliated" to refer to unitary
corporations such as GTE and Subsidiaries . The statute merely requires
that each unitary corporation file a separate corporate income tax return.
It does not mean that each component corporation of the unitary group
must file separately . The taxation statutes differentiate between simple
corporations and unitary corporations . This statute simply requires a
return for both classes of corporate taxpayers.
GTE, 889 S.W .2d at 792-93 .
The effect of this legislation was to undo the "unitary business concept"
injected into the law by GTE while allowing parent-subsidiary groups of
corporations, like those involved in the GTE litigation, to file what amounted to
a single return going forward from 1995 . In other words, the General Assembly
technically undid GTE, at least going forward, but implemented a substantially
similar scheme under the "affiliated group" approach . This allowed the General
Assembly to follow the national trend that GTE had recognized while giving it
more control over the process than the judiciary.
3. The 1998 Budget Bill
Sometime in 1996 to 1998, the Revenue Cabinet realized that GTE's
interpretation of KRS 141 .120 was creating substantial tax refund liabilities for
the state for the years prior to 1995 . The General Assembly was not apprised
of, or at least was not able to address, these problems until late in the 1998
Regular Session, when it was well into the budgeting process . Because
legislative sessions were only held every other year then, the first chance to
deal with the problem with direct legislation would come two years later. To at
least temporarily patch the problem, the General Assembly inserted a provision
in the 1998 Budget Bill barring the state treasury from paying out any refunds
sought pursuant to the theory announced in GTE . The Budget Bill would only
be in effect for two years, meaning the problem would have to be addressed
fully in 2000.
4. The 2000 Amendments
In 2000, the General Assembly finally had a chance to deal directly with
the emerging problem created by those corporations trying to file amended
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returns for years before 1995 to take advantage of GTE's interpretation of the
version of KRS 141 .120 in effect in those years .
It amended KRS 141 .120 to remove the express bar on filings under the
"unitary business concept" found in the 1996 version at KRS 141 .1. 20(11) . See
2000 Ky . Act . ch . 543, § 2 . This was not a rollback of the disapproval of the
"unitary business concept," however.
Instead, the General Assembly again amended KRS 141 .200
substantially to address the problem . See 2000 Ky. Act. ch. 543, § 1 . The
amendment added the following language :
(7) For any taxable year ending on or after December 31,
1995, except as provided under subsection (3) of this section,
nothing in this chapter shall be construed as allowing or requiring
the filing of:
(a) A combined return under the unitary business
concept; or
(b) A consolidated return .
(8) No assessment of additional tax due for any taxable year
ending on or before December 31, 1995, made after December 22,
1994, and based on requiring a change from any initially filed
separate return or returns to a combined return under the unitary
business concept or to a consolidated return, shall be effective or
recognized for any purpose.
(9) No claim for refund or credit of a tax overpayment for any
taxable year ending on or before December, 31, 1995, made by an
amended return or any other method after December 22, 1994,
and based on a change from any initially filed separate return or
returns to a combined return under the unitary business concept
or to a consolidated return, shall be effective or recognized for any
purpose.
(10) No corporation or group of corporations shall be allowed
to file a combined return under the unitary business concept or a
consolidated return for any taxable year ending before December
31, 1995, unless on or before December 22, 1994, the corporation
or group of corporations filed an initial or amended return under
the unitary business concept or consolidated return for a taxable
year ending before December 22, 1994 .
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(11) This section shall not be construed to limit or otherwise
impair the cabinet's authority under KRS 141 .205 .
KRS 141 .200 . The bill also had language stating that subsection (7) "shall
apply retroactively for taxable years ending on or after December 31, 1995,"
and that subsections (8) to (11) "shall apply retroactively for all taxable years
ending before December 31, 1995." 2000 Ky. Acts ch. 543, § 3 .
The effect of this amendment was to maintain the bar on combined
returns under the "unitary business concept" and to retrospectively apply that
bar to years before 1995 . Because there was no alternative for filing
"consolidated returns" for "affiliated groups" in those years, as had been
allowed beginning in 1995 under the 1996 amendments, this new amendment
purported to undo any effect GTE might have had prior to 1995 .
S . Subsequent Amendments
Subsequent amendments of KRS 141 .120 and .200 left the 1996 and
2000 amendments substantially intact. Also, KRS 141 .200 has been amended
to include provisions related to "affiliated groups" and "consolidated returns"
for the tax years 2004 to 2007 . This has had the effect of moving KRS
141 .200(7) - (11), as found in the 2000 version of the statute, to KRS
141 .200(15) - (19) . For present purposes, however, the law appears to be
substantially the same as it appeared in 2000 .
II. Analysis
A. Sovereign Immunity
Appellants argued that Appellees cannot obtain a tax refund in this
action from Revenue because the legislature withdrew its consent, specifically,
8
to be sued for a refund under a combined return based on the unitary business
plan in KRS 141 .200(17) . Certainly, that is the plain meaning of that section.
However,
The constitutional privilege of a State to assert its sovereign
immunity in its own courts does not confer upon the state a
concomitant right to disregard the Constitution or valid federal
law. The States and their officers are bound by obligations
imposed by the Constitution and by federal statutes that comport
with the constitutional design . . . .
Sovereign immunity does not bar all judicial review of state
compliance with the Constitution and valid federal law.
Alden v. Maine, 527 U.S . 706, 755-56 (1999) .
The Appellees have raised a federal due process challenge to the 2000
amendments . As such, their federal constitutional claims must be considered
under the Supremacy Clause . If there is a federal constitutional violation, that
law prevails .
B. Due Process
The term "due process" has two meanings in American jurisprudence: (1)
substantive due process, which is based on the idea that some rights are so
fundamental that the government must have an exceedingly important reason
to regulate them, if at all, such as the right to free speech or to vote; and (2)
procedural due process, which requires the government to follow known and
established procedures, and not to act arbitrarily or unfairly in regulating life,
liberty or property . Since the Appellees have paid taxes and are seeking a
refund by amending their separate returns to a combined return under the
unitary business concept for the years in question, they claim a property
interest will be taken without due process of law if the amended tax statutes
are allowed retroactive application to bar their claims .
It has been established that "a taxpayer has no vested right in the
Internal Revenue Code ." United States v. Carlton, 512 U .S. 26, 33 (1994) . (Nor,
by comparison, is there a vested right in the Kentucky Revenue Code.) By this
statement, written by Justice Blackmun, the United States Supreme Court
held that there is no substantive due process right which prevents retroactive
tax law applications. The Supreme Court explained:
"Taxation is neither a penalty imposed on the taxpayer nor a
liability which he assumes by contract . It is but a way of
apportioning the cost of government among those who in some
measure are privileged to enjoy its benefits and must bear its
burdens . Since no citizen enjoys immunity from that burden, its
retroactive imposition does not necessarily infringe on due process
Id. (quoting Welch v. Henry, 305 U .S . 134, 146-47 (1938)) (omission in
original) .
Having determined that matters involving taxation do not involve a
fundamental right (and thus did not implicate substantive due process), the
Supreme Court also undertook to determine whether retroactive application of
a tax statute, without notice and causing loss to the taxpayer, would violate
procedural due process. After a painstaking analysis, the Supreme Court
determined that as long as the statutory amendment was rationally related to a
legitimate legislative purpose, it would not violate due process.
The Supreme Court began its analysis by recognizing a number of cases
wherein it upheld retroactive tax legislation against a due process challenge
when the legislation was not so "`harsh and oppressive as to transgress the
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constitutional limitation ."' Id. at 30 (quoting Welch v . Henry, 305 U .S . 134,
147 (1938)) . To explain "harsh and oppressive," the Court. stated that these
words were equivalent to "arbitrary and irrational," id . , and explained:
"`Provided that the retrospective application of a statute is
supported by a legitimate legislative purpose furthered by rational
means, judgments about the wisdom of such legislation remain
within the exclusive province of the legislative and executive
branches . . . .
. . . The retrospective aspects of legislation, as well as the
prospective aspects, must meet the test of due process, and the
justifications for the latter may not suffice for the former . . . . But
that burden is met simply by showing that the retroactive
application of the legislation is itselfjustified by a rational
.'"
legislative purpose
Id . at 30-31 (quoting Pension Benefit Guaranty Corporation v. R . A. Gray
Co . , 467 U .S . 717, 729-30 (1984) (some internal quotation marks omitted,
citations omitted, emphasis added, first and third omission in original) .
The Respondent in Carlton had legitimately taken advantage of an estate
tax deduction under a revised statute which would have saved the estate a
significant amount of money. A little over a year later, Congress recognized
that the statute was overbroad and enacted a curative amendment limiting the
deduction to such a degree that it would no longer apply to the estate. It did so
by making the amendment retroactive as if incorporated in the original
deduction provision . The IRS disallowed the deduction, and Carlton paid the
asserted deficiency, plus interest. He then filed a claim for a refund, and
instituted a refund action in federal district court, claiming a due process
violation . The district court rejected his due process argument . A divided
panel of the Ninth Circuit Court of Appeals reversed on the grounds of
inadequate notice of the retroactive amendment and that the taxpayer had
relied to his detriment on pre-amendment law.
The Supreme Court found that Carlton's lack of notice was not
dispositive because a taxpayer takes his chances that there will be an increase
in the tax burden which might come about when the government carries out an
established policy of taxation . Further, it held that since the amendment had
not been made for an improper purpose, such as inducing Carlton to rely on
the statute only to target him after the fact, and given that he had no immunity
from taxation because it was neither a penalty nor a liability but only his
obligation in exchange for the benefits of government, his reliance on the preamendment statute alone was insufficient to establish a constitutional
violation .
Instead, the Supreme Court held the view of the Ninth Circuit Court of
Appeals to be an unduly strict standard: "Because we conclude that
retroactive application of the 1987 amendment to Section 2057 is rationally
related to a legitimate legislative purpose, we conclude that the amendment as
applied to Carlton's 1986 transactions is consistent with the Due Process
Clause." Id . at 35 . It is notable that this ultimate holding did not mention a
"modesty" requirement (on which the Court of Appeals relied in this case),
though the majority did note with favor that Congress had acted promptly and
applied only a modest period of retroactivity (meaning that the length of the
period of retroactivity is to be considered as part of the test of whether the
statute is a rational means of achieving the government's goal) .
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In fact, only Justice O'Connor stated in her concurring opinion that the
retroactivity period should not exceed one year, thus implying that she
considered "modesty" to be a due process guarantee . Her separate opinion
carried no other votes.
Justices Scalia and Thomas, in a separate concurring opinion, took the
view that time is not even a relevant consideration. Instead, they focused on
the fact that the taxpayer has already relied on the statute, and the
amendment comes after that reliance . They felt that whether the amendment
comes immediately after or long after does not change the fact of deprivation
after reliance on then existing law. See id . at 40 (Scalia, J., concurring) ("The
reasoning the Court applies to uphold the statute in this case guarantees that
all retroactive tax laws will henceforth be valid.") .
Retroactive application of a statute need only be (1) supported by a
legitimate legislative purpose (2) furthered by rational means, which includes
an appropriate modesty requirement. This requires analysis of the facts and
circumstances of each case, rather than applying a specified modesty period.
The pertinent question is whether the period of retroactivity is one that makes
sense in supporting the legitimate governmental purpose (rationally related) .
Despite these differences, Justices O'Connor, Scalia and Thomas did
concur in the result of the case, joining the majority in saying that retroactive
application of revenue measures is rationally related to the legitimate
governmental purpose of raising revenue, to prevent a "significant and
unanticipated revenue loss." As Justice Scalia wrote in his separate
concurring opinion,
13
To pass constitutional muster the retroactive aspects of the
statute need only be "rationally related to a legitimate legislative
purpose." Revenue raising is certainly a legitimate legislative
purpose, and any law that retroactively adds a tax, removes a
deduction, or increases a rate rationally furthers that goal. I
welcome this recognition that the Due Process Clause does not
prevent retroactive taxes, since I believe that the Due Process
Clause guarantees no substantive rights, but only (as it says)
process .
Id. at 40 (Scalia, J., concurring) (internal citations omitted) .
Clearly, eight of the nine justices viewed what may "rationally further" a
legitimate governmental interest as being broader than the one year that only
Justice O'Connor would impose as a "modesty" measure . Thus what is
"modest" or acceptable for due process purposes depends on the facts of the
case, including notice, settled expectations, detrimental reliance, etc .
This was demonstrated when, following Carlton , in 1996 the Ninth
Circuit (where Carlton originated) held in Montana Rail Link, Inc. v. United
States , 76 F .3d 991 (9th Cir. 1996), that a statute with a seven year
retroactively period did not violate due process. The facts of that case are
strikingly similar to this one .
Montana Rail was required to pay an excise tax on compensation it paid
to its employees, and to withhold a tax imposed on railroad employees under a
retirement system separate from social security though paid to the Internal
Revenue Service . For several years, Montana Rail treated as taxable
compensation its contributions to 401 (k) plans, but on advice of the Railroad
Retirement Board, stopped including 401 (k) contributions when calculating the
amount of employee compensation for retirement fund purposes in 1987 and
1988 . This resulted in what it considered to be a tax overpayment for those
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years, so Montana Rail refunded that amount to its employees, and sought a
refund of this overpayment from the government .
In December 1989, Congress redefined the railroad retirement tax
compensation base to specifically include contributions to 401 (k) plans as part
of the taxable compensation, and specifically made the change retroactive to
"`remuneration paid before January 1, 1990 . . . .' Id . at 993 n. l (quoting
Omnibus Budget Reconciliation Act of 1989, § 10206(c)(2)(A)) . This affected the
tax status of these retirement contributions from 1983, when the ambiguity
arose, forward. Montana Rail's refund request was denied . But it claimed that
it had relied on the advice of the Board and the then existing state of the law,
and that to deny its refund would violate due process. Montana Rail filed suit
in federal district court seeking the refund, but its claim was denied there also.
The Ninth Circuit Court of Appeals upheld the district court ruling,
specifically applying Carlton to find that Congress had the legitimate legislative
purpose of protecting the reliance interests of employees who were expecting to
receive higher benefits based on the taxes paid and withheld, and to avoid loss
of revenue . It specifically held that the period of retroactivity bore a rational
relation to the underlying legislative purpose, and that the seven year
retroactivity period was appropriate because
[g]iving § 10206(b) a one or two year period of retroactivity would
have severely hurt workers who had retired expecting that they
would receive a level of benefits based in part on tax payments
made from 1983 through 1987 . A shorter period of retroactivity
would have been arbitrary and irrational.
Id . at 994 (internal citations omitted) .
Further the Ninth Circuit pointed out that
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MRL erroneously equates its mistaken overpayment of taxes with
the government's "unlawful," "improper" and "erroneous" collection
of taxes. Contrary to MRL's assertion, the IRS did not violate any
federal law by accepting MRL's overpayment. Seeking a refund for
one's own voluntary overpayment of a lawful tax i s not the same as
pursuing a remedy for payment of an illegal tax.
Id . at 995 .
In light of Carlton and Montana Rail , it becomes clear that the opinion of
the Kentucky Court of Appeals gave undue weight to dicta in Justice
O'Connor's concurring opinion when it held that this case turned on a one year
"modesty" requirement. The issue instead is only whether the retroactive
statute of 2000 rationally furthers the legitimate governmental purpose of
raising and controlling revenue to prevent a significant and unanticipated
revenue loss . Applying that test here, there can be no question that the
legislature acted to correct what it viewed as a mistake in GTE 's interpretation
of the law, that it had a legitimate governmental purpose (raising and
controlling revenue) and that the statute rationally furthers this purpose.
Further, to prevent a significant and unanticipated revenue loss, Appellees had
been on notice of the revenue intent from 1988 when RP 41P225 was issued
until 1994 when GTE was decided, and could not have had any "settled
expectations" to the contrary.
Additionally, the legislature's intent to supercede GTE became apparent
almost immediately. In the 1996 session, the legislature amended KRS
141 .120 to disallow filing a combined return under the unitary business
concept, and developed its own approach to filing a consolidated return based
on affiliation, specifically ownership . It made the statute effective for any tax
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year ending on or after December 31, 1995. That taxpayers would attempt to
amend their returns to combined returns under the unitary business concept
in order to claim under the refund statute was literally an unknown, because
the legislature had no means of knowing who would wish to combine their
separate returns in order to request a refund, or even if a refund would be
required after they did .
By the beginning of the next biennial legislative session the effect of GTE
was still not clear . Sometime during the session, however, evidence of such
claims was raised, and the problem was addressed through the budget bill,
which directed Revenue not to pay refunds on attempts to amend separate
returns to combined returns under the unitary business concept in order to
make a claim for a refund under GTE . By the 2000 session, the problem had
been defined, and the legislature amended KRS 141 .200 to disallow the filing of
combined returns under the unitary business concept for any taxable year
ending on or before December 31, 1995, and to disallow the payment of
refunds on amended returns filed after December 22, 1994, (not coincidentally,
the date GTE was decided) . At the first reasonable opportunity, as it became
aware of the issues, the legislature, which met then only biennially, made
provisions and amendments .
While it might be tempting to require the legislature to be omniscient so
as to immediately understand the ramifications of case law on statutory
application, history tells us that often the development of law based on the
holdings in cases takes time to go through process before the clear impact can
be seen. Combine this with delays caused by a biennial legislative schedule,
17
and it is rational that the legislature acted with reasonable diligence in this
complicated matter.
As Carlton held, to pass constitutional muster, a retroactive statute need
only be rationally related to a legitimate legislative purpose, which in this case
as in Carlton was a significant and unanticipated revenue loss . Revenue
raising is the sole province of the legislature, and the courts should involve
themselves in it only when clear constitutional or interpretive issues arise .
While due process is certainly a constitutionally protected right, it is not
impacted under the facts of this case, given the clear and lengthy notice, the
lack of settled expectations and lack of detrimental reliance. All the legislature
did was clarify the statute after this Court interpreted it in GTE.
Taking another tack, Appellees have argued that in a case decided before
the Supreme Court later in 1994, the Court ruled that a State may not "bait
and switch" remedies when a taxpayer seeks a refund of illegally or
unconstitutionally collected taxes which require this Court to find that they are
entitled to a refund of an overpayment of taxes due to being required to file
separate returns when they were entitled to file a combined return under the
unitary business plan. Reich v. Collins, 513 U . S . 106 (1994) . This case,
however, is clearly distinguishable from the present circumstances on its facts
and legal questions .
Reich concerned a common practice where state retirement benefits were
exempt from state income taxes, but federal retirement benefits were not. After
the Supreme Court found that this practice violated the constitutional
intergovernmental tax immunity doctrine, most states repealed the special tax
18
exemption for state retirees, but did not automatically refund the illegal taxes
to federal retirees . Reich sued Georgia for a tax refund under its refund
statute. The case took several twists and turns, but finally ended up with the
United States Supreme Court holding that Georgia could not change its
deprivation remedy in the middle of the stream by arbitrarily declaring that its
clear post-deprivation remedy would no longer apply because it was going to
exclusively rely on its pre-deprivation remedy . Justice O'Connor wrote that
Reich was entitled to pursue the post-deprivation remedy, regardless of
whether Georgia also had pre-deprivation remedies, because the language in
the refund statute would lead the average taxpayer to think it obvious that he
could avail himself of that remedy. Georgia had effectively taken away any
remedy at all by changing to its pre-deprivation remedies exclusively after
Reich had already paid the unconstitutional taxes.
The Reich decision followed McKesson Corp. v. Division of Alcoholic
Beverages and Tobacco, Fla. Dept. of Business Regulation , 496 U .S . 18 (1990),
which dealt with an attempt by Florida to tax certain types of Florida products
more favorably than other products that had been found to be unconstitutional
as a violation of the Commerce Clause . The Florida Supreme Court had
recognized the unconstitutionality, but had declared that relief would be
prospective only, and did not allow a refund to the challengers . Reversing this,
Justice Brennan wrote for a unanimous court
If a State places a taxpayer under duress promptly to pay a tax
when due and relegates him to a postpayment refund action in
which he can challenge the tax's legality, the Due Process Clause
of the Fourteenth Amendment obligates the State to provide
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meaningful backward-looking relief to rectify any unconstitutional
deprivation .
Id. at 31 (footnote omitted, emphasis added) .
It is important to note that the Supreme Court made its ruling in
McKesson premised upon a refund being due for an unconstitutional
application of a tax, which naturally impacts federal due process. However,
this Court in GTE did not make a constitutional declaration, but instead
merely interpreted a constitutional statute . That decision did not in any way
impact the process for a remedy available to the taxpayers ; it merely said that
another process for filing returns was also available . Since constitutionality
was not involved, the analysis then goes from deprivation of property without
due process of law to the well-established analysis of when and how the
government may enact economic legislation, specifically revenue-controlling
legislation, under the Carlton line of cases .
The present case differs from Reich and McKesson in many important
ways. Here, Appellees claim that their right to file a combined return under the
unitary business concept pursuant to the holding in GTE was improperly taken
from them . They filed for a refund under GTE 's interpretation of the statute,
but in order to be eligible to get a refund, they had to change their return from
separate returns to a combined return under the unitary business concept,
which required taking the paperwork of several different returns and combining
them into one return . Only after this was done would Appellees become eligible
for a refund. While they may have been denied their choice of the most
advantageous return, the returns that they did file were not illegal, and
20
certainly could have been the chosen method, even under GTE, if they would
have been to the Appellees' advantage . In Montana Rail, the Ninth Circuit
made this same point, distinguishing that case from Reich , in upholding a law
that was very similar in effect to this one.
The most significant difference, however, is that Reich and McKesson did
not involve the retroactive application of a state tax statute that effectively
changed the amount of tax owed and which was enacted for a legitimate
governmental purpose . While Reich came out the same year as Carlton , the
cases are on two entirely different issues. Where the state of Georgia arbitrarily
took away a "clear and certain" post-deprivation remedy for taking
undisputedly illegal taxes in Reich, the legislature in this case took away the
dispute , and hence any illegality that might be claimed, by properly enacting a
retroactive statute that mooted the question of whether the Appellees were
entitled to a refund. By retroactively declaring that combined returns were
disallowed prior to 1995 and that no refunds would be allowed due to
amendments to file combined returns under a unitary business concept, the
legislature reestablished the status quo as it saw it prior to GTE. The remedy
provided by the refund statute was not affected at all ; it simply no longer
applies to the Appellees in this case because the underlying tax law has been
changed, just as the deduction no longer applied in Carlton .
C. Equal Protection and Other Rights
The Appellees also argue that the tax amendments violate their equal
protection rights and other rights under the Kentucky Constitution because
other corporations were allowed to amend their returns and were granted tax
21
refunds. However, the controlling fact in this case is the government's power to
tax and to enact legislation that controls the revenue stream . Since a taxpayer
has no immunity from taxation, which is not a contractual liability but rather
the shared costs of the benefits of government, no fundamental right is
involved . Carlton, 512 U.S . 33-34 . Rather, statutes or practices that have the
effect of distinguishing between entities solely on an economic basis are
"presumed to be valid and . . . generally comply with federal equal protection
requirements if the classifications that they create are rationally related to a
legitimate state interest ." Durham v. Peabody Coal Co . , 272 S.W .3d 192,
195 (Ky. 2008) (citing City of Cleburne, Texas v. Cleburne Living Center, 473
U.S . 432, 440 (1985)) . The analysis is the same under the Kentucky
Constitution . Id . This "rational basis" test is the same as required under due
process for economic legislation, and, as discussed above, the 2000
amendments to the tax statute clearly satisfy it. The question in all matters
falling short of a fundamental right, and particularly to economic or taxation
legislation, is whether there is a legitimate governmental purpose for the
action, and whether the means used to accomplish it rationally relates to that
purpose . Having found that such a purpose exists in this case, there is no
merit to the Appellees' claims .
III. Conclusion
Because the amendments to the Kentucky tax code made by the
legislature in 1996 and 2000 were made to clarify the law in regard to
combined returns under the unitary business plan and to exercise its revenueraising powers, they further a legitimate governmental purpose . Moreover, the
22
amendments were rationally related to that purpose. Consequently, Appellees'
due process rights have not been impacted and they are not entitled to tax
refunds because they could not amend their separate returns to a combined
return under the unitary business plan . The opinion of the Court of Appeals is
reversed.
Scott and Venters, JJ ., concur . Schroder, J., concurs in result only by
separate opinion . Abramson., J., dissents by separate opinion in which
Cunningham, J ., joins . Minton, C .J ., not sitting.
SCHRODER, JUSTICE, CONCURRING IN RESULT: While the majority
utilizes the correct legal framework and arrives at the correct result, I disagree
with some observations and portions of the analysis in its opinion . Therefore, I
write a separate, albeit legally similar, opinion.
From 1972 through 1988, the Revenue Cabinet (the "Cabinet")
interpreted KRS 141 .120 to allow corporations to file unitary tax returns . In
1988, the Cabinet issued Revenue Policy 41 P225, which prohibited the filing of
unitary returns, and required separate returns. I GTE challenged the Cabinet's
policy shift in a case that reached this Court in 1994 . In an opinion rendered
December 22, 1994, this Court decided in GTE's favor. GTE v. Revenue
Cabinet, 889 S.W.2d 788 (Ky. 1994) . GTE interpreted KRS 141 .120 as allowing
unitary filing, and invalidated
RP 41 P225 under the doctrine of
contemporaneous construction . Id . at 792 . Because their taxes would have
been lower under the unitary method of filing, a number of corporations,
seeking refunds, thereafter amended their returns to unitary returns for
various years in which
RP 41P225 was in effect . Although the Cabinet acted
on some of the refund claims, it took no immediate action on Appellces' claims .
The Cabinet began tracking actual and potential claimants and the
amount of their claims by the end of 1995 . At that time, the Cabinet estimated
the claims to be worth about $50 million . In the first legislative session
following the GTE decision, 1996, the General Assembly enacted H.B. 599,
The policy permitted unitary reporting only if the subsidiaries were a sham or paper
corporation with limited viable activities. GTE v. Revenue Cabinet, 889 S .W .2d 788,
790 (Ky. 1994) .
24
which abolished the filing of unitary returns for tax years ending on or after
December 31, 1995. This legislation, however, had no effect on the pending
refund claims .
In October 1996, the Cabinet estimated unpaid refund claims to be
worth approximately $160 million, which rose to $177 million by April 1997.
In response, to avoid a huge loss to the general fund, at the next legislative
session, 1998, the General Assembly included in the 1998-2000 budget bill, a
measure which prohibited the Revenue Cabinet from paying any post- GTE
refund claims . H .B . 321, § 33 . Several parties challenged the prohibition. The
Franklin Circuit Court invalidated the provision on grounds that it did not
comply with the "reenactment and republication" provisions of Section 51 of
the Kentucky Constitution . The Cabinet appealed to the Court of Appeals.
While the appeal was pending, H .B . 321 expired on its own terms (in 2000),
and the Court of Appeals dismissed the appeal as moot.
The claims had risen to nearly $200 million at the end of June 1998,
with $65 million of that being interest . At the 2000 legislative session, faced
with this massive drain of the state treasury as a result of the pending refund
claims, the General Assembly enacted H .B . 541, the legislation at issue in this
case. H.B. 541 substantially amended KRS 141 .200, and (1) prohibited refund
claims for taxable years ending on or before December 31, 1995, made by
amended return filed after December 22, 1994, based on a change from
separate to unitary return, and (2) prohibited corporations from filing unitary
returns for tax years ending before December 31, 1995, unless the
corporations filed unitary returns on or before December 22, 1994, for tax
25
years ending before December 22, 1994 . The effect of H .B . 541 was to
extinguish Appellees' refund claims .
Two declaratory judgment actions were filed in the Franklin Circuit Court
seeking to have the retroactive portions of H .B . 541 declared unconstitutional .
The two cases were consolidated and the circuit court, finding the legislation
constitutional, granted summary judgment to the Cabinet. The Court of
Appeals reversed on grounds that the period of retroactivity was excessive .
This Court granted discretionary review.
It is well settled that a tax act is not necessarily unconstitutional
because it is retroactive. Welch v. Henry, 305 U.S . 134, 147 (1938) .
Retroactive tax legislation satisfies the Due Process Clause provided that it "`is
supported by a legitimate legislative purpose furthered by rational means.'
United States v. Carlton , 512 U .S. 26, 30-31 (1994) (quoting Pension Benefit
Guaranty Corporation v. R . A. Gray 8s Co . , 467 U . S . 717, 729 (1984)) . The
United States Supreme Court has repeatedly upheld retroactive tax legislation
against a due process challenge. Id . at 30 (citing United States v. Hemme, 476
U.S . 558 (1986) ; United States v. Darusmont, 449 U .S . 292 (1981) ; Welch v .
Henry, 305 U.S . 134 (1938) ; United States v. Hudson, 299 U.S . 498 (1937) ;
Milliken v. United States, 283 U.S. 15 (1931) ; Cooper v . United States, 280 U .S .
409 (1930)) .
The General Assembly's purpose in enacting H .B . 541 was to prevent a
massive loss to the state treasury as a result of the GTE decision .2 In United
The legislative purpose of H .B. 541 could not be more clear:
26
States v. Carlton, the United States Supreme Court held that the prevention of
a "significant and unanticipated revenue loss" satisfies due process as a
legitimate legislative purpose for a retroactive tax statute . 512 U .S . at 32.
Carlton involved a new estate tax provision, 26 U .S .C . Section 2057, enacted
on October 22, 1986, which granted a. deduction for half the proceeds of "any
sale of employer securities by the executor of an estate" to "an employee stock
ownership plan ." Id . at 28. The purpose of the deduction was to promote
employee ownership . Congress initially estimated a revenue loss from Section
2057 of approximately $300 million over a five year period. Id. at 31-32 . On
December 10, 1986, Carlton, executor of an estate, used estate funds to
purchase MCI stock for $11 .2 million which he resold two days later to the MCI
ESOP for $10 .6 million, a loss of $600,000, for the express purpose of claiming
a tax deduction of $5 .3 million (half the proceeds of the sale) under Section
2057, reducing the estate tax by $2.5 million.
Shortly after its passage, Congress realized that the expected revenue
loss from Section 2057 could be as much as $7 billion, because of a loophole in
the law which did not limit the deduction to situations in which the decedent
owned the securities immediately before death. Id . at 32 . To protect the
treasury against this massive loss, on December 22, 1987, approximately one
year after Carlton's stock transaction, Congress amended Section 2057 to
"[I]f we don't do this [pass H.B. 541], it could cost us up to $190 million . . . These
corporations that are involved did not plan their business based on filing the way
that they are now attempting to come back and get refunds . . . But now they want
to come back and raid the state treasury . . . to the tune of $190 million . And that's
what this bill is all about . . . [I]f we don't do it, then we better figure out how to cut
the budget $190 million." Remarks of Chairman Moberly, Transcript of Hearing on
H.B . 541, February 22, 2000 .
27
require that the securities sold to an ESOP must have been owned by the
decedent immediately before death . The 1987 amendment was made
retroactive as if it had been contained in the statute as originally enacted in
October, 1986. Id. at 29 . Carlton's December, 1986, transaction was
invalidated, causing the estate to incur a significant loss.
The Court upheld the 1987 amendment's retroactivity against Carlton's
due process challenge . The Court held that the prevention of a "significant and
unanticipated revenue loss" was a legitimate legislative purpose, and that the
amendment was a rational means of achieving said purpose . Id. at 32, 35 .
The Court recognized that while Congress might have chosen to make up the
loss by burdening equally "innocent" taxpayers, through general prospective
taxation, it was not arbitrary nor unreasonable to choose to prevent the loss by
retroactively denying the deduction to taxpayers who had engaged in purely
tax-motivated (albeit legal) stock transfers . Id. at 32 . The Court found
Carlton's detrimental reliance upon the provision and lack of notice insufficient
to establish a due process violation, as "[t]ax legislation is not a promise, and a
taxpayer has no vested right in the Internal Revenue Code ." Id. at 33 . The
Court observed with approval that the period of retroactivity was short, just
over one year. Id . at 32-33 . The period was therefore one that did not upset
longstanding and settled taxpayer expectations. See id. at 37-38 (O'Connor, J.,
concurring) .
Similarly, H .B . 541 serves the legitimate legislative purpose of preventing
a massive loss to the state treasury as a result of refund claims being filed in
the wake of GTE . The legislature's decision to prevent the loss by prohibiting
28
amended returns under the unitary method filed after December 22, 1994 (the
date GTE was rendered) for years prior to 1995 is rationally related to that
purpose. The Franklin Circuit Court and Court of Appeals correctly found as
such.
The Court of Appeals erred, however, in concluding that H .B . 541
nevertheless violated due process because its period of retroactivity was
excessive . The Court of Appeals misinterpreted Carlton as setting a bright-line
rule as to what is an acceptable period of retroactivity, relying on the Court's
approval of the "modest" (slightly over one year) period of retroactivity in that
case . The consideration of "modesty" relates to a taxpayer's right at some point
to settled expectations . See Carlton, 512 U.S . at 37-38 (O'Connor, J .,
concurring) . In this regard, the United States Supreme Court has indicated
that where a taxpayer had no notice or could not have anticipated a change in
a tax (as in Carlton) that it is plausible a tax could attempt to reach so far into
the past as to offend due process . Welch , 305 U.S . at 148 . The Court has
never established a bright-line rule as to what this period would be . Rather,
whether a retroactive tax act "transgress [es] the constitutional limitation"
depends upon the facts and circumstances of the particular case . Id . at 147 ;
Milliken v. United States, 283 U .S . 15, 21 (1931) .
The Court has indicated, however, that where at the time of the taxable
event the taxpayer had notice of even a potential change in a tax law, due
process is not offended when the retroactive period encompasses the time of
the taxable event . See Milliken, 283 U.S . at 21, 24 ; see also Welch , 305 U.S. at
147-148 . At the time of the taxable event in this case (the receipt of income
29
during the years RP 41 P225 was in effect), the Appellees were fully aware that
their tax liability would be computed under the separate return method . They
paid their taxes under the separate return method. They were not permitted to
file unitary, and could have had no "settled expectations" to the contrary . At
this point, if there were any "settled expectations" they were the
Commonwealth's, not the taxpayers' . King v. Campbell County, 217 S .W.3d
862, 870 (Ky.App. 2006) . Nor did Appellees obtain a vested right in a refund
following the GTE decision. See id . at 869-870 . The Appellees' expectations
could not be deemed settled or vested in this case. As the majority noted, the
legislature's intent to supersede GTE became apparent almost immediately - at
the first legislative session following GTE, the General Assembly began a
process of legislatively undoing the decision . 3 As the influx of claims increased,
so did the General Assembly's response, culminating in its response here, H .B.
541 . Therefore, I agree with the majority that the period of retroactivity does
not impact due process under the facts of this case, given the clear and lengthy
notice, the lack of settled expectations, and the lack of detrimental reliance .
Finally, while it is well settled that due process requires "meaningful
backward-looking relief' for taxes collected in violation of the law or
constitution, the taxes paid by the Appellees under the separate return method
were neither illegal, nor unconstitutional . McKesson Corp. v. Div. of Alcoholic
Beverages and Tobacco, 496 U.S . 18, 31 (1990) ; Reich v. Collins , 513 U.S. 106,
114(1994) .
3 A legislative body must have reasonable opportunity to act. Welsh, 305 U.S. at 149.
30
As to the remaining issues, 1 concur with the result reached by the
majority as well.
ABRAMSON, JUSTICE, DISSENTING :
This corporate tax case
presents a rather straightforward question : how aggressively may the General
Assembly legislate after-the-fact in an effort. to retain tax monies which this
Court has held were collected in contravention of state law? Whether the
taxpayer is an individual citizen or a corporation, the answer to that question
lies in the Due Process Clause of the Fourteenth Amendment to the United
States Constitution which prohibits the taking of property without due process
of law . Generally, a sovereign must provide "meaningful relief" in the form of a
refund of the invalidly collected taxes and, while there is some latitude to
legislate tax law retroactively, that power must be exercised promptly for a
legitimate purpose and for a modest period . The 2000 Kentucky General
Assembly exceeded the bounds of due process when it passed H .B . 541 in an
effort to undo entirely this Court's ruling over five years earlier in GTE v.
Revenue Cabinet, 889 S.W .2d 788 (1994) . Neither the complete ban of all
outstanding tax refund claims associated with the GTE case nor the retroactive
rewrite of state tax law to condone the retention of corporate taxes invalidly
collected five to twelve years previously passes constitutional muster. By
upholding these long after-the-fact revisions of our tax laws, the majority
misconstrues the constitutional restraints . Accordingly, I respectfully dissent .
While a full understanding of this matter entails appreciation of various
approaches to corporate tax which are addressed later, the basic facts can be
simply stated. For sixteen years, from 1972 until 1988, any corporation which
qualified as a so-called "unitary business" was allowed to file Kentucky t
returns on a unitary or combined-reporting basis . In 1988, without any action
32
on the part of our legislature, the Revenue Cabinet issued Revenue Policy
41 P225, abruptly halting the right of virtually all corporate taxpayers to file the
unitary returns which had been accepted for years. Faced with higher taxes as
a result of the stroke of an administrator's pen, several taxpayers sued and
ultimately prevailed before the Kentucky Supreme Court . In GTE v . Revenue
Cabinet, supra, this Court concluded that the Cabinet's and taxpayers' longstanding reading of KRS 141 .120 was a reasonable one and, under the doctrine
of contemporaneous construction, that reading had become binding on the
Cabinet unless and until the General Assembly expressed a contrary intent. ,
Taxpayers responded to GTE by filing amended returns on a unitary
basis but, after processing and settling some of the refund claims, the Cabinet
sought legislative intervention . A stop-gap measure delaying all refunds was
passed in 1998 and then an attempted complete "clean up" of the situation
obliterating all rights to refunds was passed by the 2000 General Assembly in
the form of H. B . 541 . That bill had two provisions dedicated to a single
purpose. One provision withdrew from those corporate taxpayers who had filed
amended unitary returns and were seeking refunds post- GTE the basic refund
right codified in KRS 134.580 and ordinarily available to all taxpayers who
have paid taxes later determined to be invalid . The second provision was an
attempt to recast pre-GTE law and destroy the legal underpinnings of the
taxpayers' refund claims (and this Court's holding in GTE) by stating
retroactively that indeed the position stated by the Cabinet in RP 41 P225 had
always been the law.
33
Our Court of Appeals invalidated H.B . 541 as a violation of the taxpayers'
due process rights . On appeal, the Cabinet maintains that the appellate
court's due process analysis was wrong and in any event the Commonwealth's
sovereign immunity trumps the taxpayers' due process rights . The
Commonwealth argues, in essence, that it can collect taxes in contravention of
law, litigate and lose before this Court, and then assert sovereign immunity to
retain tax monies this Court found were invalidly collected . The sovereign is
powerful but it too must answer to the Constitution and, more specifically, it
too is constrained by the due process protections afforded its citizens for
otherwise that Clause would be rendered meaningless. H .B . 541 is
unconstitutional and these taxpayers are entitled to pursue the meaningful
remedy which is codified in KRS 134 .580, grounded in the Due Process Clause
and available to all taxpayers who have paid taxes subsequently deemed
invalid .
RELEVANT BACKGROUND AND PROCEDURAL HISTORY
Tax litigation is almost inevitably complex and this case is no exception.
A brief discussion of the "unitary business concept" and its history in Kentucky
tax law will provide context for the analysis that follows .
State Tax of Corporate Income - Apportionment .
Many corporations today engage in businesses that extend into more
than one state and thus states wishing to tax these corporations' income are
confronted with the problem of apportioning that income among themselves. 1
This is a problem fraught with constitutional implications, as the states' ability to
tax interstate enterprises is significantly constrained by both the Due Process
34
Almost since the inception of income taxes, various methods of effecting that
apportionment have been employed, but in 1966 our General Assembly
adopted the method devised by the American Bar Association's Commission on
Uniform State Laws and published as the Uniform Division of Income for Tax
Purposes Act (UDITPA) . See KRS 141 .120 . Under UDITPA, a multi-state
enterprise's income is characterized as either business or non-business. The
non-business income is allocated to the source state pursuant to various
sourcing rules, while the business income-income arising from transactions
and activity in the regular course of a trade or business-is apportioned among
the states contributing to that income according to an apportionment formula
based on the proportion of the enterprise's property, payroll, and sales in the
taxing state compared with its total property, payroll, and sales . Although the
General Assembly has since modified the apportionment formula to give
additional weight to the sales factor, Kentucky's approach to apportionment is
still essentially the formulary UDITPA approach adopted in 1966 . KRS
141 .120(8) .
Determining the Apportionable Income .
Separate Accounting.
Related to the problem of apportioning a multi-state enterprise's
business income is the no less fundamental problem of defining the enterprise
whose income is to be apportioned . The problem arises from the fact that
many corporate enterprises are organized not as single corporations but as
Clause and Commerce Clause. Mobil Oil Corporation v. Commissioner of Taxes of
Vermont, 445 U.S . 425 (1980) .
35
clusters or chains of related corporations . This fact has given rise to three
primary taxing responses . One response is for the taxing state to ignore the
larger enterprise and to treat each corporate component as a separate entity,
taxing the entities with nexus in the state solely on the basis of their own
individual incomes . This approach is known as the "separate entity" or
"separate accounting" approach .
Combined Reporting.
Another approach is for the taxing state to treat the entire enterprise as
in essence the entity to be taxed and to apply its apportionment formula to the
entire group's combined income. This is the approach known as the "unitarybusiness/formula-apportionment" method or the "combined reporting" method .
As one commentator has stated:
The purpose of combined reporting is to determine the
income of a multistate taxpayer attributable to a given
state. This is accomplished by applying the
apportionment factors of the unitary business to the
unitary group's business income. . . .
A combined report does not necessarily involve a single
tax return for the group. Instead, it is the name given
to a series of calculations by which a unitary business
apportions its income on a geographic basis. In
California, for example, each entity with nexus files its
own return providing schedules reflecting the unitary
activity . However, the [Franchise Tax Board] has
adopted procedures under which some or all of the
taxpayer-members of a unitary group may elect to file
a group return .
Giles Sutton, "Comparison of Group Reporting Methods and Sourcing of
Income," 9 St. 8s Loc. Tax Law. 29 (2004) . A "unitary business" for this
purpose is generally understood to be a multi-state, multi-corporate enterprise
36
whose "operations conducted in one state benefit and are benefited by the
operations conducted in another state or states. If its various parts are
interdependent and of mutual benefit so as to form one integral business
rather than several business entities, it is unitary ." Pioneer Container
Corporation v. Beshears , 684 P.2d 396, 399 (Kan . 1984) (internal quotation
marks omitted) . Where the components of a multi-state enterprise are
integrated by sufficient unity of ownership, operation, and use, the unitary
business concept has been applied . Edison California Stores, Inc. v. McColgan ,
183 P.2d 16 (Cal . 1947); Armco Inc. v. Revenue Cabinet, 748 S .W.2d 372 (Ky.
1988) . The United States Supreme Court has held that the unitarybusiness/ formulary-apportionment approach to corporate income taxation
passes constitutional muster provided that "at least some part of [the unitary
business] is conducted in the state," that "there be some bond of ownership or
control uniting the purported `unitary business,"' and that "the out-of-State
activities of the purported `unitary business be related in some concrete way to
the in-State activities .' Container Corporation of America v . Franchise Tax
Board, 463 U.S. 159, 166 (1983) . Indeed, at least in part because of its
elevation of the enterprise's substance over its form, the U.S . Supreme Court
has characterized the unitary business principle as "the linchpin of
apportionability in the field of state income taxation." Mobil Oil Corporation,
supra, 445 U .S . at 440 . 2
Many commentators have described the advantages of combined reporting,
including fairness to single-state corporations, accuracy, tax neutrality between
different forms of corporate organization, and freedom from the accounting and taxloophole problems associated with cross-border transfers among related
37
Consolidated Returns .
Kentucky's posture vis-a-vis combined reporting or the "unitary business
concept" underlies the present controversy, but before turning to the specific
facts of this case, a third legislative response to the taxing of multi-corporate
enterprises deserves mention . Under federal tax law, an "affiliated group" of
"includible corporations" may elect to file a "consolidated" return, i. e., a single
return for the entire affiliated group . 26 U.S.C . §§ 1501-1504 . Sutton,
"Comparison of Group Reporting Methods," supra. "Affiliation" for this purpose
is not defined in terms of the member corporations' unified business, but solely
in terms of ownership and control, generally including all inter-corporate
connections where there is 80% or more of both ownership and control . 3 Id. A
consolidated return is not the same as a combined or unitary report:
A combined report is an accounting method whereby
each member of a group carrying on a unitary
business computes its individual taxable income by
taking a portion of the combined net income of the
group . A consolidated return is a taxing method
whereby two corporations are treated as one taxpayer.
Caterpillar Tractor Co . v. Dept. of Rev . , 618 P.2d 1261, 1262-63 (Ore . 1980) .
3
corporations . See for example John A. Swain, "Same Questions, Different Answers :
A Comparative Look at International and State and Local Taxation," 50 Ariz. L. Rev .
111 (2008) ; Mark J . Cowan and Clint Kakstys, "A Green Mountain Miracle and The
Garden State Grab: Lessons From Vermont And New Jersey on State Corporate Tax
Reform," 60 Tax Law. 351 (2007) . Nevertheless, largely as a result of successful
corporate lobbying, as of 2005 only seventeen states had adopted mandatory
combined reporting . Id.
The "unified business" for combined reporting purposes will not necessarily be the
same as the "affiliated group" for consolidated return purposes. The unified
business may include related entities with 50% to 80% ownership, for example,
while the affiliated group will not, and the affiliated group will include all affiliates
with 80% or more ownership, whether or not part of a unified enterprise, whereas
the unified business will exclude entities that are not part of the same unified
enterprise regardless of ownership share .
38
Several states have adopted "consolidated return" provisions based on
the federal model, and in 1996, the General Assembly amended KRS 141 .200
by adding definitions of "affiliated group" and "consolidated return" that
incorporate the corresponding federal definitions and by permitting affiliated
groups to file consolidated returns, but only if the group consents to use
consolidated status for eight years. Otherwise the 1996 version of KRS
141 .200 requires separate entity reporting. The 1996 session of the General
Assembly also amended KRS 141 .120 by adding a provision expressly
disavowing the "unitary business concept." The 1996 amendments have since
been updated, and the provision disavowing the unitary business concept has
been moved to KRS 141 .200(15), but its basic reporting options remain in
effect . Since 1996 it has been clear that the UDITPA-based apportionment
provisions of KRS 141 .120 apply to single corporations with income both
within and without Kentucky and to "affiliated groups" of corporations with
such multi-state income, but not to multi-corporate "unified businesses" under
the "unitary business concept." Prior to 1996, however, the law in Kentucky
was less clear, and it is that prior law which underlies this case.
Procedural History
1972 - 1988-The Cabinet Accepts and Then Rejects Combined Reporting.
As noted above, formulary apportionment of interstate income was early
on associated with the unitary business concept and combined reporting.
Thus, although UDITPA does not itself include reporting provisions, the
General Assembly's 1966 adoption of the UDITPA apportionment scheme was
perceived by the Revenue Cabinet and by the courts as an embrace or a
39
confirmation of combined or unitary reporting in Kentucky . That perception
was based not only on case law upholding the use of combined reporting
together with formulary apportionment, for example Mobil Oil Corporation ,
supra, Butler Bros . v. McColgan , 315 U.S . 501 (1942) and Edison California
Stores, Inc . , supra , but also on the fact that UDITPA is designedly consistent
with a combined-reporting regime. In particular, as originally enacted in
Kentucky, the UDITPA scheme required that "[a]11 business income shall be
apportioned" pursuant to the property, payroll, and sales factors mentioned
above. KRS 141 .120(9) (1966) . The law defined "business income" as "income
arising from transactions and activity in the regular course of a trade or
business of the taxpayer." KRS 141 .120(1)(a) (1,966) . But "taxpayer" was left
undefined, and thus the state was free to include in its approach to "taxpayers"
the unitary business concept and to require combined reports where
appropriate if it so chose . Encouraging such an approach in Kentucky, aside
from the tenor of the times, was the fact that even apart from UDITPA,
Kentucky law recognized the notion of multi-corporate income accounting.
KRS 141 .205(1) (1966), for example, provided that
[t]he department may require any parent corporation
or subsidiary corporation doing business within this
state to file a consolidated return covering the entire
operations of the parent corporation and its
subsidiaries, whenever it finds that the inter-corporate
transactions of the related group tend to reduce the
net income of the corporation, or corporations, doing
business within this state below the amount that
4
Another change introduced by the 1996 amendment of KRS 141 .120 was
substitution of the word "corporation" for UDITPA's "taxpayer ."
40
would probably result if such corporation, or
corporations, was not a member of the related group.
For these reasons, and perhaps others, in 1972 the Revenue Cabinet
began allowing unitary businesses to file combined or unitary reports under
KRS 141 .120 . In 1974, the General Assembly apparently endorsed this policy
by amending KRS 141 .205 to provide expressly for "combined" as well as
"consolidated" returns: "The department may require either a consolidated
return or a combined return from any or all corporations conducting intercorporate transactions whenever the department finds that such intercorporate transactions reduce taxable net income . . . below the amount which
would result if the transactions were at arms-length ." The Cabinet's combinedreturn policy continued, with the acquiescence of the General Assembly, until
1988 . In September of that year, however, the Cabinet abruptly made an
about face . Without any legislative changes in the tax laws, the Cabinet issued
Revenue Policy 41 P225, by which it purported to limit combined reporting to
parent-subsidiary relationships in which the subsidiary was a mere "paper
corporation with limited viable activities ." The effect of this policy shift was
essentially to halt the filing of combined reports in Kentucky .
GTE and Its Aftermath.
Protest was not long in coming. GTE, a New York corporation active in
Kentucky that had filed combined reports uniting it with its subsidiaries,
promptly challenged the legality of the new policy. In an opinion rendered on
December 22, 1994, this Court invalidated RP 41 P225 as inconsistent with the
Cabinet's own long-standing interpretation of KRS 141 .120 . That
41
interpretation was a reasonable statutory reading, the Court held, and so,
under the doctrine of contemporaneous construction, that reading had become
binding on the Cabinet until the General Assembly expressed a contrary intent .
GTE, 889 S .W.2d at 792-93 .
In the wake of GTE , the Cabinet proposed a regulation mandating
combined reporting in Kentucky . Kathryn L. Moore, "Taxation," 86 Ky . L. J .
875, 877-81 (1997-98) . Corporate opposition was intense, however, prompting
the withdrawal of the proposed regulation and adoption instead of the 1996
amendments to KRS 141 .120 and 141 .200 discussed above, the amendments
disavowing the "unitary business concept" and providing for voluntary, federalstyle consolidated returns . Id.
In the meantime, several corporate groups, including the Appellees, that
had been precluded from filing combined reports during the life of RP 41P225
responded to GTE by filing amended returns on a combined or unitary basis for
some or all of the affected tax years. Alleging that their tax liability was
reduced when calculated on the basis of a combined report, these corporate
groups also sought tax refunds . The Cabinet initially processed and settled a
few of these refund claims, but by late 1996 or early 1997 its estimate of the
claims' worth had risen substantially, 5 and at that point, apparently, the
Cabinet ceased processing the claims and sought legislative intervention.
During its 1998 session the General Assembly enacted H .B . 321, which
merely postponed the issue by providing that no post-GTE refund claims would
5 With interest, the outstanding claims are now said to total in excess of
$200,000,000 .00.
42
be paid during the biennial budget period. That legislation expired in 2000 .
The 2000 session of the General Assembly then enacted H .B . 541, the
legislation at issue here. As previously noted, H .B. 541 seeks to nullify
Appellees' refund claims in two ways . First, it purports to withdraw
retroactively in this small class of cases the refund remedy ordinarily available
to taxpayers who pay taxes later determined to be invalid . Second, it purports
to remove the legal basis of the Appellees' claims by retroactively validating RP
41P225 .
The Court of Appeals held that the retroactive reach of H .B . 541 exceeds
what the Due Process Clause allows. On appeal to this Court, the Cabinet
challenges the Court of Appeals' reading of the due process issue and argues as
well that in any event its sovereign immunity trumps Appellees' due process
rights. But first, the Cabinet invites us to do some retroactive validating of RP
41P225 of our own by revisiting GTE. In their cross-motion for discretionary
review, Appellees maintain that H .B . 541 is unconstitutional for reasons in
addition to its due process infirmities, most notably equal protection concerns
arising from the fact that some taxpayers' post-GTE refund claims were
processed . These other concerns are significant and are given short shrift by
the majority. Because I would affirm the Court of Appeals on the due process
issues, however, I will not address those other claims .
ANALYSIS
I. H.B. 541 Unconstitutionally Withdraws The Remedy For An Illegal Tax.
Section 1 of H .B . 541 amended KRS 141 .200 in pertinent part by adding
the following two provisions, now codified, respectively, as KRS 141 .200(17)
and 141 .200(18) :
No claim for refund or credit of a tax overpayment for
any taxable year ending on or before December 31,
1995, made by an amended return or any other
method after December 22, 1994, and based on a
change from any initially filed separate return or
returns to a combined return under the unitary
business concept or to a consolidated return, shall be
effective or recognized for any purpose.
No corporation or group of corporations shall be
allowed to file a combined return under the unitary
business concept or a consolidated return for any
taxable year ending before December 31, 1995, unless
on or before December 22, 1994, the corporation or
group of corporations filed an initial or amended
return under the unitary business concept or
consolidated return for a taxable year ending before
December 22, 1994.
The first provision, KRS 141 .200(17), pertains to the remedy available to
corporate taxpayers post-GTE. As the parties note, in a case such as this one
where the tax has not been challenged on constitutional grounds, KRS 134 .580
is the applicable remedy statute. That statute provides in pertinent part that
[w]hen money has been paid into the State Treasury in
payment of any state taxes, except ad valorem taxes,
whether payment was made voluntarily or
involuntarily, the appropriate agency shall authorize
refunds to the person who paid the tax, . . . of any
overpayment of tax and any payment where no tax was
due .
KRS 134 .580(2) . The Court of Appeals held, and I agree, that the Due Process
Clause prohibits the General Assembly from withdrawing this remedy as KRS
141 .200(17) purports to do .
A. The Due Process Clause Mandates A Meaningful Remedy When Taxes
Are Collected in Contravention of Applicable Law.
The Due Process Clause of the Fourteenth Amendment to the United
States Constitution provides that no state may "deprive any person of life,
liberty, or property, without due process of law." The essence of this guarantee
is that citizens must be given an opportunity, at a meaningful time and in a
meaningful manner, to challenge the legality of the government's impositions.
Mathews v . Eldridge, 424 U.S. 319 (1976) . Payment of a tax constitutes a
deprivation of property, and the United States Supreme Court has held that to
satisfy the requirements of the Due Process Clause, the taxing jurisdiction, the
state in this case, must provide either predeprivation or postdeprivation
procedural safeguards . McKesson Corporation v. Division of Alcoholic
Beverages and Tobacco, 496 U .S . 18 (1990) . Furthermore, where the state, as
did Kentucky at the time these taxes were collected, requires or encourages its
citizens to rely upon a postdeprivation refund action, that action "must provide
taxpayers with, not only a fair opportunity to challenge the accuracy and legal
validity of their tax obligation, but also a `clear and certain remedy,' . . . for any
erroneous or unlawful tax collection to ensure that the opportunity to contest
the tax is a meaningful one." Id. at 39 (quoting from Atchison, T. 8v S.F.R . Co.
v. O'Connor , 223 U .S . 280 (1912)) . The state may not, moreover, "`hold[ing] out
what plainly appears to be a `clear and certain' postdeprivation remedy and
45
then declare, only after the disputed taxes have been paid, that no such
remedy exists ."' Newsweek, Inc. v. Florida Department of Revenue , 522 U .S.
442, 444 (1998) (quoting from Reich v. Collins , 513 U.S . 106, 108 (1994)).
This, of course, is precisely what KRS 141 .200(17) purports to do, an
accordingly the Court of Appeals correctly determined that that statute violates
the Due Process Clause .
B . The Due Process Guarantee Is Not Limited To Unconstitutional Taxes.
Against this conclusion, the Cabinet raises two arguments . It contends
first that under McKesson, supra, the due process guarantee is only implicated
by tax statutes ultimately found unconstitutional . While it is true that
McKesson involved a tax invalidated under the Commerce Clause and thus the
Court's discussion is sometimes couched in constitutional terms, the due
process principle involved-that a taxpayer may not be deprived of his or her
property without a meaningful opportunity to challenge the legality of the
deprivation-clearly applies regardless of the ground for challenging the tax,
whether federal constitution or, as here, state statute . Indeed McKesson ,
supra, cites earlier United States Supreme Court cases where due process
mandated the refund of taxes collected, not in violation of the Constitution, but
in violation of federal laws. See, e .g., Ward v. Love County Bd. Of Comm'rs ,
253 U.S . 17 (1920) (taxes assessed in violation of federal treaty) . More recently,
the Supreme Court itself has noted that McKesson "and the long line of cases
upon which McKesson depends, . . . stand for the proposition that `a denial by
a state court of a recovery of taxes exacted in violation of the laws or
Constitution of the United States by compulsion is itself in contravention of the
46
Fourteenth Amendment ."' Reich , 513 U .S . at 109 . McKesson , thus, is not
limited to deprivations which violate the U .S . Constitution, nor, indeed, should
it be confined to those in violation of federal law. A tax exacted in violation of
state law, no less than one in violation of federal law, raises the exact same due
process concerns and requires the same meaningful procedural safeguards .
C . Sovereign Immunity Does Not Trump The Due Process Guarantee .
The Cabinet also contends that KRS 134 .580, the refund statute quoted
above, effects a waiver of the state's sovereign immunity and that the General
Assembly is free to withdraw that waiver and to reassert the state's immunity
at any time and to any extent it deems appropriate . KRS 141 .200(17) is
merely, the Cabinet argues, a limited reassertion of immunity, which, the
Cabinet insists, trumps Appellees' rights under the Due Process Clause.6 In
the case just cited, however, Reich , supra, the Supreme Court noted that the
Due Process guarantee applies notwithstanding "the sovereign immunity States
traditionally enjoy in their own courts ." Id. a t 110 . Five years later, in Alden v .
Maine , 527 U.S . 706 (1999), the Supreme Court reviewed at length the
constitutional and pre-constitutional bases of the states' immunity and held
that Congress had no power to require waivers of that immunity . The Court
6
KRS 141 .200(17) makes no mention of immunity, of course, and thus the Cabinet's
reading is by no means certain . In 2007, however, the General Assembly amended
the refund statute itself by adding provisions "revoke[ing] and withdraw[ing] its
consent to suit in any forum whatsoever on any claim for recovery, refund, or credit
of any tax overpayment for any taxable year ending before December 31, 1995,
made by an amended return or any other method after December 22, 1994, and
based on a change from any initially filed separate return or returns to a combined
return under the unitary business concept or to a consolidated return ." KRS
134 .580(9) (a) and (b) . Because the General Assembly's invocation of immunity is
thus clear enough, it is appropriate to address the Cabinet's immunity argument
without belaboring the construction of KRS 141 .200(17) .
47
distinguished Reich, however, and noted that the state's obligation in that case
to provide the tax refund remedy it had held out to its citizens was not subject
to sovereign immunity because it was an obligation arising from the
Constitution .
In Reich v. Collins, we held that, despite its immunity
from suit in federal court, a State which holds out
what plainly appears to be "a clear and certain"
postdeprivation remedy for taxes collected in violation
of federal law may not declare, after disputed taxes
have been paid in reliance on this remedy, that the
remedy does not in fact exist. This case arose in the
context of tax-refund litigation, where a State may
deprive a taxpayer of all other means of challenging
the validity of its tax laws by holding out what appears
to be a "clear and certain" postdeprivation remedy. In
this context, due process requires the State to provide
the remedy it has promised . The obligation arises
from the Constitution itself, Reich does not speak to
the power of Congress to subject States to suits in
their own courts .
527 U.S . at 740 (citations omitted, emphasis supplied) . Since Alden, several
courts have noted that that case
specifically preserved Reich's promise of a state-court
remedy, noting, "The obligation arises from the
Constitution itself, . . . . .. Thus, where the
Constitution requires a particular remedy, such as
through the Due Process Clause for the tax monies at
issue in Reich, or through the Takings Clause as
indicated in First English[Evangelical Lutheran Church
v. County ofLos Angeles, 482 U.S . 304 (1987)], the
state is required to provide that remedy in its own
courts, notwithstanding sovereign immunity .
DLX, Inc . v. Kentucky, 381 F.3d 511, 528 (6th Cir . 2004) (quoting from Reich) .
See, e .g. Seven Up Pete Venture v. Schweitzer , 523 F.3d 948 (9th Cir. 2008) ;
Manning v. Mining and Minerals Division of the Ener
Minerals . and Natural
Resources Department , 144 P.3d 87 (N .M . 2006) . I agree that this is the
48
import of Reich and Alden , and conclude, therefore, that KRS 141 .200(17)
cannot be upheld even if construed as an assertion of the state's sovereign
immunity. The Due Process Clause requires a meaningful remedy where taxes
have been collected in violation of law and the taxing authority, in this case the
Commonwealth, cannot invoke sovereign immunity to relieve itself of that
constitutional obligation .
II . The Taxes At Issue Here May Not Be Imposed Retroactively.
Even if the Due Process Clause requires that invalid taxes be remedied, if
the taxes at issue in this case were valid in the first place, then of course
Appellees' refund claims would evaporate . KRS 141 .200(18) seeks to bring
about that very result by validating, in effect imposing, taxes after the fact
consistent with the position of RP 41 P225 . The statute purports to
retroactively disavow the "unitary business concept" upon which Appellees'
amended returns are based, and thus effectively resurrect RP 41 P225, the
regulation this Court struck down in GTE. The Court of Appeals ruled that
while some retroactive tax legislation is allowed, the retroactive reach of KRS
141 .200(18), which encompasses tax years some five to twelve? years before its
July 2000 enactment, exceeds what is allowed under the Due Process Clause .
The Cabinet maintains that the Court of Appeals read the Due Process Clause
too strictly . I disagree.
A. The Retroactive Reach Of H.B. 541 Is Unreasonable And So Violates
The Due Process Clause.
The Court of Appeals referred to a retroactivity period of five to nine years,
presumably because Appellees' refund claims were for tax years 1990-1994.
However, KRS 141 .200(18) actually stretched back twelve years to the 1988
adoption of RP 41 P225 .
49
The Supreme Court addressed the issue of retroactive tax legislation in
United States v. Carlton, 512 U.S . 26 (1994) . Carlton involved an estate tax
provision originally enacted in October 1986 which provided for a deduction
when an estate sold stock to an employee stock-ownership plan (ESOP) . In
December 1986, Carlton, the executor of an estate, used estate funds to
purchase stock which he then resold to an ESOP for the express purpose of
claiming the estate tax deduction. A week after Carlton filed the estate tax
return, the Internal Revenue Service announced that it would seek "clarifying
legislation" because the deduction had been intended only for estates where the
stock in question was owned by the decedent "immediately before death."
Approximately a year after Carlton's stock transactions, Congress amended 26
U.S.C . § 2057 so that it expressly applied only where the decedent had owned
the stock at death . The amendment was made retroactive to the date of the
original October 1986 enactment. In upholding the amendment the Supreme
Court noted that tax legislation is frequently made to apply retroactively to
transactions completed earlier in the year of enactment or even in the year
prior to enactment. The Court explained that
[t]he due process standard to be applied to tax
statutes with retroactive effect, therefore, is the same
as that generally applicable to retroactive economic
legislation: "Provided that the retroactive application of
a statute is supported by a legitimate legislative
purpose furthered by rational means, judgments about
the wisdom of such legislation remain within the
exclusive province of the legislative and executive
branches . . . . To be sure, . . . retroactive legislation
does have to meet a burden not faced by legislation
that has only future effects . . . . The retroactive
aspects of legislation, as well as the prospective
50
aspects, must meet the test of due process, and the
justifications for the latter may not suffice for the
former' . . . . But that burden is met simply by showing
that the retroactive application of the legislation is
itself justified by rational legislative purpose."
Id. at 30-31, (quoting from Pension Benefit Guaranty Corporation v. R.A. Gray
8, Co. , 467 U .S . 717, 733 (1984)) . The 1987 estate tax amendment passed that
test, the Carlton Court held, because
[f]irst, Congress' purpose in enacting the amendment
was neither illegitimate nor arbitrary. Congress acted
to correct what it reasonably viewed as a mistake in
the original 1986 provision that would have created a
significant and unanticipated revenue loss . There is
no plausible contention that Congress acted with an
improper motive, as by targeting estate representatives
such as Carlton after deliberately inducing them to
engage in ESOP transactions . Congress, of course,
might have chosen to make up the unanticipated
revenue loss through general prospective taxation, but
that choice would have burdened equally "innocent"
taxpayers. Instead, it decided to prevent the loss by
denying the deduction to those who had made purely
tax-motivated stock transfers. We cannot say that its
decision was unreasonable .
Second, Congress acted promptly and established only
.
a modest period of retroactively This Court noted in
United States v. Darusmont, 449 U .S. at 296, [], that
Congress "almost without exception" has given general
revenue statutes effective dates prior to the dates of
actual enactment . This "customary congressional
practice" generally has been "confined to short and
limited periods required by the practicalities of
producing national legislation." Id. at 296-297, [] . In
Welch v. Henry, 305 U .S. 134, [] (1938), the Court
upheld a Wisconsin income tax adopted in 1935 on
dividends received in 1933 . The Court stated that the
"`recent transactions"' to which a tax law may be
retroactively applied "must be taken to include the
receipt of income during the year of the legislative
session preceding that of its enactment." Id. at 150, [] .
Here, the actual retroactive effect of the 1987
amendment extended for a period only slightly greater
51
than one year. Moreover, the amendment was
proposed by the IRS in January 1.987 and by Congress
in February 1987, within a few months of § 2057's
original enactment.
Id . at 32-33 (emphasis supplied) . "Recent. transactions," then, may be
retroactively taxed, provided that the retroactive application of the statute is
itself a reasonable means of furthering a legitimate state purpose. Although
the Carlton Court refrained from defining "recent transactions" beyond noting
that they would include transactions "during the year of the legislative session
preceding that of [the retroactive statute's] enactment," the Court's discussion
indicates that the length of the retroactivity period is an important factor
bearing on the reasonableness of the legislation and that a period much in
excess of the one upheld in Welch (two years) would raise serious due process
concerns .
The Cabinet tries to downplay the prompt legislative response and the
limited period of retroactivity in Carlton , insisting that neither of those factors
is part of the due process analysis, an analysis which should focus solely on
whether there is a legitimate legislative purpose .$ Given the Commonwealth's
delay of over five years in responding to the GTE decision and the long
retroactive reach of H.B. 541, it is understandable that the Cabinet would want
s As the Court of Appeals aptly stated in its opinion in this case: "The Cabinet argues
in vain that there is no "modesty" requirement under Carlton . However, many
courts interpreting Carlton have found such a requirement, including one case
explicitly relied upon by the Cabinet . See Tate 8, Lyle, Inc. v. C.I .R. , 87 F.3d 99,
107 (3d Cir . 1996) ("[thhere [in Carlton], the Supreme Court set forth a two-part test
for determining whether the retroactive application of a tax statute violates due
process. First, for retroactivity to be upheld, it must be shown that the statute has
a rational legislative purpose and is not arbitrary; and second, that the period of
retroactivity is moderate, not excessive .") ." Opinion at fn . 32 .
52
to minimize these aspects . Unfortunately, a fair reading of Carlton does not
bear out that position. Central to the Carlton decision was the recognition that
Congress had not disturbed long-standing transactions because, as Justice
O'Connor noted in her concurring opinion, "[t]he governmental interest in
revising the tax laws must at some point give way to the taxpayer's interest in
finality and repose ." 512 U.S . at 37-38 .
Here, KRS 141 .200(18) offends Carlton's timeliness standard in two
ways . First, the statute was not passed promptly but rather five and one-half
years after GTE . Second, it reaches back from its effective date of July 2000 to
income received while RP 41 P225 was in effect, from September 1988 until
December 1994, a retroactivity period from five-and-a-half years to twelve
years . I agree with the Court of Appeals that the state's interest in avoiding the
financial consequences of refunds is an inadequate justification for belated
legislation with such a long retroactivity period . If the state had carte blanc
simply to impose retroactive taxes to avoid costly refund claims, then the
refund remedy would be rendered uncertain if not entirely meaningless, a
result that is clearly unreasonable, and in violation of Carlton's due process
standard.
The Cabinet offers two cases in support of its position that retroactive tax
legislation can reach back for an extended period of time, perhaps indefinitely,
and still satisfy due process.9 Neither case supports the unlimited power
which the Cabinet attributes to a taxing authority.
9 The Cabinet also refers in particular to two cases cited in Carlton, Milliken v . United
States , 283 U.S . 15 (1931) and Usery v . Turner Elkhorn Mining Co . , 428 U.S . 1
53
In Montana Rail Link, Inc . v. United States, 76 F.3d 991 (9th Cir. 1996), a
railroad had made tax payments based on the less favorable reading of an
ambiguous statute, a provision of the Railroad Retirement Tax Act, which is the
functional equivalent of the Social Security Act for railroad employers. In
short, the railroad had mistakenly overpaid . The railroad later sought refunds
for 1987 and 1988 based on a more favorable reading suggested by the
Railroad Retirement Board. In 1989, while the refund claims were pending,
Congress amended the RRTA to resolve the ambiguity in favor of the higher tax
and made the amendment retroactive so as to apply to the entire period of the
statute's ambiguity, from 1983 through 1989 . The amendment thus nullified
any refund claims based on the ambiguity . The Ninth Circuit held that the
retroactive aspect of the amendment satisfied Carlton's rational basis
requirement because a shorter retroactive period would have severely
decreased the benefits of some retired railroad workers . Significantly, the
(1976) . Neither of these cases was cited for, or stands for, the proposition that
retroactive tax legislation knows no limits. Milliken concerned the estate tax of a
1920 decedent's estate . It upheld the application of the 1918 estate-tax rate to a
gift in contemplation of death made in 1916 . The Court explained that the
retroactive application of the 1918 tax-rate increase was a reasonable means of
furthering Congress's intent that gifts in contemplation of death be taxed at the
same rate as the rest of the decedent's estate. Although the taxpayer did not have
notice of the increased rate, this was not a retroactive change apt to upset taxpayer
expectations, the Court noted, since estate planners were well aware that gifts in
contemplation of death would be taxed at the same rate as the remainder of the
estate . The Court did not hold, as the Cabinet suggests, that retroactive taxes are
always "reasonable" for due process purposes merely because they serve a State's
need for funds . Usere was not even a tax case, but a black-lung benefits case, cited
in Carlton for the proposition that the retroactive aspects of economic legislation
must independently satisfy the due process rational basis test . Contrary to the
Cabinet's suggestion, it in no way runs contrary to Canton's clear indication that
the length of the retroactivity period is a most important factor bearing on the
reasonableness of a retroactive tax.
54
Montana Rail Court distinguished this situation from cases such as Reich ,
supra, where refund claims were based on taxes found to be illegal:
At no point did MRL [the railroad] pay any tax barred
by the Constitution or federal law. The
constitutionality and legality of the RRTA is not in
dispute, and MRL does not challenge the legitimacy of
taxing 401 (k) contributions per se. MRL erroneously
equates its mistaken overpayment of taxes with the
government's "unlawful," "improper" and "erroneous"
collection of taxes. Contrary to MRL's assertion, the
IRS did not violate any federal law by accepting MRL's
overpayment. Seeking a refund for one's own
volunta overpayment of a lawful tax is not the same
as pursuing a remedy for payment of an illegal tax
Id. at 995 (emphasis supplied) . Montana Rail thus addressed only the
retroactive clarification of a valid tax which the taxpayer had voluntarily overpaid through its own misinterpretation of an ambiguous statute . While the
Cabinet may find Montana Rail's approval of a clarifying amendment stretching
back six years appealing, the Ninth Circuit decision makes clear that it is not
addressing the due process issues that arise when a tax has been unlawfully
exacted and then retroactive tax laws are passed.
King v. Campbell County, 217 S.W.3d 862 (Ky. App . 2006) involved KRS
68 .197, a statute authorizing counties to collect occupational license fees.
Although a 1986 amendment to the statute required counties to give taxpayers
a credit for city license fees they had paid, Campbell and Kenton Counties
maintained that the amendment did not apply to them. Both had adopted
occupational license fees in 1978 when the statute required the issue to be
placed on the ballot for voter approval and when counties were permitted, but
not required, to give taxpayers credit for their city occupational license fees.
55
Only Campbell and Kenton Counties had passed occupational license fees
under this older statutory procedure. The Court of Appeals agreed with the
counties' interpretation that the amended statute did not require them to give
county taxpayers tax credits for city occupational license fees. However, in City
of Covingtton v. Kenton County , 149 S.W.3d 358 (Ky. 2004), this Court decided
that the amendment did apply to Kenton (and implicitly Campbell too) and
thus exposed the county to potentially devastating refund claims for the
withheld credits . 10 Almost immediately, in March 2005, the General Assembly
amended KRS 68 .197 to clarify that Campbell and Kenton Counties were not
subject to the city fee credit. The legislation was made retroactive so as to
abrogate the City of Covington decision and to nullify refund claims based
upon it. In King the Court of Appeals rejected Campbell County taxpayer
challenges to the retroactive legislation . The Court found that the General
Assembly had acted promptly, consistent with Carlton , to further the legitimate
legislative purpose of avoiding severe disruption of county finances and, that
the unanticipated City of Covington decision had not interfered with "settled
expectations" on the part of Campbell County taxpayers, who had acquiesced
in the counties' interpretation of the ambiguous statute for years . I I
Unlike the amendment in Carlton, however,
which withdrew an unambiguous deduction and
deliberately undermined reasonable taxpayer reliance,
10
Under the City of Covin on rationale, Kenton County owed refunds from 2000
forward . Because Campbell County had imposed higher taxes in 1986, that
county's refund obligations would have extended back to 1986 . See King, 217
S .W.3d at 866.
The Campbell County taxpayers who filed the King case waited until March 2005 to
challenge that county's interpretation and seek refunds back to September 1986 .
56
House Bill 400 does not withdraw a provision upon
which taxpayers have relied, but seeks to clarify the
license fee credit provision in the wake of our Supreme
Court's City of Covington decision . The Campbell
County taxpayers could have sought refunds in 1986,
when Campbell County first raised its license fee rates
following the 1986 amendment to KRS 68 .197 . For all
these years, however, the taxpayers acquiesced in the
County's interpretation of that statute, an
interpretation that this Court found reasonable, but
the Supreme Court rejected . If there are "settled
expectations" in this case, they are the County's, not
the taxpayers. The taxpayers' expectations arose only
with the Supreme Court's City of Covington decision in.
November 2004, and within a few short months, in
March 2005, long before those expectations could be
deemed "settled" or "vested," the General Assembly
had acted to revise the law and to shield Campbell and
Kenton Counties from what it believed could be the
devastating consequences of the Supreme Court's
decision . In these circumstances-where the General
Assembly has not attempted to withdraw legislation
upon which taxpayers have relied in structuring their
affairs, but has promptly sought to foreclose refunds
as the result of an unanticipated judicial interpretation
of a constitutionally valid tax provision-the retroactive
provisions of House Bill 400 do not run afoul of the
timeliness concerns expressed by the United States
Supreme Court in Carlton .
217 S .W.3d at 870.
The Cabinet understandably focuses on Kind as an example ofjudicial
validation of retroactive tax legislation stretching back for a period well in
excess of the modest periods addressed in Carlton . King is admittedly more
akin to the situation before this Court than the mistaken overpayments in
Montana Rail but there are crucial differences in King and this case which bear
strongly on the due process analysis .
Campbell and Kenton Counties were the taxing authorities in Kin and
City of Covingtton but their taxing authority was constrained by state statute .
57
The counties construed the rather ambiguous statute (which significantly was
not of their own making) as inapplicable to them and this construction, as
noted above, was acquiesced in by county taxpayers for many years. The
reasonableness and good faith of that particular construction, which relieved
Campbell and Kenton of the obligation to credit county taxpayers for city
occupational fees, was underscored by the fact that the Court of Appeals
upheld it. When City of Covington was decided, as the Court of Appeals noted,
it was an "unanticipated judicial interpretation" of a valid tax . In other words,
the counties had interpreted the ambiguous statute passed by the General
Assembly in a consistent, plausible way but this Court ultimately found that
the taxpayers who eventually had begun to question the interpretation and who
had brought suit to obtain the credits were, in fact, correct. Within four
months of that decision, the General Assembly passed a statute that clarified
its "original intention" that the tax credit did not apply to "those counties where
a license fee has been authorized by a public question approved by the voters."
In short, the interpretation consistently followed by Campbell and Kenton
Counties had been the legislative intent all along .
This case presents a decidedly different scenario . Here, the Cabinet, with
the General Assembly's acquiescence, had long construed KRS 141 .120 and
141 .200 as allowing combined reporting. Only in 1988, without any change in
a settled law, did the Cabinet purport to adopt a different construction . In GTE
this Court held that the Cabinet was not free to say that the statutes meant
one thing one day and then the next day to say that they meant something
entirely different . Its original reading of those statutes was reasonable, had not
58
been corrected by the General Assembly, and thus was binding . Clearly Kin
did not involve the taxing authority suddenly and unilaterally reinterpreting an
unchanged tax law to the taxpayers' detriment. Moreover, while Kind arose
from "an unanticipated judicial interpretation," GTE could not possibly have
been unanticipated . Taxpayers challenged the Cabinet's about-face in RP
41 P225 promptly and GTE was a return to the precise reading of the statute
that the Cabinet itself had engaged in for sixteen years.
Given the long-standing, consistent interpretation of KRS 141 .120 to
allow combined reporting, KRS 141 .200(18) cannot be deemed merely to
abrogate GTE and to clarify what the law had always been . Like the estate tax
amendment in Carlton, KRS 141 .200(18) is an attempt to alter the tax law
retroactively, but unlike the amendment in Carlton it purports to apply the
change not just to recent transactions but to transactions (the receipt of
income) in tax years from five years to twelve years earlier. Although I
recognize the General Assembly's desire to spare the state's budget from the
significant refund claims springing from the Cabinet's unauthorized 1988
rereading of KRS 141 .120 and 141 .200, I agree with the Court of Appeals that
this five-year plus backward reach, particularly on these facts, exceeds what
the Supreme Court has indicated is reasonable under the Due Process Clause
and thus cannot be upheld . Simply put, difficult economic consequences can
never justify disregarding citizens' due process rights.
B. GTE Was Not Wrongly Decided.
Finally, if the General Assembly could not retroactively ratify RP 41 P225
more than five years after GTE, the Cabinet urges this Court to do so itself by
59
revisiting and over-ruling our decision in GTE. GTE was wrongly decided, the
Cabinet insists, because notwithstanding its own sixteen-year policy of
permitting combined reports, KRS Chapter 1-41 in fact precluded such reports
at all times, and thus RP 41 P225 embodied an accurate construction of the
law. The Cabinet's invitation to indulge in such revisionism should be rejected,
not simply because of stare decisis, but because GTE was right.
The Cabinet focuses first on KRS 141 .200(l) . From before 1966, when
the General Assembly adopted UDITPA, until the amendments of 1996, that
statute provided that "[e]very corporation doing business in this state, except
those exempt from taxation under KRS 141 .040, shall make a return stating
specifically the items of income and the items claimed as deductions allowed by
this chapter. Corporations that are affiliated must each make a separate
return ." In that timeframe, the General Assembly had not defined either
"affiliated" or "corporations that are affiliated," and without some definition the
second sentence is ambiguous . It can mean either "each corporation within an
affiliation must file a separate return," or "each corporate affiliation must file a
separate return." For years, as noted, the Cabinet had in effect applied the
second reading and, understanding "affiliated" to include "unitary"
corporations, had permitted combined reports . In GTE , we held that the
Cabinet's settled reading was not unreasonable and thus could not be
abandoned merely to suit its own change of policy. Such a change would need
to come from the General Assembly . The Cabinet insists that its prior reading
of the statute was not reasonable, and that we erred by holding that it was .
This disingenuous argument does not provide a sufficient reason to revisit
60
GTE . The fact remains that for sixteen years, with the apparent blessing of the
General Assembly, the Cabinet construed KRS 141 .200 to permit combined
reports . That settled construction cannot be undone by the Cabinet merely
because an ambiguous phrase might initially have been read a different way .
This Court did not err in GTE by so holding.
The Cabinet also contends that statutory uses of the term "corporation,"
are couched in the singular and thus imply a legislative intent that only
separate corporations be taxed. In general, however, statutory singulars are
understood as referring as well to plurals. KRS 446 .020. As noted above,
moreover, combined reporting does not involve disregarding separate corporate
entities to produce one comprehensive return but rather is an accounting
method by which each corporation in a unitary business accounts for its
respective share of the unitary entity's income. See Sutton, "Comparison of
Group Reporting Methods," supra. In conjunction with formulary
apportionment, combined reporting allows for determination of that portion of
the unitary business's income attributable to the taxing state . Id. That the
statutes refer to "corporation" in the singular, therefore, does not suggest that
combined reports had been ruled out. Indeed, also as noted above, KRS
141 .205 expressly required "combined returns" in certain circumstance's, a
clear indication that the General Assembly did not intend to preclude them.
Nor was combined reporting ruled out by the fact that prior to GTE the
calculation of taxable income in Kentucky began with gross income as
determined for federal tax purposes . Combined reporting merely considers
together the duly calculated incomes of unitary corporations . It did not require
61
a calculation of income at odds with the statutory definitions, as clearly
indicated, by KRS 141 .205's provision for combined reports . Again, then, the
Cabinet has not shown that its own reading of the statutes from 1972 until
1988 was unreasonable or contrary to their plain intent, and thus GTE
correctly held that that reading was not to be cast aside without legislative
direction.
CONCLUSION
In sum, I agree with the Court of Appeals that both KRS 141 .200(17) and
141 .200(18) violate the Due Process Clause and so may not be enforced. KRS
141 .200(17) unlawfully withdraws the remedy the state is obliged to provide for
illegally collected taxes, and KRS 141 .200(18) retroactively imposes a tax
beyond the period the Supreme Court has indicated is reasonable .
Accordingly, I would affirm the May 5, 2006 Opinion of the Court of Appeals
and so respectfully dissent from the majority's contrary ruling.
Cunningham, J., joins .
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