North Carolina Business Litigation Report

North Carolina Business Court: Department Of Revenue Violated State Constitution In Attempting To Collect A Tax Penalty

The Business Court spanked the Department  of Revenue again last week, just after a ruling two weeks ago when it said in another case that the DOR's position was "harsh, and potentially fatal. . . ."  This time, in Delhaize America, Inc. v. Lay, 2011 NCBC 2, Judge Tennille ruled that the attempted imposition of a $1 million tax penalty by the DOR not only violated the taxpayer's due process rights, but also a provision of the state Constitution which requires the power of taxation to be exercised in "a just and equitable manner." 

Delhaize, the North Carolina operator of Food Lion grocery stores, was audited by the DOR after it restructured its operations by placing its trademarks, trade names, service marks, and other assets in an out of state subsidiary named Food Lion Florida (FLFL).  Delhaize paid royalties and fees to FLFL, and those were repaid to Delhaize in the form of non- taxable dividends. This resulted in "income distortions," Op. ¶23, and the payment of less tax by Delhaize

Given the North Carolina statute saying that a corporation "shall not file a consolidated return" (N.C. Gen. Stat §105-130.14), and the lack of clear guidelines to taxpayers about when a combined return might be accepted, the penalty was ruled to be unconstitutional.  Judge Tennille said on the due process issue that taxpayers were individuals with a property interest who "must receive notice and an opportunity to be heard before the government may deprive them of their property." Op. ¶73.  The guidelines for when a combined return would be allowed were, as the Court put it, "so elusive" that "ordinary taxpayers 'exercising ordinary common sense' [could not] sufficiently understand or predict when a penalty will be assessed." Op. ¶75.

As for the penalty running afoul of the the North Carolina Constitution's requirement that it be "just and equitable," Judge Tennille held:

When a corporation is charged a significant penalty for complying with the law, the result of which is an automatic, non-negligence, punitive penalty assessed by the Department of Revenue, the state’s power of taxation is being exercised in a manner that is unjust and inequitable.

 Op. ¶87. It was constitutionally unjust to allow this penalty without published guidelines as to when the penalty was warranted. 

Judge Tennille also found distasteful the DOR's program, operated before the amendment of the penalty statute, by which it offered amnesty to corporate taxpayers which had engaged in restructurings.  It agreed in those negotiations to waive the 25% penalty in exchange for the payment of the lost tax revenue.  This resulted in collection of an additional $300 million in tax.  Judge Tennille referred to the threat of a penalty in this program as "deft use" by the DOR of "a club." Op. ¶77.

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Mack Sperling
Brooks Pierce, LLP
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