The Massachusetts Supreme Judicial Court recently held in The First Marblehead Corporation v. Commissioner of Revenue (“First Marblehead II”), 475 Mass. 159 (2016), that securitized loans of GATE Holdings Inc. (“Gate”) were properly sourced to Gate’s commercial domicile in Massachusetts for purposes of computing Gate’s property factor for Massachusetts financial institutions excise tax (“FIET”) purposes, and that the FIET, as applied to Gate, satisfies the internal consistency test.
Gate, a wholly-owned subsidiary of The First Marblehead Corporation, qualified as a “financial institution” for purposes of the Massachusetts FIET. Gate was a holding company that had acquired interests in securitized student loans. Gate had no employees, no office space, and no tangible assets, and all of its loans were administered by a third-party loan servicer. The issue was how Gate’s securitized loans should be sourced for purposes of computing Gate’s property factor.
Under the Massachusetts FIET, taxable income is apportioned using a three-factor apportionment formula consisting of sales, property, and payroll. In computing the property factor, a loan is properly sourced to the “regular place of business” with which it has a preponderance of substantive contacts, determined based on activities including solicitation, investigation, negotiation, approval and administration (“SINAA Factors”). Mass. Gen. L. ch. 63, § 2A(e)(vi)(A). A “regular place of business” is “an office at which the taxpayer carries on its business in a regular and systematic manner and which is consistently maintained, occupied and used by employees of the taxpayer.” Mass Gen. L. ch. 63, § 1. If a loan is sourced to a place outside Massachusetts that is not a “regular place of business” of the taxpayer, there is a rebuttable presumption that the loan is properly sourced to Massachusetts if the taxpayer’s commercial domicile was in Massachusetts at the time the loan was made. Mass. Gen. L. ch. 63, § 2A(e)(vi)(B).
In 2015, the Massachusetts Supreme Judicial Court in First Marblehead Corporation v. Commissioner of Revenue (“First Marblehead I”), 470 Mass. 497 (2015), held that all of Gate’s interests in the securitized loans were properly sourced to Massachusetts, which was its commercial domicile at the time the loans were made. The court held that because Gate had no offices or employees in Massachusetts or elsewhere, it had no “regular place of business.” The court also found that because Gate did not originate loans, the only potentially applicable SINAA Factor was administration, but that the loans had no such contacts to consider because activities conducted by agents and independent contractors, such as a loan servicer, are not taken into account.
On review, the United States Supreme Court vacated the decision in First Marblehead I and remanded the case for further consideration in light of its decision in Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787 (2015), in which the Court reaffirmed the “internal consistency test” for determining whether a state tax violates the Commerce Clause. Under the internal consistency test, a court must hypothetically assume that every state adopts the taxing scheme at issue and that hypothetical scenario must not result in more than 100% of a business’s income being taxed.
In First Marblehead II, the Massachusetts Supreme Judicial Court reaffirmed its prior decision that Gate’s loans were properly sourced to its domicile in Massachusetts. The court further held that this result does not violate the internal consistency test because, if every state enacted an identical apportionment statute and interpretation, no more than 100% of Gate’s income would be subject to tax. In every state, all of the securitized loans would be properly assigned to Gate’s commercial domicile in Massachusetts and no loans would be assigned to any other state. Therefore, the apportionment rules under Massachusetts’s FIET are internally consistent. Additionally, even though Gate assigned loans to Florida on its filed return, the internal consistency test was not violated because there was no statutory basis for Gate to assign loans to Florida.
First Marblehead has since filed a petition for rehearing with the Massachusetts Supreme Judicial Court.
The loan sourcing provisions at issue in First Marblehead are the same as the loan sourcing provisions in the Multistate Tax Commission’s “Recommended Formula for the Apportionment and Allocation of New Income from Financial Institutions” adopted November 17, 1994. Therefore, the First Marblehead decisions should be carefully examined not only by financial institutions operating in Massachusetts but also by financial institutions operating in other states that have adopted the MTC’s model rules. In particular, financial institutions that use affiliates or other third parties, such as loan servicers, to conduct loan-related activities should consider how the SINAA Factors apply (for both past and future tax years) when those third-party activities are not taken into account, especially in situations where the financial institution does not engage in loan origination activities with respect to all or a portion of its loans. Where the potential for refunds exist, taxpayers should consider filing refund claims pending the final resolution of the First Marblehead case.