GoDaddy founder, Robert Parsons, owed $1.25 million in state income tax on the sale of his interest in the company based on a 90% weighted sales factor, the Minnesota Supreme Court ruled Aug. 12.
In YAM Special Holdings, Inc. v. Commissioner of Revenue, A20-0021 (Minn. Supr. Ct. 8/12/20), the Minnesota Supreme Court affirmed the Minnesota Tax Court’s decision to apportion YAM’s $1.35 billion gain from its sale of a portion of its ownership interest in the GoDaddy business using a 90% weighted sales factor. This decision, read with a recent decision in Michigan, shows the variety of ways a taxpayer may apportion the gain (or loss) from the sale of a business interest. More importantly, this decision highlights how important it is for a taxpayer to examine available apportionment options when selling business interests.
In 2011, Robert Parsons, founder of GoDaddy, sold 71.39% of his interest in the GoDaddy business to strategic investors. Parsons owned 100% of YAM, which owned 100% of Desert Newco LLC. Desert Newco, in turn, owned a combination of flow-through entities that operated the GoDaddy business. The transaction that generated the gain was structured as YAM selling 71.39% interest in Desert Newco.
In 2011, YAM apportioned its ordinary business loss to Minnesota using the applicable three-factor apportionment formula (about 1%). YAM, however, claimed that the Due Process Clause of the U.S. Constitution prohibited Minnesota from taxing the gain because:
(1) the gain was nonbusiness income and lacked sufficient contact to Minnesota; and
(2) Desert Newco served an investment, not operational, function.
On audit, the Commissioner of Revenue assessed $1.25 million in tax, plus interest and penalty, claiming that the gain was apportionable business income.
The court reviewed applicable U.S. Supreme Court precedent, focusing on Container Corp. of Am. v. Franchise Tax Bd., and Allied-Signal, Inc. v. Director. Slip op. at 7-9. YAM conceded that it conducted a unitary business with its operating subsidiaries and the record showed that the operating subsidiaries conducted business in Minnesota. Slip op. at 10. Therefore, the court concluded that “taxing an apportioned share of the income from the 2011 sale does not violate the Due Process Clauses of the United States and Minnesota constitutions because it is business income of a unitary business and the unitary business has a sufficient connection to Minnesota to satisfy due process principles.” Slip op. at 14. Applying Allied-Signal; Hercules Inc. v. Commissioner of Revenue; MeadWestvaco Corp. v. Illinois Department of Revenue; and Minnesota Statutes Section 290.17, subd. 4(a), the court also concluded that Desert Newco did not serve an investment function and, therefore, the gain was apportionable business income.
Did the apportionment formula fairly reflect YAM’s business activities in the state? In 2011, Minnesota applied a 90% sales apportionment factor. See Minn. Stat. Section 290.191, subd. 2.(a). Therefore, only 10% of YAM’s property and payroll were considered in determining its 2011 apportionment factor of about 1%. If, instead, YAM had conducted the identical business activities in Minnesota when Minnesota equally weighted its three-factor formula, that statutory formula would have given 67% weight to YAM’s property and payroll. Under that prior legislatively approved (and presumptively fair) formula, YAM would have paid about $460,000 in tax on the gain instead of the $1.25 million it paid under the 90% sales factor–weighted formula in effect in 2011. Viewed from another angle, the 90% weighted formula imposes 172% more tax than the equally weighted three-factor formula.
YAM could not have generated any income without its property and payroll factors. Therefore, query whether the 90% weighted factor meets the Commerce Clause fair apportionment requirement when it produces almost twice as much tax as Minnesota’s legislatively approved, presumptively valid, equally weighted three-factor formula or whether such legislative weighting is arbitrary when applied to a specific set of facts.
The Minnesota statute, like most states, expressly allows a taxpayer to petition for alternative apportionment (see Minn. Stat. Section 290.20, subd. 1.). Nonetheless, unlike the taxpayer in Vectren (discussed below), it does not appear that YAM challenged the fairness of the 90% sales factor–weighted formula.
Does the recent Michigan Vectren case suggest that YAM’s 2011 apportionment factor may not have fairly apportioned the goodwill component of the gain? In this case, the gain contained a substantial amount of goodwill that had been accrued over many years. Query, therefore, whether YAM may have been entitled to apportion the gain using an alternative method (e.g., perhaps the apportionment factor in the year of sale did not fairly represent the taxpayer’s Minnesota business activities in the years in which the goodwill was accrued), as was the case in Vectren Infrastructure Services Corp. v. Dept. of Treasury (MLI); see also Semes and Hunsaker, “Michigan Court of Appeals Holding That Sale of Stock Entitled to Use Alternative Apportionment Has Broad Implications,” Bloomberg Tax Memorandum, April 6, 2020.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Michael Semes is of counsel with BakerHostetler in Philadelphia and part of the firm’s state and local tax group. He is also Professor of Practice at the Villanova University Charles Widger School of Law in the Graduate Tax Program.