2008 VT 120


TD Banknorth,
N.A. v. Dept of Taxes (2007-127)
 
2008 VT 120
 
[Filed 19-Sep-2008]
 
NOTICE:  This opinion is
subject to motions for reargument under V.R.A.P. 40
as well as formal revision before publication in the Vermont Reports. 
Readers are requested to notify the Reporter of Decisions, Vermont Supreme
Court, 109
  State Street, Montpelier, Vermont05609-0801
of any errors in order that corrections may be made before this opinion goes to
press.

 
 

2008 VT 120

 

No. 2007-127

 

TD Banknorth,
  N.A.


Supreme Court


 


 


 


On Appeal from


     v.


Washington Superior Court


 


 


 


 


Department of Taxes


January Term, 2008


 


 


 


 


Mary
  Miles Teachout, J.


 

Paul P. Hanlon, Montpelier,
and John S. Brown of Bingham McCutchen LLP, Boston,
  Massachusetts,
for Plaintiff-Appellant.
 
William H. Sorrell, Attorney General, and Danforth Cardozo, III, Assistant Attorney General,
  Montpelier,
for Defendant-Appellee.
 
 
PRESENT:  Reiber, C.J.,[1] Dooley, Johnson, Skoglund
and Burgess, JJ.
 
¶ 1.            
BURGESS, J.   Taxpayer TD Banknorth,
N.A., appeals the determination of the superior court affirming the
Commissioner of Taxes’ assessment of bank franchise taxes, interest, and
penalties against taxpayer for the 2000 and 2001 tax years.  In 2000,
taxpayer established three holding companies to manage some of the assets of
its Vermont
banks and to take advantage of favorable tax status for these entities. 
The superior court agreed with the Commissioner of Taxes that these holding
companies were, essentially, empty shells and were not engaged in substantial
independent business activity beyond the achievement of tax avoidance. 
The superior court thereby affirmed the decision of the Commissioner to
disregard the holding companies for tax purposes and impose a penalty on
taxpayer.  We affirm.
I. 
Background
A. 
The Banks
¶ 2.            
The background to this tax avoidance effort is as follows. 
Taxpayer is the parent company to three Vermont
banks: The Howard Bank, N.A., First Vermont Bank, N.A., and Franklin Lamoille
Bank, N.A. (the banks).[2] 
Each bank is a wholly-owned subsidiary of taxpayer.  Taxpayer handles the
servicing of loans, financial reporting, and other matters for the banks out of
its central office in Maine. 

B. 
The Holding Companies
¶ 3.            
In 2000, each bank established a wholly-owned holding company.[3]  Each holding company was properly
formed as a corporation under Vermont
law by filing articles of incorporation with the Secretary of State.  The
entities issued stock, adopted bylaws, and followed other corporate
formalities, but they had no independent office space, real property, tangible
assets, or employees.  The banks capitalized their respective holding
companies by transferring, among other assets, asset-backed securities,
collateralized mortgage obligations, corporate bonds, tax-exempt municipal
bonds, and restricted stocks.  In addition to the outright assignment of
those assets, the banks also transferred a package of commercial loans, real
estate loans, and consumer loans to these subsidiaries through “participation
agreements.”  The participation agreements, unlike outright assignments,
gave the holding companies 100% economic interest in the transferred loans
while taxpayer retained full management responsibilities for the assets. 
These loans continued to be serviced by taxpayer’s main offices in Maine, and the holding
companies paid an industry-standard rate for these services.  The holding
companies also maintained suretyship and asset pledge
agreements for some of the loans with the Federal Home Loan Bank of Boston. 
¶ 4.            
  The purpose of these conveyances was to take advantage of
favorable tax treatment under 32 V.S.A. §§ 5836(e) and 5837.  Prior
to the establishment of the holding companies, the banks reported the income
from these assets.  After the loans were transferred to the holding
companies, however, the income stream from these assets was reassigned to the
holding companies.  This reduction in the banks’ income resulted in the
banks reporting a loss for federal income tax purposes.  By reporting a
loss, the banks could almost eliminate any payment of the State’s bank
franchise tax (BFT), a tax that was calculated as a percentage of the banks’
monthly deposits, but generally capped not to exceed the banks’ federal taxable
income.  See id. § 5836(e), repealed by 2003, No. 152 (Adj.
Sess.), § 6.  Meanwhile, the holding companies paid virtually no tax
on this income under the exception carved out by 32
V.S.A. § 5837.  As in effect during the 2000 and 2001 tax years,
§ 5837, entitled “Investment and holding companies,” provided that
taxation of corporations 
whose
activities are confined to the maintenance and management of their intangible
investments and the collection and distribution of the income from such
investments or from tangible property physically located outside this state
shall not exceed the $150.00 minimum tax.
 
32 V.S.A. 5837, repealed by
2003, No. 152 (Adj. Sess.), § 8.[4]
 
C. 
The Bank Franchise Tax
¶ 5.            
Vermont
banks are required to file and pay the BFT quarterly, using a BFT return
form.  See 32 V.S.A. § 5836(c).  A bank’s tax liability under
this section is based on the bank’s average monthly deposits.  Each bank
must pay “0.000096 of [its] average monthly deposit” each month, see id.
§ 5836(b), although
[t]he tax
imposed by this section shall be limited . . . to the amount of [a bank’s]
federal taxable income (before net operating loss deductions and special
deductions) increased by the amount of its income from state and local
obligations and by the amount of  any deductions taken for the tax imposed
by this section.
 
Id. § 5836(e) (repealed 2004). 
Because the tax cap imposed by § 5836(e) is dependent upon a bank’s adjusted
federal taxable income, a bank’s full BFT liability cannot be assessed until
after the bank has determined its annual federal taxable income.  If it is
later determined that § 5836(e)’s federal taxable income cap applies, the
bank may request a refund of the overpaid BFT by filing a BFT reconciliation
report.  The reconciliation report compares the taxable income reported on
the taxpayer’s federal return, as adjusted in accordance with § 5836(e),
with the total BFT already paid by the taxpayer for the four quarters during
the year.  If the taxes paid exceeded the taxpayer’s adjusted federal
taxable income, the Department of Taxes issues a refund. 
¶ 6.            
For each quarter of the calendar years 2000 and 2001, the banks timely
filed BFT returns, reporting their monthly deposits.  As noted, after the
transfer of the banks’ income-producing assets to the holding companies, the
banks no longer showed positive annual taxable income on their federal tax
returns.  After determining the banks’ federal taxable income for these
years, taxpayer filed reconciliation reports, claiming that the BFT was
overpaid.  The Department allowed the requested refunds, along with
interest in some instances.  The total claimed refunds requested by the
banks for the years 2000 and 2001 amounted to approximately $3.5 million.
¶ 7.            
Noticing a precipitous drop in BFT revenues, the Department audited the
three banks in 2004.  It concluded that the holding companies had “no
economic substance or legitimate business purpose and were formed merely to
evade the [BFT].”  The Department assessed additional BFT, attributing the
holding companies’ income to its parent bank for the years in question. 
The Department also assessed a 25% penalty on taxpayer pursuant to 32 V.S.A.
§ 3202(4), later revising its assessment upward to a 100% fraud penalty, id.
§ 3202(5).  
¶ 8.            
Taxpayer appealed the assessment to the Commissioner of Taxes.  The
Commissioner upheld the BFT assessment, concluding that the holding companies
were properly disregarded for tax purposes, but imposed a 25% rather than 100%
penalty for “understatement of 20% or more of the tax.”  Id. § 3202(b)(4).  Taxpayer
appealed this determination to the superior court, which affirmed the
Commissioner’s judgment.   Appeal to this Court followed.[5]
¶ 9.            
Taxpayer raises four claims on appeal:  (1) the Department’s
assessment is time-barred because it failed to issue the assessment within the
three-year statute of limitations, see 32 V.S.A. § 5882; (2) the Commissioner
erred in disregarding the holding companies as separate entities from their
parent bank for tax purposes; (3) the Commissioner has no authority to impose
penalties that were not included in the Department’s assessment, and so
improperly assessed the twenty-five percent penalty on taxpayer; and (4) the
Commissioner cannot assess a penalty for an understatement resulting from an
erroneous tax refund.
II. 
Statute of Limitations
¶ 10.        
We first address taxpayer’s claim that the Department’s assessment was
time-barred by the three-year statute of limitations for assessments by the
Department.  32 V.S.A. § 5882.  The Department’s assessment
was conducted in 2004.  It is undisputed that the assessment occurred more
than three years from the date of some of the BFT filings, but within three
years of the filing of the 2002 and 2003 reconciliation reports.
¶ 11.        
The Commissioner properly categorized the reconciliation reports as
returns that mark the beginning of the statute-of-limitations period, and thus
the Department’s assessments are not time-barred.  Title 32 allows the
Department three years to notify taxpayers of any tax payment deficiencies or
to assess penalties and interest for payment deficiencies.  Id.  That
three year time period may begin at “the date that tax liability was originally
required to be paid,” id. § 5882(a), or, if the taxpayer did not
“file a proper return” when the tax liability was due, then the three-year
period begins at the time “the taxpayer files such a return.”  Id.
§ 5882(b)(1).  In this case, the tax liability was originally
required to be paid at the time of the quarterly BFT filings, but as explained
below, the returns were not full and accurate, and therefore not “proper,”
until taxpayer filed the 2002 and 2003 reconciliation reports.  
¶ 12.        
The BFT filings were not “proper returns” because they were subject to
the later corrections made by taxpayer based on its federal taxable income for
the year in which the BFT payments were made.  Id. § 5836(e) repealed by 2003,
No. 52 (Adj. Sess.), § 6.  Taxpayer’s 2000 and 2001 BFT filings were
finalized only after the taxpayer computed its adjusted federal income tax,
determined it was due a refund from the state based on a comparison of what it
had paid with its federal tax, and notified the Department (via its 2002 and
2003 reconciliation reports) as required under 32 V.S.A. § 5866(a). 
Section 5866 states that taxpayers are required to notify the Commissioner of
“any information which makes [a formerly filed return] materially false,
inaccurate or incomplete.”  32 V.S.A. § 5866(a)(1).  The
reconciliation reports, which corrected the amount of BFT owed, were taxpayer’s
notification to the Commissioner that its BFT returns were inaccurate due to
its subsequent federal taxable income determination.  Because § 5866(b)
also specifies that “[a]ny notice required to be
given to the commissioner under this section shall be considered to be a return
for purposes of this chapter,” it is appropriate to treat the reconciliation
reports as the “proper return” that began the three-year statute-of-limitations
period under § 5882(b)(1).  
¶ 13.        
Taxpayer asserts that reconciliation reports cannot be categorized as
“returns” because they are refund requests, do not resemble standard returns,
and do not have filing deadlines.  We find this argument unavailing. 
As discussed above, the reconciliation reports are required under § 5866(a)(1),
and all such required notices are returns for purposes of Chapter 151.  32
V.S.A. § 5866(b).  This provision does not restrict the term “return” to
any particular category of documents based on their form, content, or the
imposition of a filing deadline.  
¶ 14.        
Taxpayer next claims that the quarterly BFT returns, not the
reconciliation reports, were the operative “returns” for purposes of starting
the three-year statute-of-limitations period.  In support of this
argument, taxpayer points to § 5882(b)(1), which states that the three-year
enforcement period will be extended if the taxpayer “fails to file a proper
return . . . at the time prescribed for its filing.”  (Emphasis
added.)  Because there is no deadline for filing the reconciliation
reports, taxpayer asserts, the filing of these forms cannot extend the
three-year period.  
¶ 15.        
Taxpayer’s focus on the phrase “at the time prescribed for its filing”
ignores the plain import of § 5882(b), which was written to carve out
exceptions to the standard three-year enforcement period established by §
5882(a).  When interpreting a statute, “this Court will not excerpt a phrase and follow what
purports to be its literal reading
without considering the provision as a whole, and proper construction requires
the examination of the whole and every part of the
statute.”  State v. Trucott, 145 Vt. 274, 282, 487 A.2d
149, 154 (1984) (citations omitted).  Reading the whole provision makes
clear that subsection (b)(1) creates an exception for cases where
a taxpayer files a subsequent return that alters his or her tax liability,
ensuring that the three-year enforcement period will run from the date when the
taxpayer files the “proper” documentation, rather than three years from the
original filing date.  
¶ 16.        
By extending the three-year statute of limitations under certain
circumstances, § 5882(b)(1) addresses situations such as the one presented
here, when the Department does not have a full picture of a taxpayer’s
liability until well after that taxpayer’s initial filing.  It would defy
common sense to accept taxpayer’s narrow interpretation of § 5882(b)(1) to
limit the Commissioner’s ability to initiate enforcement actions more than
three years after a taxpayer’s initial filing, regardless of any supplemental
filings for error, updated information, or refund requests.  Such a
reading would encourage taxpayers to file false refund claims on the cusp of
the three-year period following their payments, when it would be too late, as a
practical matter, for the Commissioner to assay their claims for legitimacy.[6]  We decline to adopt such a cramped
interpretation of the statute, and thus affirm the Commissioner’s reading of
§ 5882(b).
¶ 17.        
We agree with the Commissioner and trial court that a “proper” return
was not filed here until taxpayer’s reconciliation reports were completed and
filed in 2002 and 2003.  These reports contain the final calculation of
taxpayers’ federal taxable income, and thus allowed for the correct computation
of taxpayers’ 2000 and 2001 BFT liability.  The Department’s 2004
assessment was therefore timely.
II. 
Economic Substance Doctrine
¶ 18.        
Taxpayer next challenges the Commissioner’s conclusion that the holding
companies lacked sufficient business purpose and independent economic substance
to properly be considered separate taxable entities.  Taxpayer claims that
the transfer of an income-producing asset to a corporation is sufficient to
shift the taxability of the income to that corporation, and that the holding
companies engaged in sufficient business activity to be respected as distinct
taxpayers from their parent banks.  
¶ 19.        
While never yet applied in Vermont,
the economic substance doctrine has a long history in federal caselaw.[7] 
The origin of this doctrine is the United States Supreme Court’s decision in Gregory
v. Helvering, 293 U.S. 465 (1935). The taxpayer
in Gregory desired to sell stock shares held by a subsidiary.  In
order to minimize the taxes owed, the taxpayer had the stock that was to be
sold transferred to her through a tax-free reorganization using a newly created
separate corporate entity.  After using the separate corporate entity in
this manner, the taxpayer quickly dissolved it.  Once the taxpayer owned
the stock directly, she sold the shares, resulting in a far lower income tax
assessment than if the original company had sold the shares.  The Court
dismissed the transaction as “an elaborate and devious form of conveyance
masquerading as a corporate reorganization, and nothing else,” noting that the
entity was put to death immediately following the sale of the stock.  Id. at 470. 
Although the use of the new entity followed the strictures of the federal
statute, which allowed for tax-free corporate reorganizations, the transaction
was rejected as a sham because it had no relationship to legislative
intent.  The federal statute was passed to enable corporations to transfer
assets “in pursuance of a plan of reorganization,” not to facilitate tax
avoidance.  Id.
at 469.  While the Court noted that taxpayers have a legal right to act in
a way that will decrease their tax burden, they may not do so by creating an
entity with no other business or corporate purpose, but whose “sole object and
accomplishment [is] . . . the consummation of a preconceived plan” to avoid
taxation.  Id.  

¶ 20.        
In a subsequent case addressing whether to disregard a corporate entity
for tax purposes, Moline Properties v. Commissioner, 319 U.S. 436
(1943), the Supreme Court focused both on whether the creation of the entity
had a business purpose apart from the avoidance of taxes and whether the
corporation engaged in independent economic activity.  In Moline
Properties, a new entity, Moline, was
created by an owner of real estate, Uly Thompson, to
hold Florida
realty and to act as security for an additional loan that Mr. Thompson was to
use to pay the back taxes owed on the realty.  Moline assumed all outstanding mortgages on
the realty and a voting trustee appointed by Mr. Thompson’s creditor held a
portion of its stock.  When the loan for the back taxes and other
mortgages were paid off in 1933, the stock held by the creditor-appointed
voting trustee reverted to Mr. Thompson.  Moline’s holdings were later sold over the
course of three years and Mr. Thompson reported the gain on the sales on his
individual return, which was contested by the government.  
¶ 21.        
The Court concluded that Moline
would be considered a separate taxable entity if it was created to engage in
business activity or if it in fact engaged in economic activity independent
from its stockholder.  Id.
at 438-39.  Moline engaged in a number of business activities, including
defending itself against condemnation proceedings and instituting suit against
restrictions imposed on its realty by a prior deed, leasing a portion of its
property to a third party, and remortgaging the property after the initial
mortgages were discharged.  The Court concluded that Moline “had a tax
identity distinct from its stockholder,” and income from the sale should be
reported by Moline, not its stockholder, because (1) Mr. Thompson had
negligible control over Moline when it was first created; (2) no agency
relationship appeared to exist between Mr. Thompson and Moline; and (3) Moline
was not dissolved, but continued to engage in business activities after the
1933 discharge of the loan and mortgages.   Id. at 440.  
¶ 22.        
The most succinct statement of the economic substance doctrine by the
United States Supreme Court occurs in Frank Lyon v. United States, 435
U.S. 561 (1978).  In that case, the taxpayer purchased a building from a
bank, financed mostly by a mortgage, and leased the building back to the bank
for rent equal to the taxpayer’s payments of principal and interest on the
loan.  The Supreme Court upheld the transaction, setting forth the
following standard to determine when a transaction should be respected for tax
purposes:
[W]here . . .
there is a genuine multiple-party transaction with economic substance which is
compelled or encouraged by business or regulatory realities, is imbued with
tax-independent considerations, and is not shaped solely by tax-avoidance
features that have meaningless labels attached, the Government should honor the
allocation of rights and duties effectuated by the parties.
 
Id. at 583-84.  
¶ 23.        
Federal appellate courts differ in their application of the economic
substance doctrine.  One version of the standard requires that for a
transaction to be disregarded for tax purposes, there must be both no business
purpose other than to obtain tax benefits and no economic substance to
the transaction.  See Horn v. Comm’r, 968
F.2d 1229, 1237 (D.C. Cir. 1992); Rice’s Toyota World, Inc. v. Comm’r, 752 F.2d 89, 91 (4th Cir. 1985).  Other
circuits indicate they will disregard a transaction if there is either no
business purpose or no economic substance.  See Coltec
Industries Inc. v. United
  States, 454 F.3d 1340 (Fed. Cir. 2006), cert.
denied, 127 S.Ct. 1261 (2007) (“While the
doctrine may well also apply if the taxpayer's sole subjective motivation is
tax avoidance even if the transaction has economic substance, a lack of
economic substance is sufficient to disqualify the transaction without proof
that the taxpayer's sole motive is tax avoidance”).    Still other
circuits will ignore the taxpayer’s motivation and focus primarily on whether
the “transaction had any practical economic effects other than the creation of
income tax losses.”  Sochin v. Comm’r, 843 F.2d 351, 354 (9th Cir. 1988), abrogation
on other grounds recognized by Keane v. Comm’r,
865 F.2d 1088 (9th Cir. 1989); see also James v. Comm’r,
899 F.2d 905, 908-09 (10th Cir. 1990).  Alternatively, several circuits
have held that both the business purpose and economic substance are related
factors that “inform the analysis of whether the transaction had sufficient
substance, apart from its tax consequences, to be respected for tax
purposes.”  ACM Partnership v. Comm’r,
157 F.3d 564 (3rd Cir. 1998), cert. denied, 526 U.S. 1017 (1999); see
also IES Indus., Inc. v. United States, 253 F.3d 350, 353-54 (8th Cir.
2001) (stating “we do not decide whether the [economic substance doctrine]
requires a two-part analysis because we conclude that the [transaction] here
had both economic substance and business purpose”).
¶ 24.        
This doctrine is also recognized in state tax cases.  See, e.g., Baisch v. Dep’t of Revenue, 850 P.2d 1109,
1113 (Or. 1993).  Two recent Massachusetts
decisions are especially relevant to this case because they applied the economic
substance doctrine to holding companies created in a similar manner to those at
issue here.  In Sherwin-Williams Co. v. Commissioner, 778 N.E.2d
504, 517 (Mass.
2002), the court concluded that two wholly-owned subsidiaries of
Sherwin-Williams were separate entities for tax purposes. 
Sherwin-Williams transferred its trade names, trademarks, and service marks to
the two subsidiaries, which then received royalties in return for leasing most
of the marks back to Sherwin-Williams via nonexclusive contracts.  The
entities also engaged in independent economic activity—including leasing marks
to other companies, investing the earned royalties independent of
Sherwin-Williams, and hiring independent employees—and bore the risk of owning
the marks.  The parent company subsequently took a deduction for the
royalties as business expenses.  The court explained that the economic
substance doctrine “generally works to prevent taxpayers from claiming the tax
benefits of transactions that, although within the language of the tax code,
are not the type of transactions the law intended to favor with the
benefit.”  Id.
at 512 (quotation omitted, emphasis added).  The court noted, however,
that because “the subsidiaries became viable, ongoing business enterprises
within the family of Sherwin-Williams companies, and not businesses in form
only, to be ‘put to death’ after exercising the limited function of creating a
tax benefit,” the subsidiaries were properly considered separate for tax
purposes.  Id.
at 517.  
¶ 25.        
The same court reached a different conclusion in Syms
Corp. v. Commissioner, 765 N.E.2d 758 (Mass. 2002).  In Syms,
the taxpayer similarly transferred its trademarks to a subsidiary, SYL. 
It then leased the marks back and paid royalties to the subsidiary, deducting
the cost as a business expense.  In Sherwin-Williams, the court
recounted it had found that the Syms
transaction was “specifically designed as a tax avoidance scheme; royalties
were paid to the subsidiary once a year and quickly returned to the parent
company as dividends; [SYL] did not do business other than to act as a conduit
for the circular flow of royalty money; and the parent continued to pay all of
the expenses of maintaining and defending the trademarks it had
transferred.”  Sherwin-Williams, 778 N.E.2d at 513.  Because
the transfer and license back transaction had no practical economic effect on Syms other than the creation of tax benefits, and because
tax avoidance was the clear motivating factor for creation of the subsidiary,
the deductions for royalty payments were disallowed.  Syms,
765 N.E.2d at 764.
¶ 26.        
We here adopt the economic substance doctrine in Vermont.  Under any formulation of this
doctrine, whether the focus is on the taxpayer’s motivation in creating the
holding companies, the objective economic activity of the holding companies, or
both, we affirm the Commissioner’s determination that the holding companies had
no non-tax business purpose and lacked economic substance, and that the holding
companies therefore do not qualify as independent entities for tax
purposes.  Whether a particular transaction has economic substance and
business purpose other than the avoidance of taxes is primarily an issue of
fact.  See Rice’s Toyota World, Inc., 752 F.2d at 92; Syms Corp. v. Comm’r,
765 N.E.2d at 763.  “[J]udicial review of agency
findings is ordinarily limited to whether, on the record developed before the
agency, there is any reasonable basis for the finding.”  State Dep’t of
Taxes v. Tri-State Indus. Laundries, Inc., 138 Vt. 292, 294, 415 A.2d 216, 218
(1980).  The Commissioner’s determination is presumed “correct, valid and
reasonable, absent a clear and convincing showing to the contrary.”  Id.;
see also Town of Killington v. Dep’t of Taxes, 2003 VT 88, ¶ 5-6, 176
Vt. 70, 838 A.2d 91.
¶ 27.        
As for taxpayer’s motivation to create the holding companies, the
Commissioner concluded that the plan originated exclusively as a vehicle to
reduce taxes.  The genesis of the idea was a suggestion by taxpayer’s
accountant that establishing the holding companies would be a “slam dunk
strategy” for achieving substantial bank franchise tax savings.  Taxpayer
acknowledged the same at oral argument.  
¶ 28.        
Even if we disregard taxpayer’s intent and focus solely on the economic
activity of the holding companies, it is clear that the entities conducted
insufficient independent business to qualify as taxable entities separate from
taxpayer under this doctrine.  While we recognize that an entity’s
business activity level may be “minimal,” Northern
 Indiana Pub. Serv. Co. v. Commissioner, 115 F.3d 506,
513 (7th Cir. 1997), the holding companies must engage in some noticeable
independent business activity to be viable for tax purposes.  The hearing
officer did not err in concluding that the holding companies did not do so
here.  Taxpayer operated the entities out of its back office, without any
independent property, tangible assets, or staff.  Unlike the transaction
in Moline Properties, taxpayer did not directly transfer all of its securities
to the holding companies, but rather conveyed the significant loan assets to
the holding companies, tax-free, through loan participation agreements. 
This mechanism allowed the holding companies to receive a 100% undivided
interest in the loans while the banks continued to manage and administer the
loans with borrowers exactly as before.[8]  

¶ 29.        
Additionally, the holding companies carried no economic risk. 
Indeed, taxpayer took steps to eliminate economic risk to the holding
companies, booking the losses related to uncollectable loans held by the
holding companies to the banks, rather than to the holding companies
themselves, and maintaining a right to repurchase any of the loans in case of
default.  Cf. Frank Lyon, 435 U.S. at 576-77 (finding economic
substance in a transaction where taxpayer bore risk of unpaid mortgage and
construction loans).  As correctly observed by the trial court, “[w]hatever exposure to risk that the [holding companies]
technically experienced, the facts do not demonstrate that [they] acted as
though they had any independent stake in the risks and opportunities associated
with the business they were ostensibly conducting.”  
¶ 30.        
The holding companies also did not engage in any meaningful business
with third parties.  While they did enter into suretyship
and asset pledge agreements with the Federal Home Loan Bank of Boston, these agreements were specifically
authorized and controlled by the banks for the banks’ own benefit.  Cf. Moline
Properties, 319 U.S. at 440 (holding that separate tax identity existed
where entity engaged in its own business ventures separate from its stockholder
and in independent legal actions against third parties); Sherwin-Williams,
778 N.E.2d at 517 (finding “substantive business activity” existed in
subsidiaries where subsidiaries leased trademarks to third parties).  We
thus reject taxpayer’s argument that the holding companies engaged in
sufficient independent business activity to be respected as a separate entity
from taxpayer.  
¶ 31.        
Although the holding companies met the literal requirements of
§ 5837, they will be disregarded under the economic substance doctrine if
they are nothing other than a vehicle for tax avoidance, with no independent
economic substance.  The Eleventh Circuit addressed a similar scenario in Winn-Dixie
Stores, Inc. v. Commissioner, 254 F.3d 1313 (11th Cir. 2001).  There
the court concluded that a taxpayer’s scheme to purchase company-owned life
insurance policies on all its employees for the purpose of deducting the
interest paid on the policies—while borrowing against the value of these
policies—was a sham.  Id.
at 1316-17.  The court reached this conclusion even though the Internal
Revenue Code appeared to authorize such a transaction by providing a specific
exception to the general prohibition on deducting interest on policy loans to
allow this kind of interest deduction.  It was not disputed that
Winn-Dixie’s policies fell within the code’s exception.  Despite
compliance with the letter of the law, however, the court rejected the
transaction because it lacked “economic effects or substance other than the
generation of tax benefits.”  Id.
at 1316.  The court concluded that the economic substance doctrine does
not respect such a transaction for tax purposes, even if the specific terms of
the statute appear to allow for the transaction.  Congress could not have
intended such a result, again, “because that would ‘exalt artifice above
reality.’ “  Id.
(quotation omitted).  
¶ 32.        
Similarly, here, it is absurd to conclude that the Legislature intended
§ 5837 as a means through which taxpayers could almost completely avoid
payment of the bank franchise tax by the creation of shell corporations that
have no economic substance and whose sole purpose is to minimize taxes.  A
“presumption obtains against a [statutory] construction that would lead to
[such] absurd results.”  State v. Longley, 2007 VT 101, ¶ 10, __ Vt. __, 939 A.2d 1028
(quotation omitted).  Regardless of whether the creation of the holding
companies appeared to follow the literal requirements of § 5837, the
entities must still engage in independent economic activities to be considered
legitimate for tax purposes.  See, e.g., Frank Lyon, 435 U.S. at 583-84; Moline Properties, 319 U.S. at 438-39;
Winn-Dixie, 254 F.3d at 1316.  Because the holding companies
conducted virtually no independent activities, bore little or no economic risk,
and never engaged in any meaningful business with third parties, they fail to
qualify as independent taxable entities under the business purpose
doctrine.  
¶ 33.        
Taxpayer added a claim at oral argument that § 5837 specifically
authorizes and, in fact, encourages the creation of such empty-shell holding
companies.  This argument is inconsistent with taxpayer’s brief, where it
contended that the “Holding Companies’ qualification under the [statute is]
beside the point,” and taxpayer’s argument to the trial court that it was
irrelevant whether the holding companies fit within the meaning of the
statute.  We will not address arguments raised for the first time at oral
argument, and so decline to consider this claim.  Guiel
v. Guiel, 165 Vt. 584, 585 n.2, 682 A.2d 957, 959 n.2
(1996) (mem.). 
IV. 
Penalties
¶ 34.        
Taxpayer’s last arguments address the 25% penalty imposed by the
Commissioner.  In challenging this penalty, taxpayer argues that the
Commissioner (1) cannot impose a penalty that is not included in the
Department’s assessment, (2) violated its due process rights by imposing the
25% penalty, and (3) may assess a penalty only for a failure to pay a tax, not
for an erroneous tax refund. 
¶ 35.        
We reject taxpayer’s claim that the Commissioner lacks the discretion to
impose a penalty different from that assessed by the Department.  Pursuant
to 32 V.S.A. § 3201(a)(5), the Commissioner has broad statutory authority to
“waive, reduce or compromise any of the taxes, penalties, interest or other
charges or fees within his or her jurisdiction.”  The plain meaning of
this provision grants the Commissioner discretion to amend or impose a
penalty.  See In re South Burlington-Shelburne Highway Project, 174 Vt.
604, 605, 817 A.2d 49, 51 (2002) (“The Legislature is presumed to have intended the plain, ordinary meaning of the adopted
statutory language.”).  Nor does § 5883, the provision
governing taxpayers’ right to a hearing after receipt of a notice of deficiency
or of an assessment of penalty or interest, so restrict the Commissioner from
altering a penalty assessed by the Department during an appeal hearing. 
As such, we reject taxpayer’s argument that the imposition of the 25% penalty
exceeded the Commissioner’s authority.    
¶ 36.        
Taxpayer’s contention that its due process rights were violated due to
the differential between the penalty requested by the Department and the
penalty imposed by the Commissioner is similarly unpersuasive.  Taxpayer
had full notice that the Department intended to argue for the imposition of a
penalty at the hearing, and that the Commissioner had the authority to “waive,
reduce or compromise any . . . penalties” imposed by the Department.  32
V.S.A. § 3201(a)(5).  As such, we reject the argument that taxpayer
was deprived of an opportunity “to respond and present evidence and argument on
all issues involved” in the appeal hearing.  
¶ 37.        
We also reject the argument that the Commissioner may not assess a
penalty on taxpayer because its underpayment resulted from an erroneous
refund.  Section 3202(b)(4) and (5)—the tax penalty provisions at issue
here—state that a penalty may be imposed when a taxpayer “fails to pay a tax
liability.”  Taxpayer would have us read § 3202 to bar the assessment
of a penalty when the underpayment of taxes is due to an erroneous refund sought
by a taxpayer, rather than because of an initial failure to pay.  This
narrow reading of § 3202 is defeated by both the language and purpose of
the provision.  The plain meaning of this provision authorizes the
imposition of a penalty on a taxpayer who has not paid his or her “tax
liability” in full, imposing no restrictions on the application of the penalty
for particular types of tax avoidance or underpayment.  See South Burlington-Shelburne Highway Project, 174 Vt.
at 605, 817 A.2d at 51 (we read statutes to give
effect to their plain meaning).  Taxpayer’s interpretation
would restrict the Department from assessing penalties in cases where
complications—such as erroneous tax refunds, or the filing of multiple returns,
as here—result in an underpayment.  This crabbed reading would defeat the
purpose of the provision, which is to enable the Commissioner to penalize
taxpayers when they have not properly discharged their tax burden.  We
decline to adopt such a view of the statute, and thus reject taxpayer’s argument.

Affirmed.
  

 


 


FOR THE COURT:


 


 


 


 


 


 


 


 


 


 


 


Associate
  Justice

 





[1] 
Chief Justice Reiber sat for oral argument, but did
not participate in this decision.


[2] 
The parties stipulated that the facts relating to each bank are the same for
purposes of this case, so we refer to the three entities collectively.  


[3] 
Northgroup (HB), Northgroup
(FL), and Northgroup (FV) Investment Companies were
established as wholly-owned subsidiaries of Howard Bank, Franklin Lamoille
Bank, and First Vermont Bank, respectively.  


[4] 
The Legislature adopted 32 V.S.A. § 5837 in 1989 to expand the financial
management industry in Vermont,
anticipating that the provision would attract additional business investments,
employment, and revenues into the state.  See Hearing on H.345 before
Senate Finance Comm., 1989-1990 Bien. Sess. (Vt. Mar. 24, 1989) (Statement of
Sen. Wick).  The provision was repealed in 2004.  32 V.S.A. § 5837, repealed
by 2003, No. 152 (Adj. Sess.), § 8.  


[5] 
Although an appeal from Superior Court, this Court reviews the Commissioner’s
determination with deference, presuming it “correct, valid and reasonable,
absent a clear and convincing showing to the contrary.”  State Dep’t of
Taxes v. Tri-State Indus. Laundries, 138 Vt. 292, 294, 415 A.2d 216, 218
(1980).  


[6] 
Further, as pointed out by the Commissioner, the Department has a “legitimate
interest in administrative efficiency and the fluid processing of tax
returns.”  Under taxpayer’s construction of the statute, the Department would
have to sit on even small refund requests until it had a chance to fully
scrutinize the requests prior to the release of funds, rather than processing
these claims promptly.  


[7] 
Courts have developed a number of closely related and sometimes overlapping
doctrines that can be applied to negate claimed tax benefits in tax
cases.  These doctrines are often labeled differently by different
courts.  We label the doctrine discussed herein as the “economic substance”
doctrine, acknowledging that the authority cited does not consistently use this
title. 


[8] 
The holding companies’ lack of economic independence was further reflected by
an accounting error in 2001: after incorrectly booking significant income to
the Howard Bank rather than to its holding company, Howard Bank and its holding
company did not even notice the error until informed by the Department.  



