• Oregon Tax Court Grants Taxpayer More Relief Than Requested -- Caveat Tax Litigant!!!
  • May 5, 2006
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • In Stonebridge Life Insurance Company v. Department, TC 4705, Oregon Tax Court (February 22, 2006) the Oregon Tax Court found that Oregon's three factor apportionment formula, as applied to Stonebridge, violated the constitutional external consistency test. To prevail on this argument, a taxpayer must accomplish the "daunting" task of proving by "clear and cogent evidence" that the income attributed to the taxing state is "out of all appropriate proportion" to the taxpayer's business activities in the state.

    For this reason, it is not surprising that the Supreme Court of the United States has struck down a state's apportionment formula as unfair only twice in the last seventy five years. For the same reason, it is somewhat surprising that Stonebridge prevailed in this case. What is more surprising, however -- and what should cause litigants on both sides of the tax bar some trepidation - is that the Oregon Tax Court granted Stonebridge a refund greater than it had requested.

    Stonebridge's Business

    During the year at issue (2003), Stonebridge was licensed to and provided life, accident, and health insurance coverage to customers in all fifty states and the District of Columbia. Stonebridge's primary business locations were in Pennsylvania, Maryland, and Texas and it had no physical operations or employees in Oregon.

    Stonebridge's Oregon Apportionment -- Three Factor Fraction

    All of Stonebridge's Oregon insurance policies during 2003 originated through marketing by direct mail or telephone solicitation, and all business related to them occurred at one of Stonebridge's primary business locations outside of Oregon. In 2003, Stonebridge received approximately 1% of its total premiums from Oregon policies. That same year, Stonebridge had no Oregon payroll but had a total payroll of approximately $40 million. Stonebridge received approximately 16% of its 2003 gross income from Oregon real and tangible property.

    Oregon's gross income factor -- by far the largest of Stonebridge's factors -- does not include income from Stonebridge's insurance business. Stonebridge's gross income from real and tangible property was generated from the interest it received on two loans secured by Oregon property. Neither that income nor the loans were integral or necessary to Stonebridge's insurance business in Oregon or elsewhere. As a result, Oregon's three factor formula yielded an apportionment fraction of 5.67% for Stonebridge (the average of 16% + 1% and 0%).

    The Department of Revenue applied Stonebridge's Oregon apportionment fraction to its total net income ($225 million) to determine that Stonebridge's 2003 Oregon taxable income was approximately $12.8 million and, accordingly, asserted Stonebridge's net insurance excise tax liability to be $767,008.

    Stonebridge's Arguments

    Stonebridge's gross income from all real and tangible property ($1,565,829), including its income from Oregon property, comprised less than 0.3% of its combined gross income from all real and tangible property and all insurance sales ($663,009,546). Stonebridge argued that the Oregon three factor formula distorted its income attributable to Oregon because the formula attributed one-third of its weight to Stonebridge's revenue generation to real and tangible property when that property accounts for less than 0.3% of its overall income from insurance sales and real and tangible property combined. Stonebridge also noted that the Department stipulated that Stonebridge's income from Oregon real and tangible property "was neither integral nor necessary to the insurance business carried on by Plaintiff within or without the State of Oregon." Stonebridge further contended that this unfairness was compounded by the fact that collecting $252,379 in gross income from two loans secured by Oregon real and tangible property increased its Oregon taxable income by $12,108,427 -- a difference of 1,883%! -- a level of distortion far greater than those the Supreme Court has found unconstitutional. See Hans Rees' Sons, 283 US at 134 (between 368% and 470%); Norfolk & Western, 390 US at 321-22, 326-27 (263%).

    The Department's Argument

    The Department argued that Stonebridge's 0% payroll factor neutralized any claimed distortion. The Department also claimed that factors unique to the insurance industry, such as minimum capital requirements and the benefits derived from generating revenue from sources other than premiums, offset any alleged distortion.

    The Decision

    Judge Henry C. Breithaupt provides a thoughtful summary of the Supreme Court's external consistency test. The Judge also contrasted the case before him with two recent state court decisions (Unisys Corp. v. Commonwealth, 571 Pa 139 , 812 A2d 448 (2002) and CSX Transp., Inc. v. Director, 2005 WL 1531329 (NJ Tax)) denying external consistency claims for failure to provide an alternative formula or sufficient evidence.

    After a careful analysis of the facts before him, Judge Breithaupt ultimately found "the Department's contentions unconvincing." The Court concluded that Stonebridge's "argument can be reduced to the claim that the sheer accident that 16% of its minuscule gross income from real and tangible property came from Oregon cannot justify Oregon's claim to almost 6% of taxpayer's total income, given that taxpayer had no Oregon wages or commissions and that less than 1% of taxpayer's insurance sales came from Oregon."

    The court concluded that application of Oregon's three factor formula to Stonebridge in 2003 yielded a result that was "out of all appropriate proportion to the business transacted" by Stonebridge in Oregon. The formula was distortive and, therefore, constitutionally infirm.


    Having concluded that the three factor formula did not pass constitutional muster, the question of remedy needed to be addressed. Stonebridge proposed an alternative formula that would yield a liability of $83,373 -- as opposed to the $767,008 that resulted from the application of the three factor fraction. The Court found that it did not have the authority to reapportion Stonebridge's income. Because the three factor fraction as applied to Stonebridge was unconstitutional and the Court did not have authority to impose an alternative formula, the Court awarded Stonebridge a refund of the entire $767,008.

    Blank Rome Observes:

    • This case crisply illustrates the hazards of litigation because the Court's ultimate conclusion rests outside the bounds of both parties' expectations.
    • The Court was compelled, at least in part, to reach its conclusion because the parties' stipulated record did "not lend itself well to a reopening of the record for additional evidence to support the department's assessment." Because many state tax cases are decided on a stipulated record, the Court's conclusion is a reminder of the care that must be taken in crafting a stipulated record.
    • The Court's decision granted Stonebridge a greater benefit than it would have achieved through a negotiated settlement. Nonetheless, the Court's decision is a striking reminder -- for practitioners on both sides of the state tax bar -- of the hazards of litigation.