SJC Weighs Capital Gains Tax Application Case

JAN. 5, 2022…Any Massachusetts resident who owns stock in a company based elsewhere, like Michigan-based Ford Motor Company, could get a tax bill from every state in which Ford does business if the Supreme Judicial Court upholds the commissioner of revenue’s decision, an attorney warned the justices Wednesday as they wrestled with a complicated and closely-watched case.

The seven justices of the Supreme Judicial Court sat remotely Wednesday morning to hear arguments in a case that revolves around the state’s authority to tax the capital gain realized when an out-of-state company sold its interest in a Bay State LLC. [Screenshot]

At the crux of VAS Holdings & Investments (VASHI) LLC v. Commissioner of Revenue is whether Massachusetts was right to tax VASHI on the roughly $37 million capital gain realized when it, an Illinois- then Florida-based S corporation, sold its interest in Massachusetts-based Cloud5 LLC. As commissioner of the Department of Revenue in 2016, current Baker administration budget chief Michael Heffernan determined that 100 percent of the capital gain earned by VASHI was taxable by Massachusetts and in 2017 rejected the company’s appeals for an abatement, the company said. In 2019, the Appellate Tax Board upheld the assessment on VASHI and the company subsequently requested and was granted direct appellate review by the SJC.

An operator of Canadian call centers for the hospitality industry, VASHI merged in 2011 with Massachusetts-based Thing5 into a combined company called Cloud5 valued at roughly $35 million. VASHI “had no involvement whatsoever in the business operations of Cloud5 after the merger,” an attorney wrote in a court filing, and Thing5 employees in Massachusetts took over the functions of VASHI’s Illinois offices, which closed.

The Massachusetts resident who owned Thing5 assumed management of the combined Cloud5 company, and its employees grew from 40 to 70 after the merger, with fewer than five working outside Massachusetts. Thing5 opened a new call center in Springfield with as many as 300 employees and staffing at the former VASHI call centers in Canada was reduced by 43 percent, the Department of Revenue said.

Cloud5 was sold to an independent third party for $85 million in 2013 and VASHI realized a capital gain of $37.28 million on the sale of its 50 percent stake. The state’s argument, as articulated by the Appellate Tax Board, is that the increase in Cloud5’s value and the gain realized from its sale “were inextricably connected to and in large measure derived from property and business activities in Massachusetts” and therefore are subject to the state’s capital gains tax.

But Michael Bowen, an attorney representing VASHI, told the SJC on Wednesday morning that a ruling upholding that argument could lead to chaos, even for small individual investors.

“Under the commissioner’s theory of taxation in this case, you as a Massachusetts resident, on the sale of your stock in Ford Motor Company, theoretically would owe tax in every jurisdiction in which Ford Motor Company does business because every jurisdiction in which Ford Motor Company does business would argue that they’ve somehow contributed to the appreciation of the stock that you just sold,” Bowen said.

Bowen and VASHI argue that the sale of VASHI’s interest in Cloud5 did not involve the required “minimum connection” to Massachusetts or the use of the “protections and benefits” of Massachusetts law as spelled out in the due process and commerce clauses of the U.S. Constitution.

Justice Scott Kafker said the hypothetical presented by Bowen was “frightening” and pressed Brett Goldberg, tax counsel to the Department of Revenue, to explain why Bowen’s interpretation was wrong.

“That’s wrong because a small stockholder in a publicly traded corporation would not, under the due process clause, be subject to tax in all those states because it wouldn’t have a sufficient connection with those states and wouldn’t be on notice that it would be subject to tax in those states,” Goldberg said. He added, “The small shareholder could not be subject to tax under due process because it wouldn’t have the minimum connections with a state simply because the corporation was doing business there.”

The Multistate Tax Commission, an intergovernmental state tax agency that counts 49 of the 50 states as members, has been keeping an eye on the situation and filed an amicus brief with the SJC supporting the position of the revenue commissioner and Appellate Tax Board.

“The constitutional principles that support taxing VASHI on pass-through earnings derived from Cloud5’s operations in Massachusetts apply equally to the taxation of capital gains arising from the sale of VASHI’s interest in Cloud5,” the organization’s senior counsel Bruce Fort wrote. “In both instances, Massachusetts provided benefits and protections to VASHI for which it can constitutionally ask for something in return.”

The justices of the SJC did not offer a timeline for their decision in the VASHI case Wednesday. The court says that most cases are generally decided within 130 days of oral arguments, which would mean a decision could come by the middle of May.