Something new has been cooking in the Louisiana tax law kitchen!
The Louisiana Supreme Court was recently asked to entertain the separate ideas of fraud and, for the first time, the economic substance doctrine in deciding a tax case in the State. Louisiana is certainly used to heat (as can be seen by its food and weather), but this SALT issue was truly a “hot” one.
On May 7, 2014, the Court issued its much-anticipated ruling in the case of Thomas v. Bridges, a Louisiana sales tax case involving a recreational vehicle (“RV”) purchased in Louisiana by a newly-created Montana LLC owned by a Louisiana resident (Thomas). Montana doesn’t have a sales tax. As a result, a cottage industry has sprouted, whereby “Montana LLCs” are being formed to make purchases of expensive cars, airplanes, etc. in order to avoid paying sales tax to other states.
In the Thomas case, although the RV was purchased in Louisiana, no sales tax was paid by the Montana LLC to Louisiana, because the RV was registered in Montana. Admittedly, however, the Montana LLC was created for the sole purpose of avoiding Louisiana sales tax (the Montana LLC owns no other property and does no other “business,” and Thomas had never actually been to Montana). Thomas, however, asserted that he did not violate any statutory laws in Louisiana or Montana, and thus should not be assessed the tax.
The Louisiana Department of Revenue asked the Court to disregard the Montana LLC and impose a Louisiana sales tax on Thomas as the real “taxpayer” for the RV purchase, arguing that the entire arrangement was an improper attempt to avoid sales tax. The Department, in part, asked the Court to use the economic substance doctrine to achieve this result. The Department also alternatively argued that Thomas had “pierced the veil” of the LLC entity and had committed “fraud” pursuant to the specific Louisiana fraud statute. Interestingly, it was noted by the Department’s counsel at oral argument that this specific “Montana LLC” issue had never before been addressed by any high court in the entire country.
It’s always good to see the Louisiana Supreme Court willing to get involved in tax cases and put a little SALT in the Louisiana legal gumbo.
Under the economic substance doctrine, if a particular transaction meets the stated requirements of a taxing statute but does not seem to have any “economic substance” other than tax avoidance, a court can choose to strike down the transaction and deny the claimed tax benefits. Though long available as an “ingredient” for use by federal courts and some state courts (Massachusetts being an example), this judicial doctrine has never been directly applied by a court in Louisiana (although the similar concept of “substance-over-form” has been used in a few prior cases).
The Court ultimately held in favor of Thomas, finding that the Department made key procedural mistakes in asserting its case. Specifically, the Court found that: (1) the Department assessed tax against the wrong party (Thomas, rather than LLC itself); and (2) the Department improperly looked to Louisiana law rather than Montana law in asserting that Thomas had “pierced the veil” of the Montana LLC.
“Uses of particular business entities to avoid taxes and other liabilities, far from being fraudulent, is a common and legal practice.” – La. Supreme Court
Interestingly, the Court also specifically ruled that Thomas did not commit statutory “fraud” by using a Montana LLC to avoid the payment of Louisiana taxes. The Court explained that “[t]aking actions to avoid sales tax does not constitute fraud,” and “[a]lthough tax evasion is illegal, tax avoidance is not.” The court further reasoned that “[u]ses of particular business entities to avoid taxes and other liabilities, far from being fraudulent, is a common and legal practice,” and that there would be “destabilizing implications for Louisiana law” if it found that formation of an LLC solely for tax avoidance constitutes fraud. The Court sympathized with the Department but concluded that the appropriate approach would be for the Department to pursue legislation rather than alleging fraud in court.
Unfortunately, the Court punted on the separate and even more interesting issue of the economic substance doctrine, saving its analysis of that doctrine for another day. Specifically, the Court explained that, procedurally, it could not address the “economic substance” issue in the Thomas case because such an argument was not raised by the Department at the lower court level. Thus, the question of the Court’s ultimate position on the economic substance doctrine in Louisiana is still somewhat of a mystery.
Although the economic substance doctrine was not invoked in the Thomas case, the door seems to have been left somewhat open for the Court to address the issue again in a future case, where the doctrine is properly presented and argued at the lower court. It is possible, therefore, that the Department may try to find another “Montana LLC” taxpayer and request the courts to invoke the doctrine. It is also possible the Department may try to introduce legislation on the “Montana LLC” issue at some point in the future.
Jones Walker Commentary:
This SALT lawyer personally believes any decision on the general taxability of a “Montana LLC” transaction should be left to the legislature in a state like Louisiana, which is steeped in its rich “civilian” tradition of codal law (especially in the context of a sales tax). Further, the introduction of the economic substance doctrine into Louisiana law by a court in such a case could provide the Department with an opportunity and incentive to attempt to invalidate other historically legitimate business transactions in an effort to expand the Louisiana tax base – and raise revenues – without actually “raising taxes.”
Regardless, however, it is always good to see the Louisiana Supreme Court willing to get involved in tax cases and “put a little SALT in the Louisiana legal gumbo.” If nothing else, such involvement by the Court generally tends to provide clarity and certainty for taxpayers on these types of state and local tax issues. Although… if such a fluid judicial doctrine is ultimately introduced at some point by the Court, would clarity and certainty really be achieved?