Michigan Supreme Court Rules in City of Detroit's Favor In Income Tax Sourcing Matter
On May 18, 2020 the Michigan Supreme Court released its opinion in Honigman Miller Schwartz and Cohn LLP v. City of Detroit, Docket No. 157522. Oral arguments in this case occurred on October 2, 2019 and the court's decision has been anticipated with great interest by taxpayers, tax professionals and municipalities.
The key issue in this case was the proper calculation of the revenue factor for purposes of allocating the petitioner's income to the city of Detroit. Pursuant to the Uniform City Income Tax Ordinance (UCITO), the numerator of the revenue factor must include "services rendered in the city." Petitioner, a law firm, derived a significant amount of income from legal services performed by its attorneys within the city of Detroit but delivered to clients located outside Detroit. Revenue derived from such activity, argued the petitioner, was not generated by services rendered in the city and thus was not includible in the numerator of the revenue factor. The city disagreed and assessed more than $1 million in additional tax based on its position that services rendered in the city refers to the location where the services are performed, not where they are delivered.
The Michigan Tax Tribunal granted summary disposition to the city, finding that the statute was ambiguous but that services rendered in the city required calculating the revenue factor based upon where services were performed, not where they were delivered. The Michigan Court of Appeals reversed and remanded, concluding that the term rendered is different than the term performed, which is used elsewhere in the UCITO statute. The Court of Appeals reasoned that the legislature's use of these two different terms indicated that they had two separate meanings, and that the calculation of the revenue factor should be based upon where the service is delivered to the client, not where it is performed by the petitioner.
Upon review of Michigan's statutory history with respect to sourcing income from the sale of services and an examination of the use of the term render in the context of the UCITO specifically, the Michigan Supreme Court determined that services rendered focuses upon where services are done, not where they are delivered. In its analysis, the court particularly highlighted the contrast between the computation of the payroll factor (based upon total compensation paid to employees for work done or services performed within the city) and the revenue factor (calculated based upon the gross revenue of the taxpayer derived from sales made and services rendered in the city), noting that "render" is used when referring to a taxpayer's revenue derived from doing services for a customer or client, while "perform" is used in the context of an employee's work for his or her employer.
In its conclusion, the court's opinion noted that the Michigan legislature has adopted an origin test for the calculation of the revenue factor with respect to revenue derived from services. This is in contrast to the destination or market-based test that is customarily used to allocate revenue from the sale of goods. Based on this finding, the court reversed the Court of Appeals and remanded the case back to the Michigan Tax Tribunal.