Comptroller of the Treasury v. Jason Pharm., Inc.

Zarnoch, J. ^{199 709} This appeal arises from a decision of the Tax Court requiring the Comptroller to pay interest on two refunds of sales taxes for which the taxpayer was exempt under Maryland law. The Comptroller petitioned the Circuit Court for Anne Arundel County for review of the Tax Court's decision, and the circuit court upheld the Tax Court. The issue before us is whether there was substantial evidence in the record before the tax court to support its conclusion that the taxpayer's error in paying the tax was "attributable to the State," and therefore, that the Comptroller was required to pay interest on the refund claim. BACKGROUND AND PROCEDURAL HISTORY Jason Pharmaceuticals, Inc. ("JPI") is a Maryland corporation, with its headquarters in Owings Mills, in Baltimore County.

It is a subsidiary of Medifast, which is a weight-loss and weight-management program. JPI sells and distributes weight-management and other health-related products, and it prints paper materials and sells them to customers at Medifast's weight-loss centers. JPI operates a printing shop on Maryland's Eastern Shore, where it leases four large printing machines from Xerox Corporation ("Xerox"). JPI paid sales ⁷¹⁰ tax with each lease payment to Xerox from November 2007 through January 2013.

In August 2011, JPI and Medifast hired Gabriel Massuda ("Massuda") as its Tax Director. Massuda observed the printers at the Eastern Shore printing facility soon after, and he began looking into whether the printers could meet the criteria for a sales tax exemption on personal property used in manufacturing. On May 10, 2012, after Massuda determined that JPI's printing activities might meet the exemption, he filed a refund claim with the Comptroller's Office, seeking a refund of $332,365 in sales tax overpayments for the preceding four years-from 2008 to April 10, 2012. Even after JPI filed its first refund claim, however, it continued to pay sales tax to Xerox, because Massuda had not been able to confirm whether JPI's production activities met the threshold set by the statute to qualify for an exemption.

Thereafter, on September 4, 2012, JPI filed another refund claim seeking $22,863 for the period of March 10, 2012 through August 1, 2012. Again, JPI continued paying sales tax to Xerox after filing its claim while Massuda continued to evaluate JPI's records. An auditor in the Comptroller's Business Tax Audits Section was assigned both refund claims. Between July 2012 and May 2013, the auditor reviewed JPI's tax returns, general ledger, invoices, and samples of materials printed on the printers, and visited the Eastern Shore printing facility.

In January 2013, after Massuda became confident that JPI had the records to back up its claim that the printing machines met the criteria for the exemption, but prior to the auditor concluding his field audit, JPI finally stopped paying sales tax to Xerox on the printers. The auditor concluded his audit and the Refund Supervisor at the Comptroller's Office issued a denial letter for both refund claims on May 15, 2013. The letter stated the following: The ... application for a refund of sales and use tax has been denied due to the fact that the use of the ... equipment ²⁰⁰ and materials does not satisfy the State's determination ⁷¹¹ of "used directly and predominantly in a production activity" because most of the materials being produced are not for resale. The letter further informed JPI of its right to request an informal hearing with the Comptroller.

On May 23, 2013, JPI requested an informal hearing with the Comptroller, which was held before a hearing officer. The hearing officer reversed the auditor's decision on both refund claims, finding that JPI's use of the printers met the criteria for the exemption and that JPI was entitled to a refund of the sales tax. On September 17, 2013 JPI received a check for the first refund claim in the amount of $314,655.83 for the first four years of sales tax, and on October 11, 2013, a check for the second claim in the amount of $22,863 for the period of March 2012 to August 2012. No interest was paid on the sales tax refunds.

Later, the hearing officer issued two Notices of Final Determination which concluded that, although the Comptroller had approved the refund claims, JPI was not entitled to recover interest from the State. Soon after, JPI appealed the Comptroller's final determination on the issue of interest to the Maryland Tax Court ("Tax Court"), and on August 19, 2015 the court held a hearing. The Tax Court issued its final determination and memorandum opinion on February 18, 2016, requiring the Comptroller to pay interest on the refunds, which we review in detail below. The Comptroller filed a petition for judicial review with the Circuit Court for Anne Arundel County.

Following arguments from both parties on November 14, 2016, the circuit court affirmed the Tax Court's decision. The Comptroller appealed to this Court. DISCUSSION The issue before us on appeal is whether there was substantial evidence in the record before the Tax Court to support its conclusion that JPI is entitled to interest on its refund of sales tax. Whether JPI's use of the printers met the criteria for exemption involved measuring what proportion of ⁷¹² its printed materials were for sale or resale 1 based on sample materials and JPI's own records.

There is no dispute that JPI's use of the printers met the exemption and that it was entitled to a refund of the sales tax it paid during the relevant time periods. The paramount question at stake is whether JPI's error in paying the tax was "attributable to the State." For the reasons discussed below, we hold that no substantial evidence in the record before the Tax Court supported its conclusion that JPI's error in paying the tax was attributable to the State, and therefore, we reverse. We review decisions of administrative agencies directly, looking "through" the circuit court's decision. Kor-Ko Ltd. v. Md. Dep't of the Env't , 451 Md. 401 , 409, 152 A.3d 841 (2017) (quoting People's Counsel for Baltimore Cnty. v. Surina , 400 Md. 662 , 681, 929 A.2d 899 (2007) ; see also Comptroller of Treasury v. Sci.

Apps. Int'l Corp. , 405 Md. 185 , 192, 950 A.2d 766 (2008) (Citation omitted) [hereinafter SAIC ]. Because the Tax Court is "an adjudicatory administrative agency," "decisions of the Tax Court receive the same judicial review as other administrative agencies. Gore Ent.

Holdings, Inc. v. Comptroller of Treasury , 437 Md. 492 , 503, 87 A.3d 1263 (2014) (citing ²⁰¹ Frey v. Comptroller of Treasury , 422 Md. 111 , 136, 29 A.3d 475 (2011) ) ). "When the Tax Court interprets Maryland tax law, we accord that agency a degree of deference as the agency that administers and interprets those statutes." Comptroller of the Treasury v. Wynne , 431 Md. 147 , 160, 64 A.3d 453 (2013) (citing Comptroller v. Blanton, 390 Md. at 533-35, 890 A.2d 279 (2006) ). The Court of Appeals in Kor-Ko Ltd. provided three areas of inquiry for appellate courts in reviewing administrative agency decisions: (1) whether "the findings of fact made by the agency are supported by substantial evidence in the record made before the agency;" (2) whether the agency "commit[ed] any substantial error of ... substantive law in ⁷¹³ ... formulating its decision;" and (3) whether the agency act[ed] arbitrarily or capriciously in applying the law to the facts." 2 Kor-Ko Ltd. , 451 Md. at 411 -12 , 152 A.3d 841 (quoting Md. Bd. of Pub. Works v. K. Hovnanian's Four Seasons at Kent Island, LLC , 425 Md. 482 , 514 n. 15, 42 A.3d 40 (2012) ).

We treat an administrative agency's decision as " prima facie correct" and "review the evidence in the light most favorable to the agency." SAIC , 405 Md. at 192 -93 , 950 A.2d 766 (Citation omitted). Additionally, the Court in SAIC reiterated the standard that "[w]hen we review an agency decision that is a mixed question of law and fact, we apply 'the substantial evidence test, that is, the same standard of review it would apply to an agency factual finding.' " 405 Md. at 193 , 950 A.2d 766 (quoting Longshore v. State , 399 Md. 486 , 522 n. 8, 924 A.2d 1129 (2007) ) (Internal quotation marks omitted). I. The Sales Tax Exemption and Exception to the Comptroller's Duty to Pay Interest Pursuant to § 11-102(a)(1)-(2) of the Tax-General Article ("TGA"), Md. Code (Repl. Vol. 2016), "[e]xcept as otherwise provided in [Title 11], a tax is imposed on ... a retail sale in the State; and ... a use, in the State, of tangible personal property or a taxable service." One exception to the requirement to pay sales tax is in § 11-210(b): The sales and use tax does not apply to a sale of: (1) tangible personal property used directly and predominantly in a production activity at any stage of operation on the production activity site from the handling of raw material or components to the movement of the finished product, if the ⁷¹⁴ tangible personal property is not installed so that it becomes real property ....

TGA § 11-210(b) (Emphasis added). The Code of Maryland Regulations ("COMAR") defines "production activity" as-"[a]ssembling, manufacturing, processing, or refining tangible personal property for sale or resale." 3 COMAR 03.06.01.32-2(B)(1)(a)(i). Personal property items are "used directly and predominantly in a production activity" if: (a) [the] [u]se of the property is integral and essential to the production activity, occurs where the production activity ²⁰² is carried on, and occurs during the production activity; and (b) [p]roperty used both in production activities and administrative, managerial, sales, or any other operational or nonoperational activities is used more than 50 percent of the time directly in production activities . COMAR 09.06.01.32-2(B)(2) (Emphasis added).

Accordingly, under the circumstances of the present case, JPI could meet the criteria for the exemption if JPI used the printers "more than 50 percent of the time" to manufacture printed materials that were "for sale or resale." See TGA § 11-210(b); COMAR 03.06.01.32-2(B)(1)(a)(i) and (2). When a taxpayer "erroneously pays to the State a greater amount of tax, fee, charge, interest, or penalty than is properly and legally payable," the taxpayer may file a claim for refund "with the tax collector who collects the tax." TGA § 13-901(a)(1). Further, the taxpayer may be entitled to interest on the amount of the refund under certain circumstances, as provided in § 13-603(a): Except as otherwise provided in this section, if a claim for refund under § 13-901(a)(1) or (2) or (d)(1)(i) or (2) of this title is approved, the tax collector shall pay interest on the refund from the 45th day after the claim is filed in the ⁷¹⁵ manner required in Subtitle 9 of this title to the date on which the refund is paid. TGA § 13-603(a).

A significant exception to the State agency's obligation to pay interest is that "[a] tax collector may not pay interest on a refund if the claim for refund is: ... based on ... an error or mistake of the claimant not attributable to the State or a unit of the State government ...." TGA § 13-603(b)(2)(i) (Emphasis added). JPI paid sales tax on the printers when it claimed it was not due, but argued before the Tax Court that it was entitled to interest on the refund because the error was "attributable to the State." II. The Circuit Court Erred in Upholding the Tax Court's Decision to Require the Comptroller to Pay Interest to JPI. The Tax Court provided the following findings of fact: [JPI] was aware of the exception but determined that equipment was not used directly and predominantly in a production activity.

However, [JPI] knew or should have known whether the machines were used directly and predominantly in the manufacturing of the brochures. The [Comptroller] was not in a position to make any determination until after a field audit. [ 4 ] [...] There was no convincing evidence that the various exhibits introduced during the informal hearing were any different than what was provided to [the auditor] during the course of the sales tax audit. Apparently, after reviewing the same documentation and information, the Hearing Officer decided that the printing equipment did qualify as a production activity within the meaning of COMAR 03.06.01-32-2C, and was therefore, not subject to sales tax. ⁷¹⁶ In issuing its final determination, the Tax Court's rationale was as follows: The auditor determined, after numerous material and papers were reviewed, that ²⁰³ the leased equipment was not used directly or indirectly in a production activity. This determination by the field auditor supports [JPI's] position that its error or mistake in paying the tax was reasonable.

Moreover, it is important to note that the Hearing Officer who granted the refund also reviewed the same material considered by the field auditor. The Court agrees with [JPI] that based on its understanding of the law, the Petitioner properly paid the tax in order to avoid penalty and not run afoul of the [State's] regulation. The fact that the field auditor and his supervisor agreed with [JPI], that the tax was due, supports [JPI's] view that the mistake of [JPI] in paying the tax was attributable to the State. [JPI] exercised reasonable judgment and should not be penalized when the auditors of the State wrongly concluded that the tax was due. [...] The Court of Appeals in Comptroller v. SAIC , 405 Md. 185 , 950 A.2d 766 (2008) adopted the Tax Court's standard [articulated in DeBois Textiles Int'l v. Comptroller , Income Tax No. 1630, 1985 WL 6117 (Md. Tax Aug. 23, 1985) ] for determining "what makes an error or mistake 'attributable to the State' " ...: "The Tax Court stated that '[a]n error is attributable to the State when a taxpayer using reasonable judgment under the circumstances is led by the laws, regulations, or policies expressed by the State to the mistaken conclusion that the tax is owed.' " * * * In the present case, the Respondent denied the claims after it had been provided with significant documentation and examples of the products produced at the Petitioner's printing facility. [...] Just as in SAIC case, it is illogical that a taxpayer could be said to have made an error not attributable to the State where the State took the position that the ⁷¹⁷ taxpayer was not entitled to a refund after spending months considering the taxpayer's claim for refund. The Court finds that the Petitioner used reasonable judgment under the circumstances, and was led by the laws, regulations or policies expressed by the State to the mistaken conclusion that the tax was owed.

The Tax Court's decision in this case relied principally on the holding in SAIC in which the Court held that the Comptroller's final determination letter provided substantial evidence that the error was "attributable to the State"-the second prong of the exception to the Comptroller's obligation to pay interest on tax refunds. See TGA § 12-603(b)(2)(i). Based on SAIC and the DeBois standard, the Tax Court reversed the Comptroller's decision to deny interest on the two refund claims and required that interest be paid. A. The DeBois Standard and the Holding of SAIC on Error that is "Attributable to the State" The DeBois standard arose out of a Tax Court decision in which the taxpayer, a domestic international sales corporation (DISC), was entitled to apportion part of its income outside of the State of Maryland, but erroneously paid tax on 100 percent of its income.

See id. At the time DeBois paid the tax, the state of the law in Maryland on whether DISCs were permitted to apportion income outside of the State was uncertain. Once our courts settled the issue, DeBois filed an amended return requesting a refund. After initially denying the request, the Comptroller settled with DeBois, agreeing to pay a partial refund of $44,728.36, but refused to pay interest.

Interpreting the meaning of "attributable to the State" in a predecessor to ²⁰⁴ TGA § 13-603(b)(2), 5 the Tax Court articulated what we refer to as the DeBois standard: "[A]n error is attributable to the State when a taxpayer using reasonable judgment under the circumstances is led by the laws, regulations, or policies expressed by the State to the mistaken ⁷¹⁸ conclusion that tax is owed." SAIC , 405 Md. at 201 , 950 A.2d 766 (quoting DeBois , 1985 WL 6117 , at ¹ ). The Tax Court in DeBois then applied that standard in its decision: In the instant case, Petitioner's error consisted of its belief that DISCs filing Maryland income tax returns must report and pay tax on 100% of their income. This false impression was a reasonable interpretation of the State law and policy because the issue of whether or not DISCs could apportion part of their income outside the State had not been decided by the courts at the time Petitioner filed its returns and paid the tax. During that time the Comptroller insisted that DISCs report 100% of their income on their Maryland returns and any DISC which failed to comply was appropriately assessed.

It was not until 1983 that this Court rendered a decision which held that DISCs are entitled to apportion part of their income outside the State. Thus Petitioner's mistake was attributable to the State and Section 310(c) mandates that interest be paid on the resultant refund. SAIC , 405 Md. at 201 -02 , 950 A.2d 766 (quoting DeBois , 1985 WL 6117 , at ¹ ). Because the Tax Court found that DeBois was "led by the laws, regulations, or policies expressed by the State to the mistaken conclusion that tax was owed," the error in paying the tax on all of its income, and the basis of the refund claim, was "attributable to the State." See id. at 202, 950 A.2d 766 (citing DeBois , 1985 WL 6117 , at ¹ ).

A critical finding in DeBois was that, at the time DeBois paid the tax, the State's policy and its application of the law on the issue was erroneous. Before the new Tax Court ruling that settled the issue, therefore, it was reasonable for DeBois to assume that the State would continue to apply the same erroneous policy to DeBois, despite its own knowledge of its status as a DISC. The Court of Appeals in SAIC reviewed a decision of the Tax Court in which it had applied the DeBois standard. SAIC , 405 Md. at 202 , 950 A.2d 766 .

Similar to DeBois , the Tax Court focused its findings of fact on what prompted SAIC's ⁷¹⁹ erroneous payment of the tax. In 1995, SAIC-a research and engineering firm incorporated in Delaware and headquartered in California-purchased 100 percent of shares of stock in National Solutions, Inc. (NSI). SAIC reincorporated NSI in Delaware and left its principal headquarters in Virginia. NSI provided internet domain registration services worldwide and held valuable rights to act as the exclusive registrar for internet domain names with ".com" and other common endings.

After selling almost a quarter of its NSI shares in 1997, SAIC sold another 9,000,000 of its NSI shares in 1999, which resulted in a $715,850,753 capital gain. In 2000, SAIC reported the capital gain on its Maryland income tax return for the 1999 tax period and paid $4,274,519 in taxes to the State. In 2003, SAIC amended its 1999 return, seeking a total refund of the taxes paid on the capital gain, asserting that the stock "lacked a sufficient nexus to Maryland for the gain to be taxable under the United States Constitution and Maryland law." 6 Id. at 189 , 950 A.2d 766 . ²⁰⁵ The Comptroller denied the claim for refund on December 18, 2003 in a final determination letter stating, in part, "The State of Maryland does not allow a subtraction for the exclusion of capital gain from the sale of NSI shares so we are unable to allow the requested adjustment." The Court of Appeals in Hercules provided that "Maryland may not tax income earned outside its borders, even on a proportional basis, unless there is a 'rational relationship between the income attributed to the State and the intrastate values of the enterprise.' " Hercules , 351 Md. at 112, 716 A.2d 276 (quoting Container Corp. of Am. v. Franchise Tax Bd. , 463 U.S. 159 , 166, 103 S.Ct. 2933 , 77 L.Ed.2d 545 (1983) ). The Court in Hercules provided that the necessary nexus "usually is satisfied by demonstrating the existence of unitary business, part of which is carried on in the taxing state to demonstrate ⁷²⁰ the existence of a unitary business." Hercules , 351 Md. at 109 , 716 A.2d 276 .

The U.S. Supreme Court, in Allied Signal, Inc. v. Dir., Div. of Taxation , held that an investment in a subsidiary does not render it part of a "unitary business" where it served only as an "investment," as opposed to an "operational," function. 504 U.S. 768 , 784, 112 S.Ct. 2251 , 119 L.Ed.2d 533 (1992). In a decision on SAIC's refund claim only, the Tax Court determined, based on the Supreme Court's guidance in Allied-Signal , that "there was no nexus linking the gain realized through the sale of NSI stock to any of [SAIC's] activities in Maryland." SAIC v. Comptroller of the Treasury , No. 04-IN-OO-0632, 2006 WL 2507134 (Md. Tax, May 11, 2006). In the Tax Court's subsequent decision on the issue of whether interest had to be paid on the refund, the court found that at the time of SAIC's erroneous payment of the tax, the Comptroller had maintained a policy that was inconsistent with the law. As evidence that the Comptroller had applied an erroneous policy when SAIC paid the tax, the Tax Court pointed to the Comptroller's final determination letter, in which the reason asserted for the denial was that "[t]he State of Maryland does not allow a subtraction for the exclusion of capital gain." The Court of Appeals affirmed the Tax Court's decision to reverse the Comptroller's denial of interest on SAIC's refund claim.

SAIC , 405 Md. at 206 , 950 A.2d 766 . The Court set out the proper interpretation of the exception in TGA § 13-603(b): For this exception to apply to a refund claim, the claim must satisfy two elements: 1) it must be an error or mistake of the claimant, and 2) it must not be attributable to the State or a unit of the State government. If a claim does not meet one of those two elements, i.e. , it is not an error of the claimant or it is an error attributable to the State, interest on the refund must be paid. Id. at 199 , 950 A.2d 766 .

On appeal, the Comptroller had argued that "an error or mistake cannot be 'attributable' to the State unless it was caused by an assessment or other ⁷²¹ direct action taken by the State during the claimant's original tax filing process." Id. at 203 , 950 A.2d 766 . The Court pointed out, however, that the holdings of Fairchild and Davidson demonstrate that "if the State requires a taxpayer to pay some amount