The Massachusetts Supreme Judicial Court has granted direct appellate review of VAS Holdings & Investments LLC v. Commissioner of Revenue. The appeal involves a constitutional challenge to the Massachusetts Commissioner of Revenue’s imposition of taxes on a capital gain realized by a nonresident S corporation from the sale of an interest in a Massachusetts limited liability company (LLC), Thing5, that for federal and Massachusetts tax purposes was a partnership from its formation through the tax year at issue.
The taxpayer acknowledged it had a taxable nexus with Massachusetts but disagreed with the Commissioner’s application of Massachusetts’ law resulting in a taxation of the capital gain from the sale of a partnership interest. The taxpayer argued that the sale of its interest in the Thing5 did not involve the requisite minimum connection to Massachusetts or availment of the protections and benefits of Massachusetts law. The sale of an LLC interest had only an indirect link to Massachusetts.
The taxpayer tried to distinguish its distributive share income—derived from regular business activities in Massachusetts—from the capital gain income. The taxpayer argued that from a constitutional standpoint, there is a crucial distinction between a Massachusetts tax meaning from its distribution share income from its regular business activities and a tax measured by its sale gain income derived from the sale of the partnership interest.
The Tax Board agreed with the Commissioner and held that the corporate income tax was properly imposed on the gain. The LLC value increases, and eventual sale of the interest was inextricably connected to and derived in a large part from its business activities in Massachusetts. The parties stipulated that this additional value resulted from improved management and staffing of the call center business; expansion of the product offerings of Thing5’s outsourcing and hosting technology business; the integration of the call center business with Thing5’s outsourcing and hosting technology business; and the increase in the number of customers and properties served by Thing5’s outsourcing and hosting technology business. Thus, the increase in value, and likewise the sale gain, was inextricably connected to and in large measure derived from property and business activities in Massachusetts. The business activities that gave rise to the sale gain necessarily involved availment of the protection, opportunities, and benefits given by Massachusetts, which inured to the benefit of the appellant, and which “b[ore] an inherently rational relationship to the manner in which that income was generated.” The taxes imposed were not transaction taxes but capital gains taxes on the increase in value of the appellant’s interest in the LLC, which accrued over time through the business activities of the operating entities.
The Massachusetts Supreme Judicial Court took up the appellant’s appeal and will hear the case. BKD will monitor this case and its effects.
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