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A POLICY ANALYSIS OF MICHIGAN’S MISLABELED GROSS RECEIPTS TAX Michael J. McIntyre Richard D. Pomp Wayne State University Law School Legal Studies Research Paper Series No. 08-34 Forthcoming, 2008 Papers posted in the The Wayne State University Law School Legal Studies Research Paper Series can be downloaded at the following url: http://www.ssrn.com/link/Wayne-State-U-LEG.html and The Social Science Research Network Electronic Paper Collection: http://ssrn.com/abstract=1270087 Electronic copy available at: http://ssrn.com/abstract=1270087 A Policy Analysis of Michigan’s Mislabeled Gross Receipts Tax Michael J. McIntyre Richard D. Pomp Abstract: On January 1, 2008, the State of Michigan implemented a new tax, labeled a modified gross receipts tax (MGRT). The label is misleading. The tax is not on gross receipts but rather on gross receipts reduced by "purchases from other firms," defined generally to include inventory purchased during the taxable year, capital purchases, and material and supplies. In some respects, the tax resembles a value-added tax (VAT), although it has some important features not found in a traditional VAT or in any known variation of that tax. The purpose of the MGRT, other than to raise revenue, is unclear on its face and is not clarified by the legislative history, which is virtually nonexistent. In this article, we undertake to describe this new tax, classify it as best we can within the tax taxonomy, and speculate about its effects on Michigan taxpayers and on the Michigan economy. Section I, by way of introduction, summarizes the tax reform efforts that led to the adoption of the gross receipts tax. Section II discusses the problems of classifying the tax, comparing it to a traditional gross receipts tax and to a tax on value added. Section III begins with an overview of the salient features of the MGRT and then discusses in greater detail three important features of the tax, namely its nexus rules, its apportionment rules, and its unitary business rules. We speculate about the impact of the tax on Michigan and Michigan taxpayers in the conclusion. Electronic copy available at: http://ssrn.com/abstract=1270087 A POLICY ANALYSIS OF MICHIGAN’S MISLABELED GROSS RECEIPTS TAX MICHAEL J. MCINTYRE † RICHARD D. POMP ‡ Table of Contents I. INTRODUCTION ................................................................................ 1276 II. CLASSIFYING THE MICHIGAN MODIFIED GROSS RECEIPTS TAX ... 1282 A. The Ambiguous Meaning of a Gross Receipts Tax .................. 1283 B. Michigan’s Modified Gross Receipts Tax is Best Described as a VAT .................................................................................. 1285 III. STATUTORY ANALYSIS OF THE MICHIGAN MGRT....................... 1292 A. Overview of the MGRT Statute ................................................ 1292 B. Nexus to Tax............................................................................. 1295 1. Background........................................................................ 1295 2. Substantial Nexus and Michigan’s One-Day Rule............. 1297 3. Nexus from Presence of Employees, Agents, and Independent Contractors ................................................... 1298 4. Establishing and Maintaining a Market ............................ 1300 5. Nexus from Economic Presence......................................... 1303 C. Apportionment of the Tax Base................................................ 1306 1. Constitutional Considerations ........................................... 1306 2. Defining a Michigan Sale .................................................. 1309 a. Locating a Sale of Tangible Personal Property .......... 1310 b. Locating a Sale of Services ......................................... 1312 D. Unitary Business Concept in the Context of an Adjusted Gross Receipts Tax .................................................................. 1314 IV. CONCLUSION ................................................................................. 1317 On January 1, 2008, the State of Michigan implemented a new tax, labeled a modified gross receipts tax (MGRT). 1 The label is misleading. The tax is not on gross receipts but rather on gross receipts reduced by “purchases from other firms,” 2 defined generally to include inventory purchased during the taxable year, capital purchases, and material and † Professor, Wayne State University Law School. A.B., 1964, magna cum laude, Providence College; J.D. 1969, cum laude, Harvard Law School. ‡ Professor, University of Connecticut School of Law. B.S., 1967, summa cum laude, University of Michigan; J.D. 1972, magna cum laude, Harvard Law School. The authors thank Alan Schenk, Richard Bird, Wayne Roberts, Pat Van Tiflin, and James Wetzler for comments on a draft of this article. 1. See MICH. COMP. LAWS ANN. §§ 208.1101-.1609 (West Supp. 2007). 2. See MICH. COMP. LAWS ANN. § 208.1203 (West Supp. 2007). 1275 Electronic copy available at: http://ssrn.com/abstract=1270087 1276 THE WAYNE LAW REVIEW [Vol. 53:4 supplies. 3 In some respects, the tax resembles a value-added tax (VAT), although it has important features not found in a traditional VAT or in any known variation of that tax. The purpose of the MGRT, other than to raise revenue, is unclear on its face and is not clarified by the legislative history, which is virtually nonexistent. In this article, we describe this new tax, classify it as best we can within traditional tax taxonomy, and speculate about its effects on Michigan taxpayers and on the Michigan economy. Section I, by way of introduction, summarizes the tax reform efforts that led to the adoption of the gross receipts tax. Section II discusses the problems of classifying the tax, comparing it to a common gross receipts tax and to a tax on value added. Section III begins with an overview of the salient features of the MGRT and then discusses in greater detail three important features of the tax, namely its nexus rules, its apportionment rules, and its unitary business rules. We speculate about the impact of the tax on Michigan and Michigan taxpayers in the conclusion. I. INTRODUCTION The Michigan Legislature enacted the Michigan Business Tax (MBT) on June 29, 2007. 4 The new tax regime, after amendments adopted on December 1, 2007, 5 became effective on January 1, 2008. 6 The amendments, inter alia, imposed a surcharge of around 22% on the various components of the MBT. 7 That surcharge replaces the revenue that had been expected from a 6% sales/use tax on services, which was repealed at the same time. 8 3. See MICH. COMP. LAWS ANN. § 208.1113(6) (West Supp. 2007). 4. See 2007 Mich. Pub. Acts 36. 5. See 2007 Mich. Pub. Acts 145. 6. See MICH. COMP. LAWS ANN. § 208.1101 (West Supp. 2007). 7. See MICH. COMP. LAWS ANN. § 208.1281 (West Supp. 2007). 8. The services tax was adopted on October 1, 2007 by 2007 Mich. Pub. Acts 93 and repealed, retroactively, on December 10, 2007 by 2007 Mich. Pub. Acts 148, thus suffering the same fate as Florida’s attempt to extend its sales tax to services. See James Francis, The Florida Sales Tax on Services: What Really Went Wrong?, in THE UNFINISHED AGENDA FOR STATE TAX REFORM 129 (Steven D. Gold ed., 1988). Opinion writers treated Michigan’s ill-fated services tax as a joke, due to many odd features of its base. See, e.g., Chris Christoff, Details of Service Tax Raise Questions; Oddities Confuse Public, Lawmakers, DETROIT FREE PRESS, Oct. 5, 2007, at 6. For example, it taxed personal fitness trainer services, MICH. COMP. LAWS ANN. § 205.93d(1)(i)(xxv) (West Supp. 2007), and skiing services, MICH. COMP. LAWS ANN. § 205.93d(1)(l) (West Supp. 2007), but not golf services. Many businesses opposed it because the tax applied to a host of business inputs, which should be excluded from the base of a normative sales tax. See Chris Christoff, Tax Fight Pits Big Business vs. Small: Large Firms Get Large Savings from Change, DETROIT FREE PRESS, Nov. 10, 2007, at 1 (“Some of Michigan’s biggest and most influential companies begged the Legislature this week to raise a new business tax that takes effect Jan. 1. But first, they asked, please kill the 6% tax on services set to begin Dec. 1.”). For a discussion of a normative sales tax, see RICHARD D. POMP & OLIVER OLDMAN, STATE AND LOCAL TAXATION ch. 6 (5th ed. 2005). 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1277 The MBT consists of four separate taxes: 9 (1) Business Income Tax; 10 (2) Modified Gross Receipts Tax (MGRT); 11 (3) Gross Insurance Premiums Tax; 12 and (4) Bank Capital Tax on Financial Institutions. 13 The first two are general provisions; the latter two are specific to insurance and financial institutions. 14 Only the MGRT is addressed in any detail in this Article. The four taxes contained in the MBT replace the revenue previously obtained from the Michigan Single Business Tax (SBT), which was repealed as of December 31, 2007. 15 The SBT was adopted in 1976. 16 It replaced a corporate income tax, 17 a franchise tax, an intangibles tax, a bank excise tax, a personal property tax on inventory, and other less significant taxes. 18 The SBT was amended many times in response to various criticisms and political pressures. By the time of its demise, it had so many ad hoc features that it was not recognizable within the 9. The MBT, with its four taxes, replaces the Single Business Tax, which ironically was enacted to replace the multiple taxes that previously existed. The MBT is quickly becoming known as the “Multiple Business Tax.” Patrick R. Van Tiflin, New, Five-Part Michigan Business Tax Replaces SBT, Leaving Many Questions Unanswered for Certain Taxpayer, 14 TAX MGM’T MULTISTATE TAX REP. 450 (2007) [hereinafter Five-Part Michigan]. 10. The tax is imposed at the basic rate of 4.95% on the business income tax base after allocation or apportionment. MICH. COMP. LAWS ANN. § 208.1201 (West Supp. 2007). The tax so imposed is subject to a 21.99% surcharge. MICH. COMP. LAWS ANN. § 208.1281 (West Supp. 2007). 11. The tax is imposed at a nearly 1% rate. See infra text accompanying notes 109113. 12. The tax is imposed at the greater of 1.25% on gross direct premiums written on property or risk located or residing in Michigan, MICH. COMP. LAWS ANN. § 208.1235(2) (West Supp. 2007), or the tax calculated under section 476a of the insurance code, MICH. COMP. LAWS ANN. § 208.1243(1)(a) (West Supp. 2007). The tax so calculated is subject to an additional surcharge. 13. The tax is imposed at the basic rate of 0.235% on the tax base of a financial institution after allocation or apportionment to Michigan and is subject to a surcharge. MICH. COMP. LAWS ANN. § 208.1263 (West Supp. 2007). The tax base is average net capital. MICH. COMP. LAWS ANN. §§ 208.1263-.1265 (West Supp. 2007). 14. For 2008, 2009, and 2010, the MBT provides that if the revenue collected exceeds certain baseline amounts, 60% of the excess will be refunded to taxpayers making net cash payments and the other 40% will be deposited in the countercyclical budget and economic stabilization fund. MICH. COMP. LAWS ANN. § 208.1601 (West Supp. 2007). 15. 2006 Mich. Pub. Acts 325 or MICH. COMP. LAWS ANN. § 208.151 (West Supp. 2007). 16. See MICH. COMP. LAWS ANN. § 208.1 (West 2003) (repealed for tax years beginning after Dec. 31, 2007). 17. The corporate income tax was adopted in 1967. Previously, Michigan enacted a business activities tax, which was in effect between 1953 and 1967. The business activities tax was a modified gross receipts tax properly classified as a VAT. Patrick R. Van Tiflin, Under Assault Since its Inception, Michigan’s SBT is Sure to be Repealed, But What Will Take its Place?, 13 TAX MGM’T MULTISTATE TAX REP. 310 (2006) [hereinafter Under Assault]. 18. See Jack E. Mitchell, Taxes Repealed and Amended, 22 WAYNE L. REV. 1017 (1976). 1278 THE WAYNE LAW REVIEW [Vol. 53:4 traditional taxonomy of tax regimes. It apparently had lost whatever charm it may initially have possessed. Stripped of its many ornaments, the core of the SBT was intended to be an addition-method value-added tax. 19 Such taxes are not common. The one remaining state example is New Hampshire’s Business Enterprise Tax. 20 Another example is the Hall-Rabushka flat-tax, proposed as a replacement for the Federal corporate and individual income taxes, although for political reasons its supporters often misdescribe it as a type of income tax. 21 In an additive-method VAT, the tax base is computed by adding up all business inputs, including profits, wages paid, rent, and interest paid. 22 An addition-method VAT is typically an origin-based tax. It is imposed on value added within the taxing jurisdiction, without regard for where the goods and services produced are actually consumed. It typically does not apply to value added attributable to imports into the taxing jurisdiction, but it does apply to value added attributable to exports out of the tax jurisdiction. 23 Such a tax could have the effect of making exports more expensive and giving a tax preference to imports— results that few taxing jurisdictions would favor. 24 One major difference, however, between the SBT and a paradigmatic addition-method VAT was that the SBT was apportioned between Michigan and the rest of the world using an apportionment formula. Initially, the apportionment formula was the three-factor formula (property, payroll, and sales) used by the Uniform Division of Income for Tax Purposes Act (UDITPA). 25 The effect of this formula generally was to apportion one third of the tax base to the place of production and two thirds to the place of sale. Consequently, the formula caused a firm importing into Michigan to be taxed significantly less heavily than a firm 19. ALAN SCHENK & OLIVER OLDMAN, VALUE ADDED TAX: A COMPARATIVE APPROACH 43 (Cambridge University Press 2007). 20. Id. at 395. At the national level, the only example cited of an addition-method VAT is the Israeli tax on financial institutions and insurance companies; although that tax is not administered as part of the Israeli VAT system. Id. at 43. 21. Id. at 449. 22. Id. at 42-43. 23. In the context of the discussion in the text, “imports” refers to goods brought into Michigan from other jurisdictions, including other states and foreign countries. “Exports” refers to goods shipped from Michigan to other jurisdictions, including other states and foreign countries. 24. In defending the Hall-Rabuska flat tax against the charge that it improperly burdens exports and favors imports, some commentators have suggested that currency adjustments might offset these otherwise adverse effects. For a more in-depth discussion, see Michael J. McIntyre, International Aspects of Kemp Commission Report, 70 TAX NOTES 607-09 (Jan. 29, 1996). No one suggests that the adverse effects of an origin-based tax imposed by a state would be offset by currency adjustments. 25. See MICH. COMP. LAWS ANN. §§ 208.45-.46, 208.49, 208.51 (West 2003). The SBT, with its three-factor formula, was upheld against constitutional challenge in Trinova Corp. v. Mich. Dep’t of Treasury, 498 U.S. 358 (1991). 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1279 exporting from Michigan, a result that made little sense if the SBT was intended to be passed on to consumers, as generally would be expected with a VAT. 26 Beginning in 1991, the weight of the sales factor was increased substantially. It was scheduled to reach 95% for tax years beginning after December 31, 2007. 27 The result of the shift in weighting was to greatly reduce the tax on firms manufacturing entirely in Michigan for export whereas the tax on firms manufacturing outside the State for sale in Michigan was increased. 28 This change is consistent with the goal of a tax on consumption. One of the goals of the Michigan Legislature in adopting the SBT was to provide a stable source of revenue. 29 The Michigan automobile industry was subject to large swings in profitability. Under a corporate income tax, those swings typically would cause the State to suffer a significant reduction in tax revenues at a time when the demands for government services from unemployed workers were likely to be increasing significantly. In this respect, the SBT was a grand success. Whatever the technical merits of the SBT, it became such a political liability that political leaders in both parties were unwilling to defend it. The SBT was rarely seen as a value-added tax by the businesses collecting it or by the legislators asked to revise it. Instead of being viewed as a tax collected by business and passed on to consumers, it was viewed as a peculiar and unfair tax on business. Although wages are properly included in the base of a VAT, their inclusion in the base of the SBT was widely criticized. Critics claimed that this feature of the tax 26. If a state had a monopoly position with respect to its exports, then it might maximize its own position, at the expense of its sister states, by exporting its tax to consumers in other states or foreign countries. Curiously, the SBT was adopted in 1976, around the time that General Motors was losing its role as price leader in the automobile industry. Whatever the rational for the treatment of exports, we cannot imagine even a selfish reason for exempting imports, which will compete with goods made in Michigan. 27. See MICH. COMP. LAWS ANN. § 208.45a (West Supp. 2007) (repealed for tax years beginning after Dec. 31, 2007). 28. The shift to a formula that heavily weighted sales occurred at a time when some states were moving to a sales-only formula for their corporate income tax. Michael Mazerov, The “Single Sales Factor” Formula for State Corporate Taxes-A Boon to Economic Development or a Costly Giveaway?, CENTER ON BUDGET AND POLICY PRIORITIES (Sept. 1, 2005), available at http://www.cbpp.org/3-27-01sfp.pdf (last visited June 24, 2008). The argument for use of a sales-only formula for corporate income tax purposes has almost nothing to do with the arguments for its use in an addition-method VAT. In the latter case, the argument is that the state, as a normative matter, should not be taxing exports and should be taxing imports. That argument is compelling if the point of the tax is to tax consumption in the state—the usual goal of a VAT. In the former case, the argument is that a state can get some competitive advantage over other states by departing from the UDITPA formula. Whether a competitive advantage is actually obtained is unclear. See Michael J. McIntyre, Thoughts on the Future of the State Corporate Income Tax, 25 STATE TAX NOTES 931-47 (2002); see also Mazerov, supra note 28. 29. James W. Haughey, The Economic Logic of the Single Business Tax, 22 WAYNE L. REV. 1018 (1976). 1280 THE WAYNE LAW REVIEW [Vol. 53:4 discouraged employment. 30 In addition, unlike an income tax, but like a sales tax, the SBT was collected, sometimes in substantial amounts, by businesses operating at a loss. Many businesses felt this result was unfair. Again, a normative VAT ought to be paid whether or not the business collecting the tax is profitable. In the end, business groups, state legislators, and, eventually the voting public, came to view the SBT as “a negative influence on Michigan’s attempt to participate in the good economic times being enjoyed elsewhere in the country.” 31 We are not suggesting that everyone was wrong in his or her criticisms of the SBT. Whether it actually was passed on to consumers through higher prices is a difficult (perhaps unknowable) empirical question, whose answer might vary from firm-to-firm, and from productto-product, and we have made no effort to make such an assessment. Certainly all of the special-interest modifications of the SBT made it less uniform in its application, and a non-uniform VAT is more difficult to pass on than one that applies equally to all goods and services. At a minimum, we would readily concede that the SBT was ripe for a major overhaul. The SBT was repealed without a plan for replacing the lost revenue. Michigan already had made major budgetary cuts in recent years, and it had a significant structural deficit even before repealing the SBT. 32 Consequently, the Governor was unwilling to close the budget gap through additional budget cuts. 33 Legislators apparently concluded that the gap had to be closed through replacement taxes, and that these taxes had to be perceived by the public as taxes on business. The package of tax changes flying under the MBT label included the four taxes mentioned above plus a combination of property tax cuts 34 and tax incentives intended to foster job creation. 35 The property tax cuts and the tax incentives were intended to make Michigan more attractive for 30. The effect of a state’s tax structure on economic development is exceedingly complicated. See Robert G. Lynch, Weaknesses in the Common Arguments for State and Local Tax Cuts and Incentives, 32 STATE TAX NOTES 597 (2004); Robert G. Lynch, The Effects of State and Local Taxes and Public Services on Economic Development, 32 STATE TAX NOTES 767 (2004). 31. Under Assault, supra note 17, at 309. 32. Citizens Research Council of Michigan, Michigan’s Budget Crisis and the Prospects for the Future, STATE BUDGET NOTES (Mar. 2006). 33. Jennifer M. Granholm, Radio Address, Dec. 1, 2006, available at: http://michigan.gov/documents/gov/Radio_Address_MBT_12.1.06_TEXT_179631_7.pdf (last visited June 24, 2008). 34. The MBT provides a 24 mill reduction in the rate of personal property taxation on industrial personal property, a 12 mill reduction for commercial personal property, a refundable 35% credit against the MBT for personal property taxes paid on industrial personal property (replacing the 15% credit in the SBT), a refundable 23% credit for personal property taxes paid by telephone companies in 2008, reduced to 13.5% in subsequent years, and a 10% refundable credit for personal property taxes on natural gas pipelines. MICH. COMP. LAWS ANN. § 208.1413(1) (West Supp. 2007). 35. See, e.g., MICH. COMP. LAWS ANN. §§ 208.1403-.1417 (West Supp. 2007). 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1281 business investment. The new business income tax will make the Michigan tax system somewhat more vulnerable to recessions in the automobile industry. The tax, however, is a familiar one, used by almost all of the states, and the rate is moderate. 36 Although a comprehensive review of the income tax is outside the scope of this article, we are pleased to see that it does have one excellent design feature, namely, a requirement for members of a unitary business to file a combined report. 37 However, it also lacks a common and desirable feature—a throwback rule. 38 If the business income tax is not passed on to consumers through higher prices, it should somewhat help reduce the overall regressiveness of the Michigan tax system. 39 Given the widespread criticism of the SBT for its failure to take income into account in assessing taxes, an income-based component to the replacement package probably was inevitable. The MGRT offers a relatively stable revenue source because, like the SBT, it is mostly a tax on value added, which is a more stable tax base than income. It is designed as a destination tax, thereby avoiding the heavier taxation of firms producing in Michigan for export than of firms producing outside of Michigan for sale in the State, which occurred under the SBT before the shift in the weighting of the sales factor. Although the MGRT implicitly includes wages in its base, that fact is far less obvious than it was under the SBT, which required taxpayers to explicitly add wages to their income, as computed for Federal tax purposes. 40 As a result of this change in form, the MGRT is less likely to be chastised for discouraging job creation in Michigan. 36. Range of State Corporate Income Tax Rates (2008), FEDERATION OF TAX ADMINISTRATORS, available at http://www.taxadmin.org/fta/rate/corp_inc.html (last visited July 2, 2008) (listing the 47 states with some form of corporate income taxes, with rates ranging from 1% to 10.84%). The press often simplistically compares states on the basis of their rates; however, no one serious about analyzing a corporate income tax would ignore the base of the tax. 37. For an extended justification for combined reporting and proposed solutions to most of its technical problems, see Michael J. McIntyre, Paull Mines, & Richard D. Pomp, Designing a Combined Reporting Regime for a State Corporate Income Tax: A Case Study of Louisiana, 61 LA. L. REV. 699 (2001). 38. For a discussion of a throwback rule, see POMP & OLDMAN, supra note 8, at 1021-10-22. 39. In 1996, Michigan was ranked in the top ten in terms of the regressiveness of its tax system. See Michael P. Ettlinger, et al., Who Pays? A Distributional Analysis of the Tax Systems of All 50 States, CITIZENS FOR TAX JUSTICE (June, 1996), available at http://www.ctj.org/whop/whop_txt.pdf (last visited May 6, 2008). Since 1996, the Michigan tax system has become more regressive, due in part to cuts in the personal income tax rates. See State & Local Taxes Hit Poor & Middle Class Far Harder than the Wealthy, INSTITUTE ON TAXATION AND ECONOMIC POLICY (Jan. 7, 2003), available at http://www.itepnet.org/wp2000/pr.pdf (last visited May 6, 2008). 40. MICH. COMP. LAWS ANN. § 208.9(5) (West 2003). Ironically, although the explicit inclusion of wages became a lightening rod for critics of the SBT, the use of wages, which was already calculated for federal purposes, was once considered an administrative virtue of the SBT. 1282 THE WAYNE LAW REVIEW [Vol. 53:4 In some sense, Michigan’s new business package is a rediscovery of the past. 41 The SBT was adopted as a single tax to replace a corporate income tax and a host of other taxes. 42 Now the SBT is being replaced with multiple taxes, including a business income tax. 43 Michigan, however, apparently has learned something from its past mistakes. The new corporate tax is definitely superior, in many of its technical features, to the old corporate tax. The new taxes are somewhat integrated, in the sense of using many of the same concepts and definitions, whereas the pre-SBT taxes, aside from the corporate tax, were a hodgepodge of fees and excises, often castigated as nuisance taxes. Unfortunately, the new package has a host of complex special features that can only be explained by politics running amok. 44 Nevertheless, the new package seems to have been shaped primarily by policy considerations. It appears to be designed to reduce taxes on businesses seeking to produce goods and services in Michigan and to make up the revenue by increasing taxes on businesses seeking to exploit the Michigan market. II. CLASSIFYING THE MICHIGAN MODIFIED GROSS RECEIPTS TAX By calling one of the components of the Michigan Business Tax a modified gross receipts tax (MGRT), the State has invited comparisons between its new tax and recent state taxes that are generally considered to be gross receipts taxes. The most notable addition to the list of state gross receipts taxes is Ohio’s recently adopted Commercial Activity Tax (CAT). 45 The Ohio tax is described by the Ohio Department of Revenue as “an annual privilege tax measured by gross receipts on business activities in this state.” 46 As discussed in greater detail below, the Ohio CAT is a pure business activities gross receipts tax, whereas the Michigan tax is an entirely different animal. Section II.A, below, discusses various states with taxes that are labeled as gross receipts taxes but differ in essential ways. Section II.B explains how the MGRT acts as an innovative form of value-added tax and compares it to more familiar forms of value-added tax. 41. Indeed, Michigan’s State Treasurer, Robert J. Kleine, who was appointed to that office in 2006 and who agreed that the SBT had to be eliminated, was one of the architects of the SBT in 1975 when he was director of the Office of Revenue and Tax Analysis. See Under Assault, supra note 17, at 309. 42. See Mitchell, supra note 18. 43. See supra text accompanying notes 9-13. 44. For example, the multitude of credits include a credit for infield renovations and for hosting certain motorsport events. MICH. COMP. LAWS ANN. §§ 208.1409(1)-(2) (West Supp. 2007). 45. See OHIO REV. CODE ANN. § 5751.02 (West 2008). 46. See General Information on the Commercial Activity Tax (CAT), OHIO DEPARTMENT OF TAXATION, available at http://tax.ohio.gov (accessed from homepage by selecting the “Business” tab, then selecting “Ohio Taxes,” then selecting “Commercial Activity Tax,” then selecting “General Information”) (last visited May 6, 2008). 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1283 A. The Ambiguous Meaning of a Gross Receipts Tax The State of Washington has long had a gross receipts tax, adopted during the Depression; Ohio has recently adopted one as well. 47 New Mexico also has a gross receipts tax. 48 Washington and Ohio use a traditional gross receipts tax, intended to tax business activity or “turnover.” 49 New Mexico’s gross receipts tax is actually a broad-based sales tax, intended to tax consumption. 50 Michigan’s gross receipts tax is fundamentally different from Washington’s and Ohio’s (which are similar to each other). Michigan’s is closer to New Mexico’s, in that both are intended to tax consumption, but structurally Michigan has adopted a value added form of taxing consumption, which is very different in form from New Mexico’s retail sales tax. At their cores, a business-activities gross receipts tax and a consumption gross receipts tax differ in design and intent. The classic business activities gross receipts tax is Washington’s Business and Occupation Tax, known for short as the B&O tax. 51 Washington imposes a general gross receipts tax on most business activity in the state, 52 in lieu of a corporate income tax. 53 The economic incidence of the tax is intended to fall on businesses and not on consumers. Retailing is taxed at 0.471%; wholesaling and manufacturing are taxed at 0.484%. 54 The law specifically states that the gross receipts tax shall constitute part of the operating overhead of the business, 55 which is consistent with the goal of the tax falling on business. The inclusion in the tax base of the gross receipts tax itself likewise reflects this intent. In addition to its gross receipts tax, Washington imposes a 6.5% retail sales tax. 56 Accordingly, a retail sale in the state of Washington attracts two taxes—the 0.471% tax that the retailer must pay on its gross receipts for the privilege of doing business in Washington and the 6.5% tax that the purchaser must pay on the sale of product, measured by those same gross receipts. A 6.5% use tax complements the sales tax. 57 47. See WASH. REV. CODE ANN. §§ 82.04.010-.900 (West 2006); OHIO REV. CODE ANN. §§ 5751.02-.98 (West 2008). 48. See N.M. STAT. ANN. § 7-9-4 (West 2008). 49. See Walter Hellerstein, Michael J. McIntyre & Richard D. Pomp, Commerce Clause Restraints on State Taxation after Jefferson Lines, 51 TAX LAW REV. 47, 77-78, (1995). 50. Id. at 90-92. 51. See WASH. REV. CODE ANN. §§ 82.04.010-.900 (West 2006). 52. See WASH. REV. CODE ANN. § 82.04.220 (West 2008). 53. See JOHN F. DUE & JOHN L. MIKESELL, SALES TAXATION: STATE AND LOCAL STRUCTURE AND ADMINISTRATION 57 (2nd ed. 1994). 54. WASH. REV. CODE ANN. §§ 82.04.250, 82.04.270 (West 2006). 55. WASH. REV. CODE ANN. § 82.04.500 (West 2006). 56. WASH. REV. CODE ANN. § 82.08.020 (West 2006). 57. See WASH. REV. CODE ANN. §§ 82.12.010-.995 (West 2006). 1284 THE WAYNE LAW REVIEW [Vol. 53:4 The Ohio Commercial Activities Tax (CAT), adopted in 2005, is an annual privilege tax measured by gross receipts on business activities in Ohio. 58 The rate is 0.26%. 59 Gross receipts subject to the CAT are broadly defined to include most business types of receipts from the sale of property to those realized in the performance of a service. 60 In contrast to Washington and Ohio, New Mexico has a gross receipts tax intended to be a sales tax falling on the consumer. The tax is imposed at a rate typical of sales taxes—5%. 61 Moreover, in common with state sales taxes and consistent with normative principles of a consumption tax, New Mexico provides exemptions for a wide range of business inputs, such as the sale of: tangible personal property for resale; 62 services for resale; 63 property that becomes an ingredient and component of other manufactured property; 64 tangible personal property to persons engaged in the construction business; 65 feed and fertilizers; 66 agricultural-related inputs; 67 mining, milling, or oil-related business inputs; 68 processing of components or materials used in manufacturing;69 and so forth. The fact that New Mexico has a consumption gross receipts tax is not always appreciated. One source of confusion is that the tax is imposed on the vendor and not the consumer, 70 which is irrelevant in classifying the levy but nonetheless has helped obscure its classification. Misunderstanding may also arise from the lack of a provision common in retail sales taxes requiring the separate statement of the tax. Retailers in New Mexico, however, routinely separately state the gross receipts tax. 71 Moreover, whether separately stated or not, the New Mexico gross 58. OHIO REV. CODE ANN. § 5751.02 (West 2008). 59. OHIO REV. CODE ANN. § 5751.03(a) (West 2008). 60. See OHIO REV. CODE ANN. § 5751.01(f) (West 2008). For a critique of gross receipts taxes, see James W. Wetzler, A LAWMAKER’S GUIDE TO NON-INCOME BASED BUSINESS FRANCHISE TAXES (2007), available at http://www4.uwm.edu/business/research/upload/TaxGuide07wCover.pdf (last visited Sept. 3, 2008); John L. Mikesell, Gross Receipts Taxes in State Government Finances: A Review of Their History and Performance, TAX FOUNDATION (Jan. 31, 2007), available at http://www.taxfoundation.org/research/show/2180.html (last visited June 24, 2008). 61. N.M. STAT. ANN. § 7-9-4 (West 2008). 62. N.M. STAT. ANN. § 7-9-47 (West 2008). 63. N.M. STAT. ANN. § 7-9-48 (West 2008). 64. N.M. STAT. ANN. § 7-9-46 (West 2008). 65. N.M. STAT. ANN. § 7-9-51 (West 2008). 66. N.M. STAT. ANN. § 7-9-58 (West 2008). 67. N.M. STAT. ANN. § 7-9-59 (West 2008). 68. N.M. STAT. ANN. § 7-9-65 (West 2008). 69. N.M. STAT. ANN. § 7-9-75 (West 2008). 70. N.M. STAT. ANN. § 7-9-4 (West 2008). 71. For a fuller discussion, see Hellerstein, McIntyre, & Pomp, supra note 49, at 8693, from which parts of this section are drawn. 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1285 receipts tax is excluded from the base of the tax, 72 which is a characteristic of retail sales taxes. 73 Another possible source of misunderstanding is the breadth of the New Mexico tax, especially in its coverage of services. For historical rather than normative reasons, retail sales taxes apply to a wide spectrum of tangible personal property but to a more limited number of services. 74 The New Mexico tax is notable for its broad coverage of services, 75 a feature consistent with both a broad-based retail sales tax and a broadbased gross receipts tax. The New Mexico exemption for services purchased for resale, however, is an indication that the tax should be viewed as a retail sales tax. Finally, its historical roots may explain confusion about the proper classification of the New Mexico tax. The early New Mexico gross receipts tax reached many non-retail sales of both services and tangible personal property. 76 Over time, however, many of the nonretail sales have been excluded from the tax base. 77 As this brief survey suggests, the label “gross receipts” can refer to a business activity/turnover tax or to a sales tax. These are inherently different types of taxes. Although Michigan calls its new tax a modified gross receipts tax, the emphasis should be on “modified” and not on “gross receipts.” The tax certainly has nothing in common with the Washington or Ohio gross receipts tax. It comes closer to being a tax on consumption but not like the retail sales that other states use. As discussed in the next section, the tax is more akin to a value-added tax. B. Michigan’s Modified Gross Receipts Tax is Best Described as a VAT The predominant form of value-added tax is that imposed by all of the members of the European Union (EU). 78 Canada’s Goods and Services Tax follows that model in its structural features. A Europeanstyle VAT is a transactional tax intended to be paid by the ultimate consumer but collected in stages from the retailer and any intermediaries, including the producer, wholesaler, and distributor. The basic nature of that VAT is specified in the following passage from the First VAT Directive of the European Commission: 72. N.M. STAT. ANN. § 7-9-3.5(A)(3)(b) (West 2008). 73. Hellerstein, McIntyre & Pomp, supra note 49, at 74-78. 74. See POMP & OLDMAN, supra note 8, at 6-24-6-29. 75. See N.M. STAT. ANN. § 7-9-3(F) (West 2007); see also DUE & MIKESELL, supra note 53, at 320. 76. See DUE & MIKESELL, supra note 53, at 55 n.17, 89. 77. See id. at 55 n.17. 78. Some countries, notably New Zealand and South Africa, have adopted VATs that depart from the European model in some significant respects. See SCHENK & OLDMAN, supra note 19, at 69-71. Those differences, however, are unimportant for purposes of this article. 1286 THE WAYNE LAW REVIEW [Vol. 53:4 The principle of the common system of value added tax involves the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, whatever the number of transactions that take place in the production and distribution process before the stage at which tax is charged. On each transaction, value added tax, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components. 79 The European-style VAT is classified as a credit-invoice VAT. 80 In that system, the taxpayer computes its tax liability by determining the tax applicable to its output (tax rate multiplied by the price of the output) and subtracting from that amount its input credit—a credit allowed for previously paid taxes on its business inputs. 81 For example, assuming a 10% VAT rate, a retailer selling goods purchased for $50,000 and sold for $60,000 would have an output tax of $6,000 ($60,000 × 0.10), from which it would subtract its input credit of $5,000 ($50,000 × 0.10), for a net VAT of $1,000. The tax is remitted periodically (often monthly) to the tax authorities. The VAT was invented to avoid the cascading effects associated with the traditional gross receipts tax of the type used by Washington and Ohio. 82 A cascading effect, in this context, means that a taxable object is taxable on its full value each time it is transferred or “turned over.” The result is that a taxable object that is transferred only once, from producer to ultimate consumer, is taxed only once, whereas a taxable object that is transferred multiple times before reaching the ultimate consumer is subject to multiple levels of taxation. For example, assume that ACo and BCo both produce widgets from materials that they produce themselves. ACo sells the widgets at retail for $100 each. Assuming a tax rate of 10%, the tax on each widget would be $10. Assume, however, that BCo sells its widgets to a distributor, which sells to retailers, which then sell to the consuming public. In a 79. First Council Directive of 11 April 1967 on the harmonization of legislation of member states concerning turnover taxes (67/227/EEC) (OH P 71, 14.4.1967, 1301), Art. 2, quoted in SCHENK & OLDMAN, supra note 19, at 17. 80. SCHENK & OLDMAN, supra note 19, at 38-39, 59-60. 81. Id. 82. France is generally credited as the inventor of the VAT. Its distinctive feature is that “it is not a cumulative levy like the general turnover taxes used in many other countries . . . These cumulative taxes are often referred to as ‘cascade taxes’ (taxes à cascade).” Martin Norr & Pierre Kerlan, Taxation in France, in WORLD TAX SERIES 976 (1966). 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1287 traditional gross receipts turnover tax, each widget would be taxed on each transfer, based on its fair market value in the relevant market. Thus, if BCo sold a widget to a distributor for $50, the distributor sold it to the retailer for $70, and the retailer sold it to a consumer for $100, the total tax on the transfers would be $22 ($5 + $7 + $10). The cascading effect typically results in favoritism toward big businesses, which tend to be integrated, over small, unintegrated businesses. 83 The European-type VAT avoids the cascading effect by giving each participant in the production and sale process a credit for taxes paid by prior participants in that process. 84 In the example of ACo and BCo above, the distributor would have a tentative VAT of $7 but would get an input credit of $5 for the tax paid by BCo, resulting in a net tax liability of $2. The retailer would have a tentative VAT of $10 but would be allowed an input credit of $7 ($5 + $2), for a net tax liability of $3. The result would be that each widget produced by ACo and BCo would be subject to a total VAT of $10, without regard to the number of intermediaries between the production of the widget and the ultimate sale to the consuming public. 85 The Michigan MGRT differs from a credit-subtraction VAT because the MGRT does not allow a credit for previously paid taxes. In the taxonomy of VATs, the MGRT is akin to a sales-subtraction VAT. In a sales-subtraction VAT, the taxpayer computes its VAT on the sale of goods and services by subtracting the amount of its inventory costs and other purchases from the amount of its sales and then multiplying the resulting number by the tax rate. 86 This adjustment can eliminate the cascading effect of the tax as effectively as granting an input credit. Although sometimes praised in the tax literature, 87 a sales-subtraction 83. In many countries, the value-added tax was introduced as a replacement for turnover taxes, similar to the cascading taxes used in Washington and Ohio. One of the arguments made against those turnover taxes was that they provided a tax incentive for businesses to integrate when otherwise they would not have done so. See SCHENK & OLDMAN, supra note 19, at 4. As discussed in the text, a VAT eliminates that incentive. 84. Id. 38-39. 85. If a state had an ideal 10% retail sales tax, which exempted all business inputs, it would also collect $10, the same as under the VAT example in the text. The major difference, however, is that the VAT is collected in stages whereas under an ideal sales tax, the $10 would be collected once at the retail sale. If the retailer failed to collect or remit the $10, the state would lose the full amount of the sales tax. Under the example in the text, if the retailer failed to collect or remit the tax collected from the consumer, the taxing jurisdiction would lose only $3, the difference between the $10 imposed on the retailer and the $7 input credit. This feature of a VAT is especially attractive to a country that fears it has a high rate of tax avoidance at the retail level because of the large number of small retailers dealing in cash. 86. SCHENK & OLDMAN, supra note 19, at 42. 87. See Oliver Oldman & Alan Schenk, The Business Activities Tax: Have Senators Danforth & Boren Created a Better Value Added Tax?, 65 TAX NOTES 1547 (Dec. 19, 1994). 1288 THE WAYNE LAW REVIEW [Vol. 53:4 VAT is not common. It was once used by Finland, 88 and it is now in use by the Navajo Nation. 89 We are unaware of other examples of that type of tax. Consistent with the theory of a sales-subtraction VAT, the Michigan MGRT allows a deduction from the tax base for inventory costs and other “purchases from other firms.” 90 In the example above, neither ACo nor BCo would have any deductions because they made no purchases from other firms. ACo would pay a tax of $10 per widget, and BCo would pay a tax of $5. BCo’s distributor would pay a tax of $2 per widget, computed by subtracting $50 (its purchases from BCo) from its sales of $70 and multiplying the result by the tax rate of 10%. The retailer would have a tax per widget of $3, computed by subtracting $70 from its sales price of $100 and multiplying the difference by 10%. In this stylized example, the result is identical to the result reached under a credit-subtraction VAT. 91 One practical difference between a credit-invoice VAT and a salessubtraction VAT is that a taxpayer making a purchase under the former system is entitled to an input credit only if VAT was previously paid with respect to that purchase. 92 In principle, a taxing jurisdiction using a sales-subtraction VAT could achieve a comparable result by allowing a deduction from the tax base only for purchases made from sellers subject to the MGRT. The Michigan MGRT has no comparable limitation. 93 Such a rule would be impractical for Michigan because it would require Michigan to establish a registration system for sellers; both domestic sellers and foreign sellers would need to be required to register. Getting foreign sellers to register is a practical impossibility. 88. See Carl S. Shoup, Choosing Among VATs, in VALUE-ADDED TAX IN DEVELOPING COUNTRIES 14 (Malcolm Gillis et al., eds., 1990). 89. See NAVAJO NATION CODE tit. 24, §§ 404-05, available at http://www.navajotax.org (accessed from homepage by selecting “Statutes,” then “Business Activity Tax”) (last visited May 7, 2008). The authors consulted with the Navajo Nation on the design of this tax and one of us (McIntyre) produced the first draft of the tax, drawing from the experience of the Michigan SBT with an origin-based VAT. The tax raised over $13 million for the Navajo Nation in 2007. 90. See MICH. COMP. LAWS ANN. § 208.1113(6) (West Supp. 2007). 91. We do not attempt here to catalogue the various practical differences typically resulting from a sales-subtraction VAT and a credit-subtraction VAT. For countries using multiple tax rates, the differences can be quite large since a credit-subtraction VAT typically allows a credit only for taxes actually paid, whereas a sales-subtraction method typically allows a deduction if the prior sale was subject to tax, regardless of the rate of that tax. 92. SCHENK & OLDMAN, supra note 19, at 41. 93. Professor McLure refers, disparagingly, to a sales-subtraction VAT that allows a deduction for purchases from persons not subject to the VAT as the “naive salessubtraction VAT.” See CHARLES E. MCLURE, JR., THE VALUE-ADDED TAX: KEY TO DEFICIT REDUCTION 71-79 (American Enterprise Institute 1987). Japan’s VAT is a naive sales-subtraction tax that does not rely on invoices for determining the amount of tax due. SCHENK & OLDMAN, supra note 19, at 41. 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1289 Although the Michigan MGRT has strong similarities to a salessubtraction VAT, it also differs from such a tax in several important ways. Perhaps the most important difference is in the method of computing the tax. In contrast to a European-style VAT, a salessubtraction VAT and the MGRT are not transactional taxes. Instead, the tax is computed at the end of each taxable period based on information contained in the taxpayer’s books of account. In a sales-subtraction VAT, the tax is computed by adding up all of the taxpayer’s sales within the taxing jurisdiction. In contrast, a taxpayer computes its tax due under the MGRT by determining its worldwide sales and worldwide purchases from other firms, and then apportioning a share of the worldwide modified gross receipts to Michigan, using a sales-only apportionment formula (Michigan sales/worldwide sales). 94 The use of a sales-only apportionment formula is critical to the success of the MGRT as a destination-based VAT. That mechanism substitutes for the border adjustments found in transactional VATs, which have the effect of exempting the value-added attributable to exports and taxing the value-added attributable to imports. As a result of apportionment, the taxable base of the MGRT is a crude approximation of the tax base that would result if Michigan were to impose an EU-type VAT—that is, a destination-based, transactional VAT. For a highly stylized example of the rough equivalence of the MGRT and a credit-subtraction VAT, consider ACo, a company that produces bread in Michigan worth $8,000 (net of tax). ACo sells one half of the bread in Michigan and the rest outside of Michigan. It purchases wheat grown in Michigan from BCo that has a value (net of tax) of $1,000. BCo has no purchases from other firms. The VAT tax rate is 10%, and the tax is presumed to be shifted forward to purchasers. Under a EU-style VAT, BCo pays a tax of $100 on the sale of wheat to ACo and charges ACo $1,100 for the wheat. ACo sells the bread to Michigan customers for $4,000 plus a tax of $400. It is allowed an input credit of $50 on the Michigan sales for the tax paid to BCo. ACo does not charge any VAT on its export sales. In addition, it gets a rebate of $50 on those sales. The result is that ACo pays a net VAT of $300 ($400 - $50 - $50). The government, in total, collects a VAT of $400 ($300 from ACo and $100 from BCo) with respect to $4,000 sales of bread in Michigan. The result would be roughly the same under a stylized version of the Michigan MGRT. Assuming that BCo sells the wheat to ACo for $1,100, it has modified gross receipts of that amount, all of which presumably are apportioned to Michigan because the property was delivered or shipped to a purchaser in the State. Because the tax base of the MGRT includes the tax of $100, the rate, to be comparable to the tax-exclusive VAT rate of 10%, would be 9.09% (10% / (100% + 10%)). BCo pays a tax of $100 ($1,100 × 0.0909). 94. MICH. COMP. LAWS ANN. §§ 208.1203(1), (3), 208.1301(2) (West Supp. 2007). 1290 THE WAYNE LAW REVIEW [Vol. 53:4 ACo has gross receipts of $8,000 plus whatever taxes it passes on to its customers through higher prices. Assuming ACo passes on a 10% (tax exclusive) tax to its Michigan customers and no tax to its out-of-state customers, its gross receipts from Michigan sales are $4,400 and its gross receipts from out-of-state sales are $4,000, for a total of $8,400. It gets a deduction of $1,100 for purchases from other firms, giving it unapportioned adjusted gross receipts of $7,300. Using the sales-only apportionment formula, the amount taxable by Michigan is $3,825 ($7,300 × $4,400/$8,400), and the tax is $348. The total MGRT collected by Michigan is $448 ($100 + $348), which is $48 ($348 - $300) more than the tax collected under the VAT. The extra tax of $48 paid under the stylized MGRT is due primarily to the fact that the VAT gives a full exclusion for taxes associated with exports, whereas the stylized MGRT, in the example above, does not.95 That flaw could be fixed by allowing BCo to treat $500 of its sales to ACo as out-of-state sales on the theory that half of the wheat ends up incorporated into exports. With that fix, BCo would charge ACo $1,050 for the wheat and would pay a MGRT of $50 (($1,050 × $550/$1,050) × .0909). BCo would have adjusted gross receipts of $7,350 ($8,400 $1,050), of which $3,850 ($7,350 × $4,400/$8,400) would be apportioned to Michigan. The Michigan MGRT paid by ACo would be $350 ($3,850 × .0909), and the total tax collected by the State would be $400 ($50 + $350). The obvious problem with the fix is that it presents serious administrative problems. 96 To operate as a value-added tax, the Michigan MGRT must substantially eliminate all of the cascading effects of a traditional gross receipts tax. How well the MGRT protects against cascading depends on how broadly the State defines “purchases from other firms.” In general, the statute defines that term broadly enough to cover purchases for resale 97 and purchases of depreciable property 98 and most other purchases of tangible personal property that constitute business inputs. 99 Purchases of land and certain other capital assets are not deductible, 100 but the proceeds from the sale of those assets, reduced by realized gains, are excluded from the tax base, 101 which has the effect of including in the tax base only the gain on the sale. This result may be questionable as a 95. An alternative way to fix the flaw in the MGRT would be to include only Michigan sales in the tax base but still allow a full input credit on all purchases (assuming the only sales are taxable domestic sales and export sales). 96. See Section III.C.1 for a discussion of these problems and the ambiguity in Michigan law relating to the proper treatment of goods that are sold to a producer and incorporated into goods sold outside the State. 97. MICH. COMP. LAWS ANN. § 208.1113(6)(a) (West Supp. 2007). 98. MICH. COMP. LAWS ANN. § 208.1113(6)(b) (West Supp. 2007). 99. MICH. COMP. LAWS ANN. § 208.1113(6)(c) (West Supp. 2007). 100. MICH. COMP. LAWS ANN. § 208.1113(6) (West Supp. 2007). 101. MICH. COMP. LAWS ANN. § 208.1111(1)(o) (West Supp. 2007). 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1291 policy matter, but it will not lead to cascading. In contrast, amounts paid to purchase most types of business services are not deductible. 102 Therefore, when services constitute a significant business input, the risk of a cascading effect could be quite significant. In addition to allowing a deduction for certain business purchases, the Michigan MGRT protects against cascading for unitary businesses by eliminating all transactions between members of a unitary group, including the sales of services. 103 This protection extends to intercompany transactions that would not fall within the definition of “purchases from other firms.” 104 The result is that members of a unitary group are protected from the cascading effect even with respect to services received from other members of that group. As noted above, other companies do not enjoy comparable protection. The MGRT cannot be viewed as a success unless it can be administered effectively. At least in theory, the MGRT, with its apportionment formula, should be considerably easier to enforce than a transactional sales-subtraction VAT because the apportionment mechanism eliminates the need for the State to keep track of export sales (that is, sales outside of Michigan). The State still must determine the amount of Michigan sales, although only in the aggregate. 105 As discussed below in Section III.C, making that determination is not trivial. Nevertheless, the State previously was required to make that determination in applying the SBT apportionment formula, and that determination is also required under the new business income tax. 106 By reputation, a transactional VAT is supposed to protect against tax fraud because of a self-policing feature. If a taxpayer makes a purchase from a vendor that has failed to pay its VAT, the taxpayer will be unable to obtain a deduction, in the case of a sale-subtraction VAT, or an input credit, in the case of a credit-subtraction VAT, with respect to its purchases from that vendor. 107 As a result, a taxpayer has an interest in 102. A deduction is allowed for taxpayers that purchase and resell personal services. See MICH. COMP. LAWS ANN. § 208.1113(6)(d) (West Supp. 2007). A deduction also is allowed for certain subcontractors. See MICH. COMP. LAWS ANN. § 208.1113(6)(e) (West Supp. 2007). 103. See MICH. COMP. LAWS ANN. § 208.1511 (West Supp. 2007). Michigan allows an exemption for small businesses with gross receipts under $350,000, so only purchases from larger firms face a double tax. See MICH. COMP. LAWS ANN. § 208.1505(1) (West Supp. 2007). 104. See MICH. COMP. LAWS ANN. § 208.1511 (West Supp. 2007) (excluding all transactions between persons included in the unitary business group from the combined return). 105. See MICH. COMP. LAWS ANN. § 208.1303(1) (West Supp. 2007). 106. See discussion infra part III.C. 107. See Kwang Choi, Value-added Taxation: Experiences and Lessons of Korea, in TAXATION IN DEVELOPING COUNTRIES 385 (Richard M. Bird & Oliver Oldman, eds., 4th ed., 1990): The VAT is said to be self-enforcing because of how it is usually administered. There is a measure of self-policing in that evasion by suppliers through the 1292 THE WAYNE LAW REVIEW [Vol. 53:4 seeing that its vendors report their VAT properly. This self-policing feature is far from perfect—the Europeans have been experiencing significant problems with VAT fraud in recent years. 108 Little doubt exists, however, that the self-policing feature of the EU VAT has some value in preventing tax avoidance and evasion. The MGRT will not enjoy this self-policing feature because it permits deductions for purchases from other firms without any inquiry into whether those firms have complied with their tax obligations. III. STATUTORY ANALYSIS OF THE MICHIGAN MGRT A. Overview of the MGRT Statute The Michigan Business Tax statute imposes a modified gross receipts tax on every taxpayer with nexus in the State. 109 That tax is imposed on the modified gross receipts tax base, after allocation or apportionment to Michigan. 110 The basic rate is 0.8%, 111 increased by a surcharge of 21.99%, 112 bringing the total tax rate of the MGRT to just under 1%. 113 “Gross receipts” under the MGRT means the entire amount received by the taxpayer from any activity “whether in intrastate, interstate, or foreign commerce carried on for direct or indirect gain, benefit, or advantage to the taxpayer . . .” 114 This broad definition indicates the Legislature intended to cast a wide net. “Taxpayer” includes, inter alia, individuals, firms, limited partnerships, limited liability partnerships, partnerships, joint ventures, associations, corporations, limited liability companies, estates, and understatement of the tax collected is balanced by the purchasers’ interest in ensuring that all tax payments are recorded. Similarly, evasion by purchasers who overstate the taxes they pay runs counter to the interests of suppliers. The advantages of the invoice method have not been fully realized in practice. Id. 108. See Proposal for a Council Directive amending Directive 2006/112/EC on the common system of value added tax to combat tax evasion connected with intraCommunity transactions, Commission of the European Communities (2008), available at http://eur-lex.europa.eu/RECH_mot.do (accessed from homepage by typing “Directive 2006/112/EC” in the search box and selecting “PDF” under the “COM (2008) 0147” entry) (last visited May 16, 2008); see also Vanessa Houlder, Surge in VAT fraud costs states up to €100bn, FINANCIAL TIMES (Mar. 26, 2007), available at http://www.ft.com (accessed from homepage by entering keyword “Surge in VAT Fraud” in the Search field, then selecting “WORLD NEWS: Surge in VAT fraud costs states up to €100bn”) (last visited May 7, 2008). 109. See MICH. COMP. LAWS ANN. § 208.1203(1) (West Supp. 2007). 110. See id. 111. See id. 112. See MICH. COMP. LAWS ANN. § 208.1281(1)(a) (West Supp. 2007). 113. The actual combined rate is 0.976%. 114. MICH. COMP. LAWS ANN. § 208.1111(1) (West Supp. 2007). 2007] MICHIGAN’S MISLABELED GROSS RECEIPTS TAX 1293 trusts. 115 It also includes a unitary business group, or any other group or combination of groups acting as a unit. 116 Specifically excluded as taxpayers are the United States, states, political subdivisions, persons exempt under the Internal Revenue Code, nonprofit housing corporations, and farmer’s cooperatives. 117 In addition, a taxpayer earning gross receipts attributable to certain agricultural activities is exempt with respect to those gross receipts. 118 The modified gross receipts tax base means a taxpayer’s gross receipts less purchases from other firms before apportionment. 119 Purchases from other firms includes, inter alia: (1) inventory acquired during the tax year, including charges for such things as shipping that are treated as inventory costs; (2) depreciable or amortizable assets, including the costs of fabrication and installation; and (3) materials and supplies, including repair parts and fuel.120 With some modest exceptions for services that are, in effect, purchased for resale, 121 purchases of services are not deductible. They would be deductible under a normative value-added tax. The statute provides other exclusions from the tax base that are appropriate to refine the definition of a “gross receipt.” For example, tax refunds 122 and refunds from returned merchandise—essentially negative gross receipts—are excluded from that definition. 123 Other exclusions from the definition of gross receipts are questionable because they are not required to define properly a gross receipt. 124 Two notable exclusions are for the proceeds from the sale of land and most capital assets, less any gain from the sale of such assets to the extent included in federal taxable income. 125 The effect of this rule is 115. MICH. COMP. LAWS ANN. § 208.1113(3) (West Supp. 2007) (defining “person”); MICH. COMP. LAWS ANN. § 208.1117(5) (West Supp. 2007) (defining “taxpayer”). 116. Id. 117. MICH. COMP. LAWS ANN. §§ 208.1207(1)(a)-(c), (e) (West Supp. 2007). 118. MICH. COMP. LAWS ANN. § 208.1207(1)(d) (West Supp. 2007). 119. MICH. COMP. LAWS ANN. § 208.1203(3) (West Supp. 2007). 120. MICH. COMP. LAWS ANN. §§ 208. 1113(6)(a)-(c) (West Supp. 2007). 121. MICH. COMP. LAWS ANN. §§ 208.1113(6)(d)-(e) (West Supp. 2007). 122. MICH. COMP. LAWS ANN § 208.1111(1)(k) (West Supp. 2007). 123. See MICH. COMP. LAWS ANN. § 208.1111(1)(h) (West Supp. 2007). Unexceptional exclusions include amounts received in an agency capacity, section 208.1111(1)(a), (b) (presumably these amounts will constitute the gross receipts of the principal); discounts, section 208.1111(1)(i), (j); security deposits, section 208.1111(1)(l); the original issue of stock or equity instruments, section 208.1111(1)(g); or payment of the principal portion of loans, section 208.1111(1)(m) (emphasis added). Presumably the Legislature did not mean “payment” of the principal but rather the “receipt” by the taxpayer of the principal portion of loans. 124. The definition of gross receipts is largely taken from the comparable definition in the SBT. The exclusion for the proceeds from land and certain other capital transactions was taken directly from the SBT. See MICH. COMP. LAWS ANN. § 208.7(3)(o) (West 2003). 125. See MICH. COMP. LAWS ANN. § 208.1111(1)(o) (West Supp. 2007). 1294 THE WAYNE LAW REVIEW [Vol. 53:4 to treat only the gains derived from those sales as taxable gross receipts. In addition, presumably for administration reasons, the gains are taxable only if they have been included in federal taxable income. 126 The inclusion of only net gains on certain capital transactions is consistent with the denial of a deduction for the purchase of such assets under the adjustment for purchases from other firms. Of course, consistency also could be achieved by including the sales proceeds and deducting the initial purchases. 127 The MGRT applies to taxpayers “with nexus as determined under section 200.” 128 That section provides that substantial nexus in Michigan exists if the taxpayer has a physical presence in Michigan for a period of more than one day during the tax year or if the taxpayer actively solicits sales in the state and has gross receipts of $350,000 or more attributed to Michigan. 129 The Michigan nexus rules are discussed in greater detail in Section III.B, below. The MGRT tax base (as well as the tax base of the business income tax), are apportioned for taxpayers whose business activities are subject to tax both within and outside Michigan by using a sales-only apportionment formula. 130 The numerator of that formula is the total sales of the taxpayer in Michigan during the tax year, and the denominator is the total sales everywhere during that year. 131 The apportionment rules are discussed in greater detail in Section III.C, below. Taxpayers engaged in business only in Michigan are not subject to apportionment; they have all of their adjusted gross receipts allocated to Michigan. 132 126. See id. 127. Other questionable exclusions from gross receipts include the proceeds representing the principal balance of loans transferred or sold by a mortgage company, MICH. COMP. LAWS ANN. § 208.1111(1)(s) (West Supp. 2007); and amounts received by a professional employer organization as reimbursement for its actual cost of wages, benefits, taxes and the like for an employee provided to the customer. MICH. COMP. LAWS ANN. § 208.1111(1)(t) (West Supp. 2007). The MBT also excludes from the definition of a gross receipt the proceeds from the transfer of an account receivable if the sale that generated the account receivable was included in the gross receipts for federal income taxes. See MICH. COMP. LAWS ANN. § 208.1111(1)(f) (West Supp. 2007). Th