Considered on Briefs August 31, 2015.
APPEAL FROM THE CIRCUIT COURT OF THE SECOND JUDICIAL CIRCUIT MINNEHAHA COUNTY, SOUTH DAKOTA. THE HONORABLE DOUGLAS E. HOFFMAN Judge.
CATHERINE A. TANCK, SANDRA HOGLUND HANSON of Davenport, Evans, Hurwitz & Smith LLP, Sioux Falls, South Dakota, Attorneys for appellee.
JOHN T. RICHTER of South Dakota Department of Revenue Pierre, South Dakota, Attorneys for appellant.
WILBUR, Justice. GILBERTSON, Chief Justice, and ZINTER, SEVERSON, and KERN, Justices, concur.
[¶1] Taxpayer challenged the South Dakota Department of Revenue's certificate of assessment for use tax on parts and materials taxpayer used in its service of railcars for two affiliated companies. In a separate proceeding, taxpayer appealed the Department's denial of its refund requests for sales tax paid on its service of railcars received in South Dakota but delivered and used outside South Dakota. The Department consolidated the proceedings for an administrative hearing. The hearing examiner, and ultimately the Secretary of the Department, affirmed the certificate of assessment and upheld the Department's denial of taxpayer's refund requests. Taxpayer appealed, and the circuit court reversed the Department's May 2013 final decision related to both the certificate of assessment and the Department's denial of taxpayer's refund requests. The Department appeals. We affirm in part and reverse in part.
[¶2] Although procedurally this case involves an appeal from one administrative proceeding, the case implicates two distinct tax issues. For ease of reading, we separately describe the facts related to each.
1. Use Tax Assessed on Parts and Materials used by Midwest for CarMath and M& C Leasing Railcars
[¶3] Midwest Railcar Repair, Inc. is owned by Greg Carmon and is in the
business of servicing railcars for various customers. Carmon also owns CarMath and M& C Leasing. CarMath and M& C Leasing own and lease railcars to third parties. CarMath, M& C Leasing, and Midwest are independent companies. Midwest services railcars for CarMath and M& C Leasing. In its service of the railcars, Midwest incorporates parts and materials from its inventory.
[¶4] On September 27, 2006, the South Dakota Department of Revenue issued Midwest a notice of intent to audit its sales and use tax licenses for the tax periods covering October 2003 to October 2006. In November 2006, Department employees Wayne Palmer and Willis Dreesman met with Midwest employee Timothy Hoon and commenced the audit. During the audit, Auditor Palmer informed Hoon that Midwest owed use tax on materials and parts incorporated into railcars serviced for CarMath and M& C Leasing. Hoon replied that Midwest did not pay use tax on materials and parts because the Department had issued Midwest written advice in 1996 (1996 Advice Letter) that parts and materials used in its modification of railcars were not subject to tax. Hoon presented the letter to Auditor Palmer. Auditor Palmer responded that the Department's advice letter had been overridden by this Court's decision in Butler Machinery Co. v. South Dakota Department of Revenue, 2002 S.D. 134, 653 N.W.2d 757.
[¶5] In January 2007, the Department issued a certificate of assessment in the amount of $94,046.08, which included $15,790.84 of interest. In March 2007, Midwest filed a written request for an administrative hearing and, in April 2007, a protective refund claim for taxes previously paid in the amount of $1,052,096.10. In its request for an administrative hearing, Midwest claimed the certificate of assessment was improper because the imposition of use tax is " contrary to the written advice issued by the Department on September 4, 1996[.]" Midwest asserted that the Department improperly assessed a use tax (1) on " items purchased for resale or for lease[,]" (2) " on replacement parts installed or to be installed in tangible personal property that will ultimately be held for resale or for lease[,]" and (3) " on payments of one member of a controlled group to another member of a controlled group" in violation of SDCL 10-45-20.1. And Midwest claimed that the South Dakota Constitution, United States Constitution, and the Railroad Revitalization and Regulatory Reform Act, 49 U.S.C. § 11501(b)(4) (4-R Act) prohibited the Department from assessing use tax.
[¶6] Prior to an administrative hearing, Midwest commenced suit in federal court seeking a declaration that South Dakota's assessment of use tax violated the
4-R Act. Although Midwest did not prevail, this federal suit is relevant because the Department argues to this Court that Midwest should be judicially estopped from asserting that it modifies railcars when it argued during the federal litigation that it repairs railcars. See Midwest Railcar Repair, Inc. v. S.D. Dep't of Revenue & Regulation, 659 F.3d 664 (8th Cir. 2011); Midwest Railcar Repair, Inc. v. S.D. Dep't of Revenue & Regulation, 2010 WL 2545952 (D.S.D.).
2. Midwest's Service to Burlington Northern Railcars: The Source of the Sale for Sales Tax Purposes
[¶7] In addition to servicing railcars for CarMath and M& C Leasing, Midwest services railcars for other companies, many of whom are located outside South Dakota. Its service of these railcars was not the subject of the Department's notice of intent to audit or certificate of assessment. In fact, Midwest had been paying South Dakota tax on its service of these railcars. In 2008, Midwest requested written advice from the Department on the taxation of its service based on SDCL 10-45-108. That statute provides that " a retailer shall source sales of tangible personal property . . . and services to the location where the tangible personal property . . . or service is received." Id. Midwest's written request explained that, although its service to the railcars was performed at Midwest's business location in South Dakota, the railcars were brought to Midwest from a location outside South Dakota by Burlington Northern Railroad and received by the customer outside South Dakota via the railroad. Midwest believed the sale should be sourced outside South Dakota. Midwest specifically excluded from its written request the service it provided to railcars owned and leased by Burlington Northern and its affiliates.
[¶8] The Department issued Midwest written advice on October 23, 2008 (2008 Advice Letter), providing in part that " [t]he Department agrees with your analysis that Midwest Railcar's services would be sourced to the location to where the railcars are delivered by common carrier." The Department advised that " Midwest Railcar's services of repairing and refurbishing railcars delivered by common carrier to locations outside of South Dakota would not be subject to South Dakota tax." But the Department qualified that " this written advice does not apply to railcars owned or leased by the common carrier railroad or its affiliates."
[¶9] Based on the 2008 Advice Letter, Midwest discontinued paying South Dakota tax on non-Burlington Northern railcars and submitted nine refund claims. Midwest's refund requests included taxes it paid on its service to Burlington Northern railcars. The Department granted Midwest's refund requests for taxes paid and applicable interest related to its service to non-Burlington Northern railcars. But it denied the claims related to sales tax paid on Midwest's service to Burlington Northern railcars. According to the Department, Midwest's repair service to Burlington Northern railcars was subject to South Dakota tax because Burlington Northern took possession of its railcars at Midwest's business location in South Dakota. In March 2010, Midwest appealed the Department's denial of its refund requests.
3. The Administrative Proceedings
[¶10] The Department consolidated Midwest's appeal from the denial of its refund request with Midwest's 2007 request for an administrative hearing challenging the certificate of assessment for use tax on parts and materials incorporated into Midwest's service to CarMath and M& C Leasing railcars.
i. Certificate of Assessment on Midwest's Parts and Materials
[¶11] During the administrative hearing on October 25, 2012, Midwest sought to admit invoices and lease explanations as evidence that parts and materials used in its service to CarMath and M& C Leasing railcars were not subject to use tax. The Department objected and asserted that SDCL 10-59-3 and -7 precluded Midwest from relying on the invoices and lease explanations because Midwest did not present these documents to the auditor within sixty days of the commencement of the audit. The hearing examiner overruled the Department's objection and accepted the exhibits into evidence.
[¶12] The Department also challenged Midwest's attempt to rely on the 1996 Advice Letter. The Department asserted that the letter was not issued to Midwest specifically, but to certified public accountant Jim Pfeiffer. The Department alternatively argued that even if Midwest had a right to rely on the 1996 Advice Letter, Butler Machinery Co. overruled the advice and Midwest's service is subject to tax. In response, Midwest explained that, although the Department did not issue the 1996 Advice Letter to Midwest directly, Greg Carmon had asked Pfeiffer to request written advice from the Department on Midwest's behalf. Pfeiffer forwarded a copy of the letter to Carmon, and Midwest retained a copy of this letter in its file. The hearing examiner did not specifically overrule the Department's objection.
ii. Refund for Repair Services to Burlington Northern Railcars
[¶13] Senior Revenue Agent Darrin Gerry testified that based upon the Department's training on sourcing rules, Midwest's repair services to Burlington Northern railcars implicated South Dakota sales tax. He noted that Midwest did not dispute that Burlington Northern, the purchaser, received its repaired railcars at Midwest's business location in South Dakota. Therefore, he opined that the Department properly denied Midwest's refund requests.
[¶14] Greg Carmon testified that Midwest's service to Burlington Northern railcars was no different than that provided to non-Burlington Northern railcars. Although Burlington Northern obtained possession of its railcars in South Dakota, it could not use or place its railcars into service until the repairs were accepted or rejected at Burlington Northern's place of business outside South Dakota. Midwest argued that the sale of repair services to Burlington ...