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LLC v. Department of Revenue

Supreme Court of Washington, En Banc

January 16, 2020

LOWE'S HOME CENTERS, LLC, Petitioner,
v.
DEPARTMENT OF REVENUE, STATE OF WASHINGTON, Respondent.

          MADSEN, J.

         This case concerns whether a retail seller, Lowe's Home Centers, may seek reimbursement of state sales taxes and B&O (business and occupation) taxes from the Department of Revenue (DOR) where Lowe's contracted with GE Capital Financial Incorporated and Monogram Credit Bank of Georgia (banks) to offer private label credit cards to its customers, and agreed to repay the banks for losses they sustained on defaulting customer accounts. RCW 82.08.050 provides that a seller must collect and remit sales taxes to the State. For sellers unable to recoup sales tax funds from buyers, RCW 82.08.037(1) provides that sellers may claim a deduction "for sales taxes previously paid on bad debts, as that term is used in 26 U.S.C. Sec. 166." In a partially split decision, the Court of Appeals affirmed the trial court's denial of reimbursement.

         We hold that although the banks were involved in the credit transaction, Lowe's is still the seller burdened with the loss from its customers' defaults, including their nonpayment of the sales taxes. Accordingly, we reverse the Court of Appeals.

         FACTS

         Lowe's contracted with two banks to offer private label credit cards to Washington customers. The banks offered credit to cardholders who purchased Lowe's goods. Within two days of a credit purchase, the banks would send full payment and related sales taxes to Lowe's. Lowe's then remitted the taxes to DOR.

         The banks undertook the majority of the risk of defaulting cardholders, and Lowe's contracted to mitigate this risk by acting as guarantor. When credit card holders failed to repay the purchase price and sales tax, Lowe's agreed to reimburse the banks. The contract calculated Lowe's share of the banks' finance income by providing that Lowe's "shall be responsible for Net Write-Offs during such year up to a maximum of 7.0% of Average Net Receivables." Clerk's Papers (CP) at 140. The contract termed these repayments "bad debt guarantees" and stated that Lowe's alone could claim bad debt relief. E.g., id. at 454.[1] Each month the banks subtracted amounts it had written off as uncollectible (up to the 7.0 percent cap) from the amounts it could collect from cardholders.

         On its federal income tax returns, Lowe's claimed bad debt reductions based on its bank repayments. For its 2001-2009 state tax assessment period, Lowe's asked for the same deduction. Lowe's sought a refund of over $2.2 million. DOR denied the refund. After paying its tax assessment under protest, Lowe's appealed and sought reimbursement in superior court.

         On cross motions for summary judgment, the trial court agreed with DOR that Lowe's should not receive a sales tax deduction and dismissed the case. The Court of Appeals affirmed in a published split opinion. Lowe's Home Ctrs., LLC v. Dep't of Revenue, 5 Wn.App. 2d 211, 242-43, 425 P.3d 959 (2018); id. at 243 (Maxa, J., dissenting).

         Two amici submitted briefing. Kohl's Department Stores Inc. and the Council on State Taxation (COST) filed briefs in support of Lowe's petition for review; COST also filed a brief in support of Lowe's supplemental briefing.[2]

         ANALYSIS

         At issue is whether Lowe's is entitled to a refund of sales and B&O taxes because the banks reduced Lowe's profit share from credit card transactions to meet Lowe's obligation as guarantor of the banks' bad debt arising from the banks' contract with Lowe's account holders.

         DOR urges us to deny the reimbursement. The plain language of our state bad debt provisions requires a taxpayer to satisfy four requirements: (1) be a seller (2) making sales at retail and (3) entitled to a refund for sales taxes previously paid on bad debts (4) that are federally deductible. RCW 82.08.037(1); see also WAC 458-20-196(3)(a). DOR argues that Lowe's fails to satisfy the plain language of .037(1) because Lowe's fully recovered sales tax funds and incurred no bad debt.

         Lowe's counters that state bad debt relief relies exclusively on federal bad debt relief. Because Lowe's received a federal deduction, Lowe's contends that it qualifies for a state deduction. Lowe's further contends that its contractual payments to the banks covering the banks' losses qualify as "sales taxes previously paid" under .037(1).

         Standard of Review

         We review summary judgment orders de novo. Sheehan v. Cent. Puget Sound Reg'l Transit Auth., 155 Wn.2d 790, 796-97, 123 P.3d 88 (2005). Taxes are presumed to be valid, and the burden is on the taxpayer to prove the tax is incorrect. Avnet, Inc. v. Dep't of Revenue, 187 Wn.2d 44, 49-50, 384 P.3d 571 (2016) (plurality opinion) (citing Lamtec Corp. v. Dep't of Revenue, 170 Wn.2d 838, 43, 246 P.3d 788 (2011)); Ford Motor Co. v. City of Seattle, 160 Wn.2d 32, 41, 156 P.3d 185 (2007). The taxpayer seeking a refund has the burden to prove that DOR incorrectly assessed the tax and that it is entitled to a refund. RCW 82.32.180. We look to substance rather than form when determining tax classifications. First Am. Title Ins. Co. v. Dep't of Revenue, 144 Wn.2d 300, 303, 27 P.3d 604 (2001). To qualify for a tax exemption, a taxpayer must demonstrate that the exemption clearly falls within the scope of a tax deduction statute. TracFone Wireless, Inc. v. Dep't of Revenue, 170 Wn.2d 273, 196-97, 242 P.3d 810 (2010). If ambiguity exists in an exception or deduction provision, courts strictly construe the provision against the taxpayer. Avnet, 187 Wn.2d at 50 (citing Simpson Inv. Co. v. Dep't of Revenue, 141 Wn.2d 139, 149-50, 3 P.3d 741 (2000)).

         Lowe's and DOR agreed before the Court of Appeals and reaffirmed here that there are no issues of material fact. Lowe's, 5 Wn.App. 2d at 223. We must decide whether, as a matter of law, Lowe's is entitled to a sales tax refund under RCW 82.08.037.

         Sales Tax

         Washington imposes sales tax on retail purchases. RCW 82.08.020. A buyer must pay sales tax to the seller, and the seller must remit the tax to DOR, even if the seller does not collect that tax at the point of sale. White v. State, 49 Wn.2d 716, 724-25, 306 P.2d 230 (1957) (sellers must remit the tax whether or not they collect it); AARO Med. Supplies, Inc. v. Dep't of Revenue, 132 Wn.App. 709, 716, 132 P.3d 1143 (2006). "The amount of tax, until paid by the buyer to the seller or to the department, constitutes a debt from the buyer to the seller." RCW 82.08.050(8).

         Under Washington law, a seller who collects sales tax from a buyer over time must hold those funds in trust and must remit them to DOR. RCW 82.08.050(2)-(3). A seller cannot use sales tax funds for other purposes; if a seller fails to remit the funds for any reason, the seller is personally liable. Id. A seller making a credit sale to a customer who later defaults in payment will have remitted sales tax to the State that it could not collect from a customer. E.g., Puget Sound Nat'l Bank v. Dep 't of Revenue, 123 Wn.2d 284, 287, 868 P.2d 127 (1994); James A. Amdur, Annotation, Recovery of Sales Taxes Paid on Bad Debts, 38 A.L.R.6th 255, § 2 (2008).

         The former sales tax and B&O tax administrative rule reiterated that under RCW 82.08.037 and RCW 82.04.4284, sellers are entitled to a credit, refund, or deduction for sales or B&O taxes previously paid on "bad debts" under section 166 of the Internal Revenue Code, and the former rule further provided that taxpayers "may claim the credit or refund for the tax reporting period in which the bad debt is written off as uncollectible in the taxpayer's books and records and would be eligible for a bad debt deduction for federal income tax purposes." Former WAC 458-20-196(2)(a), (3)(a) (2005).[3] The policy behind this statute is to "provide relief to vendors" left holding uncollectible sales tax. Home Depot USA, Inc. v. Dep't of Revenue, 151 Wn.App. 909, 917, 215 P.3d 222 (2009) (citing Amdur, supra).

         As noted, RCW 82.08.037(1) has four requirements: a taxpayer must (1) be a seller (2) making sales at retail and (3) entitled to a refund for sales taxes previously paid on bad debt (4) that is federally deductible.[4] Lowe's and DOR do not dispute that Lowe's has satisfied requirements one, two, and four. The parties' dispute involves the meaning of requirement four, as well as whether it satisfies requirement three. Lowe's asserts, "Washington look[s] exclusively to federal law and standards relating to bad debt losses" to determine state deductions. Pet. for Review at 12. Therefore, they assert a federal deduction automatically meets state requirements.

         Federal Bad Debt Deduction

         26 U.S.C. § 166(a)(1) allows as a deduction "any debt which becomes worthless within the taxable year." It permits a deduction for "bad debts owed to the taxpayer" and states that for this purpose, bad debt shall be taken into account as a deduction for debts that become worthless. 26 C.F.R. § 1.166-1(a). Only a bona fide debt arising from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed sum of money qualifies. 26 C.F.R. § 1.166-1(c).

         If a taxpayer agrees in the course of business to act as a guarantor of a debt obligation and makes a payment of principal or interest in discharge of that obligation as a guarantor, that payment is "treated as a business debt becoming worthless in the taxable year in which the payment is made." 26 C.F.R. § 1.166-9(a). A taxpayer's payment discharging its agreement to act as a guarantor of an obligation will be treated as worthless debt if the agreement was entered into in the course of the taxpayer's trade or business or transaction for profit, the taxpayer was subject to an enforceable legal duty to make the payment, and the agreement was entered into before the obligation became worthless. 26 C.F.R. § 1.166-9(d).

         Relevant Cases

         To resolve this case, the parties refer us primarily to two tax refund cases: Puget Sound National Bank, 123 Wn.2d284, and Home Depot USA, 151 Wn.App. 909. In Puget Sound National Bank, car dealers entered into installment contracts with buyers. When the dealers and buyers entered into the contracts, the dealers had to pay DOR the sales tax due on the purchase price of the car. Puget Sound Nat'l Bank, 123 Wn.2d at 285.. When Puget Sound National Bank (PSNB) purchased the installment contracts from the dealers, it paid the dealers the balance due on the installment contracts, including the uncollected portion of sales tax, and the dealers assigned to the bank all their rights in the installment contracts. In that case, after assignment, buyers defaulted on their payments, and PSNB repossessed the cars, selling them at a loss and writing off the loss as worthless debt for federal tax purposes. Id. at 286. PSNB unsuccessfully petitioned DOR for a tax refund on the income tax loss as the assignee of the installment sales contracts under RCW 82.08.037. The sales tax refund statute, RCW 82.08.037, permitted a refund if the seller was (1) a person (2) making sales at retail and (3) was entitled to a refund for sales taxes previously paid on debts that are deductible as worthless for federal income tax purposes. Id. at 286-87. This court affirmed that a "seller" is every person making sales at retail or retail sales to a buyer or consumer and that a "person" includes an assignee. Id. at 287. It determined that PSNB, as assignee, was a person and took a worthless debt deduction for federal income tax purposes relating to the installment contract. Id. Further, although the dealer and not PSNB made the retail sales, the court observed that no statute or public policy prohibited the assignment of a sales tax refund. Id. at 288-91. The court held that an assignment carries with it the rights and liabilities of the assigned contract and applicable statutory rights and liabilities, so when the dealers assigned the installment contracts to PSNB, the bank assumed all the dealers' rights and liabilities related to the contracts. Id. at 293. Consequently, under RCW 82.08.037, the status of PSNB included the dealers' tax attribute of "making sales at retail," and PSNB, as assignee, was entitled to a sales tax refund. Id.

         In Home Depot, the retailer and financier, General Electric Capital Corporation, agreed it would issue Home Depot credit cards to Home Depot customers. The agreement between the financier and Home Depot provided that the financier was the exclusive owner of the credit card accounts and bore the risk of credit losses on the accounts, and that Home Depot had no interest in the accounts or indebtedness of the credit card program the financier had created. The financier made all decisions regarding customer eligibility for the credit cards, and it set the finance charges, fees, and all other terms of the credit card accounts. The financier paid Home Depot bonuses in consideration for the agreements. Home Depot daily transmitted the credit card sales to the financier, which then paid Home Depot the proceeds on the sales, including retail sales taxes, minus charges for service fees. Home Depot deducted the service fees it paid the financier as a business expense on its federal tax return. The financier took the bad debt deduction under section 166 for defaulted Home Depot accounts on its federal income tax return. Under RCW 82.08.037, Home Depot sought a refund of sales tax that it paid on defaulted transactions made on the credit card that it had contracted with the financier to establish. It argued that a seller is entitled to a sales tax refund for sales taxes previously paid on debts that are deductible by any company as worthless for federal income tax purposes so long as the seller/sales tax refund claimant shows that it actually bore the risk of loss from the defaulted debt. Home Depot, 151 Wn.App. at 915. DOR denied the refund.

         In affirming DOR, the Court of Appeals noted that RCW 82.08.037 required a "seller" to be a person making sales at retail who was entitled to a refund for sales taxes previously paid on debts that are deductible as worthless for federal income tax purposes. Id. at 919. It also recognized that a seller could include an original seller's assignee and that an original seller could assign the tax attribute of "making sales at retail" to a financing entity, making it eligible for a sales tax refund. Id. It observed that Home Depot sold goods and made sales at retail, but it held that it was not "entitled to a refund for sales taxes previously paid on debts that are deductible as worthless for federal income tax purposes" because that requirement applied only to seller-claimants that incur the deductible debt. Id. at 918-19. The court reasoned that Home Depot sold all of its interest in the credit card accounts to the financier, thereby surrendering both its right to deduct losses on the credit card accounts as bad debt and its ability to claim a refund for the defaulted debt. Id. at 920. Thus, Home Depot no longer had authority to deduct customer defaults on the cards as bad debt or to seek the sales tax refund. Id.

         The Home Depot court found this holding consistent with other state laws and with federal bad debt statute 26 U.S.C. § 166, which ties the sales tax refund to a valid, existing debt between a seller and a buyer that the seller can no longer collect from the buyer and that is an enforceable obligation arising from a debtor-creditor relationship. Id. at 920-21. The court observed that when a buyer purchased an item on a Home Depot card, Home Depot paid the sales tax due to DOR, creating a statutory debt due from the buyer to the seller, Home Depot. But, immediately after the sale, when Home Depot submitted the charge to the financier and the financier reimbursed Home Depot for the purchase price and sales tax payment, the statutory debt between Home Depot and the buyer ceased to exist, and the buyer no longer owed Home Depot anything because the buyer's statutory debt, as well as the underlying debt for the purchase price, was discharged. At that point, Home Depot no longer held any debt that was "directly attributable to its sales tax payment to" DOR. Id. at 922.

         Importantly, the court noted that Home Depot no longer had any right to collect unpaid sums from the buyer and could not legally seek repayment from the buyer for any loss due to the buyer's later default because Home Depot sold all its rights to the Home Depot card account to the financier, further demonstrating that the statutory sales tax debt was no longer connected to Home Depot. Id. The court held that although RCW 82.08.037 did not explicitly require bad debts to be deductible by the refund claimant, state and federal tax laws demonstrated that "the party seeking the deduction must be the one holding the bad debt as well as the one to whom repayment on such a debt would be made." Id. (citing Alabama, Indiana, and Oklahoma cases). Home Depot was promptly paid in full, including sales tax, and was not the party who wrote off the receivable as uncollectible to get a sales tax refund, so its argument failed. Id. The court rejected Home Depot's argument that in setting agreed service fees that the financier paid to Home Depot, the parties incorporated the anticipated bad debt expenses into their pricing calculations, and so Home Depot suffered actual loss, because it would allow Home Depot a sales tax refund for an ordinary business expense. Id. at 923-24. Simply "because someone can deduct the unpaid sales tax as a bad debt does not transform an ordinary business expense or loss into a refundable sales tax debt" under RCW 82.08.037. Id. at 924.

         Relying on Home Depot, DOR, here, argues that Lowe's profit share reductions qualified as bad debt from a guarantor loss under section 1.166-9, but they did not qualify as retail sales or B&O tax bad debt under state law because they did not constitute bad debt directly attributable to the retail sale for "sales taxes previously paid" and "written off as uncollectible." Instead, DOR argues, the guaranteed profit share reduction covered the banks' credit account losses. And once Lowe's collected the taxes from buyers, it held them in trust until paid to DOR, RCW 82.08.050(2), and no authority states that Lowe's could later "negate" the buyer's satisfaction of the sales and B&O tax obligation through an agreement with the banks.

         DOR reasons that here, as in Home Depot, the banks contracted with Lowe's to provide the credit card accounts; determined the eligibility of cardholders; set the terms, fees, and penalties of the accounts; and exclusively owned and managed the credit card accounts, including account indebtedness and outstanding receivables. And Lowe's sold any right, interest, or title in any payment made by or on behalf of the account holder to the banks, which controlled all account collection. Within days of a credit card purchase, the banks paid Lowe's the full amount of the purchase, including sales and B&O taxes, so that the buyer then ceased to owe Lowe's anything, and Lowe's no longer held any debt "directly attributable" to its B&O or sales tax payments to DOR. Although Lowe's took a bad debt deduction pursuant to section 166 for the amount of the banks' bad debt that it guaranteed relating to the banks' account losses, that debt arose after the banks had paid Lowe's in full for an account purchase, including sales and B&O tax. Thus, the court held that the bad debt Lowe's paid was not "directly attributable" to Lowe's retail sale.

         We disagree. First, we note that the language "directly attributable" is nowhere in the statutes or regulations. Even if it that language did appear, there is no doubt that Lowe's was the retail seller, that it remitted sales tax to DOR, and that it was also the guarantor of the unpaid sales tax. DOR argues that Lowe's did recover the sales tax; it was fully paid by the banks, and then remitted to the State by Lowe's. But Lowe's did not receive payment from its buyers who had defaulted, and it was guarantor to the banks for the unpaid sales tax.[5] A seller making a credit sale to a customer who later defaults in payment will have remitted sales tax to the State that it could not collect from a customer. Puget Sound Nat'l Bank, 123 Wn.2d at 287.

         Similar to PSNB, which acted as assignee in Puget Sound National Bank, Lowe's contracted to act as guarantor for its customers who defaulted on credit payments and thus failed to pay sales tax that was due. As this court observed in Puget Sound National Bank, no statute or public policy prohibited the assignment of a sales tax refund. Id. at 288-91. The court held that an assignment carries with it the rights and liabilities of the assigned contract and applicable statutory rights and liabilities, so that when the dealers assigned the installment contracts to PSNB, the bank assumed all the dealers' rights and liabilities related to the contracts. Id. at 293. Here, no one questions that Lowe's was the seller and that Lowe's assumed the legal liability for losses attributable to its customers who defaulted, including unpaid sales tax. That the bad debt was created in two steps rather than one is of no moment-the policy underpinning the bad debt deduction is to "provide relief to vendors" left holding uncollectible sales tax. Home Depot, 151 Wn.App. at 917.

         As noted, section 166 allows as a deduction "any debt which becomes worthless within the taxable year." And if a taxpayer agrees in the course of its business to guarantee a debt obligation and it makes a "payment of principal or interest... in discharge of. . . the taxpayer's obligation as a guarantor," that payment is "treated as a business debt becoming worthless in the taxable year in which the payment is made." 26 C.F.R. § 1.166-9(a). A taxpayer's payment in discharge of its agreement to act as a guarantor of an obligation will be treated as worthless debt only if the agreement was entered into in the course of the taxpayer's trade or business or a transaction for profit, the taxpayer was subject to an enforceable legal duty to make the payment, and the agreement was entered into before the obligation became worthless. 26 C.F.R. § 1.166-9(d). These provisions entitled Lowe's to the sales and B&O tax credits because its payments, in the form of the banks' deductions from its profit share and made pursuant to an agreement executed before the debt became worthless, discharged its legal obligation as a guarantor of the sales and B&O tax bad debt.

         We agree with Lowe's that Home Depot does not control because there the financier was completely responsible for all its bad debt relating to nonpayment of retail sales tax and never agreed to act as Home Depot's guarantor, while here Lowe's agreed to guarantee a portion of the banks' credit card related bad debt for sales taxes previously paid that were "written off as uncollectible."

         WAC 458-20-196 entitles sellers to a refund for sales taxes or B&O taxes previously paid on bad debt under section 166 of the Internal Revenue Code, and ensures that taxpayers may claim the refund "for the tax reporting period in which the bad debt is written off as uncollectible in the taxpayer's books and records and would be eligible for a bad debt deduction for federal income tax purposes." Former WAC 458-20-196(2)(a), (3)(a). Consistent with federal standard section 166, former WAC 458-20-196 merely stated when a taxpayer may claim a credit or refund; it did not require a taxpayer seeking a tax refund to have claimed the bad debt as an uncollectible debt on its books, and it did not address a guarantor's payment of a financier's ...


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