On April 3, 2023, the North Carolina Business Court issued a decisive victory for taxpayers in a long-running dispute with the North Carolina Department of Revenue over the state’s now-expired renewable energy tax credit program. The program was intended to encourage investment in North Carolina renewable energy projects. The Department originally supported the program, but after the program expired in 2017, the Department tried to claw back hundreds of millions of dollars in credits from taxpayers who had invested in renewable energy in response to the legislature’s incentives. The Chamber has watched these cases closely, and written about them .
The taxpayer with the first dispute to reach the Business Court was the North Carolina Farm Bureau Mutual Insurance Company. The Chamber Legal Institute filed an amicus brief with the Business Court in the Farm Bureau case to protest the Department’s about-face and disregard of the legislature’s intent.
The tax credit program offered a credit equal to 35% of the cost of purchasing, leasing, or constructing renewable energy property. The tax credit statute specifically contemplated that a partnership could generate credits by constructing renewable energy property and pass the credits through to its partners. The credits were essential to attracting capital to projects that otherwise would not have made economic sense to investors. Project sponsors therefore worked with professional syndicators to find investors interested in the credits and pool them into partnerships that would then invest in the projects.
In its audits, the Department claimed the tax credit investors were not “bona fide partners” in their partnerships because they didn’t expect significant economic returns beyond the tax credits the projects would generate and because the investments were relatively low risk. In addition, the Department argued that even if the investors were true partners, they did not receive their credits through partnership allocations as the tax credit statute required but through improper “disguised sales.” The Department relied entirely on federal tax law to support its theories.
Business Court Judge Adam Conrad heard the Farm Bureau case on September 30, 2021, and released his decision in favor of the taxpayer on April 3, 2023.
The central issue in the case was whether the Department could apply federal tax law as “controlling” authority to disallow the taxpayer’s credits.
Judge Conrad held that none of the federal authorities the Department cited were part of North Carolina law. In so holding, the court cited the North Carolina Supreme Court’s 2017 decision in Fidelity Bank v. N.C. Department of Revenue. In that case, the Court held that definitions and other provisions of the Internal Revenue Code are not incorporated into North Carolina’s Revenue Act unless the General Assembly adopts the federal provision by a “clear and specific reference.” The Department had advocated for this result in Fidelity Bank but took the opposite approach in the renewable energy tax credit cases, arguing that federal Code provisions as well as federal caselaw were “controlling” precedent in deciding North Carolina tax cases.
Judge Conrad’s decision is most notable as a forceful restatement and application of the holding in Fidelity Bank. The court held that none of the federal authorities the Department relied upon had been adopted by the legislature through a “clear and specific reference” and so were not a part of North Carolina law. As a result, the case had to be resolved by applying state law.
The court’s holding thus prevents the Department from importing federal tax law into state law through its audits, litigation positions and administrative pronouncements, and is crucial to preserving the state’s control over its tax system. As the court noted, the state and federal governments have different fiscal priorities, and allowing federal priorities to control state tax decisions would seriously erode state tax sovereignty – a fundamental feature of our federal system. The court’s holding is also a major protection for taxpayers who would otherwise never know when federal tax law might be used to determine their state tax liability. This danger is highlighted by the Department’s opportunistic approach to the issue, insisting that federal law did not apply in Fidelity Bank but arguing just as insistently that it did apply in Farm Bureau.
Having determined that federal law did not apply, Judge Conrad, like the Supreme Court in Fidelity Bank, looked to state law authorities to determine the outcome of the case. In Fidelity Bank, the available state law resources were meagre. The court looked to a 19th century surety case and a public construction contract statute to determine what the legislature intended by the term “interest” in the Revenue Act. Judge Conrad was able to rely on much more cogent state law authorities. Specifically, the state’s personal income tax statutes provided clearly written definitions of the terms “partner” and “partnership.” Applying these definitions, the Farm Bureau clearly qualified as a partner in its investment vehicles. The court admitted that the personal income tax definitions did not apply directly to the tax credit statute, but the two parts of the Revenue Act were “closely related,” and “[b]y using the same words in the same (or at least a highly similar) context, the General Assembly presumably intended the same meaning.”
The court anticipated the objection that reliance on the clear personal income tax definitions might invite abuse by elevating form over substance. The court found this concern “exaggerated.” North Carolina courts “are far from powerless” when faced with abusive cases. Again relying on state rather than federal authority, the court articulated an anti-abuse doctrine that “in rare cases” the courts will apply “substance rather than form” to prevent tax “evasion” through the use of “technicalities.”
Applying this doctrine to the case at hand, the court found no abuse. The taxpayer’s transactions were real. The taxpayer had contributed millions of dollars to fund construction of real facilities that generated real renewable energy in satisfaction of clear legislative incentives to do exactly that. The fact that the investment might be low risk and unlikely to produce significant pre-tax economic returns does not change the result, especially where the investments would not be viable without the state incentives.
In summary, the Farm Bureau decision corrects an injustice inflicted on taxpayers who responded in good faith to the legislature’s invitation to invest in renewable energy and offers a path for efficiently resolving all outstanding audits without more litigation. It erects a bulwark against the erosion of state tax sovereignty and protects taxpayers who would otherwise be at the mercy of a state agency that could selectively pick its way through the vast and ever-changing library of federal tax statutes, regulations, subregulatory guidance and judicial precedent to achieve its administrative goals. Of course, all these good results are subject to the Department’s right to appeal the case to the North Carolina Supreme Court, about which the Department has not yet announced its intentions.
NC Chamber Legal Institute