Courts Rebuffing State Tax Grabs

The Dot Food case shows that courts will not always stand for states' attempts to assess taxes on out-of-state companies.
Robert WillensAugust 23, 2011

Strapped for revenue, states have been frequently advancing novel interpretations of the law with a view towards curtailing tax exemptions that taxpayers – particularly out-of-state taxpayers -have historically enjoyed.

In most instances, those attempts have failed. The reason is often that the courts conclude that the exemptions are expressly provided for by the unambiguous statutes.

Thus, they conclude, the state’s attempt to interpret such language in new ways must be set aside. One company that received such a favorable ruling in a state is Dot Foods, which sells food products to food service companies in the state of Washington. Dot contracts with its wholly-owned subsidiary, DTI, to solicit the sale of Dot’s products in Washington.

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For many years, Dot got a Business and Occupation (B&O) tax exemption for 100% of its sales because it was an out-of-state seller making sales in Washington exclusively to or through a “direct seller’s representative.” For this purpose, a direct seller’s representative is defined as someone who buys, sells, or solicits the sale of consumer products in places other than a “permanent retail establishment.”

Dot got the exemption even though some of the products purchased from it were later sold to permanent retail establishments (without Dot’s or DTI’s involvement) and even though it sold both consumer and non-consumer products.

But in late 1999, the Washington Department of Revenue (DOR) revised its interpretation of the governing law, (RCW 82.04.428). The state’s new interpretation required that, in order to qualify for the exemption, out-of-state sellers could never sell any consumer products that anyone would eventually sell in a permanent retail establishment anywhere in the “chain of distribution.”

Because some of Dot’s products eventually wound up in permanent retail establishments, like grocery stores, the DOR assessed a B&O tax against Dot for 100% of its in-state sales. Moreover, the DOR argued that Dot didn’t qualify for the exemption (from B&O tax) because it sold some non-consumer products through DTI. The Washington Supreme Court, in overturning the lower court’s holding, ruled that Dot’s exemption remained firmly intact. (See Dot Foods, Inc. v. Washington Department of Revenue, S. Ct., No. 81022-2, September 10, 2009.)

The court found that, in the wording of the relevant statute, the term “exclusively” modifies the method by which a direct seller makes its sales in Washington: sales must be made exclusively to or though a direct seller’s representative. The word does not modify the type of purchases (i.e., consumer versus non-consumer) that a direct seller’s representative must make. Thus, the court rejected the DOR’s interpretation. To do otherwise, the court concluded, would add words to and rewrite an unambiguous statute.

The DOR also argued that because some of Dot’s products end up in permanent retail establish-ments because of “downstream commerce,” DF was not exempt from B&O tax. Once again, the court disagreed with the DOR. Under the statutory provision, in the court’s view, the DOR could not hold Dot responsible for taxes on sales it has nothing to do with.

The statute’s language does not pertain to some downstream purchaser of a product after the out-of-state seller has made its final sale to or through its direct seller’s representative, the court found. In this case, Dot’s sales though DTI are the final sales as far as the transaction concerns Dot. If Dot’s final-sale customer later resells the product (or a byproduct of that product) to a permanent retail establishment, such a transaction has no effect on Dot’s tax status.

In the final analysis, Dot remained fully eligible for the B&O tax exemption, the court concluded. It was another decision in which a state’s attempt to grab revenue from an out-of-state company by revising its interpretation of the law was turned back by a state court.