NC Revenue Department disputes Philip Morris’ arguments in $8.7M tax dispute

Image of person smoking is Creative Commons via Pixabay.

Listen to this story (8 minutes)

  • The N.C. Revenue Department accuses tobacco manufacturer Philip Morris of misreading state law in a legal dispute over an $8.7 million tax bill. The dispute sits with the N.C. Supreme Court.
  • The Revenue Department argues that state law limits the value of tax credits Philip Morris was able to generate each year for cigarette exports.
  • Lower courts have ruled in favor of the state department.

The N.C. Revenue Department argues in a state Supreme Court filing that tobacco manufacturer Philip Morris is misreading state law while trying to avoid an $8.7 million tax bill.

The Richmond, Virginia-based company argues that it’s entitled to take $7.2 million in tax credits. The department disagrees. With penalties, the Revenue Department says Philip Morris owes $8.7 million. A trial judge ruled in favor of the department in September 2022.

“Philip Morris argues the decision in the case will be determined by the meaning of the phrase ‘credit allowed’ found in N.C. Gen. Stat. § 105-130.45. However, this case
is about the meaning of six words added to N.C. Gen. Stat. § 105-130.45(b) during a special session convened by the General Assembly,” according to a brief filed Friday by N.C. Justice Department lawyers. They represent Revenue in the tax dispute.

“The words ‘may not exceed six million dollars’ specifically limited the amount of credits a taxpayer could generate on the exportation of cigarettes,” state lawyers wrote. “The amendment did not disturb the separate and preexisting cap on the amount of credits that a taxpayer could use on its tax return during a single year in subsection (c). Despite a plain reading of the amended language, Philip Morris contends that subsection (b) does not limit the amount of credit that can be generated in any given year and only limits the amount that can be claimed in a tax year. Thus, Philip Morris continued to incorrectly generate credits in excess of the $6 Million Cap.”

“For tax years 2005, 2006, and 2007, Philip Morris calculated its Export Credits generated in the amount of $28,767,799, $27,374,957, and $14,310,414 respectively, far exceeding the $6,000,000 limit,” according to the brief. “Philip Morris then improperly attempted to carry forward the unauthorized credits to its 2013 and 2014 corporate tax returns.”

“Through this appeal, Philip Morris now continues to lobby for better treatment than its competitor RJ Reynolds by attempting to question the statutory construction of an unambiguous statute.” the Revenue Department’s lawyers argued.

Philip Morris filed its opening brief in the case in March.

The legal battle stems from an audit of Philip Morris’ corporate income and franchise tax returns from 2012 to 2014. The state Revenue Department disallowed tobacco export credits the company claimed for all three years.

The company challenged the department’s ruling administratively and in court. The current dispute involves credits from 2013 and 2014.

In court documents filed this spring, Philip Morris pointed back even further in time. “In 1999, the General Assembly adopted economic development legislation to provide export tax credits to cigarette manufacturers,” according to the tobacco company’s brief. “All parties agree that, under the original version of N.C.G.S. § 105-130.45 (the “Export Credit Statute”), the taxpayer could generate an unlimited amount of export tax credits based on its volume of cigarette sales, but could claim only $6 million in export tax credits per year. The General Assembly relied on the phrase ‘credit allowed’ in this statute to describe the amount of export tax credit a taxpayer could claim in any year.”

Then-Gov. Mike Easley called a special legislative session in 2003. Part of the purpose was to extend the export tax credit past 2004, according to the Philip Morris brief. But the General Assembly also developed an “enhanced credit statute” tied to jobs.

R.J. Reynolds was in the process of acquiring Brown and Williamson Tobacco Company. Lawmakers wanted to help RJR if it increased in-state employment by at least 800 jobs. But the new laws also included provisions designed to ensure that RJR did not fare better than competitors like Philip Morris if it failed to meet the job goals.

Philip Morris’ brief claimed a recent change in state government’s interpretation of the 2003 language generated the current legal dispute.

“Philip Morris always has interpreted the phrase ‘credit allowed,’ as used in the Export Credit Statute and the Amended Export Credit Statute, to denote how much credit a taxpayer may claim in a given year,” according to the filing. “For more than a decade, the North Carolina Department of Revenue never disputed Philip Morris’ interpretation. Now, the Department asserts that the phrase ‘credit allowed,’ as used in the Amended Export Credit Statute, creates not just a cap on the amount of credits that a taxpayer may claim, but also a cap on the amount of credits a taxpayer may generate in a given tax year.”

“The plain meaning of ‘credit allowed’ supports Philip Morris’ interpretation,” the company added. “The word ‘allowed’ has an ordinary meaning that connotes a permissive right to use or claim something. Both federal and North Carolina courts have applied the ordinary meaning of ‘allowed’ in tax cases. The phrase ‘credit allowed,’ as used in the Amended Export Credit Statute, should thus be given the same meaning that it has always had — a limit on the amount of tax credits that a taxpayer may claim annually, not a limit on annual credit generation.”

Philip Morris cited the history of both the 1999 and 2003 laws. “This evidence confirms the
General Assembly’s intent for the Amended Export Credit Statute to enhance credits, not limit them, as the Department now contends,” according to the brief.

The Revenue Department failed to challenge Philip Morris’ interpretation of the 2003 law for more than a decade. The department’s changing interpretation first surfaced in 2018, when it audited the company’s 2012-2014 tax returns.

“It was not until August 2020 that the Department advanced its newfound interpretation” of the law, according to the brief. “But even then, it failed to articulate a clear or accurate position. It determined that the Amended Export Credit Statute had clarified ‘the pre-existing requirement … that the amount of Tobacco Export Credits a taxpayer could generate in any single tax year could not exceed $6,000,000,’ which it said was supported by ‘the General Assembly’s contemporaneously prepared summary of the 2003 Statute.’”

But “everyone agrees” the cited provision in state law “never restricted credit generation,” Philip Morris argued. “The amended language thus could not ‘clarify’ a non-existent provision. Moreover, the General Assembly never created a document to support the Department’s interpretation.”

“This history does not support the Department’s claim that the Amended Export Credit Statute was always intended to create a new limit on credit generation,” Philip Morris’ lawyers concluded. “Rather, it shows that the Department concocted this interpretation as a newfound means of upholding the assessments and penalties against Philip Morris.”

There is no timeline for the state Supreme Court to issue a ruling in the dispute.