Midrex Technologies, Inc. v. N.C. Department of Revenue

Citations: 369 N.C. 250; 2016 N.C. LEXIS 1126; 794 S.E.2d 785Docket: 5A16

Court: Supreme Court of North Carolina; December 21, 2016; North Carolina; State Supreme Court

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Midrex Technologies, Inc. (Midrex), a Delaware corporation based in Charlotte, is appealing a decision regarding its eligibility to use a single-factor tax allocation formula as per N.C.G.S. 105-130.4(r). This formula is available to exempt corporations classified as building or construction contractors under N.C.G.S. 105-130.4(a)(4). The Supreme Court of North Carolina upheld the lower court’s ruling that Midrex does not qualify as an "excluded corporation" under this statute for the relevant period.

Midrex specializes in developing and marketing the Midrex Direct Reduction Process, which converts iron ore into direct reduced iron (DRI) for steel production. Its operations encompass three main business areas: Engineering Services and Procurement Services, Midrex Plant Sales, and After Market Sales, with a primary focus on selling Midrex Plants. 

The Engineering and Procurement Services division employs various engineers responsible for designing essential systems and equipment for DRI plants, ensuring that all technical specifications and contractual obligations are met. These services include the design of refractory linings and gas-based equipment, as well as managing client relations and construction activities both domestically and internationally, through dedicated site and construction managers. Contracts with clients detail technical specifications, payment terms, and the scope of work for both parties involved in the construction of a Midrex Plant.

Midrex's obligations under its plant sale contracts do not include the construction, erection, or installation of systems and components for Midrex plants; these tasks must be performed by the client or hired contractors. Midrex is responsible for providing engineering, equipment procurement, and advisory services associated with construction, which includes interpreting plans, advising on construction schedules, inspecting materials and workmanship, and offering commissioning advice. Although Midrex employees occasionally assist hands-on, the client retains ultimate responsibility for on-site construction supervision. After construction, Midrex's After Market Sales division addresses operational issues by supplying additional equipment and parts.

From 2005 to 2008, Midrex entered into contracts for the sale of plants and filed North Carolina C Corporation Tax Returns that used the standard three-factor income apportionment formula. Midrex later amended its returns to use a single-factor formula, claiming to be an 'excluded corporation' under N.C.G.S. 105-130.4(r), based on its assertion that it operated as a building or construction contractor. Midrex sought a refund of $3,303,703, despite admitting that its primary business was plant sales. It classified itself under NAICS code 541330, which pertains to engineering services rather than construction. Initially, Midrex did not apportion revenue in its 2005, 2006, and 2007 tax returns, but in 2009, it used the three-factor formula for the 2008 return and filed amended returns for the previous years. The case arose from the Department's rejection of the second set of refund claims for the 2005, 2006, and 2007 tax years.

Following the filing of Midrex's amended tax returns, the North Carolina Department of Revenue concluded that Midrex did not qualify as an 'excluded corporation' because it was not engaged in business as a building or construction contractor. This determination was based on the NAICS classification system, which evaluates whether an entity’s primary activities involve the construction of buildings or structures. Midrex, identified primarily as a technology company providing direct reduced iron (DRI) production technology, was not responsible for the construction or installation of its technology.

As a result, the Department rejected Midrex's refund request. Subsequently, on October 25, 2013, Midrex filed a Petition for a Contested Tax Case Hearing to challenge this denial. Both Midrex and the Department filed motions for summary judgment, leading to a Final Decision on October 10, 2014, where the administrative law judge ruled in favor of the Department, confirming no genuine issues of material fact existed and denying Midrex's refund request.

Midrex then sought judicial review in the Superior Court of Wake County. The trial court, designated as a mandatory complex business case, affirmed the administrative law judge’s decision on October 21, 2015, stating that Midrex was not classified as an excluded corporation for the tax years in question. Although Midrex conceded the absence of disputed material facts, it argued that the judge misapplied statutory provisions regarding the definition of 'building or construction contractor' and the requirement of primary business activity. The trial court focused on the plain meaning of the terms as defined under N.C.G.S. 105-130.4(a)(4) to reach its conclusion.

Midrex claimed that its field service work under Plant sale contracts constituted construction management, arguing it was involved in "construction contracting." However, the Department of Revenue countered that Midrex was not a "building or construction contractor" since its contracts did not assign the responsibility to build or erect the plant, nor was Midrex significantly engaged in the physical labor of construction. The trial court determined that classifying Midrex as an "excluded corporation" required an analysis of relevant statutory language and principles of statutory construction. It referenced definitions from Merriam-Webster and noted that the statutory definition of "construction contractor" in N.C.G.S. 105-273(5a) emphasizes the physical aspects of "building" and "installing," which includes a broader range of activities rather than excluding subcontractors.

Despite Midrex's argument that NAICS classifications treat construction managers as contractors, the trial court clarified that NAICS recognizes oversight and scheduling services but does not classify those entities as "building or construction contractors." Consequently, the court concluded that Midrex's construction management activities, which involved oversight and scheduling without actual construction responsibility, did not align with the definition of "building or construction contractor" under N.C.G.S. 105-130.4(a)(4). The court highlighted that while Midrex provided technical advice and oversight, the client remained responsible for the physical erection of the plant. Thus, the provision of field advisory services did not qualify Midrex as a "building or construction contractor," leading the trial court to find it unnecessary to consider arguments regarding the term "engaged in business" and affirm the administrative law judge’s order.

Midrex has appealed a trial court's order concerning whether the administrative law judge appropriately granted summary judgment in favor of the Department of Revenue. Under N.C.G.S. 150B-51(d), the reviewing court can issue any order permitted by G.S. 1A-1, Rule 12(c) or Rule 56, and may remand the case for further proceedings if the court's order does not fully resolve the case. The appellate court's task is to determine if the trial court properly exercised its scope of review while applying a de novo standard for summary judgment appeals, meaning the appellate court considers the matter anew and may substitute its judgment for that of the lower court.

C corporations like Midrex are subject to various taxes in North Carolina to generate state revenue. Franchise tax is based on the corporation's total issued and outstanding capital stock, surplus, and undivided profits, while income tax is assessed on net income. Corporations operating in multiple states must adhere to allocation and apportionment rules defined in N.C.G.S. 105-122(c1)(1) and 105-130.4 to determine their tax liabilities. Non-excluded corporations must use a three-factor apportionment formula based on property, payroll, and sales, while excluded corporations can apply a single-factor sales-based formula.

Midrex's entitlement to use a single-factor formula instead of a three-factor formula hinges on its classification as an 'excluded corporation.' This classification includes corporations engaged as building or construction contractors, securities dealers, or loan companies, or those deriving over 50% of their ordinary gross income from intangible property. The absence of a specific definition for 'building or construction contractor' necessitates an interpretation of this term to determine Midrex's status. Legislative intent is paramount, discerned through the statute's plain language, legislative history, and the act's overall purpose. Courts must apply the statute based on its clear meaning, avoiding alterations to the wording. Undefined terms should be interpreted according to their ordinary meanings, often guided by standard dictionaries. In this context, 'building' relates to the process of construction, while 'contractor' refers to entities providing materials or labor for such work. The definitions emphasize physical construction activities, suggesting that Midrex's claim as a 'building or construction contractor' is contingent on whether its employees engage in constructing physical assets, like a Midrex Plant. The statutory provisions indicate that the formulas used for tax calculation apply to the corporation's entire tax liability in North Carolina, treating an 'excluded' corporation as solely engaged in the activity that defines its exclusion.

The General Assembly likely did not intend for N.C.G.S. 105-130.4(a)(4) to classify entities with minimal construction activity as 'building or construction contractors.' Instead, the statute should be interpreted on an entity-wide basis rather than focusing on a minor aspect of its operations. The Department of Revenue has historically interpreted this statute in line with this understanding. The Secretary of Revenue's published Bulletins establish the interpretation of statutory provisions, which are considered prima facie correct. Taxpayers may rely on these interpretations for compliance. The construction adopted by the Secretary is a significant factor in statutory construction issues. According to the relevant Bulletin, a 'building or construction contractor' is defined based on the NAICS classification, which categorizes businesses by their primary activities. The construction sector includes those primarily engaged in building and engineering projects. Thus, under the Secretary's interpretation, an entity is not classified as a 'building or construction contractor' unless it is primarily involved in construction activities. The evidence shows that Midrex has limited involvement in actual construction, with the client ultimately responsible for the physical construction, while Midrex provides scheduling and technical assistance.

Midrex is determined not to qualify as a "building or construction contractor" under N.C.G.S. 105-130.4(a)(4) based on both the trial court's and administrative law judge's findings. The undisputed evidence shows that Midrex classifies itself as an engineering company according to the NAICS system, which requires a company to be primarily engaged in construction activities to claim such status. Midrex acknowledges that it is not primarily involved in building activities and has assigned itself an engineering-related NAICS code. Consequently, it does not meet the criteria for "excluded corporations" as defined by the Department of Revenue.

Despite Midrex's claims of providing construction management services and limited hands-on construction work, this evidence is insufficient to classify it as a "building or construction contractor." Although construction management activities fall within the NAICS construction classification, the determination of NAICS classification relies on a company's primary business activity. The record does not support that construction management is Midrex's primary activity. Furthermore, the limited hands-on construction performed by Midrex employees is not outlined in plant construction contracts and appears incidental to its primary obligations, focusing more on demonstrating tasks to other contractors. Therefore, Midrex does not qualify as a "building or construction contractor" under the relevant statute due to its primary business activities and the nature of its work.

Midrex contends that N.C.G.S. 105-130.4, as a tax statute, should favor taxpayers like itself. However, the Department of Revenue argues that tax statutes with exceptions must be interpreted against the taxpayer. The court aligns with this perspective, noting that most C Corporations in North Carolina utilized the three-factor formula during the relevant tax years, implying that Midrex's claim to use the single-factor formula under N.C.G.S. 105-130.4(r) should be strictly construed against it. Midrex argues for classification as an "excluded corporation" based on its activities as a contractor, asserting that any non-incidental construction work justifies this status. Nonetheless, the absence of the term "primarily" in the statute does not support Midrex's position, as legislative intent is determined by the full context of the law. Allowing Midrex's interpretation would broaden eligibility for the single-factor formula beyond legislative intent, which sought to restrict it to a limited class of corporations. The court emphasizes that its role is to uphold the legislature's purpose and intent in statutory construction.

Midrex was determined not to be a 'building or construction contractor' under N.C.G.S. 105-130.4(a)(4) as concluded by both the administrative law judge and the trial court. Consequently, it was unnecessary to assess whether Midrex met the 'engaged in business' criterion of the same statute. The trial court's ruling that Midrex is not entitled to a franchise and income tax refund was upheld, affirming its decision. Although N.C.G.S. 105-130.4 has been amended to permit all corporations to use a single-factor formula starting from January 1, 2018, Midrex's tax liabilities for the years 2005, 2006, and 2007 must be evaluated based on the statutory provisions in effect during those years.