November 1, 2014

Taxpayer Obtains Rare Win on Interest on Refund Claims and Non-Mutual Collateral Estoppel

Written By

By Erica Horn and Maddie Schueler

In Department of Revenue et al. v. Armstrong Utilities, Inc., Case No. 2013-CA-000987-MR (Ky. App. Oct. 31, 2014), the Kentucky Court of Appeals addressed several issues related to a cable television company’s claim for refunds of public service company property taxes (“PSC taxes”). The Department of Revenue (the “Department”) appealed to the Court of Appeals after the Franklin Circuit Court awarded Armstrong Utilities, Inc. (“Armstrong”) refunds with interest.

From 1990 to 2003, the Department issued assessments to Armstrong, a cable television company, for PSC taxes. The PSC tax was imposed pursuant to KRS § 136.120. During this time frame, KRS § 136.120 provided for imposition of the PSC tax against numerous companies including “cable television companies” and “every other like company or business performing any public service.” Effective January 1, 2006, the statute was amended to remove cable television companies from the realm of PSC tax.

Armstrong consistently maintained the Department was not permitted to tax it under KRS § 136.120 because direct broadcast satellite companies were not taxed in the same manner. Armstrong argued the Department’s assessment of PSC taxes against Armstrong violated the “uniformity clause” contained in Section 171 of the Kentucky Constitution, which requires taxes to be uniform upon all property of the same class. Armstrong paid the PSC taxes, but subsequently sought refunds. The Department denied Armstrong’s refund requests for tax years 1990, 1991, 1992, 1993, 1994, 1996 and 1997, and Armstrong appealed to the Kentucky Board of Tax Appeals.

Armstrong’s appeals were held in abeyance pending the court’s decision in Insight Kentucky Partners II, L.P. v. Commonwealth of Kentucky Revenue Cabinet, et al., Franklin Circuit Court, Civil Action No. 01-CI-01528. Insight, like Armstrong, argued the assessment of taxes against cable companies under KRS § 136.120 violated the uniformity clause, and it commenced litigation in the Franklin Circuit Court.

While awaiting a decision in Insight, Armstrong and the Department entered into settlement agreements for tax years 1997, 1999, and 2000 through 2003. The agreements for 1997, 1999, 2000, and 2001 stated refunds would be made only if KRS § 136.120 was found unconstitutional by a final judgment of the Court of Appeals or the Supreme Court of Kentucky. The 2002 and 2003 settlement agreements, however, did not contain this “final judgment” language. Instead, both agreements provided that as a final and complete settlement of the controversy, the parties agreed to several terms and conditions, including that Armstrong “shall pay all the applicable state and local property tax on the assessment … and shall not in the future request or seek a refund of any taxes paid relative to this assessment.” After execution of the agreements, Armstrong filed refund claims for tax years 2002 and 2003.

In 2004, the Franklin Circuit Court issued an opinion and order in Insight, holding the application of KRS § 136.120 to cable companies and not direct broadcast satellite companies violated the uniformity clause of Kentucky’s Constitution. The Department did not appeal the circuit court’s opinion and order.

After the court’s ruling in Insight, Armstrong filed its own suit in the Franklin Circuit Court, seeking a declaration of Armstrong’s right to its claimed refunds, with interest. The Franklin Circuit Court granted Armstrong’s motion for summary judgment, finding the parties’ settlement agreements did not prevent Armstrong’s declaratory judgment action. The court found the Department was bound by the Insight decision and prohibited from arguing KRS § 136.120 was constitutional. The court ordered the Department to issue Armstrong refunds and interest for all tax years including 2002 and 2003.

The Department raised several issues on appeal. First, the Department argued Armstrong was not entitled to a refund because KRS § 134.590 only provides for refunds “[w]hen the appropriate state government agency determines that a taxpayer has paid ad valorem [property] taxes into the state treasury when no taxes were due or has paid under a statute held unconstitutional[.]” According to the Department, this statute provides for refunds only where taxes are assessed under a statute declared unconstitutional, not where taxes are applied unconstitutionally but pursuant to a valid statute.

The Court, however, disagreed. Citing a well-established rule of statutory interpretation, the Court noted that courts should reject a construction of a statute that is unreasonable and absurd in favor of an interpretation that is reasonable and rational. The Court stated, “It is incomprehensible that the General Assembly intended that a taxpayer assessed taxes in an unconstitutional manner to have only prospective relief. Whether by reason of an unconstitutional statute or application of a constitutional statute, the General Assembly intended to grant relief to taxpayers unconstitutionally taxed.” Thus, the Court held that KRS § 134.590 provides for refunds both where taxes are assessed under a statute declared facially unconstitutional, and where taxes are assessed under a statute held unconstitutional “as applied”.

Next, the Department argued it was not bound by the court’s decision in Insight, claiming the doctrine of non-mutual collateral estoppel did not apply. In Kentucky, the elements of collateral estoppel are: “(1) identity of issues; (2) a final decision or judgment on the merits; (3) a necessary issue with the estopped party given a full and fair opportunity to litigate; [and] (4) a prior losing litigant.” Although the United States Supreme Court has held that non-mutual offensive collateral estoppel cannot be applied to the United States government, the Court noted that “Kentucky has taken a somewhat different view when applying the doctrine to state and local governments.” Citing Revenue Cabinet v. Samani, 757 S.W.2d 199 (Ky. App. 1988) and City of Covington v. Board of Trustees of Policemen’s and Firefighters’ Retirement Fund, 903

S.W.2d 517 (Ky. 1995), the Court noted that Kentucky courts have found a state or local government may be bound by collateral estoppel in limited situations.1

The Court found, under the facts, non-mutual collateral estoppel should apply to the Department in the instant case. The Court noted that, like Insight, Armstrong was a single cable company making an identical challenge to the PSC tax; thus, the stakes in the Insight litigation were similar to the stakes in Armstrong’s case. Furthermore, Armstrong could not join the Insight litigation because its cases were held in abeyance pending a decision in Insight. The Court also noted that the language in the parties’ settlement agreements—that the agreements were contingent upon a final judgment in Insight—indicated the Department believed it would be bound by an adverse decision in Insight. Finally, the court’s decision in Insight decided the substantive issue presented by Armstrong – whether a cable television company could be treated differently than a direct broadcast satellite company in the assessment of property taxes.

The Court also found the application of non-mutual collateral estoppel was appropriate because the Insight litigation and Armstrong’s case overlapped in time and subject matter, and the Department knew Armstrong’s refund requests were pending when it chose not to appeal the Insight decision. Furthermore, KRS § 136.120 subsequently was amended to exclude cable television companies from the purview of the statute, so the issue was not likely to arise in the future.

The Department also claimed the 2002 and 2003 settlement agreements prevented Armstrong from recovering refunds for those years. The language of the agreements stated they were a compromise of the controversy between Armstrong and the Department, and provided that Armstrong “shall not in the future request or seek a refund of any taxes paid relative to this assessment.” The Court agreed with the Department that this language prohibited Armstrong from claiming refunds after the agreements were executed.

Finally, the Department argued Armstrong was not entitled to interest on the refunds awarded. As stated in City of Somerset v. Bell, 156 S.W.3d 321 (Ky. App. 2005), generally, “unless authorized by statutes, interest is not collectible on taxes due the state, county, or subdivision thereof, nor on a refund thereof.” In both City of Somerset and Commonwealth of Kentucky, Revenue Cabinet v. St. Ledger, 955 S.W.2d 539 (Ky. App. 1997), the court held KRS § 134.590 does not authorize the payment of interest.

Despite the fact that both cases involved the same refund statute at issue in this case, KRS § 134.590, the Court found City of Somerset and St. Ledger distinguishable from Armstrong’s case. The Court noted that neither City of Somerset nor St. Ledger involved payment of a PSC tax under KRS § 136.120. Then, the Court relied heavily on the language of KRS § 134.580, which is the refund statute for taxes other than property taxes and taxes paid when there is a finding of unconstitutionality, to conclude Armstrong was entitled to interest on its refund claims.

Thus, the Court affirmed the Franklin Circuit Court on all issues except the award of refunds and interest for tax years 2002 and 2003.

1 In both Samani and City of Covington, the courts ultimately found the doctrine was inapplicable to the facts of the particular case. However, both cases note that collateral estoppel may be applied to a state or local government.