Supreme Court: State owes Menasha Corp., others $265 million

By Steven Walters and Avrum Lank
Milwaukee Journal Sentinel

The state Supreme Court ruled today that state government illegally collected sales taxes on customized computer software — a decision that could cost state government $265 million in refunds and interest it doesn't have.

The 4–3 decision upheld the state Tax Appeals Commission, which ruled that the Menasha Corporation was illegally charged the 5-percent state sales tax on specialized software it purchased. State tax collectors had argued what the company bought was prewritten computer software, which is subject to the sales tax.

Writing for the court, Justice Annette Ziegler said the three-member Tax Appeals Commission was created as "the final authority for hearing and determination of all questions of law and fact" on taxation issues. The commission's decision in the Menasha case had been reversed by a Dane County judge.

The Legislative Fiscal Bureau has warned that the decision could cost state government about $265 million, when claims expected to be filed from other companies for refunds and interest is figured.

Gov. Jim Doyle could call lawmakers, who are busy campaigning for their re-election in November, into special session to deal with the problem.

Doyle spokesman Lee Sensenbrenner said the governor would consider whether to call a special session of the Legislature to rebalance the budget as a result of the court decision, or whether the refunds could be handled as part of the 2009–11 budget that must pass next year.

If a special session is called, it would be the second budget fix needed since the current two-year budget was signed into law last October.

"We've managed bigger revenue challenges than this before," Sensenbrenner added.

State Revenue Secretary Roger Ervin said in a statement the decision showed why Wisconsin should join other states that have passed the Streamlined Sales Tax Agreement, a proposed national standards for items subject to the sales tax and items that are exempt.

"With this [ruling] now settled, it will be our goal to work with industry to consider any legislative or rule changes to bring more clarity to our sales tax statutes," Ervin added.

In spite of Menasha's interpretation of the law, the state imposed a sales tax on the software, which Menasha paid and then appealed. The state Tax Appeals Commission ruled in favor of Menasha, but Dane County Circuit Judge Steven D. Ebert later ruled that the Wisconsin Department of Revenue was correct in assessing the sales tax.

In 2007, the Court of Appeals in Madison reversed Ebert's ruling and said the tax should not have been assessed. The Wisconsin business community rallied around Menasha, with the Wisconsin Manufacturers & Commerce organization helping to finance the appeal to the Supreme Court, as well as filing a friend-of-the-court brief in the matter.

WMC also spent about $2 million in support of the campaign of Ziegler, a situation that caused complaints from some in Madison when she declined to step aside when the case was argued last year.

Ziegler ultimately wrote the opinion.

The decision worsened the state's budget picture significantly, because future spending commitments exceed revenues by more than $800 million — before today's ruling, which could cost an additional $265 million.

The case had been widely followed in the business community, with dozens of other companies having claims for sales tax refunds similar to Menasha's.

The case was a test of the definition of customized software under Wisconsin law. Customized software is not subject to sales tax, whereas off-the-shelf programs, such as those sold in boxes at retail outlets, are.

Exactly where to draw the line between the two categories long has been a point of contention between the state Department of Revenue and the Wisconsin business community.

The case decided Friday was seen as a test to answer that question. Specifically, it involved a companywide, multi-million dollar software package installed by the Menasha in the 1990s. Menasha, based in Neenah, is a privately held company that has sales of more than $900 million annually making packaging at plants across the United States.

It spent considerable time and money modifying the software, leading it to argue that the program had been customized and was therefore tax exempt.

Read the ruling

Budget director: Special session not necessary: The state budget director said today he sees no need for a special legislative session to respond to a state Supreme Court ruling ordering about $265 million in sales tax refunds and interest to businesses that bought specialized computer software.

"There's no sort of immediate need right now," said Budget Director David Schmiedicke. He said businesses entitled to the refunds and interest have six months to file those claims — a time frame that makes the question of how to pay the $265 million part of deliberations on the 2009–11 budget.

Schmiedicke said the only immediate impact on the current budget is an annual loss of about $28 million, because the court ruling made it clear that the 5-percent state sales tax cannot be collected on customized software bought by businesses.

An expected $106 million surplus when state government closes its books on the current budget next June 30 can more than offset the $28 million annual loss, Schmiedicke said.

Sen. Mike Ellis (R–Neenah) also said today "little would be accomplished" by calling the Legislature into special session, because the court did not specify how, and over what period, the $265 million in sales tax refunds and interest payments must be paid.

The 4–3 decision upheld the state Tax Appeals Commission, which ruled that the Menasha Corporation was illegally charged the 5 percent state sales tax on specialized software it purchased. State tax collectors had argued what the company bought was prewritten computer software, which is subject to the sales tax.