The North Carolina Business Court tugged on the reins of the Department of Revenue (“DOR”) in its recent case, Delhaize America, Inc. v. Lay.  In this case, the Court deemed the DOR’s $1 million tax penalty it attempted to impose on Plaintiff Delhaize (“Plaintiff”) unconstitutional since it ran afoul of both Plaintiff’s due process rights as well as the North Carolina Constitution.

In this case, Plaintiff, the North Carolina operator of Food Lion grocery stores, was audited by the DOR after it restructured its operations by placing its trademarks, trade names, service marks, and other assets in the out of state subsidiary “Food Lion Florida” (“FLFL”).  Plaintiff paid royalties and fees to FLFL and those were then repaid to Plaintiff in non-taxable dividends.  Such actions subsequently resulted in “income distortions” and Plaintiff paying less tax.  Thus, the DOR felt a $1 million dollar tax penalty was appropriate.

In rendering its decision, the Court noted that a North Carolina Statute unequivocally stated a corporation “shall not file a consolidated tax return.”  While this is clearly established, the guidelines for when combined returns might be acceptable are not leaving taxpayers completely in the dark on this issue.

As a result, the Court deemed the DOR’s $1 million penalty a violation of due process and the North Carolina Constitution.  In terms of the due process issue, Judge Tennille said taxpayers are individuals with a property interest who “must receive notice and an opportunity to be heard before the government can deprive them of their property.”  In terms of the penalty conflicting with the North Carolina Constitution—which requires the power of taxation to be exercised in a “just and equitable manner”—the Court labeled the penalty unjust since no clear guidelines have been released stating when the penalty is deserved.