This morning, the North Carolina Court of Appeals released its decision in Delhaize America, Inc. v. Lay, No. COA11-868 (N.C. Ct. App. 2012). Delhaize, formerly known as Food Lion, formed an intangible holding company as part of a restructuring in the late 1990s. The Secretary of the North Carolina Department of Revenue sought to combine Delhaize with its intangible holding company on the ground that combination was necessary to reflect Delhaize’s “true earnings,” which is a North Carolina statutory standard used to justify the application of forced combination. The Department assessed Delhaize approximately $20.6 million in tax, interest, and penalty, which Delhaize challenged primarily on procedural due process grounds.

The definition and application of “true earnings” has been a controversial issue. In Wal-Mart Stores East, Inc. v. Hinton, 676 S.E.2d 634 (N.C. Ct. App. 2009), the North Carolina Court of Appeals held that the Secretary of Revenue has discretionary authority to apply forced combination, and the court will not disturb the Secretary’s findings absent an abuse of discretion. Moreover, the Wal-Mart court defined “true earnings” to include income up to the limit found in the U.S. Constitution.

Delhaize presented the North Carolina trial court an opportunity to review the Secretary’s application of the “true earnings” standard in the context of forced combination. Additionally, the trial court evaluated whether the Secretary’s application of a penalty was proper. The trial court ruled for the Department on the forced combination based primarily on the North Carolina Court of Appeals’ broad interpretation of “true earnings.” However, the trial court ruled in Delhaize’s favor on the penalty issue. The trial court found that the penalty was unfair and punitive and that it violated the U.S. and North Carolina Constitutions.

On appeal, Delhaize argued that the Secretary’s application of “true earnings” changed and that Delhaize was not given adequate fair notice of the change. Specifically, Delhaize argued that the Secretary previously had found a violation of the “true earnings” standard only when a taxpayer’s transactions were not arm’s length. The Secretary did not apply this arm’s length standard to Delhaize, and Delhaize argued that it was not given sufficient notice of the Secretary’s evolved position to satisfy constitutional due process.

Today’s decision by the North Carolina Court of Appeals resulted in Delhaize losing both the combination and the penalty issues. The court rejected Delhaize’s argument that the Secretary’s changed application of the “true earnings” standard violated its procedural due process rights. The court found that Delhaize had adequate fair notice of the change because several final decisions of the Department addressing the meaning of “true earnings” and combination were available to Delhaize at the time of its restructuring. Furthermore, the court said that Delhaize could have requested a private letter ruling regarding combination, as many other corporate taxpayers did in the 1990s.

The court also reversed the trial court’s decision to grant a refund of the penalty assessed by the Department. Because Delhaize had fair notice of the definition of “true earnings,” the appellate court held that the penalty did not violate Delhaize’s procedural due process rights.