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This summer’s decision of the Wisconsin Supreme Court in Wisconsin Department of Revenue v. Menasha Corporation1 involved a relatively dry question of tax law, i.e., whether a base software package that required substantial modification to meet the needs of the purchaser was a “custom computer program” exempt from Wisconsin’s sales tax.2 But the case featured a series of less technical subnarratives raising questions of judicial ethics, state fiscal policy and, although less widely appreciated, the relationship between Wisconsin taxpayers and the state’s Department of Revenue.

Menasha Corporation is a packaging and logistics firm located in Neenah, Wisconsin. After a lengthy search process, it purchased a software package known as the R/3 system from a firm called SAP. The R/3 system was a rudimentary business and accounting system that could be modified to meet a user’s unique needs. While the R/3 system has been sold to many companies, no company can—or ever does—use it “off  the shelf.” After paying $5.2 million for the system, Menasha spent roughly eighteen million dollars to make the system usable in its operations.

Whether the need to customize a base program makes it “custom” involved interpretation of an administrative rule promulgated by the Department of Revenue (“Department”). That rule defined custom computer programs as “utility and application software which accommodate the special processing needs of the customer” and listed seven factors to be considered, along with “all the facts and circumstances,” in determining whether a program is “custom.”3 The rule distinguished prewritten programs from custom programs, defining the former as “programs prepared, held or existing for general use normally for more than one customer.”4

The Department of Revenue took the position that the base R/3 program was not “custom” and that the money paid for it, although not the amounts spent to modify it, was subject to sales tax. Menasha appealed to the Wisconsin Tax Appeals Commission (“Commission”) which held that the purchase price of the R/3 package was not subject to tax. It applied all seven factors and found that they militated in a finding that the system was “custom.” It held that the program was not prewritten because it was not ready to be used and emphasized the need to substantially modify the program to meet Menasha’s needs.

The Department appealed to the Circuit Court for Dane County which reversed the Commission’s decision. The court of appeals then reversed the decision of the circuit court and the supreme court granted review. In a 4-3 decision, the court affirmed the judgment of the court of appeals finding that the R/3 package was non-taxable.  Before addressing the court’s reasoning, let us pause over two of the three subnarratives.

The first was a question of judicial ethics. Wisconsin elects its supreme court justices to ten-year terms. In the last two years, we have seen hotly contested and heavily financed elections, spurred, in part, by a series of decisions in 2005 which seemed to suggest a move to a more interventionist jurisprudence.5 In the spring of 2006, certain business groups, including Wisconsin Manufacturers & Commerce (“WMC”), spent heavily in support of Judge Annette Ziegler in her race against Attorney Linda Clifford. Ziegler won handily. In the spring of 2007, the same groups spent heavily in support of the challenger, Judge Michael Gableman, against incumbent Louis Butler (who was himself supported by substantial independent expenditures). Gableman won a bitter race and, on the ground, the Wisconsin Supreme Court has become a highly charged subject.

As the Menasha case approached oral argument, a number of voices began to call for the newly elected Justice Ziegler to recuse herself. WMC had not contributed to Ziegler’s campaign but had independently financed ads promoting her election. It was not a party to the case and did not stand to benefit from the result. What it did do is file an amicus brief supporting Menasha’s position and it is fair to say that many of its members, businesses who might purchase software packages similar to the R/3 package —stood to benefit from a ruling in favor of Menasha.

This call coincided with our second subnarrative. Wisconsin, like many other states, faces a biennial budget crisis. The state’s Legislative Fiscal Bureau estimated that a ruling in favor of Menasha would result in lost tax revenues of almost $300 million through the end of the 2008-09 biennium and $28 million annually thereafter. Both dissents estimated the fiscal implication of the majority decision6 and press coverage of the decision emphasized the decision’s fiscal impact.7 In the wake of the decision, politicians called for various forms of campaign finance reform and public financing of judicial elections.8

Thus the decision fueled the debate around the elected judiciary and the nature of judicial elections. It also raised the following issue: whether the notion that a supreme court justice ought to recuse herself from cases in which factions that actively supported her election is ultimately irreconcilable with the idea of an elected judiciary. In last spring’s election, for example, while business interests supported the challenger, an organization associated with public employee unions, trial lawyers and Indian casinos spent heavily in favor of incumbent justice Louis Butler.

Having explored the atmospherics surrounding the case, let us return to the decision itself. For the dissenters, the analysis was focused upon the nature of the R/3 system at the time it was acquired without regard to what happened later. The amount Menasha paid for the system included no customization. It brought only a base package that was its responsibility to modify. This, in their view, made the program not “customized but customizable” and, therefore, it was not a program that “accommodate[s] the special processing needs of the customer.” Because the same base system was sold to many customers for subsequent modification, the dissenters argued that it was available “for general use normally for more than one customer.” and was, therefore, a prewritten program.

This is consistent with the notion that the legislator was trying to avoid taxation of amounts that, while ostensibly spent for tangible personal property subject to tax—i.e., software—are really compensation for the services that were or will be required to modify it.

However, there are other reasonable interpretations. Customized software will almost always begin with a commonly employed base system and the legislature may have not wished to tax what is in effect, the working material to be employed in what will be, for the most part, an acquisition of consulting services to create what will be, in the end, a unique system.

That view is consistent with the approach of the Tax Appeals Commission. It also focused on the nature of the R/3 system at the time of its acquisition but was concerned about what would happen later. Because the system was not useable by Menasha for anything but customization, it was not, in its view, available for “general use” and not prewritten. Because it had to be subject to substantial modification, it was, at the end of the day, a program that would “accommodate the special processing needs of the customer.” For the majority, the fact that the decision of the Tax Appeals Commission was not plainly erroneous or inconsistent with the statute or administrative rule required deference to the Commission.

And that is our third subnarrative. The majority declined to defer—or to even give much weight to the interpretation of the Department of Revenue because state law, in its view, placed final authority with the Commission. Deference to the state’s taxing authority would be inconsistent with the Commission’s quasijudicial function. “The taxpayer brings his or her appeal to the Commission at a significant disadvantage,” it reasoned, “if the Commission must defer to the taxpayer’s opponent.”9

Although reasonable people can differ on application of the sales tax in these circumstances, the idea that a taxpayer is entitled to a fresh look at the law when engaged in a dispute is, as Justice Ziegler wrote, an important issue for the individual taxpayer.

* Richard Esenberg is Visiting Assistant Professor at Marquette University Law School.

 

Endnotes

1 2008 WI 88.

2 Wis. Stat. § 77.51(20)(defi ning tangible personal property subject to tax as including “computer programs except custom computer programs”).

3 Wisconsin Admin. Code § Tax 11.71(1) (e).

4 Id. at §11.71(1)(k).

5 See, e.g., A Court Unbound? The Recent Jurisprudence of the Wisconsin Supreme Court (2007), available at http://www. fed-soc.org/publications/pubID.5/pub_detail.asp (last visited September 28, 2008).

6 2008 WI 88 at ¶128 (Abrahamson, C.J. dissenting)(“The fiscal implications of the new tax exemption created by the majority opinion are substantial”); Id. at ¶ 209 (Bradley, J. dissenting)(“Here’s the $300 million question…”).

7 Business Wins Big in High Court, Milwaukee Journal Sentinel, July 11, 2008.

8 See, e.g., Trust in Supreme Court Weakens After Tax Case, (press release by Rep. Steve Hilgenberg (D-Dodgeville) calling for passage of something called the “Impartial Judiciary Bill”), available at http://www.thewheelerreport.com/releases/July08/jul14/0714hilgenbergmenasha.pdf) (last visited on September 29, 2008).

9 2008 WI 88 at ¶ 59. 

Note from the Editor: The Federalist Society takes no positions on particular legal and public policy matters. Any expressions of opinion are those of the author. We welcome responses to the views presented here. To join the debate, please email us at info@fedsoc.org.