Going Retro: The Connecticut Supreme Court Abandons its Judicial Review Power in Andersen Consulting
In Andersen Consulting, LLP v. Commissioner of Revenue Services, (1) the Connecticut Supreme Court, for the second time in less than a year, applied amendments to tax legislation retroactively, thereby reversing significant taxpayer victories in the trial courts.(2) In doing so, we believe the Court has relinquished much of its judicial power to interpret tax law and granted the General Assembly the dual power to not only draft legislation but to also reinterpret the law if it disagrees with a court's interpretation of law as originally written. As a result of the Court's decisions, a disturbing trend is now emerging leaving taxpayers and tax practitioners in a precarious position whereby, in response to any lower court taxpayer victory, the General Assembly can amend legislation and now, without effective judicial review, impose such legislation retroactively, thereby reversing the taxpayer victory.
In Andersen Consulting, Andersen entered into contracts with Connecticut Natural Gas ("CNG") and Northeast Utilities ("NU"), which required Andersen to develop new computer informational systems in order to manage CNG's and NU's financial, accounting, budgeting and planning functions. With respect to the CNG software, while the final product for CNG remained the property of Andersen, CNG received a perpetual, nonexclusive license to use and modify the software. As for the NU software, Andersen upon delivery transferred to NU all intangible rights to the software but retained rights to certain tools used in the development of the software.
CNG and NU made payments to Andersen pursuant to the software development contracts and Andersen collected sales and use taxes. Subsequently, Andersen filed a claim for a refund based upon amounts charged in connection with the development and license and/or sale of the custom software itself. The Commissioner granted a partial refund with respect to the license fees under the CNG contract but denied a refund for any other charges. Andersen then filed suit in the Superior Court, seeking over $1.3 million in total refunds.
The issue at trial was whether Andersen provided "computer and data processing" services taxable under Conn. Gen. Stat. § 12-407(2)(i)(A) (as the Department of Revenue Services ("DRS") contended) or a nontaxable sale of intangible personal property, that being computer software (as Andersen contended). Both parties agreed that the "true object" of the transaction governed the issue. The trial court held in favor of Andersen, concluding that the true object of the contracts was to obtain software programs consisting of intangible intellectual property. It found that CNG and NU were seeking to obtain the final product created by Andersen, rather than obtaining the services rendered by Andersen to obtain the results realized by the computer software programs. Accordingly, the trial court concluded that "[t]he object of the contracts was not to obtain computer services, but rather, to develop software programs which, in and of themselves, would direct the performance of the computer systems." Consequently, the trial court ordered a refund plus interest to Andersen.
The DRS appealed. Less than a month after the trial court decided Andersen Consulting and while the appeal was pending, the DRS proposed legislation which amended the definition of "computer and data processing" services specifically to include "programming, code writing, modification of existing programs, feasibility studies and installation and implementation of software programs and systems even where such services are rendered in connection with the development, creation or production of canned or custom software of the license of custom software." Under the proposed revision to § 12-407(2)(i)(A), the type of customized software program developed for CNG and NU would clearly be subject to sales and use tax.
By the time Andersen Consulting, was argued before the Connecticut Supreme Court in November of 2000, the DRS' proposed legislation had become law, P.A. 00-174, without any modifications. Not surprisingly, the DRS pressed its position that notwithstanding the lower court's ruling that the true object of the transaction was the sale of intangible property, such ruling should be overturned because of the subsequent amendment to the definition of "computer and data processing" services. Accordingly, as an initial matter, the Supreme Court considered whether the amended definition of "computer and data processing services" was to apply retroactively.
As the Supreme Court in Andersen Consulting noted, it is well settled that whether a statute applies retroactively or prospectively depends upon the intent of the legislature in enacting the statute.(3) The danger, of course, of applying amendments to legislation retroactively, is to upset the settled expectations of parties under existing law and the vested rights which accrue. As a result, a presumption in favor of prospective applicability applies.(4)
Where an amendment is intended to clarify rather than change the original intent of an earlier statute, the presumption against retroactivity is rebutted and such clarifying legislation necessarily has retroactive effect.(5) In seeking to determining whether an act is a clarification rather than a change, courts acknowledge that legislative history surrounding the enactment of the amending legislation is illuminating. Because, however, it is the courts, rather than the legislature, that ultimately determine whether an act is clarifying legislation, the General Assembly cannot, "even by extensive protestations of legislative intent, convert an act that is truly curative into one that is effectively clarifying."(6) In essence, even where the legislative history is clear that the act is intended to be a clarification rather than a change in the law, it is incumbent upon the courts to decide whether or not to accept the legislative history at "face value."(7)
Thus, in determining whether legislation is a change in the law or a clarification, a court should conduct a two part analysis: first, it should determine whether the General Assembly intended the amending legislation to be a clarification; and second, it should determine on its own whether in fact such legislation, even despite the clear legislative intent, constitutes merely a clarification and not a change in the law.
In Andersen Consulting, the Supreme Court, in the first part of the two part analysis, seemed to have ignored legislative statements that shed light on the intent of the General Assembly in enacting the amending legislation. In addition, the Court seemed to have disregarded the second part of this analysis and simply held that the amended definition of "computer and data processing services" was a clarification in light of the legislative history and statutory language at the time of the amendment.
Determining Legislative Intent
In concluding that revised definition of computer and data processing services was a clarification, and thus was to apply retroactively, the Supreme Court first pointed to language in the P.A. 00-174 which provided that the section amending the definition of computer and data processing services was "to clarify that current law" subjects such services to sales and use tax. As added support, the Supreme Court then cited statements made during the legislative debate, all of which emphasized the clarifying nature of the amendments.(8)
But despite such language in the amending public act and the legislative statements, it was not clear that the General Assembly was in fact "clarifying" the meaning of computer and data processing services as originally enacted. Instead, as the legislative debates for an amendment to the P.A. 00-174 set forth below suggest, the apparent intent of the General Assembly was to codify the DRS' existing interpretation of the definition of computer and data processing services:
I refer first to Section 28 of the bill which is relevant to the so-called canned software issue and I would like to have Senator Looney confirm if it is his understanding as it is mine, very simply, that the effect of this Section, together with PA00174 passed in the last month or two on this bill, on this subject, the affect of those taken together is very simply to confirm and ratify the current practices of the Department of Revenue Services as distinct from seeking to break new ground. It is my understanding that the intention of this body is that it does not break new ground but really codifies existing practice.
Right. Yes, thank you, Mr. President. I believe, yes, Senator Nickerson is correct, Mr. President. The intent of this section is to clarify and to support existing policy of the Department of Revenue Services in terms of its procedures related to the taxation of what is designated in the bill as canned or prewritten software, as opposed to custom software.(9)
Although portions of this legislative debate were cited by Andersen in its appellate brief, the Supreme Court made no mention of these debates. Interestingly, the DRS did not cite any legislative statements in support of its position, stating simply that the intent of the General Assembly was "not to be found in legislative history such as the statements of individual legislators, but in the Act itself," which, as stated above, had specifically stated that the amending act was to "clarify" current law.(10)
ii. Independent Judicial Review
Even if the General Assembly made it clear that its intent was to clarify existing law, the Supreme Court was then obligated under the second part of the retroactive analysis to determine on its own whether in fact a clarification occurred. Stated another way, the Supreme Court then was obligated to determine whether or not "to accept the legislative history of [P.A. 00-174] at face value."(11) There was, however, no discussion in Andersen Consulting whether the Supreme Court ever considered if, notwithstanding the legislature's intent to clarify prior legislation, such amendment in fact was a mere clarification and not a substantive change to the prior law. Had the Supreme Court conducted this analysis, its conclusion regarding the retroactivity of P.A. 00-174 might well have been different. As discussed above, there is evidence that the General Assembly intended to codify the DRS' existing position which had been rejected by the trial court. If the trial court's decision in Andersen Consulting had been upheld, the State would have faced claims for significant refunds. According to an Office of Fiscal Analysis fiscal note accompanying the new law, clarifying the definition of computer and data processing services precluded a potential revenue loss of $50 million beginning with Fiscal Year 2001 and precluded potential claims of $150 million to $200 million. The legislators were made aware of this fiscal note during the legislative debates and it was reasonable to assume that they were all aware of the significant fiscal ramifications if the amendment was not applied retroactively.(12) Thus, the legislators had a great incentive to demonstrate that the changes it made were to be construed as a clarification of existing law.
Had the Supreme Court conducted its own analysis, it might have found relevant that noticeably absent from the amendment's legislative history was any reference to the intent of the General Assembly when it initially made "computer and data processing services" subject to sales tax that it meant to include the types of customized software package produced by Andersen. Additionally, it might have found relevant that at no time during the debate of the amendment was there any reference that the amending legislation was consistent with the original legislation. Indeed, reference to the understanding of the original statute would seem fundamental because by definition, clarifying legislation does not constitute a change in the law but instead merely makes explicit what was always implicit, though perhaps not clear under the original wording of the statute. In other words, to determine whether legislation is a clarification, it is crucial to understand initially the manner in which the original legislation was understood. In the past, the Supreme Court has recognized this principle and has found relevant references in the legislative history to the understanding of the original law.(13)
But unlike in these prior cases, the Supreme Court in Andersen Consulting applied legislation retroactively even though there was no evidence that the amending legislation actually implemented the General Assembly's intent in enacting the original statute. Additionally, the Supreme Court made no reference to the prior interpretations of "computer and data processing services" or the understanding of such term under the originally enacted law. Essentially then, the Supreme Court held that the amended legislation was a clarification simply because the General Assembly said such legislation was a clarification.
The absence of any independent judicial analysis in Andersen Consulting is even more stark when the analysis in the Supreme Court's earlier decision in Oxford Tire is examined. In that case, the issue was whether "scrap tires" constituted "hazardous waste" such that the removal thereof would be exempt from sales and use tax. At the time of trial, the statute defining "hazardous waste" made no reference to "scrap tires." The trial court held in favor of the taxpayer, concluding that given the broad definition of "hazardous waste," such term encompasses scrap tires.
While the DRS' appeal was pending, the General Assembly amended the definition of "hazardous waste" to specifically exclude "scrap tires."(14) The legislative history concerning the amendment contained only one statement by a representative who stated that the specific exclusion of "scrap tires" from the "hazardous waste" definition was a "technical amendment clarifying the meaning of hazardous waste." The Supreme Court admitted that the legislative history surrounding the amending legislation was "scant," but nevertheless held that this one statement provided "compelling evidence that the legislature intended to clarify, rather than to change, the definition of hazardous waste." In addition, although the parties conceded that the amendment was made in direct response to the trial court's decision that scrap tires fell within the definition of "hazardous waste," there was no indication that such amendment was meant to apply retroactively. In the past, the Supreme Court has held that "[t]he mere fact that the legislature changes the language of a statutory provision in response to a judicial decision interpreting that provision does not mean that the legislature necessarily intended that the amendatory language be retroactive."(15)
Yet, despite the scant legislative history and no explicit provisions indicating that the amending legislation was intended to apply retroactively, the Supreme Court held the amendments retroactive, thereby reversing the taxpayer victory. As it was later to do in Andersen Consulting, the Supreme Court never undertook the second part of the clarification analysis to make an independent analysis of whether in fact such amended legislation constituted a clarification or a more substantive change in the law. Thus, the Supreme Court found it unnecessary to make any reference to the understandings or interpretations of prior law. Rather, it simply accepted at face value the General Assembly's statement that such legislation was a clarification without any independent analysis of its own.
The ramifications of Andersen Consulting and Oxford Tire are not limited solely to tax statutes and thus the significance of these cases cannot be understated. Unless the rationale of these cases is later reexamined, there is no legislation that is immune from retroactive amendments. Prior to Andersen Consulting and Oxford Tire, the danger of applying retroactive legislation was reduced by the independent analysis courts conducted in order to determine that the amendments were in fact an explicit statement of what had already been established under current law. But now that the Court in Andersen Consulting and Oxford Tire has given a greater degree of deference to the legislature, no one can be sure that the rights accruing under a current statute will not be later disturbed by an amendment to the statute that in fact changes, rather than clarifies, the original statute, even if the taxpayer, or other litigant, successfully defends its position at the trial court.
Mr. Gruen is a tax partner, and Mr. SanFilippo is a tax associate at the law firm of Wiggin & Dana LLP in New Haven. Mr. Gruen is also the Chairman of the Executive Tax Section of the Connecticut Bar Association's Subcommittee on Sales and Use Tax (the "Subcommittee"). The views set forth in this article do not reflect one way or the other the position of the Subcommittee.
Endnotes:1. SC 16296 (Mar. 27, 2001). 2. In July 2000, the Supreme Court reached a similar result in Oxford Tire Supply, Inc. v. Commissioner of Revenue Services, 253 Conn. 683 (2000), discussed infra. 3. See, e.g., Connecticut v. Magnano, 204 Conn. 259, 284 (1987). 4. Coley v. Camden Associates, Inc., 243 Conn. 311, 316 (1997). 5. Toise v. Rowe, 243 Conn. 623, 628 (1998). 6. State v. Blasko, 202 Conn. 541, 558 (1987). 7. Id. 8. During the legislative debates, Senator Martin M. Looney, the Chairperson of the Committee on Finance, Revenue and Bonding, stated that "there is a section of the bill that clarifies the definition of . . . computer [and] data processing services." 43 S. Proc., Pt. 8, 2000 Sess., p. 2561. Similarly, Representative Richard O. Belden stated that under the bill, "[w]e clarify the definition of . . . computer [and] data processing services." 43 H.R. Proc., Pt. 19, 2000 Sess., p. 6187. 9. 43 S. Proc., Pt. 9, 2000 June Sp. Sess., p. 2810-12 (emphasis added). 10. Reply Brief of Appellant Department of Revenue Services at 10. 11. Blasko, 202 Conn. at 558. 12. Senator Looney specifically stated that the amendment was "to preclude a potential revenue loss." 43 S. Proc., Pt. 8, 2000 Sess., p. 2561. 13. See, e.g., Reliance Insurance Co. v. American Casualty Insurance Co., 238 Conn. 285 (1996) (legislative history indicates that General Assembly's understanding of original law irrespective of recent Supreme Court case reaching a contrary decision); Connecticut v. Magnano, 204 Conn. 259 (1987) (legislative history indicated that original law protected communications at issue despite court decision to the contrary); Tax Commissioner v. Estate of Bissell, 173 Conn. 232 (1977) (legislative debates addressed "inappropriate and unfair" results from tax commissioner's interpretation of original statute). 14. The proposed legislation was not introduced by the DRS but rather from a special interest group that objected to the inclusion of scrap tires in the highly regulated category of hazardous waste.
15. Colonial Penn Insurance Co. v. Bryant, 245 Conn. 710, 720 (1998).