Mastercard Int'l v. S.C. Dep't of Revenue

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Mastercard International Incorporated, Petitioner, v. South Carolina Department of Revenue, Respondent.

No. 20-ALJ-17-0008-CC

South Carolina Administrative Law Court Decisions

June 3, 2024

Leah Robinson, Esquire Michael J. Kerman, Esquire Bryson M. Geer Esquire For Petitioner Mastercard International Incorporated.

Adam J. Neil, Esquire Nicole M. Wooten, Esquire Jason P. Luther Esquire Sean G. Ryan, Esquire For Respondent South Carolina Department of Revenue.

FINAL ORDER AND DECISION

Milton G. Kimpson, Judge.

STATEMENT OF THE CASE

This matter is before the South Carolina Administrative Law Court ("ALC" or "Court") following Mastercard International Incorporated's ("Mastercard") request for a contested case hearing pursuant to subsection 12-60-460 of the South Carolina Code (2014). Mastercard challenges the South Carolina Department of Revenue's ("Department") assessment of corporate income taxes, license fees, interest, and penalties for the tax years 2007 through 2016 ("Audit Period").

The dispute concerns the income tax implications of Mastercard's activities in South Carolina. The Department's Determination concluded that Mastercard should have sourced to South Carolina all of the gross receipts arising from revenue generated from Merchant/Cardholder transactions initiated in South Carolina. The Department determined that Mastercard's income producing activity - the provision of a credit card network (also referred to herein as the "Mastercard Network" or "Network") - occurs in South Carolina, which subjects Mastercard to income taxes according to subsection 12-6-2290 (2014 & Supp. 2023).

Mastercard operates a worldwide credit card Network, including accepting cards at Merchant locations in South Carolina. While Mastercard contends that it does not have contractual relationships with Cardholders, the Mastercard Network enables Cardholders to purchase goods and services from Merchants using Mastercard branded credit and debit cards. Mastercard does not dispute that credit and debit card transactions occur in South Carolina, but contends its Network is not present in the State and that its income is generated elsewhere. Thus, Mastercard asserts it has no obligation to pay income taxes to South Carolina.

The Department argues that Mastercard's Network is present in South Carolina and that the provision of the Mastercard Network is Mastercard's income producing activity. According to the Department, Mastercard contracts with banks in South Carolina, advertises in South Carolina, and maintains, operates, and regulates its Network within South Carolina. Mastercard charges fees each time one of its cards is used to pay for goods or services at Merchant locations or used at an automatic teller machine (ATM). Therefore, the Department contends that Mastercard derives revenue from transactions initiated here. Because Mastercard operates its Network in South Carolina and that Network produces income the Department assessed income taxes to Mastercard.

This dispute requires the Court to decide three issues. First what is Mastercard's income producing activity? Second, did the income-producing activity occur within South Carolina such that Mastercard should have paid income taxes to the State? Lastly, if Mastercard is liable for South Carolina taxes, is it also required to pay penalties and interest because of its failure to file income tax returns and pay income taxes during the Audit Period?

EXHIBITS AND TESTIMONY

This contested case hearing began March 8, 2022, and concluded on March 11, 2022. At the start of the hearing, the Court admitted into the record 37 exhibits offered jointly by Mastercard and the Department (Joint Exhibit Nos. 1-37). During the hearing, the Court admitted two additional exhibits offered by Mastercard (Petitioner's Exhibits 1 and 2) and one exhibit offered by the Department (Respondent's Exhibit 1). Four fact witnesses and two expert witnesses gave testimony, as described below. In addition, pursuant to Rule 32(a)(2), SCRCP, Mastercard designated several statements from the deposition of Robert King, the Department's representative for purposes of Rule 30(b)(6), SCRCP, and the Department counter-designated statements of its own. The parties filed the designations during trial on March 9, 2022.

Mastercard presented three fact witnesses: (a) Ruby Naskiewicz Mastercard's Vice President of Federal Tax; (b) Ken Cavallo, a Senior Operations Engineer for Mastercard; and (c) Joe Buehler, Mastercard's Senior Vice President of Technology Risk Management. Mastercard did not believe expert testimony was needed in this matter and, accordingly, did not call any expert witnesses.

The Department presented one fact witness and two expert witnesses: (a) Orville Sharpe, the Department's lead auditor in the Mastercard audit; (b) Jim Hawkins, a professor at the University of Houston Law Center, who was admitted as an expert in "consumer credit markets"; and (c) John Swain, a professor emeritus from the University of Arizona's College of Law, who was admitted as an expert in state and local tax policy.

DISCUSSION and FINDINGS OF FACT

Having observed the witnesses and evidence at the hearing and considering the burden of proof and the witnesses' credibility, the Court makes the following findings of fact by a preponderance of the evidence:

I. Mastercard's Business Operations.

Mastercard is a wholly owned subsidiary of Mastercard Incorporated, a technology company in the payments industry, headquartered in Purchase, New York. Mastercard's primary business is transaction processing, which includes services commonly referred to as "authorization" "clearing", and "settlement". Mastercard does not itself loan money or issue credit cards to consumers and contends that it does not facilitate Merchants' acceptance of credit cards for the purchases of goods and services.

Mastercard operates a payment systems Network using what is commonly called the "four party" model. Mastercard's Network and the parties thereto are governed by a complex system of rules and regulations initially outlined in the "Mastercard Rules" (also referred to herein as "Rules"), a copy of which was introduced into evidence.^[1] In addition, the Record contains the Mastercard License Agreement, Mastercard Authorization Manual, Mastercard Settlement Manual, and various other documents and information.

Despite its name, the "four party model" actually includes five parties: (1) the Cardholder (an individual or business using a Mastercard-branded credit or debit card to pay for goods or services); (2) the Merchant (a seller of goods and services who is authorized to accept Mastercard branded cards as payment pursuant to what is referred to in the Rules as a "Merchant Agreement"^[2]; (3) the Merchant's bank or "Acquirer Bank" (the bank used by a Merchant to process credit/debit card transactions); (4) the Cardholder's bank or "Issuer Bank" (the bank that issues credit/debit cards to Cardholders, authorizes payments to Merchants on the Cardholder's behalf, and allows the Cardholder to carry a credit balance)^[3]; and (5) Mastercard itself via the Mastercard Network. If a Cardholder's transaction is authorized, there are two other steps: clearing and settlement. Clearing is the process through which Issuer and Acquirer banks reach a net position with respect to batches of transactions. Settlement occurs when Acquirer Banks and Issuer Banks actually exchange funds. Mastercard controls and facilitates all steps in these processes. During the Audit Period, some of Mastercard's Issuer Banks, Acquirer Banks, Merchants and Cardholders were located in South Carolina..

II. Mastercard's Generation of Income and the Steps in Transaction Processing.

Mastercard receives the vast majority of its income from (a) authorization, (b) clearing, (c) settlement, and (d) assessment.^[4]

(a) Authorization Approval Process for Credit Card Transactions.

Authorization, from an industry-wide perspective, refers to the overall process of seeking a payment approval or declined message for a particular card transaction. Under this meaning, authorization starts with a Cardholder's purchase attempt using a credit or debit card at the point of sale, such as a cash register or the checkout page on a website. Once the Cardholder attempts a purchase, the transaction information is routed from the Merchant's point of sale to the Merchant's Acquirer Bank. The Merchant's Acquirer Bank will then relay this information to Mastercard via a Mastercard Interface Processor ("MIP"), which is hardware located at the Acquirer Bank's data processing center used to connect to the Mastercard Network.^[5] Once Mastercard receives this information from the Acquiring Bank's MIP, Mastercard will "authenticate" (or validate) the transaction information and transmit this information to the MIP located at the Issuer (Cardholder's) Bank's processing facilities.^[6] The Issuer Bank then decides whether to approve or decline the transaction and notifies Mastercard of its decision. Mastercard transmits the Issuer Bank's response to the Merchant's Acquiring Bank and this information is thereafter relayed to the Merchant. Mastercard contends that its authorization service is complete once it delivers the Issuer Bank's decision to the Acquirer bank.

Mastercard divides the authorization process into twelve distinct steps. Attachment A to this Order is a diagram from a joint exhibit depicting the various steps in the process. In most instances, authorization takes less than seven seconds and as little as 130 milliseconds. Mastercard's authorization process begins when a Cardholder presents a Mastercard as payment for a transaction; at the end of the authorization process, a Merchant is...