Key Points

  • The South Carolina Court of Appeals held that substantial evidence supports the administrative law court's finding that Mastercard's income-producing activity under S.C. Code Section 12-6-2295(A)(5) is the provision of its payment network.
  • Fees generated by Mastercard-branded transactions at South Carolina merchants are attributable to South Carolina even though Mastercard's technical processing occurs outside the state.
  • The court approved the Department of Revenue's proxy method, based on South Carolina's share of transaction counts and dollar volume, and rejected Mastercard's proposal to source receipts by the billing addresses of its twelve South Carolina bank customers.
  • The court held that admitting the department's expert, Jim Hawkins, was not an abuse of discretion and did not prejudice Mastercard, although his failure to disclose his of-counsel employment seemed deliberate.
  • The court upheld failure-to-file penalties and rejected the administrative law court's finding that cardholders and merchants are Mastercard's customers without disturbing the result.

The South Carolina Court of Appeals on Wednesday upheld a state assessment of more than $6 million in corporate income tax against Mastercard International Inc., ruling that the payments company earns taxable income in South Carolina whenever a cardholder uses a Mastercard-branded card at a merchant in the state, even though its processing equipment is located elsewhere.

Judge Vinson wrote for a unanimous three-judge panel, joined by Chief Judge Williams and Judge Konduros. The panel affirmed the state's administrative law court, which had sided with the South Carolina Department of Revenue. The decision leaves in place the department's December 2019 assessment of $6,041,666 in income tax and $84,476 in license fees for tax years 2007 through 2016, plus penalties and interest.

The ruling extends the court's 2017 decision in DIRECTV, Inc. & Subsidiaries v. South Carolina Department of Revenue, which held that DIRECTV's income-producing activity was the delivery of its signal to customers, to a card network that has no contracts with the cardholders and merchants who use it. Fees from transactions at South Carolina merchants are attributable to South Carolina, the panel held, even though Mastercard's technical processing occurs elsewhere.

South Carolina taxes a multistate service company on a share of its income based on the fraction of its gross receipts earned in the state. Under Section 12-6-2295(A)(5) of the South Carolina Code, service receipts are attributed to the state "to the extent the income-producing activity is performed within this State." The case turned on identifying Mastercard's income-producing activity, the activity that actually generates its revenue.

Mastercard does not issue cards or contract directly with cardholders or merchants, according to the opinion. Its customers are the issuer, the cardholder's bank, and the acquirer, the merchant's bank. It earns most of its revenue from "switching," its term for authorizing, clearing and settling transactions, and from assessment fees based on the dollar volume of purchases made with its cards. Its data centers are in Missouri, and the servers that relay transaction messages, called Mastercard Interface Processors, are located at bank facilities outside South Carolina.

Mastercard argued that under DIRECTV its income-producing activity was "the last step it perform[s] in its process entitling it to revenue: delivering its service to paying customers." It likened its delivery of authorization messages to the bank-side processors to DIRECTV's delivery of a signal to set-top boxes. Because South Carolina hosts none of those processors, Mastercard contended, the state should receive none of its receipts.

The panel rejected that reading. Judge Vinson wrote that the DIRECTV decision "does not specifically refer to a 'final act' to define the income-producing activity" and instead asked which activity actually generated income. "The court must instead identify the nature of the business, regardless of who pays for the service," the opinion said.

Mastercard's own annual reports showed that its fees depend on the number and dollar amount of card transactions, the court found, and its vice president of federal tax agreed that 185 million Mastercard transactions occurred in South Carolina in 2016 alone. "In other words, the financial institutions pay for the service, but it is the actual transaction between a merchant and a cardholder that generates Mastercard's income," Judge Vinson wrote. "Thus, Mastercard derives income not from its technical relay of messaging between the issuer and acquirer, but from its facilitation of the overall transaction."

The panel also rejected Mastercard's argument that its five revenue streams reflected separate activities. Authorization, clearing and settlement "are all necessary components of the transaction processing service, but none of these services is triggered unless the transaction occurs in the first place," the court wrote. It also relied on a 1964 state Supreme Court decision holding that, for a motor carrier of freight, the hauling of the freight was the transaction that primarily earned the income.

The court also upheld the department's estimate of Mastercard's South Carolina receipts. Because Mastercard did not show its actual South Carolina income, a department auditor allocated assessment fees by the state's share of national dollar volume and processing fees by its share of transaction counts. Mastercard proposed sourcing receipts to its bank customers with South Carolina billing addresses, which it conceded would assign some receipts to the state. The panel held that method unreasonable because Mastercard has only twelve such customers, out-of-state cardholders also shop in South Carolina, and nearly 1.4 billion card transactions occurred in the state during the audit period.

The panel disagreed with one finding below. The administrative judge had concluded that cardholders and merchants were also Mastercard's customers, and the appeals court held that the record did not support that conclusion but that the error did not affect the outcome.

Mastercard also challenged the testimony of Jim Hawkins, a law professor whom the department called as an expert on consumer credit markets. After the hearing, Mastercard moved to supplement the record with evidence that Hawkins was of counsel to a private law firm, a position missing from his curriculum vitae. The panel agreed that his "failure to disclose his of-counsel employment with a law firm seemed deliberate," but held that the omission did not disqualify him and that his testimony, cumulative of Mastercard's own documents, did not prejudice the company.

Finally, the court upheld penalties for failure to file returns. Mastercard filed no South Carolina corporate income tax returns during the audit period, later conceded that it was subject to the state's filing requirement, and began filing in 2017. The administrative judge had already waived penalties for failure to pay the tax, citing Mastercard's good-faith belief that its position was consistent with DIRECTV.

Lawyers for Mastercard included John C. Von Lehe, Jr. of Nelson Mullins Riley & Scarborough, LLP. Lawyers for the Department of Revenue included Robert Merrel Cook, II of the department.

The panel, which heard argument on May 6, affirmed the administrative law court's order in full without remanding any issue, leaving the assessment and the failure-to-file penalties in place.