By: Diane Ring
The big news this week about Krispy Kreme is that they are going to be acquired for $1.35 billion. As reported in the WSJ last night, JAB Holding Co. (a European investment fund, which the WSJ noted holds an interesting mix of assets including Caribou Coffee, Jimmy Choo shoes, and Durex condoms) is about to add glazed donuts to its asset pool. But this was not the Krispy Kreme news of the week that caught my eye. I was fascinated instead to read that this week the Missouri Supreme Court ruled on Krispy Kreme’s request for a refund of sales tax it had remitted on sales of donuts and other related items from 2003 through 2005.
Krispy Kreme had collected sales tax at the 4% rate applicable to food sold that would be immediately consumed. In contrast, food sold at grocery stores generally bore only a 1% state sales tax. Essentially, as the media described it, Krispy Kreme argued that its donuts were like grocery store food, and thus should bear only the sales tax rate applicable to such food. I may not follow the healthiest of diets but even I do not think that donuts are the equivalent of broccoli from the produce aisle. What were they thinking? But then my tax brain kicked in. I immediately understood. . .
This wasn’t about a nutritionist’s view of the basic food groups; this was about a tax lawyer’s categorization of food! Now I wanted to see what the Court had to say. At the top of the May 3, 2016 decision, was the label “en banc”. My immediate reaction was that all of the judges (only the chief judge is called a justice) wanted part of the donut decision. But the court’s longstanding practice is to hear all cases en banc. In its 17 page opinion, the court concluded that Krispy Kreme did not meet the standard in Subsection 2 of § 144.014 of the Missouri sales tax law (RSMo 2000) for the lower sales tax rate. The statute provides in relevant part:
“For the purpose of this section, except for vending machine sales, the term ‘food’ shall not include food or drink sold by any establishment where the gross receipts derived from the sale of food prepared by such establishment for immediate consumption on or off the premises of the establishment constitutes more than eighty percent of the total gross receipts of that establishment, regardless of whether such prepared food is consumed on the premises of that establishment, including, but not limited to, sales of food by any restaurant, fast food restaurant, delicatessen, eating house, or café.”
Thus began the great debate about how to determine whether a donut was in fact prepared for “immediate consumption on or off the premises of the establishment.” Given that donuts constituted the bulk of Krispy Kreme sales, Krispy Kreme framed the question as whether 80% of Krispy Kreme donuts were “immediately” consumed, on or off the premises (think customers unable to restrain themselves with a warm glazed donut beckoning in their bag). Krispy Kreme agreed that many donuts were irresistibly consumed on the premises or shortly thereafter, but contended that the 80% threshold was not met because the following categories of donuts should not count toward that 80% under the statute: (1) donuts not purchased within an hour of preparation; (2) donuts sold by the dozen; (3) donuts that customers did not consume in the store or in transit (who is watching us “in transit” with our donut bags?). I was quite curious to see what evidence was presented in court.
Krispy Kreme did an online survey of customer donut consumption habits in 2012 in which it asked customers where and when they eat their purchased Krispy Kreme donuts. The Missouri Tax Commissioner accepted the survey as evidence but concluded that it did “not establish, by a preponderance of the evidence, that it reflects consumption habits during the tax periods.”
The Missouri Supreme Court, however, found the survey not sufficiently persuasive for a different reason. The Court concluded that Krispy Kreme’s focus on actual customer consumption behavior was not what the legislature intended. Rather, the Court observed (quoting a 1988 Illinois case), that the provisions “should be ‘viewed in the light of reality’ and not ‘be stripped of common sense’ or construed ‘to establish arbitrary loopholes.’” Working through the legislative history of the sales tax, the Supreme Court noted the General Assembly’s effort to distinguish between food from restaurants (including take-out, and hot and cold food) and grocery stores. Moreover, the intended emphasis of the law was not on the consumption but on whether food was prepared for consumption–similar but not identical concepts. Ultimately, the Court determined that “Krispy Kreme’s donuts are akin to food sold by restaurants and counted toward the 80% threshold” even if not consumed immediately. Thus, the higher 4% sales tax was appropriate and no refund was due.
The Court saw its decision as furthering the goals of the legislature. I saw it as precluding a devious outcome: Donut makers across Missouri would conduct customer surveys contemporaneous with their sales tax years, and tax-savvy donut lovers–knowing that their sales tax rate hung on their answers to the questions–would deny ever eating a donut before they got home.
The Krispy Kreme decision makes great reading for tax students. It offers a real-life example of the challenges of implementing statutory line drawing required by tax statutes. It might even replace my current personal favorite in line drawing , the UK VAT decision in United Biscuits (VAT Tribunal case LON/91/0160) (aka McVitie). In that case, the tribunal confronted the vexing question of whether the taxpayer’s chocolate-covered “Jaffa Cakes” were in fact cakes (good for VAT purposes) or biscuits (bad for VAT purposes). A fascinating detour into the world of British baked goods!